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HMRC internal manual

Employment Status Manual

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HM Revenue & Customs
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Salaried Member: Disguised Salary: Personal performance

ITTOIA/S863B (3)

A Disguised Salary comprises fixed amounts and amounts that are determined without reference to, or are not in practice affected by, the overall level of profits or losses for the LLP as a whole.

As a result, Condition A will be satisfied where the individual member receives a payment that is based only on their own personal performance, rather than a share of the profits of the business as a whole.

A bonus based only on the performance of the individual is not a profit share. It is variable but is:

“varied without reference to the overall amount of the profits or losses of the limited liability partnership”.

On the other hand, performance-linked profit sharing arrangements that are computed by reference to the firm’s overall profits are not Disguised Salary.

Example 1

This example illustrates the distinction between rewards for personal or team success as opposed to share of a profit of the business.

 

The FFF *LLP *has an arrangement under which an amount equal to 20% of profits is set aside as a bonus pool for its junior members to receive in addition to their fixed remuneration of £50,000 per year. This is allocated after the end of the year according to the personal performance of the junior members. All the members have an equal chance of getting a bonus. Typically a bonus represents 30% or so of base pay but it may be more and it may be less. In practice, because the performance system ranks the members, it is likely that some will get up to £50,000 and some will get zero.

On the facts, the class of members concerned is to be rewarded by a Disguised Salary of £50,000 and a profit-related bonus that is, on average, 30% of that amount.

Everyone has an equal chance of getting a bonus and the award system does not favour one individual over another. The arrangement in place is not one where it is reasonable to assume that a particular individual meets Condition A.

 

Varying the example, if the bonus pool mechanism of FFF LLP is not fixed at the beginning of the year (so no percentage of profit is earmarked), but is decided at the discretion of a remuneration committee, there is unlikely to be a reasonable expectation of the amount at the beginning of the year and Condition A is likely to be satisfied.

 

Example 2

This example looks at where personal performance is reflected by the way the profits are allocated.

 

Members are allocated profit share units at or soon after, the beginning of the year. The allocation is based on their seniority and historical performance, with an additional award of units to reward senior management roles to be held during the year.

Condition A is not satisfied. Although the profit share units are allocated partly on the basis of personal performance, all that is happening is that the proportion of the profits going to each member is being set. How much each member will receive depends upon the amount of the overall profit.

 

Example 3

This example looks at how a team leader can be rewarded for the results of their team by the way the profits are allocated.

 

Towards the end of the year, the performance of the members is assessed and additional profit share units are allocated to members based on their performance during the year. This also takes into account the performance of the team for which they are responsible.

Condition A is not satisfied. Although the profit share units are allocated partly on the basis of personal performance, all that is happening is that the proportion of the profits going to each member is being set. How much each member will receive depends upon the amount of the overall profit.

 

To return to the cake analogy, their performance partly determines how large the slice is, but the actual amount of money depends on the size of the cake. An individual who receives a bigger slice of a smaller cake may have less cake than an individual receiving a thinner slice of a bigger cake.