An LLP is similar to a private limited company in that it has a separate legal identity to that of the partners (known as ‘members’) in the LLP.
In many ways LLPs operate in exactly the same way as ordinary partnerships, but while ordinary partnerships do not have to be registered with Companies House, it is a statutory requirement for LLPs to be registered.
Each LLP must have at least two ‘designated members’ who are responsible for various administrative duties such as dealing with accounts and tax matters on behalf of the partnership. However, there is no limit to the number of ordinary members an LLP can have. Members can be either individuals or limited companies (known as ‘corporate members’) and each member acts as an agent for the LLP and can form binding contracts on its behalf.
Since the LLP has a separate legal identity to its members, legal claims against the business can only be made against the LLP itself and not its members. The liability of the members is limited to their capital contribution to the LLP, so their personal assets cannot be seized to settle the partnership’s debts.
Management of the partnership is normally shared among the members, as specified by an LLP agreement, which is a contract between the members of the LLP. This sets out the members’ rights and obligations and provides a plan for how the partnership will be run. It is essential, as best practice, to have an LLP agreement drawn up by a solicitor before starting to trade.
The information below explains what an LLP is and sets out the advantages and disadvantages of the LLP format, as well as outlining the steps to take when setting one up.
The advantages and disadvantages of LLPs
LLPs have various advantages and disadvantages. The advantages include:
- In an ordinary partnership, a partner’s personal assets can be seized to settle the partnership’s debts. However, LLPs have a legal identity of their own and their members benefit from limited liability, which means claims are made against the LLP only and members’ personal liability is limited to their capital contribution.
- As a separate legal entity, an LLP can enter into contracts in its own name. This avoids the problem sometimes encountered by ordinary partnerships where every partner has to sign certain documents.
- LLPs do not have to be dissolved on the resignation, death or bankruptcy of a member.
- The structure of an LLP can be flexible, depending on the terms laid out in the LLP agreement. A limited company, on the other hand, is strictly governed by its Articles of Association and any amendments to the Articles will require a shareholders’ resolution in order to be implemented.
- The management responsibilities of the LLP are shared and members can bring a range of different skills and experience to the enterprise, making it less dependent on the resources of just one person.
- There may be tax benefits in choosing to incorporate as an LLP, and advice should be sought from an accountant as to whether this is the best legal format to choose.
Some of the disadvantages of LLPs are:
- Most LLPs need to produce audited accounts to submit to Companies House. Public disclosure of an LLP’s accounts means that its financial circumstances and trading position cannot be kept private.
- All members of an LLP can be held responsible for any one member’s negligence if they are operating within the scope of their authority in the business.
- Formation of an LLP is more complex and can be more costly than for an ordinary partnership.
- The costs of administering an LLP are typically higher than those for an ordinary partnership due to the additional accounting and reporting requirements.
Drawing up an LLP agreement
The LLP agreement is a contract between the members of the LLP. It sets out the member’s rights and obligations and provides a plan for how the partnership will be run. It is essential, as best practice, to have an LLP agreement drawn up by a solicitor before starting to trade.
If there is no agreement, the partnership will be governed by the terms of the Limited Liability Partnership Act 2000.
Some of the important issues that need to be agreed at the outset and included in the LLP agreement are:
- The business name and registered trading address.
- The names of members.
- Details of any limit on the number of members and the process for appointing new members.
- Procedures for meetings.
- The nature of the business.
- The terms on which capital is contributed and how profits are shared.
- Working arrangements, such as the amount of time that each member is expected to devote to the business.
- Provisions for what would happen on the death or retirement of a member.
Members of an LLP are usually treated as being self-employed for tax purposes in the same way as sole traders or partners in an ordinary partnership, and so do not receive a salary from which tax is deducted through Pay As You Earn (PAYE). Instead they draw money out of the business for their personal needs and pay tax and National Insurance under the tax self-assessment system.
Anyone who is required to declare their untaxed income, such as all new members setting up an LLP, must contact HMRC to register as self-employed for tax self-assessment when starting up. Failing to register can result in a penalty of £100 and further penalties for trading illegally and not paying tax. Every year they must declare their income through a self-assessment tax return and pay any tax and Class 2 and Class 4 National Insurance that is due in January and July each year.
The LLP and each individual member (including corporate members that are limited companies) must all be registered for tax self-assessment with HMRC. At least two people must be appointed as ‘designated members’ who are responsible for keeping the business records and managing the partnership’s tax returns.
The registration process takes at least 10 working days to complete as it involves HMRC posting a 12-digit activation code, which is required when logging on to the online account.
The partners can retain and share any profits that remain after payment of tax. However, even though it is a separate legal entity, the partnership does not have a separate tax liability in addition to the partners’ personal tax liability.