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HMRC internal manual

Employment Status Manual

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HM Revenue & Customs
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Salaried Member: Condition C: An increase in the contribution

ITTOIA/S863D

Where Condition C is not met, strictly, an increase in the contribution requires the test to be re-determined. The general rule (see sub-section 2.6.1) will apply. In practice, where Condition C is not met and there is an increase in the contribution (without any other change in circumstances), the condition does not need to be re-determined as, clearly, the condition will continue not to be met.

Where Condition C is met, however, an increase in the contribution will require the test to be re-determined.

In this case, two special rules need to be considered which take priority over the general rule. Both rules are intended to prevent individuals from flipping between Salaried Member (employee) and partner status through short-term increases in capital contribution.

 

i) The first special rule (S863D(6) and (7)) provides that any increase in contribution which would, apart from this rule, have the effect of Condition C ceasing to be met is disregarded unless it is reasonable to expect that the condition would not be met (again, ignoring this rule) for the remainder of the tax year.

This means that it must be reasonable to expect that the increase will be a permanent one that will not later be reversed in the tax year.

ii) The second rule (S863D(11)) provides that any days in the tax year prior to the date on which the increased contribution is made and on which Condition C is met are excluded days, and are used to proportionally reduce the amount of the increased contribution on a pro rata basis before comparing to the Disguised Salary for the tax year.

 

This means that an LLP member who meets Condition C will not be able to fail the condition through an increased contribution unless the increased amount (after being reduced for excluded days) is at least 25% of the Disguised Salary.

 

*Example *

This example illustrates how the test is applied when the capital contribution is increased by an existing LLP member who already meets Condition C

J is a member of KLM LLP. At 6 April 2014, her capital contribution is £20,000.

She is expected to receive Disguised Salary of £100,000 in the 2014/15 tax year. As J’s capital contribution is less than 25% of her Disguised Salary.

Condition C is met.

On 6 January 2015, J increases her capital contribution to £25,000. It is expected that the contribution will remain at this level for the rest of the tax year. As there has been a change in the contribution, Condition C needs to be re-determined.

As the change is an increase in the capital contribution and the Condition is previously met, the contribution is reduced on a pro rata basis, before comparing this to J’s Disguised Salary for the whole tax year (i.e. not just the amount for the remainder of the year).

J’s capital contribution is deemed to be £6,250 (£25,000 x 3/12). As this amount is still less than 25% of her Disguised Salary, she continues to meet Condition C for the rest of the tax year.

In contrast, if J increased her capital contribution to £100,000, instead of £25,000, then the contribution would be treated as being £25,000 (£100,000 x 3/12). As this amount is equal to at least 25% of her expected Disguised Salary in the tax year, she will not meet Condition C from 6 January 2015.

It is important to remember that, in a case where Condition C continues to be met despite the increase by virtue of the special excluded days rule, this is only fixed until the end of that tax year, assuming that no further changes are made. At the start of the next tax year, Condition C will need to be re-determined and the increased capital contribution may then be sufficient to fail Condition C until such time as the Condition needs to be re-tested.