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LLPs offer IFAs many advantages

James Went Manches 2012 - New

Although the limited liability partnership (LLP) has been around for more than 10 years it is a poorly understood vehicle and take up among the IFA community has been low.

Most IFAs continue to operate in corporate structures which for many businesses results in an increased tax burden and organisational inflexibility.

It is perhaps unsurprising that to date IFAs have been reluctant to consider alternative structures.

The use of a limited liability company is a well trodden path with a clear distinction between management by the board of directors on the one hand and ownership by shareholders on the other.

For a lot of IFAs there is no real distinction between the management and ownership of the business. But many could be missing out on a number of significant tax and organisational benefits offered by LLPs.

The radical restructuring of commission arrangements and the regulatory framework with effect from the beginning of next year, is likely to result in a period of significant consolidation within the industry. Inevitably this will give IFAs the opportunity to review the most effective business structure within which to operate. The use of the LLP should be high up on the agenda for many of these businesses.

What is a limited liability partnership?

An LLP is a hybrid between a limited company and a general partnership offering limited liability to its members while retaining the tax transparency and flexibility of a partnership.The LLP is a separate legal entity and, while the LLP itself will be liable for the full extent of its assets, the liability of the members will be limited to the amount of capital they invest.

Unlike limited companies, LLPs do not make the distinction between ownership and management. Each of the partners is a “member”. This avoids the need to assume the onerous responsibilities of directors and the cost and administration of issuing, transferring and buying back share capital.

An LLP does not pay tax on its income – it is tax transparent. Instead, the members pay tax on the profits they receive from the business. This is taxed as personal income and not treated in the same way that a company’s profit is subject to corporation tax.

Advantages of LLPs over companies

The nature of a limited company structure and company law impose many restrictions which do not fit well with the needs of many IFA businesses.

This is particularly the case for a typical IFA business which is usually highly dependent on the individual performance of its owner/managers.

Ownership of a company involves owning a certain number of shares and the rights of the owners are linked to the number of shares they hold. Over time, a significant gap can develop between the ownership entitlement of shareholders and their individual contribution to the business.

In addition, owners typically pay themselves remuneration as employees through a salary that carries a heavy burden of tax and national insurance contributions. Dividends can be paid without incurring NICs (though out of income already subject to corporation tax) but they are paid in proportion to shareholdings.

Some companies attempt to overcome this by issuing differing classes of share and paying differential dividends to the owners based on individual performance. However, this can be a cumbersome structure. There are many formalities to go through when a company pays a dividend that can be unattractive if regular payments are to be made. Such structures can also be challenged by HMRC.

In contrast, an LLP offers considerably more flexibility in structuring remuneration for members in a tax-efficient manner. The members of an LLP can agree on an annual basis exactly how the profits of the business are to be divided and there is almost complete freedom in deciding the right structure for the business. This means profit shares can be paid and tailored to the individual contributions of the members and these can be adjusted year on year.

Income tax is payable, but on a self-assessment basis, which can offer useful cash flow advantages.

In addition, employer’s NICs of 13.8 per cent can be saved on remuneration paid to members because they are treated for tax purposes as self-employed.

Similarly, an LLP is more flexible when an owner/manager leaves the business.

On leaving a company, they either retain their shares and continue to benefit from the efforts of others, or those shares have to be bought back, potentially involving disputes about valuations and on most occasions with the need to pay out cash to the departing shareholder.

In contrast, in an LLP, the members can agree that their interests will terminate on ceasing to work in the business without the need of any goodwill payment and the administrative and cost issues surrounding the transfer or buy-back of shares.

Due to this flexibility, it can be easier to introduce new members into an LLP. This way, the new member is acknowledged as part of the team but without the need to appoint them as directors or shareholders which would be necessary in a company.

Taking the next step

Converting to an LLP is generally straightforward and involves establishing a new LLP and the transfer of the contracts, assets and liabilities of the business to the new vehicle. For many IFA businesses operating as a limited company, the potential savings in employer’s NIC can often cover the costs of conversion in the first year of operation.

The appropriate FSA authorisations will need to be arranged in the same way as for the existing business. IFAs in good standing with the FSA should nothave any difficulties with obtaining authorisation for conversion to an LLP which is simply taking over the existing business and being operated by the same people.

With all this in mind, IFAs should look hard at the opportunities and organisational flexibility offered by the LLP structure for them and their businesses.

James Went is a senior corporate associate at law firm Manches

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