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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: Guaranteed payments/floors

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, a Disguised Salary includes any sum that the member will receive whether or not the LLP makes sufficient profits.

The clearest example of this would be where a member will receive that sum even if the LLP makes a loss. Such payments are referred to below as guaranteed payments.

Example 1

This example illustrates the treatment of guaranteed payments.

 

The MNS LLP makes a loss of £500,000. However, under the profit sharing arrangements, members A, B, C, D & E will all receive a profit share of

£100,000 whilst F has a loss of £250,000 and K Ltd has a loss of £750,000.

 

The shares payable to members A to E are not affected by the fact that the LLP has made a loss and are disguised salaries. Members A to E satisfy Condition A.

The key point is not how the payment is described; rather that it is a sum that the member expects to receive and is not, in practice, varied with reference to, or affected by, the overall profitability of the firm, even if it is expressed to be linked to profit.

Here are some examples of arrangements which will be regarded as guaranteed payments:

 

  • Member A is entitled to draw £10,000 a month. Under the terms of the agreement, he is not required to repay the money once drawn.
  • Member B has a guaranteed profit of £120,000 a year.
  • Member C has a priority draw on profits and will be paid £120,000 a year (but no more) unless profits are less than £120,000. When the arrangement is entered into, there is no practical likelihood that profits will be less than £120,000 (and the expectation of both parties is that the reward will be £120,000).

 

It is reasonable to expect that the amounts payable to A, B and C for services to the LLP will be £120,000. Receipt of this sum is not in practice in doubt since only a commercially remote event could prevent such payment being made.

Their cases can be contrasted with Member D, who is simply entitled to a percentage of the profits. He has no priority entitlement to any sum. For much of the year, he draws out money from his current account (last year’s undrawn profits). Towards the end of the year, it is agreed that the LLP will pay him £10,000 a month in anticipation of his profit share for the period. Member D does not have a Disguised Salary and fails Condition A.

Example 2

This example looks at an amount of profit that it is agreed that a member will receive even if the share allocated to that member would otherwise be lower.

 

D joins the ABC LLP. In his first year, he is guaranteed a total profit share of no less than £30,000. If his allocated share of the profits is less than this, then his share will be £30,000 and the shares of the other members reduced accordingly.

 

D’s guaranteed profit share of £30,000 is Disguised Salary as it is fixed. Accordingly, unless it is reasonable to expect that ultimately D’s share for the period will exceed £37,500, such that his overall return is not substantially wholly fixed, he will meet Condition A.

Example 3

This example illustrates a guaranteed payment for a new joiner.

 

S joins the K LLP. The arrangement under which she joins the LLP provides that, in her first year, she is to be awarded 20 profit sharing units at the beginning of the year, with a guaranteed minimum profit of £80,000. This is intended to reassure her that in her first year, she will be remunerated at least the amount she was paid at her previous firm. When the units are awarded, each unit is expected to give a profit share of £4,500. In the event, the profits are higher than anticipated so that each unit is worth £5,500, giving her an actual profit allocation of £110,000.

 

At the start of the period, S has a Disguised Salary of £80,000 and is expected to have a total profit share of £90,000, meaning that Condition A is satisfied. This is not reviewed with hindsight. Obviously, if the profits are expected to be in line with those for the current period then this is taken into account when the test is applied again.

Example 4

This example illustrates a bonus that simply lifts a profit share to an agreed figure.

 

It is agreed between the firm and member C that she will receive £100,000 as her profit share for the year. She is allocated 20 profit sharing units at the beginning of the year, which, based on budget, will be worth £80-100,000. At the year end, in accordance with the original arrangements, she is awarded a performance based bonus to make up for any shortfall and ensure that the total is £100,000.

 

Condition A is satisfied. The reality is that member C’s remuneration is £100,000 and the amount will not vary with firm’s profits.

Example 5

This example looks at guaranteed payments and rewards that are not part of the overall profits.

 

The XYZ LLP decides to expand into a new business area. A new member, P, is recruited to run the new business area.

As it is expected that the new business area will initially make a loss, P will receive a guaranteed profit share of £100,000 plus a percentage of the turnover of the new business area.

 

Neither the guaranteed payments (which may be called “guaranteed profit share”) nor the payment based on a percentage of the turnover of that business area is based on the profits of the LLP as a whole. Condition A is satisfied for the duration of the remuneration arrangements.