Following the government’s crackdown on the use of limited liability partnerships (LLPs) to disguise what would otherwise be employment relationships (thereby avoiding the need to pay employer’s National Insurance contributions on the remuneration of the LLP’s members), members of LLPs are now taxed as employees unless they satisfy one of three tests, all of which it may be difficult for a member of an LLP which is a fund or involved in fund management to satisfy.
The additional employer’s National Insurance payable by an LLP whose members fail to satisfy any of the tests can be very significant. In addition, the use of corporate members to reduce or defer tax has been stopped in its tracks by robust anti-avoidance measures. These ensure that profits channelled to a corporate member but ultimately destined to benefit individual members are fully taxed in the hands of those individuals at the outset.
LLPs may also be falling out of favor because it is difficult to structure deferred remuneration through them, the profits in each year being taxed on the members even if actual allocation of the profits may be deferred or even subject to forfeiture at a later date. By contrast, the Remuneration Code for Alternative Investment Fund Managers promotes the deferral of remuneration in order better to align the interests of fund managers with the long-term interests of investors.
Members of LLPs also have exposure to personal liability in circumstances additional to those applicable to shareholders in a company. Amounts withdrawn by a member of an LLP in the two years preceding an insolvent liquidation can in certain circumstances be required to be repaid under so-called ‘clawback’ provisions. Whilst these circumstances may not often apply, in cases where they do a member’s drawings and additional profit shares and any repayments of capital and loans received by him can all be clawed back.
Consequently, some operating in the financial services industry are considering abandoning the LLP as a business vehicle in order to continue business through a limited liability company. Two possible methods of achieving this are for the LLP to transfer its business and assets to a corporate member by way of a distribution in kind or for the business to be transferred to a newly incorporated company in exchange for loan notes issued by the company which are then transferred to the LLP’s members as a distribution in kind. In both scenarios, pending FCA approval of the company, the LLP can, if itself FCA authorized, provide regulated services to the company under a transitional services agreement. Numerous third party consents to the transfer of a business are often required, including those of a particular majority of the members themselves and those of counterparties to important contracts held by the LLP. Employees of the LLP would normally automatically transfer to the company under TUPE. Members of the LLP would need to agree to become employees of the company, employed under service contracts. Some or all would also become shareholders of the company.
A number of tax issues will be relevant, the tax analysis depending on the precise structure and profit sharing arrangements of the LLP and the company. Care will be needed to minimize tax charges arising on the transfer of the business, including considering the availability of reliefs and exemptions. Stamp duty can arise on the transfer of any shares held by the LLP, as can stamp duty land tax where the LLP holds real estate which is transferred. VAT should not be payable where the business is transferred as a going concern.
Going forward, any income or gains of the business will be treated for tax purposes as accruing to the company (rather than directly to the members of the LLP), resulting in taxation at both the company level and, when dividends are paid, at the shareholder level. A member will lose his right to entrepreneur’s relief on a subsequent disposal of his shareholding in the company unless he holds at least 5 percent of the ordinary share capital conferring at least 5 percent of the voting rights.
The devil is always in the detail. Conversion of an LLP to a company may seem an attractive proposition but the process will give rise to innumerable issues all of which need to be carefully addressed and resolved. Not for the faint-hearted.
Tina Williams is a London-based partner at law firm Fox Williams who specializes in international mergers and acquisitions, corporate finance and private equity.