One of the most commonly asked questions when starting a business is whether it should operate as a sole trader, partnership or limited company. However many businesses instead choose to form a limited liability partnership (LLP), but how does this compare to other forms of legal entity?
An LLP combines many of the aspects of a partnership with those of a limited company. Perhaps the main benefit for most small businesses is that it allows the partners to easily allocate profits, and to draw money from the business, in any way they see fit without having to worry about shareholdings and dividends.
From a taxation point of view, an LLP is similar to a partnership. The business is not treated as being a separate entity, instead the profits are simply divided between the partners in a pre-determined manner, and the partners each pay income tax and national insurance contributions on their share of the profits.
The advantage of this is that it simplifies matters – there is no corporation tax or personal tax on dividends, and you can draw as much cash from the business as you see fit without the risk of having to pay tax on an overdrawn director’s account (section 419 tax) or having your director’s account taxed as a benefit in kind.
The disadvantage from a taxation point of view is that you are likely to pay more tax than if you were part of a limited company, as you will be liable for Class 4 National Insurance contributions at 12% as well as income tax at 20%. Corporation tax is only 20% for small companies and this often means paying less tax.
LLPs do have some similarities to limited companies as well. As their name would suggest, the business has limitied liability status, so that the directors would not be personally liable in the event of financial difficulty. A separate legal entity is also formed, with its own partnership number assigned by Companies House.
The disadvantage of this is that the statutory requirements of an LLP are similar to those of a limited company. You must file annual accounts at Companies House in the correct format, an annual return must be completed each year, and directors’ responsibilities are similar to those of a limited company. This means greater administration time and accountancy costs.
A few years ago the government announced tax benefits for LLPs and they briefly became popular as a result of this. However these tax breaks were subsequently withdrawn and LLP formations since become less common.
For most businesses the benefits of forming an LLP are outweighed by the disadvantages – you get limited liability status and simpler taxation rules, but you will often pay more tax whilst still having to meet the statutory requirements of running a separate legal entity such as filing documents at Companies House. That said, many business do go down this route and it remains a popular choice for professional organisations such as architects and solicitors.
For further advice please visit the main website of N S Accountancy, providing bookkeeping and accountancy services in the North East..