Inland Revenue Tax Bulletin - Issue 50

This article was written by the Tax Faculty of the Institute of Chartered Accountants in England and Wales and circulated to their members. The text was agreed with the Inland Revenue and DTI before publication.

Introduction

Businesses have been obliged to pay the National Minimum Wage (“ NMW”) to their workers since 1 April 1999. The Department of Trade and Industry (“ DTI”) is the Government department responsible for NMW policy and legislation, and the Inland Revenue for enforcement. As there has been confusion about whether directors must be paid the NMW, the Tax Faculty asked the DTI to clarify the circumstances in which an individual who is a company director must be paid the NMW and how the Revenue will enforce the NMW legislation. We use “he” in the general sense to mean any person.

General Comments

1. In general terms, how does the NMW legislation impact on directors?

If a person is a director and he does not have an explicit employment contract, then he is highly unlikely to be subject to the NMW legislation even when he carries out a wide variety of activities. These might include, for example, working in the company's shop. Such activities can be done in his capacity as an office holder (director), rather than as a worker. If a director has an explicit employment contract he will be within NMW in respect of earnings under that contract as he and the company will then have chosen to create a worker/ employer relationship alongside the director/ company one.

The basis for this is the national minimum wage legislation which works on a simple principle. All those who are “workers” are covered by the National Minimum Wage Act, 1998 (“ NMWA 1998”); individuals who are not “workers” are therefore not covered. Section 54 of the Act (see Annex) defines a “worker” as someone working under a contract of employment (an “employee”) or someone working under some other form of contract (called a “worker's contract”) under which he agrees to perform work personally for someone else but is not self-employed.

Individuals who are directors properly appointed under the Companies Acts and who assume the rights and obligations of a director are office holders and not necessarily “workers”. For a director also to be a worker under the NMWA 1998 there has to be an extra legal arrangement between the two parties, which involves obligations on both sides. It follows that if a director is not bound by an explicit contract, then he is not likely to be a worker who needs to be paid the national minimum wage.

It is up to the director and the company concerned to decide whether or not they wish to create a relationship of employer and employee or worker. They do not have to do so, but if they do create such a relationship, for whatever reason, they must accept all the rights and obligations which the law confers upon them, of which NMW is but one.

The DTI have told us that if there is no written employment contract or other evidence of an intention to create an employer/ worker relationship they will not seek to contend that there is an unwritten or implied employment relationship between a director and his company. As the Inland Revenue administers NMW as agents for the DTI they will adopt this policy also. The DTI are aware that this position has been represented in some quarters as a change in policy by the Government. But they point out that the Government has always made clear that directors would only be covered by the law if they were also workers as defined by the Act and that remains the case.

2. How does the NMW legislation apply to family members who work for the company but are not directors?

An employee will always be a worker, and will be subject to the NMW (unless exempted by some specific and extremely limited provisions, for example where he is under 18 years old). The exemption for work done by certain family members of the proprietor of a business does not apply where the business is carried on by a company. One of the consequences of incorporation is to confer the full protection of employment legislation including the NMW on such people.

The absence of a formal written contract does not mean that no contract exists. A contract of employment can be express or implied; if it is express it can be oral or in writing. The distinction between a director and other workers who are not self-employed is that the existence of a directorship is sufficient to explain the relationship between the director and the company whereas for other workers the relationship can normally arise only from an unwritten contract of employment. If a person works for a company without any remuneration at all, he may well not be an employee as the relationship may be explained by a desire to assist the company voluntarily. An employment contract, like any other contract, requires consideration (that is, the receipt of some benefit by both parties to the contract).

The approach of the courts

3. What if the matter is not clear-cut?

Where there is uncertainty, a tribunal or court, if called upon to decide, would take into account a number of factors that might indicate whether or not there is a contractual relationship. Among these might be whether or not the individual is required by someone more senior or by a contract to turn up at work at a certain time and work a set number of hours rather than being free to come and go as he chooses. Another pointer in the case of non-directors, or where it is doubtful whether the individual is a director at all, is whether the individual is rewarded by payments in the form of a wage or salary. There are also situations which will be outside the NMW where people carry out work where there is no contract or payment, for example welfare or committee work or helping out a friend. At the end of the day, in the event of a dispute, it is for employment tribunals or Courts to decide.

Examples

Example 1: Family company

4. Mr and Mrs Smith run their shop as follows:

• Mr and Mrs Smith each own 50% of the issued share capital of Smith's Food Retailers Ltd. The business of the company is running a greengrocers store. The company's Articles of Association are standard Table A. Mr Smith is the only director of the company and Mrs Smith is the company secretary. Neither of them has a written service agreement, and there is no other documentation relating to the services they provide to the company.
• Mrs Smith works approximately two hours per day on company business and in the period from 1 April 1999 has been paid an annual salary of £4,000 in equal monthly instalments.
• Mr Smith works an average of sixty hours per week serving in the company's only shop. Since 1 April 1999 he too has been paid a salary of £4,000 in equal monthly instalments.
• In the year to 31 March 2000 the company will make £80,000 pre-tax profit and this will be distributed by way of dividend in equal shares to Mr and Mrs Smith.

5. Are Mr and Mrs Smith workers for purposes of the NMW legislation?

Mr Smith is a director. He has no written contract of employment. Company law does not limit what a director can do, so in this example the fact that Mr Smith, who is director of the company, is carrying out work that one might expect to be carried out by an employee, does not mean that he is an employee working under an implied contract. The fact that he also draws a salary from the business and is paid a dividend does not matter as his being a director is sufficient reason for him to be doing the work.

Mrs Smith works as the company secretary and receives a wage. `Company Secretary', like `Director', is the title of an office. So she too is an office holder and unlikely to be covered by the NMW legislation unless she is also explicitly bound by an employment contract in addition to holding this office.

Example 2: Pure director

6. Facts as above save that there is another director, Mr Jones, whose only input to the business is to attend Board meetings, which are held four times a year and last three hours, and who is an equal shareholder with Mr and Mrs Smith. He is not paid a wage but receives a dividend on his shares.

Mr Jones, like Mr and Mrs Smith, is clearly an office holder and as such he is not covered by NMW.

Example 3: Employees who become directors

7. Facts as in Example 1 save that business is booming and Mr and Mrs Smith's son, John, joins the company full time. He is taken on as an employee initially and is equal shareholder with Mr and Mrs Smith, so the dividends are split equally three ways. Later on he is made up to sales director. He has no written contract of employment at any time. Does he have to be paid the NMW?

Before John becomes director, even though he has no written contract, he has an implied employment contract and so he is a “worker” and is entitled to NMW.

Whether or not John is entitled to NMW following his change of status depends on whether his contract has really been terminated before he becomes a director.

If John's employment contract is terminated and he is then appointed director in accordance with Companies Acts procedures, eg the appropriate return is made to Companies House and a Board resolution is passed, he is no longer a worker but is a director and as such the company is no longer obliged to pay him the NMW in relation to the time after he becomes a director.

This is the case even where John, having been appointed director and other procedures having been followed correctly, is for example denied access to the books of account or is otherwise not able to fully assume the rights that go with the responsibilities of being a director (if this happens he may choose to take legal action against the company but this is beyond the scope of this note).

However if “sales director” is no more than a glamorous title and his employment contract is not terminated and the Companies Acts procedures for appointing John as director are not followed, then John will not be an office holder but remains a worker for NMW purposes. In other words, a company is still bound by its responsibilities towards such an individual as an employee after giving him the title “director” unless he has his original employment terminated and becomes a genuine director with all the rights and responsibilities which go with the title.

There is a third and more confusing scenario: if John is made a proper director following Companies Act procedures but nonetheless for some reason his employment contract is not terminated, he could then be both a director and a worker. This is the situation which gives rise to most uncertainty. It is clear to see from this example that the answer is to ensure that no one is working under an employment contract if this is not the intended relationship. Otherwise there is a real possibility that John might be able to claim the minimum wage in his capacity as a worker despite his also being a director of the company. It is the existence of this possible scenario that prevents the DTI from giving a definite assurance that NO director can be unintentionally covered by the National Minimum Wage Act.

Example 4: Group companies

8. Smith's Food Retailers Ltd in example 1 has a subsidiary company called Nigel's Food Retailers Ltd, which owns a second greengrocers shop. Nigel, Mr and Mrs Smith's son, is the sole director of the subsidiary. Mr Smith serves in the subsidiary company's shop for half a day a week and sometimes Nigel serves in the shop owned by Smith's Food retailers Ltd. Nigel is paid solely by the subsidiary. Do Smith's Food Retailers Ltd need to pay Nigel the NMW in respect of the time that he spends serving in its shop?

No. A director has a duty to further the interests of the company of which he is director. By serving in the shop of another group company, it can be argued that Nigel is individually furthering the interests of the group as a whole, thereby furthering the interests of Nigel Food Retailers Ltd.

Example 5: Associated companies

9. Facts as in Example 4 save that both Smith's Retailers Ltd and Nigel's Food Retailers Ltd are owned directly by Mr and Mrs Smith. Nigel, Mr and Mrs Smith's son, is the sole director of Nigel's Food Retailers Ltd. Mr Smith serves in the shop owned by Nigel's Food Retailers Ltd for half a day a week and sometimes Nigel serves in the shop owned by Smith's Food Retailers Ltd. Neither individual expects or asks to be paid by the company that he is not director of for the time spent serving in that company's shop. Does Smith's Food Retailers Ltd need to pay Nigel the NMW in respect of the time that he spends serving in its shop?

On the face of it, the common ownership of shares in both companies by Mr and Mrs Smith may not create a sufficiently close link for the director of one company to be considered to be furthering the interests of his company when working in the other company's shop. However, given the family relationship, there is a strong argument that NMW is not due because the individuals are helping out on a voluntary basis and have not entered into contracts involving mutual obligation.

Other situations

10. Set out below are various other situations where it would not normally be necessary to pay the NMW to the directors (assuming none has an express contract of employment with any of the companies).

1. new businesses: many start-ups need time to build up activities and profitability. Cash flow is tight and hours worked are long. During this time directors take no salaries, preferring to live off savings;
2. loss-making family companies: in the year to 31 March 1999, a company made a loss of £200,000. It is at the limit of its overdraft facility. The directors, all of whom work full time in the company, have some personal savings and are living off these. They are not paying themselves any salary because there is no money to pay themselves;
3. group companies: directors of the holding company are frequently on the boards of subsidiary companies. They are usually paid by the holding company and receive no payment from the subsidiary;
4. dormant companies: there are many dormant companies that have directors where some administrative work is necessary. Such companies have no money and are therefore unable to pay the directors for any work done;
5. trade associations: various independent companies have formed a trade association, which is structured as a limited company. The directors of the sponsoring companies spend an hour or so a month on association business. The association has little money and does not operate a PAYE scheme. The directors, who are directors of and paid by the sponsoring companies, work unpaid for the association;
6. public duty: some people accept a directorship out of a sense of duty. Whilst this may be for a family company, it might also be for the public good, for example the trading subsidiary of an education college. The director does not want to be paid for his work; and
7. flat management companies: many people live in blocks of flats where the lessees own the freehold by way of a flat management company. Each lessee is a director and some of the individuals manage the block.

11. If the above companies had workers, then would NMW be payable to the workers?

The fact that a company is, for example, making a loss is no excuse for paying its workers below the NMW. The company is liable to pay the NMW and keep sufficient records to prove it has paid the NMW. The Government's policy is that no UK company should exist on the basis that it has to pay its workers below the minimum wage. Examples (a) to (d) are all cases where the NMW would almost certainly apply. In examples (e) to (g) one would wish to make sure that there really is a contract of employment between the company and the worker. In (e) the work may well be done in the capacity of employee of the sponsoring company rather than of the trade association. In (f) and (g) it would be unusual for an employment contract to exist.

Enforcement

Generally

12. Which Government departments are responsible for NMW?

The DTI is the Government department responsible for NMW policy and the legislation.

Under provisions in Section 13( 1)( b) NMW Act 1998 the Secretary of State for Trade and Industry appointed the Revenue as the enforcement agency for NMW. The Secretary of State also appointed Ministry of Agriculture, Fisheries and Food (MAFF) (for England and Wales), and the Scottish and Northern Irish agricultural departments to enforce minimum wage in the agricultural sector, where there are already statutory agricultural wage regimes.

13. How in general does the Revenue intend to enforce compliance with the NMW legislation? Will the Revenue act solely if a complaint is received or will enforcement officers take a proactive stance?

Enforcement is undertaken in two main ways. First Revenue enforcement officers follow up complaints from workers about non-payment of NMW or conduct investigations as a result of information from third parties. Secondly they undertake risk analysis of all employers to identify those employers most likely to be non-compliant.

The Revenue also runs a national helpline which issues DTI literature and takes calls from a variety of people. The Revenue follows up letters and phone calls, and carries out proactive visits in trade sectors where the DTI feels there may be more widespread non-compliance with the NMW.

The Revenue enforcement officers carry out this work by visiting employers to examine their wages records in order to satisfy themselves as to whether NMW has been paid. There are sanctions which the Revenue are able to use in the event of a refusal to pay NMW. These include powers to:

• serve an enforcement notice requiring an employer to pay NMW within a specified period;
• issue penalty notices in the event of failure to pay following the issue of an enforcement notice;
• bring a case on behalf of a worker before an employment tribunal; and
• prosecute employers for committing criminal offences under the Act.

NMW is a separate ring-fenced activity within the Revenue. However, whilst it is separate from tax inspection work, the Employment Relations Act 1999 gives NMW teams access to tax information and Section 148 of the Finance Act 2000 allows the Revenue to use information obtained under NMW powers for other tax purposes.

The Revenue have found that employers generally have been compliant and in many cases where non-compliance has been discovered employers have agreed to put matters right and pay any arrears of NMW which are due. Enforcement notices have now been served in around 250 cases and at twenty Employment Tribunal hearings the Revenue have succeeded in obtaining NMW for workers.

14. Does the Revenue consider itself bound by statements made by other government departments relating to the scope of the NMW provisions particularly statements made by the DTI?

The DTI leads on government policy on NMW and the scope of the provisions is a matter for their lawyers, who drafted the legislation. The Revenue follows the direction of DTI lawyers on such matters.

Enforcement in specific cases

15. If a breach of NMW legislation had taken place in 1999-2000 and this was repeated for the years 2000-01 and 2001-02, what action would be taken by the Revenue in terms of the NMW legislation, if, say, the matter came to the attention of a PAYE auditor at an inspection visit some time in March 2002?

The Employment Relations Act 1999 includes provisions for the exchange of information between Revenue staff generally and NMW enforcement officers. If during the course of an inspection a PAYE auditor had reason to believe that there was a failure to pay NMW, then the relevant information might be passed to a NMW enforcement officer.

If it was subsequently established that there had been a failure to pay NMW over a period of several years then the employer would be required to make good any payment of wages which was due from 1 April 1999.

16. What action would be taken by an officer enquiring into the company's accounts to 31 March 2000 if it became apparent during the course of that enquiry that an employee was entitled to the NMW but was not receiving it?

The response to the previous question also applies here.

17. If the company were required to pay arrears of NMW to an employee, what would be the situation so far as concerns:

a) the deductibility and timing of deductibility for the company;

The arrears paid would be a deductible expense in computing the employer's Schedule D Case I profits.

The Revenue's usual starting point in the computation of Case I profits is the treatment in accounts prepared in accordance with generally accepted accounting practice. So if at the balance sheet date (of any particular year to which the “arrears” relate) there was insufficient evidence of the likelihood of arrears for that year going to be paid in due course, for accountancy purposes it is more likely that the arrears would be deducted in the (later) year in which it became clear that the employer had an obligation to pay the arrears. For tax purposes the Revenue would follow the timing of the deduction made in accordance with generally accepted accountancy practice. Section 43 Finance Act 1989, which prohibits a deduction for a provision where the emoluments are not paid within the following nine months, will not apply (as Section 202B( 1)( c) ICTA 1988 deems the emolument to have been paid when they became due).

b) the application of PAYE/ NIC (including interest and penalties);

If it is decided that because of NMW an employer has to pay arrears of remuneration to an employee, the view of the Revenue is that the worker was entitled to the arrears at the time of the original (inadequate) payment. That entitlement date is effective both for the purposes of the receipts basis of assessment and the time of “payment” for PAYE by virtue of Section 202B( 1)( c) ICTA 1988.

This means that when the employer makes the physical payment of NMW arrears, the sums can be paid net of the tax due at the time PAYE was exigible, namely the time of entitlement. The arrears of tax will normally be sought from the employer by means of a settlement and interest will be due in the normal way. Penalties will not be sought. The NICs legislation differs from that relating to tax, and NICs should be accounted for in the normal way at the time of actual payment of the arrears.

c) the employee's self-assessed tax liabilities and exposure to interest and penalties (assuming that no reference had been made to remuneration on his self-assessment returns other than to any remuneration or dividends actually received from the company)?

The employee is assessable for each year of entitlement on the gross amount of the arrears for that year, with a credit for the PAYE tax deducted. How the taxpayer's affairs can be adjusted will depend upon whether or not the taxpayer has self-assessed and, if so, what the position is regarding time limits for Revenue enquiries or taxpayer amendments. Outside of these time limits there is the possibility of error or mistake claims or discovery assessments. The normal rules relating to interest/ repayment supplement will apply to the outcome of any adjustments, but there will be no question of penalties. Any payment of arrears of remuneration for any year because of NMW legislation will not affect the taxation of any dividends received from the company for those years.

Annex

Section 54, National Minimum Wage Act 1998

Meaning of “worker”, “employee”, etc.

(1) In this Act “employee” means an individual who has entered into or works under (or, where the employment has ceased, worked under) a contract of employment.

(2) In this Act “contract of employment” means a contract of service or apprenticeship, whether express or implied, and (if it is express) whether oral or in writing.

(3) In this Act “worker” (except in the phrases “agency worker” and “home worker”) means an individual who has entered into or works under (or, where the employment has ceased, worked under)

(a) a contract of employment; or

(b) any other contract, whether express or implied and (if it is express) whether oral or in writing, whereby the individual undertakes to do or perform personally any work or services for another party to the contract whose status is not by virtue of the contract that of a client or customer of any profession or business undertaking carried on by the individual; and any reference to a worker's contract shall be construed accordingly.

(4) In this Act “employer”, in relation to an employee or a worker, means the person by whom the employee or worker is (or, where the employment has ceased, was) employed.

(5) In this Act “employment”

(a) in relation to an employee, means employment under a contract of employment; and

(b) in relation to a worker, means employment under his contract;

and “employed” shall be construed accordingly.

Limited Liability Partnerships

This article sets out the Revenue's views on how the members of a Limited Liability Partnership (“ LLP”), regulated by the Limited Liability Partnership Act 2000 (“ the LLP Act”), which carries on a trade or profession, will be taxed.

In this article the following expressions are used:

“Ordinary Partnership” means a partnership within the meaning of the Partnership Act 1890.

“Limited Partnership” means a partnership regulated by the Limited Partnership Act 1907.

“Old Partnership” includes both an “ordinary” and a “limited partnership”.

During the passage of the LLP Act, Ministers announced that the tax treatment would be reviewed for those LLPs used for businesses for which the LLP structure was not originally intended. Legislation would be brought forward in the Finance Bill 2001 after appropriate consultation. This review was prompted by concerns that some businesses, particularly investment businesses, could be motivated to adopt LLP structure for tax reasons rather than to obtain limited liability. Further details of the tax treatment of LLPs were announced by the Chancellor in his Pre Budget Report (PBR) on 8 November 2000. Details and an invitation to comment were given in the PBR Press Release - Inland Revenue 5. An announcement will be made in due course of the further changes to the tax treatment of LLPs (if any) which are required because of points raised during this consultation.

General

LLPs are in law regarded as “bodies corporate” and will be subject to aspects of company law. But for tax they will generally be treated as “partnerships”. As mentioned above this guidance covers LLPs carrying on a trade or profession. It does not cover the detailed tax treatment of investment businesses for which the LLP structure was not originally intended.

Section 10 of the LLP Act ensures that where an LLP carries on a “business with a view of profit” the members will be treated for the purposes of income tax, corporation tax and capital gains tax as if they were partners carrying on business in partnership.

That is to say the LLP will be regarded as transparent for tax purposes and each member will be assessed to tax on their share of the LLPs income or gains. For members liable to income tax their share of the partnership's profits to be charged to tax will be calculated in accordance with the rules set out in Section 111 ICTA 1988 and for those members liable to corporation tax in accordance with the rules set out in Section 114 ICTA 1988.

This article deals with the UK tax treatment of LLPs formed under the LLP Act (i. e. UK LLPs as opposed to overseas LLPs). It would be for the tax authorities of other countries to decide how to tax UK LLPs under their own tax codes.

Computation of taxable profits of professional businesses

In Tax Bulletin, Issue 38 (December 1998, page 606) the Revenue set out guidance on what is meant by “true and fair view” for the purposes of calculating the taxable profits of a professional business.

It is confirmed that those rules will apply equally to the computation of the Case II Schedule D profit of a LLP which carries on a professional business for the purposes of calculating the Income Tax liability of the members of the LLP.

Capital Allowances

Where a LLP succeeds to a business previously carried on by an old partnership this will not of itself give rise to a balancing event for the purposes of the Capital Allowance provisions.

Interest Relief

Members of a LLP, who are individuals, will be entitled to claim interest relief on the loans they obtain in order to defray money applied in the circumstances set out in Section 362( 1) ICTA 1988; provided that they otherwise meet the conditions of the relief.

ESC A43 covers interest for investments in partnerships. Where an ordinary partnership converts to a LLP, the existing terms of the extra-statutory concession are not appropriate, to preserve existing relief. To rectify this we are currently considering what changes should be made to the text. (A 1907 limited partner would not have been entitled to such relief in the first place, so it would be inappropriate to extend ESC A43 to those circumstances.)

Loss Relief

a. Unlike Section 117 ICTA, the undrawn profits of a member of a LLP cannot normally be added to their subscribed capital in order to calculate the limit of their entitlement to sideways loss relief. This is because, subject to any agreement between them, a member's undrawn profits will normally be regarded as a debt of the LLP. This means that the member ranks, for that sum, alongside the other creditors in the event of liquidation. If however the terms of the agreement between the members specifically provide that the undrawn profit stands as part of a member's capital contribution and that agreement is unconditional then that amount can be taken into account in calculating the limit.

b. The following is an example of how the provisions of Section 118C-D will apply:

Mr A becomes a member of a LLP on 6 April 2003. He introduces capital of £10,000 into the partnership. The LLP carries on a trade. During the year ended 5 April 2006 he makes a further capital contribution of £6,000.

His share of the LLP's Case I loss is as follows and he claims relief under Section 380 ICTA for those losses against his other income.

• Ye 5 April 2004
  • £6,000
• Ye 5 April 2005
  • £6,000
• Ye 5 April 2006
  • £3,000

Mr A is entitled to Section 380 relief as follows:

• 2003/ 2004
  • £6,000 (unrelieved capital contribution £4,000)
• 2004/ 2005
  • £4,000( 1) (unrelieved loss £2,000)
• 2005/ 2006
  • £5,000( 2) (unrelieved capital contribution £1,000)

1) sideways loss relief is restricted to the unrelieved capital contribution brought forward of £4,000. The balance of the loss of £2,000 (£ 6,000 - £4,000) is carried forward.

2) sideways loss relief of £5,000 available i. e. loss of year £3000 + unrelieved loss brought forward £2,000. Unrelieved capital contribution carried forward is £1,000 i. e. total contributions £16,000 less total sideways loss relief given £15,000)

Where a member of a LLP makes a capital contribution to a partnership in order to meet a liability for negligence for which they are personally responsible then that amount will be taken into account in determining the amount of their capital contribution to the partnership for the purposes of Section 118ZC ICTA. Provided that the conditions for relief are otherwise met then that partner will be entitled to relief up to a maximum of the amount of that additional contribution either under the normal sideways loss relief provisions, or under Section 109A ICTA if he/she has left the partnership, or the partnership has ceased business.

c) The provisions in Section 118C-D ICTA (restriction of sideways loss relief to members of a LLP) do not apply to a LLP which carries on a profession; only to one which carries on a trade. Provided that the conditions for relief are otherwise met; a member of a LLP, which carries on a profession rather than a trade, will be entitled to loss relief, either under the normal sideways loss relief provisions, or under Section 109 ICTA, if he/ she has left the partnership, or the partnership has ceased business.

Overlap relief

Where a partnership carries on a trade or profession each partner is deemed to carry on a personal trade or profession. The basis period rules are applied to that deemed trade or profession and any overlap profit is personal to each partner.

If, on conversion, a LLP succeeds to the business previously carried by an old partnership then a partner's personal trade or profession will be regarded as continuing. He/ she will be entitled to a deduction for overlap relief at the time they finally retire from the LLP (or perhaps earlier if the LLP changes its accounting date).

Demergers

Where a LLP takes over only part of the old partnership's trade, such an event constitutes a “demerger” to which Statement of Practice 9/ 86 applies. Unless it can be shown that on the demerger the part of the business carried on by the LLP is recognisably “the business” previously carried on by the old partnership then the cessation provisions will apply. In that event each member of the old partnership will be entitled to their personal overlap relief. Equally the commencement provisions will apply to all the members of the LLP.

But if it can be shown that the LLP does carry on “the business” previously carried on by the old partnership then, as it will have succeeded to the old partnership's business, the cessation provisions will not be applied to the old partnership and any overlap relief will be carried forward. Equally the commencement provisions will not be applied to the members of the LLP. But the old partnership will be assumed to have commenced a new business in relation to the part of the trade it retains.

Whether or not the business carried on by the LLP is recognisably “the business” previously carried on by the old partnership is a question of fact.

Cash basis - catching up charge

Again if on conversion the LLP succeeds to the business previously carried on by an old partnership then the spreading rules for the catching up charge will continue to apply as if the conversion had not occurred.

Cessation

Where a LLP succeeds to a business previously carried on by an old partnership this will not of itself involve the cessation of the old partnership's trade or profession.

Tax returns

Where an old partnership incorporates as a LLP during an accounting period then if the partners so wish a single partnership return need only be made for the one tax year. They may do this even if the partnership changes its accounting date. Single PAYE returns may also be made for the tax year in which an old partnership incorporates as a LLP.

UK branches of overseas LLP's

The tax treatment of a UK branch of an overseas Limited Liability Partnership, and the members of such an LLP, will depend on how the foreign entity is regarded for the purposes of the UK taxation provisions. Where the foreign LLP is regarded as a “body corporate” for the purposes of the UK Taxes Acts the profits of the UK branch will be chargeable to corporation tax. On the other hand if it is regarded as a partnership then members will be separately liable to tax on their share of the branch's profits under the existing legislation for partnerships rather than under the LLP Act. The latter act only applies to UK registered LLPs.

Double Taxation Relief

Where an overseas tax authority regards a foreign branch of a UK LLP as a “body corporate” the UK members will be entitled to claim Tax Credit Relief in respect of their proportionate share of the foreign tax paid on the overseas branch's profits.

Dividends

A UK LLP is not itself “liable to tax” in the UK as the LLP tax provisions identify other persons (i. e. the members) as the persons who are to be taxed. Accordingly for the purposes of the Double Taxation Agreements (DTA) the LLP it is not regarded as being resident in the UK and cannot itself therefore claim relief from foreign taxes under such Agreements. As is now the case with ordinary and limited partnerships the members must make the claim.

Assuming they are UK residents in accordance with the provisions of the relevant DTA the members of an LLP will be entitled to relief for any withholding tax on overseas dividends. Normally a DTA provides for withholding tax of a maximum of 15% to be deducted and relief for that tax will be given. Where a partner is an individual then no relief will be due in respect of the taxes paid (the underlying taxes) on the profits out of which the dividend is paid.

In the very narrow circumstances where the LLP is not treated as transparent, but instead as a body corporate for tax purposes (such as when the LLP is in liquidation or being wound up in circumstances where transparency cannot be retained in the manner explained below under “Capital Gains - Liquidation /Winding Up”), we can confirm the LLP could itself claim relief for foreign taxes, including if appropriate underlying tax.

Partnership Annuities

Where an obligation to pay an annuity is transferred from the old partnership to the LLP then the members of the LLP will be entitled to higher rate income tax relief for their share of the ongoing payments; and incoming LLP members who assume part of that obligation will also be entitled to such relief for their share.

If an obligation to pay an annuity is not transferred to the LLP and the members of the old partnership continue to pay it they will be entitled to higher rate income tax relief for their share of those payments until such time as they cease to be a member of the LLP or until the business originally carried on by the old partnership ceases, whichever is the earlier.

Capital Gains

Partners capital interests

So long as the LLP carries on a trade or profession with a view to profit a partner's capital interest as a member of a LLP will not be regarded as a chargeable asset in its own right. In these circumstances the members of the LLP will be directly taxable on their share of the chargeable gains arising on the disposal of the LLP's assets and there will be no concurrent charge on a non-transparent basis.

Temporary cessation of trading

The transparency of a LLP, for capital gains purposes, is not disturbed by reason of temporary periods of time during which no trade or profession is carried on by it. For example, if the LLP ceases to carry on one business and disposes of its assets in order to realise funds to commence another business then those asset disposals, and any gains or losses arising in consequence, will be treated as those of the members.

Transfer of a business to a LLP

Where a business, previously carried on by an old partnership, is transferred to a LLP then, for the purposes of the Capital Gains legislation, this will not of itself constitute a disposal by the partners in their interests in the old partnership's assets. This applies equally to the members of partnerships in Scotland as it does to those in England and Wales.

Furthermore such a transfer will not affect:

1. the availability of indexation allowance.
2. the ownership period for retirement relief.
3. the holding period for taper relief.

Application of Statement of Practice D12

The rules set out in Statement of Practice D12 apply equally to the members of a LLP as they do to members of an old partnership. When D12 is next updated it will be amended to incorporate this confirmation.

Liquidation/ Winding up

Liquidations

Where a LLP ceases to carry on a trade or profession then it will no longer be regarded as a “partnership” for the purposes of the taxation provisions and will instead be regarded as a “body corporate”. The LLP will thus cease to be transparent (Section 59A( 2) TCGA).

Where a LLP goes into liquidation, chargeable gains on the disposal of the LLP's assets by the liquidator will be computed by reference to the date on which they were first acquired by the LLP and their cost at that date. In the liquidation period, the LLP's capital gains will be treated in precisely the same way for tax purposes as those for any other body corporate (Section 8( 6) TCGA).

LLP members will be taxed on any gain (or given relief for any loss) that arises on the disposal of their capital interests in the LLP. The base cost of a partner's capital interest is not equal to the market value of that interest at the time when transparency is lost. The allowable acquisition cost of each partner's interest will be determined according to the historical capital contributions made as if the LLP had never been transparent. This treatment does not affect preliquidation asset disposals, which remain undisturbed.

Informal Winding up

Where the members of a LLP proceed to wind up its affairs in an orderly way, without the formal appointment of a liquidator, by settling outstanding liabilities and realising the assets following or in the course of a cessation of commercial activity, then it will be accepted that the transparency of the LLP will be preserved during the period in which the assets are being disposed of provided the conditions set out below are met.

Those conditions are:

• that the LLP is not being wound up for reasons connected in whole or in part with the avoidance of tax, and
• that, following the termination of the LLP's business, the period of winding up is not unduly protracted taking account of the LLP's assets and liabilities.

If these conditions are not met, then the transparency of the LLP may be regarded as coming to an end before the informal winding up process has been completed. It is also emphasised that, whatever the circumstances, transparency cannot continue beyond any date on which a liquidator is formally appointed (whether or not that liquidator is charged for a period with completing any outstanding business transactions).

CGT roll-over relief

Where, as a result of claiming business asset roll-over relief (Sections 152 - 154 TCGA 1992) a LLP member postpones a chargeable gain through their acquisition of a share in a LLP asset, there is the potential for that gain to fall out of charge in the future by reason of the LLP ceasing to be transparent. This could occur, for example, where the LLP asset remains unsold when the LLP goes into liquidation and vests in the liquidator (who will compute the gain arising on the disposal of the asset in the course of liquidation without regard to past roll-over relief claims by any LLP member). Accordingly, there is a tax liability on the member, at the point in time when the LLP ceases to be transparent, which is based on an amount equal to the postponed gain or gains which have not then come back into charge (Section 156A TCGA 1992). Gains which accrue to a member in consequence of this special provision do not attract taper relief.

Annuities

Provided that the rights remain substantially the same then:

• the transfer of a partner's annuity rights and/ or
• the transfer of annuity obligations to former members

from an ordinary partnership to a LLP will not be regarded as a chargeable disposal.

Similarly where an annuitant agrees to the substitution of the LLP for the predecessor partnership as the payer of the annuity, and the terms otherwise remain substantially the same, then the annuitant will not be regarded as making a chargeable disposal.

Inheritance tax

Business property relief and agricultural property relief

Where an old partnership incorporates as a LLP a partner's period of ownership for both reliefs will not be regarded as being interrupted.

Deemed transfers by close companies

Because Section 267A( d) IHTA 1984, inserted by Section 11 of the LLP Act, deems transfers of value to be made by the members of the LLP and not by the LLP itself, liability under Section 94 IHTA 1984 cannot arise even if the LLP might otherwise be a close company.

Availability of reliefs

The normal reliefs and exemptions available to partners in an old partnership will equally be available to members of a LLP. In particular Section 10 IHTA 1984, which provides an exemption for dispositions not intended to confer gratuitous benefit, will apply.

Stamp duty

Transfer of property to a LLP

Section 12 of the LLP Act requires that for the stamp duty exemption to apply the proportions of property conveyed or transferred into a LLP must either be unchanged “before” and “after” the transfer, or the proportions must not have been changed for tax avoidance reasons. Strictly under property law the partners' interest in the LLP will replace their interests in the old partnership's assets. In determining whether the stamp duty exemption applies the Revenue will not, however take this point.

The Revenue will accept that any property transferred to the LLP within one year of its incorporation will qualify for relief from stamp duty under Section 12 of the LLP Act, provided that the conditions for that relief are met.

Section 12( 2) of the LLP Act prevents stamp duty exemption being available if property is transferred at the time of the LLP's incorporation and also there are retirements of former partners and/ or admission of new partners to the LLP.

Provided that all the other conditions for the exemption are met the Revenue accepts that this charge can be averted by arranging matters so that the change of partners takes place the instant before or after incorporation. To confirm that matters were organised in this way the Stamp Office will need to see all associated documents effecting any change in the membership of the old partnership and of the LLP prior to and/ or after incorporation, as well as evidence that any stamp duty appropriate to those documents has been paid. It may be necessary to call for further information once these documents have been reviewed.

Transfers of interests in a LLP

An interest in a LLP is not a chargeable security for Stamp Duty purposes. So if stamp duty is due on the transfer of such an interest it will be payable at the 1%, 3% or 4% rate, as appropriate, rather than the 0.5% rate applicable to shares. This is in line with the intention behind the LLP Act that the treatment of LLPs should be the same as for partnerships. Since the sale of an interest in any other type of partnership bears duty at the property rates, the sale of an interest in a LLP will be charged in the same way.

General

As with all transactions potentially liable to stamp duty, the Technical Services Unit Manager at any Stamp Office will be happy to assist customers in connection with any enquiries regarding the operation of the stamp duty relief in the Act.

National Insurance Contributions

The National Insurance Contributions (NICs) position of members of a LLP is the same as that of partners in an ordinary partnership. Thus the members of a LLP will be liable to Class 2, Class 3 and Class 4 NICs as appropriate.

Employees sent on secondment to work in the United Kingdom