UK employment tax ruling impacts LLPs

Hatice Ismail and Jamie Robson of Pinsent Masons were commenting after the UK Supreme Court clarified (43-page / 369KB PDF) two of three conditions relevant to whether the so-called salaried members rules apply to LLP members or not.

Where the salaried members rules apply, affected LLP members are considered to be employees for tax purposes. This means they should be paid through the PAYE system with income tax and National Insurance contributions (NICs) deducted prior to payment. The LLP is also required to pay employer NICs on payments to those members. Generally, LLP members are paid on a self-employed basis and employer NICs are not payable, so falling within the rules could be costly for an LLP.

The salaried members rules apply to an LLP member where three conditions are met: that it is reasonable to expect that at least 80% of the individual’s total remuneration – fixed and variable – should be deemed to be “disguised salary” (‘condition A’); that the individual doesn’t have significant influence over the affairs of the partnership (‘condition B’); and that the individual’s capital contribution to the partnership is less than 25% of their expected “disguised salary” (‘condition C’).

The Supreme Court assessed conditions A and B in the case before it.

With condition A, the Supreme Court considered whether “discretionary allocations” – bonuses – paid to certain individuals working for investment firm BlueCrest Capital Management (UK) LLP constituted disguised salary.

The Supreme Court said that the purpose of condition A is to distinguish between what is typical remuneration for a partner and typical remuneration for an employee. It said in a typical partnership, overall profits would be shared. It considered that there was not a substantial link between the bonuses paid by BlueCrest and the overall profits of the partnership for BlueCrest’s members to avoid falling within condition A.

For condition B, the relevant test for determining whether an individual exerts significant influence over the affairs of the partnership was found to be related to their influence over the affairs of the partnership as a whole, in all cases based on the contractual, legal or equitable rights as a member. In practice, the court said that their level of influence on “managerial” or “strategic” decision-making is likely to be most relevant in this regard. While it did not exclude the possibility of ‘significant influence’ being demonstrated in other ways, it explicitly ruled out influence over “day to day management or operational management of only a part of the business” as being sufficient to navigate condition B.

The Supreme Court ruled in favour of HM Revenue and Customs (HMRC), which had taken issue with BlueCrest’s arrangements.

Funds tax expert Hatice Ismail of Pinsent Masons said: “This decision has been keenly awaited by the fund management industry but also other industries and sectors that commonly structure their businesses as LLPs, such as legal and accounting firms. The Supreme Court confirms that a narrow interpretation applies to the meaning of ‘significant influence’ for the purposes of condition B. This includes strategic-decision making influence exercised over the affairs of the partnership as a whole deriving from legal sources governing the operation of the partnership such as statute and the LLP agreement, but not day-to-day management or de facto influence that is linked to a person’s commercial or financial performance or importance to the partnership. This kind of significant influence will be exerted, in practice, by relatively few people within the business.”

“Condition A remains difficult for asset managers to fail given remuneration models that are heavily geared towards individual or team performance. The Supreme Court made it clear that discretionary profits allocated to individual members needed to be truly variable by reference to the profits or losses of the partnership as a whole – it was not sufficient that they were capped and would not be paid if the partnership did not have sufficient profits,” she said.

Tax expert Jamie Robson of Pinsent Masons said: "Both of the court’s interpretations make it harder for larger LLPs in all sectors, whether financial services, legal or accounting, for example, to fall outside of the conditions – in each case broadly requiring either remuneration to be referable to, or influence to be over, the partnership as a whole. Many such LLPs may be relying on condition C not applying which may mean, in practice, that the impact of this decision is most keenly felt by those small to mid-sized partnerships that are not.”

“The third condition, condition C, relates to the level of a member’s capital contribution and was not in point in this case. Having made reference in guidance to the application of anti-avoidance rules and capital contributions, it will be interesting to see where HMRC goes from here. Having ticked off two of the three conditions in their favour in this case, the question is whether they will seek a further favourable ruling in relation to condition C via separate litigation," Robson said.

Ismail and Robson said businesses in the form of LLP will need to look carefully again at their LLP agreements and remuneration models in light of this judgment.