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Finance Bill 2014 means urgent review needed in tax status of LLP Members

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The tax status of fixed share members in LLPs has been brought into sharp focus by the Finance Bill 2014 and the expected reclassification is set to affect many, explains Steven Grant, Head of the Commercial Group.

Since LLP’s were established in 2005, there has been a presumption that all LLP members are self-employed for tax purposes.  Last year the government examined this as part of a wide range of measures to clamp down on perceived tax loopholes.  The Finance Bill 2014 sets out a new test of whether a member of an LLP is self employed.

The new test consists of three parts.  An LLP member need only satisfy one part to remain self-employed for tax purposes.  A member should either:

(a) derive more than 20% of their total remuneration from a variable profit share of the firm as a whole

(b) have a significant influence over the affairs of the LLP or

(c) maintain capital in the LLP equal to at least 25% of their fixed remuneration.

The new test will apply to members as at 6th April 2014 although the Bill itself is not expected to become law until later on in the year.  Members who do not pass the new test will be treated as employees for tax purposes unless changes are made before 6th April.

These changes are expected to have a significant impact on professional firms such as accountants and solicitors, who traditionally use a two or three tier partner system to encourage career progression and ultimately succession. The concept of fixed share members works because it allows people a taste of being in business before committing to full equity status.

LLPs should undertake an urgent review of their members’ remuneration now.  Some firms may be happy for fixed share members to be reclassified as employees for tax purposes while others will want to ensure that some or all pass the new test.

Firms that are happy for members to be reclassified as employees for tax purposes should bear in mind the financial changes including employers national insurance, pensions and bonus/profit share arrangements.  Firms must also consider whether the change of tax status impacts on a member’s legal status.  It is quite possible that a member could be taxed as an employee but remain self-employed for legal purposes, for example where a member has capital and a share of profits below the levels described in the Finance Bill.  Firms should review their LLP agreement in view of changes and consider whether it is best to invite members to become employees for legal purposes in which case an employment contract will be needed.  Care should be taken to involve members in the discussion to avoid them feeling that they are being demoted.  That could have a disastrous impact on management and succession in some firms.

There are clear options available to firms wishing to retain fixed share members.  Firms should consider which of the three tests they wish to use.  Some firms may use a combination of two or all three.  It’s expected that small firms will look closely at the management test whereas this test will be a lot less attractive to larger firms where management is often delegated to a management committee or board.

Most firms are likely to ask members to contribute additional capital, which seems the simplest method.  The capital contribution can be by way of a loan and interest can be paid by the LLP to the member so that the member isn’t actually out of pocket.  Care should be taken to ensure that the capital contribution satisfies the requirements set out in the Finance Bill.  We can help by reviewing or drafting a suitable capital policy and/or loan agreements.  Members will need to agree how the capital will be used by the firm.  Some members may want to increase their fixed or variable share of profits bearing in mind the new degree of risk that they are taking on.

If you need advice on this or other commercial issues, please contact Steven or the commercial team on 02380 717717 or visit their section of the website here.


This is for information purposes only and is no substitute for, and should not be interpreted as, legal advice.  All content was correct at the time of publishing and we cannot be held responsible for any changes that may invalidate this article.