Following a Summer of suggested tax proposals, the latest has been floated and would bring members of LLPs, on whom this article is focused on, within the scope of Class 1 (Employer) NICs. If implemented, this would have a significant tax impact on members, particularly those with high earnings, given there is no upper cap for this class of contribution.
Current System
Partnerships are tax transparent, meaning that whatever profits are made by them, are taxable on the members in proportion to their allocation. There is no tax due at the partnership level itself. Individual members will pay income tax at 20%/40%/45% and Class 4 NICs at 6%/2% progressively, based on various thresholds and de-minimis exemptions.
Employees will pay income tax on their salary at the same income tax rates, but their Class 1 NIC will be payable at 8%/2% again progressively. Their employer will also pay Class 1 NIC at a rate of 15% above the de-minimis.
Proposal
The thinktank behind the proposal claim that a member, who essentially does the same job as an employee, will pay less tax overall than the employee would. Their report states an additional rate taxpayer as a member has an effective tax rate of 47% against 53.9% for an employee in a company.
It is argued that the introduction of Employer’s NIC on member profits would therefore restore some equity.
Whilst the practicalities may still need ironing out, the suggestion is that members will pay a “top-up” rate such that their effective tax rate will increase. This will take into account the fact that the Employer’s NIC is a cost to the business and so deductible. As there is no mechanism for the partnership to pay this (given that the members are not on the payroll), the additional amount will presumably be paid via the members’ self-assessment tax returns.
Impact
These increases in the effective tax rates would be 6.9% for additional rate taxpayers, 7.6% for higher rate taxpayers and 9.6% for basic rate taxpayers. By way of an example, a member, whose sole income is from a partnership, earning £500,000 would pay £222,460 in income tax and NIC, with an effective rate of 44.49%. Under the proposed change, this rate would be 51.39% or £256,950, an increase in tax of £34,490.
Whilst this will impact all individual members of any LLP, this structure is mostly adopted by those in the legal, financial services and accountancy industries, causing disruption here the most. Those in financial services will particularly feel the full force of this in years where they are in receipt of performance fees.
There are several unanswered questions and no doubt there will be more as things develop, some of which include:
- What happens to the “profit spreading” on the change of basis; will this be subject to the top-up? If so, do we need to consider accelerating these?
- Employees benefit from employment rights, but members do not, and will not under the proposal; should this not be considered and therefore argue a lower rate of Employer’s NIC for members?
- Members invest their capital which is at risk, there is no equivalent for an employee; surely this needs to be factored into the equation.
- There are already rules in place dealing with members being treated as disguised employees, so any deemed abuse has been addressed. The recent and on-going Bluecrest case is also addressing the scope of these rules. If HMRC felt that they were not satisfied with the Court’s decision, then they could alter the law to address this.
Options
Whilst it is too early to take any definitive action, members should certainly be thinking about what their next steps could be and seeking advice at the appropriate time. Some suggestions include:
- Reconsider whether the partnership structure is still relevant to the business model; remember, tax isn’t always the main factor to consider. If it is, then the additional liability will need to be absorbed by the members and/or business.
- Incorporate, though this does not come without its complexities, particularly for large partnerships. This may be a viable option for smaller financial services firms, particularly if they are happy to roll up the profits within the company and plan an exit in the near future.
- Transition (back) to a traditional partnership, assuming these won’t be included in the scope. Sufficient professional indemnity cover will need to be purchased due to the loss of limited liability.
- Relocate to another jurisdiction; this may be a little drastic but since the abolition of the non-domicile rules, many have done exactly that.
Is this the beginning?
When Gordon Brown introduced a de-minimis exempt amount for companies from corporation tax, we saw a wave of sole-traders incorporate almost overnight. Soon after, these de-minimis levels were removed.
Perhaps the introduction of employers NIC is just phase one of more to come. Is there any guarantee that NICs will not be introduced on dividends (as currently being floated for rental profits) or perhaps, the dividend tax rates will be abolished altogether.
Either way, whatever option you may be considering, it is important to seek professional advice.
Conclusion
Whilst this is still at the proposal stage, initial thoughts are that this is likely to be implemented in some way shape or form, on the basis that it will impact a small percentage of the workforce, particularly those in the higher decile of earnings. Politically, this seems to be less contentious than some of the suggestions over the Summer and is expected to generate an additional £2billion per annum, to fill the ever growing “black hole”.
Ideally, HMRC should have a window for consulting the wider industry and other experts on this, but they are not required to and for the reasons cited above, are probably not going to do so. This appears to be a short-term fix that is likely to push people to restructure their business or, leave the UK tax net altogether.
Let’s Talk
Concerned about how the strongly rumoured proposal to bring Partnership profits within the scope of Employer’s NIC, speak to one of our Private Client team today, to gain a deeper understanding of the options available to you.
