PM255660 - Caps on profit shares

ITTOIA/S863B (3)

Sometimes a member’s share of the profits may be “capped”. This means that the member will receive a percentage of profits, but only so long as the profits do not exceed a certain figure.

The result is that the member’s share of profits is capped at a certain monetary amount. This may mean that the member’s reward is not in practice affected by the overall amount of the firm’s profits.

Example 1

This example looks at how the legislation applies where there is a monetary maximum share or “cap” on a member’s share.

E joins the DEF LLP. It agrees that her profit share will be calculated as a proportion of the total profits of the LLP, but her share cannot exceed £100,000.

If it is realistic to expect that the cap will not be engaged, then the member’s reward will in practice be affected by the level of the firm’s profits and will vary by reference to them. If the LLP expects that her profit share would be between £120,000 and £150,000 so realistically she will always receive £100,000, it would imply that her total reward was not, in practice, a variable share of total profit but was simply a fixed sum meeting Condition A.

Example 2

This example illustrates that a cap that limits the return for services to a payment that will, in practice, be highly likely to be paid gives rise to a Disguised Salary even though there is a theoretical risk that the payment will not be made.

AA LLP is a UK firm that has set up a business in Australia and is highly profitable. AA LLP cannot operate directly in Australia for legal reasons.

Instead, the business in Australia is operated through a general partnership AA GP. The two firms work closely together.

A, B & C are individuals who are members of AA LLP. The only other member of AA LLP is Z Ltd, which is also a partner in AA GP.

A, B & C have each been told that they will receive £100,000 fixed salary, subject to there being sufficient profits. Any profits in excess of this amount are to be allocated to Z Ltd which will distribute the amounts to the AA GP in Australia, for the benefit of the Australian partners. Profit projections show that profits of AA LLP are likely to be significantly in excess of £1m per annum.

A, B and C meet condition A. Their return is to be £100,000, which will not in practice be affected by the amount of the firm’s profits.