Workshop: When is a partner not a partner

The pending HMRC consultation regarding the appropriate tax treatment for 'junior', 'fixed share' or (heaven forbid) 'salaried partners' flags up important issues which practitioners need to take into account when drafting new - or reviewing existing - LLP agreements whether for themselves or for other professional practices. This is in light of HMRC's stated aim of targeting those LLPs used to disguise employment from the more favourable treatment of income tax and NIC of being treated as a member of an LLP.

The implications are not just limited to revenue consequences but also have an impact on potential exposure to employment legislation.

Open to challenge

It's fairly safe territory where an LLP consists solely of individuals, each contributing a similar level of capital, each sharing a similar level of risk and reward, (even if in differing ratios), where each is party to guaranteeing the business premises lease and/or bank facility, equally sharing in the decision-making processes of the firm. LLP agreements can be presumed to be regulating arrangements between persons who have come together to carry on business in partnership for the purposes of carrying out a business for profit, and HMRC will be fairly comfortable with each partner being deemed to enjoy schedule D status as being genuinely self-employed.

The problems arise where one or more of the partners is, to a greater or lesser extent, other than a full partner in that one of a number of elements is lacking, indicating that they are not really entitled to sharing profits nor are they taking any real commercial risk and the arrangements are in truth a sham.

The attractiveness for an LLP of paying a lower rate of National Insurance combined with the cash flow advantage of avoiding PAYE and certain benefits which follow schedule D status may be open to challenge as a consequence.

The LLP may well find that their second tier of partners may be unprepared to open themselves out to fluctuating income or an element of appreciable financial risk needed to maintain schedule D status, but rather prefer the security which may follow from simply being employed.

Rather than await the outcome of the consultative paper or the implementation of legislation, there may be merit in revising now any existing partnership agreements, so that they should fall comfortably within the guidelines being discussed at present (see box). If nothing else, the ancillary benefit of a review is that it may help the firm identify the contributions made by the individual partners on an ongoing basis and how they should be properly remunerated.

The suggestion is that HMRC will look at the LLP and test whether the 'partner' would be regarded as an employee if the business was carried out as a straight-forward partnership rather than an LLP.

Care has to be especially exercised if the LLP contains corporate members which have been introduced specifically to enable the corporate to attract a share of the profit purely as a tax mitigation strategy.

With the new legislation effective from 6 April 2014 there is little merit in delaying the exercise.

The implications for the LLP could be significant, since if the arrangements fail to demonstrate one or more 'partners' actually is not taking any real economic risk, then the prudent course of action is to put them back onto schedule E. Of course that then means they fall back into the category of being employees.

The employment status of partners was examined by the Court of Appeal in Tiffin v Lester Aldridge [2012] EWCA Civ 35. It found that a fixture partner who had been a signatory on the client and office account, who had make a capital contribution of a few thousands and who in addition to his basic pay of £62,500 pa was entitled to five 'profit share points' (around 2 to 5 per cent of the full equity partners entitlement) with a similar share of the assets on winding up, was indeed a partner. He was entitled to participate in some decisions, but excluded from many and no longer had the benefit of protection of the employment tribunal. One wonders whether those facts would satisfy HMRC on their current thinking?

Consequently practitioners need to take proactive steps to review existing LLP agreements and approach their junior partners to see whether they are prepared ?to take the necessary economic risks necessary to maintain their schedule ?D status. It should lead to a few ?interesting discussions.