Limited liability partnerships

Advantages and disadvantages

Introduction

Limited liability partnerships became available in the UK in April 2001 as a half-way-house between a partnership and a limited company. They were made available to combine the flexibility of partnerships with the protection of limited liability. Although still not widely used, many professional partnerships have chosen to convert to an LLP.

Two or more people can form a limited liability partnership (LLP) by registering it at Companies House. There must always be at least two members (partners). The LLP can admit a new member by filing a notification form at Companies House.

Constitution

An LLP would be wise to have a partnership agreement to set out the agreement between the members, but it is not necessary. The LLP does not file any form of constitution. The members can agree profit sharing or other arrangements amongst themselves verbally and change those arrangements as often as they agree.

Annual financial statements

The LLP must file financial statements at Companies House. These can be so abbreviated that they tell an outsider very little about the business.

Limited liability

The members of an LLP should not be liable for claims against the LLP. For example, a member should not be liable for business debts, employee claims, or public liability.

There is some doubt about professional negligence claims. An individual member who personally gives a negligent service may be liable for the consequences of that negligence. If it arises, the member will need specialist legal advice on this matter.

Taxation

The tax rules for an LLP are the same as an ordinary partnership. The members are self-employed. The LLP will file an annual tax return, but each partner will report their share of the profit on their personal tax return. The individual partners will pay income tax and class 4 national insurance on their profit share.

Taxation compared with a limited company

At present tax rates, a limited company paying corporation tax and then distributing its profits as dividends will normally pay less tax on the income than self-employed individuals or partners. The Chancellor of the Exchequer has announced changes in tax rates that will reduce the benefit of trading as a limited company.

The major tax disadvantage of a limited company is the taxation cost of changing the shareholdings. A limited company pays dividends in proportion to the number of shares held by each shareholder. There can be substantial tax charges on changing the shareholdings. In particular, giving more shares to an individual to reward them for working for the company can be very expensive.

By contrast, there are no tax charges on changing the profit sharing arrangements in an LLP. The members of an LLP can review the division of the profits as often as they like. Each partner pays tax on their share of the profits and HM Revenue & Customs are not concerned with how the members calculated that share.

Should an existing partnership convert to an LLP ?

Converting a partnership to an LLP has no effect on the tax status of the partners.

Partnerships should draw up annual financial statements for their internal use and must file a partnership tax return. There is slightly more work in preparing an LLP’s financial statements for Companies House.

Otherwise there is very little additional ongoing administration.

Naturally, there will be some work in changing the banking, insurance and other commercial arrangements.

The partners can have the benefit of the protection of limited liability for these very small additional costs.

Should a new business be formed as an LLP ?

If it is clear that there will be no change in the ownership or profit sharing arrangements of the business for a long time, there are likely to be taxation advantages to a limited company.

If there may be changes to the profit sharing, for example the admission of a new member, a change in the working hours or the retirement of a member, an LLP should be seriously considered. This is because of the tax charges that can apply to changes in the shareholdings in a limited company.