Limited liability partnerships (LLPs) are facing significantly increased tax bills after HM Revenue & Customs (HMRC) issued draft legislation this week confirming that salaried partners with little or no share in the equity will be classed as employees for tax purposes.
The draft Finance Bill, which will come into effect in April next year, says that partners with less than 20% of their remuneration linked to the profits of the firm will be regarded as having a ‘disguised salary’ and subject to both income tax and national insurance.
LLP members must also have an influence in the running of the firm and have 25% of their disguised salary invested in the firm to be classed as a partner for taxation purposes.
Measures have also been introduced to catch individual profits of the partnership being allocated to a corporate member who pay a lower corporate rate of tax.
The unpopular draft legislation, which covers any business set up as an LLP, has been criticised by the legal profession for being far too broad brush and reducing the pot available to re-invest in working capital.
Chair of Baker Tilly’s professional practices group George Bull said: ‘We are disappointed that HMRC has ignored many of our recommendations, in particular those that addressed commercial concerns.
‘In addition, HMRC has ignored profession-wide requests not to apply such a ‘broad brush’ approach which has, as predicted, caught so many genuine partnership businesses using the structures to accumulate profits for internal investment. This now gives the partnership model a very real disadvantage in comparison to the traditional corporate model.
The draft legislation was issued after last week’s Autumn Statement from the Chancellor, George Osborne, who announced plans to ‘ensure the tax advantages of partnerships aren’t abused’.
Responding to the changes Andrew Loan, a tax partner at Macfarlanes, said: ‘All LLPs will have to think how they allocate profits to their members if it’s not a straight profit split.’
However, Iain Scoon, a tax partner at Shearman & Sterling, downplayed down the impact of the measures, commenting: ‘It’s unlikely to have a significant impact on the legal industry because of the way partnerships work. If you’re contributing more than 25% of your return you’re unlikely to be treated as an employee,’ he says.