Advantages & disadvantages of LLP
When setting up in business, most people weigh up the pros and cons of operating as an unincorporated business or a limited company. However, there is another option where more than two persons are involved – to operate as a limited liability partnership (LLP).
One of the main reasons for the government creating the LLP format was that many partnerships, particularly those in the professional sector, have grown considerably, with some firms having hundreds of partners in different countries. In ordinary partnerships, each partner is generally personally liable for the firm’s liabilities meaning that a partner can become liable for the negligent acts of another, possibly someone they have never met.
LLPs allow a partnership structure where each partner’s liabilities are limited to the amount they invest in the business. Under an LLP, if the partnership fails, the creditors cannot go after a partner’s personal assets or income.
Advantages of LLP vs company
An LLP and a limited company are similar in that they are both corporate bodies with the same features of separate legal personality, and limited liability protection. However, one of the main advantages of an LLP over a company is the flexibility to share profits and losses in a tax-efficient manner, reducing the overall tax payable by the LLP members.
The partners are taxed at their individual marginal tax rates and, by specifying the profit-sharing ratio as they wish for each accounting period (even changing one year to another), can agree on the allocation of profits in a tax-efficient manner. In contrast, a company’s profit allocation is constrained by the fixed shareholding percentages held by the shareholder owners (although alphabet share arrangements or dividend waivers can overcome this problem).
Disadvantages of LLP vs company
Pre-2023 the main disadvantage in forming an LLP compared with a company was that a company could take advantage of the 19% corporation tax rate on retained profits compared with the 40%/45% marginal rate (plus NIC) applying to the member’s share of profits. Post-2023 the increase in the corporation tax rate up to 25% for some businesses may mean that the numbers no longer stack up in favour of incorporation.
Another potential disadvantage is that profit cannot be retained in the same way as a company limited by shares as members are assessed on their share of the LLP profits regardless of the actual amount withdrawn. Therefore, this means that all earned profit is effectively distributed with no flexibility to hold over profit to a future tax year when the tax rates may be lower.
An LLP must have at least two members whereas a company can have a sole shareholder. If one member leaves the partnership, the LLP may have to be dissolved.
As with a company, the limited liability protection afforded by an LLP can be restricted in specific ways, e.g., if an individual LLP member gives a personal guarantee to any creditor, that individual member will be liable should the LLP not repay the loan.
For more information about LLPs, please visit the official government website.