Alan Pink considers situations where a limited liability partnership structure may benefit over ordinary unincorporated partnerships.
First of all, it’s worth saying something about the still widespread misconception that limited liability partnerships (LLPs) are only ‘for’ accountants and lawyers. LLPs can conduct any kind of business, including an investment business, and can be very flexible structures for doing so, as I hope to demonstrate in what follows.
To sum up what an LLP is in one sentence, it is a body corporate which in most respects is like a limited company, importing separate legal personality and limited liability; but which is treated for many tax purposes, by a kind of legal fiction, as if it was a partnership. So, members of an LLP which carries on a trading or an investment business are treated under this legal fiction as if the LLP wasn’t there, and they were simply conducting the business jointly as partners.
One thing trading through an LLP does do is to import greater formality for accounting purposes. LLP accounts have to be prepared in a format similar to that of a limited company, and certain parts of those accounts have to be put on public display. Therefore, LLP accounting is both more expensive and more open to outside scrutiny, which can definitely be seen as disadvantages.
However, the LLP does also have major advantages (or they wouldn’t be so popular) as compared with general partnerships. I would sum up the two main areas in which the two structures differ from each other as ‘limited liability’ and ‘substance’.
Limited liability: but be careful
LLPs were first introduced in 2001 in response to pressure, predominantly from the accountancy profession, to limit the liability of individuals trading in partnership, whilst at the same time enabling them to keep the tax (and National Insurance contributions (NICs)) benefits of being self-employed. They appear to have been modelled on the US LLC structure, which has, or can have, the same effect. So, an individual can be treated as self-employed for tax purposes, with tax benefits in the areas of NICs liability and reduced taxation on benefits-in-kind (e.g. cars) without exposing himself to possible bankruptcy if the partnership goes bust.
One immediately needs to sound a note of caution here, though. This is to the effect that you should look very carefully at the LLP’s constitutional document, which is the LLP agreement. Not all LLP agreements make it clear that, in the event of the LLP incurring a loss, that loss should not be debited to the members’ capital accounts. The agreement should say, in my view, that whilst profits are credited to current or capital accounts of members with the LLP, losses are definitely not debited, or at least not automatically. Why is this?
Effectively, if losses can be debited, you as a member are voluntarily forfeiting the benefit of limited liability. Let’s take an example.
Example: LLP losses
Risky LLP has an agreement to the effect that profits are credited, and losses debited, equally to the two partners, Mr Adams and Mr Brown.
The LLP trades quite happily for a number of years, but then there is a catastrophic claim against the LLP which is upheld in court, meaning that the LLP is ordered to pay the claimant £1 million. As a service providing business, Risky LLP has no assets to meet this claim and goes into liquidation.
The liquidator, noting the LLP agreement terms, draws up accounts showing the £1 million as a loss, which then gets debited as to £500,000 each to Mr Adams and Mr Brown. As a debit to their accounts with the LLP, this becomes a debtor which the liquidator can demand be repaid to the LLP by Messrs Adams and Brown.
The other aspect of interest which results from the (hopefully) limited liability status of an LLP is the ability to bring into ‘partnership’ individuals who would not otherwise have been willing to step up to that status. If you are senior management in a business, but not an owner, you can understand the reluctance to become a partner in that business if it is a general partnership; because decisions made at the top level (that is, the level of the owners) might act to your detriment if they result in the insolvency of the partnership. However, with an LLP whose agreement strictly limits your liability, this reason to say ‘no’ to the offer of partnership disappears.
From the point of view of the partnership, where senior individuals become members, this has the very solid financial advantage of avoiding 13.8% employers’ NICs on their income, and also makes the provision of benefits-in-kind potentially more favourable from the point of view of tax and NICs. Following changes to the rules in Finance Act 2014, to be treated as self-employed an individual needs either to have a set amount of capital in the business, a set amount of income variable by reference to the profits of the LLP, or be able to exert ‘significant influence’ over the LLP under the LLP’s constitution. Pass any (or all) of these tests, though, and you could be saving an awful lot of employers’ NICs, for a start.
‘Substance’
This is chiefly of significance for businesses which derive their income from the exploitation of valuable assets, particularly property investment businesses. The problem with these partnerships, in a nutshell, is that there is no guarantee that HMRC will agree that they are a ‘partnership’ at all. A partnership is a concept which generally implies some kind of active trading.
With an LLP, however, whatever the LLP does is treated by the legal fiction I referred to as if it were carried on in partnership, thus putting the existence of a partnership beyond doubt. There seem to me to be at least three advantages of being able to settle the matter in this way:
Flexibility - In a partnership, as opposed to a joint ownership situation, it’s possible to apportion income between the partners in a flexible manner, which isn’t tied down to the proportions in which the owners hold the income producing property. So, for example, individual family members can be brought into membership of the LLP without any formal transfer of property ownership or rights to them, and they can receive (subject to ‘settlements’ anti-avoidance constraints) whatever share of the income is tax-efficient. This allocation can also differ from year to year.
Corporate partners - A limited company, connected with the individual members, can also be introduced as a partner. Within an LLP, there is no need to give it any particular interest in the property, and the tax (capital gains tax and stamp duty land tax (SDLT)) problems which could arise from a simple transfer of an interest in the property to the company, are avoided. The benefits of the company’s membership may include the ability to allocate profits to the company, on which it will pay a lower rate of tax than the individual members would have.
Stamp duty land tax (SDLT) - Where it is decided to incorporate real property (e.g. in London) into a limited company, a transfer from an LLP can make use of the effective SDLT ‘relief’ for transfers from partnerships to connected companies. If the company had only been a joint owner or, worse still, had no ownership rights over the property, this could well mean that the transfer of the property to the company would have given rise to SDLT. For this reason, many promoters of the idea of incorporating property portfolios suggest that they be put into LLPs first – although care needs to be taken to avoid this sequence of events (personal ownership to LLP ownership to company ownership) being looked on as ‘preordained’ and subject to anti-avoidance provisions.
