New proposals affecting the taxation of LLP members

Over the past year HMRC has introduced numerous new measures to close what it regards as tax avoidance loopholes for businesses operating as LLPs (limited liability partnerships). Having already tackled several types of structure, its main current objective is to tackle ‘disguised employment’ i.e. where it perceives that LLP members benefit from lower levels of taxation, yet do not face any of the associated risks of self-employment or fluctuations in their income.

In order to tackle this, HMRC recently announced a proposal to introduce new rules governing taxation of LLP members in an attempt to ‘catch’ greater numbers who they perceive are using LLP membership disguise employment. They are suggesting that if any member of an LLP satisfies the following three conditions, they should be taxed as an employee and not as a self employed person:

• 80% or more of their remuneration is either fixed or variable without it being affected by the LLP’s total profit fluctuations;
• The member does not have significant decision making influence – note however that this might be the case if the LLP is simply comprised of a large number of partners who all share decision making rights; and
• The member makes a financial contribution to the LLP which is less than 25% of the annual remuneration they receive.

The difficulty with these proposals is that they may well catch perfectly commercial scenarios; for example many LLP members will have historically negotiated a fixed share of profits, which may be derived from a sub-set of total profits. Consider a situation where a firm of architects is operating as an LLP and has two divisions; one for residential properties and one for commercial properties, which each operate autonomously under a common brand identity. It is entirely reasonable for the partners to have been awarded a relatively static profit share for their portion of the business only, and to have limited decision making rights. Equally, it may not be necessary for each partner to be making a significant contribution to financing the business with capital (of over 25% of remuneration), since it is selling professional services and may not require a high level of working capital.

In this case, according to HMRC’s proposed new rules, the income of the members would be regarded as ‘disguised salary’ and an example of tax avoidance, yet the firm’s partners would be operating legitimately as members of an LLP in what are really very ‘ordinary’ circumstances.

These proposals are currently at the consultation stage and many bodies will be putting forward comments such as the above and objections where perfectly commercial arrangements are to be suddenly perceived as ‘tax avoidance’.

Our advice to clients operating within an LLP structure is to keep an eye on these proposals, and in the meantime, if you think your business may be affected, consider amending the way in which you operate in the meantime.

Whilst this particular change is at the consultation stage, a number of other changes to the taxation of LLPs have already been introduced. For instance, in the 2013 Autumn Statement, George Osborne announced changes affecting LLPs which have corporate partners which we have already blogged about. These changes will have an impact on how LLPs should be structured in the future, and in some cases it will be beneficial for existing structures to be changed.

For more information on how to structure your business in the most tax efficient way contact Lesley Stalker.