It’s a fact that the vast majority of taxpayers in the UK are on PAYE, whether they work for large or small firms, government organisations or even their own limited companies. So we make no apologies, in this new ‘season’ of tax-planning articles, for reviving the ever-relevant topic of how to take your remuneration, as a cog in the business wheel, with the minimum tax. And, of course, by the word ‘tax’ we are also including National Insurance (NI), a tax in all but name.
This month’s topic
And, in fact, this month’s topic is all about saving NI, by a neat but very effective arrangement – one which is still available despite a full-frontal assault by HMRC in this year’s Finance Act.
To come straight to the point, what we are talking about here is the arrangement under which a certain class of employees can be taken on instead as limited-liability partnership (LLP) members.
A bit of history
It only seems a few months ago, and indeed it was only a few months ago, that it was possible to take every single person who worked for a business out of PAYE: just like that. Everyone, from the managing director down to the cleaner, could, it seems, have been introduced as a member of an LLP carrying on the business and be instantly categorised as self-employed for tax purposes and therefore also, of course, for NI purposes.
When you consider that on a band of earnings broadly equivalent to the basic rate income tax band an employee’s NI burden is no less than 25.8% of his earnings, whereas with a self-employed person this is only 9%, you can see the huge (and, frankly, mystifying) difference between the two categorisations of earnings for NI.
Of the 25.8% charge we’ve mentioned, 13.8% is contributed by the employer, meaning that planning involving turning employees into the self-employed is often something mainly driven by the employer’s interests.
So you have all the ingredients for a NI ‘scheme’, which can be marketed to employers by tax advisers and others and is apt to save the employer up to 13.8% of his total payroll. Wow!
But, of course, this is exactly the sort of thing that makes HMRC see red. Sensible tax- and NI-saving ideas can in practice go on with the Revenue’s effective acquiescence for years: but as soon as the tax ‘scheme’ boys get their teeth into it, you’re likely to see another rainforest felled to print the legislation that will emanate from 100 Parliament Street.
Faced by the choice of whether to deal with avoidance in a simple or a complicated way, good old HMRC invariably chooses the complicated route. So the Finance Act 2014 contains several pages of legislation on this obviously important topic, from the taxman’s point of view. From 6th April 2014, if you’re going to tap into all the goodies of self-employment by being an LLP member, you need to pass just one (not all) of three tests:
- the ‘capital’ test
- the ‘significant influence’ test
- the ‘variable income’ test.
We’ve put it like this, as a series of positive tests, but the legislation itself actually expresses these requirements negatively.
Oh, and as well as those tests, HMRC has put in a rule to say that anything you do specifically to get round the new rules will be ignored. A nice touch, that.
So how do we steer a path through this new minefield and win through to the reward of true self-employment?
The capital test
One way you can do this is if the individual ‘partner’ has a certain level of equity capital invested in the LLP. This is obviously intended to weed out one category of individual who is basically completely an employee rather than a partner in any true sense of that word.
The level of capital a person must have to pass this test is 25% of their expected annual income.
So let’s do a few sums. Let’s say that a prospective LLP member is on £50,000 per annum, meaning that, to be treated as self-employed under this test, they’ll need to have a capital contribution sunk in the firm of one quarter of this, that is £12,500.
Now let’s suppose, being wildly optimistic, that they could have invested that £12,500 in the bank at an interest rate of 1%. This means that putting the money into the firm is ‘costing’ them £125 a year. Contrast this, though, with the difference between the NI burden that the individual and the business combined will bear. Under the self-employment route the total NI burden, we make it, is something like £7,000 a year less. So for this individual, it’s always going to be worthwhile having the capital invested until banks start paying interest on deposits of something like 60%!
Do bear in mind the rule about not setting up arrangements just to circumvent the new rules, although this doesn’t seem to have put off a number of city law firms who, we understand, have asked junior ‘partners’ to put their hands in their pockets to avoid treatment under PAYE from 6th April 2014.
This is an extremely nebulous concept. What you actually have to do is have arrangements such that the individual would be expected to exert significant influence over the way the LLP is run. Interestingly, the rules seem to be more about what the legal agreement is rather than what the practice is. However, anyone relying on this escape route from PAYE would obviously be very well advised to make sure that the individuals concerned actually do exert an influence.
And not only that, but can be proved to do so. So minute those all-important ‘managers’ meetings’ at which suggestions are made, since evidence would be very important if the Revenue decided to take a look at your particular LLP.
Again, in framing your LLP rules, avoid introducing anything whose sole motivation is to make it look as though Fred Brown and Sally Smith are in the category of bosses rather than the bossed.
We think it’s fair to say that HMRC approached the task of stamping on LLP ‘abuse’ in a sensible way, in that it sought the views of everyone who replied to its consultation papers, and actually changed the rules in response to some of the answers it received.
We think, though, that this third test is something where it either disregarded the answers or didn’t get any which solved a basic problem.
The variable income test, paraphrased, is that the individual ought to have an element of income which is variable by reference to the performance of the LLP as a whole and should be at least 20% of their expected total income. But what happens if, in the event, the individual gets a ‘bonus’ which is way below the 20% mark, or even nil? Reading the rules literally, these people will suddenly find that they are denied self-employed status. Hmm.
Hopefully, the Revenue will adopt a sensible approach to this, though, and won’t penalise genuine arrangements under which individuals are motivated to increase the business profits.
One important point to note is that the bonus must be by reference to the total profits of the business, not the individual’s own contribution to it. If you have, say, a business where salesmen receive a bonus based on the amount of new business they bring in, this won’t qualify.
Well, why not make each individual a separate LLP, then, the more adventurous may ask? Well, you could try, but once again you’ve got to remember that catch-all clause about arrangements set up to circumvent the new rules.
Brave new world
So where does all this mess of new law leave us? What everyone was expecting, probably, was that HMRC would introduce a requirement that individuals should be ‘really’ self-employed, using all of the immense battery of case law precedent for deciding this question. What it has actually done has surprised the profession, in that this is not a test at all where we are looking at LLPs. Interestingly, and even puzzlingly, this now introduces a difference between LLPs and unincorporated partnerships, where the test is very much one of self-employment in ‘reality’ still.
Reactions have been mixed. Some businesses have shut down their LLPs altogether and gone back to the good old tried-and-tested (and expensive) arrangement where everyone is employed by a limited company.
We think that those who’ve looked at the new rules, though, rather than responding thoughtlessly, have managed to retain the huge self-employed NI benefits for at least a significant proportion of their staff.
So this sort of planning is very much a live issue for a large proportion of businesses and their workers. Ignore it at your cost!