21 April 2023
The salaried member rules are a set of income tax provisions which seek to ensure that only those individual members of a limited liability partnership (LLP) firm whose duties reflect those of a ‘traditional’ partner, are taxed as self-employed individuals. These provisions have been with us for nine years, but some firms are still applying them incorrectly.
Whilst the majority of firms seem to understand the basic premise of the rules, we continue to see their application come under intense scrutiny from HMRC. This has also become an increasing area of interest in the financial due diligence carried out in the course of buyouts, mergers and acquisitions. Naturally, the ongoing attention from HMRC has made this an area that potential suitors are increasingly interested in, as they do not want to be caught out by the failures of predecessors to apply the legislation correctly.
Firms are getting the basics wrong, including not having good tax governance procedures in place, not considering the tax impact of arrangements when partners join or retire from the firm, and not having an understanding of what represents ‘disguised salary’.
The judgment in the case of Bluecrest Capital Management LLP V HMRC, the first case to consider the salaried member rules, clearly illustrates that HMRC has and will continue to focus on this area.
Reminder of the rules
The salaried member rules operate by requiring the working and remuneration arrangements of each individual member to be considered against three conditions. If the individual satisfies all three conditions, they should be treated as an employee for tax purposes, resulting in pay as you earn (PAYE) obligations and a liability to class 1 employer and employee National Insurance contributions (NICs).
The three conditions are:
- A: it is reasonable to expect that at least 80% of a member’s share of profit is ‘disguised salary’;
- B: the individual does not have ‘significant influence’ over the affairs of the LLP; and
- C: the individual’s capital contribution is less than 25% of the amount of the disguised salary it is reasonable to expect the member to receive during the relevant tax year.
The legislation defines disguised salary as an amount which is:
- variable, but without reference to the overall amount of the profits or losses of the LLP; or
- not, in practice, affected by the overall profits or losses of the LLP.
The idea of significant influence is subjective and, as such, HMRC will look at the mutual rights and duties of the members and the LLP. It will consider whether the member can and does exert significant influence over the LLP’s business.
Many firms rely on condition C. However, if there are any changes in fixed profit shares or in the membership of the LLP (ie through the introduction of new partners or retirement of existing partners), the capital contributions invested in the firm of individuals meeting conditions A and B must be reviewed and, where appropriate, increased. Failure to maintain capital contributions at the required level will result in a requirement for the LLP to deduct income tax and NICs under PAYE from each affected partner’s drawings.
Given the risks involved it is important for firms to work with appropriate tax professionals to regularly review the processes and procedures they have in place to stay compliant with the salaried member rules. An initial assessment is a relatively straightforward but extremely valuable project, with many firms finding they need to make changes following review to ensure their position is and remains robust against potential challenge. Such changes provide comfort to firms and their partners that they will not fall foul of the anti-avoidance tax legislation and the way in which HMRC applies the rules.