Following its introduction in 2001, the UK limited liability partnership (LLP) has tended to be the vehicle of choice for fund managers looking to operate out of the United Kingdom. When compared to a UK limited company (LTD), the draw of the LLP has been twofold; a LLP offers commercial and legal flexibility alongside a lower overall tax cost. However, given recent changes to UK partnership tax rules as well as proposals to lower the rate of UK corporation tax, the choice as to operating through a LLP rather than a LTD is not as clear cut as was previously the case. The Attraction of the LLP The primary benefits of the LLP when it was first introduced were the various UK tax advantages afforded to its members. The LLP has the benefit of being an entity with separate legal personality whilst simultaneously being fiscally transparent. Traditionally, this has resulted in an attractive effective tax rate when compared to LTD structures, where tax is suffered at both the entity and shareholder levels. In addition, members in a LLP were treated as self-employed, meaning: (i) a national insurance contribution (NIC) saving of 12-13 percent per annum was often achieved; (ii) membership interests could be given to new members without attracting an employment tax charge; and (iii) the complex analysis surrounding "employment-related securities" was frequently avoided. Other non-tax benefits have contributed to the appeal of LLPs. Perhaps the most attractive of these is the flexibility in profit sharing arrangements. This is in contrast to a LTD, where if a dividend is declared in respect of a share class, it must be declared for the entire class. It is similarly easy to re-allocate profit shares year on year, and (subject to the terms agreed by the members) generally easier to remove members of a LLP when compared to employees in a LTD. LLP agreements, unlike a LTD's articles of association, also remain private documents.
Time to Reconsider?
Following legislative changes in recent years, certain of the benefits of using a LLP have become more difficult to secure. The "salaried member rules" have resulted in certain members being treated as employees for tax purposes, extinguishing one of the key tax savings associated with LLPs.1
New rules also impact hybrid structures (comprising corporate and individual members), limiting the amount of profits that can be allocated to corporate members of a LLP, a method previously used to retain or defer profits in a tax-efficient manner. Further legislation covering disguised remuneration and the treatment of carried interest has created additional considerations to address when seeking to use a LLP in a fund management context.
While the attraction of the LLP could be considered to be diminishing, the appeal of the LTD is, in many respects, increasing. Of particular interest are comments made in the aftermath of the vote for the UK to leave the EU on July 23, 2016, where the then UK Chancellor gave strong indications that cuts to the rate of UK corporation tax, potentially to less than 15 percent, would likely be at the heart of the UK's efforts to attract investment in the post-Brexit world. However, given the recent appointment of a new UK Chancellor, it could be the case that the proposed reduction in UK corporation tax is not actually implemented.
The Benefits of the LTD
A cut in the rate of UK corporation tax, particularly to less than 15 percent, could make the effective tax rate for LTD structures lower than the 47 percent effective rate generally associated with a LLP structure. Further tax benefits for LTDs could possibly follow in the coming years to encourage foreign investment into the UK.
There are further benefits to the LTD that, prior to the above mentioned legislative changes, were often overshadowed by the benefits of using a LLP. When compared to the LLP, such benefits could include: (i) the LTD offering greater flexibility in terms of employee incentivisation and/or business exit strategies; (ii) the ability to retain profits within the LTD, perhaps to meet regulatory capital requirements, or as working capital for the business; and (iii) depending on the investment strategy employed by the manager and the related need for proprietary software and intangibles, the ability to secure UK tax reliefs for expenditure on research and development.
The Conversion Process
For managers thinking of converting their LLP to LTD status, there is an extra layer of issues to consider.
Depending on arrangements already in place, a conversion process typically involves, as a minimum, (i) the incorporation of a new company; (ii) the transfer of the LLP's business to that company; and (iii) the cessation of the LLP. Further to this, each asset of the LLP (including suppliers, employees, finance agreements and leases) needs to be transferred and each contract assigned or novated, a large administrative task in and of itself.
From a UK tax perspective, the transfer of a business may attract a VAT liability, whilst transfer of interests in UK real estate typically result in UK transfer taxes being due. Further, capital gains tax may arise on the disposal of each asset, although relief may be available for individuals transferring a business as a going concern in exchange for shares.
From a regulatory perspective, an application can be made to the Financial Conduct Authority (FCA) for a "change in legal status" in order for the LTD to retain the LLP's existing FCA permissions. There is a streamlined application process for such a change in legal status application; for example, there is no need to resubmit a detailed regulatory business plan. As a statutory matter, the FCA still has the full six to 12 months processing time as with any fresh application, but in practice the FCA would typically process such change in legal status applications more quickly.
Finally, there would also be employment and data privacy issues to consider.
When the recent tax changes and/or proposals are coupled with recent legislation that serves to eliminate some of the historic draw factors of LLPs, the decision between the LTD or LLP structure is one that increasingly demands attention.