Contractors' Questions: Which LLP users will be deemed as employees?

Contractor’s Question: My accountant has mentioned that the taxman now says that there are two situations in which individual LLP members will next year be treated as if they were employees, and therefore liable to PAYE income tax; what are these situations?

Expert’s Answer: Under current law any member of an LLP is treated as a self-employed person rather than as an employee. HM Revenue & Customs believes that this gives rise to scope for avoiding tax and NIC by introducing to the LLP individuals whose economic relationship with the business has more in common with employment than with co-ownership of the business. 

There are thus two circumstances in which individual LLP members will from April 2014 be treated as if they were employees of the LLP (with consequent obligations on the part of the LLP to operate PAYE on payments to the member). The new rules will apply to an individual member if:  

• On the assumption that the LLP is carried on as a partnership by two or more members of the LLP, the individual would be regarded as employed by the partnership by reference to the normal tests of employment. These deal with matters such as control, the requirement for personal service, financial risk, the ability to profit from sound management, and so on.  In some cases it will be plain that the terms on which the “salaried member” is engaged are indistinguishable from employment: in others (especially in 'eat what you kill' partnerships) it may be very easy to show that relationship is not one of employment.
• Alternatively, HMRC proposes to treat a salaried member as an employee if he or she is not an employee under the first test but is nonetheless someone who:

- Has no significant economic risk (loss of capital or repayment of drawings) in the event that the LLP makes a loss or is wound up;

- Is not entitled to a significant share of the profits beyond the “fixed share”; and

- Is not entitled to any significant share of surplus assets arising on any winding-up of the LLP.

What is “significant” will be determined in the light of all the circumstances and by reference to the overall package: but – for example - an entitlement to a share of profits which in practice would never exceed 5% of any fixed share would be unlikely to be regarded as “significant”.

Action for LLP members to take

Over the period to April 5^th 2014 partnerships and LLPs will need to consider carefully

• whether any individual member is at risk of being re-categorised as an employee from that date and
• what changes to the relationship may be necessary to preserve the current self-employed status
• the commercial impact of any such changes

The Expert was David Whiscombe, senior tax partner at accountancy firm Berg Karpow Lewis.