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The final word on HMRC’s review into Limited Liability Partnerships

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24 February 2014
Since the closure of the consultation period on the draft legislation for fixed share partners and mixed partnerships at the beginning of February, we have all been waiting for the Revenue to outline their final views and provide any amendments to the draft legislation before it is enacted with effect from 6 April 2014.  As of 4.30pm on Friday 21 February the wait is now over.
The good news is that an individual still only has to “fail” one condition in order to maintain self-employment status.  In addition, the Revenue have clarified that all tests will be applied “looking forward” on the basis of the facts known at that time.  Provided the test is applied realistically, it does not need to be revisited with the benefit of hindsight if it is found that any of the assumptions were incorrect. Therefore, documenting changes to the partnership as and when they occur will be more important than ever.
The guidance also makes it clear that these rules are tax rules only and are independent of employment law.
Capital (Condition C)
In our experience, the most popular condition for many practices to try to “fail” has been in relation to capital.
There has been no change to the amount of capital required - it is still at least 25% of total anticipated remuneration in the year - and again it needs to be reviewed if circumstances change.  However, the Revenue have been generous, as they are going to give practices an extra period of time to allow them to obtain loan finance if additional capital needs to be invested.
The legislation has been amended so that, as at 6 April 2014, if there is an unconditional requirement for that member to provide capital, and that capital is contributed within three months of 6 April 2014, then the member will not be deemed to be employed.
For new partners being appointed after 6 April 2014, there is still an unconditional requirement at the time they become a member, but the contribution must be made within two months.
Clearly, the Revenue have come under some pressure from banks here, who have been contacted by many practices looking for additional funding.
Definition of capital
When the draft legislation was issued in December 2013, there was quite a lot of excitement about the definition of capital, as the indications were that the new legislation would not fit in with the existing legislation on capital for LLP members.
The Revenue have taken on board comments made during the consultation period, and have rewritten the section in relation to ‘Contributions to LLPs in respect of capital’.
Capital must have a degree of permanence and give rise to an economic risk to the member.  It cannot be sums that an individual may be called upon to pay at some time in the future, undrawn profits (unless by agreement they have been converted into capital), or other sums held by the LLP for the members, e.g. tax reserves.
It is now clear that it does not matter if the capital is classed as members’ loans as opposed to members’ interests.  What matters is how it is recorded in the LLP Agreement, and it must be to the permanent endowment of the practice. All  practices should be looking at their LLP Agreement wording at the same time as dealing with the capital being introduced.
Anti avoidance
There are various anti avoidance clauses in relation to members’ capital.  A capital contribution may be considered to fall foul of these clauses if:
1. The capital is derived from a non-recourse or limited recourse loan.
2. The capital comes from the practice itself, either from the LLP to the individuals or when additional funding is taken from the LLP’s bank and the firm’s total indebtedness is reduced at the same time.  This is an important point, bearing in mind the level of debt some practices have from banks and who may be looking to reduce their overall exposure.
3. The LLP loans the money back to the individual.
4. The LLP, rather than the individual member, pays or otherwise bears the cost of the interest on the loan.  This may catch arrangements where interest is being paid as an additional profit share, and therefore needs to be considered in light of the overall arrangements for all members.
5. An individual is to be brought into the LLP for a fixed term assignment, and it is reasonable to assume that the capital contribution has been made so that the individual fails the test for the duration of that assignment.
For many practices the capital condition still probably remains the easiest one to deal with in order to maintain self-employment status, but there are still a few hurdles to get over to ensure that the LLP Agreement is correct and that the overall indebtedness to the bank does not change.
Significant influence (Condition B)
The Revenue have been pressed to clarify the wording of “significant influence”.  They have been reluctant to do this, but have provided various scenarios in their Technical Release.  The overriding question remains that, put simply, can it be said that the individual is the business rather than merely working in the business.
The Revenue recognise that the conditions will be different for smaller and larger practices, and for smaller practices, provided that the members have equal rights and participate equally in the management of the business and all meet regularly to discuss major business decisions, they will fail condition B and therefore be treated as self-employed.
However, merely being able to vote or express a view on such matters would be unlikely in itself to constitute significant influence.
For larger practices, and particularly where there is a management committee, this condition could be more difficult to satisfy, as it is likely that only a handful of individuals will have a significant influence over the affairs of the whole practice.  The Revenue have indicated that if the committee’s role is largely administrative then this would not qualify, as the requisite level of influence over the affairs of the business would not be significant enough.
The Revenue recognise that different types of influences may be relevant to the test, and have given examples of the kinds of decisions which might be involved.  These are not intended to be prescriptive or definitive, and it is not necessary that the same people are involved in all decisions:
  • Appointment of new partners
  • Deciding on where the firm conducts it business
  • Deciding on the firm’s area of business
  • Strategic decisions
  • Deciding on business acquisitions or disposals
  • Management of key contracts relating to the firm generally (e.g. with the bank)
  • Appointment of key personnel
  • Allocation of roles to key staff
  • Decisions in important financial commitments
  • Formulating the firm’s business plan
  • Approving major new clients or investments, especially where this is a regulatory requirement
  • Deciding on the firm’s marketing strategy
In addition, having significant, or even controlling, influence over just one of the above would not necessarily mean that the member has significant influence over the practice as a whole.
Where practices are regulated by the Financial Conduct Authority (FCA) and that individual is an FCA approved person, they are deemed to have sufficient influence in order to satisfy the requirements under Revenue rules.
It is important that the LLP Agreement reflects the type of influence each type of member has.  However, if in practice voting and members’ decisions are not made in line with the LLP Agreement then the Revenue will look at the implied arrangement.
Although some of the examples given by the Revenue have been helpful to clarify the position, the LLP Agreement itself becomes a more important document to clearly show what level of influence individuals have.
Earnings (Disguised Remuneration) (Condition A)
There are no significant changes to this condition, but there has been some clarification.  It is now going to be explicit in the legislation that if at least 80% of an individual’s earnings relate to their own performance or that of their department without reference to the overall profits or losses of the LLP, or are a fixed amount which is not variable, then they will be deemed to be a disguised salary, i.e. PAYE will apply.
In order to fail this condition, an individual has to demonstrate that 20% or more of their earnings are linked to the profitability of the practice as a whole as opposed to their own position.
There had been some uncertainty about whether the policy on drawings could influence the disguised salary position.  The Revenue have clarified that the fact that a member is paid drawings on account of profits does not necessarily convert the payment into disguised salary.  If the member’s reward is a genuine variable share of the overall profits, the manner of taking it does not convert it into something else.  Genuine payments on account of a share of overall profits are not made by the payer in exchange for services, but are partial realisations of an anticipated profit based on the expectancy of a share in future profits.
In recent years we have seen an increase in the number of practices where members are remunerated on an “eat what you kill” model.  The Revenue have stated that if this is an arrangement for the partners to be paid a share of profit then it will not be disguised salary.  However, if it is an arrangement upon which a partner receives a cash amount, i.e. a proportion of the billing as opposed to total profit, the partner would be treated as being employed.
The Revenue have taken on board that “one size does not fit all” and have provided numerous examples within their guidance to help determine what falls into disguised remuneration. Each LLP will need to examine its arrangements carefully in light of these guidelines.
The revised Technical Note and Guidance from the Revenue has been very helpful to clarify a number of issues.  What is clear is that the wording of the practice’s LLP Agreement will be key in ensuring individuals are self-employed going forward (if this is what is required), and therefore now is the time to have a look at these documents and amend them if need be.  However, as with all tax legislation, it is not only what is expressed in the agreement, it is also what is applied in relation to day to day activities.
This article is not intended to be a comprehensive review of the new guidance but is intended to give you an overview of the main issues.  If you have any questions or require advice in relation to your particular practice and the impact it will have on you then please do get in touch.