CLIENT MEMORANDUM

LIMITED LIABILITY PARTNERSHIPS

The purpose of this Memorandum is to give details of an alternative medium for

carrying on business – the Limited Liability Partnership (“LLP”). This medium has
been available since 6 April 2001, and it offers some interesting advantages, both for
people who are already in business and for people who are about to set up in business.

What is an LLP?

An LLP is in some ways a “cross” between a conventional partnership and a

company.

One of the problems of a conventional partnership is that each partner has unlimited
liability for all the debts of the partnership. Operating through a limited liability
company overcomes this problem, of course, but one of the draw-backs is that a
company is taxed as a separate entity. This can lead to high National Insurance
contributions on drawing remuneration and a possible double charge to Capital Gains
Tax when a company realises a capital gain and the shareholders wish to share in the
benefit.

A partner in an LLP has liability only to the extent of his (or her) investment in the
LLP unless negligence is involved. Although an LLP is a separate entity, tax is
charged on a “transparent” basis, i.e. profits are taxed on each partner.

In the case of an LLP which carries on a trade or profession, it is possible therefore to

avoid the “double Capital Gains Tax effect” which applies to companies (whereby a
gain is taxed in the company and there is further tax to pay if profits are removed
from the company).
How does it work?

An LLP has to be registered at Companies House, and it has to file audited accounts
along similar lines to a company. This therefore distinguishes LLPs from ordinary
partnerships as the accounts for the latter are not normally information in the public
domain. However small LLPs can file abbreviated accounts which do not contain a
full balance sheet and profit and loss account. Currently to qualify for abbreviated
accounts the LLP must meet at least two of the following conditions:

• annual turnover must be no more than £6.5 million

• balance sheet total must be no more than £3.26 million

• average number of employees must be no more than 50

The minimum number of partners is two, and these can be individuals or companies.
An LLP does not have share capital, nor does it have a Memorandum and Articles of
Association.

An LLP does not have a company secretary, but it does need two designated partners
to deal with legal and compliance formalities on an ongoing basis.

It is permissible to have a partners’, or what the legislation characterises members’,

agreement setting out the terms on which the partnership operates. If there is no
agreement, or if there is only a limited agreement, the LLP will be deemed to operate
in accordance with terms laid down in the Limited Liability Partnership Act 2000
(and various Statutory Regulations).

How are LLP’s financed?

The individual partners can inject capital into the LLP in the same way as with a
conventional partnership. They can borrow this money, if desired, and obtain tax
relief on interest paid, assuming that certain criteria are met.

The LLP can itself borrow money or operate overdraft facilities. In many cases, of
course, the bank will require collateral or personal guarantees from the individual
partners.

What happens about partnership changes?

A partner can join or leave an LLP without undue formalities. However, special rules
apply if the LLP goes into liquidation. Many of the provisions of the Insolvency Act
1986 apply to an LLP which goes into liquidation.

Can an LLP own property?

Yes, an LLP can own freehold and leasehold property in its own right, unlike a
conventional partnership.

What is the tax position?

As previously mentioned, each individual partner will be taxed to Income Tax on his
or her share of the taxable profit. The basis of assessment is similar to that which
applies to a conventional partnership. The LLP has to file an annual tax return and
each partner also has to include relevant details on his (or her) own self assessment
tax return form. National Insurance Contributions are payable under class 2 and class
4, i.e. on the self-employed basis.

If the LLP disposes of a capital asset any gain or loss will be allocated to each of the
partners.

If the partners have “overdrawn” loan accounts, there is no special tax liability –
contrast this with the treatment of directors’ loan accounts where both the company
and (if the loan exceeds £5,000) the director may be liable to tax.

A company can be a member. If so, it will pay Corporation Tax on its share of the
profits including gains, and that element of the profits will be computed on normal
Corporation Tax principles (including the availability of indexation allowance).

If a partner leaves the LLP, this will constitute a disposal of the partner’s interest in
the various assets of the LLP. This has capital gains tax consequences, but for trading
partnerships the gain may be within entrepreneurs’ relief (subject to the detailed rules
of that relief). The rate of tax under entrepreneurs’ relief is10%.

It should be particularly noted that the “transparent” tax treatment will not apply if
the LLP does not carry on a trade or profession, or if it ceases to do so. This can pose
problems when a LLP ceases to trade, prior to liquidation.

If an LLP makes tax losses when carrying on a trade or profession, these will be
treated in the usual way as for partnerships generally

Are there any tax problems in converting to an LLP?

If a trade or profession is being carried on in a normal partnership and is then

transferred to an LLP there should be few problems, as long as the entire business and
assets are transferred. The transfer will not give rise to a disposal for Capital Gains
Tax purposes provided that certain conditions are met.

The following points should be noted in these circumstances:-

• The transfer may be treated as a “transfer of a going concern” for VAT

purposes, and it may be possible to use the same VAT registration.

• Stamp Duty will apply to the transfer, but a claim for exemption can be made
in certain circumstances. This would normally apply if the transfer is made
within one year after setting up the LLP.

• For Inheritance Tax purposes, the two-year qualification requirement for

Business Property Relief can take account of ownership both in the
partnership and in the LLP.
 It should be noted, however, that the costs of conversion to an LLP may not fully
qualify for tax relief.

Are there any other points to bear in mind?

If an LLP creates a charge or mortgage over any of its assets, details must be
registered at Companies House. If this is not done within 21 days, the charge will be
void against creditors, an administrator or a liquidator.

It is also necessary to pay attention to contractual arrangements.

If the LLP replaces an existing business carried on as a sole trade or as a conventional

partnership, then the following matters will need to be dealt with (after consulting the
LLP’s legal advisers).

• New letters of engagement will be needed as between the LLP and its clients.
If the LLP does not supply professional services, then existing contracts with
customers will almost certainly need to be revised.

• It will also probably be necessary to consult suppliers, lessors etc and arrange
for new contracts to be drawn up.

• If employees are being transferred to the LLP it is important to comply with

Employment Law. New service contracts will probably be required. It will also be
necessary to deal with pension arrangements and to ensure continuity of entitlement.

Summary

The LLP concept has proved popular so far, especially with the construction industry,
pharmacies and garages. The concept has also been embraced by professionals,
including solicitors, accountants, engineers and surveyors.

LLPs are also being used in cases where a trust becomes involved in carrying on a
business. The availability of limited liability via an LLP can be very useful in these
circumstances.

As previously mentioned, considerable care is needed when setting up an LLP, and –

before reaching a final decision – the tax and legal implications should be fully
researched.

There are no special tax reliefs for “disincorporation” of an LLP, so a change of mind
after setting up an LLP could prove costly.

It should be emphasised that the profits of an LLP are taxed on the respective partners
and may attract Income Tax liability at up to 50% in the current and future fiscal
years , as well as National Insurance Contributions. Companies, which are an
alternative vehicle, are taxed as an entity in their own right and the current rates of
Corporation Tax vary between 21% and 29.75%, depending on the level of profit.
From April 2011, the small companies’ rate of corporation tax will be 20% and the
main rate (for profits over £1.5m will be 27%. In addition, there are a number of anti-
avoidance rules to be considered when forming an LLP.
We will be happy to advise whether an LLP would be advantageous in your particular
circumstances.

FOR GENERAL INFORMATION ONLY

Please note that this Memorandum is not intended to give specific technical advice
and it should not be construed as doing so. It is designed to merely alert clients to
some of the issues. It is not intended to give exhaustive coverage of the topic.

Professional advice should always be sought before action is either taken or refrained
from as a result of information contained herein.