Where are we on LLP’s?
To judge by the advice that a lot of accountants are giving their clients, you’d have thought that the LLP was dead. Always a minority interest, plugged by sneaky tax avoiders and those who write in the Schmidt Tax Report, the government have now put their foot down with a firm hand, and effectively abolished LLP’s. Or so you’d have thought, the way some people are now talking.
Actually, though, I think this is so far from the truth that those “knee jerk” advisers, who have told all their clients to become, or go back to being, limited companies, must be on a totally different planet from the one I’m living on. I’ll come on to justify this statement in a minute. But, first, what is it that has caused this panic flight from limited liability partnerships (LLP’s) in some quarters?
“What’s the Damage”
Like the three “hammer blows of fate” in the finale of Mahler’s 6th Symphony, the government have taken three viscous swipes at the tax benefits of LLP’s, in the Finance Acts 2013, 2014, and 2015.
In 2013 they made it taxable for a limited company to lend money to a connected LLP; 2014 saw the swingeing new rules on how much profits you could allocate to a limited company who was a partner; and, most recently, in March 2015, they made involvement in an LLP “an investment” activity (and therefore non favoured) for entrepreneur’s relief on the shares in a company.
Now the dust is beginning to settle – for the time being – on this bombing campaign by HMRC, where precisely does this leave us? Is it, in fact, the case that we should all stop trying to get tax planning benefits out of running a business through an LLP, and follow the herd into the “safety” of limited company structures?
No doubt that is the answer, in fact, for some people, but in my view this may well be a minority.
Let’s update our pre 2013 planning, and summarise what LLP’s could do for you before the attack by the authorities; and what they can do for you now. In no particular order:
- Capital Assets and Tax Planning
Probably a majority of businesses involve the use of some kind of capital asset or other: even if this is only the “goodwill” of a business, which builds up just by way of trading profitably. There are also tangible assets like buildings, and other intangible sorts of property like computer software developed in-house, trade marks etc. I’ve always thought it to be a bad idea in principle to have assets like this within limited companies. Put very briefly, if you sell an asset such as this which appreciates in value, your gain is taxed twice between being made and ending up in your personal hands: first at company level, if you have kept the asset in a limited company, and secondly at personal level. So very often you can end up paying much more tax on the gains on capital assets if you hold them within a company.
An LLP is a much friendlier animal, because you can easily cut down the double tax charge to only a single tax charge.
- Company Cars
It’s long been a cause of complaint – justifiable, in my opinion – that the “company car” tax regime is an arbitrary and penal attack on businesses which need to use cars to operate efficiently, or at all.
If you run your business, and your car, through a limited company, you are subjected to tax and national insurance at employee rates on a fairly random number, made up by taking the list price of a car then new and multiplying it by a percentage based on the car’s CO2 emissions. This figure doesn’t vary, regardless of how much business mileage you do, or how little private mileage. So the businessman who simply needs to travel a large mileage in each year to visit clients, customers, suppliers etc can end up paying heavily in terms of personal tax, and the company itself in terms of employer’s national insurance, for something which isn’t a “benefit” to him at all.
The LLP regime for cars, on the other hand, is not so much “tax efficient” or an example of “tax avoidance”, as a straightforward, sane, and fair way of dealing with cars used on business. You take the total cost of running the car (including depreciation, standing costs such as road tax and insurance, basically the kitchen sink) and claim the proportion which relates to business motoring. The rest you simply disallow. And that’s that.
The average amount of tax and national insurance saved by your typical business owner has been estimated at being £5,000 to £10,000 per car per year. A solid advantage of using an LLP, even if there weren’t any other.
The one note of caution I would sound, in this area, is that you shouldn’t operate an LLP just for the purpose of providing yourself with a tax efficient car. If you actually run the main business through a limited company, and set up an LLP, with a car in it, to provide “your” services to the company, you’re very much in the danger area as far as HMRC are concerned. They’ve recently won a case to say that, in this sort of situation, it’s really the company “providing” the car to you – so you’re back into the penal company car regime.
So using an LLP for tax efficient motoring does involve using it for quite a lot else besides – including running a genuine freestanding business.
In comparison with the rigid structure that is a limited company, with its fixed share capital and its highly specific Memorandum and Articles of Association, an LLP is a very free animal. Not only can members (partners) receive flexed profit shares each year depending on their input, but you can easily have different proportions of rights to income, capital, and control between the different members. The LLP agreement is a completely blank sheet of paper until you start writing something on it.
One way in which this flexibility is particularly useful is, perhaps counter-intuitively, in the field of inheritance tax planning. Even if you’re not running a “business” as such, there are attractions in holding your assets (for example a buy to let property portfolio) through an LLP. To take just one example, you may have grown up children with whom you want to start sharing your wealth. You can transfer capital in an LLP to them by way of gift, and also you can allocate them income (which might be taxed a lower rate as a result) without necessarily giving them a fixed share in the portfolio or in the LLP. And you can control 100% (if you want to) how the assets of the LLP are dealt with, and whether any members are allowed to draw actual hard cash out of the LLP at any time. So long as you are exercising your control for the benefit of the family rather than of yourself, you can therefore have your inheritance tax planning cake and eat it, in the sense of retaining control over the assets you have given away.
- The New Dividend Tax
When I was talking just now about the herd of tax planning sheep flocking together into the “safety” of the limited company structure, I put that word “safety” in inverted commas. And the reason for this is that nowhere is safe with Mr Osborne in his current mood of attacking the business community.
An egregious example of these attacks is the new dividend tax, which came pretty much as a bolt from the blue for most people in the July 2015 Budget.
In case your haven’t caught up with this, basic rate taxpayers, who currently pay no tax at all on dividends (because the company will already have paid 20% corporation tax – or at least is presumed to have done so) will have to pay 7 ½% tax on dividends received, subject only to a tax free band of £5,000 per person per year. Higher rate taxpayers, who currently have a liability of 25% on the net amount of the dividend will find themselves having to pay 32.5%. And those in the top bracket of all, that is those whose income is more than £150,000 have a dividend tax liability of just over 38% (against just over 30% currently).
Now, for basic rate taxpayers, a company is still (just about) preferable as a way of taking income out of your business than an LLP: because there is a 9% “national insurance” charge on earned income received through an LLP, whereas limited companies don’t pay NI, even if they then pay out their profits as dividends to the main shareholders. But 9% isn’t much more than 7.5%, and so this benefit of companies has now almost disappeared. And when you get into the higher rate bracket, the picture changes. Broadly speaking, you’re then paying 2% national insurance at the margin, if you take your income as a profit share in an LLP; whereas there’s an extra 7.5%, dividend tax, if you take your income through a company. The same basic differential applies to those at the top rate of tax as well.
What’s more, if the business of the LLP is one that isn’t subject to national insurance, for example letting property, then the LLP is far and away superior since it gets you out of paying the dividend tax completely.
Verily, what the Chancellor of the Exchequer taketh away with one hand, he taketh away even more with the other hand, and following the attacks on LLP’s, the attack on limited companies has changed the tax planning environment yet again.
- Bringing People into Equity
This was always a situation where the LLP structure scored significantly over the limited company structure. If you want to bring new blood into equity ownership in your business, if that business is run through a limited company the way to do this is by transferring shares to them. And here beginneth the big problems with HM Revenue and Customs.
Firstly, you have to try to work out what a shareholding in your company is “worth”. This is a highly rarefied theoretical calculation, based on an imaginary willing seller and a imaginary willing buyer. In the case of assumptions commonly made by those in HMRC’s Shares Valuation Division (an ivory tower if ever there was one) the value of such shares can actually be unfeasibly high.
So you are faced with the choice of asking your prospective fellow shareholder to pay through the nose for his shares (which he is unlikely to be able or willing to do) or submit to a tax charge – and the company a national insurance charge – on the wholly theoretical “undervalue” you are giving him the benefit of.
Share Schemes? If your company already has this hypothetical value, forget them!
Now contrast this nightmarish situation where a lot of money has to be found to pay tax on a purely theoretical benefit, with the much more sensible regime that applies to LLP’s. A new member of an LLP, providing he is sufficiently “important” within the LLP to be treated as self employed, basically has no tax problem at all on receiving a slice of the cake. This is by longstanding practice, but I think the practice is justified by the fact that there is no comparable provision, in the sphere of self employed taxation, with the complex and profuse “employment related securities” rules, part of the benefit in kind rules, which apply where the taxpayer is an employee. As he must be if the business is run by a limited company.
- Limits on the New Rules
Those who consider that the three HMRC hammer blows have knocked LLP’s completely on the head also don’t take into account, it seems to me, the fact that the changes mentioned are quite specific in their scope and don’t always apply in any given situation.
For example, the 2013 changes, amongst other things, impose a 25% tax charge where you have a company which lends money to the LLP. Unbelievably, this rule doesn’t seem to have applied before 2013! Even after this date, though, it’s generally considered, by those who have read the rules and thought about it, that a company can still have equity capital invested in an LLP of which it is a member. The new rules very much apply to loans or other creditor relationships, rather than to equity capital.
Secondly, despite the 2014 rules which restrict the amount of profit you can allocate to a company partner in an LLP (to take advantage of the company’s 20% corporation tax rate) that’s not the same as saying you can’t take advantage of this tax efficient arrangement at all, where you have an LLP with a limited company member.
For example, the company might have equity capital invested in the LLP. If it has, a proportion of the profits can be allocated to the company based on a fair “interest rate”, taking account of all the circumstances. There’s a bit of dearth of really effective guidance on what a fair interest rate is, but in my view one has to take into account all of the facts, including the question of whether the company has any security for its hypothetical “loan”. If it hasn’t got any security, my view is that any real investor, acting at arm’s length, would require a reasonably substantial “premium rate” interest in these circumstances. For your average small (and therefore risky) business, carried on in an LLP, 10% is likely to be well justifiable in my opinion.
Finally, in 2015 they tightened the screws on limited company partners and LLP’s even further. The way they did this was to treat an investment in an LLP as an investment activity for entrepreneur’s relief purposes.
Capital gains tax entrepreneur’s relief is very important in lots of circumstances, because it brings about a 10% rate of capital gains tax on the sale of a company’s shares, if that company is treated as a “trading company” for the purposes of the relief. Without this relief, you would be likely to be paying 28% on all or most of your gain.
So it’s really quite a mean thing to do, to treat a company that’s trading as LLP member as if it were actually undertaking an unfavoured “investment” activity. But that’s precisely what the new 2015 rules do.
Having said all of the above, though, this isn’t necessarily a reason to abandon the LLP. It may be possible (indeed it usually seems to be) to take the company out of membership of the LLP and have its relationship with the LLP more at arm’s length. Or, in individual cases, it may be that the company has its own trade which is significantly large to prevent its membership of the LLP from fouling up its availability of entrepreneur’s relief. It’s very much a matter of fact and degree: and, remember, you have the “facts” under your control, in that you can rearrange the way the company and the LLP relate to each other, and the role each take in the business, in order to maximise your chance of getting entrepreneur’s relief.
It may be something of a cliché, now, but I think it’s definitely true to say that rumours of the death of LLP’s have been greatly exaggerated!