New pitfalls in relation to the tax status of fixed share partners
Martin Ramsey · Posted on: May 9th 2024 · read
Firms have been able to operate in a known environment when dealing with fixed share partners ever since the introduction of HMRC’s Salaried Member Rules in 2014, but that is now changing.
It is routine for the treatment of fixed share partners to be regularly considered to ensure they meet at least one of the existing three tests below. By meeting one of these tests the firm is satistfying itself that the partner is not being inappropriately treated as self employed (i.e. they are receiving employment income ‘disguised’ as a profit share). The three criteria are as follows:
- 20% or more of the profits of a fixed share partner must be variable with reference to the LLP’s profits.
- The member has significant influence over the affairs of the LLP.
- The member contributes capital to the LLP of at least 25% of their fixed remuneration.
If any one of the above tests are met then the firm may treat the individual as a self-employed partner i.e. they are taxed in the same manner as equity partners. In our experience the majority of practices rely on the third criteria above by actively managing the level of capital partners have invested in the business. This is an easy metric to meet being measurable and predictable.
HMRC has recently updated their guidance in relation to the third criteria to the effect that where capital contributions are increased purely to meet the self-employed criteria for tax purposes, then the anti-avoidance regulation will apply and the person will be treated as an employee.
What is clear is that simply updating capital levels regularly to scrape through the 25% test is no longer appropriate.
In recent weeks we have seen several large firms announce changes to the structure of arrangements with fixed share partners, including significant increases in the capital contributions required such that the capital is significantly in excess of the amount required under the rules. What is clear is that simply updating capital levels regularly to scrape through the 25% test is no longer appropriate.
This change brings a wider challenge for firms and new partners in that they may find themselves with a greater amount of risk capital in their firm but without the upside benefit of equity partnership. By way of an example, if a senior employee earning £80k is promoted to fixed share partner on £100k, they will have to think whether the additional £20k is good value once they have put, say £30k of their own money at risk, lost their employer pension contributions and employment rights, and are now generally open to greater personal risk. For ambitious individuals this ‘stepping stone’ probably makes perfect sense, but for others the landscape has suddenly become much less attractive.
One point to consider is that following the basis period reform which is in progress, the timing benefits of being self employed are now much less generous, and more generally, the benefits of self-employment are of less impact than they once were. Therefore, before going through the (sometimes arduous) process of altering members agreements and negotiating new arrangements with partners, it may be worth considering modelling the impact of treating certain individuals as salaried rather than self-employed.
We certainly recommend that all firms with fixed share partners undertake a review of their arrangements.
One point to consider is that following the basis period reform which is in progress, the timing benefits of being self employed are now much less generous, and more generally, the benefits of self-employment are of less impact than they once were.
For further information
If you have any questions on these new rules and how they could impact you, please contact our Professional Practices team who would be happy to assist you.
