Most Important Features of Limited Liability Partnerships by Sponsor Francis Clark

LLPs have become a common structure for law firms. For those that are still operating as a traditional legal partnership the following covers some key basic aspects of an LLP structure.

 

The key advantage of an LLP compared with a traditional partnership is that the members of the LLP are able to limit their personal liability if something goes wrong with the business, in much the same way as shareholders in a company have always been able to do. Of course anyone lending money to the LLP such as a bank may still require personal guarantees from the members, as they frequently do with directors/shareholders in a company.

 

Where business owners have wanted to limit their personal liability in the past, they have normally set up companies and any profits made by those companies are subject to corporation tax. Dividends paid by the companies can then be taken as income of the shareholders. LLPs are taxed quite differently in that the profits are treated as the personal income of the members as if they had run their business as a partnership.

 

The taxation of companies and partnerships is very different but taxation should not be the main consideration in choosing a business vehicle. However, some LLP members can be taxed as if they are employees in certain circumstances (See Tax treatment for certain LLP members).

 

LLPs must produce and publish financial accounts with a similar level of detail to a similar sized limited company. LLPs must submit accounts and an annual return to the Registrar of Companies each year. This publication requirement is far more demanding than the position for non-incorporated partnerships and specific accounting rules may lead to different profits from those of a normal partnership. The filing deadline is nine months after the period end. Companies House provides a useful guide to the requirements in respect of LLP accounts.

 

Setting up LLPs or converting an existing partnership

 

An LLP is set up by a legal incorporation process which involves sending certain documents to the Registrar of Companies along with the relevant fee. Although it is not legally necessary but would be common place in a law firm, every LLP should have a thorough and comprehensive members’ agreement in place. In the absence of a members’ agreement the law makes a number of assumptions about the LLP which may not reflect what the individual members intended should there be a dispute.

 

Existing partnerships can convert to an LLP by exactly the same process of incorporation and providing there are no changes in membership or in the way in which the partnership operates, there may well be no impact on the partnership’s tax position. There are a number of areas and processes that need to be considered when converting to an LLP and care and advice needs to be taken before any decisions are made.

 

What liability might members of an LLP have if something goes wrong?

 

Because LLPs are relatively new compared to other forms of businesses, there are no decisions yet by the courts where something has gone wrong. This is therefore a hard question to answer but it looks as if the following describes the position as most people understand it at present:

  • If, for example, a member of an LLP were to give bad advice to a client and the client suffered a loss as a result, the client may be able to take the LLP to court and be awarded appropriate compensation.
  • In certain circumstances it could be possible that the member who actually gave the advice may also be required by a court to pay compensation to the client.
  • It is however probable that any other members who were not directly involved in the advice will not have any personal liability. In a normal partnership it is quite possible that they would have had a personal liability.

Law firms will have mandatory professional indemnity insurance cover in place but the above points still need to be considered. The other area that needs to be considered is to do with what the law calls unlawful or insolvent trading. In just the same way as company directors can be prosecuted for these offences, members of an LLP can also be prosecuted (and can be disqualified from being a member of an LLP in the future).

 

Tax treatment for certain LLP members

 

The LLP is a unique entity as it combines limited liability for its members with the tax treatment of a traditional partnership. Individual members can be deemed to be self-employed and taxed on their respective profit shares.

 

However, deemed self-employed status is not automatic for all members. For example, individuals who would normally be regarded as employees in high salaried professional areas such as the legal sector, originally benefited from self-employed status for tax purposes. The tax treatment of certain LLP members was changed so that their taxes are paid under PAYE.

 

The rules apply when an individual is a member of an LLP and three conditions are met. The conditions are: 

  • There are arrangements in place under which the individual is to perform services for the LLP, in their capacity as a member, and it would be reasonable to expect that the amounts payable by the LLP in respect of their performance of those services will be wholly, or substantially wholly, disguised salary. An amount is disguised salary if it is fixed or, if variable, it is varied without reference to the overall profits of the LLP.
  • The mutual rights and duties of the members and the LLP and its members do not give the individual significant influence over the affairs of the LLP.
  • The individual’s contribution to the LLP is less than 25% of the disguised salary. The individual’s contribution is defined (broadly) as the amount of capital which they contributed to the LLP.

 How we can help

 

At PKF Francis Clark we have assisted a number of law firms convert to an LLP. We would be delighted to discuss the merits of the business structure and assistance we can provide. Please contact us for further information.

 

This publication is produced by Francis Clark LLP for general information only and is not intended to constitute professional advice. Specific professional advice should be obtained before acting on any of the information contained herein. Whilst Francis Clark LLP is confident of the accuracy of the information in this publication (as at the date of production), no duty of care is assumed to any direct or indirect recipient of this publication and no liability is accepted for any omission or inaccuracy.

 

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