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Limited companies and limited liability partnerships (LLPs) share many characteristics. They must incorporate (register) at Companies House, they provide limited liability protection to their members (owners), and they have more complex filing and reporting requirements than unincorporated businesses like sole traders and traditional partnerships.
However, there are significant differences to take into consideration when deciding whether to run your business as a limited company or an LLP, such as:
- Taxation of profits
- Tax-planning opportunities
- Flexibility of internal structure and members’ rights
- Capital investment opportunities
- Whether the business will be for-profit or not-for-profit
Choosing the most appropriate legal structure depends on the kind of business you currently have (or plan to have in the future), whether you want to run the business alone or with other people, and which business model offers the best taxation options.
A limited company is the most tax-efficient structure for many types of businesses. If you plan to set up a profit-making business, a limited by shares company is the better choice. This structure also provides the option to sell shares in the business in exchange for capital investment.
If you’re setting up a charity or non-profit organisation, on the other hand, a limited by guarantee company would be best. There are no shareholders or shares in this type of company because all surplus income (profit) is generally reinvested in the business.
The limited liability partnership format was introduced in 2001 by the LLP Act 2000 to meet the needs of certain professionals who usually form traditional partnerships, such as solicitors, doctors, accountants, and architects. This business model provides the same benefits as a traditional partnership, but it has the added advantage of limited liability protection.
An LLP structure is a good choice for businesses with minimal employees (if any) and only a few partners, each of whom makes similar contributions to the business, enjoys equal rights and responsibilities, and takes a similar share of business profits.
The main differences between a limited company and an LLP
- A limited company can be registered, owned, and managed by just one individual who can be both the sole member (shareholder or guarantor) and sole director. Alternatively, a company can have any number of directors and members.
- To set up an LLP, you must have a minimum of two LLP members. One way around this is to set up a dormant company as the second LLP member. However, if you want to set up and run a business by yourself, a limited company would be the better choice.
- The liability of company members is limited to the nominal value of the shares they hold or the financial guarantees they provide.
- The liability of LLP members is limited to the amount each member guarantees to pay if the business runs into financial difficulty or is wound up.
Loans and investments
- A limited company can receive loans and capital investment from outside investors.
- An LLP can only receive loan capital. It cannot offer equity shares to non-members because LLPs do not have shares.
Taxation on profits
Limited company tax
- Limited companies pay Corporation Tax on all taxable income.
- Directors’ salaries are not liable to Corporation Tax, but they are subject to Income Tax, National Insurance contributions (NIC), and employers’ National Insurance.
- Typically, directors are also shareholders, which means they are entitled to dividends from shares. Dividends are paid from post-tax profits, and the first £1,000 of dividend income is tax free. Above that sum, dividends are subject to dividend tax, which provides more favourable rates than Income Tax.
- By taking a director’s salary up to your tax-free Personal Allowance (£12,570 for 2023/24 tax year) and withdrawing the remainder of your income as dividends, you will pay less personal tax than you would as a sole trader or an LLP member.
Limited companies provide additional tax-saving opportunities if you have surplus income that you want to reinvest in the business or withdraw in future tax years. This means that you can deduct capital allowances from your taxable profits if, for example, you purchase new business equipment.
In terms of personal tax savings, you can delay certain dividend payments until the new tax year to avoid paying Higher and Additional rates of Income Tax or at least delay the higher tax rates until the following year.
These are just a couple of examples of the many tax-saving and tax-planning options available to limited company directors and shareholders, so we would recommend speaking to an accountant or tax advisor for specialist help and advice in this area.
Limited liability partnership tax
- LLP members are treated as self-employed individuals for tax purposes. They have to register for Self Assessment and pay Income Tax and NIC on their individual profits, regardless of whether they take all of this income as a salary or reinvest some of it in the business.
- Depending on the amount of profit generated, the tax liability of LLP members can be rather high. If an LLP member’s income exceeds their tax-free Personal Allowance, they will be subject to the following Income Tax rates:
- 20% (Basic rate) on taxable income between £12,571 and £50,270
- 40% (Higher rate) on taxable income between £50,271 – £125,140
- 45% (Additional rate) on income above £125,140
- LLPs do not have to pay employers’ National Insurance on members’ earnings unless they are salaried members who are paid through PAYE.
- Regardless of whether members take all of their annual profit entitlement or reinvest some of it in the business, all profit is subject to Income Tax and NIC in the financial year it is generated.
- A limited company can be set up as a profit-making business (limited by shares) or a non-profit business (limited by guarantee).
- LLPs must be set up with the intention of making a profit, so it is not a suitable structure for charities or non-profit ventures.
Internal management structure
An LLP can offer greater flexibility than a limited company in terms of altering the rights, duties, and profit entitlement of individual members. Such arrangements can be agreed verbally amongst LLP members, and they can be quickly and easily changed at any time.
However, it is commonplace to draw up an LLP Agreement that sets out the internal management structure of the business and the various arrangements in place. This type of formal agreement minimises the risk of internal conflict and disputes.
It is more difficult to change the rights and profit entitlement of shareholders because these provisions are dictated by the prescribed particulars attached to shares. If you want to alter any members’ rights, you will need to alter the prescribed particulars or issue different types of shares.
If you set up a company with more than one shareholder, it is advisable to draw up a shareholders’ agreement to outline members’ rights, responsibilities, and duties.