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February 5, 2024
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Limited liability partnership
Tax
What does being a partner really mean? How is it different to being an employee? Each term carries different legal and tax implications that we will unpack in the blog post below.
What does being a partner really mean? If you have never come across terms like salaried partner, fixed-share partner or equity partner then you may not understand how any of them are different from the term employee. However, in a complex world of business structures, each term carries different legal and tax implications for the business and the professional.
When we discuss partners, we generally refer to people who are members of a partnership or a limited liability partnership (LLP). For anything else, the person would be considered an employee. This blog post aims to delve into the intricacies of LLPs, shedding light on the distinction between being a ‘partner’ and an ‘employee’. We hope that understanding these facets can better guide your decision-making process when considering entering into or forming a LLP.
Professionals operating as partners vs employees have different employment status in the eyes of HMRC. As an employee, individuals pay income tax and Class 1 NICs on earnings which are deducted at source through the Pay As You Earn (PAYE) scheme by the employer.
As a partner, for tax purposes, you are treated as a self-employed individual and need to complete a self assessment tax return. So unlike most employed individuals where the process of paying taxes on their income is handled by the PAYE scheme, partners must register and complete a self assessment tax return annually to pay income tax and national insurance contributions. Additionally, National Insurance Contributions (NIC) paid as a partner are different to that of an employee, namely partners are subject to Class 2 and Class 4 NIC.
In a 2018 briefing paper on NICs and the self-employed, Antony Seely outlines that employers have more incentive to engage self-employed workers rather than take on employees because it saves 13.8% employer national insurance contributions. This has led to a phenomenon where some businesses will set up a limited liability partnership with the sole purpose of paying less taxes rather than to harness the true reason of operating as an LLP.
The limited liability partnership (LLP) model stands out as a unique model, combining elements of comradery and shared responsibility of a traditional partnership with the limited liability of a company. Prior to limited liability partnerships, there were traditional partnerships, which did not have limited liability and partners running the business could risk losing their personal assets. To learn more about the different business structures, check out our in depth blog here.
However, after heavy lobbying primarily from the big five accountancy firms in the UK, legislation was passed to introduce limited liability partnerships. You can read an interesting House of Lords debate on this topic which provides some history behind the introduction of the LLP, here.
Since its introduction in 2000, LLPs have garnered a lot of success. Their tax transparent status means that income is taxed at an individual partner level rather than at the level of the entity, which can make it easier to operate and also more flexible. The LLP model also offers an edge over traditional business models because it allows members the flexibility to define their mutual roles and the governance of the business whichever way they see fit. This is known as the partnership agreement or deed. Without such an agreement, the LLPs by default will adopt the rules outlined in Limited Liability Partnerships Act 2000 (LLPA 2000), which some businesses may prefer not to.
With the safety of limited liability, it paved the way for entrepreneurial initiatives and individuals who aspired to run a business with a strong emphasis on teamwork, collaboration and camaraderie the flexibility to set up a business. The partnership business structure is not limited to a specific sector. Although it is most common to have the LLP model amongst accountants, law firms, architecture, surveyors and academics, we have seen and set up the LLP model in almost every sector.
However, you can’t get all the benefits of operating as an LLP without the democratic nature of decision-making, which is what makes the limited liability partnership model special. Earlier in the blog we discussed how compared to a traditional employee relationship, the partnership structure saves 13.8% employer national insurance contributions (NICs) and there are other cases to be made where operating as an LLP may be more profitable for a business rather than as a limited company. This had prompted some individuals to set up limited liability partnerships with the sole purpose of paying less tax rather than the intended goal of LLPs, which is to create a collaborative working environment where individuals are treated as partners of a business, not employees.
This brings us to the question, can a member of an LLP be an employee? Like anything that involves legislation, the answer to this question isn’t straight forward. Section 4(4) of the Limited Liability Partnership Act 2000 (the Act) states:
“A member of a limited liability partnership shall not be regarded for any purpose as employed by the limited liability partnership unless, if he and the other members were partners in a partnership, he would be regarded for that purpose as employed by the partnership.”
You may be thinking that this doesn’t clarify much and it truly doesn’t, which has resulted in courts often being relied on to determine whether a particular individual is an employee or a partner. Therefore, let’s approach the question posed above from a different angle - salaried member rules.
Following consultation, legislation was added to section 863 of Income Tax (Trading and Other Income) Act (ITTOIA) 2005 in an attempt to tackle ‘disguised employment’. Referred to as the “Salaried Member”, it aims to ensure that members of LLPs who provide services more akin to an employee rather than a partner, will be treated as an employee for tax purposes. Therefore, only individuals whose duties and remuneration arrangement reflect those of a partner in a business are taxed as self-employed, thereby preventing businesses from setting up LLPs solely for more favourable tax treatment.
The salaried member rules contain three conditions (A, B, and C), if all three are met, the individual is treated as an employee for tax purpose, meaning they are subject to PAYE and Class 1 NICs taxes and are not self-employed. The LLP will begin operating as an employer for that individual and must register for PAYE and run payroll. To learn more about PAYE and payroll requirements, check out our blog here. If at least one of the conditions is not met, then the individual is not taxed as an employee and remains a partner.
To summarise the three conditions:
When set up properly, often limited liability partnerships choose to mimic many of the characteristics of traditional employment, such as an agreed minimum monthly income as well as access to maternity leave, pension scheme and holiday allowance. This is referred to as fixed share partner and would be outlined in the partnership agreement.
In contrast, salaried partners that are part of an LLP would not have signed the partnership agreement and, instead, would be working under some form of employment contract. As part of the employment contract they would be subjected to and have full employment law protection. For example, by law in the UK, employers are required to enrol their employees into a pension scheme. Although this is not the default position for LLPs, some chose to offer this to include their members on a voluntary basis.
When setting up LLPs ourselves or advising, we always stress the importance of setting up limited liability partnerships with correct documentation that outlines the governance of the business as well as profit share allocation and contribution. This ensures that in periods of uncertainty or when HMRC requires further proof about the status of the members, there is the paperwork that can be referred back to for support. If you need help setting up limited liability partnerships or want to learn more about them, feel free to reach out.
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