Article by Mark Lee FCA, Deputy Chairman of the Tax Faculty of the Institute of Chartered Accountants and Director of Taxation at WJB Chiltern Limited. Published in the January 2002 issue of Tax Adviser. Are you labouring under the mistaken belief that this new business structure, the first for almost a hundred years in the UK, is only for large professional firms? During my talks on LLPs (e.g. for Butterworth Tolley’s Tax Conference and during the Tax Faculty’s road show around the country in February). I am endeavouring to raise the awareness of accountants and tax advisors as regards the relevance of LLPs for current and future clients.
I assume that this is why your esteemed editor asked me to prepare this article after hearing me speak at the recent TaxAid Conference in London. Space clearly does not permit more than a selection of the points I addressed. A full analysis of the background and technical details is set out in the 7500 word chapter I wrote on this subject for the Tax Faculty’s Tax Planning 2001-2002 book last summer. This is available from the Tax Faculty. Indeed Members may download individual chapters from the Tax Faculty’s website (www.taxfac.co.uk). Non-members should be able to do the same, for the payment of a small fee, via accountingweb.co.uk.
I believe that we must all get used to the idea that the choice of start up medium for new businesses now includes limited liability partnerships. All of the usual issues need to be considered from the perspective of what is important to the client both now and in the future. In the vast majority of cases, the tax consequences of starting a business as an LLP will be exactly the same as those that apply to a conventional partnership. In choosing the right structure in each case, do note that of course that an LLP has a similar advantage to a company in terms of its members limited liability. This comes at the same price as for any other body corporate. Thus, despite the tax transparency which allows the members of the LLP to be taxed rather than the entity itself, it is subject to filing and other obligations usually associated only with companies.
I believe that for many small businesses, corner shops, husband and wife partnerships as well as professional firms, an LLP will become the inevitable structure of choice if:
- the protection of limited liability is of genuine value to the owners; and
- there is little opportunity to accumulate profits in the business.
For new businesses that might otherwise incorporate as limited companies, purely to obtain the protection of Limited Liability, the LLP approach has another advantage; it obviates the need to arrange a payroll to deal with payments to the owners. As members they can receive their drawings from the LLP in the same way as partners in a conventional partnership. There is no Class 1 or Class 1A National Insurance Contribution (NIC) and no need for PAYE or forms P11D. There are also no equivalent restrictions or procedures to those which apply to companies which can only pay dividends out of realised profits and need to pass formal resolutions to so do. Finally, the tax payment regime is better for cash-flow, loss relief is more generous and there is no potential double taxation on the disposal of business assets.
Private companies have the advantage of limited liability of course and shareholders can claim Business Asset Taper Relief on disposal of their shares although this is only worth having if the shares have achieved significant value. On the other hand corporate structures can lead to all sorts of unforeseeable problems, such as the difficulty of removing shareholders and the appearance of unwelcome new shareholders following a death or divorce.
I would certainly recommend anyone thinking of starting a new professional firm in future, for example, as a breakaway from an existing conventional partnership, to consider an LLP structure from the outset (as long as there will be at least two members).
Many joint venture activities may also be established as LLPs in the future, but be aware of the complications that could arise if any members are non-UK resident or if the LLP has investment or overseas activities.
Limited Liability Partnerships will normally be governed entirely by a formal agreement between the members. We all know that many partnerships, contrary to best practice, operate without the existence of a signed and up to date partnership agreement. I certainly do not condone such an approach given the disadvantages of operating a partnership ‘at will’. There is similarly no legal obligation on the members of an LLP to approve a ‘members agreement’.
A written members’ agreement can provide virtually anything that the members want it to in relation to how the LLP would be managed, how decisions relating to the LLP will be taken, how profits will be distributed and how capital will be contributed. As the LLP is a body corporate with a separate legal personality from its members, the agreement should also define the duties owed by members to the LLP, by the LLP to the members and by the members to each other. The agreement will be a private document between the members and need not be filed at Companies House.
All commentators agreed that it is essential to have such a written agreement in place before the LLP starts operating in businesses. If the members of an LLP do not have an agreement between them as to how the LLP will operate, various default provisions apply under the Limited Liability Partnership Act 2000. However these are extremely brief and unsatisfactory and less comprehensive then those in the Partnership Act 1890. For example, they provide that members will share profits equally irrespective of capital contributions to the LLP and that no member may be expelled for any reason. There are few precedents for straightforward member agreements at this time. Discussions about such agreements are invariably a valuable opportunity to provide informed tax input, certainly if my experience with partnership agreements is anything to go by!
The government has long been concerned to prevent tax loss through investment and property investment LLPs. The anti-avoidance provisions can now be found in the Finance Act 2001, s. 76 and Sch. 25. I believe that these provisions will serve principally to discourage tax exempt investors from investing in property investment LLPs as any income or gains derived therefrom would be subject to tax. This will affect pension funds, the pension business of life insurance companies and the tax exempt business of friendly societies.
An investment LLP is defined in the new Income and Corporation Taxes Act 1988 (ICTA 1988), s. 842B such that the case law and guidance relating to the definition of an investment company (ICTA 1988, s. 130) may be applied for LLPs. Section 842B then defines a property investment LLP by building on the definition of an investment LLP.
The provisions do not, of themselves, prevent LLPs from being used for property investment or other investment activities.
The other quite separate anti-avoidance provision introduced by FA 2001 affects tax relief for interest paid on loans to buy into an investment LLP. In effect, the same restriction will apply (by way of an amendment to ICTA 1988, s. 362 (2)(a)) as for loans to buy into 1907 Limited Partnerships. Thus, no tax relief will be available in such cases. We are told that this is to prevent tax loss and to avoid potential distortions in investment patterns. There is however no equivalent restriction on the tax relief available to an investment LLP where it is liable to pay interest on borrowings taken out by the LLP itself. However such an approach to gearing may not make commercial sense or be attractive to lenders unless members agree to guarantee such loans.
A question I am regularly asked is whether companies can become LLPs. Indeed, Companies House website gives a positive answer to the question because as a matter of law this is correct. However, the Revenue have stated that the same consequences will ensure for shareholders in a company that disincorporates to form an LLP has currently follow where a company disincorporates to form a conventional partnership.
We are all familiar with the capital gains tax (CGT) hold-over reliefs that exist when un-incorporated businesses are transferred into corporate structures. However, no equivalent provisions exist to facilitate the disincorporation of a company to partnership or sole trader status without adverse tax consequences.
Back in 1987, the Revenue identified a package of measures that would remove the obstacles to disincorporation, addressing both company law and fiscal issues. However, 14 years later, none of these measures have been introduced. Accordingly it is most unlikely that many limited companies will seek disincorporation and re-registration as limited liability partnerships. The adverse tax consequences include:
- two tier CGT charges – the company would have a liability by reference to the excess market value over cost of its assets (including goodwill); and shareholders would realise a gain by reference to the excess of distributions over and above the cost of their shareholdings;
- there is no facility to carry forward corporate tax losses (income or capital) for off-set against income from the partnership or LLP;
- the transfer of assets (including goodwill) to shareholder directors could be treated as a benefit in kind; and
- no facility exists to continue loan interest relief in respect of borrowings to acquire shares in a limited company, or loans to the limited company, although this could be resolved through a refinancing exercise.
Relatively new companies with no goodwill, no carried forward losses and no other assets, might be able to re-register as LLPs without unacceptable tax charges arising, but the relevant company law issues would need to be addressed and legal advice sought where necessary. Another approach, subject to normal caveats, might be to establish an LLP carrying on a complimentary business and to build this up while winding down that of the original corporate entity. I am also exploring a couple of other solutions which may be appropriate in certain circumstances.
The draft Statement Of Recommended Practice (SORP) which purports to determine the format of LLP accounts has been widely criticised and is subject to review (at the time of writing). Once everyone is clear as regards the accounting issues I am convinced that a growing number of our clients will adopt LLP structures and that it will become a popular tax effective business structure for a wide range of clients (including professional firms!).
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January 2002 by