As featured in The Southern Reporter - www.thesouthernreporter.co.uk
Our ‘Business Brain’ article this week deals with the very recent tax change in relation to transferring a business to a limited company and the treatment of goodwill. This may be a significant development for professional practices, such as solicitors, surveyors, financial advisers and some consultants, already trying to deal with previous tax changes in the 2014 Finance Act earlier this year.
Professional practices have traditionally favoured partnership and limited liability partnership (LLP) structures for their business operations, mainly due to the tax efficiency of being able to have flexible profit sharing arrangements and ‘look through’ treatment for Capital Gains Tax with the potential for a 10% tax rate on disposal of the business.
These types of businesses however often require high levels of working capital to fund the cost of ongoing work and debts due from clients. It is preferable to fund working capital from profits suffering the lowest possible rates of tax and this led to many firms using a company, with a corporation tax rate of only 20%, in their structure. Often a company would be formed to become a partner, minimising the tax charge on profits left in the business to fund working capital.
This type of arrangement was effectively blocked in the 2014 Finance Act by a ruling that the company profits would be taxed as those of the partners. At the same time, certain LLP members were reclassified as employees for tax purposes, unless the profit share of the member is variable based on the firm profits, they have a significant influence in running the business, or significant capital at stake. These measures brought about a need for partnerships and LLPs to review the structure of their business and the arrangements with individual LLP members. Some firms considered incorporation of the business into a limited company but the most recent measures are a new disincentive to that route.
So what now for professional practices? The first step, for LLPs, is to review the status of all ‘fixed share’ type members. All professional practices should also monitor their business structure to ensure the most appropriate and tax efficient arrangement. For many the flexibility of a partnership or LLP will remain important. A parallel service company may work, perhaps holding employee contracts or performing a specific function of the business, but care should be taken around potential HMRC challenges on inter-business debts and profit margins. Another possibility may be for the business to be undertaken by a limited company, or companies, with the shares being held by the partnership or LLP. Complete incorporation, with the business being undertaken by a limited company, remains an option but there are new even fewer tax advantages with this arrangement.
If you wish to discuss the options for your professional practice or require advice on this or any other tax matter, please contact Mark Thompson at Rennie Welch on 01573 224391 or email firstname.lastname@example.org
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