Background 
LLPs were introduced in 2000 and quicky gained in popularity with owner-managed professional services firms, such as accountants, lawyers and asset managers, due to the combination of flexibility and limited liability status that the structure offered. A key feature is the transparency of tax and partners are classified as self-employed. This view was supported by early tax cases. The main advantage for LLPs having self-employed members is the saving of employers’ National Insurance (NI) (currently at 15.05%).

However, over the years, HMRC grew uneasy that certain individual partners were providing services akin to employees (disguised employees) and in April 2014, the Salaried Members Rules (SMR) were introduced. Statutory provisions were introduced as the Income Tax (Trading and Other Income) Act (ITTOIA) 2005 Sections 863A to 863G by Finance Act 2014, stating that if Conditions A to C are all met (see below), the member will be taxed as an employee.

For the avoidance of doubt, these rules do not apply to general partnerships or limited partnerships that are formed under Partnership Act 1890 and Limited Partnerships Act 1907 respectively. Additionally, they do not apply to entities outside the UK that have structures broadly equivalent to a UK LLP.

Despite HMRC’s efforts to enforce the legislation by sending notices of enquiry, checking partnership tax returns and issuing nudge letters, there have been no judicial decisions until the recent First Tier Tribunal (FTT) decision on BlueCrest Capital Management (UK) LLP v HMRC [1] released on 29 June 2022. The amount of employer NI at stake is circa £55 million.

It should be noted that FTT decisions are not binding and that either BlueCrest or HMRC, or both, may appeal. The case will however impact many in the asset management industry, especially those who rely on their members failing the set conditions.

On a positive note, the case has provided some helpful interpretation of the rules.

The rules
SMR treats LLP members as employees for tax purposes if all the following three conditions are met:

A) If at the relevant time it is reasonable to expect that at least 80% of the total amount payable by the LLP for the individual’s services in individual’s capacity as a member of the LLP will be ‘disguised salary’. This includes payments which are either fixed, variable but without reference to the overall profit or loss, or is not in practice affected by the overall amount of profits or losses of the LLP.

B) The mutual rights and duties of the individual do not have significant influence over the affairs of the LLP.

C) The individual’s capital contribution is less than 25% of the amount of the disguised salary it is reasonable to expect the member to receive.

In essence, these rules are there to ensure that only ‘proper’ members of an LLP receive the benefit of the corresponding tax treatment.

Key findings
In the case of BlueCrest vs HMRC, the FTT was only required to consider conditions A and B since both parties accepted that condition C was met and not in question, as it was agreed that members had not made the required capital contributions.

Condition A 
Priority distribution of a fixed amount was agreed to be disguised salary, while allocation of what was left after distributing those amounts was agreed not to be disguised salary. The argument centred around the treatment of discretionary allocation. The variable profit share must be linked to the overall profits and losses of the LLP and not to individual or divisional performance to avoid being considered a disguised salary. Both portfolio and non-portfolio managers’ discretionary allocation was considered to be disguised salary.

Condition B 
Condition B requires the examination of the ongoing contribution a partner would make in a traditional partnership. In contrast to HMRC’s guidance and normal practice, the FTT suggested significant influence encompasses more than just management influence; it means that the partner has influence over financial and operational aspects of the LLP as well. Additionally, the member does not need to have influence over all aspects of the LLP, but they must demonstrate significant influence over a part of it that makes a significant contribution to its operations.

All individuals, with the exception of the portfolio managers with capital allocations of $100 million or more and the desk heads, irrespective of their capital allocation, met Condition B.

Although the case relates to an investment manager LLP, there will be parallels for all professional service firms.

Next steps 
As mentioned above, HMRC are already undertaking reviews of LLPs to ensure that they are being compliant with the SMR and the BlueCrest decision will only see an increase in their compliance activity. LLPs should therefore be taking the following action:

• LLPs that have received adverse decisions from HMRC should consider their position, both historically and going forward
• For LLPs relying on members failing conditions A, the LLP should ensure any bonus or performance share varies with overall LLP’s profit/losses
• All LLPs should review their LLP structure in light of this judgement. This entails having a robust process in place to demonstrate that they failed one of the conditions and revalidating their conclusion at each re-test date
• Reassess compliance regularly using trigger points such as year-end, recruitment, promotion, retirement, new teams and business lines etc.

How we can help
As we represent a number of LLPs in the Financial Services sector, our team has in-depth experience and knowledge of the SMR. We can help you assess member activities to determine if you are compliant with SMR and mitigate any risks identified. For more information or to discuss the above, please contact your normal haysmacintyre contact or the Employment Tax Team.