LLPs in the spotlight

Under the Finance Bill 2014, salaried members of limited liability partnerships (LLPs) will become employees under certain conditions, while excess profits in mixed partnerships will be reallocated.

It has been discussed, debated and written about. Now the Budget has re-announced that legislation will be introduced in the Finance Bill 2014 to change the treatment of a salaried member of a limited liability partnership (LLP) from that of a partner to that of an employee for both income and corporation tax purposes. 

The new rules will apply at any time when an individual (M) is a member of an LLP and three conditions are met:

  • Condition 1: there are arrangements in place under which M is to perform services for the LLP, in M’s capacity as a member, and it would be reasonable to expect that the amounts payable by the LLP in respect of M’s performance of those services will be wholly or substantially wholly fixed; or, if variable, variable without reference to, or in practice unaffected by, the overall profits or losses of the LLP (‘disguised salary’);

  • Condition 2: the mutual rights and duties of the members and the LLP and its members do not give M significant influence over the affairs of the LLP;

  • Condition 3: M’s contribution to the LLP is less than 25% of the disguised salary which it is reasonable to expect will be payable by the LLP in a relevant tax year in respect of M’s performance of services for the LLP. 

In determining whether the salaried member rules apply, any arrangements with a main purpose of circumventing the rules will be disregarded. 

The salaried member rules will apply to an individual who is not a member of an LLP if the individual performs services for the LLP under arrangements involving a non-individual member of the LLP and those arrangements have a main purpose of securing that the salaried member rules do not apply to the individual. 

The salaried member rules will not, however, apply to an individual, where they would otherwise apply, as a consequence of arrangements with a main purpose of ensuring that the new profit allocation rules do not apply. 

The legislation will also provide for a deduction for certain expenditure in respect of a salaried member’s employment that would not otherwise be deductible, subject to certain provisions that provide for disallowance on normal principles. 

In order to give partners time to make the necessary arrangements, a firm commitment to make a sufficient contribution within three months will be taken into account to determine whether condition 3 is met. Where an individual becomes a member after 6 April 2014, a two-month period will be allowed to provide the capital, subject to a firm commitment to do so.

It is important to remember that all three conditions must be met for a partner to be treated as an employee. 


C LLP was founded by two individuals: A and B. A and B are entitled to the residual profits, make all the major decisions and they have invested all but a nominal amount of the capital. The other members receive a fixed monthly sum plus an annual discretionary bonus, typically 20% to 30% of the first charge. The other members are all salaried members, satisfying conditions 1, 2 and 3. While the bonus is sometimes more than 20% of the reward package, it is discretionary, not linked to the profits.

After a while, C and D start to take on more of the work done by A and B, and their terms have changed. They will receive a lower monthly sum and will receive a share of the profits. A reasonable estimate is that about 25% to 30% of the rewards will be profit share. They will also take part in all major decisions. Conditions 1 and 2 are no longer met, so they are no longer salaried members. 

Where a member’s status changes during the year, new sections 863 E and 863F set out the formula for ascertaining the appropriate amount of the capital contribution. 

Financial implications

The basic tax charge will not be increased as a result of this legislation, but there will be a charge to tax on benefits in kind, as a result of the reclassification. There will also be an increased charge to national insurance. 

The employee will suffer a cashflow disadvantage by coming within the PAYE rules and will be charged class 1 national insurance, rather than class 2 at £2.75 and class 4. An employee earning £100,000 per year will pay class 1 contributions of £5,232 for 2014/15 whereas a self-employed person would pay a total of £4,358 in class 2 and 4 contributions. Whereas the tax would have been paid on 31 January in the tax year and 31 July after the end of the year, the tax will now be paid monthly throughout the year. 

The allocation of profits now taxed as salary will have no tax effect on the remaining partners, but the cashflow will be disadvantaged. The difference for national insurance will be significant with an extra £12,702 on each £100,000 salary, together with an additional charge on benefits in kind. 

Anti-avoidance legislation will deal with the situation where remuneration is dealt with through associated persons. Where there is a conflict, the legislation in section 850D will take precedence over section 863. 

Little time remains for firms to make any arrangements prior to 6 April 2014, but remember that there is a three-month period of grace! 

Partnership and mixed membership

Legislation will be introduced in the Finance Bill 2014 in relation to mixed membership partnerships to reallocate excess profits allocated to a non-individual partner to an individual partner where the following conditions are met:

  • a non-individual partner has a share of the firm’s profit;

  • the non-individual’s share is excessive;

  • an individual partner has the power to enjoy the non-individual’s share or there are deferred profit arrangements in place;

  • it is reasonable to suppose that the whole or part of the non-individual’s share is attributable to that power or arrangements. 

The legislation will include provision so that excess profits can be reallocated to an individual who is not a partner if it is reasonable to suppose that the individual would have been a partner but for the new rules, and the whole or part of the non-individual’s share is attributable to the individual’s power to enjoy the non-individual’s share or to deferred profit arrangements. 

Legislation will also be introduced in the Finance Bill 2014 to deny certain income tax loss reliefs and capital gains relief for a loss allocated to an individual partner where the individual is party to arrangements, one of the main purposes of which is to secure that some or all of the loss is allocated, or otherwise arises, to the individual, instead of a non-individual, with a view to the individual obtaining relief.