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
LLPs (limited liability partnerships) have been around for many years and for the right type of business offer advantages. The best use of an LLP tends to be in connection with professional service based businesses where the intellectual property is the people rather than its products. LLPs are widespread in businesses where the “exit” is selling to other members rather than a trade sale.
HMRC objections to LLPs
To exploit the tax planning opportunities LLPs used to offer artificial schemes such as members providing services via limited companies. HMRC saw that as abuse not least because it felt it was losing out on employer’s national insurance contributions which it would have received if the member was employed.
The use of service companies to pay out what was effectively a member’s draw as a dividend at a lower effective tax rate was also an area of lost tax for HMRC.
Similar rules apply for partnerships.
Salaried members of LLPs taxed as employees
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.
Uncertainty for LLPs
The outcome is never entirely predictable as a “manager” can range from someone in charge of paper clips to running the business’s accounts and signing off for the auditor.
Areas for LLPs to consider
The members of the LLP should 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. Examine the role of corporate members of the LLP carefully. It is wise to flag up to the members that they should take advice if they are unclear of their position as their tax treatment will have likely changed.
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. Regular review
LLPs need to keep the position under regular review because if the LLP fails to operate PAYE in cases where it is due there are very onerous penalty and interest payments due to HMRC.
Corporate members of the LLP
Another area of scrutiny from HMRC is the use of personal service companies as members of the LLP. Companies cannot be used to moneybox income arising from the LLP for members.
Genuine companies who are members of an LLP but where 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
It can be very difficult for a member of an LLP to comply with his personal tax obligations to submit a tax return which is correct to the best of his knowledge where the LLP member disagrees with the LLP tax return.
There has been a recent case where the partners were successful in appealing against the assessment to tax which was based on the LLP return. However, this is the first case of its type.
Tax Tribunal for disputes on allocation of profits or losses arising to the LLP
Under current tax law if a member disagrees with the LLP tax return the position is uncertain until the matter is resolved. Tax legislation provides that the LLP tax return is conclusive. This seems to mean that the member should pay his tax, believing that the LLP tax return is wrong and then once the issue is resolved claim reclaim any over payment it transpires the member made. There is a special tax Tribunal procedure for the resolution of disagreements over the allocation of profits.
A LLP tax return which has been referred to the tax Tribunal cannot be referred again even on an unrelated matter until the first dispute has been determined.
Disputes about the quantum of LLP profits or losses
The special tax 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.
Impact on LLP agreements
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 and adhered to.
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.