How safe is your LLP tax position?

The Supreme Court has put companies with Limited Liability Partnership (LLP) structures on notice that their business arrangements must comply with strict tax legislation.

Under LLP rules, members are generally treated as self-employed for income tax and national insurance contribution purposes. However, the salaried member rules, introduced in 2014, mean that members need to meet certain conditions to be able to benefit from this tax treatment.

In a notable recent court case, HMRC v BlueCrest Capital Management (UK) LLP, the Supreme Court upheld the Court of Appeal's decision that in assessing these conditions, only ‘influence’ deriving from legally enforceable rights and duties should be taken into account and not ‘de facto’ influence arising from other arrangements. This is a narrower interpretation of the rules than had previously been understood to be the case. 

BlueCrest Capital Management, a hedge fund, had been challenging HMRC’s attempts to tax dozens of its partners as employees but lost in the Supreme Court, and may owe some £200 million.

The decision could have repercussions for many professional services and investment firms that use the LLP business structure. Now is the time for LLPs to review their member agreements and governance frameworks.

How does the salaried member rules work?

The case hinged on one of three conditions that must be met for the salaried member rules to apply, that of ‘influence’.

The three conditions that must all be met for the rules to apply are:

• Condition A: Broadly, at least 80% of the members' reward is ‘disguised salary’, i.e. fixed or variable, without regard to the overall profits of the LLP.
• Condition B: The mutual rights and duties of the members of the LLP do not give them 'significant influence' over the affairs of the LLP. 
• Condition C: The member's capital contribution is less than 25% of their disguised salary.

While HMRC failed in two earlier tax tribunal cases, the Court of Appeal (CoA) set aside those decisions, finding the tribunals had erred in law in accepting the wider construction of ‘influence’ set out in HMRC’s published guidance. In assessing Condition B, only 'influence' deriving from legally enforceable rights and duties of members should be taken into account and not 'de facto' influence arising from other arrangements.

The Supreme Court says

The Supreme Court agreed with the lower courts that the BlueCrest members met Condition A, pointing out that the purpose of the condition is to distinguish between what is typical remuneration for a partner and a typical remuneration for an employee. Most of the BlueCrest partners' remuneration was 'disguised salary'. It did not reflect a share in the profits and losses of the partnership as a whole; it was referenced to the profits generated by the partners themselves or by their team.

Condition B – significant influence

The Supreme Court agreed that the Court of Appeal's narrower interpretation of Condition B was correct, and 'significant influence' concerned legally enforceable rights and duties of members under the LLP agreement. The court found that informal influence derived from members’ strong performance, personal qualities or relationships is not relevant.

Significant influence over the affairs of the LLP requires influence, not control. ‘Significant’ means a degree of influence that has commercial substance in the conduct of the LLP’s affairs and must be exercised over the partnership's business as a whole, not parts of it.

This suggests that a person could only have such influence if they have a voice in the management of the LLP's affairs, such as participating in or influencing high-level or strategic decisions. Day-to-day decision-making at a purely operational level is less likely to qualify, especially if that is only in relation to part of the business.

Do you need to reassess your Partnership Agreements? If you are unsure of your LLP structure and tax position, contact us. We’d be happy to help.

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