LLPs and tax on members

HMRC can treat certain members of a limited liability partnership (LLP) as employees for tax purposes, requiring Income Tax and National Insurance contributions to be accounted for through PAYE. Reclassification of a member previously taxed as self-employed can create additional tax liabilities for both the member and the LLP. There may, however, be scope to improve your position, as we explain below.

If you have a query relating to your partnership or LLP, please get in touch. We can assess your position and outline the potential options for addressing any issues.

HMRC policy on LLPs

HMRC introduced the salaried member rules to prevent individuals who are effectively working as employees from being treated as self-employed partners for tax purposes. Similar concerns have arisen in relation to arrangements involving service companies and other partnership structures.

An individual member of an LLP is treated as a salaried member for tax purposes only if all three statutory conditions are satisfied. These concern disguised salary, significant influence and capital contributions.

• Disguised salary - Condition A is met where it is reasonable to expect that at least 80% of the amount payable to the member for their services will be fixed, varied without reference to the overall profits or losses of the LLP, or not in practice affected by those profits or losses. Remuneration linked to an individual’s performance or a particular business division may therefore qualify as disguised salary.
•  Significant influence - Condition B is met where the member does not have significant influence over the affairs of the LLP. The assessment depends on the member’s rights, duties and actual influence. Changes in responsibilities or the LLP’s governance arrangements may affect the outcome.
• Capital contribution to the LLP - Condition C is met where the member’s capital contribution is less than 25% of the disguised salary reasonably expected to be payable for their services during the relevant tax year. Changes to remuneration or capital contributions may affect whether this condition is satisfied.

Is the LLP member an employee?

A member’s status can raise questions under both tax and employment law. The salaried member rules determine the tax treatment of qualifying LLP members; they do not, by themselves, determine employment status for all other legal purposes.

LLPs may also face claims from members seeking employment rights, including unfair dismissal protection or equal pay rights. Employment status depends on the relevant legal test and the facts, including the rights, obligations and responsibilities arising from the actual working arrangements.

How to set up an LLP the right way

LLPs should regularly review their LLP agreement and members’ remuneration arrangements to ensure that they reflect the commercial reality of the business. The following are five areas to consider:

• Suitable LLP agreement - Ensure that the LLP agreement is appropriate for the business and that all members are bound by its terms. It should provide suitable flexibility while clearly setting out members’ rights and obligations. Consider including appropriate tax indemnity and deduction provisions to address PAYE liabilities arising under the salaried member rules. Tax retention arrangements may also be useful.
• Document responsibilities - Review and clearly document members’ actual management responsibilities, decision-making powers and influence over the LLP. Keep records of members’ meetings and decisions to evidence how responsibilities are exercised in practice.
• Partners’ risks - Consider whether the balance of risk and reward reflects genuine participation in the business. Profit shares that are effectively fixed and do not reflect the LLP’s overall profits or losses may attract scrutiny. Changes to remuneration arrangements can be commercially sensitive and may require careful planning, consultation and a wider review of the business strategy. We can provide an objective assessment of the options.
• Set up a company to be an LLP member - Some LLPs have companies as members. The tax treatment of these arrangements depends on the facts and the applicable legislation, including the mixed-member partnership rules. A corporate member does not automatically prevent HMRC from challenging the arrangements, and artificial structures designed to avoid the salaried member rules may be ineffective.
• Have a clear accounting policy in LLP agreement -  Set out how profits and losses are calculated and allocated, and how accounting disagreements are resolved. Disputes may concern restructuring costs, unbilled work in progress or other adjustments. Clear contractual provisions can reduce uncertainty and provide a framework for resolving disagreements before they escalate.