Are partners really self employed?

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The question of a partner’s status – i.e. employed or self employed crops up for tax purposes and also when looking at employment rights and in particular the right of a partner to claim unfair dismissal.  In theory a partner’s status for tax is not necessarily the same as the same partner’s status for employment law rights but in practice they are linked. There is no statutory definition of partner or member of an LLP.

It can be difficult to work out what is what.  To help you plan and prepare we have summarised some of the indicators to review based on our experience of dealing with both the partnership and individual members.

Tax – is the partner self employed

Partners who can establish they are self employed for tax purposes will pay less overall tax than the equivalent employee. But, HMRC have clamped down on abuse.  There is no difference in tax treatment between LLPs and old style partnerships.

Anti avoidance tax legislation applicable to all partners

HMRC has laid down strict conditions to be satisfied in order to be treated as self employed for tax purposes. To be treated as self employed a partner of any partnership must satisfy at least one out of the following three tests.

1. Disguised salary

Disguised salary means that at least 80% of member’s drawings are either fixed or variable but varied without reference to the overall profitability or loss of the partnership. If the salary depends 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 overall. It is the sharing of losses which we often find causes problems.

2. Significant influence

Significant influence means that the member’s rights and duties do not give the member significant influence over the partnership affairs. If a partner has influence over one part of the business, e.g. Head of Finance, that is not enough. Most partners of larger professional firms do not meet this criterion.

3. Capital contribution

Capital contribution means that the member’s capital contribution to the partnership is less than 25% of the disguised salary that is reasonably expected to be payable to him for his services for the tax year. The capital contribution position needs to be reconsidered by the partnership each year. This is because as the profits go up the profit entitlement of the partner might be larger than four times his capital contribution, making him a salaried member during the tax year. HMRC will use anti-tax avoidance legislation to tax artificial and short-lived increases in partners’ capital contributions used to avoid tax.

4. Other anti avoidance legislation

There are further rules where the partnership includes a member who is a limited company.  The idea is that HMRC can now attack the use of companies where the use has been to reduce the overall tax burden for partners.

Genuine trading companies operating trades outside of receiving a share of partnership income are not caught.

Steps for partnerships to take

Partnerships should always include tax indemnities within the partnership agreement.  The tax indemnity will enable the partnership to reclaim tax it is assessed to under PAYE from the individual partner.

Employment – is the partner an employee

If a partner can establish that for employment law purposes s/he is an employee they will benefit from the full range of employment rights.  In our experience the position often comes to light where there are attempts to make the partner “redundant“. Another area where it becomes relevant is where there has been sex discrimination or equal pay claims made.

Employment rights include the right to:

  • Holiday pay
  • Time off for maternity or paternity leave
  • After two years service the right to claim unfair dismissal.

Determining employment law rights

It is necessary to look below the surface and understand the relationship between the individual and the partnership or LLP. The fact that someone is held out as a member does not necessarily mean that they are treated as members for all purposes.

The name given does not in itself determine employment law status

A whole range of factors needs to be taken into account to determine status for employment law purposes.

Factors to consider in determining if an individual is an employee or a partner include:

  • Whether the individual receives a fixed remuneration payable irrespective of the partnership profitability and whether they have a share of the profits and losses of the firm.
  • Whether they receive an express or implied indemnity against debts and liabilities of the partnership from other members, or merely a contribution towards those owed to third parties.
  • Whether they are required to make a capital contribution, or are entitled to share in the partnership’s surplus assets.
  • The level and extent of the right to participate in management decisions, management meetings and partnership votes.
  • Whether the individuals name appears on all partnership documentation, they have the right to hire and dismiss partnership employees and whether they have banking authority.
  • Whether they are “carrying on a business” with a view to profit.

Control over members of a partnership or LLP

The issue of control has for a long time been regarded as an important consideration when considering the obligations. The greater the power to command and control the partnership (such as through the partnership vote and participation in management), the more likely that an individual will be regarded as a partner. Conversely, the less that an individual has power and rights, the more likely they are to be an employee.

Indicators of employment status

The following pointers do suggest the partner is an employee:

  • The individual agrees that, in consideration for a wage or other remuneration, they will provide services for the partnership.
  • The individual agrees that in the performance duties they will be subject to the control of the partnership and its partners.
  • The other provisions of the contract are consistent with it being akin to an employment relationship.