PE execs may lose employment rights

Changes to UK tax rules could mean some partners will pay employment taxes without corresponding legal rights.

UK private equity professionals may end up paying employment taxes without the right to redundancy pay, paternity or maternity leave and other labor rights if changes to the UK’s limited liability partnership (LLP) move ahead in April without change, legal sources tell PE Manager.

The reforms remove tax breaks for “self-employed” partners in LLPs, a popular private equity structure, when UK tax authority HMRC believes the partner is actually more akin to an employee of the firm – what the HMRC dubs a “salaried member”.

Under current LLP law, individuals do not have to pay employment tax (known as national insurance contributions) for taking on the risk of being a self-employed professional in a business partnership. But by being self-employed, partners forfeit their statutory employment rights.

Nonetheless, if HMRC deems a private equity partner a salaried member the individual is considered employed for tax purposes only. Consequently the partner ends up paying national insurance without being entitled to employment rights.

Legal experts speaking to PE Manager say many private equity firms can simplify matters by making their junior partners employees again.

Otherwise junior partners can avoid being labeled a salaried member by meeting one of three requirements: having at least 20 percent of their pay tied to the financial performance of the LP; wielding “significant influence” over the affairs of the partnership; or making a capital contribution to the LLP that amounts to at least 25 percent of their annual salary.

However, legal experts say two of these escape routes are only suited to senior partners. They argue most partners in a firm receive remuneration based on personal or team performance, and significant influence appears to be only available for partners in very small LLPs, or those in an executive committee of a larger partnership.

Legal sources say even partners sitting on the investment committee cannot be guaranteed immunity through the “significant influence” route as HMRC’s guidance says a partner must have influence over the whole LLP, and not just a business unit.