The path to achieving HMRC’s aims of increasing the amount of tax paid by the members of UK LLPs began in spring 2013. Since then, the process has seen vigorous protests from professional firms who fear that necessary responses to tax changes will operate to the detriment of:

1. Highly evolved partner compensation mechanisms;
2. Good governance;
3. Sustainable practice finance.

Following the publication of specific proposals in December 2013, a fresh period of consultation was opened. This concluded on 4th February 2014. HMRC has now published revised guidance on the new tax rules for salaried members of LLPs. This reflects a substantial amount of time and effort on the part of HMRC: we welcome their efforts to produce a workable set of rules.

In overview, the revised guidance notes represent a modest step in the right direction. These rules come in to force on 6 April 2014. Calls for the new rules to be scrapped altogether, or postponed until 6 April 2015 to enable them to be properly evaluated, have not been heeded.

The rules will tax salaried members as employees. This will have a dramatic impact on those individuals and their firms. LLPs whose members will be affected must now decide how to ensure that their members continue to be taxed as “true partners”, to quote HMRC, but without falling foul of the new anti-avoidance rules.

In order to be taxed as a “true partner”, a member must fail at least one of the three conditions published in December 2013. Amendments have been made to each of the conditions.

Disguised salary (Condition A)

The revised notes promise changes to the 10 December 2013 draft legislation to make it clear that the new rules will apply where it is reasonable to expect that at least 80% of the amounts payable by the LLP for the member services - excluding benefits in kind - will be disguised salary. By providing a statutory definition of “wholly and substantially”, LLPs and their members will be able to proceed with much greater confidence. A number of other clarifications are also made in respect of Condition A, with sensible confirmation that drawings on account of an eventual profit share will not of themselves be treated as a fixed profit share as they will be later tallied up with the actual profits.

Significant influence (Condition B)

Predictably, this test continues to be hard work for HMRC. Although the revised notes attempt to recognise the realities of life for a member of a professional LLP, there will be many circumstances in which a member cannot show that he or she has significant influence over the affairs of the LLP.

Capital contributions (Condition C)

With banks and professional firms alike maintaining that it would be impossible to reorganise every firm’s finances such that all members had the requisite amount of capital in place by 6 April 2014, HMRC is offering a relaxation: in determining whether Condition C is met, a firm commitment in place by 6 April 2014 to contribute capital within three months will be taken into account. Members who join an LLP after 6 April 2014 will have two months to introduce capital.

What happens if PAYE applies?

The new guidance notes provide a clearer statement of what will be required should sums paid to a member be subject PAYE and NIC.  The notes cover not only “pay” and benefits in kind but also statutory payments, statutory maternity pay, statutory sick pay, statutory adoption pay and statutory paternity pay.  These are relevant because, if a member is taxed as an employee, the LLP will be secondary contributor for NICs.  The notes are silent on student loan repayments and pensions auto-enrolment, suggesting that it is not intended that these will apply.  If not explicitly covered in the notes, further confirmation may be required as slip-ups in these areas could cause considerably difficulty for the members. 

Beware of the anti-avoidance rules

For capital contributions made on or after 6th April 2014, firms must take care to ensure that they are not caught by new anti-avoidance rules. Strings attached by the bank to new partner capital loans may defeat their purpose – for example a requirement by the bank that new partner capital can only be used to reduce the LLP’s indebtedness to the bank. Firms relying on the period of grace to take in new capital under condition C on or before 5 July 2014 will need to exercise particular care and be able to show that the use of the money received by the LLP has been considered separately by the firm’s management and is not simply following a flow back to the bank in line with terms set down by the bank when the loan agreements were made.

Subsequently, the firm will need to take care in respect of capital received from new members.

George Bull is Chair of the Professional Practices Group, Baker Tilly Tax and Accounting