When comparing whether to operate as an LLP or a limited company, in our view, LLPs are still the currency of choice for most professional service businesses. Companies tend to be better for trading businesses. But there are tax and commercial issues which differ between businesses.
If you have a business and need a steer on which corporate structure is best please do call us. We are always happy to provide an initial review and cost estimate.
LLP vs Ltd
- We help businesses manage all aspects of structure from set-up and management to dispute resolution and exit strategies.
- We look at tax structures as part of the legal service.
- Understanding of the differences in structure between a partnership and a company;
- Expertise in changing the structure.
LLP vs Ltd differences in structure
At first glance, there are many similarities between a limited liability partnership and a limited company. The LLP structure was introduced in 2000 and designed to promote the growth of partnerships. The design is also to encourage ownership of a business and flexibility in management and pay.
Similarities between partnerships and companies
Both an LLP partnership and a company are separate legal entities from the people behind them and can enter into business contracts in their own right, including offering fixed or floating charges over assets as security.
Limited liability applies to LLP partnerships and companies
LLP partners and directors both enjoy limited liability. This limited liability protects each partner from losing personal assets if the business fails. LLP members and directors can both enter into personal guarantees to support business loans.
If the partnership is not set up as a LLP the partners will carry personal liability. More and more partnerships are converting to LLP status. We work with businesses to help them transition and review the tax position and and any liabilities carried over on conversion.
Shareholders of companies may carry financial risk but never personal risk.
Differences between partnerships and companies
A main difference is between a partnership and a company is in how it is controlled.
- A partnership is controlled by its members and the partnership agreement.
- A company is controlled by its shareholders under the articles of association and shareholders’ agreement.
Both partnerships and companies 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.
There is a big difference between companies and LLPs.
A company must file its articles of association at Companies House. These articles are publicly available. Behind the scenes limited companies can regulate their affairs via shareholders’ agreements, which are private to the members and are not available to the public. Decisions are passed by the directors or the shareholders. Companies are regulated by the Companies Act in a more rigid way than partnerships governed by the Limited Liability Partnership Act.
An LLP is not required to hold board or shareholder meetings, or make decisions by resolution. A confidential members’ agreement defines the LLP members’ relationship and this document is not available to the public.
LLPs are tax transparent, which provides more certainty. Partners receive profit allocations taken as drawings and are usually treated as self employed, subject to HMRC tests.
A company pays corporation tax on profits. Directors receive salaries subjected to PAYE. Shareholders have a stake in the business and pay income tax on dividends voted by the directors.
LLPs blend the position of directors and shareholders in that the partners have a share in the business and are responsible for running the business.
Appointing a partner within an LLP does not carry and tax consequences. However, the position is not the same for companies. Companies face regulations that do not exist for partnerships, when awarding or selling shares or options to employees and directors. Depending upon the trading history there can be a tax charge when shares are provided to staff.
Tax on profits paid to partners shareholders
An LLP’s partners pay income tax as well as 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. But the tax is due on the respective shares even if the partner does not draw some or all of his entitlement for any reason.
Tax on retained profits
If the intention is to build up cash within the business a company is more efficient. This is because post corporation tax profits not paid out as either salary or dividend are not subject to further tax. And, the rate of corporation tax in the UK is relatively low at around 18%.
The rate of tax payable upon profit extraction is lower for companies. For example, if the qualifying conditions are met a company share buy back can be very attractive.
Varying the profit allocation
In practice, both an LLP and a Ltd company can vary the allocation of profits to each member or shareholder, each year. The means of achieving this varies between LLPs and companies.
Partnership agreements can be drafted to set out the means of profit allocation. In the absence of agreement the profits or losses will be shared equally between members. Many LLPs operate on a points system which can be drafted to be flexible.
For companies, flexible profit allocation is trickier but still possible. One solution is that each shareholder owns a different class of share. With different classes of shares different rights can be given to shareholders. For example, the directors can vote different dividend payments for each share class.
When an employee or director leaves the company he or she will retain his shareholding unless provision has been made for compulsory transfer. In practice the articles or shareholders’ agreement will need good and bad leaver provisions.
LLP vs Ltd: changing the structure
Generally speaking the exit route for a partner is to pass his interest to other partners. With companies the exit route is most likely to be a third party sale.
- The transfer of shares in a company at a profit will trigger a disposal for capital gains tax purposes on which capital gains tax is payable. If the qualifying conditions are met Business Assets Disposal Relief (entrepreneurs’ relief) is available.
- But in a partnership the transfer of an interest to another partner will not trigger a disposal for capital gains tax purposes unless the partner makes a gain on his capital account.
- Companies will accumulate growth if they trade successfully, which is not taxed until the shares are disposed of.
- Partnerships tend not to accumulate growth in the same way, as the tax legislation requires that income is taxed annually.
- When a partner leaves an LLP his entitlement to profit comes to an end. There may be the opportunity for Business Assets Disposal Relief (entrepreneurs’ relief) if the outgoing partner receives any capital profit.
Executing the change in structure
The way a sale is executed differs between companies and partnerships.
In practice a “sale” can be implemented in one of two ways:
- By way of admission of new partners and the retirement of outgoing partners; or
- A sale of assets such as the client base, employees, goodwill, trading 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.
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 shareholders’ 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.