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Q: I am starting up a brand design consultancy business with two colleagues. I have been advised that a company would have a lower tax rate than a Limited Liability Partnership (LLP) but am wondering if there may also be some tax advantages in using an LLP. Andrew, Edinburgh
A: You are absolutely correct, the headline rate of corporation tax payable by a small company is 20% and this is lower than the higher rates of Income Tax, at 40% or even 45%, payable by an LLP with good profits. Class 4 National insurance is also paid on LLP profits.
The variation between rates becomes particularly relevant if profits are not fully drawn from the business. LLP members pay tax on profits regardless of whether they are drawn whereas profits remaining in a company are taxed at only 20%.
The LLP does however have advantages, particularly for professional practices. The first is flexibility in profit sharing arrangements. A company is restricted by the shareholding arrangements and any attempt to move shares or equity between business owners is likely to give rise to a tax charge under the share related remuneration rules. LLP members can vary profit sharing arrangements from year to year with complete flexibility and can also increase the equity interest of new members without any tax charges.
In the event an LLP makes losses, perhaps in the early years of trading, there may be scope to offset the losses against other income sources of the members, although there are restrictions to be considered.
The greatest advantage of an LLP lies in the ‘look through’ treatment for income and gains. Your business may grow and develop a goodwill value, in the form of the business name and client base. When good will is sold by a company, the gain is taxed at company tax rates, most likely 20%, but a further tax charge arises when the proceeds are extracted from the company into the hands of the business owners. The effective tax rate on goodwill sold by an LLP business is 10%, providing Capital Gains Tax Entrepreneurs Relief applies.
In summary ,an LLP structure works well for businesses where the main asset is an intangible, such as goodwill, where flexibility is required among the business owners on profit sharing arrangements and where there is a requirement to move equity between the owners tax efficiently.
Rennie Welch LLP accept no liability on the basis of this article and detailed advice, taking into account individual circumstances, should be obtained before entering into any transaction.
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