Change in the Salaried Members Rules – What it means for fixed share partners

Recent changes to HMRC’s guidance on the interpretation of the Salaried Members Rules (the ‘Rules’) have caused firms to review the arrangements in place for fixed share partners and consider whether new measures might need to be implemented to ensure continued compliance with the Rules.

The background

The Salaried Members Rules were introduced in 2014 to tackle the avoidance of PAYE and NICs by LLPs whose members are, in reality, employees. In essence, HMRC will tax members as employees if all three of the following conditions are met:

Condition A:     At least 80% of the member’s remuneration is a ‘disguised salary’, i.e. it doesn’t vary, or it varies without reference to the LLP’s profits.

Condition B:     The member doesn’t have significant influence over the affairs of the LLP.

Condition C:    The member makes a capital contribution to the LLP of less than 25% of the ‘disguised salary’.

The statute includes a ‘Targeted Anti-Avoidance Rule’ (‘TAAR’) which, broadly, provides that any arrangement whose principal purpose is to ensure that any member of the LLP is not an employee (by virtue of any one or more of these conditions not being satisfied under the arrangement) should be ignored. Where the TAAR applies, therefore, the member will be treated as an employee of the LLP even though these conditions are not fully met.

What has happened?

HMRC’s guidance has changed insofar as the TAAR affects Condition C. The change suggests that a simple increase in the member’s capital contribution so that it hits the 25% threshold may not prevent Condition C from being met, if the driver or main driver behind it is to prevent Condition C being met.

What is the potential impact?

Given this change, one can speculate that LLPs may seek to alter the basis of membership of fixed share partners so as to avoid falling foul of the TAAR. That alteration could conceivably involve fixed share members having to contribute an amount significantly in excess of that 25% threshold and/or the imposition of further responsibilities relating to the management and running of the firm.

What does that mean for those seeking partnership?

The position of the fixed share partner is often viewed as the bridge to full equity and part of the transition from employee to business owner. The traditional law firm model is predicated upon the premise that if you work hard enough, one day ‘all this will be yours’! The great equity carrot.

However, with this change and the possible requirement to inject further capital and assume additional regulatory responsibilities, who will want to carry such burden on to that bridge? For ambitious young lawyers generating significant profits, without the commensurate financial reward or status, the equity carrot may forever remain on the distant shore, and the lure of fee-sharing firms such as Keystone Law will grow even greater.

If you have questions about the change to Salaried Member Rules, please contact Michael Fluss and Mark Machray.