It is a well proven business principle that: ‘Business structure should follow business strategy’. However, this is often not the case. The starting position for the business becomes an ongoing default commercial position. Inertia, fear of change and a lack of proactive input are the major inhibitors to a business owner’s desire to review and ensure an optimal structuring of the business to achieve their commercial and financial objectives.
In the new era of increasing taxes, and the need for commercial ‘fitness’, removing all unnecessary financial and structural waste in a business is a key business goal and strategy. Tax in a business is the single largest cost.
To assist you in considering the possibilities we have provided a basic overview of the business structures. Our recommendation is that you consider where appropriate not a ‘mono-corporate’ structure i.e. just a limited company, but a flexible potential structure which includes a dynamic combination of structures to ensure you achieve your commercial and personal financial goals.
The 4 main structures available to you and your business are:
The form of structural entities you choose and utilise can have a significant impact on the way you are protected under the law and the way you are affected by taxation rules and regulations.
These four basic forms of business organisations each have their own benefits and drawbacks and are treated differently for legal and tax purposes.
A sole proprietorship is typically a business owned and operated by one individual.
A sole proprietorship is not considered to be a separate legal entity under the law, but rather is an extension of the individual who owns it. The owner has possession of the business assets and is directly responsible for the debts and other liabilities incurred by the business. The profit or loss of a sole proprietorship is combined with the other income of an individual for income tax purposes.
A sole proprietorship is perhaps the easiest form of business to own and operate because it does not require any specific legal organisation, except, of course, the normal requirements such as licenses or permits. A sole proprietorship typically does not have any rules or operating regulations under which it must function. The business decisions are solely the result of the owner’s abilities.
In a partnership, two or more individuals join together to run the business enterprise.
Each of the individual partners has ownership of company assets and responsibility for liabilities, as well as authority in running the business.
The authority of the partners, and the way in which profits or losses are to be shared, can be modified by the partnership agreement. The responsibility for liabilities can also be modified by agreement among the partners, but partnership creditors typically have recourse to the personal assets of each of the partners for settlement of partnership debts.
A partnership is a legal entity recognised under the law and, as such, it has rights and responsibilities in and of itself.
A partnership can sign contracts, obtain trade credit and borrow money. When a partnership is small, most creditors will require a personal guarantee from the general partners to provide them with credit.
A partnership is also required to file an income tax return. A partnership typically does not pay income tax; the information from the tax return is combined with the personal income of the partners to determine their overall tax liability.
A limited company is a separate legal entity that exists under the authority granted by statute.
A limited company has substantially all of the legal rights of an individual and is responsible for its own debts. It must also file tax returns and pay taxes on income it derives from its operations.
Typically, the owners or shareholders of a limited company are protected from the liabilities of the business. However, when a limited company is small, creditors often require personal guarantees of the principal owners before extending credit. The legal protection afforded the owners of a limited company can be useful.
A limited company must obtain approval from Companies House to use its proposed name. A limited company must also adopt and file a Memorandum and Articles of Association, which govern its rights and obligations to its shareholders, directors and officers.
A limited company must file annual tax returns (corporation tax returns) with HM Revenue & Customs.
Incorporating a business allows a number of other advantages such as the ease of bringing in additional capital through the sale of share capital, or allowing an individual to sell or transfer their interest in the business. It also provides for business continuity when the original owners choose to retire or sell their shares.
The Limited Liability Partnerships Act (LLPA 2000) creates a new type of business entity, the Limited Liability Partnership (LLP). The concept is very similar to the United States LLC.
An LLP is a hybrid of a Partnership and a Limited Company due to the combined characteristics. LLP’s are designed to combine factors of:
LLP’s have been available for use since 6 April 2001 and provide a totally new business vehicle (LLPA 2000). LLPs are becoming an increasingly familiar part of the business landscape.
Although an LLP has several of the features of a partnership, it is not really a partnership at all, but is more akin to a company. The legislation provides that partnership law does not apply to LLP’s, except in a very limited way.
An LLP is a separate legal entity from its members. Therefore, it may enter into contracts and deeds, sue and be sued and grant floating charges over its assets in its own name. This avoids the problems that exist in relation to partnerships, where technically it is often necessary for every partner to be party to certain documents or litigation, and the creation of floating charges is not possible.
The main “price” paid in return for limited liability is public availability of financial statements. An LLP must file audited accounts (prepared on a “true and fair view” basis) annually at Companies House, which must include the name and profit share of the highest paid member.
Provided an LLP carries on a trade or a profession and is not simply an investment vehicle it is tax transparent – that is the LLP itself is not taxed on its income or capital gains at all. Instead the members are taxed on their shares of the LLPs’ profits and gains, just as partners in a partnership are currently taxed.
A UK LLP is tax transparent – it is taxed as if the members were in partnership. Income or gains of the UK LLP are therefore treated for UK tax purposes as the income or gains of the members, in the proportions specified in the members’ agreement. Non-UK resident members of a UK LLP who are in receipt of capital gains or non-UK source income are outside the UK tax net. The UK Inland Revenue has indicated that they will introduce specific anti-avoidance measures against UK LLPs which invest in UK property AND whose membership consists of:
The UK Inland Revenue also intends to remove interest relief for investments in investment LLPs (as defined) so that individuals will not be able to claim tax relief for the interest paid on monies borrowed to invest in them.
This means that the LLP may be more tax efficient than a limited company. This is because ordinarily a limited company is taxed on its income and capital gains and the company’s shareholders are taxed on distributions from the company to them, giving rise to potential double-taxation.
LLPs were primarily intended for use by the professions. However, any type of business operating for profit may use LLPs. An LLP may be suitable for use as a joint venture vehicle or as an alternative to a limited company, particularly for small businesses.
The following are some of the other primary characteristics of the UK LLP:
As referred to above, non-UK resident members of a UK LLP whose trade is conducted outside the UK and whose income profits have a non-UK source will be outside the territorial scope of UK taxation.
This creates the possibility of a UK body corporate managed and controlled from a zero tax base such as Jersey, the Isle of Man, Cyprus or some other reputable offshore financial centre.
With appropriate planning, the profits of such a UK LLP will not be subject to UK taxation.
Although there are no residence requirements for LLP members it may be commercially sensible to appoint a UK member to whom a small profit allocation is made, as the UK Inland Revenue may react unfavourably to large numbers of UK LLPs being registered that disclose no UK tax liabilities at all.
UK resident but non-domiciled members of a UK LLP whose business is managed and controlled outside the UK will derive benefits from using a UK LLP rather than a UK company. Non -UK trading income will be treated as income arising from a foreign possession under Schedule D Case V. This means that such income will not be taxed unless and until remitted to the UK.