It can be argued that the first requirement of the ‘successful’ business structure is limited liability: without this protection against failure, many businesses would simply not assume the commercial risks necessary to succeed. If this is correct, then the available choice of structure is straightforward: a Limited Liability Partnership (LLP) or Limited Company?
An LLP and a Limited Company are both corporate bodies that provide limited liability to their members or shareholders. The choice is not necessarily determined by whether a corporate or more collegiate partnership ethos is favoured. A company may be managed as a quasi-partnership and, similarly, a partnership may have a corporate management structure.
The ability to accommodate a very different business ethos in one structure, whether LLP or Limited, is illustrative of a crucial requirement of the chosen structure; it should not get in the way. The foremost requirement is flexibility, an ability to accommodate the changing commercial requirements of the business and its owners over time and, importantly, on a tax-efficient basis.
In terms of comparative flexibility, the LLP, significantly, has no share capital or capital maintenance requirements and it is this that makes it much the more flexible (and potentially attractive) structure.
The profits of an LLP may be allocated on a wholly discretionary basis. By comparison, the allocation of profit by a Limited Company is constrained by the fixed shareholding percentages held by the owners (although this can be overcome by arranging for different classes of share, so called alphabet share arrangements, to target profit distributions to individual shareholders).
Flexibility for an LLP
Making distributions is a further area of flexibility afforded to the LLP. Subject to the cash being available the LLP may freely distribute profits, advance loans, and return capital with minimum formality. The Limited Company requires available reserves to distribute and must meet restrictive company law requirements in making loans and returning share capital whether by way of share buyback or liquidation.
A further flexibility available to the LLP, is the ease with which new members may be admitted (and removed). This flexibility may again be compared with the relative difficulty in introducing new members in a Limited Company and of removing director shareholders and in recovering their shares.
Most significantly, this flexibility is available to the LLP on a tax-neutral basis. The distribution of profits, the return of capital, the introduction and removal of members may all be achieved without tax costs for the LLP or its members. By comparison, the payment of dividends, the return of capital, the transfer of shares between members, the admission of new shareholders on favourable terms are all occasions of potential tax charge to shareholders. On the face of it, therefore, the LLP is more flexible and outperforms the Limited Company in that other requirement of a successful structure: tax efficiency.
Inevitably this is not the complete picture and in one important respect is positively misleading. The LLP‘s apparent tax efficiency is misleading. It is described as a partnership not simply because of its particular company law attributes but because it is treated as a partnership for tax purposes. As a partnership its profits are charged directly on its members (partners) as they arise (are recognised in the accounts) and irrespective of whether the profits are distributed or retained in the business. If profits are taxed on the members on an arising basis and at their marginal rate of income tax (which may be 47 per cent for an additional rate tax payer) their subsequent distribution has no tax significance. Hence the tax neutrality and apparent tax efficiency of the LLP. If all the profits have been taxed as they arise then what happens thereafter is of little interest to HMRC!
Tax implications of a Limited Company
In contrast a Limited Company is taxed independently from its shareholders and pays corporation tax at a rate of 20 per cent on its profits. There is no tax charge on the shareholders until those profits are distributed as dividends or returned on liquidation. The limited company therefore offers a material tax deferral (of as much as 27 per cent) as compared to the members of an LLP where the individual might be paying income tax at a marginal rate as high as 47 per cent.
For the first time that decision between the LLP and Limited Company has to be faced rather than fudged. Of course, if profits are to be fully distributed to the owners then the arising basis gives no disadvantage (or more correctly the deferral advantage of the Limited Company does not arise) and the greater flexibility of the LLP will generally favour that structure. But what of the situation where profits are required to be retained in the business to fund growth and working capital? The ability to retain such profits taxed at corporate rates of 20 per cent rather than profits taxed at marginal rates of income tax as high as 47 per cent will favour the Limited Company, for all the desirable flexibility of the LLP.
But this assumes that the decision over structure, LLP or Limited, reduces itself to simply what is the more important: flexibility or tax efficient funding? These are generally the most important considerations: but not in all cases or at all times. Inevitably there is no ‘correct’ answer. Much will depend upon individual circumstances and may even, as suggested earlier, extend to such ‘soft’ benefits as to whether a partnership or corporate ethos more properly reflects the relationship between the owners. The best that might be concluded is that when in doubt perhaps the flexibility of the LLP once again favours it: certainly it is a relatively more simple matter to fully incorporate an LLP into a Limited Company (and on a tax neutral basis) than to try to restructure by moving in the opposite direction!
Neil Simpson is tax partner at haysmacintyre.
Further reading on company structure
