HMRC has updated its guidance on salaried members, which could have significant implications for members of limited liability partnerships (LLPs). While this update doesn’t reflect a change in legislation, it offers insight into HMRC’s interpretation of existing laws and serves as a reminder for LLPs to follow the proper guidelines for salaried members.
Before the introduction of the salaried member rules, some individuals were appointed as LLP members and were automatically taxed as self-employed, despite functioning more like employees in practice. This update underscores the need for LLPs to ensure that their members are classified correctly for tax purposes.
What are the Salaried Member Rules?
The salaried member rules, introduced in 2014, apply specifically to members of limited liability partnerships (LLPs), not to general partnerships or limited partnerships. These rules establish three conditions—A, B, and C—that determine when an individual should be considered more like an employee than a partner. The rules apply where all three conditions are met:
- Condition A: Targets LLP members who are compensated similarly to employees, receiving a “disguised salary” rather than a share of the firm’s profits. This disguised salary resembles an employee’s fixed salary and performance-related bonuses, rather than fluctuating with the firm’s profitability.
The assessment of whether Condition A applies is forward-looking, based on current arrangements. Disguised salary encompasses payments for services that are not linked to LLP profits and includes amounts unlikely to be influenced by profit variations.
For example, some LLPs pay members a fixed profit share, such as £75,000 annually, which is guaranteed unless the firm performs very poorly. Although this fixed share isn’t strictly guaranteed, it is reasonably stable and thus considered a disguised salary.
However, anticipated profit shares, which adjust based on actual profits and may result in either additional profits or a debt to the firm, are not classified as disguised salaries. These are viewed as profit shares accessed through drawings rather than fixed salaries.
- Condition B: This condition applies when an LLP member does not have significant influence over the LLP’s affairs. It targets individuals who are employees or contributors without substantial control or decision-making power in the business.
Members with significant influence are typically those engaged in overall management or senior roles with the authority to impact the firm’s strategic direction, even if they aren’t involved in daily operations.
- Condition C is met when a member’s capital contribution to an LLP is less than 25% of the expected disguised salary for the relevant tax year. This disguised salary is the amount the member is anticipated to earn from their services.
Capital contributions are typically well-documented. For new members, the test is based on their committed capital contribution at the time of joining.
Members who joined before April 6, 2014, must have an agreement to contribute capital within three months to satisfy Condition C. Those who joined on or after April 6, 2014, have a two-month period to provide the capital, provided they had a commitment to contribute from the start of their membership.
These rules are intended to prevent PAYE implications during the brief period when members are arranging their capital contributions. The rules include several anti-avoidance measures, one of the most important being that if arrangements are made with the primary purpose of circumventing the salaried member rules, those conditions will be disregarded.
Many LLPs have structured their members’ capital arrangements to ensure they clearly fail to meet Condition C. Often, LLP agreements required all members to maintain a capital account equal to at least 25% (or more, if a buffer was deemed necessary) of any ‘disguised salary’ they were expected to receive during the year.
This approach—provided that the member genuinely had capital at risk within the LLP, thereby taking on the characteristics of a partner in a general partnership—was always considered reasonable and not likely to trigger the anti-avoidance provisions.
The recent update to the HMRC manual, which clarified the Salaried Member Rules, may signal a particular area of focus for future compliance reviews. While this has raised some concerns, the update simply reinforces what LLPs should already be doing. If your business operates as an LLP, it’s crucial to regularly review your agreements and ensure that you are correctly applying HMRC’s provisions.
