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US and UK tax on carried interest
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The LLP SORP contains the following table – but what does this mean in practice?
| Nature of element of a member’s remuneration | Treat as |
| Remuneration that is paid under a contract to provide services to the LLP, which may be referred to as a contract of employment (salaries) | Expense, described as ‘Members’ remuneration charged as an expense’, and deducted after arriving at ‘Profit for the financial year before members’ remuneration and profit shares’ |
| Other payments, arising from components of members’ participation rights in the profits for the year that give rise to liabilities in accordance with section 22 of FRS 102, such as mandatory interest payments (“salary-like” and “interest”) | |
| Automatic division of profits ("automatic") | |
| Any share of profits arising from a discretionary division of profits (i.e. where the LLP can choose never to divide the profits, and the decision to divide the profits is taken after the profits have been made) (“dividend-like”) | Allocation of profit or “distribution in equity” |
This means amounts that members are contractually entitled to receive: the LLP has no choice or discretion to withhold payment.
This includes:
The accounting entry is: DR Members’ remuneration as an expense (P&L), CR Amounts due to/from members (balance sheet)
Where there is no automatic division of profits because the LLP has an unconditional right to avoid delivering cash or other assets until those profits are divided by a decision taken by the LLP, they are shown within equity as an undivided amount available for appropriation (like retained earnings for a company).
Profit allocations or divisions of profits are accounted for in a similar way to equity dividends declared by a company (so are “dividend-like”): when the LLP makes the decision to divide the profits, the reserves are reduced by that amount and the amounts become payable to the members.
The accounting entry is: DR Allocation of profit (balance sheet), CR Amounts due to/from members (balance sheet).
It is also possible to allocate losses however this will result in there being amounts due from members in respect of the losses (so implying that the members would be required to “make good” that loss).
It is possible that a combination of the above may arise: for example, if 90% of profits are automatically divided with the remainder at the discretion of the LLP after year end, the 90% will be treated as an expense and the remainder will remain in reserves at year end and be treated as an allocation of profit in the following year.
The LLP agreement usually states when profits will be divided amongst the members and the timing of this is key to the presentation of the accounts.
Profit allocations can be made in the year that the profits were made or after signing the accounts (i.e. are presented in reserves at year end, similar to retained earnings of a company before a dividend is declared). The entry for allocations of profit is DR Reserves, CR Amounts due to/from members.
If the timing of the cash payments and the accounting profit allocations differs, there may accordingly be amounts due to or from members at the year end.
This is useful to bear in mind when drafting your LLP agreement: if it says profits will be allocated "after the year end" or "when the audited accounts have been signed”, the profits will remain in reserves at year end in the accounts, and there may be larger balances shown as due from members. This can be avoided by allocating profits at interim stages (e.g. in line with drawings taken) or by revising the LLP agreement to ensure profits are automatically or contractually allocated as described above.
Actual cash payments to members are distinct from the remuneration itself. The accounting entry is: DR Amounts due to/from members (balance sheet), CR Cash (balance sheet).
This is offset by the “members’ remuneration as an expense” or allocation of profit accounting entries above.
A cash payment in advance of profits being allocated results in amounts being presented as being owed back to the LLP until the profits are allocated, which may not be until after the accounts have been audited.
Some LLP agreements may say that drawings are not repayable. In that case, there is an immediate interim profit allocation to the member as well (see above).
In short, no.
LLPs are special entities that are accounted for (and have limited liability) like companies but are taxed like partnerships. LLPs are not subject to tax in their own right: any taxable profits are instead divided amongst the LLP’s members and are taxed on the members.
Note that taxable profits are different from the accounting profits. They may be higher or lower as some expenses may be disallowed or some tax deductions such as capital allowances may be made. Members; remuneration as an expense for non-employee members is not deducted when arriving at this taxable profit figure. For example, if my accounting profit after members’ remuneration is £100k, my taxable profits might be £100k + members’ remuneration of £150k + disallowed expenses of £10k = £260k – a very different figure.
In terms of timing, all of the taxable profits of the LLP must be allocated between members and taxed in the year that they arise, regardless of when the accounting profits are allocated in the financial statements or when cash has been paid to the members.
If the LLP has taxable losses, these must be allocated to members for tax, but they do not have to be allocated to members for accounting purposes and can remain in reserves (as long as the LLP agreement allows this).
Anti-tax avoidance legislation applies to LLPs. This includes “salaried members’ rules” which are intended to identify members who should be taxed as employees rather than on a self-employed basis. When setting up your LLP, it is important to understand this legislation to ensure that the tax position of the members is clear.
If an individual member is deemed to be a “salaried member” under tax law, they are subject to PAYE and Class 1 National Insurance contributions (NICs) on their income from the LLP like an employee (and the LLP would pay NIC) rather than being taxed as a self-employed individual.
If a member is deemed to be a “salaried member” under the tax rules, then their fixed remuneration (excluding any discretionary bonus) would be included in “members’ remuneration charged as an expense” in the accounts.
It is very important to note that the inverse is not the case: a member whose payments are included in “members’ remuneration charged as an expense” will not necessarily be taxed like an employee because the rules are different, therefore this accounting presentation will not contradict your tax analysis.
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