LLP accounting: handling remuneration reporting Understanding the membership agreement is critical when accounting for remuneration of members in LLP accounts, says Buzzacott senior manager, Katie White One of the fundamental questions to resolve when preparing the financial statements of a limited liability partnership (LLP) is the treatment of the remuneration of members of the LLP. Consideration of the treatment of members’ pay is of particular importance since, in April 2014, HMRC introduced rules that reversed the previous presumption that LLP members are self-employed for tax purposes. In particular, HMRC is looking at profit share arrangements that are actually ‘disguised salaries’. HMRC stated that the tax treatment of members should not affect their employment status but, in the case of Clyde & Co LLP v Bates van Winkelhof in May 2014, the Supreme Court held that a former partner of an LLP was a 'worker' for the purposes of the Employment Rights Act, which has raised further questions about the status of LLP members. It is therefore important to understand the remuneration arrangements set out in the LLP’s membership agreement, firstly to ensure that the legal documentation agrees with how the remuneration arrangements work in practice, and also to prevent any unintended consequences (whether relating to taxation or otherwise) that could arise from the remuneration arrangements in place. The membership agreement also may not align with the perception of the LLP members themselves, particularly for those who were used to being paid a salary before becoming a self-employed LLP member. They may think of their regular drawings in advance of profit share as a salary, when this is not the case. Once the membership agreement is understood, it is also crucial to account for the remuneration correctly, both to ensure that the users of the accounts are given an accurate picture and also, potentially, because the presentation could be looked at if a challenge is raised by HMRC or under employment law.

Accounting for members’ remuneration Members’ remuneration is ‘any outflow of benefits to a member’. It may include, among other things, salary (and bonuses), interest and an allocated share of the LLP’s profits. The LLP SORP makes a distinction between whether the remuneration is an expense (and charged in the profit and loss account/statement of comprehensive income), like a salary, or is an allocation of profit, which would be analogous to an equity dividend in a company.

When considering the nature of members’ remuneration, it is a common pitfall to think of only the movement of cash. It is not whether cash is paid that is important, but instead it is issues such as whether a member has the right to keep cash received or could be required to repay it to the LLP, or has the right to demand cash which the LLP cannot refuse that are critical to the accounts presentation. It is often helpful to consider what might happen if the member left the LLP – would they have the right to keep the drawings they have taken without any further discussion, or would they have to repay the cash unless the LLP makes the decision to allocate them some profit to match what has been drawn? Remember, for self-employed members, it is profits, rather than drawings, which are taxed, so a member who has been allowed to take cash in excess of his or her profit share leaves the remaining members to pay the tax.

Remuneration paid under an employment contract Where the LLP member has an employment contract setting out a salary, this is treated as ‘Members’ remuneration charged as an expense’ in the profit and loss account (or statement of comprehensive income) and as a liability in the balance sheet (or statement of financial position) to the extent that it is unpaid.

Interest on debt capital and other payments Interest on capital classified as debt must be presented within 'Members' remuneration charged as an expense', (ie, it will be treated as a charge against profits and not an allocation of profits). Where there are no equity participation rights in the profits for the year, it follows that all amounts becoming due to members in respect of those profits must be presented within 'Members' remuneration charged as an expense'.

Automatic division of profits Where profits are automatically divided as they arise or are determined so that the LLP does not have an unconditional right to refuse payment, the amounts arising are liabilities due to members. They should therefore be treated as an expense in the profit and loss account (or statement of comprehensive income) in the relevant year and, to the extent they remain unpaid at the year end, they should be shown as liabilities in the balance sheet (or statement of financial position).

No automatic division of profits Where there is no automatic division of profits, the LLP has an unconditional right to refuse payment of the profits of a particular year unless and until those profits are divided by a decision taken by the members (or a committee of the members to which the authority to divide profits has been delegated); and accordingly, following such a division, those profits are classed as an appropriation of equity rather than as an expense. They are therefore shown as a residual amount available for

appropriation in the profit and loss account (or statement of comprehensive income). Once profits are divided, the amount of the divided profits is treated as an appropriation which is deducted from equity reserves and should not be presented as an expense within the profit and loss account (or statement of comprehensive income). To the extent that any divided profits remain unpaid at the year end, the amount unpaid will be recorded as a liability. Undivided profits remain as ‘Other reserves’ until such time as they are divided.

A combination It is possible that a combination of these circumstances may arise, for example if 75% of profits are automatically divided, but the remaining profits are only divided at the discretion of the LLP, then the 75% will be treated as an expense in the profit and loss account (or statement of comprehensive income) and a liability in the balance sheet (or statement of financial position) and the remainder when divided will be treated as an appropriation in the profit and loss account.

Pitfalls and tricky areas Timing and documentation of the decision to divide profits From a practical point of view, the members must ensure that they minute the decision to allocate profits that are not otherwise automatically divided. When the members wish to show profits allocated as at the year end, it is important to hold the required meeting before the year end and minute the decisions made. Drawings in excess of profits Drawings taken by a member in advance of a discretionary profit share would generally be disclosed in the balance sheet as repayable by the member to the LLP until the profits are shared. Any excess draw over the profit allocated may remain on the balance sheet as repayable by the member to the LLP. The nature of the circumstances where the member would have to repay this must be considered in detail in order to ensure the accounting reflects the terms of the agreement (and also the expectation of the members). For example, would the member have to repay the amount on demand, or would the amount only be recoverable from future profits of the LLP? Treatment of losses Stipulations about what happens should an LLP make a loss are often not included in the LLP’s membership agreement. This may be because, due to the nature of the business model, professional practices would not generally be expected to be lossmaking. Where there is no specific requirement set out in the membership agreement and a loss is incurred by an LLP, the loss should be allocated to 'Other reserves' on the balance sheet (or statement of financial position).

Particular care needs to be taken in these circumstances as losses can lead to complications that extend beyond the presentation of the account. For example, consideration must be given to the circumstances if a self-employed member takes drawings before the LLP becomes profitable, then leaves the LLP. If the member is allowed to keep their drawings, despite there being no profit on which they can be taxed, this could indicate that the remuneration is salary-like (or even a ‘disguised salary’). Furthermore, it could mean that the remaining members have to pick up the tax bill for profits that were previously paid to the former member when the LLP does become profitable, which may leave the other members out of pocket.

Conclusion Unlike companies, LLPs have considerable flexibility over how the participation rights of members are structured. As a consequence of this flexibility, the accounting is subject to judgment, and this can lead to a risk of presenting the financial statements incorrectly. It is therefore not possible to prepare an LLP’s accounts without fully understanding the membership agreement. Accountants preparing financial statements on behalf of an LLP should also discuss the remuneration arrangements with the LLP’s members to ensure that the members’ perception of how the arrangement works is consistent with the accountant’s interpretation of the agreement in place. Discussing the agreement at least annually can also encourage the LLP’s members to revisit their membership agreement and consider if it should be adjusted or clarified, particularly in the light of HMRC’s recent rule changes or to protect the LLP’s members in the case of losses or insolvency. What you need to know: LLP SORP versions The treatment of members’ remuneration is set out in the Statement of Recommended Practice Accounting by Limited Liability Partnerships (LLP SORP). The current LLP SORP was issued in March 2010, however a new LLP SORP, updated for the new UK GAAP, was released in July 2014 and is effective for accounting periods beginning on or after 1 January 2015 (or earlier, if the LLP chooses to early adopt FRS 102, The Financial Reporting Standard applicable in the UK and Republic of Ireland). The LLP SORP 2010 and LLP SORP 2015 do not differ in their treatment of members’ remuneration other than an update of references to UK GAAP, so the guidance in this article applies for both versions of the SORP.

LLP SORP treatment of members' remuneration Nature of element of a member's Treat as remuneration Remuneration that is paid under an employment contract (1) Other payments, arising from components of members' participation rights in the profits Expense, described as 'Members' for the year that give rise to liabilities in remuneration charged as an expense', and accordance with FRS 25 and UITF deducted after arriving at 'Profit for the 39/section 22 of FRS 102, such as financial year before members' mandatory interest payments (2) remuneration and profit shares' Automatic division of profits (3) Any share of profits arising from a division of profits that is discretionary on the part of the LLP (ie, where the decision to divide the Allocation of profit profits is taken after the profits have been made) (4)