Lee Sharpe looks at tax aspects of converting a general partnership into a limited liability partnership.
The key benefit of a limited liability partnership (LLP) is that it limits the liability of each of its members (partners).
A ‘vanilla’ (i.e. general) partnership – when two or more persons carry on a business in common with a view of profit – is governed by the Partnership Act 1890. It can come into existence informally, or even unintentionally. Each partner is jointly and severally liable for the partnership’s debts (i.e., can be held personally responsible for the whole partnership’s entire liability. Simply put, a general partner risks his or her home as a result of something done by any partner).
An LLP cannot be set up ‘by accident’ but has to be formally constituted and registered at Companies House. Basically, the personal liability of each member (partner) of an LLP is limited to the extent of his or her investment therein.
Broad comparison: General partnerships vs LLPs
Advantages
- Each member enjoys personal limited liability protection
- Still very flexible business vehicle
But…
- Requires formal constitution / partnership agreement, registration at Companies House
- Annual return and accounts information has to be filed on public record at Companies House – possibly even an audit, if the LLP is large enough
- Restriction on sideways loss relief (see below)
- Possible re-categorisation as an employee, with attendant tax/NICs implications (see below)
Transition from general partnership to LLP
While LLPs are strictly companies (or legally distinct bodies corporate, at least) in all but a few quite unusual cases, LLPs are nevertheless taxed exactly like ordinary general partnerships, so long as they are carrying on a business with a view of profit (LLPA 2000, s 10). In such circumstances, the transition to LLP is quite straightforward.
Income tax/National Insurance contributions – Provided there is at least one LLP member who was also in the predecessor general partnership, there will be a deemed continuation of the business at the partnership level, and each ongoing partner/member’s personal activity will carry on as before, without invoking cessation and commencement rules (ITTOIA 2005, s 863); likewise there is no balancing event for capital allowance purposes. An individual member’s overlap profits are preserved, and losses then arising may be carried back to set against pre-transition partnership profits (but see point about sideways loss relief below).
Capital gains tax – Just as with a general partnership, there is no capital gains tax (CGT) event on transition provided that each member’s underlying interest in LLP assets remains consistent with his or her former interest in the assets when they were in the general partnership. Changing a member’s share in capital assets at the point of transition would, however, trigger a CGT charge in line with HMRC’s Statement of Practice D12 (TCGA 1992, ss 59, 59A).
For entrepreneurs’ relief, (renamed ‘business asset disposal relief’ in the latest Finance Bill), the qualifying holding period also ‘looks through’ the transition to LLP status.
Stamp duty land tax – A transfer of a chargeable interest in land from the former partners to LLP will be exempt from a stamp duty land tax (SDLT) charge (FA 2003, s 65), provided:
- The transfer is in connection with the incorporation to an LLP and is made not more than one year after that transition;
- There is unity between the former partners and the subsequent members in the LLP – they are one and the same; and
- There is no change in ownership proportions (or if there are, they are not for tax avoidance reasons).
Inheritance tax – There will be continuity of eligibility for business property relief, such that the period of ownership, etc., prior to the transition is aggregated with the period following incorporation to LLP status.
VAT – Unlike direct taxes, VAT law considers a general partnership to be a distinct entity, identified at partnership level on the VAT register. However, an ongoing business transferred to an LLP will usually be a transfer of a going concern, which is outside the scope of VAT (although particular care is required with regard to property transfers, so as not to trigger anti-avoidance legislation).
Interest relief – At the individual level, interest on loans to acquire an interest in a general partnership carrying on a business are allowable against one’s total income. See HMRC’s Partnership manual at PM131430 et seq. for further information on HMRC’s position on the tax treatment of conversion to an LLP.
However…
- Changes in the composition of the LLP – Its underlying partners, or in capital or profit-sharing ratios, could trigger CGT or SDLT charges.
- Income tax losses – While a general partner might in some cases be able to claim partnership losses against his or her other income, this mechanism is deliberately restricted for an LLP member; relief is given for an LLP’s trading losses only to the extent that a person’s aggregate claims do not exceed their residual capital invested in the business – in effect, the amount that a member really risks personally (ITA 2007, s 107 et seq). This applies only to trading losses (not losses from professions) and only to the extent that the loss is claimed against income other than the LLP trade itself (e.g. on carry-back). This restriction is separate from the general cap on unrestricted reliefs.
- Interest relief – The traditional guidance (which goes back to Tax Bulletin 50 (December 2000)) and relied on ESC A43 (as legislated at ITA 2007, ss 409, 410) has been interpreted by some to mean that if relief to acquire an interest in a partnership is already allowable before transition to an LLP, the member will qualify through the LLP as well, regardless. But relief for interest on loans to invest in a partnership is specifically restricted where that partnership is ‘an investment LLP’ (i.e. an LLP whose business consists wholly or mainly of the making of investments, and the principal part of whose income is derived therefrom). This test should be applied for each period of account, so a non-trading property investment general partnership that then converts to a property investment LLP is likely to be disqualified from relief, on transition to the LLP. To be fair to HMRC, the guidance does now explicitly say that interest relief should not be given for loans to invest in LLPs that ‘carry on an investment business’.
Capture for PAYE/NICs – Anti-avoidance legislation was introduced from 2014/15 to combat perceived abuse, typically in professional LLPs, whereby relatively junior colleagues were designated as members/partners but their incomes were basically fixed and their capital was not substantively at risk; in other words, they were really only employees.
In a general partnership, an individual’s status would be determined by reference to extensive case law. But once in an LLP, legislation provides that a ‘partner’ or member-designate will still be subject to PAYE and NICs as an employee if, simply:
- 20% or less of the member’s income is subject to the profits of the LLP as a whole (and the rest is fixed like salary); and
- The member has little influence over the LLP as a whole (minimal voting rights, etc.); and
- The member’s capital contribution is less than 25% of their fixed income.
Is there a partnership?
Where there is no trade but only investment, HMRC may need to be convinced that a general partnership existed in the first place, to transition to an LLP.
For example, HMRC has traditionally been quite resistant to the idea of property businesses being carried on in general partnership, preferring them to be considered mere joint investments, where each investor operates independently of the other(s). This could trigger a charge to SDLT on the transition to LLP status and (potentially) to CGT on the mutual introduction of assets to the LLP as if it were a brand new partnership (by virtue of Business Brief 03/08).
Conclusion
While generally considered a straightforward exercise, transitioning from a general partnership to an LLP does require care – particularly if a partner wants to retire or to be admitted. There are also longer-term implications such as relief against total individual income for losses or interest. Finally, note that the Scottish and Welsh equivalents to SDLT have their own idiosyncrasies to consider.
