Chancellor eyes tax raid on law firm partner profits to close 'loophole'

Law firm partners could face a new tax charge under plans reportedly being considered by the chancellor ahead of next month’s Budget.

According to The Times, Rachel Reeves is looking at measures to raise £2 billion from members of limited liability partnerships (LLPs) - the structure used by almost all major law firms - as she tries to plug a £30 billion hole in the public finances.

Closing a 'loophole'

Under current rules, most LLP members are treated as self-employed, meaning they pay a lower rate of national insurance on their income - and firms pay nothing in employer contributions, which are levied at 15%. The Treasury is said to view this as unfair.

The Times reports that Reeves plans to "impose a new charge on partnerships", set slightly below the employer rate, to help close the gap.

Analysis from Tax Policy Associates - headed by Clifford Chance's former UK tax head Dan Neidle - suggests the impact could be significant. A partner earning £2 million currently takes home around £1.07 million, but if employer NICs were applied, that would fall to £934,000 - a tax hit of roughly £138,000.

A raid on professional services

A change would not only hit the legal sector but a wide swathe of professional services firms, including accounting and asset management firms structured as LLPs.

The historical justification for the current regime is that partners are business owners - not employees - and don’t benefit from unemployment protections and things like statutory redundancy or sick pay. HMRC already applies tight rules to determine self-employed status for LLP members, including capital contributions of at least 25% of a partner’s profit share.

Rumours of a move to close the "loophole" circulated ahead of last autumn’s Budget but never materialised. With a fiscal gap estimated at between £20 billion and £40 billion, the chancellor is under pressure to raise revenue, and professional services firms appear to be firmly in the crosshairs.

Industry pushback

Commenting on the proposed measures, David McNeill, director of public affairs at the Law Society, said the new tax would be a "big hit on the legal profession, a sector which the government is depending on as part of its growth strategy."

"Law partnerships don’t get the same tax breaks for investment as other businesses but are now having to pay the same levels of tax," he added. "On top of that, law firms are facing the risk of new regulation costs and bureaucracy. This makes no logical sense as a joined-up growth strategy."

Addleshaw Goddard partner and head of professional services William Wastie said extending employers' national insurance to partners "distorts the true nature of membership of LLPs" which were designed by Parliament to be tax transparent and where partners' capital is at risk.

"LLPs are not just vehicles for high earners," he said. "They are the structure through which most professional firms invest, employ and share risk."

Update: This article was updated after publication to include comment from industry figures.