When two or more individuals (or two corporate bodies or companies) decide to join hands to pursue their shared or collective goals, such as co-founding profit-making ventures, while simultaneously benefitting from limited liability, a Limited Liability Partnership (LLP) comes into existence.
An LLP is a business structure that offers its members liability protection and operational autonomy.
If you are keen on reading an in-depth analysis of an LLP, read: What is a Limited Liability Partnership (LLP)?
Nonetheless, despite all the associated advantages, an LLP, like other business setups, is not immune from taxation.
Thus, this post illustrates the key tax responsibilities of LLP members to help them understand all the tax obligations that arise by virtue of their membership in an LLP.
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What are the tax responsibilities of LLP members?
The following are the tax responsibilities of LLP members that are crucial to understand in order to ensure tax compliance with HMRC.
Ensuring tax transparency:
As stated above, similar to any other business arrangement in the UK, an LLP must also ensure that it is tax-transparent.
To specify, whenever an LLP conducts a business, such as trade, with the prime purpose of earning profits, its gains are often taxed in the name of its members instead of the LLP itself.
Continuing further, taxation of the members occurs whenever the LLP earns profits, irrespective of whether the gains have been shared or distributed to the members. Doing so also falls under the ambit of tax transparency.
Registering for VAT:
If we consider an LLP as an entity, it is not liable to pay taxes. For instance, after incorporating your LLP company, you are not obligated to pay Corporation Tax or even file company tax returns on behalf of your LLP.
By contrast, if the LLP’s annual turnover or revenue, which is taxable, surpasses the figure of £90,000, you must register for VAT with HMRC. It may be pertinent to mention that £90,000 is the threshold for VAT registration effective from 1 April 2024.
Besides, while the LLP collects and pays VAT, individual members personally involved in the LLP’s VAT operations must ensure that VAT is properly reported on their self-assessment returns.
Tax responsibilities of LLP members:
Interestingly, an LLP is an combination of normal partnerships and limited companies. While the LLP emperors its members to work under the same roof to achieve collective objectives, it protects their personal assets if any debts or losses are incurred, as happens in a limited company structure. Moreover, unlike normal partnerships, LLPs do not pay the Corporation Tax.
Furthermore, the LLP itself does not pay any tax on its gains or profits. Rather, its members or co-founders are liable for tax. Each member is taxed individually based on the value of gains/profits they receive. Typically, the tax responsibilities of LLP members are similar to those of the rules applicable to the partners in traditional partnerships.
To achieve this, each partner in the LLP must register with HMRC so that they can pay their Income Tax through Self Assessment.
In addition, each member shall file a tax return annually and pay National Insurance contributions (NIC) alongside Income Tax on their income.
Income tax on LLP members:
All LLP members are individually taxed on the value of the profits yielded as a result of the partnership, regardless of whether the profits have been divided among the members. Thus, LLP members are required to report their share of the LLP’s profits on their self-assessment tax returns.
More specifically, the total amount of tax payable depends on which income tax band the individual member’s income falls in.
For greater clarity, the income tax rates in the UK for the 2024/25 tax year are as follows:
Basic income tax rate: 20% on income up to £50,270
Higher-income tax rate: 40% on income between £50,271 and £125,140
Additional income rate: 45% on income above £125,140
Therefore, for an LLP member falling under the category of a higher or additional rate taxpayer, the income tax rate would be 40% or 45% based on the LLP profits.
Capital Gains Tax (CGT) responsibilities on LLP members:
Capital Gains Tax (CGT) responsibility on Limited Liability Partnership (LLP) members occurs when an individual member sells or disposes of their share of the LLP or when the LLP itself dissolves. Further, the capital gains are determined by calculating the difference between the selling price of the interest and the purchasing/acquisition cost.
Besides, it is advisable to check the latest capital gains tax rates updated by the UK government for the ongoing year.
More importantly, the CGT procedure may differ based on whether the member is an individual or a corporate entity. Likewise, reliefs or exemptions may apply, such as Business Asset Disposal Relief for individual members.
Business Asset Disposal Relief, which was formerly known as Entrepreneurs’ Relief) makes the LLP members eligible to claim the reduction in their capital gains tax rate under certain conditions. To elaborate, Entrepreneurs’ Relief reduces the CGT rate to just 10% on the first £1 million of profits generated from the sale of qualified business assets.
Taxation of LLP’s directors:
The taxation of the LLP’s directors is another major component of the tax responsibilities of LLP members. It is distinct from the taxation of company directors, who normally receive their salaries through the Pay As You Earn (PAYE) system.
On the contrary, LLP directors do not have their income directly taxed at source. Rather, they must register for Self Assessment if they receive dividends from the earned profits or any other tax-free income.
Hence, apart from any LLP salary LLP, directors must prepare and submit their own tax returns. It will ensure they accurately report their income and pay any taxes owed on the profits.
Maintaining accurate financial records:
Another significant aspect of the tax responsibilities of LLP members is to keep accurate accounting records. The LLP members should substantially have to maintain the financial record of all the profit-making activities, like business or trade, that they conduct.
As a result, they will use these records in order to prepare and submit their Self Assessment tax returns. Ultimately, accurate record-keeping and comprehending the tax implications are significant for LLP members to optimise compliance and mitigate tax liabilities.
Considering tax implications for foreign LLP members:
Considering the tax consequences for the LLP members residing out of the country where the LLP has been established is also one of the major tax responsibilities of LLP members. For example, additional tax implications are likely to emerge if the LLP has foreign partners. In that case, the UK tax residency rules must be considered.
Even though the members are non-residents, they may still be responsible for paying taxes. However, only their UK-sourced income would be taxed, and not the income earned outside the UK.
Similarly, they can avert paying double taxation since the UK has agreements with several states to prevent double taxation. As an outcome, these double taxation treaties can impact the taxation of foreign LLP members.
Summary:
All in all, Limited Liability Partnerships (LLPs) have become an increasingly favourable option for entrepreneurs in the UK who want to collaborate for a lucrative or profitable venture. Nevertheless, despite offering flexibility and limited liability, LLPs are not exempt from tax obligations like any other business structure.
In all likelihood, if you plan to set up an LLP and reap its benefits, you should essentially comprehend the tax responsibilities of LLP members. As an alternative, you can book a consultation with a seasoned accountant at Accountingfirms who will guide you through effective tax planning.
Disclaimer: The information provided on AccountingFirms.co.uk is for informational purposes only and should not be considered as financial advice. Always consult with a professional accountant to ensure compliance with UK laws and regulations.