By David Teal, Senior Tax Consultant, DTE Business Advisers
Use of Limited Liability Partnerships has increased a great deal in recent years. Sometimes this has been for tax planning reasons. However they also offer an attractive alternative to forming a limited company, especially for joint venture activities.
How are LLPs taxed, and what are the points to look out for?
Although an LLP is a separate legal entity, this fact is ignored for most purposes by the tax legislation. LLPs are “transparent” which means their income and gains are taxed on the members of the LLP in the appropriate proportions. Individual members will pay income tax or capital gains tax on their share of profits and gains. Corporate members will pay corporation tax.
2. Not Transparent?
There are two exceptions to the transparency rule. One is where the LLP does not carry on a business with a view to profit and some members clubs or societies fall within this category. The other is where the LLP is in liquidation or is being wound up by Order of the Court. In these circumstances the LLP will become chargeable to corporation tax on its profits or gains.
3. Status of Members
Until recently, an individual member of an LLP was automatically treated as a self-employed person in respect of the LLP’s income. From 6 April 2014 this is no longer the case. If the member meets certain key tests they will be regarded as an employee and their income from the LLP will be subject to PAYE and NIC. The tests are designed to distinguish between true proprietors of the business as distinct from individuals who are really employees, apart from the fact that they happen to be LLP members.
4. Mixed Member Partnerships
Some LLPs have both corporate members and individual members. Since December 2013 there have been anti avoidance provisions in place to prevent excessive amounts of the LLP profit being apportioned to a corporate member. This is done for tax planning reasons because corporate members pay a lower rate of tax than individual members. These rules will normally have effect where the individual members are also the directors and shareholders of the corporate member. These rules actually apply to all partnerships and not just LLPs.
5. Sales of Goodwill in Mixed Member Partnerships
Many taxpayers have found mixed member partnerships a useful mechanism for realising some of the value of their goodwill in a business, without the business itself being sold. Individual members can sell some of their goodwill to a corporate member and obtain a 10% CGT rate. When companies buy goodwill in these circumstances they are usually able to claim a corporation tax deduction for the depreciation in the value of the goodwill over time. Owing to a technicality involving the relevant tax legislation, this CT deduction will not be available to a corporate member within an LLP (although it seems it would be available in principle to a corporate member in an ordinary partnership).
6. Stamp Duty Land Tax
Expert advice should always be sought involving any transfers of property in an LLP, as the SDLT issues can be complicated. Note, however, that where an ordinary partnership is converting to an LLP it will usually be possible to claim an SDLT exemption in respect of property being transferred to the LLP, provided that the date of transfer is within 1 year of the date of incorporation of the LLP, and certain other conditions are satisfied.
The recent changes in legislation to counter some of the Tax Planning arrangements surrounding LLPs may reduce the number of new LLPs being formed in the future, but the commercial reasons for the use of an LLP remain strong. However the use of corporate members in LLPs is clearly giving the authorities some cause for concern. There have even been suggestions that corporate members might be prohibited in LLPs in order to enhance the transparency of UK company ownership and increase trust in UK business. It remains to be seen what, if anything, comes of this proposal.