Legal standing

The legal standing of an LLP and a limited company are similar in that they are treated as separate legal entities from members/shareholders. They can sign contracts, employ staff, own property, and be sued in a dispute. The key is that the liability of members, shareholders and directors will be limited to their capital investment into the LLP/limited company. So, from a legal standpoint, there is not much difference between an LLP and a limited company.

Flexibility

There is greater flexibility with an LLP where members can change the share of profits, management structure, how decisions are made and how members are appointed and retire. Directors of a limited company also have a degree of flexibility, but this is dictated by the Companies Act 2006, which also has several restrictions.

While both entities are registered at Companies House, an LLP agreement is private, while a limited company’s articles of association are available to the public.

Distributions

The subject of distributions, payments to members and shareholders, is one where the two entities have significant differences. Under an LLP structure, profits at the end of the year are automatically distributed to members – under a pre-arranged split. Limited companies have a different setup, where profits can be retained or paid to shareholders as dividends based on shareholding.

Double taxation

Double taxation is a common subject when looking at the pros and cons of LLPs against limited companies. Due to the way that LLPs are structured, no tax is paid by the LLP. Instead, income tax and capital gains liabilities are passed to members. When you consider that companies are susceptible to corporation tax on their profits and shareholders’ dividend tax on their distributions, there is an element of double taxation.

Taxation of profits

The taxation of profits is an area in which LLPs and limited companies vary enormously. Regarding LLPs, there is no corporation tax payment; instead, LLP members are liable to pay national insurance and income/capital gains tax on their share of annual profits.

Limited companies pay corporation tax on their profits, starting at 19% for annual profits under £50,000 a year, tapering up to the standard 25% rate between £50,000 and £250,000 a year. Companies making profits over £250,000 per annum are charged corporation tax at the standard rate of 25%. This is where the issue of double taxation emerges!

Example of LLP and limited company distributions

The best way to demonstrate the taxation of profits/distributions from an LLP and limited company is to show the breakdown via a bonus, dividend and LLP distribution.

In the following table we have calculated the net receipts from a gross £300,000 payment via an LLP vehicle, which comes in at £159,000. We also show the equivalent gross figures required to arrive at the same net receipts using limited company bonus and dividend payment methods.

Description	Bonus	Dividend	LLP
Pre-tax payment	£348,027	£349,547	£300,000
Employers National Insurance @ 13.8%	£48,028
Corporation tax @ 25%		£87,387
Net payment	£299,999	£262,160	£300,000
Tax @ 45%	£135,000		£135,000
National Insurance @ 2%	£5,999		£6,000
Dividend tax @ 39.35%		£103,160
Net cash received	£159,000	£159,000	£159,000
Effective tax rate	54.3%	54.5%	47%

As you can see, when using either limited company route, the gross payment required is approaching £50,000 more than an LLP. In summary, there is a significant difference between the effective tax rates for an LLP payment compared to a bonus or dividend distribution.

However, profits from an LLP are taxed and distributed to members annually. In contrast, dividend/bonus payments are optional and can be retained within the company and paid at a later date. A time which may be more beneficial to the recipient from a taxation perspective?

Benefits in kind

There is an interesting anomaly regarding benefits in kind and how they are treated within an LLP and a limited company. As a member of an LLP:-

• you are not officially recognised as an employee and, therefore, not liable to additional taxation for benefits in kind, such as using a company car owned by the LLP
• the LLP is not your employer; therefore, national insurance paid by an employer on benefits in kind is also null and void

Using a company car as an example, an LLP is also able to offset capital expenditure such as:-

• Cost of the vehicle (up to 100%)
• Servicing
• Petrol
• Insurance

Although (excluding the cost of the vehicle) only for the percentage of time which the vehicle is used for business purposes. So if there is a 50/50 split between personal and business use, then only 50% of the capital expenditure can be offset against profits.

As LLPs can employ individuals, if the individuals (not members) have access to, for example, a company car, and are remunerated under the PAYE system, then both parties may be liable to additional charges related to benefits in kind.

Where an individual has access to a company car via a limited company, for business and personal use, the tax situation is different.

There are still various capital allowances which can be used to offset the purchase price of the vehicle but, classed as a benefit in kind, there are:-

• national insurance liabilities for the company
• the employer has both national insurance and income tax liabilities based on the value of the benefit in kind

This value calculation will vary according to the cost of the vehicle, type of vehicle and the emissions.

There have been numerous tribunal challenges involving HMRC and members of LLPs – watch this space!

Change in Ownership

The subject of a change in ownership is very different when looking at LLPs and limited companies, for the simple fact there are no shares in an LLP. If a limited company is sold, a third party buys the outstanding shares, and they become the owners. With an LLP, there are two options when looking to sell a business:-

• Existing members resign, and new members are admitted to the LLP in exchange for a financial settlement
• The assets, goodwill, client base, employees, etc within an LLP are sold, funds realised and then distributed to members, at which point the LLP is wound up

On the surface, LLPs and limited companies have much in common, but when you dig deeper, there are some significant differences.

Summary 

There are various pros and cons when it comes to LLPs compared to limited companies, some of which have been listed above. The recent increase in the standard rate of corporation tax has extended the potential value of LLPs for higher-rate taxpayers. However, one of the significant potential drawbacks is that LLPs cannot retain profits from previous years. Distributions are taken monthly with a balance payment at the year-end when the total annual profits have been confirmed.

It is important that you take advice from your accountant as to the best setup for your business. While taxation is obviously an important consideration, there are many other factors to take into account.

When operating a business, you must appreciate both corporation tax and personal tax obligations. Consequently, you may have come across a topical subject regarding the benefits of Limited Liability Partnership (LLPs) against limited companies. However, before looking at LLPs in more detail, it is essential to remember that no two situations are the same. Therefore, it is crucial that you seek advice from your accountant about the best setup for your situation.

What is an LLP?

As the term suggests, an LLP is a type of partnership where the liability of each member is limited. In this case, to the investment/obligations made by each member. It is a helpful way of protecting a member’s personal assets, especially for businesses that tend to operate as general partnerships:-

• Solicitors
• Doctors
• Architects

As you will notice, those involved in an LLP are referred to as members instead of directors, shareholders or guarantors. In some settings, you may see members referred to as “partners”. There must be a minimum of two members to register an LLP, but there is no upper limit on the number of members allowed.

The history of LLPs

The history of LLPs in the UK goes back to the Limited Liability Partnership Act 2000, which came into effect in April 2001. This effectively created a hybrid form of traditional partnership and limited company. The Limited Liability Partnerships (Application of Companies Act 2006) Regulations 2009 incorporates some of the legal obligations associated with Companies House and limited companies.

While there are numerous differences between LLPs and limited companies, there is one common trait in law; an LLP is also recognised as a separate legal entity. Consequently, an LLP can sign leases and enter into various commercial arrangements but can also be sued, although any financial liabilities are retained within the LLP. At this point, it is essential to recognise that an LLP is not suitable for non-profit organisations.

Each LLP must have at least two “designated members” who have additional responsibilities regarding statutory obligations and requirements. If there are less than two “designated members”, all members will be deemed to be designated. In a similar fashion to limited companies, all LLPs must also:-

• Register with Companies House
• Have a registered UK office address for incorporation
• Supply information about People with Significant Control
• Submit financial accounts to Companies House for public record

Unlike limited companies, also obliged to submit articles of association to Companies House for public record, the member’s agreement of an LLP is not filed at Companies House. This confidential agreement clarifies the split of profits, particular roles within the LLP and remuneration. It is essential to have a members agreement; otherwise, all members are treated the same and entitled to an equal split of profits.

What are the differences between an LLP and a limited company?

We will now dig a little deeper into the specific differences between an LLP and a limited company and how this may impact issues such as taxation, distribution of profits, etc.

Taxation

How profits are taxed could not be more different concerning LLPs and limited companies. As an LLP has no shareholders and is not a company, there is no corporation tax liability. Consequently, profits from an LLP are shared annually (they cannot be retained), and each member is responsible for paying their tax liability. However, if the member is a corporate body, such as a limited company, that member will be liable to pay corporation tax on their share of profits.

This method of distributing untaxed profits to LLP members offers greater flexibility in managing your overall tax liabilities.

If you compare this to a limited company, currently paying 19% corporation tax, rising to 25% in April (dependent on the level of profitability), the attractions of an LLP become more evident. Historically, many limited company directors have paid themselves a low salary to mitigate national insurance contributions while maintaining their entitlement to a state pension. This would be topped up with dividend payments and has proven to be tax-efficient in the past. However, things are changing!

From April 2022, national insurance contributions will increase by 1.25 percentage points, meaning an increase in payments for employees, employers and the self-employed. The current 7.5% dividend tax rate will also increase by 1.25 percentage points to mitigate the tax benefits of dividend payments. The combined increase in corporation tax and dividend tax (the first £2000 of dividends are tax-free) has prompted many people to look for alternatives to limited company status.

Liability

In a similar fashion to limited companies, the personal liability of each LLP member is limited to their particular investment/exposure to the LLP. However, unlike limited companies, it is also possible for each member to protect themselves from the impact of misconduct by another LLP member. This is one of the reasons why LLPs are popular amongst accountancy firms and solicitors. If you are seeking protection from the actions of other members, it is vital to take advice as this is a complex subject.

Flexibility

While there are several similarities between LLPs and limited companies, LLPs are more flexible when it comes to the structure of a business. Even though both entities are managed by Acts of Parliament, the Companies Act 2006 is much more rigid. An LLP members agreement is a relatively flexible tool used to determine the share of profits, remuneration and different roles within the LLP. While all annual profits must be paid out in full, there is nothing stopping:-

• Individual/corporate members reinvesting their net profits back into the LLP
• Members retaining their share of profits on deposit/within a company structure, outside of the LLP

It is impossible to cover all of the potential flexibilities associated with LLP member agreements; therefore, it is crucial to take advice.

Privacy

There are several issues to consider with regards to privacy and LLPs. While all LLPs must register at Companies House and provide annual accounts, private member’s agreements are not filed at Companies House and not public property. So, while the ultimate profit for each LLP will be public knowledge, as will the list of People with Significant Control, details of the member’s agreement will remain private. Similar to limited companies, the LLP’s registered office will also be public knowledge; therefore, it is essential not to use a private/recognised address for those wishing to maintain a degree of anonymity.

Joint ventures and stand-alone entities

Many individuals and limited companies use LLPs to separate joint ventures and stand-alone entities from their primary operations. While each member’s share of profits will still be drawn into their personal tax/company tax calculations, this offers a useful option when structuring operations. It can also help to simplify the sale process compared to the paperwork and potential cost of selling part of a limited company.

Summary

Since the introduction of LLPs back in 2001, this type of hybrid structure has proven popular with many businesses, including doctors, solicitors, architects and other sectors where “partnerships” are the preferred ownership structure. Due to recent tax increases, it may be sensible to consider switching from a limited company to self-employment, partnership or an LLP, depending on your situation. However, it is crucial to take professional advice due to the often complex nature of taxation and individual status.