Employment Status of Equity and Salaried Partners

What is happening?

In the Finance Bill 2014 new legislation will be enacted that tightens up the rules regarding the employment status of partners (in partnerships and LLPs).  Under the proposed legislation (section 863B ITTOIA), which is due to be effective from April 6 2014, partners will have to satisfy at least one of three tests to avoid being taxed under the earnings rules, and retain the tax advantage of being self-employed:
• Test 1: At least a quarter of their pay must be dependent on the profit made by their partnership.
• Test 2: The partner must have contributed at least 25% of their “fixed pay” to the firm’s capital.
• Test 3: The partner must have significant influence on the overall partnership.

Practical Implications – Equity Partners

In respect of equity partners who are on fully variable profit shares they will clearly satisfy at least one (probably all) of these tests so there are likely to be no issues or changes to current practice.

In respect of equity partners who are on a variable and fixed share arrangement we would expect them to at least meet test 3 as they have an equity vote and presumably they are involved in the management of the partnership. They may also meet test 1, depending on the variable element of their profit share, and/or test 2 depending on the level of capital contribution made. So we would not expect an issue to arise here either.

One issue that could arise is if there are junior equity partners, who don’t meet tests 1 or 2, and who HMRC could argue do exert significant influence. Clearly the firm would argue they do not exert significant influence (as much as any other partner) and it would seem to be hard to prove either way with something so subjective. To be absolutely watertight it may be worth looking at the capital contributions made, and/or the split of fixed / variable earnings to ensure one of these tests is satisfied so that an argument over test 3 is irrelevant.

Practical Implications – Salaried Partners

In respect of salaried partners more often than not they are on a fixed profit share and are not required to make any capital contribution. Therefore they are unlikely to meet tests 1 and 2. It may be possible to meet the requirement of test 3 if the are involved in the management of the partnership but this is always going to be difficult to prove, that said, with a “one man one vote” decision making process seemingly satisfying test 3 above, this still remains an option.

What to do next?

We would recommend that you review the employment status of any equity and salaried partners to ensure that the new legislation is not going to affect your business and working practices. It may be possible to adopt certain measures to ensure that the above tests are satisfied. If you need further assistance we can of course assist and advise further.

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