Time to consider tax efficient business structures?

Limited liability partnerships (LLPs) became available as a UK business structure in 2001. Prior to that, individuals operating their business as a partnership generally had unlimited liability for its debts. As such, limited companies were the usual structure for small and medium sized businesses operating in risky business environments. LLPs are a form of incorporated entity that are taxed as if they were a partnership. Since LLPs were introduced, around 154,000 have been incorporated, of which some 52,000 remain active. In the same period, approaching 11.25m companies have been incorporated, of which around 4.9m are still active. Companies are clearly much more common than LLPs, but should businesses looking for tax efficiencies operate as LLPs?

Prior to the introduction of LLPs, professional practices had, for various reasons, usually been run as partnerships. LLPs were introduced to provide such businesses with limited liability without needing to operate as limited companies. Whilst LLPs are generally encountered in the context of professional practices, any business can operate as an LLP.  

Whilst owners considering their business structure will need to consider the wider commercial and legal implications on their particular business, there are several tax drivers to consider.

What companies should look for in a tax efficient business structure

Effective tax rates

Employers National Insurance contributions (NICs) on salaries at 13.8% means that with 45% income tax, 2% employee NICs and 0.5% apprenticeship levy (for large employers), around 46% of the top slice of business profits are left in the pocket of the highest earners when they are paid out as salary. However, with self-employed taxation there is only the top rate of tax of 45% and NICs of 2% on the highest marginal earnings, meaning the highest earners take home 53% of the profits they earn. No employers NICs are paid on self-employed income, and LLPs therefore provide an environment where high earners can often be paid on a self-employed basis, thereby reducing their tax costs.  

With corporation tax generally now charged at 25%, dividends are often not the tax efficient means of profit extraction that they used to be. £1m of pre-tax profit in a company funds a £750,000 dividend which, if taxed at the additional rate of income tax on dividends, leaves only £454,875 in the recipient’s pocket after tax – an overall tax cost of 54.5%.  

Other tax impacts

Company cars, other than electric cars, are no longer common. However, because benefit in kind scale benefits do not apply to self-employed people, cars can be tax efficient in LLPs – particularly where there is high business mileage. The same thinking can make LLPs attractive where a business provides assets, such as property, for the use of its senior people.  

From a legal standpoint, being a member of an LLP is like being a shareholder in a limited company. In the same way as it is normal for shares in a company to be held by both spouses, both can be members of an LLP and be paid profit shares. However, it would not be possible to pay a non-active spouse a substantial salary where the active spouse was doing all the work. 

Finally, whilst income tax and NICs deducted via PAYE on director and employee salaries is generally payable in the month after the payment of salary, the self-employed pay tax through self-assessment. This gives a cash flow advantage – particularly with a new LLP. 

Consider your options

It is not always straightforward for businesses to benefit from an LLP structure. However, with the Chancellor expected to increase the tax burden for the rich in her forthcoming Autumn Budget, is it worth getting expert advice on how an LLP might add tax efficiency to your business?  

For more information, please get in touch with Tim Parr or your usual RSM contact.