Budget tax threat to LLPs

The Chancellor's Budget announcement that the anticipated review of partnership tax rules will focus on the 'misuse' of Limited Liability Partnerships (LLPs) to disguise employment relationships, has caused some alarm in the legal and accountancy professions. Under the Limited Liability Partnership Act 2000, members of an LLP are regarded as self-employed and are not charged employer's National Insurance Contributions on their profit shares.

The Budget document claims that "mis-use" of partnership rules has been a feature of many tax avoidance schemes closed down in recent years. The chancellor's objective is to prevent the artificial allocation of profits to employees treated or labelled as partners to achieve a tax advantage.

It is not clear what measures the government proposes to take. One possibility must be the repeal or amendment of section 10. While the LLP bill was going through parliament in 2000, Lord McIntosh noted a desire, from professional partnerships in particular, "for an entity which will allow them to operate with limited liability, while maintaining a partnership ethos - that is, the flexibility to organise their own internal structure, and to participate in the ownership and running of the business".

In introducing the bill, the then under-secretary of state for trade and industry, Dr Howes, commented: "Without such provisions, they would be taxed as companies because, elsewhere, the bill provides that they are corporate bodies. Although LLPs will be corporate bodies, they will retain their partnership ethos at their core. Like partnerships, LLPs will consist of members who are involved in running the firm. We anticipate that they will continue to be an important source of working capital. It was therefore agreed that it was more appropriate for LLPs to be taxed as a partnership than as a company." But both houses anticipated that the LLP model would be attracted to "start-up businesses and to multi-disciplinary business" and that it would be wrong to try to restrict the LLP to the professions. This would give rise to a risk of LLPs being used for purposes for which they were not intended "where the primary or only attraction may be their tax status". It was therefore anticipated back in 2001 that "measures" might be introduced in the 2001 Finance Bill to combat unintended tax avoidance "without undermining the commercial certainty of taxation as a partnership for those businesses for whom the entity was intended".

Surely the correct approach for the government to take now is to follow the lead taken by the courts thus far in interpreting the LLP Act and, in relation to the misuse of intermediate service companies, IR35 correctly.

Partner or employee?

The essential problem is the correct determination of the employment status of the putative members of the LLP. Section 4(4) of the LLP Act provides: "A member of a limited liability partnership shall not be regarded for any purpose as employed by the limited liability partnership unless, if he and the other members were partners in a partnership, he would be regarded for that purpose as employed by the partnership." The question is therefore whether under the Partnership Act 1890 the alleged member would be a partner or an employee. This is a perennial problem the courts have had to consider in a number of contexts, including the unfair dismissal jurisdiction, and most recently in determining whether a member of an LLP could be a "worker" for certain employment protection purposes (Clyde & Co LLP & Another v Krista Bates van Winkelhof [2012] EWCA Civ1207). In that case, the Court of Appeal held that a true member of an LLP could not be a worker and could not be an employee. At the heart of that judgment is the court's ruling that in the relationship a worker or an employee has to an LLP "there must be a degree of subordination" which cannot exist in the partnership relationship.

In all partnerships, the presumption of self-employment is just that: a presumption. The true employment status must be established and there are many factors that will need to be taken into account such as the classic employment tests of control, integration and, in both the employment and partnership context, the extent to which there is subordination. The Revenue's IR35 initiative was seen, intended to and had an effect as a tax avoidance measure intended to ensure, so as far as possible, that all those supplying services as an employee rather than as an independent contractor through an intermediate service company, would be paying tax and national insurance contributions accordingly.

Judicial intervention

In determining the lawfulness of IR35, the Administrative Court (Burton J) held that whether services were deemed to be performed by the worker for the client in an "employee" capacity was to be determined according to the existing common law principles of employment.

We can surely expect that the promulgation of proper guidance from HMRC and, in those cases where it is necessary, appropriate judicial intervention will ensure that as few as possible of the 1,529 law firms that are currently classed as LLPs make people who are really employees, partners just to save NIC, which appears to be the mischief the government seeks to address.