LLP to Limited Company – advice on conversion
The conversion of a partnership into an LLP is a relatively easy concept to envisage and is one that was adopted by many partnerships after the introduction of the Limited Liability Partnership Act 2000. In principle, the assets owned by the partners, which are reflected in the partners’ capital accounts, were transferred to the LLP and the partners became members of the LLP. However, the legal agreement covering the transfer of the business can be complex.
An LLP is a corporate entity
An LLP is a corporate entity and has its own legal identity. Despite being described as a form of partnership, the assets are owned by the LLP; they are not owned directly by the members. However, it is the members who are taxed on the LLPs income and gains, not the LLP itself.
Why convert an LLP to a Limited Company?
A significant number of LLPs have been formed to take advantage of the tax rules that apply to self-employed individuals, whilst operating with the benefit of limited liability. However, changes to the tax rules may have resulted in an increase in costs for many LLPs and many will wish to consider transferring the LLP's business into a limited liability company.
Some of the considerations to be made prior to conversion
Should the members of an LLP wish to convert the LLP into a company, the members must agree to transfer the LLPs assets to the company. There will again be a myriad of legal and tax aspects to consider. One recent change is that on a sale of goodwill on incorporation, the capital gain is charged at full rates with no entitlement to Entrepreneurs Relief.
Aside from dealing with the customer, supplier and employment contracts, finance agreements and leases etc, the company will need to put in place new funding arrangements. LLPs that converted from a partnership will be familiar with the extensive agreements required when transferring the partnership’s business to an LLP. Similar agreements covering the transfer of the business of the LLP into a company will need to deal with all of the LLPs assets, although some assets may be left with the LLP.
An LLPs liabilities cannot normally be transferred without the agreement of each of the creditors concerned and the settlement of the LLPs liabilities will need to be considered carefully. It is likely that the LLPs liabilities will have to be settled by way of arrangements with individual creditors, and/or from borrowings or profits generated by the company. Budgets and cash flow forecasts covering the months immediately preceding and following the business transfer will be paramount.
A particular problem facing members of an LLP, when considering the transfer of the business assets to a company, is that the members themselves may have liabilities to the LLP if their drawings have exceeded profits. Due to the penal tax consequences of transferring a member’s debt to the company, it may be that members will want their debt to remain with the LLP. However, this can result in additional tax being payable if the LLP does not carry on a business with a view to making a profit after the transfer.
Disposal of the LLP's goodwill
In planning the transition, there may be an opportunity to deal effectively with amounts owed by members to the LLP if the value of the business transferred includes goodwill. The disposal of the LLPs goodwill to a company will represent a capital disposal for tax purposes which would be assessed on individual members of the LLP. This could result in a significant reduction or elimination of the amounts owed by members to the LLP.
What if there are financial problems after the LLP is converted to a Limited Company?
If an LLP can manage all of the above, there should be no reason preventing it from transferring its business to a limited liability company. However, if the company subsequently fails the transfer of the business and the steps taken before and after the transfer will be considered carefully by a liquidator or administrator.
Should an LLP find the cost and cash flow consequences of transferring its business into a company an obstacle, the members could consider restructuring the LLP by way of a Company Voluntary Arrangement (“CVA”) or an Administration as part of the process of transferring the LLP's business to a company. Beware though, that when an LLP is placed into liquidation its tax status changes to that of a company and the corporation tax rules will apply. This would have significant potential tax cost consequences for members who have liabilities to the LLP after the business has been transferred.
Summary - seek professional advice
A proposal to transfer a business from an LLP into a limited liability company requires careful planning and professional advice covering legal, tax and potential insolvency issues.
The commercial justification for considering this option is being driven by the changes in the tax legislation which are giving rise to an increase in costs for LLPs. Many LLPs will be contemplating the change.
If the extent of the LLP's liabilities is driving the members towards an insolvency process, members should consider carefully the extent of their own liability to the LLP, which may give rise to additional tax costs. If required, these costs may be mitigated by way of a CVA or Administration, leading to compromise arrangements with the LLP's creditors. Either may also assist with the financing of the company’s working capital.
Every LLP will be different in its constitution and how it manages its business. Careful consideration of all the legal, tax and insolvency aspects will be essential, as well as the cash flow forecasts, costs and commercial impact of trading from a new corporate entity.
If you would like advice, please do not hesitate to contact us.
Date: 29th June, 2015
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