The new legislation deals with the deemed self-employed status that LLP members were able to take advantage of, and how this had been used to make individuals self-employed that were previously subject to PAYE.
The way they have chosen to tackle this is not to rely on previous tribunal cases that deal with employment status, but to introduce three new conditions. Members will fall under this legislation and be classed as employed for tax purposes if all of Conditions A, B and C are true.
Condition A: the amounts payable by the LLP in respect of the services provided by the member are wholly, or substantially wholly, fixed, or if variable, variable without reference to, or in practice unaffected by, the overall profits or losses of the LLP. In other words they cannot benefit from years where the profits are high or suffer when the LLP makes a loss;
Condition B: the mutual rights and duties of the members of the LLP do not give that member significant influence over the affairs of the LLP; and finally
Condition C: the member’s capital contribution to the LLP is less than 25% of the disguised salary which it is reasonable to expect will be payable by the LLP in a relevant tax year in respect of the member’s performance of services for the LLP.
In other words, if either a member’s capital contribution is more than 25% of the disguised salary; or the member has significant influence; or the member’s rewards are substantially linked to the profits of the LLP – they would remain as self-employed.
Furthermore, any members who fall under this legislation, and become employed for tax purposes, may still not necessarily be classed as an employee under employment law, meaning they will not benefit from employment rights such as statutory redundancy pay.
These new rules are certainly complex and will require any LLP with a hierarchy of members to consider whether all members still qualify as self-employed.
The other perceived abuse the Chancellor sought to tackle with the new legislation was the use of mixed partnerships. This generally means partnerships or LLPs that include a company as a partner to take advantage of the lower tax rate that corporate entities enjoy. The new legislation deals primarily with two tax advantages enjoyed by mixed partnerships by amending the amount of deemed profit allocation to the non-individuals.
The new legislation notes that there should now only be two situations where a profit share can be allocated to a non-individual partner, namely for a return on the capital it has invested in the partnership; and for a commercial return on the activities the non-individual undertakes for the partnership.
One issue will be how will one decide the appropriate rate of return on the non-individual's capital? The obvious answer is to look at the rates available in the marketplace but the choice is extensive to say the least. The HMRC guidance that accompanies the new legislation uses a rate of just 2%, but is this an appropriate rate? It seems unlikely, even in the current market, that a partnership could obtain unsecured finance at a rate anywhere near 2%.
The second limb looks at a return on the commercial activities the non-individual partner undertakes, but again this is fraught with issues. If the non-individual partner employs staff to contain the employment risk outside the partnership what is this worth in commercial terms? It could conceivably range from say 5% all the way up to say 25%. The appropriate level will depend upon the type of activity it undertakes, the risk and the market rate.
What this does mean is that the computation of the non-individual partner’s share will be more complex and the methodology used will perhaps need to be disclosed to avoid an enquiry based upon discovery in later years.
The rules do specifically state that they apply only to mixed partnerships but it is clear that s850D looks to those situations where as a result of the introduction of the above changes to single corporate partner structures, partnerships decide to change their ownership so that all the partners previously running the business cease to be partners, by perhaps replacing each of them with their own company – a multiple corporate partner structure. In this case s850D would appear to deem those partners as still forming part of the business and are caught from 5 December, but what about those who already had a multiple corporate partner structure prior to 5 December? Well for these entities it would seem that for the time being this legislation will not affect the way they share their profits but it is unclear whether HMRC may focus on such businesses going forward.
The changes are complex and we are in the process of reviewing the impacts on an individual basis with all of our clients that have either adopted one of the above structures, or are in the process of reviewing their structure with us. Specific guidance is required for each business’s specific circumstances.