Should your law firm company convert to an LLP?

The last Budget increased the Corporation Tax rates for those law firms that are set up as Companies.  It also reduced the Dividend Allowance, which gave some income tax free to shareholders.  If your firm is a Company, it may therefore be costing you a lot of money and may be time to change to a Limited Liability Partnership, (LLP).

Background

Many firms converted to companies to take advantage of a wheeze, to capitalise the value of Goodwill in their partnership, and then extract that value tax-free, through withdrawal of the capital balances due to them.  Income paid out was, typically, almost all by way of dividends, except for a small salary, which was used to use up their Personal Allowance and ensure they continued to be entitled to State Benefits, especially the State Pension.  Most firms have now paid out all that capitalised Goodwill.

However, companies have been awkward to manage, with share valuations required whenever an owner left or joined, and banks often not being able to provide loan capital to those who wanted to buy shares in a firm.  They would, however, be prepared to lend to someone becoming a partner in a partnership or in an LLP!  Dividend payments required formal declarations and the administration is bureaucratic.

The amount of cash you can take home in 2023/24, compared to 2022/23 has fallen substantially, perhaps, in the worst case, (depending on the profits of the firm and other factors, such as whether there are other group companies), by about a tenth.  This is because of the increases in both Corporation Tax and Personal Tax.

For example, each £1,000 of income the firm earns, assuming the company is a sole trader and distributing most of its annual profit by dividend:

• In 2022/23 £536.63 went to the owner if they were paying Higher Rate tax but
• In 2023/24 £486.94 went to the owner paying Higher Rate tax.

That is a 9.25% reduction in take-home income for the owner of the law firm company.

It’s even worse if you fall into the Additional Rate, where the take-home pay could fall to £445.78.

Solution

It may now be time to revert to the partnership model.  That avoids the Corporation Tax charge and allows the owner to decide more flexibly whether to reduce their income to the Higher Rate and avoid the even more penal Additional Rate of personal tax.  This can be done through the allocation of profits and by taking advantage of the more flexible pension rules for the self-employed.

An LLP must have two members, but one could be a company owned or controlled by the other member.  It will need a new SRA registration as an authorised body and there is a multitude of detailed matters to deal with, such as PII, (which is not normally a problem), leases, contract novations, Practice Management Systems, (PMS), and Document Management Systems, (DMS), rebranding of buildings and web and social media presences and banking arrangements.  Some banks can simply rename the existing accounts and transfer them to the new LLP.  It would be preferable to do that to avoid confusion for the client and having to run two systems for a while.