Understanding the implications of becoming a salaried member of an LLP

If you work in professional services and have been invited to become a salaried member of a Limited Liability Partnership (LLP), congratulations! This is a significant milestone that often comes with benefits like increased status and financial rewards. It is also important to understand the implications of this change, how it affects your tax position, employment rights, and responsibilities within the LLP. In this article we explore these implications to provide a clearer overview on managing the transition to being a salaried LLP member.

What is a salaried member of an LLP?

A salaried member of an LLP is someone who has been invited to become a member (or partner) but is remunerated similarly to an employee, through a fixed salary rather than receiving variable profits. While salaried members are legally partners of the LLP, they can sometimes be treated as employees for tax purposes under certain conditions.

Key legislation: HMRC’s salaried member rules

HMRC introduced rules in April 2014 to determine when salaried members are taxed as employees rather than as self-employed individuals. These rules are based on three tests:

Disguised salary test: Does the individual receive remuneration that is substantially fixed, with little or no link to the profits of the LLP?
Significant influence test: Does the individual have significant influence over the affairs of the LLP? If not, the test is met.
Capital contribution test: Has the individual contributed less than 25% of their ‘disguised salary’ as capital to the LLP?

If all three conditions are met, the salaried member is treated as an employee for tax purposes.

What are the tax implications of becoming a salaried member?

Salaried members taxed as employees will have PAYE (Pay As You Earn) and National Insurance Contributions (NICs) deducted from their earnings. If treated as self-employed, they are responsible for paying their own income tax and NICs through self-assessment.

Example: tax differences between employee and self-employed

Scenario: An individual earns a fixed salary of £60,000 as a salaried member.

If treated as an employee:
- Income tax is deducted at source through PAYE
- The LLP pays employer NICs at 13.8% (current rate).
- The individual pays employee NICs at 8% on earnings above the primary threshold.
If treated as self-employed:
- Earnings are received gross of tax, and income tax is paid as part of the self-assessment tax return process.
- The individual pays Class 2 NICs at a flat rate, and Class 4 NICs based on her earnings – the rate here is 8% on earnings about the primary threshold.

For employees, tax compliance is simpler because it is handled by the LLP, but self-employed individuals often have more control over their tax planning and may benefit from more allowable deductions.

Significant influence

Of the three tests imposed by HMRC to determine if a salaried member should be taxed as an employee or self-employed, perhaps the most subjective test is that of significant influence.

A recent tax case examined this condition, and the taxpayer was defeated by HMRC. In the past HMRC have taken the view that a member must be able to influence the affairs of the whole LLP in order to have ‘significant influence’.

This recent tax case highlighted that the Court of Appeal take a different view to HMRC, judging that significant influence is determined by the legally enforceable rights and duties of members. This may enable LLPs to better define whether members have significant influence or not, where the rights and duties are a matter of fact, rather than something that can other be subjective.

Capital contributions

LLPs often require members to contribute capital, which may be used to fund the business. If you are required to contribute at least 25% of your annual fixed ‘salary’ this then may overcome the HMRC rules and ensure that you are taxed as a self employed person. HMRC do have a targeted anti-avoidance rule however to prevent arrangements being put in place which have the purpose of avoiding meeting the capital condition test.

Employment rights

LLP members cannot be employees of the LLP under English law. Therefore, unlike employees, LLP members generally do not have statutory employment rights such as:

Protection from unfair dismissal
Statutory sick pay
Statutory redundancy pay

LLP agreements may however include provisions to protect LLP members so understanding the legal aspects will be important for anyone offered a LLP member position.

It is important to be aware that depending on the facts of each case and the substance of the relationship a salaried member may be a partner of the LLP or may be considered an employee of the LLP from an employment status point of view. LLP agreements should make it clear whether an individual is a member or an employee and in either case on what terms. It is a complex area of the law and legal advice is advisable before entering into an LLP agreement.

Other responsibilities, liabilities and pension contributions

As a member of an LLP, you assume responsibilities and potential liabilities. Unlike employees, members may have personal liability for LLP debts, if the LLP agreement includes such provisions.

If for example, an LLP incurs a significant loss, and its agreement states that members must contribute to cover the shortfall, a salaried member may be required to contribute proportionally, depending on the terms of the agreement.

If taxed as an employee, the LLP is required to make pension contributions under auto-enrolment rules. Self-employed individuals, on the other hand, must make their own pension arrangements.

Key considerations before accepting the role

Review the LLP Agreement: Ensure you understand the terms of your membership, including your capital contribution, voting rights, and profit-sharing arrangements.
Understand your tax position: Consult with a tax specialist to determine how HMRC’s Salaried Member Rules will apply to you.
Assess your employment rights: Consider whether the LLP agreement offers protections equivalent to those of an employee.
Evaluate financial implications: Assess the financial impact of capital contributions, tax treatment, and potential liabilities.
Seek legal advice: If you are unsure about any aspect of the LLP agreement or your role, seek advice from a solicitor with experience in partnership law.

Closing thoughts

Becoming a salaried member of an LLP can be a rewarding career move, offering increased status and potential financial benefits. It is essential however to understand the implications for your tax position, employment rights, and responsibilities within the LLP. By reviewing the LLP agreement carefully and seeking professional advice where needed, you can ensure that this transition aligns with your career goals and financial objectives.

We always recommend that you seek advice from a suitably qualified adviser before taking any action. The information in this article only serves as a guide and no responsibility for loss occasioned by any person acting or refraining from action as a result of this material can be accepted by the authors or the firm.

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