Treasonable thoughts: Are law firms being persecuted by HMRC?

On 5 November 1605, Guy Fawkes was found in the cellars of the House of Lords as he was about to light the fuse connected to 36 barrels of gunpowder. Fawkes, Robert Catesby and the other conspirators had conceived the Gunpowder Plot in response to the persecution of the Catholic minority in England by the new Scottish king, James I.

Watching a spectacular firework display and the burning of the Guy on Bonfire Night, I wondered whether there might a group of disgruntled lawyers rolling barrels of gunpowder into the cellars under parliament. Would there be a modern-day Guy Fawkes striking a match to light the fuse in order to protect a modern-day persecuted minority: solicitors?

You will probably find, like me, that if you tell your friends that lawyers are having a hard time, they simply laugh. But the world around us is changing rapidly as a result of the Legal Service Act. The minister who steered the Legal Services Bill through parliament once declared that her aim was that obtaining legal advice should be as easy as buying a can of baked beans. This has led to alternative business structures of every shape and size challenging the profession.

And now HM Revenue & Customs seems to be going out of its way to make our lives more uncomfortable.

HMRC targets service companies

After minimal consultation, HMRC has undermined the tax structure underpinning the use of service companies and, in effect, brought this practice to an end. Is it odd for HMRC to treat this as a tax loophole when it has spent many years negotiating arrangements for service companies with professional service firms?

Many find it irritating that HMRC did not seem to take the consultation process seriously and instead simply announced on 25 October 2013 that it was closing the door on this practice with immediate effect and would introduce retrospective legislation to enforce its position.

This robust attitude adopted by HMRC in respect of service companies does not bode well for the review of two other arrangements which have been adopted across the profession for some years.

HMRC seeks to redefine partners as employees

Practitioners will know that HMRC has described a significant number of partners in law firms that are LLPs as disguised employees. The consultation paper draws attention to certain characteristics of partners who, HMRC argues, should be regarded as employees. These include the amount of exposure to risk, fixed salaries, role in management and whether or not there is a right to profits or assets when an LLP ceases to trade.

These issues are not new, but HMRC seems keen to cast its tax net wider in order to move more members of LLPs to PAYE taxes and national insurance contributions. Assuming that HMRC intends to pursue this line, I wonder if a problem for many practices will remain a lack of certainty.

How much risk does a member have to accept in order to satisfy HMRC? And, how much involvement in management will be needed to satisfy the test? At what level of capital contribution will the bar be set?

All LLPs, not just law firms, will need to look again at their membership structure. They will have to debate whether they wait for HMRC to make a ruling on their particular structure or whether they decide now to modify the terms of some members so that they are clearly employees or clearly not employees.

For many firms, this will strike at the heart of the practices and structures that they have used to bring on young lawyers by allowing them to join the LLP as junior partners, a stepping stone towards full equity.

HMRC narrows in on corporate members

As part of the now-closed consultation, HMRC also focused on arrangements under which partnerships or LLPs include mixed members (whether individuals or companies), which may create a tax advantage. The main target here seems to be corporate members.

Many corporate members have been created by practices in order to put capital aside in a tax-effective manner for investment. So, a side effect of any attack on corporate members by HMRC could be to decrease investment and restrict growth in professional practices.

Gunpowder, treason and plots

The Gunpowder Plot was driven by members of a Catholic minority who believed that they were being persecuted. Is it now the turn of solicitors to feel persecuted?

What do you think? Are we being persecuted by HMRC or are we just whingers?