Those changes upended ten years of established practice in applying the rules and would have left many LLPs facing considerable uncertainty, so HMRC’s latest change of position is very welcome. However, exactly how HMRC will seek to apply Condition C in the future remains unclear and taxpayers will need to wait for revised guidance to be published to fully understand where matters now stand.
The salaried member rules govern how individual members of an LLP are treated for tax purposes.
LLPs are corporate entities. However, since their introduction in 2001 LLPs have subject to special rules that, for tax purposes, deem the firm’s members to be carrying on its business in partnership. Under those rules individual LLP members were therefore automatically taxed as self-employed individuals, irrespective of the substance of their relationship with the LLP.
This automatic deeming of self-employed status led to historical concerns among policy makers that some LLPs were being artificially used to ensure individuals that were in substance employees were taxed as if they were self-employed (which generally has a more favourable tax treatment).
The then Conservative government responded to this in 2014 by enacting the salaried member rules, which provide a statutory framework for determining whether an LLP member should be taxed as an employee or self-employed. The salaried member rules do this by reference to the following three Conditions:
An individual is taxed as self-employed if they fail any one Condition, i.e. if more than 20% of their remuneration is variable, if they have significant influence, or if their capital contribution exceeds 25% of their disguised salary.
These tests were chosen by the government after a period of public consultation because they reflected what were seen as the most important characteristics of a partner in a traditional general partnership.
As is typical in modern UK tax legislation, the rules also include a Targeted Anti-Avoidance Rule (TAAR) that requires one to disregard any arrangements put in place in order to secure that the rules do not apply.
Condition C provides a straightforward way to establish with certainty how an individual LLP member should be taxed: if their capital contribution exceeds 25% of their total remuneration, then they must fail Condition C and be taxed as self-employed.
Following the introduction of the salaried member rules, therefore, some LLPs sought to amend the capital contributions required of their members to ensure that they failed Condition C. HMRC’s position was understood to be that such contributions were permitted (indeed the Condition C legislation explicitly anticipates such additional capital contributions) and would not engage the TAAR provided the capital contribution was genuine and “on risk”. Effectively, Condition C operated as a safe harbour: any member who had made a capital contribution sufficient to fail Condition C had a strong hallmark of being a partner and should be taxed as self-employed.
This understood position prevailed for approximately 10 years, during which some LLP members made further capital contributions to maintain their Condition C position as LLP profits naturally increased. In some cases, HMRC closely reviewed LLP arrangements of this kind and (following the established position) did not challenge them under the TAAR.
However, this changed in early 2024 when HMRC began to enquire into LLP tax returns querying the application of Condition C and the TAAR. In parallel, and without prior consultation, HMRC also amended the guidance in its Partnership Manual in February 2024 to indicate that “top-up” capital contributions made with a view to failing Condition C would be disregarded under the TAAR.
HMRC’s change of approach was a cause of concern for many LLPs.
As well as changing the future tax treatment of some LLP members, the fact that HMRC was seeking to apply the guidance to past periods (during which LLPs had proceeded based on HMRC’s original position) meant potentially significant changes for the past for some firms. Those changes were potentially far-reaching, altering the entire basis on which affected individuals were taxed which, among other things, would have altered the NICs due and the way in which the remittance basis applied to individuals’ LLP profit shares. Moreover, some LLPs faced significant compliance challenges, for example where affected individuals had since left the firm but where the firm arguably had a liability for that individual’s tax under PAYE.
Given these difficulties, and the fact that HMRC was departing from 10 years of established practice, affected businesses, their advisers and industry representative bodies robustly queried HMRC’s approach. They argued that HMRC’s revised position was technically incorrect, but also highlighted that the manner of the changes was unfair to taxpayers, imposing an effectively retrospective change of practice without any consultation.
Recognising the force of those representations, HMRC undertook to carry out an internal exercise to review and reconsider its position.
After c.9 months, perhaps prolonged by the 2024 general election and the October 2024 Budget process, HMRC’s internal review concluded. HMRC wrote to several representative bodies on 7 February 2025 stating:
HMRC have not explained why their position has changed from that expressed in the February 2024 guidance, however the fact that they are reverting to the original approach for both the future and the past suggests that they accept this is the correct technical approach to the Condition C legislation. The well-reasoned representations made across industry were no doubt a major factor in HMRC arriving at that conclusion.
Whatever the reasons, this change is a significant step in the right direction. It is to be hoped that this will put an end to a period of difficult uncertainty for many LLPs, however some questions remain. For example, there remains some doubt about how HMRC will distinguish between “genuine” capital contributions and those that would fall foul of the TAAR, including whether HMRC considers the commercial use to which contributions are put is relevant to that assessment. This will hopefully be clarified in the revised guidance that we expect HMRC will publish in the coming months.
