When comparing LLP vs Ltd companies, in our view, LLPs are still the currency of choice for professional service businesses with genuine partners. LLP’s remain attractive, despite recent taxation changes.
However, business partnerships should ensure partners are genuine partners in the eyes of HM Revenue and Customs.
Our LLP v Ltd services include:
LLP vs Ltd company: difference in organisation
At first glance, there are many similarities. Both an LLP and a Ltd company are:
- Registered at Companies House;
- Separate legal entities, and can:
- Enter into business contracts in their own right,
- Offer fixed or floating charges over assets as securty.
An LLP’s members enjoy limited liability. This limited liability protects each partner from losing personal assets if the business fails.
A Ltd company’s shareholders also enjoy limited liability. If, e.g. the shares are full paid, shareholders won’t lose additional personal assets if the business fails.
The LLP is controlled by its members and the partnership-agreement.
In both cases there is a risk of a dispute if these documents are not well thought out and executed.
Both an LLP and a Ltd company must file their profit and loss accounts at Companies House. These accounts are publicly available, i.e. anyone can see them. A partnership which is not an LLP, i.e. where partners have unlimited liability, does not file accounts at Companies House.
Ltd company: documents
A Ltd company must file its articles of association at Companies House. These articles are publicly available. Ltd companies regulate their affairs via board and shareholder meetings.
LLP partnership: documents
An LLP is not required to hold board or shareholder meetings, or make decisions by resolution. A confidential member’s agreement defines the LLP members’ relationship. Thus LLP members avoid a Ltd company’s rigid internal structure, and Companies Act 2006’s provisions.
LLP vs Ltd company: tax advantages & disadvantages
LLPs are tax transparent, which provides more certainty: Usually LLP members are taxed as self employed, subject to HMRC tests. A Ltd company pays corporation tax on profits and shareholders then pay income tax on dividends.
Tax on profits paid to members or shareholders
An LLP’s member pays income tax, Class 2 and Class 4 National Insurance Contributions on their share of their LLP’s profits. This is usually less tax than an employee would pay on an equivalent salary.
If each year you usually draw the bulk of the LLP partnership’s profits, then frequently an LLP is more tax efficient than a Ltd company. A shareholder’s income tax and national insurance liability is similar to an LLP member’s. However, a Ltd company pays employer’s class 1 National Insurance. Class 1 National Insurance is far greater than Class 2 and Class 4 National Insurance.
Tax on retained profits
However if the business re-invests profits back into the business, a Ltd company may be more tax-efficient. It depends whether the only liability is corporation tax, so there are no payments to members or shareholders. UK corporation tax rates are lower than many other jurisdictions.
Flexible profit allocation
In practice, both an LLP and a Ltd company can vary the allocation of profits to each member or shareholder, each year. Members or shareholders can receive a different percentage of profits in different years. The percentage could depend on the member’s or shareholder’s contribution to the business.
LLP’s gain this flexibility from the partnership agreement.
For Ltd companies, flexible profit allocation is trickier. One solution is that each shareholder owns a different class of share, which requires bespoke articles of association. Thus the shareholders can agree different dividend payments for each share class.
LLP vs Ltd company: partner or shareholder changes
It is easier to pass ownership of the LLP to other members. To transfer shares in a Ltd company requires the sale of shares and management of tax issues.
LLP: succession and promotion to partner
An LLP’s internal flexibility promotes participation in management. Two designated members must be registered at Companies House. Promotion to partner is straightforward. A partnership can easily change members, or their status, without undue formalities or incurring tax charges.
Thus an LLP works for businesses where a members’ “exit” is a sale to other members, rather than to a company or investor. Consequently, LLP’s are common in “people businesses, e.g. the professional service industries, where price/earning ratios are low compared to the ratios achieved by “product” businesses.
This structure attracts high-flyers since gaining partner status is probably easier than gaining director status. LLPs tend to have more partners than an equivalent sized Ltd company has directors.
However, if you promote a former employee to partner, the new partner does not automatically gain self-employed tax treatment. Nevertheless, we often navigate this difficulty.
If a partner receives a capital profit on leaving the partnership, then usually entrepreneur’s relief is available, i.e. a 10% capital gains tax rate.
Note, LLPs with corporate members used to be popular. However, after recent changes in LLP taxation this practice is diminishing.
Ltd company: disposal of shares and promotion to shareholder
Ltd companies face regulations that do not exist for partnerships, when awarding or selling shares or options to employees and directors. There are tax implications and commercial considerations. Thus the Ltd company structure suits businesses where the “exit” is a sale to a third party, e.g. a trade sale.
If the shareholder meets the qualifying conditions for entrepreneurs’ relief the rate of capital gains tax will be 10%. Any growth in value on the shares will be subject to capital gains tax which is a lower rate tax regime than income tax and national insurance.
Key issues include:
Tax charge on taxable value
An LLP employee promoted to partner carries no tax charge.
Approved, tax efficient share plans
There are no tax approved partnership schemes.
Forced transfer of shares
When an employee and shareholder leaves a Ltd company you can force the employee to surrender their shares. This depends on whether the shareholder’s agreement is appropriately drafted. If there are distributable profits, a company share buy back can be attractive.
A Ltd company’s shareholder is entitled to receive dividends. For higher rate tax payers, dividends carry a lower tax rate than income.
An LLP cannot pay dividends.
LLP vs Ltd company: business sale
The way a sale is executed differs between Ltd companies and partnerships.
LLP partnership sale
It is more complicated to sell an entire LLP. A share in a partnership cannot be sold in the way that Ltd company’s shares are sold.
The solution is an asset sale of e.g.
- Trade name;
After the asset sale, the partnership is wound up. Members then receive the sale’s proceeds as capital, in accordance with agreed capital allocations.
Ltd company sale
To sell a company, the shareholders and the purchaser sign a sale agreement. The purchaser acquires the rights in the shares, and takes control of the company.
Often the company’s shareholder’s agreement forces minority shareholders to sell their shares along with the majority shareholders on the same terms. These provisions are termed “drag-along” provisions.
Individual shareholders can sell their shares, if the articles permit. The sale is completed using a stock transfer form on which stamp duty is payable. The position of the remaining shareholders is unchanged.