Change to HMRC’s approach to Salaried members and Condition C 

In 2014, legislation was introduced to prevent the abuse of Limited Liability Partnerships (LLPs). This aimed to stop the conversion of genuine employment relationships into self-employment arrangements to save on National Insurance. Anecdotally, there were stories of hundreds of cleaners being signed up as members of LLPs! 

To prevent this abuse, three conditions were defined to determine if LLP members were ‘proper’ partners.  This looked at their role in the management of the LLP, whether they truly shared in the profits of the business, and whether they had a material amount of capital in the business, based on their fixed profit share.   

This last condition, ‘condition C’ is where HMRC have issued new guidance in their manuals.  In headline terms, if an LLP member had more than 25% of their fixed profit shares invested as fixed capital in the business, they were considered to be self-employed.  Only one of these conditions has to be met for the member to be treated as self-employed.  (The conditions are written in the negative, but this adds to confusion).  

It is important to note that these rules only apply to LLPs.  General partnerships covered by the 1890 Partnership Act are outside these provisions.  Whilst we will use the term partnerships below, for the purpose of this note, we are only considering LLPs.

There is an anti-avoidance provision within the rules that says, if the ‘purpose, or one of the main purposes’ of any arrangements is to ensure that the exemptions do not apply, then these arrangements can be disregarded.

With this background, it is worth setting out their revised example in full – HMRC Partnership Manual 259200  

Example of change to HMRC’s approach to Salaried members and Condition C

This example looks at an arrangement where members can alter their capital contributions in each period to avoid meeting Condition C.

In 2018, upon joining the ABC LLP, member X contributed capital of £15,000 (this was not part of any arrangement with a main purpose of securing the salaried members rules do not apply and is a genuine contribution).

In 2022 it is expected that X’s remuneration for the next period will consist of £100,000 Disguised Salary, meaning that their contributed capital is below the 25% threshold, and they will meet Condition C. 

X contributes a further £10,000 as part of a separate arrangement with the LLP, where members increase their capital contribution periodically in response to their expected disguised salary, in order to avoid meeting Condition C. 

This arrangement will trigger the TAAR (Targeted Anti-Avoidance Rule) and no regard can be given to the £10,000 when considering whether X meets Condition C. As such X will meet Condition C as their contributed capital remains at only £15,000. 

Let’s unpick the HMRC manual a bit.  They say that the £15,000 contribution is a ‘genuine’ contribution.  Why would the later £10,000 be anything other than an equally ‘genuine’ contribution?  If the member is putting capital at risk that would seem to be equally genuine.

We must also go to the purpose of the legislation.  The original guidance issued at the time of the 2014 Budget, following consultation, gave detailed examples (pages 45-49) which provided a sensible approach to the operation of the TAAR.  

This change to the Partnership manual has caused consternation amongst professional practices, and there is ongoing engagement between representative bodies and HMRC.   

So, absent of any further clarification being forthcoming, what should partnerships do?  

It is a fact that partnerships need working capital that is provided by the members/partners, as well as external financing.  How that financing should be split between those who may be classed as equity and those who might be commercially salaried partners, is for the LLP/partnership to decide. However, as a rule of thumb, the more you get out typically means the more you have to put in to support working capital.   

Partnerships should, as good business practice, prepare medium term cash flows to identify their working capital requirements, including to cover members exiting the LLP.  It may well be that as a result of that work, an appropriate share of the funding of the LLP will be by a salaried member contributing 25% of that fixed share.  To the extent that the fixed share increases, then a concomitant increase in funding should not fall foul of HMRC’s revised guidance.   

Given that there is likely to be increased scrutiny from HMRC in this area, this arrangement should ideally be included in an updated LLP agreement. The justification for such a treatment should be retained by the firm should it be questioned at a later date. This would have the impact of de-personalising any arrangement as it would be based on the commercial requirements of the business.

If you would like any advice about the topics discussed in this article, please do get in touch.