Structuring for success

For a few crucial reasons, the LLP continues to be the optimum business structure for UK management firms, argues tax expert Neil Simpson. Here he explains why. 

For investment management businesses, as with others, great weight is placed upon achieving the “optimum business structure” and, by implication, optimum tax efficiency. It is a futile quest, at least in terms of any fixed structure, and for two reasons.

Firstly, the main requirement of a “successful” business structure is limited liability: without this protection against failure many businesses would simply not assume the commercial risks necessary to succeed. If this is correct then the available choice of structure is not one of infinite variety but essentially between a Limited Liability Partnership (LLP) or Limited Company. Both are corporate bodies and both provide limited liability to their members or shareholders.

Secondly, the optimum business structure must be tested against what is to be optimized and when! Tax efficiency is the immediate and stock answer. But tax rules are fluid and a tax efficient structure under today's rules will not be tomorrow. While tax may dominate considerations of structure it is not the only or main determinant. There are a wide number of commercial considerations that should be taken into account and these may vary in their relative importance over the life cycle of the business. The foremost requirement of a successful business structure therefore is flexibility – an ability to accommodate the changing commercial requirements of the business and its owners over time – and, of course, on a tax efficient basis.

In terms of flexibility, the LLP is the much more attractive base structure. Its flexibility is evident in a number of areas important to business owners.

The profits of an LLP may be allocated on a wholly discretionary basis. By comparison, the allocation of profit by a Limited Company is necessarily constrained by the fixed shareholding percentages held by the owners.

Making distributions is completely flexible. Subject to the cash being available the LLP may freely distribute profits, advance loans, and return capital with minimum formality. The Limited Company requires available reserves to distribute and must meet restrictive company law requirements in making loans and returning share capital whether by way of share buyback or liquidation.

The admission of new members (and withdrawal of old) is free of any great formality – the simple execution of a deed of adherence to the Members Agreement being sufficient to introduce a new member. Compare this with the relative difficulty in introducing new members in a Limited Company (in funding the acquisition of shares or in dilution of other shareholders interests) and of removing director shareholders and in recovering their shares (employment rights, valuation and funding the purchase of the departing shareholder's shares).

Most significantly, the above flexibility is available to the LLP on a tax neutral basis. The distribution of profits, the return of capital, the introduction and removal of members may all be achieved without tax costs for the LLP or its members. By comparison, the payment of dividends, the return of capital, the transfer of shares between members, the admission of new shareholders on favorable terms are all occasions of potential tax charge to shareholders. On the face of it the LLP is more flexible and out performs the Limited Company in that other requirement of a successful structure: tax efficiency. 

However, this is not the complete picture. The profits of the LLP are charged directly on its members (partners) as they arise (are recognized in the accounts) and irrespective of whether the profits are distributed or retained in the business. In contrast, a Limited Company is taxed independently from its shareholders and pays corporation tax at a rate of 20 percent on its profits. There is no tax charge on the shareholders until those profits are distributed as dividends or returned on liquidation. The limited company therefore offers a material tax deferral (of as much as 27 percent) as compared to the members of an LLP where the individual might be paying income tax at a marginal rate as high as 47 percent.

For many investment management businesses the deferral advantage will not be important. For example, where profits are fully distributed rather than retained in the business or where the investment manager of a private equity fund participates in the capital profits of the fund by way of a “carry”. Here it is the structure of the “carry” rather than that of the business that will determine tax efficiency.

However, the absence of the “deferral” may be an issue, particularly where the “carry” is a performance fee to be received as revenue. A Limited Company may now be the preferred recipient. Similarly, when seeking an exit will the sale of an LLP maximize the value of the business when most purchasers still regard an LLP (unfairly) with some suspicion when it comes to making a corporate acquisition. Again, the flexibility of the LLP assists as it is a relatively simple matter to fully incorporate an LLP into a Limited Company (and on a tax neutral basis).

To conclude, flexibility is key to the successful structure and the LLP will generally be favored, not least because that flexibility allows the business owners to change their minds.  

Neil Simpson is a London-based, specialist tax partner at accounting firm Haysmacintyre. Â