LLPs and tax on members
HMRC can tax LLP members or partners as employees, subject to income tax and national insurance under PAYE. Treating a member who was previously taxed as self employed as an employee gives rise to increased liabilities for both the member and the LLP. There may be scope to improve your position as we explain below.
If you have a query relating to your partnership or LLP please do give us a call. We are always happy to provide a scope for how the issues can be resolved.
In reviewing LLPs and tax we have explained for you:
Thinking of HMRC on LLPs
HMRC object to abuse by LLPs in treating staff who were not true partners as self employed to take advantage of the lower tax rates for the self employed. Service companies were another widely used avenue to money box profits HMRC objected to as it in effect deferred tax that would be payable if all profits were treated as paid to the individual. The same objections from HMRC apply to other types of partnership.
How HMRC tackled abuse
LLPs have to operate PAYE on drawings paid to a member who fails to satisfy one of three tests: disguised salary, significant influence or capital contribution.
1. Disguised salary received from the LLP
Disguised salary means that 80% of the member’s drawings are either fixed, variable but varied without reference to the overall profitability of the LLP or not in practice affected by the overall profitability of the LLP. If the drawings depend on the performance of the partner or performance of a business division HMRC will consider the salary as fixed as it does not vary by reference to the partnership profits and losses.
2. Significant influence within the LLP
Significant influence means that the individual member’s rights and duties do not give the member significant influence over the LLP’s affairs. Where a partner has influence over a business division, e.g. Head of Tax, that may not be enough because the influence needs to be over the business overall. Changing roles can have an impact on whether this test has been satisfied or alternatively a promotion can bring someone who was previously taxed as an employee into self employed status.
3. Capital contribution to the LLP
Capital contribution means the member’s capital contribution to the LLP is less than 25% of the disguised salary that is reasonably expected to be payable to him for his services for the tax year. Changing profit allocations from year to year can cause this test to be met or mean it is no longer met.
The question of whether a member is an employee arises not only on the tax front but also from an employment law perspective.
LLPs have always been at risk that members claim they are employees to benefit from mainly unfair dismissal protection and equal pay rights. Decisions are always based on the facts and involve a review of true management functions and responsibilities.
Areas for LLPs to consider
The members of the LLP should keep under review their LLP agreement and arrangements for members’ pay. The top five actions to consider are:
1. Suitable LLP agreement
Make sure you have an LLP agreement suitable for your business and that all members have signed up. You need flexibility in practice to respond to challenges as they arise.
2. Document responsibilities
Review the actual management responsibilities and clearly document ownership of responsibilities. Retain minutes of members’ meetings where such duties are discussed and agreed.
3. Tax indemnity
Include a tax indemnity in the LLP agreement so that the LLP can deduct the income tax and national insurance operated under PAYE for any member who satisfies the test from that member’s drawings. Tax retention accounts can be helpful.
4. Partners’ risks
Consider risk and reward. In broadest terms partners take risk as they are in business whereas most employees do not. The practice which has grown up of paying fixed profit shares which are not related to the profits and losses of the business can be challenged by HMRC. This is an area where LLPs will meet resistance from partners reluctant to pin earnings to profits in businesses which are not doing terribly well.
Introducing fundamental changes need to be planned and managed and often require an overhaul of strategy. We can provide an objective view that can help clear this hurdle.
5. Genuine companies
Genuine companies who are members of an LLP and the directors can demonstrate that the company is in business seeking revenue as a trading businesses will be more difficult for HMRC to attack. HMRC will look for multiple streams of income from sources other than the LLP.
LLP tax returns
There is a special tax Tribunal procedure for the resolution of disagreements over the allocation of profits. The Tribunal does not deal with disputes about the quantum of partnership profits. Common areas of dispute are often around restructuring costs and unbilled work in progress. In practice the difficulties in challenging profits and losses included on the LLP tax return can be overcome by including provisions in the LLP agreements to deal with disputes. Another idea is to have the accounting policy set out in the partnership agreement.
Partnership law and tax is a specialist area which the team do well.
Gannons resolved a very nasty partnership dispute for me. I was pleased with the outcome.