Salaried members’ rules: what are the learning points from the first case?

Members of LLPs are generally taxed as self-employed, rather than employees, which can give a significant saving in NICs. The salaried members’ legislation taxes members as employees in some circumstances. This is generally where their work relationship is similar to an employment relationship.
In this case, the LLP undertook investment management activities and provided support services to the wider group. The members were broadly categorised into portfolio managers and non-portfolio managers.

Under the salaried members’ legislation, if three specific conditions are met then a member will be taxed as an employee. HMRC had assessed members of this LLP as meeting all three conditions, A, B, and C.
The Tribunal disagreed with HMRC in part and found these rules to apply only to the members who did not have significant influence over the LLP’s affairs, and so did not meet condition B. The members were found to meet condition A as they could not illustrate a clear link between the profits of the LLP and their discretionary profit allocations.

Salaried member conditions and application to this case

Condition C (capital contribution) –all parties agreed that this was met by the members. The LLP therefore needed to prove that one of condition A or B was not met for the members to have self-employed status.
Condition A (disguised salary) – a proportion of the members’ compensation was comprised of discretionary allocations referred to internally as ‘bonus’. This was ultimately determined at the discretion of the board. The judgement was to determine whether the discretionary allocations were disguised salary, and therefore whether condition A was met.For portfolio managers, the judge held that discretionary allocations were disguised salary on the basis that these were effectively determined by reference to an individual’s own profit and loss account. While this amount could vary, it varied by reference to their own personal performance rather than by reference to the LLP profits and was therefore more akin to an employee’s bonus.
Furthermore, there was no evidence that the board took the LLP’s profits into account when considering the final discretionary allocations for any of the members within the appeal.

All members therefore met condition A.
Condition B (significant influence) – the LLP asserted that any portfolio manager with a capital allocation to invest of $100m or more had significant influence over the LLP’s affairs. The LLP also considered non-portfolio managers to have significant influence.
The judge took the view that significant influence does not need to be over the entire affairs of the LLP and can instead be over one or more aspects. In addition, he held that it is not limited to managerial influence and can include, for instance, financial or operational influence. It should be noted that this judgement is a significant departure from HMRC’s position and therefore may be subject to appeal.

All parties agreed that, when determining significant influence, a realistic examination of the facts is required. It is well established that significant influence must be tested on an individual basis, and, in this case, the judge found in favour of the LLP in respect of certain members only.

Condition B was not met in respect of the portfolio managers with capital allocations of $100m or more as these were found to have significant influence. The activities they undertook were comparable with that of a partner in a traditional partnership.
For the non-portfolio managers, the judge determined that they did not have significant influence, or at least that the LLP had not provided evidence that they did, with the exception of the original executive committee. Furthermore, the judge noted that many of the roles undertaken by these individuals would be undertaken by employees specialising in those areas rather than by partners in a traditional partnership.

Targeted anti-avoidance rules (TAAR)

The salaried member legislation contains an anti-avoidance provision, which broadly provides that any arrangement with the main purpose of securing that a member is not to be deemed an employee is to be disregarded.

In this case, the LLP’s in-house tax team obtained professional tax advice following the introduction of the salaried member legislation. Subsequently, an internal paper broadly stated that the members’ discretionary profit allocations should be compared to the LLP’s profits to determine if there was sufficient profit to pay these. This was intended to ensure an individual failed condition A.
The judge noted that the main purpose, or one of the main purposes, of the board’s resolution relating to this recommendation was to ensure members would not be treated as employees. This means that if the members had not met condition A, then the TAAR would have applied.

This case therefore creates a level of uncertainty about whether any restructuring of arrangements to ensure individuals remain self-employed would work.

Key takeaways

Although the judgment may be appealed, there are several key points that firms may want to consider now:

• HMRC is opening enquiries that relate to the salaried members’ legislation. Now is the time for all firms to review their salaried member testing process.
• The burden of proof of establishing whether each of the conditions is met rests with that particular member and/or the LLP.
• This case reinforces the need for firms to have detailed, contemporaneous documentation and a clear, applied methodology when determining a member’s profit allocation.
• Firms relying on condition C (capital contribution) must consider this judgement when determining the quantum of any profits considered to be disguised salary (condition A).
• The judge’s view that significant influence does not need to be over the entire affairs of the LLP, is not limited to managerial influence and can include, for instance, financial influence. This is a departure from HMRC’s published guidance; and
• Any actions a firm has taken to ensure that its members do not satisfy these conditions should be reviewed in light of the judge’s comments regarding the TAAR.

Next steps

The comments above are high level and based upon a case with complex facts. The application of the judgement in respect of a firm’s own affairs will be dependent on its own specific facts and circumstances.
We would be delighted to help you navigate the impact of this judgement in respect of your own business and can provide an independent review of your testing process including an assessment of your compensation methodology.

NT ref- NTAJ14082249