Doctors, lawyers, accountants, fund managers, and other high earning professionals are often members of partnerships and LLPs. They’re not employees – and so there’s no 15% employer national insurance. This creates a big tax saving. The Times is reporting that Rachel Reeves is considering changing this – and that it could raise £2bn.1
UPDATE evening of 22 October: The Times is now reporting that, to avoid hitting GPs, the change would be limited to LLPs and would not affect general partnerships. That would be a serious error which would create unfairness and economic distortion, and open up avoidance opportunities.
Taxing people differently just because of their choice of legal vehicle is irrational – and there’s certainly a principled justification for equalising the position.2 It also achieves the political aim of mostly affecting only high earners – around 0.1 % of taxpayers receive 46% of all partnership income, and 98% of the tax raised would come from the highest earning 10% of taxpayers.3
But it’s not without political cost – more reasonably paid professionals (like GPs) would also be affected: the average GP who’s a member of a partnership earns £118k, and would see their take-home pay fall by about £6k (although some of the tax revenues raised by the new measure could be used to fund an increase in GP pay).
The response of those affected, and the impact on tax revenues and the wider economy, is hard to predict. There are also practical problems, and fairness issues around where precisely the line would be drawn.
This is certainly something any Chancellor should consider – and there may be ways of squaring the circle, and raising revenue without hitting GPs or creating a series of unfair new anomalies.
The think tank/academic group CenTax published a detailed report in September analysing HMRC data around LLP/partnership taxation. The £2bn figure comes from their report – which I highly recommend. Note that their data is from 2020 – so realistically all the figures should be uprated by around 15-20% for inflation/wage growth.
The figures
This calculator shows how much additional tax would be paid by a partner if the most straightforward version of the proposal were adopted. It also shows how much of that additional tax would be saved if the partnership incorporated. The calculations are local to your PC/phone, and nothing you type is sent over the internet.
There are worked examples in this spreadsheet.
This is all very much a quick approximation, and it doesn’t take the many complicating factors into account.4 Please don’t rely on it for anything more than an illustration of the impact of the proposal.
The current situation – the doctors
When someone is employed, their employer applies employer national insurance to their pay packet. So, for example, if a hospital has £118k to pay its doctors,5 about £16k comes out immediately as employer national insurance. The doctor only ever sees the remaining £100k – and of course pays income tax and employee national insurance on it. He takes home about £70k.
The doctor never sees that missing £16k, and might be completely unaware of it – but in the long term, evidence shows that he’s paying it (because it reduces his wage).
Now imagine a doctor who’s a “locum”. They’re often (but not always) taxed as self-employed. There’s no employer’s national insurance. So the doctor is paid the whole £118k. She’s paying more income tax and national insurance (because of the higher gross pay), but ends up taking home around £76k. Our locum is £6k better off than an employed doctor.6
Let’s take a third category – a GP. The £118k figure I’ve been using comes from the CenTax report – they estimate it’s the average earnings of a GP who’s a member of a partnership.
Most GP practices are set up as partnerships. A traditional partnership is just people working together in business, but many GPs use a more modern entity, a “limited liability partnership” which behaves like a company in most respects but is taxed like a partnership.
A member of a partnership isn’t an employee and (usually) is taxed in the same way as someone who’s self employed. So a GP will be taxed in the same way as the locum. No employer, and overall she’s £6k better off than an employed doctor.
This is a very irrational result.
It looks more irrational when we get to very highly paid professionals.
Highly paid partners
Most of the £2bn revenue comes from people earning far higher amounts than the £118k received by the average GP. Around 0.1 % of taxpayers receive 46% of all partnership income.
This is from the CenTax report:
Not shown on this table are much less profitable partnerships such as farm partnerships. CenTax proposes an allowance or exemption that prevents them being affected.
The greatest number (but not the highest earners) are solicitors. CenTax reckons the average income of solicitors who are partners/members of LLPs is £316,000.7
A solicitor whose gross income is £316k currently takes home about £180k. If his income was subject to employer national insurance, he’d take home £158k.8
This is a very big difference. His effective tax rate (i.e. overall tax divided by overall income) has gone up from 43% to 50%. His marginal tax (i.e. the % tax they pay on the next pound he earns) has gone up from 47% to 54%.9
We see more dramatic effects if we go to the largest law firms, where many partners earning well into seven figures.
A partner earning £2m currently takes home £1,072k. If employer NICs applied, she’d take home £934k – meaning £138k more tax. Her effective tax rate has gone up from 46% to 53% and her marginal tax rate is now 54%.10
This puts our £2m partner in the same position as (say) a trader at a bank where their salary and bonus pot are together £2m. Previously she paid less tax; now she pays the same.
An important point: the reason law firms are usually structured as partnerships is history rather than tax. Until relatively recently, solicitors were required to practice as partners or sole practitioners. Firms weren’t able to become companies until 1985. Even today, most of the big firms aren’t in practice able to incorporate because, whilst it would be permissible for their English lawyers, it’s not permitted for many of the foreign lawyers they practice with.
Similarly, auditors (and thus many accountants) historically had to structure as partnerships, and still do in some countries.
However many professionals absolutely do structure as partnerships for tax purposes. Most fund management businesses – private equity and hedge funds – are structured as LLPs rather than companies. The main, and perhaps only, reason for this is tax. Other businesses are in the same category, e.g. some estate agents and architect firms.
According to CenTax, the average member of a financial services partnership earns £675,000. There will be some earning ten or twenty times this figure. Someone earning (say) £6m would pay £414k more tax if employer national insurance applied to their pay.
The arguments for and against
There are several obvious arguments in favour:
- If the Chancellor is to stick to her fiscal rules then, absent very large spending cuts, she needs to find additional tax revenue. This is a relatively easy way of taxing high earners.
- It’s in principle correct that everyone who makes their living from work should be taxed the same way.
- This are complex rules to stop people disguising employment as LLP membership. Those rules could now be abolished.11
CenTax estimated that imposing employer national insurance on partnership members’ pay would raise around £2bn. Their analysis seems sensible to me – although it’s based on 2020 numbers so the figure today would be around 15-20% higher.
There are, inevitably, several arguments against.
Consistency – LLPs
The second Times article suggests the measure would only apply to LLPs, and not traditional partnerships. That seems hard to justify. One of the most profitable law firms in the country is structured as a traditional partnership, not an LLP. Can it be right they pay less tax because of this historical accident?
The original CenTax proposal looked at taxing partnerships generally; restricting any change to LLPs would be a bad mistake. Any rule which doesn’t apply to all professional tax-transparent vehicles will be unfair, economically distortive and – inevitably – gamed. We could expect large-scale avoidance, as firms seek to convert into either general partnerships or (more likely) foreign entities that have many of the benefits of LLPs but aren’t subject to the new tax rule. If ever there were sectors willing and able to structure their way out of a tax they don’t those sectors would be it’s accounting firms, law firms, and fund managers.
The more general consistency problem
More fundamentally: some lawyers practice as individuals. They wouldn’t pay employer NICs. That seems odd. If LLPs/partnerships result in much more tax than sole traders, we’ll (at the margins) see some people breaking away from firms to set up on their own. And some sole traders that would have gone into partnership, won’t.
What about barristers? Junior barristers at leading commercial barristers’ chambers can earn up to £360,000 in their first year. Some senior KCs earn ten times that. Barristers aren’t (usually) members of partnerships; but it’s hard to see why a barrister who earns £2m should pay less tax than a solicitor who earns the same.
This becomes quite hard to fix unless employer national insurance (or something equivalent) is applied to all the self-employed (and see further below).
Behavioural response
It’s easy to calculate the “static” revenue from a tax change – it’s just multiplying numbers together.
Estimating the actual revenue is much more difficult, because you have to take into account the “behavioural response”.
Here there will be several:
- Some people will move from LLPs and partnerships to become self-employed consultants (and escape the new tax). Sometimes this would be real. Sometimes this would be artificial avoidance – one could imagine a GP practice or law firm splintering into multiple “consultants” all claiming to be self-employed. New anti-avoidance may be required on top of existing rules.
- Large law firms practice all over the world. In many cases it’s possible to do much the way work in Dubai as in London. So (at the margins) we will see some members of these firms move from London to Dubai to escape the tax. And not just Dubai – for various reasons, lawyers in many European countries pay lower tax than lawyers in the UK.
- Some people will work less, because they are less motivated. Conversely, others will work more, because they need to work more hours/years to earn the same amount.
- Some firms will restructure into companies. The partners/members will become shareholders. On the fact of it this saves just a small amount of tax – my calculations suggest an average GP could save £3k, and even a £2m law firm partner would save only £13k. However in practice it may save more than this, as the companies could retain and reinvest profit. That may even have business and economic advantages.12
- And another response that won’t impact revenue: we should expect some of the incidence to be borne by firm employees, e.g. with employed lawyers receiving smaller pay rises than they otherwise would. Some of the incidence may be borne by clients, in the form of increased fees.
CenTax used historical “elasticity” data to estimate that imposing NICs on partnerships would cause a loss of tax revenue equal to about 20% of the “static” estimate. That feels in the right range.
The question is whether there would be a wider impact on UK law firms, fund managers etc, beyond just the loss of tax revenue, and perhaps a wider impact on the City and the economy as a whole. I don’t know the answer to that.
Complication
There will be, inevitably, complications in how this works. For example:
- Some of the return received by partners represents remuneration for their labour. Some is a return on capital. There would need to be some mechanic for differentiating between the two, without allowing people to over-allocate their remuneration to a capital return. The return on capital is currently usually quite small; that in part may reflect low risk, but may genuinely be less than it should be.
- Many of the largest law firms are single partnerships/LLPs, with partners/members all over the world. The new rules would have to only apply to distributions to UK partners/members – and sometimes particularly for US firms) the distributions are significantly of foreign profits which are taxed abroad and not here.13
- Fund management LLPs often stream fund returns as well as what is realistically labour income. Differentiating between the two may not be straightforward.
How a messy compromise could produce a principled result
I am not very good at politics, and try not to make political predictions.
That said: it seems to me there are likely to be few people opposed to the idea of increasing the tax of millionaire lawyers. There may be rather more people opposed to the idea of increasing the tax on GPs. A £6k cut in take-home-pay is likely to go down badly with GPs, particularly when compared with the (net) £2,000 increase they received from the most recent pay deal.
That raises obvious political questions: but exempting doctors from any new rule would be unprincipled. The Times is suggesting that might be the direction the Government is going, but that would be a serious mistake (for the reasons noted above re. consistency).
A better answer, suggested by CenTax, is for central Government to increase GP pay, funded by the new tax measure.
Or a more principled approach – and one which avoids revisiting the doctors’ pay deal – would be to create a per-partner/member exempt amount, set at a level so doctors pay little or no additional tax.
If the exempt amount were set at the average GP partner pay of £118,000, I estimate this would reduce the yield from about £2bn to about £1bn (calculation on the second tab of the spreadsheet).14
That kind of messy compromise could actually prepare the way for the most principled change of all: applying employer national insurance to all forms of work, employed and self employed. That’s clearly out of the question (at least politically) if we’re talking about the moderately paid self-employed (e.g. tradespeople). But if it’s done with an exempt amount, then suddenly it seems more realistic. We could apply to other forms of income too, such as rent.
And all this has the laudable side-effect of dealing with the consistency problems identified above. It might even pave the way towards abolishing national insurance altogether – the first step towards abolition is ensuring that everybody pays it.
Obvious disclosure: I was a partner in a large law firm. I have no economic interest in any law firms today, but it goes without saying I am going to be influenced by my background.
Front page © News UK / The Times, and excerpted for purposes of criticism and review.
Footnotes
This is just the latest in a long series of articles reporting on Budget speculation. The speculation is damaging and I wish whoever in the Government is responsible for the leaks would stop. ↩︎
Historically, many people have justified the lower tax on self employed and partners by saying they take more entrepreneurial risk than the employed. That is sometimes true – but not always. An employee in a small start-up is probably taking more entrepreneurial risk than a partner in a large accounting or law firm. And someone starting up a new business through a company will usually be taking much more risk – but their overall effective rate of tax (corporation tax and income tax) is usually much higher than that of a partner in a firm. ↩︎
See page 3 of the CenTax paper. ↩︎
Such as: student loans, childcare subsidies, pensions, return on capital – there are many more. ↩︎
Of course I’m simplifying; there are many other costs of employing people, not least pensions – but the conclusions are the same even if we cater for all the real-world complexity. ↩︎
It’s a surprisingly small difference, given that before tax she was £16k better off. The reason is the high 62% marginal rate on earnings between £100k and £125k. ↩︎
Obvious point: this is not the average earnings of solicitors – most solicitors aren’t partners. ↩︎
That’s because he is paying for the employer national insurance – it reduces his gross wage. You can see the calculations in the spreadsheet. ↩︎
A pedant might say that the employer national insurance isn’t his tax. That’s true in a pure legal sense – it would be the partnership paying the tax. But realistically, and in economic terms, it absolutely is the tax of the partners. ↩︎
The real rates may be higher than this – law firms often have significant non-deductible expenses, which tend to increase the effective and marginal rates beyond what one would expect. ↩︎
On the other hand there would need to be new rules differentiating between professional partnerships and other partnerships, e.g. passive investment partnerships. ↩︎
As partnerships/LLPs can’t reinvest profit without creating “dry” tax hit for partners. ↩︎
One solution might be to make the tax apply at the level of UK resident partners/members, so completely differently from normal employer’s national insurance. ↩︎
The disadvantage is that partnership is still a tax saving for people earning less than £118k. ↩︎
47 responses to “The £2bn lawyer tax – should Rachel Reeves tax LLPs?”
Hi Dan
Your article seems to focus mainly on lawyers but I think the centax report misses an important nuance of the behavioural response of a tiny number of people (mainly the partnerships from the finance community)
Figure 3 on page 26 suggests that approximately 6% of partners will account for 58% of the revenue raised. Taking N as 191,000 as suggested implies 11,500 partners picking up an additional tax bill of approximately £1.1bn tax bill or approximately £95,000 per person and implying that these partners earn around £1.35m per year each.
What’s not stated in the report is the concentration of taxpayers at the very top end. In 2024, for example, just 60 taxpayers paid £3bn in income taxes. (source bbc https://www.bbc.co.uk/news/articles/cqlvggr9qz5o). How many of these were in partnerships, and what % of the £3bn did they contribute? The £3bn figure is likely skewed again so that a handful of people are contributing the majority of that figure. It may seem stunning and I think the report could be made more granular to illustrate the incredibly small number of people who are paying the majority of partnership income.
Obviously the behavioural response of a tiny minority becomes much harder (versus a large group) to predict and significantly exposes the tax raising thesis because if just 30 partners earning a total of say £1bn leave (or alternatively don’t choose to work here in the first place because tax rates are uncompetitive), this would immediately lose £500m of revenue without accounting for the lost revenues of the people they employ or ecosystems they create etc etc.
The numbers provided here might at first seem fantastical (30 people earning £1bn?!), but are backed up by the aforementioned bbc article and a quick google on hedge fund partnership pay.
Do you know if it’s possible to evaluate more granular detail? The report does seem to have very good granularity so does indeed seem like it could go further.
I think that in the USA this issue does not arise because those who are self-employed are generally responsible for both employee and employer contributions (called FICA or social security contributions). Of course, it helps that in the USA employee and employer contributions are each approximately 6.2% of earnings – up to the maximum cap of $170k. (Compared to >13% for each up to the cap of $65k in the UK).
And all because the government will not combine income tax with NI….
Your calculator ignores the impact of a company needing to pay a salary to the former members of the LLP. Whilst many contractors just pay themselves £12,500, this would not work for professionals. This impact means a Ltd company would still be worse
One does have to wonder whether in the not too distant future, with the AI revolution well under way, we will marvel that we charged NI as an extra cost of employing a human. As you suggest it is politically very difficult to amalgamate IT and NI, but it might be that soon we will have to incentivise employing staff vs machines rather than charging NI on the employer. Other than that, you can see the logic in extending employers’ NI to partners (except that they have a material risk with the business compared to employees).
It is not clear if traditional partnerships (such as one of the biggest in the City where I used to work is) or just LLPs would be included (or sole trader lawyers as I am (solicitor) or indeed plumbers (plenty of whom earn more than many solicitors) and cleaners). Perhaps there will be a de minimis profit level below which it will not apply to anyone.
Employer NI was originally capped, just as employee NI was until we added an upper uncapped 1% and after the now 2% upper NI rate. So it did not much matter who was paying it as it was a relatively small sum. I would prefer we abolished employee and employer NI and merged it into income tax as the modern “fiction” of contributory benefits is confusing and complex.
An LLP can be two people with no employees at all or a huge enterprise. It is going to be hard to be fair if this proceeds. My sole trader upper marginal rate of NI is the same 2% PAYE employees pay but I did not have SMP when I gave birth. I have never had sick pay. I have no employer pension contribution.
I think this emphasises yet again that if you want a “perfect” tax system then you have to create it perfect on day 1. Any attempts to change existing systems, even on grounds of fairness, always run into the fact that changes will create winners and losers. Then you have to try to cope with all those behavioural changes. I don’t really envy anyone the job.
Not all partners are millionaires; in fact, the vast majority are nowhere near (articles tend to focus on the top end of the equity at Magic Circle and US firms, which represent a very small proportion of the overall group). For many, this unexpected tax reform will have a very substantial and deleterious effect on their familial finances, with even low to average earners having to pay hundreds more in tax per month. I would hope that any moves to implement these proposals will not be taken for some time (FY27/28 at the earliest) to give affected people time to plan accordingly.
Will we see service companies being set up, partly justified by non-tax considerations?.
It would be interesting to know what issues might arise from this approach.
If a uniform tax position were applied across all GPs regardless of their employment/work status (and assuming that drove the behavioural change on fees that you describe), you’d soon find locums just disappear. Why would someone accept working without full employment rights, paid holiday, sick pay etc. if they’re no longer getting any financial benefit? Given the current strain on GP resources that seems an entirely self-defeating exercise to me.
The same is true with partnerships – Starmer made lots of noise during the election campaign about wanting to do away with GP partnerships and bring everybody under direct employment within the NHS umbrella, partly due to the perceived leakage of costs (including, presumably, tax). The response from GP partners that I know was almost universally that they would immediately shun all of the extraneous management activity they currently just naturally do as an LLP member that they would no longer need to do (nor be paid to do) as an employee – without that financial incentive, but simply, why would you bother? It’s not as if it is highly paid relative to the level of skill or the stress of the job.
So, we are left with needing to exempt doctors in some way. The second you do that you rather destroy the principle on which you set out in the first place. I agree a de minimis might work but to use your example, even assuming no behavioural change that appears to halve the tax take to £1bn/yr – would it really be worth such a massive upheaval of professional services in the UK for that? I am not convinced.
Finally – a point which I don’t think you made – given all e.g. law and accountancy firms would be affected (bar the odd one if it’s not also applied to general / foreign partnerships), surely this just leads to (another) significant inflationary event in the market for legal / other professional advisory services?
I was a GP partner and did towards the end , when I was senior partner and sorted out the finances of the partnership, very successfully remunerated . However as a vehicle to improve primary care it’s a disaster as we would take whatever fad NHSE came up with and tick all the boxes but kept the profits. We provided good care but if the doctors had been salaried by the local trust I suspect more could have been done for the money. The counter argument is of course that GP’s are the only are of the NHS in the last few years to increase their productivity , albeit patients prefer seeing doctors not PA’s . As I am semi retired I am now salaried at the local DGH and much less stressed as a consequence!
Another messy bolt on to address an anomaly in the tax system that will have significant behavioural consequences The extra fees accountants may earn in putting in place more messy mitigation strategies for their clients will offer partial compensation to them . Doctors will have another reason to strike. I am a retired professional who enjoyed the heady sayings of unlimited pension contributions , minimal self employed nic rates and lower rates of income tax . That I saw this as a reward for growing an entrepreneurial business with capital at risk and in a worse case scenario personal bankruptcy . When will we ever get to the only real solution a tearing up of the existing tax system and starting again with one simple set of rules for all.
It seems like the Chancellor will be fishing around to raise taxes from wherever they can be raised on an ad hoc basis, until there’s a public outcry and they lose even more political capital, conduct a focus group and reverse the policy. The notion of taxing GPs more when there’s a crisis of recruitment and retention is extraordinary. How about some holistic tax reform :
1/ get rid of stamp duty for anyone over 65 who sells and buys to downsize their property.
2/ streamline tax by amalgamating income tax with NICs : 32% and 42%.
3/ introduce a Superannuation scheme similar to Australia with mandatory employer contributions. Australian funds are giving a 10% annual return.
4/ introduce widespread road pricing tolls in anticipation of losing excise revenue when EVs reach critical mass.
Hi Dan, Thank you for reporting on this. It would be good to see measures that equalise the tax everyone pays regardless of employment structures. Maybe it’s too simplistic but I wish that a government would be bold enough to abolish employer/employee NI and replace it with increased income tax. This seems to have so many benefits from equalising earned/unearned tax rates, ensuring everyone pays tax at the same rates regardless of employment structure, eliminating the need for so many measures that try to prevent tax avoidance, and allow everyone to see the true rate of income tax they actually pay.
Will be interesting to see whether international firms put the whole of this additional tax charge onto their UK parters.
got to assume it’s only UK profits that get taxed
Chat GPT says that where the profits are generated is irrelevant, so UK partners at a US law firm (for example) will still see tax rates increase from 45% to around 55% even if 99% of the firm’s profits are generated in the U.S. What do you think Dan?
that must be how it would work – partners resident in the UK suffer employer NICs on their income… wherever it comes from.
Gosh…effective tax rates of 52-55% [on top of VAT on school fees]! HK/Dubai getting another influx! And the Tories (gulp) coming back into power…
Agree it will only be UK profits subject to the tax, but I think C Bevan point / question is that it will be interesting to whether for firms that aggregate profit from multiple jurisdictions before allocating to partners via a points system, whether all partners (UK and elsewhere) share the UK E/er NI cost as a cost of business in the UK OR whether this is seen as a personal cost of the partner.
Yes, sorry I could have been clearer. What I mean is that employers NICs are an expense of the business- profits of the whole LLP will be lower as a result. It’s presumably open to a firm to decide for itself who actually bears the cost- whether it’s deducted from each of the UK partners’ profit share (so partners overseas are unaffected) or whether to stick to how profits are currently shared (so that every partner in the firm takes a hit because they’re getting the same proportion of a smaller pot).
I am an LLP member and tend to regard my profit share as a weird mixture of payment for work and return on investment. Through that lens I find it harder to follow all of the propositions in this piece and the CenTax report. We don’t tax investment income and work income in the same way (actually the targets of this policy would pay more tax on profits from a company than they do today on their draw from an LLP, factoring in Corp tax and top rate div tax).
LLP members are not regarded as self employed merely by virtue of their status, they must also demonstrate to HMRC that they have sufficient capital at risk. This is a big difference when compared to employees. If the business fails, we can’t walk away like an employee, we lose that capital. Though our risk exposure is a lot lower than in an unlimited partnership, it can still be a lot of money; enough to bankrupt many.
I suspect that it will make LLPs look very unappealing and would result in a big incentive to sell firms to external funders, given that the tax incentive to take capital gains over income. That could bring uncertainty to the legal sector which may not be welcome.
I’ve some knowledge of how similar questions are dealt with in Sweden. There, partners’ income can be paid as both salary (which can vary year to year and declared afterwards) and profit, with the salary portion being liable to the social security contribution and local income taxes as an employee would pay and the profit being treated differently. The business as a whole can only pay profits to partners to a maximum which is determined by the amount of salary it pays.
That system has its own pros and cons (including a limit on the number of partners for the best tax position, which is clearly distortionary). It also reflects that Sweden tends to tax company profits more lightly than salaries. But the principle seems sounder to me.
Well put, Simon. Just out of interest, when we’re having this discussion about behavioural changes, one should take account of behavioural responses to the existing system, which has been with us for years. Perhaps law firm and other partners get a better deal, but perhaps that encourages them to take on more staff, be less stingy with costs and plough more money back into the economy. Perhaps they’re less focused on replacing employees with AI and the rest of it. Our creditors will force it on us sooner rather than later but when are we going to debate root and branch of our mediocre public services. When will we get politicians who are seriously wedded to reform and value for money for the taxpayer and with sufficient moral courage to push it all through?
I didn’t get into the whole AI thing but clearly that is another driver towards external capital at the moment. LLPs seem to me to be a genuinely good vehicle for a business based on human capital that needs to be able to seemlessly change with the generations. AI won’t change that completely but it is shifting the model towards extra investment and external ownership. And shareholders won’t like spending on extra associates if they aren’t strictly needed. So maybe you are right!
As an aside, I answered a question from an American friend earlier about how to tip on his trip to Scotland. It immediately got me thinking about NI on gratuities (funny that). I know we aren’t as likely to attract public sympathy as might restaurant staff but their employers benefit from that arrangement too. The singling out smarts!
GP partnerships traditionally contract with the NHS via General Medical Services (GMS) and my understanding, as a former GP partner, is that GMS partnerships are not allowed to be limited liability. GMS accounts for the majority of GP practices in England and, I think, 100% of GP partnerships outside England.
Unless I have missed it, you omit that the calculation of taxable profit for partners is different to commercial profit, so that disallowable costs for tax purposes already drive up the effective tax rate by 3-5%. Applying Eer NIC at 15% would result in an effective tax rate of c 68%, clearly counter productive if you believe in the Laffer curve. Even 8% would take it to c 61% tax. As Laffer shows, there comes a point when it is destructive
And we should not drive tax rates up to the tipping point, for at that point the economy is already in decline.
thanks – yes, I was keenly aware of the disallowable cost point when I was a partner! It’s referred to in a footnote.
I work exclusively with SME law firms. So worth noting that (and as per the law society’s own data) the average law firm partner earns more like £120k. So the same logic applied in the article to smaller GP firms would actually apply to most law firms too – hence a threshold in/around the existing income tax additional rate threshold would help ease the pain for smaller firms.
It’s long been the case that being a smaller Ltd co law firm is more tax efficient (roughly worth £5k per partner) hence why 1000s of smaller firms have made that change in recent years. So being LLP is already often a decision not made for tax reasons.
that may be the median, but CenTax’s data analysis shows the mean is £360k
I agree that the difference is almost certainly between mean and median. The law society(helpfully) does also disaggregate its data. So for example in law firms with T/o <£2m median partner income is £106k. But to be clear that <£2m threshold represents nearly 8,000 firms or about 85% of the total. In short – there are some spectacularly paid City square mile lawyers and (very literally) 10,000s of high street lawyers earning nothing even close to that.
I’ll throw a couple of thoughts into the mix.
I suggest that where the main source of income for members of an LLP are the taxpayer, i.e. GPs, then it makes little sense for the Gov’t t give with one hand and take with the other. I accept that simply cutting the taxpayer funded contribution to GPs is unacceptable politically. Perhaps therefore an exemption to the claimed plan for taxpayer funded LLPs is called for?
Second, whilst law and accounting firms are organised as LLPs, so are many (many) hedge funds and companies on the fringes of the financial world. So are many tax avoidance vehicles. These would be political targets for a centre left Chancellor and perhaps risk free in terms of the voting electorate.
Many hedge funds these days have offshore connections (Malta is popular) but still generate much of their turnover from the London markets. Would we support taking a chunk of money from such beasts? I suspect that many would.
The article ends with the comment that obviously having the same NIC/tax regime for all people would solve this issue but that it’s out of the question for moderately paid tradespeople. I don’t believe you can be saying that if historically we’d had a universe in which all tax was the same and we’d never had these differences between employed and self-employed NICs – perhaps because NICs had never been separated from income tax – then everyone would be clamouring specifically for income tax breaks for the self-employed, even if there were other forms of relief for such they could be calling for.
I agree. I should say “politically out of the question”.
The FTT is saying that it’s all partnerships, not just LLPs (and as you say, that’s what CenTax proposes too).
The interesting questions for me are:
(1) What happens to corporate members? Presumably corporate members of JVs shouldn’t suffer NICs, but also presumably it wouldn’t work for me to incorporate a company to hold my membership interest in an LLP.
(2) We’ll need some sort of exemption for funds, many of which are structured as LLPs, and even more of which are structured as LPs. Otherwise there’s a 6% to 9% additional tax charge in every UK fund which is presumably fatal to the funds industry.
(3) Will there be an exemption for carry, or will the carefully negotiated 34.1% carry rate now jump up to 40%?
(4) The territoriality is interesting. Should a UK partner in a foreign LLP pay UK NICs on foreign income of that LLP? Should a foreign partner in a UK LLP pay UK NICs on UK LLP earnings? The analogy with employer NI quickly breaks down.
I was slightly confused by CenTax’s suggestion that it was impossible to levy the proposed partnership NI on partnerships directly because they are tax transparent. Of course, most professional firms do pay employer’s NI themselves anyway, so why couldn’t they just pay the new tax directly rather than have this attribution to members?
This was urged on the the Chancellor just after the election in July 2024 and the Centax report misses the point that was made at that time that the simple solution is a “small business” exemption.
Dan
You don’t mention:
•equity partners put in capital. Often meaningful amounts. Employees don’t.
• law firms go bust and partners lose all their capital.
• equity partners get paid their profit entitlement up to two years after the profit is earned. Employees get paid from day one.
• when there is a cash flow crisis partners drawing are even further pushed back whilst employees are paid.
• partners might be in a foreign partnerships and paid by that foreign partnership.
• the effective tax rates for the self employed law firm partner is materially higher than 45% because of disallowed business expenses.
Whilst I agree with much of what you say and reform is necessary it is not straightforward if principles of equity are to be applied.
this is all true for entrepreneurs setting up startups. They take much more risk than your average BigLaw partner. Yet they pay much more tax on dividends/employment income.
One point missed in the article is that partners in legal and other firms do not receive the benefits of SSP, SMP, depending on the partnership agreement they may not get paid holidays and they are not protected by HR laws in connection with termination.
I act for many in the medical profession and I agree that adding employer’s NI to the taxes doctors pay would potentially be disasterous. This year alone we have lost doctor clients to USA, Australia and Canada. They have gone for better conditions, better pay and in some cases more respect. Generally doctors are not in a happy place at the moment.
One of the most common complaints I hear about is the tax band of 60% in England and Wales and 67.5% in Scotland for earnings between £100K and £125,140. This makes many of them restrict their precious services to 3 or 4 days a week to stay below £100K.
In my opinion if we have to have it, the loss of personal allowances should be spread over a much bigger band, say between £100K and £200,560. By doing this, the tax rate will be slightly increased but there will be little incentive to cut hours to save 2% or 3% more tax. We also see people making pension contributions they can’t really afford to reduce their income below £100K. This also results in the Treasury having to pay more into pensions that they would otherwise do. I know for sure that most of the clients earning up to £150K a year would be far less bothered about maximising pension contributions if it wasn’t for this cliff edge tax. This in itself would save the Government the credits to the pension funds and would leave more money in people’s pockets to spend and keep the wheels of other businesses turning.
Any tax rate which exceeds 50% is an immediate barrier to people doing more work. A Scottish friend of mine refuses all overtime and keeps his wages just below higher rate tax. The reason is that when he earns between £43,662 and £50,270 he faces tax at 42% and NI at 8% which is in his eyes 50% tax. This means he earns less per hour in his hand on overtime than he does for his normal hours taxed at basic rate.
Higher taxes are leading to less productivity and an unwillingness to work and we have already reached that tipping point. There needs to be a bit more constructive thought given to tax rates and bands to provide the incentives for people to work harder and longer and feel they are getting the rewards of their work, rather than being punished.
My final word on your article: if everyone including sole traders are going to have to pay employers NI (bit of an Oxymoron) then why not scrap employer’s NI and just make it all employee’s NI. This would also remove the requirement for IR35 legislation which has been hugely damaging despite what HMRC might argue (On HS2 who is paying for the people who were previously working through their one man/woman service companies, grossing perhaps £100K, who are now on salaries of c£150K with paid holidays, paid sick leave, pension contributions etc etc? I think that will be the taxpayer so not much of a win there).
All LLPs and partnerships would disappear if you did this. Members combine earnings as “employees” and profits as companies. If the tax rate on retained (undistributed) profit is much higher the corporation tax rate, all firms will have to become companies. GP practices are not a good example because the profit is artificial due to the way NHS payments work, creating a “salary”. Large professional firms may be the same, but where partner “earnings” are genuinely the variable profits of a business the need to be taxed as such.
A likely behavioural response not listed would be for [ accountancy and law firms at least ] to increase the charge out rates for themselves and their staff to maintain the partnership profit.
Which would I suppose increase the tax take !!
Do you believe the Chancellor has considered the tax incidence of the policy that it may well result in one of lower salaries for employees and therefore the lower employers NIC on those, or higher prices for clients, resulting in lower taxable profits for them.
And how do square your silence on this point when an LLP member yourself?
And you can’t use the example of a GP when claiming it is irrational that LLP members are not taxed like employees. GPs are in effect state employees with the benefits and protections employment offers. LLP members are not. What was your statutory holiday pay/parental leave rights when a member at CC for example?
Thanks Dan. I also declare an interest as a (current) partner in a law firm – but will start by saying that I broadly agree with the proposal to equalise taxes irrespective of the legal vehicle through which businesses operate. However, a few points of detail:
1. It is worth remembering that many professional service firms will just have faced paying tax on 23 months profit all in one year due to basis period reform. This will (at minimum) have resulted in a big cashflow hit to many businesses. It might be nice to give us a year or so’s grace before hitting us with another big tax increase.
2. You hint at the dry tax charge from reinvesting profits. Yet all LLPs will need to have done this to fund working capital. In my own case I have around £400,000 of capital in the firm, much of which represents £750,000 of profits which have already paid tax, but which I will not see until I eventually retire. Had I had the opportunity to reinvest having suffered only 25% corporation tax, the compounding effect (over a 30 year period as partner) would be significant.
3. Doctors can make significant pension contributions (or rather have significant final salary pensions built up for them) tax free. By contrast your average partner in a law firm (on Centax’s figures) will be capped out and can put far less into a pension. If we are going to iron out anomalies then this should also be one of them.
4. And it would be quite handy if our profits were taxed 9 months after our actual year-end rather than 9 months after the end of the tax year.
This isn’t intended as a special pleading. Just to say that if we are going to remove anomalies then there are others to iron out too.
I wonder why most lawyer who are members on an LLP put slightly more than 25% of their “salary” in as a capital contribution of the LLP. Not 20% or 24.9% but slightly more? It does feel quite strange that almost all the law firm partners? Is it because putting this a Goldilocks level of capital in it gets them out of paying employer’s NIC? Goldilocks because it is not too much commercially and not too little tax wise?
If the government does make this change, (which I would support as I do not like hidden tax subsidies) then it also needs to decide what to do about non-UK partnerships with limited liability that practice in the UK. How many websites of “UK” law firms have a footer that says something like “Overcharge & Partners LLP, which is formed under the laws of the State of Delaware in the United States and authorized [sic] and regulated by the Solicitors Regulation Authority with registration number xyz”.
Also some UK law firms have corporate partners that allow profits to be funneled to the partners of the US firm without paying the same level of income tax (UK CT rather than UK IT). Should that be changed too?
What about those firms where the UK lawyers get £100 of their profit share from the UK firm and the remaining £4,999,900 from the US firm. The UK guys are partners of the US firm but don’t work in the US. The US firm, they say, does nothing in the UK. They say hat no UK NIC is due on the £4,990,000 because, well, they don’t want to pay NIC and forget what the US firm actually does in the UK.
I would expect a lot of dynamic effects. From the simple (does salary sacrifice for pension contributions work now), through incorporation (CT rates on money retained in the business rather than income tax on all profits) and succession planning (incorporate, sell to an EOT and take what is economically the pay for the next five years and pay it tax-free through deferred consideration).
I think you are demonstrating that you do not understand partnership tax.
Capital at 25% was in response to the (imo) ridiculous implications of BlueCrest on other LLPs that were not trying to create the same tax advantage. Capital contributions are intended to create longevity of tenure – in many cases a new parter is worse off than from a cash-flow perspective in their early years, but see this improves with longer tenure.
The reason some LLPs will have the US/Delaware HQ is because they are US law firms with a UK branch or subsidiary – nothing nefarious!
I understand partnership tax.
The 25% capital is as a result of Condition C of the salaried members rules which predates BlueCrest. In my experience it is incredibly common for law firms (and others LLPs, like asset managers) to manage capital contributions for Condition C. There are detailed spreadsheets making sure that the right amount of capital is contributed at the right time. While there is a commercial need for law firms to have partners contribute capital, the timing of extra capital contributions just before pay rises and the quantum of those contributions is to prevent PAYE and employer’s NIC from being due. And most (but not all) asset managers that rely on Condition C do not have the need for the extra capital from partners. That’s not speculation but experience.
I guess in some cases a partner is worse off from a cash perspective for making that capital contribution. But most will have just signed a piece of paper that means that the bank lends them the cash to contribute to the LLP (without that cash appearing in the individual’s bank account at any stage). None of that is controversial.
Oh, and BlueCrest had nothing to do with Condition C, just Conditions A and B.
The fact that some UK resident partners of international law firms get the vast majority of their profits from the US firm (rather than the UK firm) is just what happens. This is for various reasons but the main UK tax ones are that (i) UK partners on the remittance basis won’t pay tax on their profits from the US firm (the vast majority of their income), (ii) profits from the US firm (which, they say, does not carry on its trade in the UK) are not subject to NIC (whether remitted or not, whether domiciled in the UK or not), and (iii) it means that the salaried member rules do not apply to the US income (and this can be very relevant as newly recruited partners can be on substantial guaranteed payments which would make the capital contribution for Condition C to be quite large). And if you want to double check my NIC assertation, you can look at s15(1)(c).
In relation to corporate partners that provide a funnel / valve to the rest of the firm. That’s been established for a long time, and their use has been growing post-mixed partnership rules (often with a non-stat clearance that the mixed partnership rules do not apply). Whether that saves NIC will depend on the relevant social security agreements. But it saves a bit of hassle and often a lot of UK income tax.
You might think that “The reason some LLPs will have the US/Delaware HQ is because they are US law firms with a UK branch or subsidiary – nothing nefarious!”. I am sure that is right in a few cases. In some cases it will be because there is much less accounts disclosure than a UK LLP. But if it was a branch of the US firm then the UK partnership would not be a different partnership to the US one (which is easy to check if you are bored). And the subsidiary point would make sense if it was normal for foreign groups not to use locally incorporated entities (e.g. Microsoft UK was a US company).
Very interesting article. Given that student fees are rising again and Martin Lewis calculates that young people repaying them pay 9% extra “tax” in repayments the 8% rise for folk earning over 70K seems fair.
There is an issue with GP partners having to pay “employers“ pension contributions out of their profits from NHS work whereas the hospital consultant has this paid by his employer. The employers contribution is 23.7% although GPs contribute 14.38% under a transitional arrangement with remaining 9% contributed by NHS. It is true if a GP comes out of the scheme they receive the 14.38% employers contribution whereas a hospital doctor would not. It is important to understand this difference when comparing GP profit share with hospital consultant pay as in the example above. I expect a very serious unintended political consequence if the reform above took place since GP are already in dispute with government and many finding it hard to maintain their profitability whilst providing an adequate level of service to their patients with the fixed funding they receive. There was no recognition of the increased costs to them of employer NI when that was increased whereas for other NHS employers there was.