A partnership to a limited company conversion is gaining popularity due to recent tax changes. We take you through the process and remove the hurdles.
Our services for partnership to limited company conversion include:
- Partnerships affected by tax changes;
- Partnership to limited company conversion process;
- Partner to company director transition;
- Asset transfer from partnership to company;
- Best time for partnership to limited company conversion;
- TUPE & partnership to company conversion; and
- Partnership to company conversion track record.
Partnerships affected by tax changes
The government believes that business partnerships allow ‘disguised employment’. People, labelled as partners and taxed as self employed, enjoy a guaranteed income yet possess little decision-making power. Since HMRC considers many partners should be taxed as employees, the tax rules changed. The changes affect:
- LLP partnerships;
- Unincorporated partnerships;
- Partnerships where there is no written partnership agreement.
Partnerships now risk claims from HMRC for underpayment of PAYE for individuals who did not pass the self-employment test. If an individual is no longer with the business, it may be difficult to recover the PAYE tax from that individual. HMRC may seek to recover tax from the remaining partners.
Nevertheless, it pays to evaluate whether conversion delivers benefits.
Hence, we often convert long established, unincorporated partnerships into ltd companies. Other partnerships seek the limited liability status of a company to protect their partners. Sometimes succession planning is another driver.
Partnership to limited company conversion process
We translate the working of your LLP partnership to that of a new limited company. They are different:
- LLP partnership: operates on the basis of membership;
- Ltd company: operates on the basis of equity control.
The process typically involves:
- A shareholders’ agreement that mirrors key features of the existing partnership agreement;
- Bespoke articles of association for the new company.
- Discussion or negotiation with partners to gain their buy-in and answer questions;
- Partners’ approval of the transaction.
In detail, the steps comprise:
Change existing partnership’s name
Most clients want to continue using their current trading name. Their trading name is their brand. It signals a quality, a reputation and is known by customers and prospects. It carries goodwill.
Unfortunately, Companies House does not register similar trading names in the same field, so we first change the partnership’s name.
Opening new bank accounts takes time. Hence we create the company early in the process, so the banking process proceeds in parallel with the partnership conversion.
1. Minority protection/reserved matters
Company directors make the day-to-day decisions. Important decisions require shareholder approval, and might require all or over 50% of shareholder’s votes, e.g.:
- Appointment and removal of directors;
- Director’s remuneration;
- Capital expenditure;
- Issue additional shares.
2. Transfer and issue of shares
A shareholders’ agreement can give shareholders’:
- A right to veto the issue or transfer of shares;
- Provide existing shareholders with the right to first refusal;
- The right to specify the percentage of votes required for the issue or transfer of shares.
Note the difference between equity stakes in a partnership and a limited company. In a:
- Partnership: it is easier to transfer equity stakes, as equity is informally decided between the partners.
- Company: the share is a right, that is shown on public records at Companies House.
We mirror the partnership’s equity stakes in the limited company. Different share classes can accommodate different interests, e.g. different rights to:
- Assets on company sale or winding up.
3. Dispute resolution
Good shareholders’ agreements contain a dispute resolution clause. Disputes can often be quickly resolved, with little business disruption. Courts now pressure parties to be:
- Proportionate in their costs;
- Use alternative to litigation, e.g. mediation.
- Shareholders’ agreements often require shareholders to undertake mediation before the dispute reaches court.
4 Partners overdrawn income accounts
Review any partner’s overdrawn income accounts, alongside the new trading company’s share premium account. The trading company’s share premium account replaces the partnership’s capital account.
Partner to company director transition
Partners lose their partner status and gain director status with new duties and responsibilities. Potential directors should check the following documents:
Directors should require service agreements. Usually the directors service agreement dovetails with the shareholders’ agreement. Typical issues are the shareholders’ power to control the directors’ actions.
Although it is possible to terminate a director’s employment, without a board resolution the person remains a director. However, without a shareholders agreement the person remains a shareholder. To avoid director disputes, how a director can be dismissed, e.g. for under performance, should be drafted into the director’s service agreement.
Review the employment documentation. The partnership’s employment documentation may not be appropriate for the new company.
Rewrite post termination restrictions to ensure they are effective. Often a partnership or LLP can enforce post-termination restrictions that a limited company cannot enforce.
Asset transfer from partnership to company
The asset transfer agreement formally transfers the partnership’s assets and liabilities to the new trading company. The partners must approve this agreement. Often there are complications:
Power to transfer contracts
For example the partnership might have won contracts, that do not include the power to transfer i.e. cannot be assigned to another company or partnership. The client wanted the partnership to execute the contract. Often it is not commercially sensible to terminate the contract.
One solution is to create a bridge between the partnership and the new company, with a cross-charging policy. Staff in the new company then provide services to the partnership, until they complete the contracts.
Intellectual Property ownership
Often partnerships develop their own intellectual property, e.g. copyright, trademarks, designs etc. This IP requires protection, and must be property transferred from the partnership to the ltd company. Otherwise, the new company might not prevent infringement of its IP.
Assets & stamp duty
LLP partnerships often own assets. Certain assets such as land and buildings may generate a charge to stamp duty on transfer. There are exemptions from tax.
Best time for partnership to limited company conversion
From an accounting perspective, the end of the existing partnership’s financial year is the most convenient point for conversion to limited company status. It is simpler to draw up accounts for complete years.
In our experience, commence the conversion process at least three months before the end of the partnerships’ financial year.
TUPE & partnership to company conversion
Partners are not subject to the Transfer of Undertaking (Protection of Employment) Regulations 2006 (TUPE). However, staff and employees have rights under TUPE.
Under TUPE, employees automatically transfer to the trading company. The new trading company inherits all the rights, liabilities and obligations related to the partnership’s employees.
Under TUPE, employers must inform and consult with employees. An employer who fails to manage TUPE correctly risks claims from each employee for 13 weeks’ uncapped pay, for a failure to consult. Employers should schedule time to inform and consult employees.
If you are planning redundancies, due to the partnership to company conversion, then TUPE may restrict your options. We provide solutions.
Partnership to company conversion track record
Recent partnership to company conversions include:
Converted trading platform software company from LLP status to a limited company. A key reason was the desire to incentivise younger, newer employees with equity.
The agency’s three partners would not pass HMRC’s tests for self-employed status. We reformed the business as a limited company with one shareholder. The company engaged the former partners as directors and employees. This worked for the new directors, who were happy to reduce some of their management responsibilities.
The law firm no longer satisfied regulatory requirements, after the Government abolished the advantages of a corporate member. We converted the firm to a limited company, and satisfied regulatory requirements.
The partnership needed additional investment under the Enterprise Investment Scheme. To comply with the scheme’s requirements, the business had to be a limited company.
We draw on considerable partnership to company conversion experience. Not only do we offer legal advice on partnership law, corporate governance and employment law, but also personal and business tax solutions.
Talk to us, and discover our practical, effective approach tailored to your circumstances.