Professional advice is crucial when establishing a business, as multiple structures are available. One option is a Limited Liability Partnership (LLP), which combines aspects of a Limited Partnership (LP) and a limited company. While this can be an effective arrangement, it is essential to thoroughly understand its structure, profit distribution mechanisms, and tax obligations.
The structure of an LLP
Before we go any further, it’s critical that you appreciate the structure of an LLP and how it differs from a limited company (and, in some cases, a Limited Partnership).
Liability
When it comes to liability, limited company shareholders are limited to their investment; with an LP, general partners are liable for the overall debt/obligations, while limited partners have limited liability. With an LLP, the value of a partner’s liabilities is limited to their contribution to the LLP. While limited companies and LLPs are seen as separate legal entities, this is not the case for LPs, which are not legal entities.
Ownership
In a typical business structure, a 30% shareholder would receive 30% of company payments to shareholders, but this is not necessarily the case with an LLP. Partnership arrangements can define and vary the amount of LLP profits passed to individuals, providing substantial flexibility.
Management
While there are no directors or secretaries regarding LLPs or LPs, unlike limited companies, there is a difference regarding management. With an LLP, management obligations are distributed equally between the members. The general partner is responsible for management duties with an LP, although they can be transferred to a third party through power of attorney. The board of directors of limited companies are solely responsible for managing the business.
Tax treatment
When it comes to taxation, LPs and LLPs are often described as “pass-through vehicles”, meaning that the partnership’s gross profits are paid annually to the partners. LLP payments are recognised as gross income for each partner, and the individual must fulfil their tax liability. In essence, each partner is treated as self-employed, based on their profit share from the LLP, and is obliged to lodge a self-assessment return each tax year.
Expenses and LLPs
Before looking at expenses and LLPs in more detail, it’s important to note that LLP members cannot (usually) offset (LLP) expenses against their self-assessment tax return. Any costs relating to the business must be offset within the LLP before the gross profits are distributed to the partners. A partner must submit any expenses they have covered before the LLP financial year-end.
When looking at broader business expenses, these could include:-
- Staff costs
- Office and equipment costs
- Professional fees
- Marketing and advertising
- Vehicle and travel costs
- Insurance premiums
- IT and software expenses
- Bank and financial charges
- Home office expenses
- Subscriptions and memberships
As all business expenses must be offset within the LLP, there is no need for a P11D submission to HMRC. A P11D return relates to expenses or benefits given to directors, employees, or, in this case, salaried partners. A non-salaried LLP member/partner is classed as self-employed, and therefore, any expenses they incur would be lodged as part of their personal tax return.
Salaries
Most partners in an LLP are not formally employed by the business, but they can still hold an official salaried role within the LLP if needed. Regardless of whether a partner is salaried, their share of the LLP’s profits is treated as self-employment income and is subject to:-
- Income tax
- Class 2 National Insurance
- Class 4 National Insurance
If a partner is designated as a salaried member, their salary is taxed under PAYE, meaning the individual and the LLP must pay standard income tax and national insurance contributions (NICs) on the salary. The profit share, however, is still treated separately as self-employment income and is not taxed under PAYE.
Directors’ loans
Unlike limited companies, LLPs do not have directors, so the S455 tax on overdrawn directors’ loan accounts does not apply. However, LLP partners may still need to withdraw funds from the partnership, which can be handled in two primary ways:-
Drawings as an advance on profits
A partner can withdraw funds as an advance on their profit share, known as “drawings.” These withdrawals reduce the partner’s capital account balance without creating a formal loan. Drawings are typically not treated as a debt owed to the LLP but rather as an early distribution of profits.
Formal loan to a partner
Alternatively, a partner can take a formal loan from the LLP, subject to the LLP agreement’s terms. This formal loan would be considered a debt owed to the partnership, and all partners must agree to the loan terms. Interest rates, repayment schedules, and other conditions are typically outlined to avoid misunderstandings.
Potential tax implications of partner loans
If a loan to a partner includes preferential terms, such as a reduced or zero interest rate, HMRC may view it as a benefit-in-kind (BIK). This could result in additional tax implications for the partner, similar to how employee loans are treated in limited companies. Setting terms that comply with HMRC’s guidelines is essential to avoid unexpected tax liabilities.
Considerations for loans between limited companies and LLPs
In cases where a limited company lends money to an LLP in which one of the partners is a director of that company, the situation becomes more complex. Such loans may be subject to additional scrutiny from HMRC, especially regarding connected parties and potential tax avoidance concerns. This could impact the company and the LLP in terms of tax obligations and compliance.
Given these complexities, consulting a tax adviser is advisable before arranging loans to or from an LLP, particularly where partners have connections to other entities. Professional advice can help structure the loan appropriately to avoid unintended tax consequences and ensure compliance with relevant regulations.
Tax rates for LLP partners
Depending on their income, some LLP partners may be subject to higher tax rates than sole proprietors, traditional partnerships, or shareholders in limited companies (when considering NIC). As LLPs tend to be used in relatively high-value professions such as law, accounting, and consultancy, most partners will be towards the higher end of the income tax bracket.
So, while LLPs may offer a degree of flexibility and, in some areas, reduced administration, it’s essential to consider the overall picture before deciding on the best structure for your business.
Summary of the pros and cons of an LLP
In summary, there are numerous advantages and potential disadvantages when looking at an LLP. These include:-
Advantages
- Limited liability protection – partner assets are protected
- Tax efficient structure
- An enhanced degree of flexibility
- Separate legal entity ensures continuity
- LLPs can enhance business credibility
- Reduced paperwork compared to limited companies
Disadvantages
- LLPs are required to file financial statements with Companies House
- The setup cost is more than that of a traditional limited partnership
- There are limitations to raising capital
- A new agreement would be necessary when partners leave/die
The structure and the partners’ roles, responsibilities, and liabilities must be considered when setting up a business.
Summary
As you can see above, an LLP contains elements of a limited company and a limited partnership. For many, the flexibility and transparency, not to mention limited liability, are behind significant growth in the use of LLPs in recent years. You must discuss your business plans in detail with your adviser to identify the best structure for your situation.
Our experienced team has helped many clients set up LLPs and maximise their benefits. If you would like to discuss your situation and plans in more detail, don’t hesitate to contact us, and we can arrange a meeting.