Business Models and Partnerships

Question 1

What is a partnership?

Answer 1

No formality is required because a partnership is defined simply as a relationship between persons carrying on a business in common with a view to making a profit. A partnership is NOT a legal entity separate from the partners themselves. There must be at least two persons to form a partnership.

Question 2

When is a partnership formed?

Answer 2

Whether a partnership actually exists will be determined on the facts. There does not have to be any intention on the part of the parties to be, or form, a partnership. A partnership arises if, on the facts, the criteria in s 1(1) PA 1890 are met.

Section 2 PA 1890 contains a list of rules for determining the existence of a partnership. The purpose of s 2 is to provide more detailed guidance in determining if the criteria in s 1(1) PA 1890 have been met. For example:

• Evidence of profit sharing will be prima facie evidence of a partnership but not necessarily conclusive evidence (s 2(3) PA 1890). Case law provides that if there is an agreement to share losses as well as profits, this makes the existence of a partnership more likely.
• If all individuals take part in decision making, this also makes it more likely that a partnership will be held to exist.
• A loan of money by one party to another does not create a partnership. Case law has also held that if the person is not being ‘held out’ as a partner this makes the existence of a partnership less likely.

Question 3

Do partners have a fiduciary relationship?

Answer 3

There is an overriding duty of good faith in a partnership.

The duty owed by the partners to one another is similar to that owed by a trustee to a beneficiary. These equitable principles are reflected in the following sections of the PA 1890:

· Honest and full disclosure (s 28 PA 1890)

· Unauthorised personal profit (s 29(1) PA 1890)

· Conflict of duty and interest (s 30 PA 1890)

Personal liability for partnership debts

Because a partnership has no separate legal personality from the partners, the partners are personally liable in relation to contracts which are binding on the firm. The PA 1890 contains provisions relating to the nature and extent of such liabilities. In some circumstances, non-partners can also become personally liable.

Question 4

What kinds of liability do partners have towards each other?

Answer 4

Contractual liability

Every partner in a firm is liable jointly with the other partners for all the debts and obligations of the firm incurred whilst they are a partner (s 9 PA 1890).

Tortious liability

In tort the partners’ liability is joint and several (ss 10 and 12 PA 1890).

Note that if a creditor obtains judgment against one, or a number of the partners, this will not discharge the others (section 3 Civil Liability (Contribution) Act 1978) so technically liability is joint and several.

Question 5

Do non-partners have any potential liability?

Answer 5

Liability of non-partners: new partners (s 17 PA 1890)

Under s 17(1) a new partner will not automatically be liable in relation to any debts incurred by the partnership before they joined.

Under s 17(2) a partner will still be liable after they retire in respect of debts incurred by the partnership whilst they were a partner. In order to relieve a partner from an existing liability once they retire, a partnership may novate the relevant agreement; this must be with the consent of the creditor (s 17(3)).

Liability of non-partners: former partners (s 36 PA 1890)

It is also possible for a former partner to become liable for partnership debts incurred after they have left. If a partner leaves, a third party can treat all apparent partners of the firm (ie before the departure) as jointly liable to pay any new debt incurred by the partnership UNLESS that third party has been notified of this change either by:

• actual notice (s 36(1) PA 1890) - for those who have had actual dealings with the partner before departure; or
• constructive notice by virtue of publication of the departure in the London Gazette (s 36(2) PA 1890) -for those who have not had actual dealings with the partner before departure.

However, a former partner will not be liable for debts to any third party who did not know them to be a partner before they left. No notice at all has to be given to such persons.

Question 6

What is holding-out?

Answer 6

Liability of non-partners: ‘holding out’ (s 14 PA 1890)

Generally, a person who is not a partner has no personal liability for partnership debts.

However, s 14 PA 1890 sets out circumstances where a non-partner may be personally liable on a partnership debt if they have held themselves out as a partner (or have knowingly allowed themselves to be so held out).

The elements required for s 14 PA 1890 to have effect are:

(i) a representation to a third party to the effect that a person is a partner,

(ii) the third party’s action in response (‘giving credit to the firm’, eg by supplying goods or services to the firm), and

(iii) the third party’s state of mind (‘believing (having faith in) the representation’).

It is important to appreciate that s 14 PA 1890 relates to the liability incurred by the NON-PARTNER, not the liability of the firm. The liability of the firm for the acts of a non-partner is established by applying the common law principles of agency.

The relationship between the firm and outsiders: contracts binding the firm

In practice, you may need to decide whether or not the partnership is bound by a contract which an individual has purported to make on its behalf.

In a partnership context, your approach to answering the question of whether or not a firm is bound by a particular contract will differ depending on whether the individual acting on the firm’s behalf is a partner or not.

Question 7

Who is an agent in a partnership?

Answer 7

Partners

Section 5 PA 1890 introduces a special statutory rule of agency which applies only when the agent in question is a partner in the firm.

The common law of agency may also apply where s 5 is not relevant.

Non-partners

The common law of agency will apply.

Section 5 PA 1890 does NOT apply.

Question 8

1. Partners content with agent’s act (whether partner or non-partner)

Answer 8

In many cases, an individual acting as a firm’s agent (whether a partner or not) will simply have put into effect the wishes of the partnership as a whole.

If all the partners are happy for the firm to enter into the contract and have given actual, express or implied authority to bind the firm, then the firm will be bound.

In any event, if the partners are happy to be bound, the situation is not problematic even if the agent had no authority at the time the contract was made.

The partners are able to ratify (ie approve) the agent’s act and adopt the contract, either expressly or simply by going ahead and performing it.

Question 9

2. Partners not content with agent’s act

Answer 9

The situation is more complex where the other partners are not content with the agent’s act.

(a) Power of a partner to bind the firm against the others’ wishes: s 5 PA 1890

Section 5 PA 1890 provides for the firm to be bound in certain circumstances, even where the other partners are not happy to be bound by the contract made by the agent. Since s 5 PA 1890 is intended to protect the third party to the contract, it is that third party’s view of what is happening that counts.

Section 5 PA 1890 is always the first place to look when deciding whether or not an act of a partner binds a firm but does not displace the application of ordinary common law agency entirely. In some circumstances, s 5 PA 1890 alone will not get you to the end of the story. If a partner has purported to form a very unusual kind of contract on behalf of the firm, a s 5 PA 1890 analysis may lead you to conclude that the firm is not bound under statute. However, the particular facts and circumstances of the case may mean that this partner did have their partners’ apparent authority at common law to conclude the contract.

Following s 5 PA 1890 a partner’s unauthorised act will bind the firm if, viewed objectively:

• the act is for carrying on businessof the kind carried on by the firm (ask, for example, ‘is this the kind of contract that one would expect to be entered into in the course of business of this kind?’); and
• the act is for carrying on such a business in the usual way (ask, for example, ‘is this the kind of contract that a partner acting alone would usually make on the firm’s behalf or is it a contract of the kind an outsider would expect all partners in a firm to sign individually?’).

The firm will not be bound, however, if:

• the third party actually knew that the partner in question was not authorised to enter into the contract on behalf of the firm; or
• the third party did not know or believe that the partner was a partner.

A partner who binds their firm without actual authority may be liable to the other partners for breach of contract.

(b) Power of a non-partner to bind the firm against the partners’ wishes: apparent authority at common law

Section 5 PA 1890 does not apply at all if the person entering the contract is not in fact a partner. In that case, the common law rules of agency establish whether or not the firm is bound as principal.

At common law, an agent who has no actual authority may still bind the firm if he has apparent authority to enter into a contract. Apparent (sometimes called ‘ostensible’) authority arises when the principal (here the firm) represents or permits a representation to be made to a third party that a person has authority to bind the firm. For example, if a firm employs somebody under the title ‘marketing manager’ that title confers on that person apparent authority to bind the firm on marketing decisions. Once the principal’s representation has been made to, and relied upon by, the third party, the principal is bound by the actions of that person.

If the representation is that a particular person is a partner (when, in fact, they are not), then the firm is said to be ‘holding out’ that person as a partner. A person who has been held out as a partner has apparent authority to bind the firm in the same way as a real partner can. An example of holding out is in relation to an ex-partner, when the firm carries on using old letterhead (including that partner’s name) after they retire.

Question 10

How are partnerships taxed?

Answer 10

Each partner is liable to tax as an individual on their share of the income or gains of the partnership. This is described as tax transparency.

Even though a partnership is not a distinct legal entity and therefore does not itself pay tax, HMRC requires a partnership to make a single tax return of its profits which must be agreed with HMRC (as with sole traders, partnerships choose their own accounting period).

Partners also submit their own individual tax returns containing all income received from the partnership as well as other income receipts (including, for example, from savings, dividend and/or rental income).

Partners in a partnership are liable to pay both income tax and capital gains tax. The details are set out on the next slide.

Taxation of Partnerships

Income tax:

Each partner is personally liable for the income tax on their share of the partnership profits.

Unlike with other partnership liabilities where each partner is jointly and severally liable, a partner is not liable for the tax on other partners’ shares of partnership profits.

Capital gains tax:

Normal capital gains tax principles apply on disposal of a capital asset by a partnership.

Each partner is treated as owning a fractional share of the asset. On disposal by the partnership, each partner is treated as making a disposal of their share and will be taxed on this share of any gain, subject to the availability of any reliefs available to individuals. A partner’s fractional share shall be based upon the agreed profit sharing ratio (PSR) or, if there is no agreed PSR, then equally in accordance with s 24(1) PA 1890.

Question 11

What is the PA 1890?

Answer 11

PA 1890 provides the framework for regulating traditional partnerships, but the statutory provisions are really ‘fall-back’ provisions in the absence of a partnership agreement, or where the agreement is silent on any matter. Other than ss 1 and 2 which regulate when a partnership comes into existence and ss 5 – 18 which determine the relationship between partners and third parties as well as liability for partnership debts, which you considered in the previous element, most of the sections of PA 1890 may be overridden by agreement.

The partners’ mutual rights and obligations (under an agreement or under PA 1890) can be varied at any time by their unanimous consent (s 19 PA 1890), and this can be express or inferred from a course of dealing.

The PA 1890 contains a default code which applies to relations between the partners themselves in the absence of any contrary agreement; whether written or oral, express or implied. Most traditional partnerships will have a formal written partnership agreement, which will set out the terms on which the partners have agreed to run the business. In this element we consider the clauses that should be considered for inclusion in such a partnership agreement, with reference to the fallback provisions of PA 1890 in each case.

Question 12

What is included in a partnership agreement?

Answer 12

Most partnerships will have some form of express written partnership agreement governing the way in which the partnership will be run. As a minimum, this will normally include provisions concerning the matters set out below:

• Commencement and duration
• Partnership name and place of business
• Partnership property
• Capital, profits and losses
• Drawings / Salary
• Accounts
• Dissolution of the partnership
• Duties, powers and restrictions on partners:
• Work input and roles; any limits on the authority of partners
• Partnership decision making
• Incoming partners
• Retirement/expulsion of existing partners
• Non compete / other restrictions

Question 13

What is in the Commencement and duration clause?

Answer 13

Although a partnership will commence when s 1(1) PA 1890 is satisfied, it is useful for the agreement to set out a date on which the partners agree that the particular rights and obligations contained in the agreement will commence. If the partners begin working together prior to the commencement date then the default provisions of PA 1890 will apply until the commencement date of the agreement.

The agreement may have a fixed term or may continue until terminated in accordance with its provisions.

If the agreement has a fixed term but the partners continue in business after the expiration of that term without entering into a new agreement, they are presumed to be partners on the same terms as before (s 27 PA 1890).

Question 14

Partnership name and place of business

Answer 14

The partnership name must not include ‘limited’, ‘ltd’, ‘LLP’, ‘public limited company’ pr ‘plc’, be offensive, be the same as an existing trademark, contain a sensitive word or expression or suggest a connection with government without permission. The place of business should also be set out as well as the nature of the business.

Question 15

Partnership property

Answer 15

As a partnership does not have a separate legal personality, each partner is deemed to own a share in the property belonging to the partnership. An individual partner does not have a right to any particular partnership asset.

The default provisions of PA 1890 are set out below.

Whether or not a particular asset is partnership property is a question of fact, depending on the intentions of the partners at the time they acquire it. This subjective element can be difficult to prove, so it is sensible for partners to agree which assets are partnership property to minimise the potential for dispute later.

Partnership property (ss 20 – 21 PA 1890)

Section 20 PA 1890 provides that all property brought into the partnership whether by purchase or otherwise, on account of the firm or for the purposes and in the course of the partnership business, is partnership property.

Section 21 PA 1890 provides that all property bought with money belonging to the firm/partnership is deemed to have been bought on account of the firm/partnership, unless the contrary intention is shown.

Question 16

Shares in income and capital and profits and losses

Answer 16

The default provisions of PA 1890 provide, subject to any express or implied agreement between the partners, that all partners are entitled to share equally in the capital and profits of the business, and to contribute equally towards the losses of the business. This is the case even where the parties have contributed to the capital unequally although if the partners have contributed capital unequally there might be an implied agreement that they are entitled to withdraw their capital unequally.

This will not affect the capital profits being shared equally unless there is a specific agreement to that effect.

Often, the default provisions will not accord with the partners’ wishes therefore it is extremely important that there is an express provision in the agreement setting out a profit sharing ratio (‘PSR’).

Question 17

What monetary benefits can partners receive under PA?

Answer 17

Capital and profits (s 24(1) PA 1890)

Partners are entitled to share equally in the capital and profits of the business, and to contribute equally towards the losses of the business.

Drawings / Salary

Partners own the business and may take ‘drawings’ of income profits. The partnership agreement should set out how much each partner may draw in any given period. In the absence of agreement, s 24(1) provides that all partners are entitled to share equally in income profits.

In some partnerships, the partners may intend that each receives a salary in addition to an income profit share. This must be expressly set out in the agreement as the default position is that there is no entitlement to salary.

Remuneration (s 24(6) PA 1890)

Without an agreement a partner is not entitled to a salary.

Question 18

Work input and roles; limits on authority

Answer 18

Under PA 1890, every partner may take part in the management of the partnership business (s 24(5)) but are not required to do so. The partnership agreement should therefore set out the requirements for each partner in terms of the work they do for the business. Commonly, the agreement will state that all partners must devote the whole of their time and attention to the business.

The roles of partners and any limits on their authority should also be clearly defined.

Management (s 24 PA 1890)

Every partner may take part in the management of the partnership business.

Decision making

The agreement should deal expressly with decision making and management.

All partnership decisions must be decided by a majority, other than the following which require unanimity:

• Changes to the nature of the partnership business (s 24(8));
• Introducing a new partner (s 24(7));
• Varying the rights and duties of partners (s 19).

Decision making (s 24 PA 1890)

Decisions arising during the ordinary course of the business are decided by a majority, except for any change to the nature of the partnership business.

Question 19

Incoming partners

Answer 19

Under s 24(7) PA 1890, the unanimous consent of all partners is required for a new partner to join the partnership.

Whilst this may be what the partners themselves want, it is still advisable to include an express clause requiring written consent of all partners for a new partner to join the partnership, to avoid any doubt as to whether consent was in fact given.

New partners (s 24 PA 1890)

No person may be introduced as a partner without the consent of all existing partners.

Question 20

Outgoing Partners

Answer 20

Expulsion

Under PA 1890, a partner cannot be expelled by majority vote unless all of the partners have previously expressly agreed that a majority can do this. This effectively means that in the absence of prior agreement, it is impossible to expel a partner, unless they agree to their own expulsion (highly unlikely).

The partners should therefore agree expulsion provisions in advance, otherwise it will be impossible to remove a partner without dissolving the partnership.

Expulsion (s 25 PA 1890)

A partner cannot be expelled by majority vote unless all of the partners have previously expressly agreed that a majority can do this.

Partner leaving

If there is no partnership agreement or if the agreement is silent on retirement or termination, the effect of a partner leaving is that the partnership is dissolved (s 26 PA 1890).

This is because ‘partnership’ is a collective noun meaning ‘all the partners’, so the continuity of a partnership is broken when there is a change in the identity of the individuals who constitute it.

In most cases this is a ‘technical dissolution’. This means that a new partnership is formed by the remaining partners who continue the business.

However, it is open to any of the partners to apply to court to have the old partnership wound up (ie sale of the assets for the repayment of the partnership debts and for the distribution of the assets or liabilities amongst the partners).

To prevent dissolution when a partner retires, the partnership agreement should state explicitly that the partnership will continue as between the remaining partners and should contain details of how a partner can leave (which may include a provision in the event of death) or be expelled without the partnership being wound up. This would usually include a mechanism for the remaining partners to buy out a departing partner’s share and for calculation of the value of such share.

Automatic dissolution (s 26 PA 1890)

Where no fixed term has been agreed for the duration of the partnership, the partnership will be dissolved by any partner leaving.

Non-compete clauses

It is common for a partnership agreement to contain an express clause preventing current partners from competing with the firm. This is implied by default under s 30 which states that if a partner, without the consent of the other partners, carries on any business of the same nature as and competing with that of the firm, they must account to the firm for all profits made by them in that business.

Duty not to compete with the firm (s 30 PA 1890)

Restrictions on outgoing partners

The partners may wish to also put limitations on the powers of outgoing partners to compete with the partnership after leaving. There are no such default clauses in PA 1890.

Restrictions on outgoing partners can be provided for in the partnership agreement by using any of the following:

• Non-compete clauses: prevent former partners competing with the business;
• Non-solicit clauses: prevent former partners from soliciting business from the partnership’s clients;
• Non-dealing clauses: prevent former partners from entering into contracts with clients, former clients or employees of the partnership.

These types of clauses are known as restraint of trade clauses and will only be enforceable if they are reasonable in terms of duration, geographical area and scope and are necessary for the protection of a legitimate business interest of the partnership.

Question 21

Dissolution of Partnership

Answer 21

A partnership can be dissolved (terminated) in a number of ways under PA 1890:

• automatic dissolution (subject to contrary agreement) under:
• expiry of fixed term (s 32(a))
• completion of specific venture (s 32(b))
• death or bankruptcy of any partner (s 33)
• dissolution of partnership by notice from any partner (ss 26 and 32(c)). This applies where the partnership has no fixed duration;
• dissolution of partnership if the partnership business becomes unlawful (s 34);
• dissolution by the court as a last resort (s 35).

If an event occurs which causes a partnership to be dissolved, the partnership relationship ceases, and any partner may demand that the assets of the business are realised. Since automatic dissolution is undesirable, it is important to ensure that the partnership agreement deals with when a partnership may be dissolved and the effect of this, as detailed above in the discussion on partners leaving.

Collecting in and distributing assets on the dissolution of a partnership

Subject to any written partnership agreement, where a partnership is wound up, once all debts and liabilities have been paid, any money/assets left will be distributed so that each partner is paid back their original capital first (s 44(b)(3) PA 1890).

It is common for a partnership agreement to have a provision dealing with the proportion in which any surplus assets are to be shared out following dissolution. This is called the asset surplus ratio or ‘ASR’.

If there is no agreed ASR then s 44(b)(4) PA 1890 applies, and surplus assets are shared in accordance with the agreed profit share ratio (PSR).

If there is no PSR then the surplus assets are shared equally in accordance with s 24(1) PA 1890.

Question 22

What is an LLP?

Answer 22

An LLP is a hybrid vehicle. This means it has elements of both a company (legally it is a body corporate and is treated as a separate legal entity from its members: s 1(2) Limited Liability Partnerships Act 2000 (‘LLPA’)) and a partnership (it is treated as tax transparent).

Consequently, an LLP has the flexibility of a partnership with the added advantage of limited liability for its members. Because an LLP is a body corporate, it has a legal personality which is separate to that of its members. As a result, it is liable for its own debts, and is able to contract with third parties.

The LLPA was enacted for several reasons, chief of which was the perception amongst professional partnerships that as a result of the growth in litigation, the current partnership model, whilst having many commercially useful features, did not provide the kind of protection that was available to limited liability corporations (this is because partners in traditional partnerships have unlimited liability for the debts of the partnership).

LLPs are increasingly important, and many law firms are now run as LLPs.

Question 23

Commercial Uses for LLPs

Answer 23

Apart from being commonly used for professional partnerships, such as solicitors, surveyors or accountants, the LLP is also a flexible business vehicle for joint ventures, certain investment schemes and some venture capital investments.

LLPs are particularly useful for investment structures (despite certain tax avoidance measures being applicable to LLPs which may impinge on private investors who are members of an LLP).

This is because, as stated, LLPs are tax transparent, so they allow a high level of participation in management by the members whilst giving the members the benefit of limited liability.

LLPs are also increasingly being used by property developers involved in one-off joint venture development projects.

Question 24

Formation of an LLP

Answer 24

Section 2(1)(a) LLPA states that two or more persons associated for carrying on a lawful business with a view to profit can incorporate an LLP. A ‘person’ in this context can be a company as well as an individual. The use of the word ‘business’ requires that there must be some commercial activity, so LLPs are not normally used by non-profit organisations as business vehicles.

Registration at Companies House

The subscribing members fill out a Form LL IN01, which is sent to Companies House with the relevant fee. The form must state, inter alia, the name of the LLP, its registered office’s address and which members, if not all of them, are to be designated members (s 2(2) LLPA).

Certificate of Incorporation

Once registered, the Registrar of Companies issues a certificate of incorporation as conclusive evidence that all legal requirements have been complied with. The name of the LLP will be entered on the index of company names and given a number.

Question 25

Continuing Registration Regime

Answer 25

Once registered, LLPs are obliged to continue to file information with Companies House as follows:

• change of name,
• change of registered office,
• changes in membership,
• creation of a charge,
• annual confirmation statement, and
• accounts(under the Limited Liability Partnerships (Accounts and Audit) (Application of Companies Act 2006) Regulations 2008).

In addition to its obligations to file information at Companies House, an LLP must maintain certain in-house records, including registers of its members and of its ‘people with significant control’ (‘PSCs’ who are, broadly speaking, those with a more than 25% interest in the LLP or have significant influence or control over the LLP).

Question 26

Members of LLP

Answer 26

The members of an LLP are those who subscribed to the incorporation document and those who became members at a later date by agreement with the existing members. Section 4(2) LLPA states that persons, not just individuals, can be members of an LLP – therefore corporate bodies may be members of an LLP.

An LLP must have at least two formally appointed members at all times. There is no limit on the maximum number of members an LLP can have.

At least two members of the LLP must be ‘designated members’. Their obligations include, amongst other things, signing the accounts on behalf of the members, making filings at Companies House and acting on behalf of the LLP if it is wound up.

Section 4(3) LLPA states that a member will cease to be a member of the LLP upon:

• their death;
• agreement with the other members of the LLP;
• giving notice to the other members of the LLP; or
• dissolution (if the member is a body corporate).

Question 27

The LLP Agreement

Answer 27

An LLP has no Memorandum or Articles of Association. The LLPA and the 2001 Regulations do not lay down any particular management structure to be adopted, in contrast to companies. LLPs therefore have complete flexibility in terms of management. Therefore, it is necessary in practice to have an LLP or Members’ Agreement stating how these issues are to be dealt with by the LLP and its members, in a very similar way to how a partnership agreement is designed to operate.

The LLP Agreement is a private document which sets out the formal procedures and arrangements which the members have agreed to be the basis of the operation of their business.

Note that members of an LLP are not obliged to have a formal Members’ Agreement to regulate their relationship.

In the absence of any such agreement, the 2001 Regulations contain eleven default provisions in regulations 7 and 8. Note that any other gaps will not be filled by partnership law under PA 1890, since PA 1890 is disapplied with respect to LLPs by s 1(5) LLPA.

Question 28

The eleven default provisions in the absence of an agreement to the contrary are as follows:

Answer 28

• Members share equally in capital and profits(Reg 7(1));
• An LLP must indemnify its members for payments made and personal liabilities incurred by them in the ordinary and proper conduct of the business of the LLP (Reg 7(2));
• Every member may take part in management (Reg 7(3));
• No member is entitled to remuneration for managing the LLP (Reg 7(4));
• No person can become a member or assign their membership without the consent of all existing members (Reg 7(5));
• Ordinary decision making may be by the majority of the members. Any proposed change to the nature of the business requires the consent of all the members (Reg 7(6));
• The books and records of the LLP must be available for inspection by the members at the registered office (Reg 7(7));
• Each member must give true accounts and full information of all things affecting the LLP to any member or his legal representative (Reg 7(8));
• If a member (without consent) carries on any business of the same nature as, and competing with, the LLP then they must account for and pay over to the LLP all profits made by them in the business (Reg 7(9));
• Every member has a duty to account for benefits derived from transactions with the LLP and its business or property (Reg 7(10));
• There is no implied power of expulsion of a member by the majority unless the members have expressly provided for such a power in a Members’ Agreement (Reg 8).

Question 29

Taxation of LLPs

Answer 29

One important difference between an LLP and a company is that, for tax purposes, the LLP is treated as a partnership.

If two individuals set up an LLP, each will be taxed as an individual, ie liable to income tax or capital gains tax on their share of the income or gains of the LLP. In other words, an LLP is ‘transparent’ for tax purposes – the LLP is not taxed, but the partners are.

By contrast, a company, established by the same two individuals, would pay corporation tax on its own income profit and chargeable gains. If the individual owners then receive dividends out of the company’s profits (after corporation tax has been paid by the company), they may be liable to pay income tax on their dividend income. This could be significant, for example, because different rates and reliefs might apply to the different regimes.

A trade, profession or business carried on by an LLP with a view to profit will be treated as being carried on in partnership by the members (not the LLP itself). Many of the same reliefs available to partners also may be available to LLP members, such as relief on interest, or set off of losses against other income.

Assets held by the LLP will be treated as being held by the members as partners for capital gains tax purposes. Accordingly, a disposal of an LLP asset, such as land, will be regarded by HMRC as a disposal by the members of the LLP while it is trading.

The LLPA gives relief from stamp duty where a partnership is incorporated as an LLP and assets of the partnership business are transferred to the LLP, subject to strict tax avoidance conditions. In some circumstances, stamp duty and/or SDLT is payable on the transfer of an interest in an LLP at the relevant rate.

As regards VAT, the LLP itself may register for VAT, not the members.

Question 30

Corporate Characteristics LLPs

Answer 30

• Separate legal personality;
• Limited liability for members, subject to the restrictions mentioned;
• LLPs have to file accounts at Companies House on much the same basis as companies, leading to a loss of financial privacy (which is one of the main attractions of using a partnership structure);
• LLPs, like companies, are capable of creating a floating charge over the assets of the LLP, unlike a partnership; and
• Some provisions of company law (in particular the CA 2006) and corporate insolvency law (as contained in the Insolvency Act 1986 and the Company Directors Disqualification Act 1986) apply to LLPs in modified form.

Question 31

Partnership Characteristics LLPs

Answer 31

• LLPs have no share capital or capital maintenance requirements;
• No real distinction between members and the management board (unlike a company, in which the members/shareholders and board of directors have very distinct roles);
• Members can agree amongst themselves how to share profits, management duties, how decisions are to be made, how new members are to be appointed and what retirement provisions shall apply;
• The Members’ Agreement (if there is one) is like a private partnership agreement;
• LLPs are tax transparent in the same way as a partnership;
• The corporate insolvency regime also applies to LLPs but there is an important disadvantage for members of an LLP compared to those of a company. LLPs are subject to the ‘clawback’ rule, which means that in certain circumstances money taken out of the LLP by members up to two years before commencement of a winding up of the LLP can be clawed back into the pool of assets available to repay LLP’s creditors (s 214A IA).