Using an LLP to maximise Entrepreneurs Relief and reduce capital gains tax
The Entrepreneurs Relief provisions provide anyone selling a trading business with a significant reduction in their capital gains tax liability.
Many business owners will look to establish businesses using a company. This has the advantage of allowing tax to be avoided on retained profits but is it always the preferred option if you're looking to sell the business in the future?
Using a company
If you use a company you'd need to sell the shares in the future to benefit from Entrepreneurs Relief. A disposal of the business assets by the company itself would not qualify for any Entrepreneurs Relief.
So you'd need to make sure that you owned the shares in the company. Any gain that arose on you would qualify for Entrepreneurs Relief providing its a trading company and:
Provided this applies any capital gain you realise on a sale of the shares would in principle qualify for Entrepreneurs Relief.
Remember that the maximum Entrepreneurs Relief is fixed at gains of £10,000,000. So to maximise Entrepreneurs Relief you need to spread ownership amongst a number of different shareholders. Each though would need to meet the above conditions.
What is an LLP?
Limited liability partnerships ('LLP's) were introduced in 2001 and offer a cross between a partnership and company structure. They were mainly introduced to offer large professional firms that trade as partnerships (accountants, lawyers, surveyors etc) the opportunity to benefit from limited liability, as a company can.
An LLP is simply a partnership, which provided the partners with the benefits of limited liability - thus ring-fencing their personal assets from any potential business creditors.
Although in general law a LLP is regarded as a 'body corporate'and is like a company, for tax purposes a LLP is normally treated as a 'partnership'. Therefore an LLP will normally be regarded as transparent for tax purposes and each member/partner will be assessed to tax on their share of the LLP's income or gains as if they were members of a 'normal' partnership
Thus if a LLP carries on a trade then each registered partner is taxable on the income they derive from the LLP as trading income.
This is a crucial difference from being a shareholder in a company. A company shareholder is regarded as a separate entity for both legal and tax purposes. An LLP however is a separate legal entity purely in legal terms.
Therefore a company shareholder is not taxed on the profits of the company, just the cash that is extracted from the company (either as salary/benefits or dividends). A member of an LLP is however taxed on his or her share of the profits that are generated by the partnership.
How are LLP's taxed on a sale of the business?
As a share of an LLP is treated as a share in a 'normal' partnership, on a future disposal of the partnership the tax treatment would be the same as for a disposal of a partnership interest.
Entrepreneurs Relief will be due to the partners of the LLP provided what is being sold is a business or an interest in a business.
The Finance act states that:
'...the disposal by an individual of the whole or part of the individual's interest in the assets of a partnership is to be treated as a disposal by the individual of the whole or part of the business carried on by the partnership...' Therefore a partner selling the partnership interest would qualify for Entrepreneurs Relief. There is no requirement relating to 5% of the profits or assets or any kind of employment or other service provision.
This could therefore give an LLP an advantage over a company in terms of maximising Entrepreneurs Relief on a disposal of the business. So if you're setting up a business with the intention of selling at a substantial profit does this make an LLP a good option?
It can do - especially when you taken into account the problem with one of the typical advantages in using a company.
One of the traditional problems with a company would be that although the rate of corporation tax is lower than the LLP's income tax rate to get the cash out of the company a further tax charge may then be payable (25% on a dividend extraction from a company for a higher rate taxpayer).
It may therefore be advised that cash should be retained in the company ( to avoid income tax) to ensure a lower tax rate over using a partnership structure. However if maximising Entrepreneurs Relief is a key concern this may not in any case be a good reason to use a company.
Entrepreneurs Relief applies where there is a 'trading business'. This is defined as a business without substantial non trading assets or income. Substantial non trading assets can include cases where more than 20% of the net assets consists of cash not required for the business purpose. So using a company in such circumstances anyway may not be a good option to maximise Entrepreneurs Relief.
By using an LLP you could have unlimited partners qualifying for the £10,000,000 relief. You could also potentially use unequal income and capital ratios to still preserve a higher share of the profits for certain partners.