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.
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.
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 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.
|Employers National Insurance @ 13.8%
|Corporation tax @ 25%
|Tax @ 45%
|National Insurance @ 2%
|Dividend tax @ 39.35%
|Net cash received
|Effective tax rate
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%)
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.
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.