What is a Limited Liability Partnership and should you have one?

What is a LLP?

A LLP combines the internal flexibility of a partnership with limited liability for the members of the LLP, but it is also a body corporate with a legal personality which is separate from its members.

LLP v Company

A LLP is much more like a company than a partnership because:

• It is a body corporate with a separate legal entity;
• Its members, like shareholders, have limited liability;
• When members agree that the LLP is to enter into a contract, they bind the LLP like directors of a company, not one another like partners;
• Members may be liable for their own negligence like company directors;
• LLPs have to file accounts at Companies House;
• Most of the insolvency and winding up procedures for companies will apply equally to a LLP and its members.

LLP V Partnership

LLPs have some residual similarities to partnerships:

•  A LLP has no share capital and there are no capital maintenance requirements;
• There are no rigid distinctions between capital and reserves, or between members and the board;
• The members are free to agree how to share profits, who is responsible for management and how decisions are made, when and how new members are appointed and the circumstances in which members retire;
• LLPs are subject to the "clawback" rule which means that members are more exposed than directors and shareholders of a company, and therefore to a limited extent more like partners.

Formation

A LLP can be incorporated by two or more persons (including companies) by subscribing their names to any incorporation document for the purpose of undertaking commercial activity for profit. In other words, LLP status is available in the same circumstances as partnership status. A limited liability partnership has unlimited capacity and therefore a LLP can do anything which an individual, a partnership or a company can lawfully do.

Incorporation

LLPs are incorporated by registration at Companies House. The Registrar then registers the LLP and issues a certificate of incorporation. After incorporation, the LLP's designated members are responsible for filing the annual return.

Structure

A LLP does not have a memorandum or articles of association or a specified management structure. In practice, however, it is important that the members enter into a valid and effective agreement between themselves before the LLP is incorporated.

The act of incorporation creates obligations under the LLP Act and it is important to agree how these are to be shared. The members' agreement should cover many of the issues normally contained in partnership agreements. Otherwise the default provisions applies which assumes equal profit/loss sharing, equal shares in capital and equal rights to take part in management, unanimous approval for introduction of new members, no right for remuneration and no right to expel a member, and will rarely be appropriate in practice.

The legislation contains no facility for converting a LLP into a company, even though it is a body corporate.

Taxation of LLPs

The LLP Act confers on LLPs the tax transparency enjoyed by partnerships. Broadly speaking, therefore, the members of a LLP will be in the same income tax or corporation tax position as if they were partners in a partnership.

A further benefit for members who are individuals is that Class 4 National Insurance Contributions (NICs) will be payable, as in the case of a partnership, so no employers' NICs will be payable in respect of members' profit shares.

Assets held by the LLP will be treated for capital gains tax purposes as held by its members as partners. Therefore disposals of assets by the LLP (for example, on a sale of a building by the LLP) will be treated for capital gains tax purposes as disposals by the members of the LLP while it continues to trade.

Since a LLP is a body corporate, the LLP itself is the legal entity for VAT purposes and it is liable for VAT registration, subject to the normal VAT registration rules.

Uses of LLPs

As well as being a vehicle for professional partnerships, such as accountants and lawyers, LLPs will provide a potential opportunity for many types of business such as joint ventures, entrepreneurial businesses and investment structures.

The partnership structure has been very effective in creating an entrepreneurial culture, especially in businesses which involve large numbers of highly trained people who can share in profits and management of the business without significant tax problems when partners are appointed and retire. It will be possible to generate the same kind of culture within a LLP, making a LLP an attractive structure wherever it is wished to motivate key business generators.

These individuals can be brought into the LLP and participate directly in decisions and in profits without being exposed to limited liability. The effective rate of tax on the profits of the LLP itself is likely to be lower than in the case of a company. Members who are individuals will be taxed on their shares of profits directly, and no employers NICs will be payable in respect of members' profit shares. Also, distributions by companies out of their taxable profits will have suffered a higher effective rate of tax than LLP profits. In addition, the partnership tax regime will make it easier to arrange for interests in a LLP to be transferred between members without a capital gains tax charge.

Establishing a LLP in a start-up situation is likely to be relatively straightforward and company formation agents will probably provide standard form documents (although "off the shelf" LLPs are unlikely to be possible owing to the requirement of a business). However, a well drafted members' agreement will be essential and there will be no convenient statutory Table A to incorporate by reference.

Thus, LLP's are likely to be popular vehicles for businesses where motivation of key staff and limited liability is thought to be important and the public filing of accounts is a price worth paying for this protection.

The members' agreement

As Partnership Law does not apply, a properly drafted and a comprehensive members' agreement will be crucial. Issues to be covered include the following:

• Agreement to incorporate the LLP and to be members.
• Capital contributions made by.
• Shares of profits and losses.
• Accounts system.
• Members, including whether there special classes of membership with different rights and obligations.
• Decision-making, including whether all members have an equal vote on all matters or whether the day-to-day management should be delegated to an executive or board.
• Joining of new members, retirement, restricting covenants to be applied to departing members, winding up, dispute resolution.

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