Getting the structure right
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Publication: Article What’s best? A limited liability partnership or a private limited company?
In our experience, the success of most new ventures is down to detail and planning.
One of your first planning decisions relates to the structure of the business. Business structure will significantly impact taxation, further growth and eventually, your exit from the business.
For limited liability businesses, you have a choice between a limited liability partnership (LLP) and a private limited company (LTD).
Companies House filing
Both LLPs and LTDs must be registered at Companies House and file annual accounts.
Whilst the filing requirements are broadly similar, there is one significant difference. With an LTD, its Articles of Association are publicly available at Companies House. The partnership agreement of an LLP is not public.
Tax treatment
Because the ownership structure of LLPs and LTDs are substantially different, each is treated differently in relation to tax.
An LLP does not directly bear any tax on its profits. Partners are treated as direct owners of the business, each person is deemed to be carrying on the trade of the partnership and, for tax purposes, they are self-employed. The partners are taxed individually on their profits in the year they arise.
By contrast, an LTD is a separate taxable entity and is liable to Corporation Tax on the profits as they arise. The company’s shareholders are taxable on the dividends they draw from the business and any salary they take.
Flexibility
Historically, LLPs have been used primarily for professional service businesses, and LTDs for trading businesses.
However, when it comes to deciding the structure of your business, what matters most is your operational strategy. It is important to consider how the business will operate in both the short and long term.
Of the two structures, an LLP offers greater flexibility. Profit-sharing arrangements and ownership percentages can be changed year on year without triggering a tax charge.
Provided it does not contravene anti-avoidance rules, you can change the amount of profit allocated to each partner annually. You can also introduce new partners and have partners leave without triggering a tax liability.
Consequently, an LLP can be a good option if you want to change the profit-sharing arrangement regularly or introduce new partners.
An LTD has share capital, and dividends must be paid equally on all shares of the same share class. Because of this, it is impossible to change the ownership-dividend ratio year on year. While some flexibility can be built in by using different share classes, it is less flexible than an LLP. It is also harder to change the share capital of an LTD without triggering a tax charge.
Capital structure
Whilst an LLP offers greater flexibility regarding profit-sharing arrangements, an LTD offers its own benefits.
LTDs are often seen as more attractive from an investor’s point of view, both in terms of investment and sale. Investors can buy and sell share capital in the business without being directly involved. This is not possible in an LLP.
Additionally, an LTD can take advantage of schemes which are not available to an LLP — the Enterprise Investment Scheme (EIS), for example. This scheme offers several highly beneficial tax incentives for investors in unquoted trading companies looking to raise external finance, including:
- An immediate tax break of 30% on the investment
- The ability to defer capital gains
- Tax-free disposal after 3 years.
An LTD can also take advantage of HMRC-approved share schemes, such as R&D tax credits, which can incentivise employees.
An HMRC-approved share option scheme allows employees to participate in the proceeds of a sale at Capital Gains Tax rates, without having to give them actual shares in the business. It triggers a tax charge only when the business is sold.
So, which is better — LLP or LTD?
As with most things in life, there is no one-size-fits-all answer. Your choice of business structure depends on your long-term plans for the business.
In broad terms, an LLP is generally most beneficial if:
- The business is owner-operated — hence their strong prevalence in the professional services sector.
- You want to change how profits are shared on an annual basis, and easily introduce new partners to participate in the business day-to-day.
An LTD is beneficial if:
- You plan to attract outside investors and are looking for growth.
- You want the option of a possible exit through sale to a third party.
In addition, several other factors may affect your decision — the impact of subsidiaries, international elements, and long-term tax reliefs such as Business Property Relief for Inheritance Tax.
In conclusion, it’s important to seek expert advice when choosing your business structure. It makes the decision-making process considerably easier.