The Finance Bill 2014 includes some of the most significant changes to LLP taxation since the introduction of self-assessment in 1997. The legislation will generally take effect from 6 April 2014.
One of the three aims of the new legislation is to tax a member of a LLP as an employee if all the following conditions are met:
• Condition A: If an individual performs services for the LLP and the amounts payable by the LLP in respect of the individual’s performance of those services will be fixed or, if variable, variable without reference to the overall profits or losses of the LLP (‘disguised salary’).
• Condition B: The mutual rights and duties of the members and the LLP and its members do not give the individual significant influence over the affairs of the LLP.
• Condition C: The individual’s contribution to the LLP is less than 25 per cent of the disguised salary.
This represents a massive departure from established rules which tax LLP members as self-employed. The rules relating to salaried members of LLPs could therefore present real problems for many firms, and virtually all partners in larger professional firms who have delegated management to a small management team.
We do not think that tax changes should force firms to modify legitimate, commercially sound profit-sharing and management arrangements. We expect many professional LLPs to increase their capital requirements to ensure that the self-employed tax status of their partners is not prejudiced. However, that too may be seen as a retrograde step, forcing firms to make greater use of partner capital instead of organising firm-level medium-term finance with their banks.
Notwithstanding the further period of consultation on aspects of the draft legislation, there is a widely held view that there will be few, if any, amendments to the proposed changes. The best we can expect is some further clarification and additional technical guidance on some of the more complex areas of the proposals. This period of consultation ended on 4 February 2014 with implementation still scheduled for 6 April 2014.
While the legislation and guidance notes are being finalised, firms should:
• Evaluate the impact of the changes.
• Decide whether to reorganise the profit-sharing arrangements.
• Consider whether to escape the provisions by restructuring the firm’s capital requirements. These LLPs must commence early conversations with their bankers to fund professional practice loans. Banks are already indicating that they will not be able to assess and respond to all such applications by 5th April 2014. As a result, HMRC may be forced to allow capital contributions to be completed within, say, six months of the required date.
HMRC has given businesses structured as LLPs and partnerships very little time to react to what will be a significant change to their business operations. Indeed, with more than £3billion of tax at stake over the next five years, it is difficult to escape the conclusion that HMRC is imposing a similar short-term agenda on firms.