Following its introduction in 2001, the LLP quickly became the vehicle of choice for those looking to start an asset management business. Offering the protection of limited liability, along with the flexibility and tax-planning possibilities of a partnership, the LLP was often a clear choice.
But many of the historic advantages of the LLP have eroded in recent years, leaving many of today’s new managers with a genuine dilemma.
The specific advantages and disadvantages range across various areas.
The principal benefit of using an LLP is often the ability to treat highly remunerated individuals as self-employed for tax purposes. The resulting absence of employer National Insurance Contributions (NICs) on allocations of LLP profit shares, as compared to payments of salary or bonus to an employee, offers a significant saving of 13.8 percent on remuneration costs (or 14.3 percent where the Apprenticeship Levy applies).
In addition, a marginal personal National Insurance saving can arise when comparing members’ total Class 2 and Class 4 liabilities to employee Class 1 contributions. As a result, there is often an immediate and obvious tax… Continue Reading
Prior to the introduction of the salaried member rules, as well as the “mixed member” rules that also became effective in April 2014, many asset management businesses took advantage of the partnership structure offered by an LLP to implement a variety of tax planning measures.
The introduction of the mixed member rules largely eliminated planning designed to take advantage of the lower tax rate paid by corporate members. Contributing factors to the significant decline in the use of LLPs for tax planning purposes include
An LLP potentially offers a small overall tax saving, though much will depend on personal circumstances.
In the example below, all profits are distributed by a company in the form of dividends (as opposed to salary or bonus, which are taxed at higher rates); and all taxes are paid on dividends/profit share at the highest rates (disregarding any lower marginal rates of tax).
Tax-Efficient Profit Retention/Reinvestment
Prior to the introduction of the mixed member rules, it was customary for an asset management LLP to be established with a limited company member. The corporate member typically would be owned by the equity-owning individual members, and the corporate member often would act as the managing member of the LLP.
A principal tax advantage of having a corporate member was that it allowed the LLP to allocate profits to the corporate member, on which it would be taxable at corporation tax rates (which historically have been, and remain, significantly lower than income tax rates). This effectively enabled the individual members to retain or reinvest… Continue Reading
Due to the tax transparency of the LLP vehicle, LLP members pay income tax on their share of the profits of the LLP. If the LLP makes no profit, they pay no tax. This is the case even if they receive drawings from the LLP during loss-making periods.
Employees of limited companies are subject to income tax and NICs on payments of salary or bonus received from a limited company, even if the company is loss-making.
In both cases, the payments to the member/employee reduce the capital available to the business, but the difference in tax treatment is stark. In the longer-term, if the business is profitable, the position will even out. LLP… Continue Reading
Subject to the terms of the LLP agreement, new members generally can be admitted to the partnership free of a tax charge. This allows LLPs to promote employees to partnership status and to recruit new partners laterally, with ease. It also allows such new members to be admitted into the equity of the LLP without an obligation to pay market value for such rights.
For a limited company to grant an equity interest, it must issue new shares or transfer shares from the existing shareholders. Due to the complex “employment-related security” (ERS) rules, such issues or acquisitions of shares will be subject to income tax in the hands of the… Continue Reading
Subject to the terms of the LLP agreement, members of an LLP are free to vary the basis on which the members share in the LLP’s profits. This allows significant flexibility to adjust members’ profit shares on an annual basis to reflect their contributions to the business.
While limited companies have the flexibility to pay discretionary bonuses to reward personal performance, such payments are subject to employer NICs at 13.8 percent (or 14.3 percent if the Apprenticeship Levy is due).
Profits may be distributed to shareholders free of NICs in the form of dividends. However, dividends generally must be paid to shareholders pro-rata to their shareholdings, and varying the proportions in which equity is held is itself ordinarily taxable.
Although seniority or importance to a business established as a limited company is frequently demonstrated through a wide range of impressive job titles, there remains a certain distinction for many to being a “partner” in a business.
Partnership can help create a greater sense of ownership in the business, as well as a club-like atmosphere among the key individuals. Partner status also may serve as an incentive to lateral recruits. The importance of this factor will vary from business to business but is rarely a critical aspect in decision making.
It is common for senior executives to be bound by restrictive covenants following an exit from the business. Such covenants typically aim to prevent the disclosure of confidential information, competition with the business and solicitation of clients or employees.
In general, restrictive covenants are at risk of being void as a restraint of trade, unless they protect a legitimate proprietary interest, and the protection sought is reasonable in light of the interests of the parties and the general public.
Though restrictive covenants are highly fact-specific, the courts generally are more inclined to enforce them against partners of an… Continue Reading
Although the degree of complexity is principally a result of the commercial arrangements between the principals and with any co-investors, limited companies generally remain simpler, quicker and less expensive to establish than LLPs.
In many cases, particularly where the principals are from non-UK jurisdictions and unfamiliar with LLPs, limited companies are better understood and perceived to be easier to operate.
Investing in a limited company may enable business investment relief to be claimed in order to prevent a taxable remittance if:
- The founders are non-UK domiciled individuals claiming the remittance basis. Broadly, it permits such individuals to elect to be taxed in the UK on non-UK source income and gains, only to the extent such income and gains are remitted to the UK
- Such individuals propose to fund the business establishment from non-UK income or gains
An investment in a UK LLP is not a qualifying investment for business investment relief purposes, and would constitute a taxable remittance if funded with non-UK income or gains. Although the potential extension of business investment relief to investments in partnerships has been mooted on a number of occasions since this relief was introduced in 2012, there currently are no plans for such an extension.
Managers looking to the long-term at choice of structure may consider the tax treatment expected in connection with a future sale of the business. While it is difficult to depend on the current tax regime remaining in place at an undetermined future date, there is potential availability of “entrepreneurs’ relief,” based on present rules.
Currently under considerable political scrutiny, entrepreneurs’ relief potentially enables business owners to pay capital gains tax at only 10 percent on their first £10 million of gains arising from a sale of their interest in the business or assets used in the business (providing a potential tax… Continue Reading
The UK tax rules applicable to carried interest have changed significantly during the last five years. Although it was never the intention of the legislative changes to favour limited companies over LLPs, in some cases this may be a practical consequence.
A key change to the taxation of carried interest was the introduction of the “income-based carried interest” (IBCI) rules in April 2016. Broadly, these rules look to the weighted average holding period of a fund’s investments in determining whether any carried interest in relation to the fund should be taxed as income or capital gains. An average holding period of at least 40 months is… Continue Reading