Limited companies and LLPs are a lot alike, especially when it comes to the financial responsibility of the owners. However they differ when it comes to things like capital investment opportunities, the flexibility of the internal structure, members’ rights and the way business profits are allocated and taxed.
So it’s important to choose the right legal structure for your business, or the one you plan to have one day.
As a general rule, for-profit businesses typically opt for being limited by shares. This structure is also best if you’re planning to employ lots of people or you want to be able to sell shares. Whereas non-profit companies get a better deal by being limited by guarantee.
LLPs on the other hand come with the same benefits as traditional partnerships, but with less financial responsibility for the owners. This structure is a good idea if you only have a few employees and partners with comparable contributions, rights, responsibilities and profit shares.
The main differences between a limited company and an LLP…
Limited Company
- Can be registered, owned and managed by one person who acts as the director and shareholder.
- Shareholders or guarantors’ liability is limited to how much is paid on their shares.
- Can receive loans and capital investment from third-parties.
- Has to pay corporation and capital gains tax.
- Can be run not-for-profit.
LLP
- Requires two or more people to set up (though you can alternatively set up a limited company as the second member).
- Members’ liability is limited to how much each member guarantees to pay should the business get into trouble or be would up.
- Can only receive loan capital and can’t offer equity shares to non-members.
- Has no tax liability but members must pay Income Tax, National Insurance and Capital Gains Tax.
- Easier to change the internal management structure and profit distribution.
- Must be established with profit as an objective.
The different tax liabilities…
Limited Company
- All taxable income generated is subject to 20% corporation tax.
- All directors’ salary is liable for Income Tax, NI and employers’ NI.
- If directors are also shareholders, profits can be distributed so that a lot of the money doesn’t get taxed.
LLP
- LLP members must register as self-employed and pay Income Tax and National Insurance on all profits, whether or not they take the profits as salary or invest it back into the business.
- They don’t have to pay Employers’ National Insurance on their income.
An LLP member’s income will be subject to the following rates if it’s over £11,000 (the Personal tax-free Allowance threshold for 2016-17)
When to leave the money where it is
In an LLP, all profit is subject to Income Tax during that financial year, regardless of whether members leave their annual profit entitlement in the business or withdraw it. A limited company, however, is more tax-efficient if you’ve made more annual profit than you’ll need to take out of the business. In these cases, it’s better to leave the money in the business to defer that financial year’s tax.
Your internal structure and profit allocation
A limited company offers less flexibility than an LLP when it comes to the rights, duties and profit entitlement of its members. And while these are often just verbally agreed between the members, it can be a good idea to draw up an LLP Agreement. This is a document that helps members avoid conflicts by setting out the management structure and other arrangements.
Businesses typically issue just one type of share, giving each member equal rights and profit entitlement. However, the individual members’ rights and entitlements will still be governed by any particulars attached to their shares. This can make it difficult to change the rights and profit entitlement of shareholders. So most companies will create a shareholders’ agreement to outline the way the company should operate, as well as their rights, responsibilities and duties.