Both types of legal business entity, Limited Liability Partnership (LLP) or Limited Company will protect the personal assets of either the partners (LLP) or owner(s) (Limited Company). While protection from business debt and liability are important, the differences in the tax liability are definitely worth considering.
Limited Liability Partnership
The LLP was introduced in 2001 (under the LLP Act 2000) as a structure to provide the same benefits as a traditional partnership but with the advantage of reduced financial responsibility for the partners.
A minimum of two “partners” is required to set up an LLP; and this business structure can only receive loan capital and cannot offer equity shares in the business to non-LLP members. Legal protection for a LLP is limited to the funds each partner invested and the personal guarantees they may have provided to secure finance. It can be easier to change the internal management structure and distribution of profits in an LLP.
What type of business does it suit?
The LLP structure tends to be more suited to certain professions that typically have “partners” (e.g. solicitors, doctors, accountants, and architects), and it tends to suit businesses with limited staffing requirements (e.g. admin, reception), which typically run with a fixed number of partners. In this structure, all/both partners contribute equally to the business, hold equal rights and responsibilities, and benefit collectively from the business profits.
LLP members pay income tax, national insurance (NI), and capital gains tax (CGT) on all taxable income.
The LLP itself has no tax liability: LLP members are treated as self-employed, which means that they must register for self-assessment with HMRC and pay income tax and NI on their individual profits, whether or not they take all profits from the partnership as a salary or leave some of it in the business. LLPs are not liable for employers’ NI on their income.
Depending on the profit generated, LLP members can be hit with a relatively high tax bill if their individual income exceeds the personal tax-free allowance threshold (£11,500 for 2017/18).
Unlike the LLP, a limited company can be registered, owned, and managed by on person. Also unlike an LLP, which must be set up with the intention of making a profit, a limited company can operate as a non-profit business or a profit-making business. Discover more about Limited Company Formation and How to start a limited company?
A limited company can receive loans and capital investment from outside investors. Liability of company shareholders or guarantors is limited to the amount paid or unpaid on their shares, or the amount of their guarantees. There are two sorts of company structure: one is limited by guarantee and tends to be used by non-profit organisations; the other is a company limited by shares and tends to be the option chosen by profit-making businesses.
What type of business does a limited company structure suit?
Company limited by shares
Business that have high staffing requirements ‒ for example, a manufacturing business with a research and development arm, sales and production departments, and numerous, and fluctuating numbers of workers on the factory floor ‒ and the sort of business that will want the option of selling shares to raise capital investment, tend to opt for a company limited by shares.
Company limited by guarantee
Non-profit organisations ‒ for example, a charity, raising funds but not intending to make a profit for shareholders ‒ and unlikely to need to raise capital for investment, tend to opt for the company limited by guarantee.
The limited company structure tends to be more tax-efficient. Directors, often also shareholders of the company, are treated as employees: a limited company pays corporation tax (at 20%) and capital gains tax on all taxable income, and directors pay income tax and national insurance on their salary. The business is also liable for employers’ NI and is or will be liable to pay workplace pension contributions if it employs people.
Where does the efficiency come in?
Tax efficiency enters the equation in the distribution of profits to directors. Ensuring that the greater portion of a director’s income is not subject to corporation tax or income tax is why many limited company directors hire an accountant.
Often a director of a limited company will draw a salary of no more than the tax-free personal allowance (11,500), and then take dividends. Dividends are paid from post-tax profits with the first £5,000 tax-free; and anything over that is taxed according to the tax bracket of the individual. Tax planning is how you make running your own limited company tax efficient.
In reply to your question about which type of company structure is better, clearly, the limited company structure offers opportunity for greater tax efficiency. However, as you can see, it does depend on the nature of your business: a company limited by shares is best for profit-making businesses; a company limited by guarantee is better for non-profit organizations; and a LLP may well suit professionals such as solicitors, doctors, accountants, and architects. It’s your choice, but do seek advice if you are not certain about the advantages for your individual circumstances.