THIS is the third article in the series of “What shape should I be?” The first two looked at limited companies and the tax implications of using a limited company. Here I am looking at Limited Liability Partnerships (LLPs).
In structure, an LLP is a corporate entity which has to be owned by at least two members. LLPs are registered with Companies House in a similar manner to companies.
As an LLP is a separate legal entity, it can enter into contracts and it continues independent of changes in membership. The key difference which sometimes makes the LLP more attractive than a traditional partnership is the limited liability of members to contribute on a winding up (subject to the Insolvency Act).
LLPs do not have joint and several liability amongst the members. Effective protection under an LLP is similar to the corporate position, where directors are only personally liable to the extent of any personal guarantees given, or individuals are found to be negligent or committing fraud.
Useful structure
LLPs came into being in the Limited Liability Partnership Act 2000 which came into force on 6th April 2001 and since then many partnerships have incorporated into LLPs. An LLP is also a very useful structure for joint ventures as it offers more flexibility than a limited company on sharing profits and how new members can join and leave.
As you might expect, in exchange for limited liability, there are certain regulatory requirements, most of which are similar to provisions applying to companies and company directors: for example, financial disclosure, wrongful trading, disqualification, etc.
To form an LLP and incorporate it, documents have to be filed with the Registrar of Companies and the Registrar will then issue a certificate of incorporation. There are the usual corporate restrictions on the choice of the name which must always end with Limited Liability Partnership.
To include the word “veterinary”, permission will additionally be required from the RCVS.
The LLP has to file annual accounts and an annual report. There is an audit exemption below a turnover of £6.5 million. Abbreviated accounts can be filed for small companies but there is a statement of recommended practice requiring the LLP accounts to be drafted in a specific format. Changes in members have to be notified to Companies House and the two designated members are responsible for running the LLP, to include signing and filing annual financial statements.
It is important that members should draw up an agreement similar to a partnership deed or shareholders agreement to govern their rights and duties to one another. This is a private document and does not need to be filed with Companies House.
Like any partnership deed, such an agreement should also cover key issues such as capital and profit sharing ratios. If there is no LLP agreement, the assumption will be that capital and profits are shared equally.
Where a partnership transfers into an LLP, it is treated as a continuation, so no cessation of trade will be triggered for tax purposes. There should not be any capital gains tax arising on the transfer of the partnership property to the LLP, provided there are no changes in the ownership ratios at the same time as the transfer.
No goodwill valuation
There is no opportunity to value goodwill on transferring into an LLP as would be the case on the incorporation into a limited company. A partnership’s VAT registration can be carried over into the LLP and, provided that the membership of the LLP is the same as the original partnership and that the members’ interests in any property are the same as before and after it is transferred, there are no stamp duty land tax implications.
So how is the LLP taxed? For all tax purposes, a trading LLP is treated as a partnership, and the members as partners (the rules are slightly different for non-trading LLPs). The LLP files an annual tax return with HMRC, together with tax computations and financial statements, but all of the profits are taxed on the members. Individual members are liable to income tax under the self-assessment rules on their share of the profits arising in the accounting period ending during the relevant tax year – regardless of their actual drawings.
This is in contrast to the rules for limited companies. Profits after corporation tax can be retained in the company, giving opportunities to make dividend payments and pay salaries to have a smoothing effect on income of the owner-directors.
Future attraction
This advantage of using a limited company structure may become particularly attractive in future, in the light of the new higher rate tax charges announced in the 2009 Budget and the erosion of personal allowances on total incomes above £100,000 for 2010-11.
Turning to losses (not because I anticipate veterinary practices to be running at a loss, but because there is always the possibility of using an LLP for any new venture), members are entitled to tax relief for their share of losses incurred in the business of the LLP.
Relief can be claimed against the individual member’s total taxable income for current or previous years, with the balance carried forward to set against his or her future share of LLP profit.
For a trading LLP, the tax relief against non-LLP income is restricted to the amount of the member’s contribution to the business. Therefore, an LLP structure may not suit ventures anticipating large losses in early years if the owners want to off-set these losses against other income.
As an LLP is a separate legal entity, it has the ability to raise finance for the business based on the balance sheet values. This is not the case generally with partnerships. However, an LLP cannot use the Enterprise Investment Scheme or Enterprise Management Incentive share option scheme. Pension contributions must be made individually by the members.
As with a traditional partnership, members are subject to class 2 and class 4 National Insurance. Assets are treated as being held by the members for capital gains tax purposes and on disposal of these assets the members are liable to tax on their share of chargeable gains.
For VAT purposes, however, an LLP is viewed as a body corporate, so, unlike a partnership, an LLP is eligible to be a member of a group registration. For inheritance tax, business property relief applies, as with a partnership, and is subject to the same rules and potential pitfalls.
Finally, when it comes to exit routes, an LLP structure again offers more flexibility than a limited company: there is no need to sell shares or enter liquidation. Members can carry on having current and capital accounts and conduct their finances in much the same way as they would within the structure of a partnership, making it much easier to withdraw funds from an LLP on retirement.
