Background
The salaried members rules are intended to ensure that LLP members who are more like employees than partners in a traditional partnership are, for tax purposes, treated as employees. They only apply if three conditions are met. Broadly, these are:
- it is reasonable to expect that at least 80% of the individual's total remuneration is "disguised salary" (basically, remuneration that is fixed or does not vary by reference to the overall profit or losses of the LLP) ("Condition A")
- the right and duties of members do not give the individual significant influence over the affairs of the LLP ("Condition B"); and
- the individual's capital contribution is less than 25% of the disguised salary that it is reasonable to expect will be payable to them in the relevant tax year ("Condition C").
Each condition was designed to address a facet of true partner-like status, and provided an individual has one of those facets (so fails one of the conditions), the rules do not apply.
Importantly, there is also a targeted anti-avoidance rule ("TAAR") that requires, when applying the salaried members regime, the disregard of arrangements which have a main purpose of ensuring that the regime does not apply.
A key benefit of falling outside the salaried members rules is that compensation paid to individual members of an LLP is not subject to employer social security contributions (currently 13.8%, rising to 15% from 6 April).
February 2024 changes
In February 2024, HMRC amended its published guidance in relation to capital contributions (Condition C).
Crucially, HMRC added a new example (Partnership Manual 259200 available on the HMRC website) that made clear that it considered that the TAAR applied to arrangements that allowed individual members to make so-called 'top-up' capital contributions in respect of expected compensation changes in order to avoid meeting Condition C.
These changes prompted considerable concern amongst affected firms, many of whom include private capital managers and large legal, accounting and consultancy firms. For nearly ten years, firms making 'top-up' contributions had believed they were faithfully following the law, placing significant financial reliance on the assurances given by HMRC. To many, HMRC's guidance changes therefore looked like an attempt to retrospectively 'move the goal posts'.
The manner in which the guidance changes were announced – without notice, discussion or consultation – was also a cause for significant concern, with the potential to cause material damage to the UK's reputation for business certainty and the rule of law.
In light of these concerns, last Spring, HMRC announced that it would launch an internal review into the controversial guidance changes.
HMRC's review
Due to the intervening General Election, and change in Government, there has been some delay in the outcome of HMRC's review. However, in a welcome development, last Friday HMRC announced the outcome of its internal review, confirming that it intends to, in effect, reverse its guidance changes in relation to top-up capital contributions.
Specifically, HMRC says that "an arrangement which results in a genuine contribution made by the individual to the LLP, intended to be enduring and giving rise to real risk will not trigger the TAAR.
This means that a contribution made under a top-up arrangement will not, in HMRC's view, trigger the TAAR if the arrangement results in a genuine contribution made by the individual to the LLP, intended to be enduring and giving rise to real risk."
Comment
On the basis that the new guidance takes us back to the position before the February 2024 changes, HMRC's revised stance is a 'victory' for affected taxpayers. Provided that top-up contributions are genuinely made, intended to be enduring and give rise to real economic risk, taxpayers should have comfort that HMRC will accept that top-up contribution arrangements comply with Condition C both on a historic, but also go-forward, basis. This will be a welcome development for those that were facing the prospect of significant financial distress were they required to revisit the treatment of partnership profits paid to individual members.
In our view, such a revised stance also reflects the correct interpretation of the law. The salaried member conditions provide a series of objective tests for whether an individual member should be considered a deemed employee. Where a taxpayer puts in place arrangements that have genuine economic consequences for the parties and the arrangements are consistent with Parliament's intentions (i.e. they have heeded a legislative "keep off the grass" sign), we do not consider that they should be penalised under anti-avoidance rules for doing so.
HMRC has prepared amended guidance on Condition C and will share it for technical consultation before being published more widely. A key point for advisers involved in the technical consultation phase will be ensuring that the new guidance faithfully reflects HMRC's stated position that it intends to effectively reverse the February 2024 changes.
Looking ahead, given the outcome of the Bluecrest Court of Appeal decision on the significant influence condition (see our "Court of Appeal gives narrow interpretation of "significant influence" exclusion from salaried members rules" briefing), and the degree of mathematical certainty that comes with Condition C, if we are back to where we were before the February 2024 changes, we are likely to see some firms either doubling-down on Condition C or restructuring their affairs in order to rely on it to fall outside the salaried member rules. However, firms not currently relying on Condition C will need to think carefully about the material economic consequences that arise for individual LLP members needing to make genuine and enduring capital contributions to an LLP (particularly where their personal position might require them to obtain debt financing to meet the relevant contribution threshold).
Finally, whilst we welcome the expected changes to HMRC's guidance on Condition C, the episode is another example (in an increasingly long list) of where tax legislation has been drafted in a way that is deliberately broad, but then taxpayers are invited to rely on HMRC's guidance to narrow the scope and effect of that legislation. Taxpayers should always remember that HMRC's guidance is not the law (it only reflects HMRC's view of the law) and is never a substitute for a close analysis of the underlying legislation.
Given the manner and suddenness with which HMRC had been prepared to resile from its published guidance, in future, one might also expect that advisers and taxpayers will be increasingly sceptical of HMRC assurances given during the legislative process that, despite obvious deficiencies and uncertainties in the drafting of legislation, they can rely on HMRC to interpret the law in a way that ameliorates those problems. At a time when growth is the Government's number one 'mission', and in the context of an advanced economy that trades on the value of business certainty and the rule of law, there is a political and economic imperative that in future, legislation is drafted in a way that precisely reflects the circumstances that HMRC is seeking to target and taxpayers are not forced to rely on HMRC guidance.
