In a lockstep model partners share profit by points that rise with seniority, whatever each partner bills; in a merit model shares are set each year by performance; a hybrid combines a lockstep core with a merit pool. Tax follows whatever the agreement says, under section 850 of the Income Tax (Trading and Other Income) Act 2005, but in an LLP a reward that depends on personal performance rather than overall firm profit can count as disguised salary under the salaried member rules.

Tax investigation insurance from £108.75 a year (£9.06 a month).Pays up to £100,000 of your accountant's fees if HMRC opens an enquiry. No excess. Buy online in a few minutes.

See my price in 2 questionsHow the cover worksAccountant? Offer cover to your clientsor call 01795 841 310

How does a lockstep model work?

Each partner holds a number of profit sharing points. A new partner starts on a low number and moves up a fixed ladder, often one step a year, until reaching a plateau shared by all senior partners. Profit for the year is divided by the total points to give a value per point.

The appeal is simplicity and collegiality: partners have no reason to hoard clients or argue over credit for work, and junior partners can see their path. The weaknesses are that a strong performer subsidises a weak one, and that a firm with no way of slowing progression can struggle to deal with a partner who stops contributing. Many lockstep firms add gateways, where moving up the next step depends on meeting agreed standards, and a power to hold or reduce points.

How does a merit based model work?

Shares are set each year by reference to measures such as fees billed, new work won, client service, management roles and staff development. At one extreme, sometimes called eat what you kill, profit tracks each partner’s own billings closely. More often a committee or senior partner scores each partner and converts the scores into shares.

Merit systems reward contribution and can attract high billers, but they demand a fair and trusted process, they can make partners reluctant to share clients, and annual reviews can be divisive. The measures need to reward the work that keeps a practice healthy, such as supervising staff and managing risk, not only billing.

Run an accountancy or bookkeeping practice? Solar Protect runs fee protection schemes for practices, so the cost of dealing with an HMRC enquiry into a client is covered rather than written off.

See how our accountant schemes work or call 01795 841 310.

What is a hybrid model?

A hybrid splits profit into a core shared on lockstep points and a merit pool allocated by performance. The merit pool is commonly a minority of profit, so partners have a stable base with a performance element on top. Some firms also have fixed share partners who receive a set amount, sometimes with a small share of residual profit, as a step between employee and full equity partner.

What does the law say if the agreement is silent?

Section 24(1) of the Partnership Act 1890 says that, subject to agreement, partners share equally in capital and profits, and section 24(6) says no partner is entitled to remuneration for acting in the business. Regulation 7(1) and 7(4) of the Limited Liability Partnerships Regulations 2001 apply the same defaults to LLP members. Section 19 of the 1890 Act allows the partners’ mutual rights to be varied by consent of all partners, which may be express or inferred from a course of dealing. A firm that drifts from an agreed ladder without recording the change risks a dispute about what was agreed. See partnership agreements.

How is each model taxed?

For general partnerships and LLPs alike, section 850(1) says a partner’s share of profit or loss for a period of account is determined for income tax in accordance with the firm’s profit sharing arrangements during that period. Points, merit awards and fixed shares are all ways of setting those arrangements, so the tax allocation simply follows the agreed result. Each partner is taxed on their allocated share whether or not they draw it, which is why firms with large merit awards decided after the year end need a clear mechanism in the agreement and sensible tax reserves. See how partnership profits are shared for tax and tax reserves.

Where a firm has a corporate member, section 850C can reallocate excess profit to individual partners in some cases, so a merit pool routed through a company needs care. See mixed member partnerships.

Can merit pay or fixed shares make an LLP member an employee for tax?

Yes. Under section 863A of the 2005 Act an LLP member is treated as employed if conditions A, B and C are all met. Condition A, in section 863B, is met if it is reasonable to expect that at least 80% of the amount payable for the member’s services will be disguised salary, meaning an amount that is fixed, is varied without reference to the overall profits or losses of the LLP, or is not in practice affected by them.

HMRC’s Partnership Manual applies this directly to profit sharing models:

  • PM255100 says that if the reward is fixed, or varies as a result of personal performance or the profits of part of the business, it is disguised salary, whereas a reward that varies with the overall profits of the firm is not.
  • PM255910 says that points or units which reasonably vary with the profits of the business as a whole are not disguised salary, even if profits are highly predictable. A pure lockstep share is therefore a profit share.
  • PM255620 distinguishes a merit system where performance decides the size of each partner’s slice of overall profit, which is not disguised salary, from one where a member simply receives a percentage of their own billings, which is.
  • PM255650 treats a guaranteed minimum as disguised salary. In its example a new joiner guaranteed £80,000 with an expected total of £90,000 meets Condition A.

Meeting Condition A alone is not enough. A member escapes employee treatment if they have significant influence over the affairs of the LLP (Condition B, section 863C) or if their capital contribution is at least 25% of their expected disguised salary for the tax year (Condition C, section 863D). HMRC’s PM255300 notes that in professional firms the relevant period for Condition A will usually be a year, because remuneration is normally reviewed annually. See LLP salaried members.

How do the models compare in numbers?

Illustration only. A firm has profit of £720,000 and three partners on lockstep points of 6, 8 and 10.

Partner Points Pure lockstep Hybrid core Merit award Hybrid total
A 6 £180,000 £153,000 £54,000 £207,000
B 8 £240,000 £204,000 £36,000 £240,000
C 10 £300,000 £255,000 £18,000 £273,000

Under pure lockstep a point is worth £30,000. In the hybrid, 85% of profit (£612,000) is shared on points at £25,500 a point and a merit pool of £108,000 is awarded by the remuneration committee. Because every figure is a share of the firm’s whole profit, none of it is disguised salary. If instead the firm paid A a guaranteed £150,000 plus 20% of A’s own billings, both elements would be disguised salary for an LLP member.

What should the partnership agreement cover?

  • The points ladder, the plateau, and any gateways or power to hold, reduce or accelerate points.
  • The size of any merit pool, who decides awards, the criteria, the timetable and any appeal.
  • Whether shares are fixed before the year starts or settled after the year end, and how drawings and tax reserves work meanwhile.
  • How a profit share is calculated for a partner who joins, leaves or is on long term leave during the year.
  • How losses are shared, and any guaranteed minimums, recognising their effect on salaried member status.
  • How the model is changed, given that section 19 of the 1890 Act otherwise needs every partner’s consent.

What mistakes come up?

  • Paying LLP members a fixed amount or a share of their own fees and assuming they are self employed.
  • Making merit awards with no written basis, so the allocation on the return is hard to defend.
  • Assuming drawings rather than the agreed allocation determine each partner’s taxable share.
  • Leaving a lockstep ladder with no way to deal with underperformance.
  • Changing the model by informal practice without recording the agreement of all partners.

Solar Protect runs fee protection schemes for accountancy and bookkeeping practices. See how our accountant schemes work or read fee protection schemes for accountants.

Related Accountapedia entries

Sources

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 24 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.