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A Partner Writes: Salaried Members Tax Rules

Posted by Nigel Wright on 29-Apr-2014 12:08:05
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David Evans, Tax Manager at Howard Worth Chartered Accountants, outlines the proposed HMRC conditions that determine whether a member of an LLP should be treated as an employee for tax purposes.

When LLPs were first introduced tax legislation was created to ensure that they were treated as partnerships for tax purposes, rather than as companies. The legislation specifically provided that any individual LLP member should be treated as self-employed for tax purposes and therefore be subject to income tax and class 4 NIC’s on the partnership profit share. In effect LLP members were to be treated as partners are in traditional partnerships.  HMRC believes that this system has led to abuse as it has become evident that many LLPs have members who are actually more like an employee of the LLP, rather than a traditional partner.

To combat this abuse, HMRC has provided three conditions to determine whether a member of an LLP should be treated as an employee for tax purposes, rather than as a partner. All three of these conditions must be met for the member to be deemed an employee.

The legislation as outlined below was introduced by the Finance Bill 2014 and despite the House of Lords recommending a delay until April 2015, it appears to be going ahead.


Condition A: Disguised Salary

The first condition is intended to identify those members who are working for the LLP on terms that are more like those of an employee; they are paid for their services regardless of the actual performance and profitability of the LLP.

This condition is met where at least 80% of the total amount payable to a member is determined to be “disguised salary”. This comprises of any amounts that will not be affected by the overall profitability of the firm, including:

1. A fixed salary
2. A bonus based on a member’s personal performance (i.e. without reference to the success of the business)
3. Any guaranteed payments or non-refundable drawings.


Condition B: Significant Influence

This condition is examining the role of the individual in the LLP; are they merely working for the business or do they make the business? If it is determined that a member does not have significant influence over the affairs of the LLP, this condition is met.

Significant influence is defined as being involved in the management of the business as a whole. HMRC provides a list of the kinds of decisions a member with significant influence may be involved in, but this list is by no means a definitive list. A person may have significant influence or even complete control over just one area but still not be classified as having significant influence over the firm as a whole.

Members of the board or management committee of a large firm are likely to be deemed as having significant influence and will therefore avoid meeting this condition. Merely being able to vote or express an opinion however, is unlikely to constitute significant influence.
This condition is particularly important for the members of smaller LLP’s as it is easier to demonstrate significant influence over the business as a whole the fewer members there are, hence avoiding meeting this condition.


Condition C: Capital Contribution

The final condition looks at the level of investment into the LLP made by the member. Is the investment significant enough to mean that there is risk to it, resting on the success of the business?

This condition will be met when the member’s contribution to the LLP is less than 25% of the disguised salary expected to be payable to the member.
Individuals who are members of an LLP on 6 April 2014 will have 3 months grace to contribute sufficient capital if they want to avoid meeting this test.
For individuals who become a member on or after 6th April 2014, an undertaking must be in place to contribute the capital from the day of becoming a member, and that capital must be provided within 2 months.

The capital does not take into account any amount of capital that is held to enable the member to avoid being classified as a salaried member – the investment must be permanent and be at risk dependent upon the success of the business.



Once the legislation is in place, members who are deemed to be salaried members (by meeting all three of the conditions above) will be treated as being employed by the LLP and therefore their earnings will be subject to PAYE and National Insurance.

While the new legislation intended to crack down on firms which use a LLP model to avoid tax on salaries, it actually gives a rather clear cut check list of how to make sure that partners are taxed as partners and not as employees. The condition that is the most clear cut and most likely to be focused on is condition C, as it is plain to see whether the required capital has been contributed or not.  Once this condition is broken members are deemed to be partners, as all three conditions must be met for them to be classed an employee.

We are advising our clients who are affected by this to review their member’s agreement and consider whether they can request fixed share members to contribute capital.


If you have any questions regarding these new rules please contact David Evans, Tax Manager at Howard Worth Chartered Accountants on 01606 369 000.

Topics: Howard Worth, tax rules

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