This client alert discusses recent developments relevant to members of UK LLPs in respect of the UK's salaried member employment tax rules. In particular, it focuses on recent developments in relation to Condition B (the significant influence test) and Condition C (the capital at risk test) of those rules. A short summary of these rules and the conditions is included at the end of the alert for those who would find a refresh helpful.
Key Takeaways
In light of the Court of Appeal's recent decision in the case of BlueCrest Capital Management (UK) LLP v HMRC (BlueCrest), any UK LLPs and their members that rely on falling outside the salaried member rules by virtue of the relevant member(s) having "significant influence" over the affairs of the LLP should review their existing arrangements. As a result of the decision in this case, it is now important that the manner in which the LLP operates in practice, and in particular the rights and duties of the members, are specifically reflected and set out in the LLP agreement.
The BlueCrest case, combined with the recent focus by HM Revenue & Customs (HMRC) on LLP members "topping up" their capital contributions in order to avoid being treated as a salaried member of an LLP (i.e. by virtue of "failing" Condition C of the rules), makes it clear that HMRC are now looking very closely at the use of LLPs in general.
Following the Court of Appeal's decision in BlueCrest, HMRC has released a statement that it intends to "wait and see" what happens next in the BlueCrest litigation (i.e. whether leave to appeal is granted by the Supreme Court) before entering into any formal litigation processes with any LLPs that are the subject of an ongoing salaried member compliance check by HMRC. Whilst this seems like a practical approach pending the final outcome of BlueCrest, we note that HMRC has not taken the opportunity to confirm that it will consider whether or not the new interpretation of the rules advanced by the Court of Appeal should be applied only on a go-forward basis; instead (subject to the final outcome of BlueCrest), it appears HMRC may intend to proceed to litigate when an LLP has not been compliant with the BlueCrest requirements at any point in time.
HMRC's Guidance on Condition C (capital
contributions to the LLP)
Looking at the above topics in a little more detail, the
first development is a recent update to HMRC's guidance
regarding the application of Condition C of the salaried member
rules.
Last year, HMRC made a surprise change to its published guidance on the LLP salaried member rules. HMRC's "new" position was that the practice of periodically making additional "top-up" capital contributions to an LLP was not, and never had been, effective as a means of falling outside the rules (specifically Condition C). This new position was taken despite HMRC having previously expressly acknowledged that it was aware of this practice and not having raised any objections.
This change in approach by HMRC was problematic because it effectively had a retroactive effect. Many LLPs had relied on falling outside the salaried member rules by virtue of failing Condition C because, unlike some of the other conditions, this one uses an objective, quantitative threshold.
Following considerable market disquiet and lobbying from industry bodies, HMRC has now published further revised guidance on Condition C. Ultimately, this revised guidance reverses the changes it announced last year, where the capital contributions made are "genuine".
This is a welcome development for the many LLPs that expected to be affected by the previous change in HMRC's published practice.
The Court of Appeal's Decision in BlueCrest
(Condition B and the meaning of "significant influence"
over the affairs of an LLP)
The second development relates to the Court of
Appeal's decision in BlueCrest, which looks at (among other
things) how "significant influence" over the
"affairs" of an LLP should be determined for the purpose
of Condition B of the salaried member rules. This is important as,
to the extent that an LLP member has "significant
influence" over the affairs of the LLP, that member should
fall outside those rules, which can otherwise operate to treat the
LLP member as an employee for UK tax purposes.
In summary, the Court of Appeal has effectively narrowed the application of Condition B, finding that significant influence over the affairs of the LLP must have its source in the rights and duties of the members of the LLP as provided by relevant law and/or the LLP agreement, and that only those rights and duties of the LLP members that are legally enforceable should be taken into account.
Conversely, de facto influence (i.e. actual influence as a result of formal or informal arrangements), which is not legally enforceable, does not count for the purposes of Condition B; as such, the First Tier and Upper Tier Tribunals erred in law in considering the de facto position to determine what type of influence is "qualifying" for the purposes of Condition B.
In addition, the Court of Appeal agreed with HMRC that the "affairs of the partnership" means the affairs of the LLP generally, viewed as a whole (and in the wider context of the BlueCrest Group), with a focus on decision-making at a strategic level; in other words, it is not sufficient to have influence over a certain element of the business.
The Court of Appeal's decision on the construction of Condition B and the meaning of significant influence goes against well-established market practice and is also contrary to the existing HMRC published guidance. That guidance states that whether or not a member has significant influence should be applied on the basis of a "realistic view" of the facts of the case and that "all relevant information must be considered" in applying Condition B (i.e. the position is considered in a wider context than just looking to legally enforceable rights and duties of the members).
Viewed from a practical perspective, the Court of Appeal's decision in many cases will narrow the sources of significant influence solely to the LLP agreement. This is on the basis that it is commonplace for an "entire agreement" clause to be included in most LLP agreements (so that it overrides any other written agreements or positions that otherwise might be taken into account), and for this to also exclude default positions under the LLP Act.
Further, the Court's decision makes it clear that significant influence in a certain area of the LLP's affairs — for example, financial or, in the case of an investment fund manager, as a member of the investment committee — is not sufficient to constitute significant influence over the "affairs of the partnership". This approach mirrors existing subtle shifts over time in HMRC's guidance in this area.
BlueCrest has sought leave to appeal the decision, and so the Court of Appeal's narrower interpretation of Condition B may yet be found incorrect or incomplete. However, to the extent that an LLP and its members are relying on failing Condition B to fall outside the salaried member rules, then those existing LLP agreements should be reviewed now to ensure that the manner in which the LLP operates in practice is reflected in the rights and duties of the members as set out in the LLP agreement.
If leave to appeal is not granted (or, on appeal, the Supreme Court agrees with the Court of Appeal), some LLP members may find that they are unexpectedly brought within the scope of the salaried member rules.
We would be happy to assist anyone with existing LLP arrangements or agreements that need to be reviewed in light of these developments. Please reach out to your usual Goodwin contact if you'd like to discuss this or any aspects of this update further.
The Salaried Member Rules: Background
The salaried member rules treat certain individual UK LLP members as employees for UK tax purposes (and therefore subject to employment income tax and employee/employer national insurance contributions) if they do not meet certain statutory requirements such that their role is seen as being more like an employee than a partner. As such, there can be a significant tax cost to falling within these rules.
An individual partner of a UK LLP is deemed to be a salaried member of that LLP if all of Conditions A, B, and C are met. In other words, "failing" any of these three conditions can prevent an individual from being treated as a salaried member.
Condition A is met if it is reasonable to expect that at least 80% of the total amount payable by the LLP in respect of the member's performance during the relevant period of service for the LLP in their capacity as a member will be "disguised salary". Broadly speaking, disguised salary is an amount payable that is either fixed or that is variable without reference to the LLP's overall profit and loss. In other words, if less than 80% of the total amount payable to the member would be treated as disguised salary, then Condition A would be failed and the salaried member rules should not apply to that member.
Condition B is met if the mutual rights and duties of the members of the LLP do not give the individual member "significant influence" over the affairs of the LLP. HMRC guidance states that the purpose of this condition is "to exclude from being Salaried Members those individuals who have a real say in the business". As such, if the individual member does have "significant influence" over the affairs of the LLP, then Condition B would be failed and the salaried member rules should not apply to that member.
Condition C is met if the member's "capital contribution" is less than 25% of the amount of disguised salary the member would have received from the LLP in return for performance of services during the relevant period of service — i.e. when the member's capital contribution is 25% or more of this amount, then Condition C is failed and the salaried member rules should not apply to that individual member.
The rules also include a targeted anti-avoidance rule, which disregards any arrangements the main purpose of which is securing that the salaried member rules don't apply.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
