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Limited company or partnership: which is best?

22nd Nov 2005
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Inspired by yet another posting on the subject of incorporation. AccountingWEB decided to comission a guide to help you with this challenging and common issue. Nick Antoniou of Smith & Williamson highlights the pros and cons.

The choice of legal status for your business is a complex one and is dependant on a number of tax, commercial and legal considerations, which impact on the business for many years to come. Getting it wrong can have many negative consequences, which are not simply costly in terms of tax, but many practical difficulties concerning future succession and sale of the business. Take time to consider the pros and cons of each option as the time invested at the business planning stage will be of benefit in the future.

Should you operate as a limited company or partnership? Or perhaps go for limited liability partnership (LLP) status, which some believe offers the best of both worlds? It is essential to select the appropriate status for your business, as this will determine a number of other issues including tax, future succession of the business and many other factors.

Whilst it is frequently assumed that incorporation brings substantial tax benefits and greater financial protection to directors, this is not always the case. In fact, for some businesses, running as a partnership can be the most efficient and rewarding route.

Each firm must assess its particular ambitions in view of current circumstances and decide the most appropriate route. Indeed, selecting the best operating vehicle for your organisation is just one part of business planning, but first, let's recap on some basic differences between limited companies and partnerships.

A limited company is a legal entity, run by directors and owned by shareholders, who are frequently the same people. Each company must publish its annual accounts, although small organisations need only provide a basic financial summary and for those with turnover under £5.6 million per annum, no audit is required.

In contrast, partnerships are owned and run by individual partners who are personally and jointly responsible for the actions of their fellow partners which partly accounts for the importance of a partnership agreement or deed. Partnerships do not have to publish or audit their accounts, however large they get, although there is a move towards increased transparency.

A few of my clients have set up a limited liability company to run alongside the partnership to which different types of projects are directed. This affords maximum flexibility and helps the business to protect itself. It can also be a useful means to ensure succession as partners leaving a partnership can result in dissolution whereas a company continues, even when directors retire or leave.

Limited liability partnership, which became available from 6 April 2001, brings the benefits of limited liability whilst maintaining a traditional partnership. Not surprisingly, an increasing number of businesses of all sizes are considering this.

As the members have limited liability, the protection of those dealing with an LLP requires that the LLP maintains accounting records, prepares and delivers audited annual accounts to the registrar of companies, and submits an annual return in a similar manner to companies. The exemptions (and limits) available to companies with respect to delivering abbreviated accounts and exemption from audit also apply to LLPs.

Do you need to limit liability?
The type of work you undertake or your client portfolio often dictates whether or not limited liability is required. Typically, if you have regular overseas projects or work for quite large clients, incorporation may be appropriate from a commercial point of view.

But limited liability does not protect the proprietors entirely; for instance personal guarantees may be required if loans or other finance are required. In any event, insurance should always be considered to cover potential liabilities.

How much do you want to take out of the business?
Broadly speaking, if you plan to leave or re-invest money in the business, incorporation can offer advantages as profits left in a company attract corporation tax at lower rates than income tax. The highest corporation tax rate of 30% is only paid on profits exceeding £1,500,000. In contrast, partners pay income tax of up to 40% on the whole of their profits whether or not they draw all those profits.

Whilst income tax rates for partners and directors are the same, directors of a limited company pay national insurance contributions (NICs) at a much higher rate than members of a partnership which adds significantly to both the company's and individual's tax bill. Indeed, to pay the director of a company and member of a partnership £65,030 net, the company would have to make 14.3% more profit than the equivalent partnership. Indeed, in the example below, the limited company pays a total of £49,272 to the Government, whilst the partnership pays £34,970.

  Limited Company Partnership
Profits 114,301 100,000
Director's remuneration (101,331)  
Employer's NIC (12,970)  
Retained profits Nil  
Directors/partners gross income 101,331 100,000
Income tax (32,491) (31,959)
Employee's/parners contributions (3,810) (3,011)
Net income 65,030 65,030

However, if directors take a lower salary and reinvest more in the firm, limited liability may offer financial advantages. In short, different levels of profitability create a different financial picture and any decision regarding structure requires careful consideration of your current and future objectives.

Many companies also enjoy substantial flexibility to structure an efficient reward package, largely because the roles of shareholders and directors are blurred in owner-managed businesses. Profits can therefore be extracted through a mix of salary, bonuses, pensions, dividends and other benefits to create a tax efficient package.

The recent case of Arctic Systems Ltd, set a dangerous precedent for companies where husband and wife shareholdings exist. As a result of this case, HM Revenue & Customs (HMRC) can challenge dividends paid to the spouse who is not actively involved in the business and seek to assess that spouse's income as part of the other spouse's income, and crystallise a higher rate liability.

HMRC) can challenge dividends paid to the spouse who is not actively involved in the business. HMRC can then, in turn, seek to assess the less active spouse's income as part of the other spouse's income, which could lead to a higher tax charge.

Who should own the business?
Traditionally share ownership was seen as providing flexibility to owners of a company. For example, ownership can be extended to spouses and children, who can often be paid very efficiently in dividends (depending on the individual's other income). Additionally, owners of a company can promote senior staff to director level providing a useful incentive without having to devolve ownership of the business. Planning opportunities are limited in this context, since the case of Arctic Systems Ltd, as described above.

Shares can also be used as a means to reward and incentivise staff, particularly if you set up a share scheme such as the Enterprise Management Incentive scheme. This scheme has been recently extended and represents a particularly good deal for employers and employees alike.

Spreading ownership is more difficult in a partnership, although a practice can appoint 'salaried partners' (who may adopt some of the responsibilities of partnership but continue to be paid under PAYE) as well as 'equity partners'. This really is a halfway stage and most salaried partners would expect equity partnership in due course.

Costs of incorporation
Anyone setting up a limited liability company will have to pay an incorporation fee of £250. In addition to this, there can be, for example, the cost of drawing up shareholders agreements etc.

Setting up a limited liability partnership costs £250, but you must also reckon on paying legal costs for the LLP agreement. This might set you back anything from £1,000 depending on complexity.

In short, there are potential tax savings available to both partnerships and companies. Deciding the best route for your business is likely to depend on your current level of profitability, investment needs and goals.

  Partnership LLP Limited Company
Limited liability No Yes unless negligent Yes unless negligent
Laws and statutes Partnership Act1890 - 50 sections Limited Liability Partnership Act 2000 and LLP Regulations 2001. Legislation based on Companies Act etc - 76 pages of regulations Companies Acts 1985 and 1989 - over 900 sections and schedules. Insolvency Act 1986 - over 450 sections and schedules
Audit requirement No Yes - Subject to exemption limits Yes - Subject to exemption limits
Disclosure of information None LLP Regulations 2001 and GAAP. Certain provisions of the Companies Act. In accordance with Companies Acts and GAAP
Remuneration Profits/drawings Profits/drawings Salary/dividends
Taxation Income tax Income tax Income tax, NIC and corporation tax
Ownership Partners Partners Shareholders
Management Partners Partners Directors
Costs of changing No additional costs Legal costs in setting up. Audit costs Legal costs of conversion. Audit costs. Additional tax costs
Aprroximate set up costs
Legal costs (members / partnership / shareholders agreements etc.)

Nick Antoniou, director at Smith & Williamson, the accountancy and financial advisory group
Tel 0208 492 8600, [email protected]

By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.

Smith & Williamson is an independent professional and financial services group employing over 1,100 people. The group is a leading provider of investment management, financial advisory and accountancy services to private clients, professional practices and mid-size corporates. It operates from offices in London, Belfast, Bristol, Guildford, Salisbury, Southampton, Tunbridge Wells and Worcester. Nexia Audit Limited is an independent company which works alongside Smith & Williamson to complement its specialist financial advisory services.

Smith & Williamson Limited
Regulated by the Institute of Chartered Accountants in England and Wales for a range of investment business activities. A member of Nexia International.

Nexia Audit Limited
Registered to carry on audit work and regulated by the Institute of Chartered Accountants in England and Wales for a range of investment business activities. A member of Nexia International.

Replies (8)

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By Taxi
26th Nov 2005 00:07

Goodwill - no tax relief on goodwill purchased from a
connected person.

Sole traders v. Ltd Cos, I find that a Ltd co is the safer bet (providing the client recognises that a company is a separate legal entity). One pays less tax, and once you have set up correctly, it is easier to manage.

A further major advantage is in respect of investigations. As a director of a limited company, you will only suffer an investigation into your personal tax return. The full "books and records" inspection is suffered by your company, and provided that you have not used your company as a personal bank account, this makes the whole process cleaner and easier.
OK, so there are PAYE issues, again it is just a matter of good housekeeping.

As to LLP's, well I understand when traditional partnership want them - GPs, Architects etc, but again, I think many of them would be more suited to a Ltd Company.
Finally, LLPs are soon going to be accounted for like companies. Terribly confusing for clients, who I think find the whole LLP thing rather cumbersome.
Most accountants, I wager, would really rather stick to the tried and trusted Ltd Co. vehicle.

Thanks (0)
23rd Nov 2005 10:44

Re message from Alistair Kennedy
Can companies write off purchased goodwill when it is transferred from a sole-trader or partnership?! It is still purchased by a ltd co but no tax relief is available as far as i am aware

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By AnonymousUser
22nd Nov 2005 17:44

Capital issues - Ltd v partnership
The article is v. light on technical content. The argument for lower taxes in Ltd co provided income is taken as dividend & not salary is well rehearsed. What is not mentioned is the loss of 100% BPR where individuals retain a property that is used in a ltd co. Also ltd cos can write off purchased goodwill which partnerships cannot.

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By stephenkendrew
22nd Nov 2005 15:40

missing the point??
Surely the main reason many have gone down the incorporation route has been to reduce their tax liabilities.

In the example quoted, a limited company could make a profit of £77,988 (i.e. 22% less than the partnership) and the directors/shareholders still take home £65,030 if salaries are paid to the (two) directors of £4,895 with the rest of the profit taken as dividends - total tax liability £12,958!

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By AnonymousUser
22nd Nov 2005 14:33

Company v. Partnership the only choice?
Presumably this well-presented comparison of companies versus partnerships was written for the non-technical browser. If so, doesn't the absence of mention of the sole trader option mislead?

Thanks (0)
22nd Nov 2005 16:58

Incorporation fee?
Since when has there been a £250 fee to incorporate a company? Does Nick Antoniou actually mean that his own firm charges this for a formation?

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By AnonymousUser
23rd Nov 2005 09:37

Limited Liability
As a matter of course, these days, I advise all my clients to go Ltd.
With compliance set to increase, HMRC wanting all self-employed on the payroll plus all the normall trade risks there really can be no other option.
I have been in the profession for forty years and up untill a few years ago I would have looked at all the options so I haven't taken this decision lightly. I have not seen or heard of one arguement that persuades me otherwise and I have a very open mind.

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The usage of companies and LLPs in #PropertyInvestments, especially in the residential market in the wake of the recent regulatory changes has made it a sticky point in advisory. Given that individual income arising from personally owned residual property is taxed higher than those owned by companies, the case of using a corporate entity to structure ownership has been attractive recently. Many property investors are moving ownership into companies, despite having owned them in personal names. Mortgage interest relief, having been disallowed for individuals, yet allowed for companies, makes companies an attractive entity for ownership. Recently, property lenders have also become flexible in lending to companies, especially where there is a simple ownership structure.

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