Deciding to ‘go limited’ is definitely a wise choice, but once that decision is made you then have to decide whether to form a private limited company (LTD) or a limited liability partnership (LLP). This decision can be complicated as both structures handle tax, profits and membership differently.
Outlined below are the key differences which will hopefully help you make an informed decision about what is best for your business.
Why ‘go limited’ at all?
First, let’s look at why going limited is a wise choice.
- As the owner of the business, you will only be liable for business debts up to the value of your original investment.
- Personal assets, such as your house, car or computer will not be at risk if the business runs into difficulties.
- If claimants sue, they will sue the company, not you or any of your investors.
In a nutshell – it gives you financial peace-of-mind and who doesn’t want that.
Company formation: LTD vs LLP
The key criteria required for setting up an LTD or an LLP are different and may give you an immediate indication of which option is best for your business.
Limited companies are a popular choice for companies owned and run by one person and tend to be used for goods and and services businesses. The company is owned by shareholders who entrust the day-to-day running of the business to a board of directors.
To form a limited company:
- You must have at least one shareholder. This shareholder can be either a person or a company.
- You must have at least one director. One of your directors must be a person. Your directors may also be shareholders or different people entirely.
- It can either be profit making or a non-profit business.
LLPs are owned by its members. Although LLPs are commonly thought of as specific to certain professions, such as accountants, lawyers or architects, it can be used for any type of partnership. To form a LLP:
- You must have at least 2 members. One of these members must be a person. The other members can be either people or a company.
- It has to be a genuine partnership in the eyes of HMRC.
- It must be set up with the intention of making a profit.
Whilst LTD profit distribution isn’t as flexible as an LLP, you can roll over profits (and losses) to the following year, which can have tax advantages, especially if your business income fluctuates.
|Profit distribution (1)||In proportion to shareholding||On a discretionary basis|
|Profit distribution (2)||Only if distributable reserves are available.Loans cannot be made to shareholders.||As long as there is cash available profits can be distributed, loans made or capital returned.|
Many people opt to form a LLP to avoid the double layer of tax faced by LTDs – the company pays corporation tax on profits and the shareholders pay income tax on dividends. However, depending on the amount of profit generated, the tax liability of LLP members can be very high whilst the distribution of profits to directors of LTDs can be done in such a way that most of the money is not subject to either corporation tax or personal income tax.
|Taxation of profits||Corporation tax at 20% is paid on profits||No tax is paid|
|Taxation paid by shareholders/ members||Shareholders may have to pay income tax on dividend payments, return of capital or transfer of shares.||All members of the partnership will have to pay tax on profits, even if they have been paid as dividends.|
LLPs offer greater flexibility than a LTD in terms appointing and removing members or altering their rights and duties; however, if a partner retires or resigns leaving a sole member you will need to either find a new member or close.
|Appointing new directors & shareholders/members||New directors can be easily appointed.It is more complicated to appoint new shareholders||New members can be easily admitted by executing a Deed of Adherence to the Members Agreement|
|Removing directors & shareholders/members||It is easy to remove directors as long as they are not shareholders; however, you must ensure employment laws aren’t breached.||Members can be easily removed by executing a Deed of Adherence to the Members Agreement|
So which legal structure should you choose for your business?
You need to choose the structure which best suits your personal circumstances, the type of business you are running and your future plans. If, for example, you are planning on attracting other professionals to join you, then LLP might be the best option. However, it’s worth remembering that while it is easy to change from LLP to LTD, it’s not so easy to change from LTD to LLP.
I hope this post has helped clarify your thoughts on which ‘limited option’ is best for your business. If you are still unsure, or would like more detail about the potential profit and tax implications, please get in touch.
Read the HMRC’s advice on choosing a legal structure for your business.