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Limited Liability - LLP vs Ltd
Ever wondered what the main differences were between a Limited Liability Partnership and a Limited Company? Here's a concise article written by Mark Lee, founder of The Tax Advice Network
Limited Liability Partnerships (LLPs) - a better business structure than a limited company?
by Mark Lee
This article provides some clarification as regards Limited Liability Partnerships (LLPs) as they are not well understood.
Choice of business structure
Many people assume that being in business is synonymous with running a company. This is not the case. There are actually four alternative common forms of business structure in the UK:
• a sole trader;
• a conventional partnership (where the individual works with one or more partners in the business);
• a limited liability partnership - LLP - (this provides the individual and their partners with the protection of limited liability, just as with a company); or
• a limited company.
There is also a fifth option - the Limited partnership (as distinct from LLP) - but this is rarely an attractive or feasible choice for smaller businesses. These old style limited Partnerships were very restrictive, required at least one partner to have unlimited liability and precluded the limited partners from being involved with the management of the business. The LLP is a very different animal.
Background re LLPs
Introduced into the UK by the LLP Act in 2001, they were originally intended as an alternative business structure for professional firms such as accountants and lawyers. Indeed over the last few years most of the biggest professional firms have become LLPs. (Technically speaking they have incorporated as LLPs). The concept took a while to take off as it was not until 2003 that the rules were established for how to present LLP accounts. Anyway, that's all history.
The idea did catch on in some quarters and it is now apparent that LLPs can be used by any business that wishes to secure the benefits of Limited Liability without the constraints and complications of operating as a limited company. Already the vast majority of LLPs registered at Companies House are NOT professional firms.
Advantages and disadvantages
These will depend on what matters to you. For example if you make more profits than you need to draw out of your business each year, you will probably want to use a limited company. Alternatively if you have a fundamental objection to allowing your accounts to be made public you will want to operate as a sole trader or a conventional partnership.
In the UK, one of the prices we have to pay for the privilege of trading with the protection of limited liability is registration at Companies House and the publication of certain business information.
The protection of limited liability for the members of an LLP is essentially the same as for the directors and shareholders of a limited company.
These days one person can establish a limited company but there need to be at least two persons to form a Limited liability partnership. However there is nothing to prevent you setting up your own (non active) company and for the LLP members to simply be you and your company.
If you plan to build up your business for sale - or you are likely to require third party investment you will probably want to run your business through a limited company as you can sell shares in a company. There is no such concept in an LLP. Some people will loosely talk as though you can buy and sell shares in an LLP but it's not that easy.
The law imposes restrictions on limited companies as regards what is called 'capital maintenance'. This often causes problems when the owner tries to pay dividends when there are insufficient accumulated profits. There are no equivalent rules for LLPs.
Companies, but not LLPs are required to hold, record details and maintain minutes of Directors' meetings, shareholder meetings, annual and extraordinary meetings. There are some annual reporting requirements and a specified format for LLP accounts but this is not much different to the rules for a limited company.
Big limited companies and LLPs are required to have a formal audit but typically only if their turnover is greater than £5.6 million.
In certain restricted circumstances the members of an LLP can be required to repay drawings and profits back to the LLP after it become insolvent.
Directors of failed companies can be banned from holding subsequent directorships.
Headline tax issues
Simply stated the profits of an LLP are taxed in the same way as for a sole trader. This will often be more attractive than operating your business as a limited company.
In recent years there has been a tendency in the most straightforward of cases to pursue hoped for tax savings by incorporation of small businesses. ie: to operate as a limited company. The 'plan' was invariably to then limit your salary to the level of the personal allowance each year and to distribute the remainder of the company's profits by way of dividend payments.
In many cases there is no longer a headline tax saving if you operate as a limited company, but even when there is you need to understand a number of other key points:
1) This apparent tax saving will be reduced by the additional fees you will pay your accountant if you operate your business through a limited company;
2) The prospective tax changes announced in 2007 will reduce this headline tax saving in future years;
3) There are other tax and related issues to consider before making a decision. For example - will you want to draw out all of the profits of the business? Do you need to invest in any capital equipment? Do you have any business loans to repay? How high are your non tax deductible business related expenses? Do you use a car for business purposes (see link below)? Can you cope with the payroll tax obligations? Do you need to show high business profits or salary for mortgage purposes (dividends may not count)? And so on.
It can be dangerous to assume that incorporation will be preferable in the longer term just by reference to an apparent headline tax saving in the current year.
Additionally the tax traps awaiting newly incorporated small businesses might well negate the apparent savings. This is even more the case when people start trying to disincorporate their companies. All such issues should certainly be considered beforehand so that a reasoned choice of business structure can be made and justified in full knowledge of all the consequences.
Tax trap for the naive
If this expose of the potential attractions of LLPs makes you yearn to transfer your business from a limited company to an LLP, please take professional advice. There are a number of potential tax traps to be avoided - and some of them can be quite nasty and only catch up with you years later. Simply stated no tax reliefs are available when transferring a business from a limited company to an LLP. Thus tax can become payable on DEEMED capital gains, DEEMED benefits and/or DEEMED dividends. Also any unutilised losses will be lost. There are also various related tax reporting obligations when the company ceases to trade.
Adapted from an original Blog from Ecademy.com, written by Mark Lee in June 2008