Trick or treat? When partners discover they’re really employees in disguise

When is a partner not a partner? The answer matters more than many firms realise. Get it wrong, and a partner could turn out to be an employee in disguise, bringing employment rights, tax liabilities and potential claims along with them.

Partnerships

A limited liability partnership (LLP) is a popular business structure and is particularly common in the accountancy and legal sectors.

A key advantage is that members of an LLP (often called ‘partners’) are treated as self-employed for tax purposes. This means no employer National Insurance contributions (NICs) are paid on the profits they draw. LLPs have grown in number since they were introduced in 2000. However, there is growing concern that some LLPs are being used to avoid paying employer NICs through ‘disguised employment’.

Labelling someone a ‘partner’ does not make them one, regardless of whether they enter into a partnership agreement. When testing employment status, an employment tribunal would look past the label and scrutinise how the relationship works day to day, applying a series of tests developed through case law to determine the correct status.

While no two partnership arrangements look quite the same, there are a few key features that help separate a genuine partner from an employee.

Employment status

So, what is the difference between a partner, worker and employee? UK employment law recognises these three categories of employment status:

1. Employees are individuals who work for their employer under a contract of service. They qualify for the most comprehensive statutory protections, including the right not to be unfairly dismissed. Employee status is usually determined by assessing whether there is mutuality of obligation (the employer’s obligation to provide work and the employee’s obligation to perform it), the degree of control and authority the employer has over the work and, amongst other factors, the level of the employee’s integration into the business
2. Workers are individuals who provide work or a service to someone, but not as part of running their own business. Workers have fewer rights than employees, but are still entitled to paid holidays, the minimum wage and whistleblowing protection
3. Partners are generally self-employed. The line between partnership status and employment status can be blurred, particularly in professional services firms with salaried or fixed-share partners. A fixed-share equity partner shares in the profits and risks of the business and has a real say in how it’s run.

Salaried partners

A salaried partner is a partner who is paid a fixed amount, much like a salary, rather than a genuine share of the firm’s profits. The position of a salaried partner may look more like that of a ‘disguised’ employee than a genuinely self-employed partner. This is particularly the case if the salaried partner has no meaningful voting rights and carries little or no financial risk.

HMRC introduced the Salaried Members Rules in 2014 to tackle disguised employment through LLPs. Under these rules, a partner can be taxed as an employee if they meet all three of the following conditions:

1. At least 80% of their pay is fixed or is not linked to the LLP’s overall profits
2. They don’t have ‘significant influence’ over the LLP’s affairs
3. Their capital contribution is less than 25% of their fixed pay.

The good news is that failing just one of these three conditions is enough for the partner to be deemed self-employed for tax purposes.

Professional services firms typically fail condition A and condition C (pay or capital conditions), meaning their partners are not considered disguised employees. Firms are reluctant to rely on condition B. This is because a partner’s ‘significant influence’ must extend over the whole LLP, not just one part of it. This is a difficult threshold to meet, particularly in scenarios where there are several partners who have authority over discrete areas of the firm’s affairs.

Risks

If you recruit partners into your business or promote ‘from within’, you should review each partnership arrangement carefully, as the risks associated with getting it wrong could have severe financial and reputational consequences.

A partner who is, in reality, a disguised employee could challenge their employment status and, if successful, bring an unfair dismissal claim and claim backdated holiday pay if removed from the firm. HMRC could also look to recover backdated PAYE and National Insurance payments from the employer.

Changes on the horizon

The Labour government has set out its plan to introduce a single status of worker with a carve-out for those who are genuinely self-employed. While we await further guidance from the Labour government on its proposals, there are immediate steps that businesses can take to avoid the risks associated with disguised employment:

• Review your partnership agreements to make sure they reflect the arrangement that operates in practice
• Give fixed-share partners genuine features of partnership, such as a real profit share, a capital contribution and voting rights
• When promoting an employee to partner, make sure the arrangements genuinely change, not just the job title
• Keep emails, letters and meeting minutes consistent with the intended relationship, as employment tribunals may rely on them
• Take advice before removing a partner from the firm, particularly where the partner’s status is unclear.