Are you thinking about starting up a new boutique hedge fund or asset management firm but worried about the news in the Autumn Statement regarding LLPs? Following the 2013 Budget, it became clear that the Government was keeping a watchful eye on the limited liability partnership (LLP) structure, however LLPs are still the currency of choice for professional service organisations keen to attract the most talented individuals. If your business is going to involve mainly professional staff it is likely that the benefits of the LLP structure will outweigh the benefits of a Company structure.
BACKGROUND
An LLP is a partnership that is registered at Companies House for limited liability. This limited liability protects the individual partners from losing personal assets if the business nose-dives in the same way as a limited company protects shareholders. An LLP has a separate legal entity and can enter contracts in its own right and offer fixed or floating charges over assets as security.
So why register as an LLP rather than a Company?
TAX
The easiest way to explain the difference between the taxation of Companies and LLPs is that LLPs are tax transparent. For Companies there is a double layer of taxation – a Company pays corporation tax on profits and then shareholders pay income tax on dividends. The partners in an LLP are taxed as self employed.
Thus members of an LLP will be liable to income tax and Class 2 and Class 4 NICs in respect of the profits of the LLP.If a shareholder/director of a Company also wishes to receive a regular salary from the Company, this is less tax efficient than receiving a profit allocation from an LLP.
While the income tax/NIC liability for the shareholder will not be greatly different to that of a member of an LLP, the company will be liable for Employer’s Class 1 NIC, (currently 13.8%), whilst for self employed LLP members the current Class 4 NICs stand at 9% on profits between £7,606 and £42,475 and 2% on all profits above.Thus for those entitled to high profits from their business, it is likely that a LLP will be more tax efficient than a Limited Company, although each individual should run their own numbers to check this.
FLEXIBILITY REGARDING PROFITS
A significant advantage for LLPs is the flexibility offered to vary the allocation of profits. Members of an LLP commonly agree in their LLP Agreement for different apportionment of income profits and capital profits between members and allow for distinctions in percentages of profits payable to different members for different years.For companies, all shares of the same class in a company must all have a dividend declared at the same level for each share and it is not straightforward to vary this.
FLEXIBILITY IN MEMBERSHIP
An LLP can easily make changes to the membership. The internal flexibility of LLPs allows participation in management. Whilst two designated members must be registered at Companies House, all other members can join or leave an LLP without undue formalities.It is often easier for current employees of a limited company to become members of an LLP with the incentive that brings to participate in the growth of the business rather than implementing share scheme arrangements which have to make provisions for good and bad leavers and attract various tax charges.
CONFIDENTIALITY
While articles of association have to be filed for Companies, LLP’s members are free to define their relationship within a confidential members’ agreement and there are no requirements for board or general meetings or decision-making by resolution. By operating as an LLP, members can avoid the rigid internal structure of a Company.
STATUS
In the financial services industry as for law firms and accountants, the LLP structure is by far the most common. High flying individuals are attracted to LLPs, looking to membership of the LLP for both financial advantages and managerial opportunities.
Service Company plus LLP
Prior to the Autumn Statement, it was possible to obtain the benefits of both an LLP and a limited company through the use of a service company which provides services to the LLP in return for an arm’s length fee, although following the review of partnerships in Budget 2013, the Autumn Statement confirmed that the government is going to take forward the proposals to counter the use of corporate partners. Thus the use of profit and loss allocation in mixed partnerships will now be restricted.
Essentially, profits deemed to be awarded to a corporate member will be reallocated for tax purposes to an individual member in certain circumstances, namely (i) if that corporate member has an “excessive” share of the LLP’s profit, because it is taking a deferred profit of the individual or because it exceeds the appropriate notional profit; (ii) the individual has the power to enjoy the profits of the corporate member (i.e. the individual owns the corporate member); and (iii) the total amount of tax for which the individual and the corporate member are liable are lower than they would have been absent these arrangements.
It remains to be seen exactly how this will be interpreted, however the introduction of a service company must at a minimum be commercially justifiable and the fees that it charges to the LLP must be at arm’s length rates. But even this may not be enough to save the service company from HMRC scrutiny – watch this space…
Another change confirmed in the Autumn Statement is that income tax relief or capital gains relief will be denied for partnership losses allocated to an individual partner in consequence of, or in connection with, arrangements where the main, or one of the main, purpose(s) is to obtain loss relief.