Should you set up a LTD or LLP?

One of the first questions many business owners ask when setting up a new venture is whether to set up a Private Limited company (LTD) or a Limited Liability Partnership (LLP). What are the differences?
On the face of it, LTDs and LLPs offer many of the same advantages — such as limited liability for the business owners along with similar obligations such as filing requirements with Companies House.

We have broken down some of the key aspects that business owners look at when considering the formation of their business entity. 

Tax on the company and the LLP (or its members)
A LTD is liable to pay Corporation Tax on the profits it realises during its accounting period. The current Corporate Tax rate is 19%, however the Government has pledged to reduce this further still until it reaches 17% in 2020.

Contrast this with an LLP which is treated as transparent for tax purposes. An LLP will not itself have a tax liability; instead, the members will be taxed on their share of the trading profits of the LLP. Based on current Income Tax and National Insurance Contribution (NIC) rates, profits could be taxed at a marginal tax rate of up to 47%.

Tax for the business owners
LTDs offer a range of profit extraction methods, such as:
  • Salary and benefits (e.g. medical insurance, company cars);
  • Dividends; and
  • Interest payments on loans provided to the company.
This is often appealing as it can allow business owners to vary the way in which they are remunerated in order to obtain the most beneficial package. The option for companies to pay dividends to its owners, rather than salaries, is usually more attractive as they are subject to a lower marginal rate of tax (38.1% when compared to salary, 47%).

Dividends also do not attract any national insurance charge for either the individual or the company.

On the other hand, members in an LLP are unable to differentiate their methods of profit extraction; instead, the members are able to draw down on their allocation of the profits.

The example below considers a member in an LLP receiving £100,000 profit with a LTD company turning over the same amount with full distribution. We have assumed no other income, with the LTD owner paying a small salary and drawing the remainder through dividends.

Despite being able to choose the method of profit extraction, the above examples show that while a corporate entity usually offers the shareholders a more tax efficient method of profit extraction, the difference is not significant under current legislation.

Timing of tax
Members of an LLP are taxable on their share of the profits as they arise, not when the profits are drawn.

LTDs are also  taxable on their profits as they arise, however, they are able to retain cash after the payment of Corporation Tax without incurring any further tax liabilities. The individual owners will only be taxed personally when they withdraw this money from the company.

This ability to retain cash can be beneficial for businesses to provide working capital or, alternatively, defer personal tax liabilities for the owners when the cash may not be needed personally.

Profit sharing allocations
Where partnerships offer significant advantages is through their flexibility to alter both their income and capital profit sharing arrangements between their members. This is often provided for in the LLP agreement and in practice is used significantly by partnerships to reward key members of their firm. Companies find this significantly more challenging as shares of the same class will have equal rights to dividends. This will mean dividends paid to one shareholder will have to be paid at an equal rate to the other shareholders of that class. 
The focus of this article has been the various tax implications of a particular vehicle choice. While tax is an important factor, it is not the only factor. It is important that both tax and non-tax centric factors are considered, especially in a market where tax rates are subject to change in the future.

This article was taken from the Autumn issue of the Professional Practices Group Newsletter. To download a PDF version of the full newsletter please click here.
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