Salaried Member: Disguised Salary: Drawings on account of profit share or Disguised Salary
It is common for members of LLPs to receive monthly payments on account (“drawings”) of their subsequent profit share. Typically, the amount of the monthly share will reflect the expected profit share so, for example, a member who is expected to be allocated a profit of £120,000 for the period of account may be paid drawings of £8,500 a month representing 85% of the expected profit. Such drawings are, nevertheless, a payment on account of expected profit and are subject to clawback should the expected profits not materialise.
The fact that a member is paid drawings on account of profits does not necessarily convert the payments into Disguised Salary. If the member’s reward is a genuine variable share of the overall profits, the manner of taking it does not convert it into something else. Genuine payments on account of a share of overall profits are not made by the payer in exchange for services, but are partial realisations of an anticipated profit based on the expectancy of a share in future profits.
On the other hand, the member may have been told that the drawings represent a priority minimum payment which could only be refunded in the event that the profits of the firm are insufficient to cover the drawings of that member and other members with the same preferential right to payment. If the reality is that the LLP always makes profits significantly greater than those minimum drawings (with that excess to be allocated to other senior members), it is reasonable to assume that the member will retain the amounts and that those amounts will not in practice be affected by the profits (and that accordingly the payments constitute a real reward for services).
The distinction between these cases is subtle and requires consideration of what the payments are referable to. Drawings would not be considered to be Disguised Salary if they are genuine payments on account of an amount that is itself not Disguised Salary. In such a case, it would not matter whether the drawings were made on a prudent or optimistic basis since in either case they would not be Disguised Salary.
Alternatively drawings may themselves either represent a fixed entitlement or be payments on account of an amount that is itself Disguised Salary.