Disguised Employees in the Midst

Self-employed partners will be reclassified as employees

In the Autumn Statement of 2012 the Government indicated that aspects of the tax rules relating to partnerships would be considered as part of its review of high risk areas of the tax code. Budget 2013 then announced that there would be two areas which would be consulted upon and we now have the consultation document.

'Partnerships: A review of two aspects of the tax rules' will run until 9th August of this year and will address two issues, namely:

• Limited Liability Partnership (LLP) members who work for the LLP on terms that are equivalent in effect to employment; AND
• Profit and loss allocations of any partnership where the main purpose is to secure an income tax advantage for any person.

LLP's were introduced as a new form of legal entity in 2000 and have increased in popularity with more than 50,000 LLP's on the Companies House register.

An LLP is a unique corporate body that provides its members with the benefits of limited liability. It is not however taxed in the same way as a limited company. Individual members are taxed as self-employed partners and subject to income tax whereas company members are liable to corporation tax according to their respective profit shares.

Even where individual members are paid fixed salaries they are still taxed as a self-employed partner.

HMRC believe that LLP's are being used to shield disguised employees at polar ends of the spectrum. At one end, groups of low paid workers who would normally be regarded as employees are being taken on as LLP members as a condition for them obtaining work. At the opposite end of the scale high-salaried professionals operating in areas such as the legal and financial services sectors are benefitting from self-employed status whereas they would normally be regarded as employees.

The Revenue therefore want to prevent a member of an LLP being able to rely on automatic self-employed status when the terms of their engagement with the LLP are really one of employment. To achieve this HMRC propose that where a member meets either of two conditions they will be classed as a “salaried member” and subject to PAYE tax and NIC's that will have to be deducted by the LLP.

Condition 1

A “salaried member” of an LLP is an individual member of the LLP who, on the assumption that the LLP is carried on as a partnership by two or more members of the LLP, would be regarded as employed by that partnership.

This condition will be determined by reference to the normal employment status tests which HMRC think will be “relatively straightforward”!

HMRC state that this condition is likely to apply to members who are engaged on standard terms as part of a mass recruitment exercise or who having been employees of a company then become members of a successor LLP on essentially identical terms.

Condition 2

A “salaried member” of an LLP includes an individual member of the LLP who does not meet the first condition but who:

1. has no economic risk (loss of capital or repayment of drawings) in the event that the LLP makes a loss or is wound up;
2. is not entitled to a share of the profits; and
3. is not entitled to a share of any surplus assets on a winding-up.

The terms of the LLP agreement may not indicate whether a contract of service exists so HMRC will look for significant factors within the agreement that confer equivalent employment rights. These factors will be a member having no significant entitlement to reward that is related to the LLP's profits and in the event that the LLP makes a loss there is no significant “downside” for the member. “Downside” refers to the risk of loss of capital or an obligation to repay drawings to the LLP that are paid on account of expected participation in profits for the period in question.

If it is reasonable to regard the risk or entitlement as insignificant then this condition will apply. Where a profit share would never be more than 5% of any fixed entitlement this is likely to be regarded as insignificant.

A targeted anti-avoidance rule will be introduced to prevent circumvention of the two conditions.

Subject to consultation, the Government proposes to introduce these changes from 6th April 2014.

The proposed rules are more far reaching than IR35 because they are not contract specific but rather examine the member’s relationship to the LLP as a whole. As IR35 also applies to LLP's those organisations will now have a double status headache.