Earlier this year we reported on the Government’s proposed changes to the tax treatment of certain members of limited liability partnership (LLPs). Despite strong protests from bodies such as the Law Society and the Institute of Chartered Accountants in England and Wales, the Government has refused to back down and the changes will be implemented next month.
Salaried member status
The changes mean that with effect from 6 April 2014, an individual who provides services to an LLP will be taxed as an employee (rather than on a self-employed basis) if:
- 80% or more of the member’s remuneration is fixed or not dependent on the overall profits and losses of the LLP;
- the member has no significant influence over the LLP’s affairs; and
- the member’s capital contribution is less than 25% of their remuneration.
But what are the practical effects of these changes for the member and the LLP?
For the salaried member
Prior to 6 April 2014, the salaried member will have paid self-employed National Insurance Contributions (NICs) at the following rates:
- class 2 contributions on annual earnings in excess of £5,885, which is a flat rate amount of £2.75 per week;
- class 4 contributions at 9% on profits between £7,956 and £41,865; and
- class 4 contributions at 2% on any profits above this.
From 6 April 2014, a salaried member will now be liable for primary class 1 contributions at 12% of earnings between £153 per week and £805 per week and 2% on any earnings over £805 per week. These amounts will be collected by the LLP and paid to HMRC every month via the PAYE system.
Income tax on a salaried member’s remuneration will also be collected by the LLP and paid to HMRC each month via the PAYE system. A potential upside for the salaried member, therefore, is that they will no longer face liability to HMRC for unpaid tax if the LLP becomes insolvent. Typically, an LLP retains the tax on its members’ remuneration in a ‘tax reserve account’ and then pays this over to HMRC on the members’ behalf when the tax is due. If the LLP becomes insolvent, the tax reserve account generally forms part of the LLP’s assets and so would be used to satisfy the LLP’s debts and obligations leaving the members to fund their accrued tax liabilities from their own pockets.
For the LLP
As well as collecting the employee’s primary class 1 NICs referred to above, from 6 April 2014 the LLP will have to account for secondary class 1 NICs of 13.8% on amounts over £153 per week. These amounts are due from the LLP itself and will have to be paid every month via the PAYE system.
As noted above, LLPs typically retain the tax element of their members’ profit shares in a tax reserve account. That reserve then forms part of the LLP’s working capital until it is needed to pay the relevant tax liabilities on behalf of the members. From 6 April 2014, however, the tax element of salaried members’ remuneration will have to be paid to HMRC each month under the PAYE system and will no longer be available to the LLP as working capital.
What to do?
HMRC has confirmed that measures put in place prior to 6 April 2014 will not be treated as anti-avoidance so now is the time to act to avoid being caught by the rules.
Since only senior partners or members of a firm’s management board are likely to have ‘significant influence’ over the LLP’s affairs, firms either need to adjust their remuneration structures, so all members have more than 20% of their remuneration dependent on the LLP’s overall performance, or else increase members’ capital contributions, so all members have capital contributions in excess of 25% of their remuneration. The Government has given members a three month window from 6 April 2014 to make any increased capital contributions to the LLP.
For more information, email firstname.lastname@example.org.