An LLP is normally regarded as transparent for tax purposes and each member is assessed to tax on his/her share of the LLP’s income or gains as if s/he was a member of a general partnership governed by the Partnership Act 1890. Specifically s. 863 of the Income Tax (Trading and Other Income) Act 2005 (ITTOIA/05)/ S863 provides, for income tax purposes, that, where an LLP carries on a trade, profession or other business with a view of profit:
- all the activities of the LLP are treated as being carried on in partnership by its members (and not by the LLP as such),
- anything done by, to or in relation to the LLP for the purposes of, or in connection with, any of its activities is treated as done by, to or in relation to the members as partners, and
- the property of the LLP is treated as held by the members of the LLP.
One of the consequence of this tax treatment was that LLPs were used by members (otherwise normal employees) to avoid payment of employment taxes by disguising employment relationships using the LLP structure. Simply put, being self-employed for tax purposes, a partner of an LLP is not an employee and no employment taxes were due!
However, this has all changed now. A new section 863A Limited liability partnerships: salaried members will be introduced from 06 April 2014 for income tax purposes and from 01 April 2014 for corporation tax purposes. Should a member be caught by this section, the profit share is treated as employee remuneration and taxed under PAYE rules. Consequently the LLP will become liable for employers’ National Insurance as well. Once classed as an employee the member ceases to be self-employed and will no longer be included in the LLP tax return. Of course, the LLP will be entitled to a tax deduction for the ‘salary’ and the employers’ National Insurance.
In order to be caught by this section a member will need to ‘pass’ all the tests as stated below:
Condition A is that the services performed by the member and the amounts payable there for constitute ‘wholly or substantially wholly’ disguised salary. Amounts payable will be disguised salary if it is fixed or variable without reference to the overall profitability of the LLP. Substantially wholly is taken to mean 80%. This is to identify those members who are working for the LLP on terms similar to employees. However the test is limited to the payment aspects. The test is applied at the later of the date the member first joins the LLP and 6 April 2014. The test is only revisited if there is a change in circumstances. Members will be caught by this condition unless more than 20% of their variable remuneration is linked to the overall profitability of the business.
Condition B is that the mutual rights and duties of the members of the limited liability partnership, and of the partnership and its members do not give the member significant influence over the affairs of the partnership. Basically the question is whether the member has influence over the affairs of the LLP. Many large LLPs are likely to be caught by the condition because they are run by a Board comprising a small number of members whilst the vast majority of the members may not have any influence over the affairs of the LLP. The test is applied at the later of the date the member first joins the LLP and 6 April 2014. The test is only revisited if there is a change in circumstances.
Condition C: Again this test is applied at the later of the date the member first joins the LLP and 6 April 2014 but is revisited at the beginning of each tax year. Basically the test is whether the capital invested in to the LLP by the member is less than 25% of the total amount of the disguised salary which, it is reasonable to expect, will be payable in the relevant tax year by the limited liability partnership in respect of the member’s performance of services. Capital contribution includes long term loans and undrawn profits to the extent converted into capital.
Whilst for purposes other than tax there is no change to the status of the members or the LLP, it is ideal that LLPs review their structure and re-organise where necessary before 06 April 2014.