Limited Liability Partnerships (LLP) were introduced in 2001 as an alternative to a traditional partnership arrangement. These structures combine the flexibility of a partnership in terms of:
- management structure
- succession planning
- profit distribution and
- duties of partners
with the reduced personal financial risk associated with Limited Companies.
It is unsurprising that the LLP vehicle became an extremely popular choice for fund managers, lawyers and accountants. Traditionally these industries are less capital intensive and as such the majority of the profits achieved each year can be distributed to the principals.
While the attractiveness of the LLP structure remains, over recent years there have been a number of changes in respect of the taxation of LLP members. This has led businesses to reconsider whether such a structure is right for them.
With the murmurings of further changes ahead, particularly in respect of National Insurance as the Chancellor seeks to recover the costs of the Government’s COVID-19 support packages, we take a look at the comparative benefits of LLPs and whether converting to a Limited Company structure is something that should be considered.
Benefits of an LLP
The main benefit of an LLP is increased flexibility, both in respect of profit sharing and in the introduction of new members. In a Limited Company, the distribution of profits is either through bonuses, which are tax inefficient, or dividends, which are restricted to the proportion of shares held by an individual.
However, an LLP is free to distribute its profits between its members as it sees fit. There are also fewer tax implications of changing the ownership of an LLP; for a Limited Company employment-related securities issues can make this an expensive process.
At present LLPs do not pay Employers’ National Insurance on profits allocated to members. A Limited Company, by contrast, has to account for National Insurance of 13.8% on bonuses paid to its employees. This means that the effective tax rate on profits allocated from an LLP, for an additional rate tax payer, is 47% compared to 53.43% on a bonus. While the effective tax rates on the receipt of a dividend is a more comparable 49.86%, the link to share capital makes this a more restricted option. There is an added benefit in that the income tax payable by LLP members is not collected via PAYE so there is a delay between the receipt of drawings and the payment of tax.
The effective rate of tax of an extra £100,000 of profits for an additional rate tax payer:
|Profit available for payment||100,000||100,000||100,000|
|Employers National Insurance||12,127|
|Net payable to employee||87,873||100,000||81,000|
|Tax at 45%||39,543||45,000|
|NI at 2%||1,757||2,000|
|Tax at 38.1%||30,861|
|Net cash received||46,573||53,000||50,139|
|Effective tax rate||53.43%||47%||49.86%|
One of the drawbacks to the use of an LLP is that all of the profits need to be allocated between the members. This can mean that retaining capital within the business for future investment or regulatory capital purposes is much more expensive than would be the case for a company, where such profits would only be subject to Corporation Tax at 19% (although this is rising to 25% from April 2023).
Historically, LLPs could benefit from the best of both worlds by appointing a corporate member which could be allocated profits to be reinvested in the business. Due to increasing use of tax planning opportunities which exploited certain aspects of partnership taxation the mixed membership rules were introduced from 6 April 2014 which effectively put an end to this practice.
Additionally, the introduction of the salaried members rules also introduced from 6 April 2014 has added an extra layer of complexity to partners’ tax affairs and in certain cases removes the National Insurance and timing benefit for partners. This can particularly affect junior partners in larger organisations.
Even with these changes, for many businesses the use of an LLP structure will still be more efficient than a Limited Company. For others, however, converting the LLP to a Limited Company may be beneficial.
Benefits of a Limited Company
For businesses which need to retain capital for regulatory or expansion purposes the use of a Limited Company could be attractive, as profits can be retained in the business at a net tax cost of 19% (or 25% from April 2023). The use of a Limited Company also allows for the possibility of Research and Development tax credits to be claimed which may be of particular interest to fund managers who are making advances in machine learning or the development of complex trading algorithms.
For many, the simplicity of receiving a salary, bonus and dividend as opposed to paying tax on an allocation of taxable profits – which doesn’t necessarily correspond to the amounts received from the business – is worth the additional tax cost.
While changes in the ownership of the business are simpler and more tax efficient with an LLP, it may be possible to reduce the tax burden significantly through the use of Government-approved share schemes such as Enterprise Management Incentives. Furthermore, if the management team is expected to remain relatively fixed then the ability to change each person’s relative share is of less importance.
The conversion process is fairly straightforward but there are a number of practical points to consider. Care also needs to be taken, particularly in the fund management space, that the conversion from an LLP to a Limited structure doesn’t trigger any tax issues under the Disguised Investment Management Fee legislation.
How can we help?
We’ve helped numerous clients to assess whether an LLP or Limited Company structure is right for them. We have also advised on a number of conversions, both from LLP to Limited Company and Limited Company to LLP.
If you are looking to set up a new fund management business or need help in deciding whether your current structure is right for you both now and in the future please get in touch with your usual Blick Rothenberg contact or with Stephen Kenny.