Under the salaried members rules, LLP members are taxed as employees unless they fail one or more of three specific conditions:

1. The individual receives a fixed profit share (Condition A);
2. The individual does not have significant influence over the affairs of the LLP (Condition B); and
3. The individual has contributed less than 25% of their expected profit share to the LLP as fixed member’s capital (Condition C).

Where one or more of the conditions is failed, the member’s profit share from the LLP is taxed on a self-employed basis.

Since the rules were introduced over 10 years ago, many firms have required their fixed share members to contribute a sufficient amount of capital to the LLP in order to fail Condition C. In our experience, this approach has proved popular due to Condition C being easily measured and offering the greatest degree of certainty. It has also been very beneficial to firms’ cashflow.

The salaried members rules include a Targeted Anti-Avoidance Rule (“TAAR”), which effectively ignores any steps taken where the main purpose, or one of the main purposes, is to avoid the member being taxed as an employee. However, HMRC were aware that firms would restructure their businesses prior to the rules taking effect in 2014, and their guidance states:

“HMRC would not consider that genuine and long-term restructuring that causes an individual to fail one or more of the conditions to be contrary to this policy aim.” and “The capital contribution requirement is fairly prescriptive. 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.”

HMRC have recently made some changes to their guidance, which they refer to as a ‘clarification’ of the application of the TAAR to Condition C. Although their guidance still contains the above two statements, HMRC have qualified this by stating that a genuine contribution made by the individual to the LLP, intended to be enduring and giving rise to real risk, will be disregarded if the main purpose, or one of the main purposes, is to avoid the member being taxed as an employee.

They have also added a new example indicating that they consider the TAAR to apply where there is a separate agreement between the member and the LLP that allows the member to increase their capital contribution periodically in response to increases in their profit share, in order that Condition C continues to be failed.

The updated guidance has led many firms to revisit their arrangements, to ensure that they would stand up to any HMRC scrutiny. Where they do not, firms may wish to consider whether their fixed share members should be paid through the payroll in future, or explore the idea of relying on Condition A or B instead of Condition C.