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:-
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.
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.
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.
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.
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.
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.