The Legal Services Act 2007 brought with it the possibility for Alternative Business Structures (ABS) to operate within the legal sector. In essence, it allowed non-lawyer managers to operate within and/or own law firms. Whilst this has been the case for some time now, the Jackson Reforms which came into force on the 1st of April 2013 have made some stop and have another look at their business structure.
In this article we summarise some of the key points to consider when comparing the existing partnership model to a Limited Liability Partnership (LLP). We then move on to consider the idea of incorporating a corporate member into your structure
Partnership or LLP
Since 2001, LLPs have been a possibility for law firms wishing to reduce their liability, acting as a type of half-way house between partnership and limited company.
The LLP model was specifically designed in a manner that was attractive to existing partnerships in an attempt to minimise the disruption in the transfer from partnership to LLP. Partnerships and LLPs share many of the same traits, with a couple of key exceptions:
- LLPs are registered with Companies House and have annual filing requirements just like a limited company. There is therefore an increased onus on openness and transparency when it comes to reporting.
- The traditional partnership model comes with unlimited liability. Given rising PI costs this can be a somewhat perilous position. An LLP by contrast is regarded in law as a separate legal entity from the individual members (partners) and so gives increased protection to its members , in most cases putting only the member’s capital and current accounts at risk (although there are exceptions). It should be stressed however that third parties such as banks often require cross personal guarantees from members within an LLP which can limit the effectiveness of reduced liability.
Although there are some very detailed tax issues to consider, in the main an LLP is taxed no differently from a traditional partnership. The members of the LLP are taxed as though they are self-employed; exactly as if they were partners in a partnership.
There are many other factors to consider in determining whether to become an LLP or not, including the impact on existing commercial arrangements, the increased administration burden, perception by clients and associated costs.
One of the inherent limitations with both the partnership and, to a lesser extent, the LLP model, is that of being able to generate growth via external investment. The idea of a corporate member is a relatively recent concept and is usually created by setting up a limited company and allowing it to take (in most cases) a controlling stake in an LLP.
The members of the LLP would then have a stake in the LLP (no change there) and also a shareholding in the corporate member. We mentioned above that this is a fairly recent concept and for good reason. It is only now, post ABS, that anyone can hold shares in a corporate member of a legal practice and for this reason they have become more attractive as a means of attracting external investment.
Legal practices going down this route can use this as a means of generating external investment into the corporate member which can subsequently use the funds to acquire smaller legal practices thereby growing the business through acquisition at a faster rate than would otherwise be achievable via organic growth.
In addition to the investment opportunities, a corporate member also provides increased flexibility when it comes to rewarding employees through staff share schemes and can also allow provision to be made for retired partners. The latter is a particularly pertinent point given the difficulty that can sometimes be experienced when partners of an LLP retire.
In a corporate structure where a retired partner retains a share in the corporate member only, they can be rewarded from the business that they helped to grow, even after retirement. Structuring the ownership of the corporate member is something that must be given due care and attention and there are numerous tax implications which we will not go into in this article.
Corporate members can also provide additional flexibility regarding taxation on profits. However, a word of caution here, saving tax should not be the key driver behind the decision to register a corporate member and HMRC can challenge these structures.
The tax advantages of companies over LLPs and partnerships are still present in some cases but are not what they once were.The decision should be based on commercial reasoning to benefit the organisation as a whole.
Whether your structure works for you is something only you and your fellow partners can decide. In particular the idea of a setting up a corporate member is something that must be given considerable thought.
Contact our specialists
At Hawsons we have a wealth of experience in dealing with different legal structures of all sizes and the numerous tax pitfalls and we consider each case on its merits after reviewing the information provided. No two legal practices are the same and what works for one may not work for the other.
As members of HLB International, our expertise is not limited to UK operations and we have access to prompt and accurate advice on a worldwide basis.
Please visit www.hawsons.co.uk for details. For more information on this or any other matter, please contact our specialist legal team.