Update On Finance Bill 2014 ‘Salaried Member’ Proposals Affecting LLPs And Their Members

1. The new 'salaried member' guidance from HMRC

HMRC issued updated guidance on 21 February 2014 on the draft Finance Bill 2014 'salaried member' provisions for members of an LLP. There are some important points, which this new guidance has clarified, and some notes indicating that the Government intend to make some refinements to the original draft legislation. It appears we may not now see the updated draft legislation until around Budget 2014 on 19 March.

It will only be possible to get a non-statutory business clearance with respect to the application of the new rules once the legislation has received Royal Assent (which is likely to be in July 2014). However where a business has a customer relationship manager or customer co-ordinator it will be able to discuss the PAYE implications of the new rules in the interim.

As a reminder there are three conditions, which if they are all met, will mean that on or after 6 April 2014 the member is regarded as an employee of the LLP for all tax purposes:

• Condition A (disguised salary, dependent on the level of variable profit share) and Condition B (significant influence) are assessed at 6 April 2014 or when the individual becomes a member and are not reassessed unless the member's arrangement with the LLP changes.
• Condition C (sufficient capital contribution to the LLP) – there are to be a number of changes to this. The guidance includes some examples of when HMRC would consider arrangements put in place to avoid members being treated as employees as a result of this condition to be avoidance and disregarded.

There is further detail on these points below, and the updated guidance also contains examples of how the rules would apply to international and cross border situations.

2. Condition A: disguised salary

The updated guidance contains many more examples covering different scenarios. Some points of interest include:

• The original legislation stated that the test in assessing whether a member's remuneration would be disguised salary was met if it was reasonable to expect that amounts payable in respect of services were wholly or substantially wholly fixed, or not in practice variable by reference to the firm's overall profit. The guidance indicated that this would be applied with an 80% test. The legislation will be revised to make explicit that the legislation applies where it is reasonable to expect that at least 80% of amounts payable in respect of services will be disguised salary.
• It is the amount payable that is considered in determining the amount of 'disguised salary'. Member's entitlement to benefits (that could include sick pay, entitlement to holiday, termination rights, partnership car and fuel benefits) are not taken into account in that determination.
• An arrangement requiring members to repay their allocation in the event profits are insufficient to justify initial allocations, where it is generally unexpected that profits would be so low, will not be sufficient on its own to result in a failure of condition A.
• If a member is rewarded by a fixed amount plus a bonus dependent on the performance of a particular division, branch or unit of the LLP's business, this will be disguised salary. However it is possible for an arrangement that rewards a member based on the profitability of the firm to take account of personal or divisional performance without condition A being met.
• Where a member's remuneration is capped if it exceeds a certain level, then only if it is realistic to expect the cap not to be engaged could this condition not result in the member meeting condition A.

Great care will need to be taken in the drafting of member agreements to ensure that the level of reward is sufficiently variable and not so dependent on personal performance so as to meet condition A if this is not the intention.

3. Condition B: significant influence

The updated guidance lists the kind of decisions involvement in which could indicate significant influence resulting in a failure of condition B. It is recognised by HMRC that having significant influence or control over one of them would be insufficient to fail condition B.

The examples also highlight how verbal and implied agreement on matters of influence over the management of the LLP can mean a member apparently excluded from management under the terms of the documented agreement, can fail the significant influence condition by the designated management members deferring to that other member's advice. The kinds of decision that could indicate significant influence include:

• appointment of new partners;
• deciding where the firm conducts its business;
• deciding the firm's areas of business;
• strategic decisions;
• deciding on business acquisitions or disposals;
• management of key contracts relating to the firm generally (eg with the bank);
• appointment of key personnel;
• allocation of roles to key staff;
• decisions on important financial commitments;
• formulating the firm's business plan;
• approving major new clients or investments, especially where this is a regulatory requirement; or
• deciding the firm's marketing strategy.

4. Condition C: contribution to the LLP

This condition requires that a member contribute to the LLP at least 25% of what would be their disguised salary to avoid this condition being met. The original draft legislation determined 'contribution' using the definition in ITA 2007 section 108, but did not exclude amounts received back from the partnership within five years.

The updated guidance announces two changes to these rules:

• The definition of 'contribution' is being incorporated in the legislation rather than basing the definition on ITA 2007 section 108, although there is no further detail on whether the definition has changed.
• Some flexibility is to be introduced regarding the time limit for meeting the contribution condition.
  • Existing members who have made an 'unconditional commitment' to provide the required level of capital will be given three months from 6 April 2014 to meet that commitment;
  • Those becoming new members after 6 April 2014 who make an 'unconditional commitment' to provide the required amount of capital will be given two months in which to meet that commitment.
• Amounts that will not be treated as a contribution include:
  • sums that may be called at a future date;
  • undrawn profit unless it has been converted to capital;
  • sums held by the LLP for the member (such as the taxation account);
  • amounts which are not intended to be permanent during the individual's membership and which do not give rise to economic risk to the individual; and
  • the giving of a guarantee.

The contribution level required may have to be adjusted pro-rata on a time basis to reflect the time at which it is paid during the tax year. The current draft legislation can give rise to some unusual results, particularly on an increase in capital. In particular, we have some difficulty understanding the logic of the legislation as demonstrated by example 44 in the revised guidance. The example appears to illustrate an unfairness in the way new sections 863B(6), 863B(13) and 863B(15) operate for changes of circumstance that do not occur on 6 April in the tax year, as no credit appears to be given for the fact that capital previously contributed could have franked disguised salary amounts expected to be received before the date of change of circumstance. Care will need to be taken with changes during the tax year, if the draft legislation becomes law.

5. Anti-avoidance

While arrangements put in place with a main purpose of avoiding the application of the salaried member provisions are to be ignored under the targeted anti-avoidance (TAAR), the updated guidance confirms that making a capital contribution that is intended to be enduring and gives rise to real risk for the individual will not be ignored under the TAAR.

The updated guidance does indicate some factors relevant to contributions, which if present could lead HMRC to apply the TAAR. These include:

• The use of non-recourse loans;
• The use of funds derived from the LLP itself, including where the loan is made from the bank and as a result the partnership's indebtedness is reduced;
• The LLP loans the money back to the individual;
• The firm rather than the individual member pays or otherwise bears the cost; or
• The individual is to be brought into the firm for a fixed period and it is reasonable to suppose that the capital contribution has been made so that the individual fails condition C for that period.

While the guidance includes examples of application of the TAAR to arrangements with the above features, it is not precisely clear how HMRC would consider the TAAR to apply in the following situations:

• Where the bank collects interest payments in respect of member loans from the partnership bank account for expediency, with the interest amounts being allocated to a member's drawing account in the partnership;
• As a commercial matter, where the partnership banks at the same bank as one from which a partner obtains a loan, the bank requires surplus partnership cash to be applied in reducing partnership borrowings (such as the overdraft), so that amounts contributed by individuals over and above what they have already contributed, if anything, result in a reduction in the partnership's indebtedness;
• Where amounts contributed by individuals to the partnership are held in a deposit account (effectively ring fenced until the member leaves the partnership) in the name of the partnership, but the same bank has advanced funds to the individual for the purpose of the loan.

6. Other matters

Although a person deemed to be a 'salaried member' will be treated as an employee for income tax purposes, there is confirmation that where they receive dividends from a partnership capital asset such as shares in a company, these will not count as employment income; neither will interest received (due to being a member) be treated as employment income.

The disguised remuneration rules apply where an individual is an employee (ITEPA 2003 section 554A(1)(a)), not where an individual is deemed to be an employee. It is not precisely clear how these rules would apply where an individual is deemed to be a salaried member, but it would seem fairly clear that any arrangement seeking to exploit any apparent weakness in the legislation here would most likely be caught by the application general anti-abuse rule (GAAR).

For firms with partners meeting all three conditions, and taxed as employees going forward, HMRC has separately announced a staged deferral of the introduction of real time information (RTI) interest and penalties:

• automatic interest charges on late in-year payments apply from 6 April 2014;
• penalties for late filing of submissions apply from October 2014; and
• automatic in-year late payment penalties apply from April 2015.

We have taken care to ensure the accuracy of this publication, which is based on material in the public domain at the time of issue. However, the publication is written in general terms for information purposes only and in no way constitutes specific advice. You are strongly recommended to seek specific advice before taking any action in relation to the matters referred to in this publication. No responsibility can be taken for any errors contained in the publication or for any loss arising from action taken or refrained from on the basis of this publication or its contents. © Smith & Williamson Holdings Limited 2014