16.09.2024
United Kingdom: The End of the LLP for Fund Managers?
Private Equity (“PE”) funds are impacted by recent HM Revenue & Customs (“HMRC”) changes in the UK relating to the Limited Liability Partnerships (“LLPs”) structure, meaning some partners are treated as employees for tax purposes.
Current Landscape
Privately owned PE businesses in the UK are typically structured as LLPs, not companies. One key benefit is tax saving.
In a company, a senior employee pays income tax (up to 45%) and employee National Insurance Contributions (“NICs”) (at 2%) on their remuneration, whilst the company pays employer NICs (at 13.8%). The company will also pay corporation tax (at 25%). In an LLP, there is the same income tax and employee NICs, but no corporation tax or employer NICs.
The ’Salaried Member’ Rules
There are many commercial and legal reasons for choosing a structure, but all things being equal, tax may be a factor. However, one cannot decide to use an LLP, make everyone a partner (rather than an employee), and simply reduce tax.
Specific rules (the ”Salaried Member” rules) seek to ensure only genuine business owners are treated as partners by recategorising other LLP members as disguised employees for tax purposes. The result is the LLP being liable for employer NICs.
A member of an LLP will be treated for tax purposes as an employee if they meet all these three conditions:
A. Receive 20% or less of their profit share in a manner which is variable by reference to the overall LLP profits.
B. Do not have significant influence over the LLP’s affairs.
C. Do not contribute capital to give them a real, at risk, significant investment in the LLP.
Most LLP members avoid being in Condition C by contributing cash greater than 25% of their ‘disguised salary’ to the LLP. It is typical for LLPs to assist members in obtaining a loan for this, but the amount needs to be genuinely ‘at risk’. Whilst a formulaic test, targeted anti-avoidance rules (“TAAR”) in effect state that one needs to disregard any actions taken specifically to avoid being caught.
The Shift
There are now reports of HMRC using their guidance to investigate LLPs on Condition C. This creates the threat of backdated employer NICs plus penalties and interest equating to £millions.
Until recently, HMRC guidance on Condition C could broadly be paraphrased as saying that the TAAR would not be applied if capital was truly at risk. Under new guidance, the TAAR may be applied if the sole reason for increasing capital contributions is to exceed the 25% threshold. This means some members may now be treated as employees and the LLP will have underdeclared and underpaid NICs on distributions to those individuals.
Until the outcome of these compliance checks, it is difficult to predict the impact on PE firm structures. It is likely that the new guidance will impact large LLPs, where junior members will not have significant influence nor a profit share depending on the LLP’s profits. PE firms will need to weigh up the pros and cons of continuing the LLP model.
These challenges are distinct from upcoming changes to the tax treatment of carried interest.
For LLPs, now is the time to review the structure through HMRC’s lens.
f you wish to discuss these topics, please contact:
FTI Consulting LLP, London
Article published in WTS Global Financial Services Infoletter #3/2024
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