The right structure for a law firm.

Article | James Burrett | 6th March 2019

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The detailed review of the Limited Liability Partnership (LLP) structure by the government and the courts has led some to comment that the LLP structure is in terminal decline, however our experience is quite to the contrary. A more mixed picture is emerging with the company structure now sitting alongside the general partnership and the LLP as a viable structuring option.

There will never be a single right vehicle for all law firms, each has pros and cons and the priorities of each business and its owners vary enormously, however every firm should regularly review its operating structure considering the following point:

Tax
  • Unlike companies partnerships are tax transparent with trading profits all taxed in the hands of the partners. This is the same for traditional partnerships and LLP’s. Profits in a limited company are subject to corporation tax in the company and then income tax when paid out as dividends.
  • The tax rates mean if all profit is extracted from the company, by way of a dividend, the shareholder’s marginal tax rate should be lower than if it was distributed by a partnership.
    Conversely if all profit is extracted from a company as a salary as opposed to using the dividend route, the marginal tax cost will be higher than if it was distributed by a partnership, plus the tax will have to be paid sooner.
  • Partnership rules allow drawings whether profit has been realised or not. To achieve this certainty of income in a company structure, a combination of salary and dividends may be required which would diminish any tax benefits.
  • Retention of profits within the firm to build up reserves is expensive in a partnership model, as all profits are taxed whether they are distributed or not. A company structure allows profits to be retained net of Corporation Tax at 19% (decreasing to 17% from April 2020).
  • The tax position on chargeable gains is not straightforward. However LLPs and Partnerships do have one material advantage over companies in this respect. To qualify for entrepreneur’s relief on exit company shareholders have to hold at least 5% of the share capital, however no such threshold applies for partnerships.
Finance
  • An LLP has a separate legal personality and can give security in much the same way as a company. A general partnership does not have a separate personality, so lending to the partnership is effectively lending to the individual partners.
  • External investment is more complicated in Partnerships (general and LLPs), as external investors expect protection for their ownership stake, management influence and detailed information rights but with have half an eye on the exit strategy.
Governance
  • Partnerships are subject to minimal constraints however companies and LLPs have to operate within the constraints of the Companies Act 2006. Profit sharing arrangements, such as lockstep or allocation by reference to fee income is easily achievable in a partnership (general and LLP) but less easily done in a company. Potentially his could be achieved with multiple classes of share but increases the complexity and may be subject to HMRC scrutiny.
  • Partnership vehicles are free to choose how to admit and terminate partners however a ‘partner’ terminated by a limited company may need to terminated in three capacities (shareholder, director and employee).
  • The other point relates to transparency, LLP’s members are listed at Companies House, as are its accounts. In addition for a company the articles of association are on public record. For a general partnership everything is kept private.
  • As a result from a governance perspective partnership vehicles have considerable advantages over companies and for small firms these can be a decisive factor.

 

Strategic Objectives
  • A firm’s strategy may influence the structure, in particular if the strategy is one of growth; this will require funding (see above regarding financing).
  • Regarding succession the partnership and LLP structure can allow junior members to be created, which if structured correctly can create a tax advantage whereas creating equivalent position in a limited company is far more difficult.
Conclusion

It seems likely that general partnerships will become increasingly rare in particular for larger firms, however the choice between LLPs and companies is becoming more finely balanced. We do not expect any one structure to become dominant but it is clear that the partnership vehicle will remain relevant for a number of years to come.

About the author

James Burrett

James joined PEM in 2005, as a trainee, having completed a Geology degree at Durham University. He was appointed Partner Read more …

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