Last month HMRC changed its guidance on ‘fixed share partners’, which in this context means members of a limited liability partnership who receive their remuneration substantially in the form of ‘disguised salary’.  Reports are filtering through of LLPs increasingly being asked difficult questions by HMRC.  The Lawyer has reported that HMRC is questioning the treatment of fixed share partners on the basis that they are trying to sidestep anti-avoidance rules in an artificial way (as opposed to sidestepping them in a graceful, balletic way that HMRC cannot help but appreciate / applaud). 

The challenges all surround the much-used ‘Condition C’ of the Salaried Member Rules. By way of brief recap:

  • There is potentially a substantial tax advantage to being a member of an LLP versus an employee - no employer NICs, which are charged at 13.8% of (most) remuneration.  In this way, members of an LLP can end up with more in their pocket after tax than they would if they were all employees.
  • Abuse of LLPs as a tax avoidance vehicle led to the ‘salaried member rules’ being introduced in 2014 - if these apply, then a member of an LLP is subject to tax in the same way as an employee, including those painful employer NICs.
  • The legislation included three conditions. Meeting all of these gets you in to the salaried member tax charges so (somewhat oddly) you often want to be able to demonstrate that you fail one of the conditions, to demonstrate that you are a ‘real’ member of an LLP. Condition C means that you are not subject to these rules if the member has made a capital contribution to the LLP equal to at least 25% of their expected ‘disguised salary’ for the year (disguised salary simply being the legislation's term for any component of pay which doesn't vary by reference to the overall profits of the business - fixed share being the classic example, but the term also captures pay that may be variable but based on individual or team / division performance as opposed to the overall performance of the LLP).

So what's changed? Well, the legislation leaves HMRC a back door to challenging arrangements even if they (on the face of it) fail one of the conditions.  There is a Targeted Anti-Avoidance Rule.  This rule requires that any arrangements, which have as their main purpose, or one of the main purposes, ensuring that the regime does not apply, must be disregarded.

HMRC now seems to be suggesting that if a capital contribution is motivated solely by the tax rules (i.e. to fail Condition C) then it might not ‘count’ for these purposes.  Quite how far this interpretation goes is as yet unclear.  It is completely normal for LLPs in all sectors to be aware of the tax rules and to factor them in to the structuring of their membership arrangements, and some do indeed require capital contributions that scale according to remuneration in some way.  If an LLP's policy is to require a 25% capital contribution, which is refreshed each year, does that fall foul of the new guidance?  

We are given few clues. The new guidance and example is framed within the context of the anti-avoidance legislation being intended to prevent the use of artificial structures or arrangements. HMRC are clear that a “genuine and long-term restructuring” should not be affected and there are other examples that continue to identify genuine and enduring contributions that carry real risk as being the key elements to the assessment. Failing Conditions A or B will not realistically be available to all LLP structures without considerable reworking of membership arrangements. Perhaps the answer to Condition C is to have a clear and documented long-term policy, that is equally and fairly applied across the board and which recognises the purpose of the capital in the broader context of each individual’s membership of the LLP (e.g. working capital, ownership and risk). In doing so, LLPs would be seeking to align the LLP’s capital policy with the intention underlying the legislation.  HMRC explicitly recognises that the legislation is intended to provide a series of tests that collectively encapsulate what it means to be operating in a typical partnership, even though the tax rules seem to stray ever further from that position.

LLPs with a significant fixed share member contingent (or indeed any LLP that has members who do not share in the full equity of the LLP, such as those with an ‘eat what you kill' model) should be reviewing their arrangements to consider the risk of HMRC challenge.  For LLPs that do get challenged, it’s unlikely that the individual members’ tax liability will change too much; their income tax will be broadly the same as a deemed employee.  It’s the employer NICs that make the biggest difference.  Any LLP finding themselves on the wrong side of a PAYE enquiry can find themselves with a substantial bill for historic and future employer NICs.

Image courtesy of OpenAI's Dall-E