HMRC crackdown on LLPs could leave professional services and private equity partners facing bigger tax bills

Two recent moves by HMRC indicates that they are starting to take a closer look at limited liability partnerships (“LLPs”), as commonly used in legal practices, accountancy firms, and private equity houses. HMRC have taken a harder line on the ‘salaried member’ rules, which seek to identify partners who are more akin to employees, and tax them as such.

With Labour proposing additional funding to HMRC with the aim of collecting an additional ￡5.1bn per year, it can be expected that HMRC will be taking a closer look at the remuneration of LLP members.

What are the salaried member rules?

Members of LLPs who meet the following three conditions are treated as employees for tax purposes:

1.???????? Condition A is met if it’s reasonable to expect that at least 80% of the total amount payable by the LLP, in respect of an individual’s performance, will be “disguised salary”. Broadly, this is remuneration which is either fixed or otherwise not varied or affected by the overall profits of the LLP.

2.???????? Condition B is met if an individual does not have “significant influence” over the affairs of the LLP. This is the most subjective of the three tests.

3.???????? Condition C is met if an individual’s capital contribution to the LLP is less than 25% of their disguised salary.

For many LLPs, Condition C has been used as a ‘safe harbour’ to ensure that their members are not taxed as employees, by ensuring that members maintain sufficient capital contributions.

HMRC had accepted that “a genuine contribution made by the individual to the LLP, intended to be enduring and giving rise to real risk” was sufficient to fail Condition C (PM259310, archived). However, at the end of February 2024, HMRC removed this assurance from their manuals.

At the same time, HMRC inserted an example suggesting that where “members can alter their capital contributions in each period to avoid meeting Condition C” then anti-avoidance provisions will prevent the member failing the condition (PM259200).

If HMRC’s position is correct, there is no longer an easy safe harbour under Condition C.

What can LLPs and their members do?

If a member has a fixed salary, or a substantially fixed one within Condition A, then this leaves three options:

1.???????? Seek to rely on HMRC’s previous guidance for existing arrangements;

2.???????? Increase members’ capital contributions significantly so that they do not need to be varied each year; or

3.???????? Prepare documentation to support that the member has significant influence over the LLP and so Condition B is failed.

All three options carry a degree of risk.

HMRC attacked the third option last year in the case of BlueCrest by seeking to broaden the scope of Condition B. This attempt failed, as the taxpayer successfully argued that “influence” was distinct from managerial control. Therefore, significant influence does not need to be exerted over the whole of the LLP’s affairs, which would otherwise limit Condition B to managing partners.

The safest approach is to ensure that Condition A is not met. Again, BlueCrest provides helpful guidance and a cautionary tale. The LLP gave bonuses to members which were limited should the partnership make a loss. However, it was found that the bonuses were variable in relation to individual performance and not the performance of the LLP as a whole. Therefore, great care must be taken in designing a remuneration package which has a sufficient component which is sufficiently variable in the right way.

What are the consequences of a partner falling within the salaried member rules?

If a partner is taxed like an employee, the primary difference is in National Insurance contributions (NIC). Partners pay Class 4 NIC at the main rate of 6%, whereas employees pay Class 1 NIC at the main rate of 8%. The main rate is capped for earnings above ￡50,270.

The biggest difference, however, is for the firm: the LLP has to pay NIC at 13.8% for employees (with no cap), but none at all for partners.

If an LLP member with remuneration of ￡1m is taxed as an employee instead of a partner, they will have to pay an extra ￡22,011 [PT1]?[PT2]?in employee’s NIC. Moreover, the firm will have to pay ￡136,745 of employer’s NIC.

While this article does not provide formal tax advice, the stakes for LLPs are high, and with an election within the next month, formal professional advice should be sought as soon as possible.

The information contained in this article is general guidance only. The application and impact of laws can vary widely depending ?on the specific facts involved. The information in this article is provided with the understanding that the authors and presenters are not giving legal, tax, or other professional advice and services. As such, it should not be used as a substitute for consultation with professional legal, tax or other competent advisers. Before making any decision or taking any action, you should consult a Child & Child professional.