UK: LLPs And Salaried Members: What Now?

Last Updated: 12 June 2014
Article by Pamela Sayers

Pamela Sayers discusses the immediate and longer-term implications of the changes to LLP taxation.

Despite intense lobbying, even in the last few days leading up to 5 April 2014, the new proposals for the so-called 'salaried member' rules went ahead. While revised guidance published by HMRC on 27 March provides greater clarity on some aspects, uncertainty remains for many firms as to whether they might 'fail' one of the conditions to allow their partners to remain as self-employed for income tax purposes.

Firms looking for additional comfort by applying to HMRC's non-statutory clearance team are unlikely to receive a response until late summer. HMRC has stated that it will not respond to applications until the Finance Act 2014 has received Royal Assent, probably in mid-July.

In the meantime, some firms could be storing up significant penalties for incorrect completion of real-time information (RTI) returns and application of PAYE from April 2014.

Action required

All firms should ensure that they are clear whether their 'salaried members' should now be paid through their payroll and that their LLP payroll records and RTI returns are accurate from April 2014 or face unintended consequences and potential penalties.

Welcome grace period

Existing partners who have committed to contribute capital have been allowed an additional three months, to 5 July 2014, to make payment. This is welcome news, especially for banks, which have been inundated with requests for loans for additional partnership capital.

Many firms have sought to proceed with Condition C, the capital contribution route, as it is an arithmetical test and so provides the greatest certainty. The other routes involve more subjectivity, relying on interpretation of phrases such as "reasonable to expect" and "significant influence".

Many firms are concerned that HMRC may look to make the rules more onerous in the future. For example, it may decide that partners would need to 'fail' two conditions to remain as self-employed for tax purposes. If this is the case, for many partners the only other easily accessible route is Condition A – the quantum of profit share by reference to the overall profitability of the business. For large firms, Condition B – the significant influence test – is still largely unworkable.

Partnership capital levels

Now that firms are operating under the new regime, they will need to be more organised about reviewing the adequacy of partnership capital levels (see opposite). Partners may need to increase capital levels if, for example, there is an increase in the fixed profit share, bonus award or other so-called 'disguised salary'. Additional capital must be introduced immediately from the date of change – i.e. there is no grace period – by reference to a formula. However, new partners being admitted to the partnership will have two months from the date of admission to provide capital.

Additional capital – what are the options?

Many firms are asking partners to introduce additional capital as a result of the recent LLP tax changes and face the unusual dilemma of what to do with it.

While the additional capital introduced by partners may strengthen the balance sheet, in many cases there may be no obvious need for it at the present time.

Debt repayment?

One route firms may choose is to reduce or repay debt. However, there is a possibility that this could trigger the Government's targeted anti-avoidance provisions (TAAR). We understand that the TAAR will not be triggered if the capital contribution is deposited in an account with the same bank. But it will be triggered if the loan provided to the member causes the bank to reduce the amount available to the LLP.

Capital projects?

Firms may be planning to use the additional capital for projects such as an IT upgrade, an office move or to open a new office. However, firms with a service company and which, from 25 October 2013, are charging the marked-up price for the provision of services, will be accruing profits in the company unless dividends are being paid up to the LLP and out to partners. Undertaking such projects in the service company may be more tax efficient.

Impact on the partnership model

The new capital requirement may prove to be a disincentive for new partners, especially if they have plans to take out a new mortgage. The tax changes could therefore have a negative impact on the ambition of individuals coming through and their desire to become a partner.

Where firms have made a conscious decision not to ask partners for additional capital and are seeking to meet Condition A – more than 20% as variable profit – we could see a move towards a single class of partner.

Partnership or company?

While it is proposed that the main rate of corporation tax be aligned with the small companies rate by 2017, it is not expected that there will be a rush to convert partnerships to companies, as the partnership model is still a very efficient and flexible business vehicle. No doubt there will be some conversion to limited companies but each will need to be decided upon its own merits.

Corporate partners

A serious review will be required by firms that have both individual partners and corporate partners, with an urgent decision needed as to whether to cease the corporate partner as a partner altogether, or to reconsider the allocation of profits.

We have taken great care to ensure the accuracy of this newsletter. However, the newsletter is written in general terms and you are strongly recommended to seek specific advice before taking any action based on the information it contains. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. © Smith & Williamson Holdings Limited 2014. code 14/518 expiry 30/11/2014

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