UK fixed-share partners may retain the rights of employees

The classic model of the solicitors’ partnership sees employed solicitors being elevated to the ranks of the partnership, with their share in the profits of the firm (and perhaps their capital contribution) steadily increasing with seniority.

Salaried partners or fixed-share partners, as they are often called, are not new. However, the trend more recently has been for equity to be more tightly held and controlled and not diluted so widely or so easily.

This trend has accelerated in recent years, with difficult economic times. The equity partners of the firm are reluctant to give away equity that cannot be recaptured and to share profits from what may be a diminishing pot.

The growth in limited liability partnerships (LLPs) in recent years has also prompted many firms to re-examine their partnership structures. Firms have often taken the opportunity of a transition to LLP status to create a new tier of fixed-share members, akin to fixed-share partners.

The arrangement has benefits for both the firm and the individual. The firm can show another partner and the individual can claim partnership status (which helps with client acquisition and retention).

There are tangible tax benefits both to the firm and the individual. National insurance bills are lowered, more expenses are claimable, tax payments are delayed and less tax can be payable.

A further benefit to the firm – but not to the individual – is that the protection for an employee against unfair dismissal does not apply to a partner or member of an LLP.

Other differences between a partner and an employee include that the former has no statutory parental rights and owes a duty of good faith (wider than the employee’s duty of trust and confidence), and that restrictive covenants are more readily enforced against a partner than an employee.

While everything is going well, the firm and the individual focus very much on the mutual benefits. But when it goes wrong and the firm terminates the individual in accordance with the (perhaps quite short) notice provision in the partnership deed or LLP members’ agreement, the individual’s thoughts (or those of the solicitor he consults) turn to the remedies of an employee, in particular unfair dismissal. The issue can also arise in the context, for example, of maternity leave or the enforcement of restrictive covenants.

It is at this point that firms are often surprised to discover that the parties’ definition of the relationship between themselves, and the tax treatment by HM Revenue & Customs (HMRC), are not necessarily determinative.

Determining status

A range of factors have to be taken into account to determine whether an individual is a partner or an employee and each case will depend on its own facts; the distinction between a salaried employee and a fixed-share partner can be a very fine one. Factors can include: 

• whether the remuneration is fixed or whether the employee shares in the profits and losses (but having a share in the profits is not in itself determinative of the issue);
• whether and to what extent the individual is indemnified for the firm’s debts;
• whether the individual makes a capital contribution or can share in any surplus assets;
• the extent to which the individual participates in management decisions and meetings, and partnership votes; and
• the authority that the individual has, such as to hire and fire. 

The tax treatment of the arrangement often becomes relevant where there is a dispute. Firms may argue that the individual has treated himself as self-employed and cannot now claim employment rights on the basis that his contract has been tainted with illegality as a result of his misrepresentation of his employment status to HMRC.

This issue came up before the Employment Appeal Tribunal in June 2011 and it decided that performance of the contract was only illegal if the solicitor claimed self-employment status knowing it was unsustainable to do so.

So, in a typical case where an individual is described as a fixed-share partner or member, it is likely that the case will not be so clear as to make it unsustainable to claim self-employment.

Of course, a successful claim of employment may result in HMRC deciding to reassess the individual as an employee and looking to the firm for pay-as-you-earn tax and national insurance contributions (with penalties, interest and so on).

When one considers that the firm may well have a number of individuals in the same position, a firm will often choose not to fight a claim and risk not only the tax consequences but also the realisation by a number of other ‘partners’ that they are in fact employees, with all the rights that this entails.

Firms with such arrangements should consider objectively whether the relationship is really one of employment and perhaps take some steps to improve their position, because there will be an increasing number of cases brought on this basis by junior partners.

cg@gannons.co.uk