Turner Little are often asked by clients whether they should form a limited company or a limited liability partnership (“LLP”). Inevitable the answer we give depends upon a clients present circumstances as well as his aims for the future.
Either way you are are creating a “Limited” entity and whilst, in the early days of setting up a business it is likely to make little difference which way you go, in the longer term it could have consequences.
Both entities share similarities. The most notable in both cases derives from the word “Limited” which provides, reduced financial liability for the owners. Some would say ‘financial responsibility’ with which Turner Little disagrees; the financial responsibility is the same no matter what entity you own and run, what is different is the financial liability which might fall upon the owner if things go wrong. Whilst similar in some ways, they do have some significant differences as well.
Limited Companies come in various forms.
- Capital investment opportunities.
- Flexibility of internal structure and members’ rights,
- The allocation and taxation of business profits.
Choosing the most appropriate legal structure will depend entirely upon the kind of business you currently have, or plan to have in the future. A company limited by shares is the most common choice for profit making businesses whereas a company limited by guarantee is often chosen for non-profit making organisations. An owner’s liability in the event of liquidation is limited to the notional value of shares held. If you plan to build your business, employ lots of people and might want, at some time to sell your business or a part of it, then a limited company structuremight be best. It is also a more tax-efficient option for many types of businesses.
The ability to incorporate LLP’s was made possible by the LLP Act 2000. It had existed as a legal entity for many years in lots of overseas jurisdictions but was a latecomer to the UK where the norm was for traditional partnerships most often seen in firms of solicitors, accountants, architects, doctors practices and so on.
LLPs provide the same benefits as traditional partnerships with the added benefit of limited liability for their members. An LLP structure is a good choice for businesses who would normally benefit from having a traditional partnership structure. When first introduced it was felt that there would be a major exodus from traditional partnerships to LLP’s; the fact is that it never happened. Whilst some solicitors, accountants and the like did migrate to the new format, many remain as they were with traditional partnerships. LLP’s work best with few partners, a small number of employees and partners who have equal membership of the partnership. Partnerships can at first seem quite confusing in that there can exist a simple partnership not even committed to in writing, a more formal partnership which would have a partnership agreement, a Limited Partnership (full details available from Turner Little) or, a limited liability partnership. .
Significant differences between Limited Company and an LLP
- A limited company can be registered, owned, and managed by just one individual – that person can act as both the director and shareholder (or guarantor in the case of a Company Limited by Guarantee). At least one director of a Limited Company must be a real person and not a corporate entity. In the case of an LLP, a minimum of two members are required. This can be got around where an individual wants to set up an LLP simply by them also setting up a Limited Company which they own and control and which becomes the second member of the LLP. Typically the Limited Company set up in this scenario would remain dormant.
- The liability of company shareholders or guarantors is limited to the amount paid or unpaid on their shares (often the notional value of the shares), or the amount of their guarantees. The liability of LLP members is limited to the amount each member guarantees to pay if the business runs into financial difficulty or is wound up.
- A limited company can receive loans and capital investment from outside investors. An LLP can only receive loan capital and cannot offer equity shares in the business to non-LLP members.
- Limited companies pay Corporation Tax on their profits and Capital Gains Tax where applicable. Members of an LLP pay Income Tax, National Insurance and CGT on all taxable income. The LLP as an entity itself has no tax liability.
- It is much easier to change the internal management structure and distribution of profits in an LLP than in a Limited Company.
- A limited company can be operated as a non-profit business. An LLP must be set up with the intention of making a profit.
Tax Liabilities on LLPs and Limited Companies
Limited Company
All profits generated by a limited company and some taxable income regardless of whether the company is in profit, is subject to corporation tax of 20% or whatever rate is applicable at the time. Any salary a director receives will be liable for Income Tax, National Insurance and employers’ NI just as it would be for any other employee. However, directors are often also shareholders and are therefore treated as employees of their own company. The distribution of profits to directors can be done is such a way that much of the money they receive is not subject to corporation tax or personal Income Tax.
By paying a director a salary of no more than his/her tax-free Personal Allowance, and distributing additional profits by way of shareholder dividends, a director can legally minimise his/her personal tax liability. Dividends are paid from post-tax profits; therefore, no further tax has to be paid on this money by the company or its directors.
LLP
LLP members are treated as self-employed individuals. They must register for self-assessment and pay Income Tax and National Insurance on their individual profits, regardless of whether they take all of the profits as a salary or leave some of it in the business. However, most importantly, they are not liable for Employers’ National Insurance on their income.
Depending on the amount of profit generated, the tax liability of LLP members can be rather high. If an LLP member’s income exceeds the Personal tax-free Allowance threshold (£10,600 for 2015-16 tax year), he or she will be subject to the following Income Tax rates:
- 20% on income between £0 – £31,785 (you will start paying this rate on income above the £10,600 Personal Allowance threshold).
- 40% on income between £31,786 – £150,000 (you will start paying this rate on income over £42,385).
- 45% on income over £150,000.
Tax efficiency – leaving money in the business
In instances where you will make more annual profits than you need to take out of your business, a limited company is more tax efficient. There is no need to withdraw all surplus income immediately; instead, limited company owners can leave some of the profits in the business and defer tax by withdrawing this surplus income at a later date.This enables you to manage tax liabilities, when they arise and when you pay them.
This is not possible with an LLP. Regardless of whether the members take all of their annual profit entitlement or leave some in the business, all profit is subject to Income Tax in the financial year it is generated. The ability to manage tax affairs is therefore strictly limited and indeed can only be managed by way of managing profits in the partnership.
Internal Changes and Allocation of Profits
An LLP can, in many respects afford greater flexibility than a limited company in terms of altering member’s rights, duties and profit entitlement. Such arrangements can be verbally agreed amongst LLP members and they can be quickly and easily changed at any time.If an LLP agreement is in place however, the terms of this agreement must be complied with regarding changes, whether they are writing and so on. This document will outline the internal management structure of the business and the various arrangements in place, thus avoiding internal conflict and disputes. Unless the agreement says so, and that is unlikely, then verbal amendments to it will simply not be effective.
In Limited Companies, the voting rights and consequent profit entitlement of shareholders are governed by the prescribed particulars attached to their shares. In most instances, companies will issue just one type of share, Ordinary Shares, thus providing equal rights and profit entitlement to all shareholders. It is more difficult to change the rights and profit entitlement of shareholders because they are stipulated in these prescribed particulars. Notwithstanding it is possible to create different classes of shares with different attributes and thus get around the problem for instance, of paying one dividend to one class of shareholders and a different dividend, even none, to another class of shareholder. An alternate way would simply be to draw up a shareholder agreement which would allow individual shareholders to be treated differently from other shareholders.
Turner Little
Turner Little was founded in 1998 and it has since become a well-established UK based professional Company Registration Agent, Registered Bank Intermediaries and Business Consultants, as well as Trust provider.
