The first condition states that “A salaried member of an LLP is an individual member of the LLP who, on the assumption that the LLP is carried on as a partnership by two or members of the LLP, would be regarded as employed by that partnership.”
The intention is that this condition would be decided through a relatively straightforward test, one that is no more complicated than the test used to assess whether a person is genuinely self-employed or not.
The second condition goes a stage further:
“A salaried member of an LLP includes an individual member of the LLP who does not meet the first condition but who:
a) has no significant economic risk (loss of capital or repayment of drawings) in the event that the LLP makes a loss or is wound up;
b) is not entitled to a significant share of the profits; and
c) is not entitled to a significant share of any surplus assets on winding up.”
This is in line with our views in our recent Legal Focus, in that individual members of the LLP need to demonstrate financial risk and reward. Significant in this instance is deemed to mean more than 5% of the fixed entitlement.
Interestingly, the consultation document makes reference to professional partnerships, in that it recognises that individuals are generally taken on in a professional partnership at an appropriate point in their career in recognition of their professional knowledge and personal skills, and sacrifice an entitlement to salary in exchange for the opportunity to participate in the business in much the same way as a senior partner, even if as a junior partner they are substantially rewarded by a fixed profit share. The conditions are not intended to apply in these circumstances.
The penalty of not passing either of the two tests is that the individual will be treated as an employee, and therefore employer’s national insurance will be payable on their earnings. This could be expensive for a practice, particularly if more than one individual is affected.
As the legislation is being introduced with effect from 6 April 2014, there is plenty of time to review all matters and ensure all members where appropriate comply. We are in the process of reviewing the status of all fixed share / salaried members within our legal practice clients, and will be contacting them in due course.
The use of limited companies within a partnership
The second element of the consultation document refers to the use of corporate entities within a partnership arrangement. It is referred to as ‘Profit and Loss Allocation Schemes’.
There are three distinct types of arrangement that the Revenue plan to address:
1. Partnerships with mixed members (typically companies and individuals) where profits are allocated to a member that pays a lower rate of tax.
2. Partnerships with mixed members where losses are allocated to a member that pays a higher rate of tax.
3. Partnership arrangements where members reduce their profit entitlement in return for payments made by other members who will be taxed more favourably on those profits.
The first of these arrangements is the most widely used within the legal profession. The overriding feeling of the consultation document is all about fairness. Interestingly, the Revenue recognise the commercial reasons of introducing corporate partners into a partnership structure, such as making working capital requirements much more tax efficient, but believe that the ‘fairness’ issue overrides this. It will certainly be interesting to see how this issue is addressed throughout the consultation period.
The main areas of emphasis for the Revenue with the first arrangement are the following scenarios:
1. A company receiving a non-commercial profit share; e.g. an arbitrary amount designed to minimise the underlying profits in the partnership/LLP that would otherwise have been assessed to income tax, where that corporate entity makes nil or negligible contributions to generate the firm’s profits.
2. Profits that are allocated to a corporate member, which are then retained within the business as additional ‘working capital’ to finance the future growth of the business.
3. Arrangements where it appears that individual members are taxed only on the profits that correspond to their ‘remuneration’ that needs to be drawn from the business whilst the remainder of the profits are allocated to a corporate entity.
This could therefore affect arrangements where an individual remains a ‘human partner’ and also has their own limited company partner within the partnership.
In these circumstances, the Revenue’s proposed counteraction is to allocate all or part of the profits allocated to the corporate entity back to the individual member or members. The reallocation between members would need to done on a just and reasonable basis.
Interestingly, at this stage the consultation document does not seem to target situations where a partner has retired as a ‘human partner’ and instead set up their own limited company and transferred fully across to the limited company their full entitlement to profit.
The consultation period is open until August. We will be contributing to the debate in order to make the commercial implications of the proposal clear. We will keep you updated throughout the process with our thoughts and ideas, and will be contacting our clients that could be affected by these proposals.
If you do have any questions, or think that these proposals could affect you, please feel free to contact us.