Paul Berlyn, managing partner of Arram Berlyn Gardner, explains how the Finance Bill 2014 will impact on the members of limited liability partnerships.
Jonathan Benjamin: When do the new rules set out in Finance Bill 2014 come into effect?
Paul Berlyn: From 6 April 2014.
Jonathan Benjamin: Do the new rules apply to partnerships as well?
Paul Berlyn: No. The new legislation does not apply to general partnerships or to limited liability partnerships formed under the law of jurisdictions outside the UK, even if the firm is operating in the UK. It is only directed at members of LLPs formed under the Limited Liability Partnership Act 2000 (LLPA)
Jonathan Benjamin: How are members of LLPs currently taxed?
Paul Berlyn: A member of an LLP is deemed to be self-employed under the LLPA. Therefore, no tax is deducted at source through the PAYE system. Instead, the member is liable to income tax under self-assessment on his or her share of the LLP’s profits. Self-employed status also means the LLP is not liable to pay any employer’s national insurance contributions (NIC) – currently at a rate of 13.8% – and the individual is liable to the marginally lower rates of Class 2 and Class 4 NIC, rather than Class 1 NIC.
Jonathan Benjamin: What do the new rules change?
Paul Berlyn: If certain conditions are met, a member of an LLP will be treated as an employee of the LLP for income tax and NIC purposes.
Jonathan Benjamin: What are these conditions?
Paul Berlyn: There are three conditions, all of which have to be met for the new rules to apply. First, there is the reward condition, which is met if the member is paid wholly or substantially wholly, by way of disguised salary. Disguised salary is an amount which is either completely fixed or, if variable, is variable without reference to the profits and losses of the LLP. This condition will be met unless more than 20% of the member’s expected remuneration is based on the profits and losses of the business as a whole.
Secondly, there is the significant influence condition, which is met if the member does not have significant influence over the affairs of the LLP as a whole. This condition is unlikely to be met by members of LLPs that have a flat membership structure. However, rank and file members of LLPs that have a hierarchical membership structure or delegate management to a management committee will be caught.
Thirdly, there is the contribution condition, which is met if the member’s contribution (normally capital) to the LLP is less than 25% of the disguised salary that it is reasonable to expect will be payable by the LLP in a relevant tax year in respect of the member’s performance of services for the LLP in his or her capacity as a member of the LLP. This condition must be met from year to year, so an increase in fixed pay may require a top-up capital contribution to avoid it.
Jonathan Benjamin: When are the conditions applied?
Paul Berlyn: The reward and significant influence conditions are applied on 6 April 2014 for existing members and on the date when new members become members. Once the tests have been applied, they do not need to be applied again until there is a change of circumstances that may result in a change.
The contribution condition is applied on 6 April 2014 or, if later, the date on which the member became a member and then after that, at the beginning of each tax year. It is also applied if there is a change in the member’s contribution or otherwise a change in his circumstances, during a tax year.
Jonathan Benjamin: If the new rules do apply to a member, will he or she also be treated as an employee for employment law purposes?
Paul Berlyn: No, unfortunately not. The member will have no employment rights despite having employment status imposed for tax purposes.
Jonathan Benjamin: Are there any anti-avoidance measures to prevent the new rules being side-stepped?
Paul Berlyn: Yes. First, any arrangements that have a main purpose of circumventing the salaried member rules are disregarded. Secondly, if an individual, who is not a member, works for an LLP and, to avoid becoming a salaried member, enters into arrangements so that someone else, such as a company, becomes a member and receives amounts due to the individual, then the individual is deemed to be a salaried member. Also, the sum paid to the company in relation to the individual’s services is treated as being paid to the individual and the sum is treated as employment income of the individual.
Jonathan Benjamin: What action should be taken by LLPs before 6 April?
Paul Berlyn: LLPs should establish whether the new rules are likely to affect any of their members by reviewing, firstly, how they reward individual members and secondly their management structure and decision-making processes. Also, consideration should be given to fixed-profit share or salaried members making capital contributions. ABG would, of course, be delighted to assist with this process and to work with the LLP to find a practical, tax-efficient structure going forward.