LLPs: some common pitfalls

2023 could be the year of the Limited Liability Partnership (LLP) as when corporation tax rate hikes kick in from April, it could be significantly more tax effective for some businesses to set up in this type of structure. LLPs have been around since the early 2000s. Whilst there may be a spike in their popularity this year, LLP use since 2000 has grown significantly due to a number of potential tax benefits available (as highlighted in this earlier piece) and LLPs can now be found across most industries and professions.

An LLP is a corporate structure. As the name suggests, the owners of an LLP, known as LLP members, have limited liability for its debts. However, for tax purposes the individual LLP members are taxed like sole traders/partners on their profits. This can often provide significant tax benefits to businesses trading as LLPs (such as on National Insurance contributions (NIC), benefits in kind, and taxation of profits). However, LLPs do have some special rules that businesses need to be aware of, both when considering whether an LLP is an appropriate structure and for established LLPs.

The first is not having access to Research and Development (R&D) tax reliefs. This is a system of tax incentives set up to encourage investment in R&D work. Whilst there are circumstances where businesses using LLPs in their structure may be able to access R&D tax reliefs, broadly most LLPs are excluded.

The next is the potential risk to tax relief on capital expenditure on plant and machinery. Businesses can usually claim the Annual Investment Allowance (AIA) on plant and machinery, giving a deduction of 100% of qualifying expenditure in the year of purchase. There is a cap on the AIA (currently £1 million per annum). If an LLP is made up solely of individual members, then it will be able to claim the AIA.

However, if it has any non-individual members, such as a company or a trust, then it cannot claim the AIA and instead is stuck with the normal writing down rates, which would allow it to take a tax deduction for 18% or 6% (depending on the type of asset) of qualifying expenditure in the year of acquisition, and 18% and 6% of the tax written down value of the capital assets in subsequent years. LLPs with non-individual members are still eligible for some types of First Year Allowances (FYAs), which are available for specific types of assets, including electric cars. FYAs are uncapped and allow eligible businesses to claim a deduction of 100% of qualifying expenditure in the year of purchase.

LLP members also need to be careful with the salaried member rules. Broadly, if these apply the LLP members are taxed as employees for PAYE income tax and NIC purposes, resulting in an employers’ NIC liability at up to 13.8%. The LLP should be set up such that these rules do not apply. However, careful thought does need to be given as the consequences of these rules applying can be dramatic.

LLPs are becoming increasingly attractive options for businesses due to the increasing corporation and dividend tax rates and the other tax benefits of LLPs. Care does need to be taken though when setting up as an LLP to ensure their specific tax rules do not cause unforeseen problems.