Disguised employment in LLP’s – is it time to review your members’ pay arrangements?

You may recall that legislation came into effect in April 2014 in an attempt to remove the presumption of self-employment for members of an LLP. This was a hot topic for many LLPs at the time of its introduction but, to some extent, has fallen off the agenda since, partly because of the apparent lack of follow-up from HMRC. However, HMRC do now appear to be querying the structure of some LLP’s pay arrangements so, 4 years on, it seems like a good time to revisit this legislation.

The legislation was introduced as a means to remove the inconsistency with traditional partnerships whereby it was possible for LLP’s to make its employee’s members for the sole purpose of avoiding the additional cost of Employer’s National Insurance, which currently stands at 13.8%.

The new rules dictated that if a member of an LLP meets all of the following 3 conditions, they will be deemed to have a disguised employment and the entirety of their remuneration package would be subject to PAYE. These conditions should be looked at prospectively at the start of each financial year and reviewed on the introduction of any new members. It is one of the rare occasions where failure is the preferred option!

• Condition A – At least 80% of the amounts payable by the LLP to the member is ‘disguised salary’

In essence, Condition A will be met if it is reasonable to expect that at least 80% of the remuneration received consists of fixed payments or are not generally affected by the profits or losses of the LLP as a whole.

This does not include performance related bonuses based on the performance of the individual member or on a section or department of the LLP.

• Condition B – The member does not have significant influence over the affairs of the LLP as a whole

For large LLP’s, only members of the management board are likely to be deemed to have ‘failed’ this condition, whereas HMRC are likely to accept that all members of a small family run business will have significant influence.

• Condition C – The member’s capital contribution is less than 25% of their disguised salary

If a member risks losing capital equivalent to at least 25% of their disguised salary should the business be unsuccessful, they will ‘fail’ condition C and continue to be treated as self-employed. It’s important to remember that undrawn profit shares or tax reserves of members do not constitute capital contributions.

Many LLP’s will have complex profit-sharing arrangements based on a wide range of factors, or have members who receive a fixed profit share, so it is important that LLP members have a good understanding of this complicated area of legislation, or risk incurring the cost of expensive Employer’s NIC and possible fines and interest.