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An LLP is a body corporate with limited
liability and legal personality. It is therefore legally a
type of limited company (albeit without a conventional
share capital) which can function like a partnership in
practice and which is deemed to be transparent for UK tax
purposes, with the members of the LLP being treated as if
they were partners in a partnership (which strictly they
are not).
The relationship of the members is normally governed by
an 'Operating Agreement' and there would seem to be no
reason at all why Member A should not be able to receive
all income profits (and bear all losses) and Member B to
be attributed with all capital profits (and losses).
Accordingly it should be possible to 'stream' an LLP's
income profits to a limited company member and its capital
profits to an individual member. This suggestion is
developed in the following notes. (The illustrations in
these notes disregard the impact of Stamp Duty Land Tax).
SCENARIO ONE
Mr X is UK-resident and UK-domiciled and intends to
purchase a commercial property for letting to an unquoted
trader. He is a higher rate taxpayer. Assume that Mr X
holds £300,000 in cash and intends to borrow £700,000 to
purchase a property for £1,000,000. The loan is at 7% per
annum repayable over 14 years. Mr X forms X Limited and
takes up all allotted shares. He lends £100,000 to X
Limited. X Limited and Mr X then together form a UK LLP.
The LLP
Capital £300,000 (say £100,000 from X Limited:
£200,000 from Mr X).
Income profits/losses: 100% to X Limited.
Capital profits/losses: 100% to Mr X.
The LLP borrows £700,000 and buys the property for
£1,000,000. It is let to a trading tenant at £100,000
per annum.
Cash flow
Annual rent £100,000
Interest (averaged out) £24,500
Incidental costs (est) £5,500
Net rental profit £70,000
CT at say 19% £13,300
Post tax profit £56,700
Capital repayment p.a. £50,000
Annual surplus £6,700
The LLP's accounts will reflect these figures. All the
net rental income will be attributable to X Limited and CT
will be paid thereon (hopefully at the 19% rate).
The Outcome
After 14 years the loan will be repaid. Assume the
property is sold forthwith for say £2,500,000. The
capital gain will be £1,500,000 (wholly attributable to
Mr X) on which CGT will be calculated after maximum
business taper - say tax £150,000.
As for X Limited, its assets will consist of
accumulated post-CT profits being £56,700 times 14 years
= £793,800 so the options for Mr X as controlling
shareholder are:
1. Liquidate or dissolve X Limited - if resident or
ordinarily resident Mr X will pay at an effective rate of
24% (after maximum non-business taper).
2. Retain X Limited and defer tax charge indefinitely:
e.g. invest funds (perhaps in a new property) and pay
out annual dividends.
It may of course be appropriate to keep the property
indefinitely.
Conclusion
The LLP in these circumstances is essentially a
deferral mechanism since the 24% tax charge on eventual
dissolution means that £100 of pre-tax net rental income
reduces to £61.56 after 19% CT, and CGT. This compares
with £60 after a 40% higher rate income tax charge (had
Mr X received the income personally).
Nevertheless:
1. there has been a valuable cash-flow advantage - had
income tax at 40% been paid on the net rental profit of
£70,000 (in the above illustration) there would have been
insufficient income to fund capital repayments of the bank
loan;
2. the tax charge on dissolving X Limited could be
deferred indefinitely by deferring dissolution;
3. opportunities may exist for Mr X to become
non-resident and either receive the distributable reserves
in X Limited as a capital gain or, perhaps better, as a
pre-dissolution dividend.
The use of the LLP is less efficient if the CT rate
within X Limited rises significantly above 19% or if the
use of X Limited impacts on the CT rate within an
associated company.
Variations on Scenario One
1. Assume that Mr X owns the issued share capital of X
Limited which is the holding company of its 100%
subsidiary: X Trading Limited. Assume also that after
purchase the property will be used by X Trading Limited.
Mr X and X Limited could form an LLP to purchase the
property and then let it to X Trading Limited. Rent will
accrue to X Limited, but on eventual disposal of X Limited
there would be the prospect of taper at the maximum
business rate on any capital gain arising.
2. Again, assume that X Limited is the holding company
of a 100% subsidiary X Trading Limited. X Limited has all
the funds necessary to pay £300,000 to purchase the
property (with the assistance of bank finance £700,000).
We wish the net rental profits to be taxed at 19% but the
capital gain to have the benefit of maximum business
taper. Simplified version of suggested transactions:
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X Trading Limited establishes UK FURBS for Mr X and
contributes say £20,000 (ITEPA tax and NICs payable) to
the trustees.
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X Limited lends say £150,000 to the FURBS (probably
interest free).
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FURBS and X Limited form LLP (income profits to X
Limited; capital profits to FURBS) and both parties
contribute £150,000 capital (total £300,000); LLP
borrows £700,000 to buy property which is let to X
Trading Limited.
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Ultimately the capital gain will accrue to the FURBS
trustees (subject to maximum business taper); the
accumulated post-CT profits in X Limited ought not to
affect any claim to business taper on the eventual
disposal of the shares in X Limited.
3. Assume the facts are as in Variation 2 except that X
Limited intends to invest in a commercial property to be
let to an unconnected trading tenant (unquoted). The UK
FURBS is similarly established and a contribution made. X
Limited lends £300,000 interest-free to the FURBS. The
FURBS forms Newco (UK) Limited as a 100% subsidiary and
then forms an LLP with Newco (all rents to Newco; all
capital profits to the FURBS). The FURBS ought to be able
to claim business taper on its eventual gain on sale of
the property. The routing of net rents through Newco will
give rise to useful deferral and cash flow advantages,
although of course there will be the familiar extraction
problem from Newco after the property has been sold.
SCENARIO TWO
Mr X is UK-resident but non-domiciled. He wishes to
purchase for £1,000,000 a residential or commercial
property to be let as an investment. He has £300,000 to
invest and intends to borrow £700,000. The property will
generate pre-tax net rental income of £70,000 (as per
Scenario One); the bank loan will similarly be at 7% per
annum repayable over 14 years. Mr X has established an
offshore trust through which to own the property, and
settles £300,000 on the trustees.
The Problem
Mr X wishes to gain the CGT benefits of purchasing the
property through a non-UK trust. However as a beneficiary
of the trust, all UK source rental income will be
attributed to him personally under section 739 ICTA 1988
and therefore taxable at 40% making it difficult to fund
the capital repayments of the loan.
Possible Solution
Following the approach in Scenario One, the offshore
trustees will form Newco (UK) Limited which will be
UK-resident by virtue of its UK incorporation. Then the
trustees and Newco will form an LLP (income profits 100%
to Newco: capital profits 100% to the trustees). The
trustees and Newco will together inject £300,000 as
capital into the LLP; the LLP borrows £700,000. The
property will be purchased for £1,000,000 and let for
£100,000 per annum (£70,000 net rental profit) as per
Scenario One. The net rents are declared by Newco and
subject to CT (hopefully at 19%), and in this way a
section 739 charge on Mr X is avoided. Ultimately after
the sale of the property the capital gain thereon will
accrue to the trustees. Newco can be liquidated. No CGT
will be due from the trustees (being non-resident) or from
Mr X (sections 86/87 TCGA 1992 being non-applicable
because he is non-domiciled). The capital gains can later
be remitted to Mr X by the trustees without tax.
This approach, if successful, makes possible both the
complete avoidance of CGT and tax on net rental income at
the advantageous rate of 19%. It can be used for all types
of investment property, residential as well as commercial.
CREATING THE STRUCTURE
A1 Company Services can assist you with various parts
of this structure. We can register new limited companies
and new LLPs and can put you directly in touch with an
expert in the requisite tax planning to discuss the manner
in which the new corporate bodies and the investor
interact for the maximum possible benefits.
Our combined package is as follows and is available at
a fully inclusive fee (VAT, Duties, etc) of £400.00:-
New Limited Liability Company, including:
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Registration of Company
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Provision of Company Secretary and
Full Secretarial Maintenance for One Year
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Preparation & Filing of the Annual Return
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Fast Track corporate bank account with Barclays Bank
Plc or Barclays International (as appropriate)
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3 Bound copies of the Memorandum & Articles of
Association
New Limited Liability Partnership, including:-
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Registration of LLP
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Preparation & Filing of the LLP Annual Return
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Fast Track LLP bank account with Barclays Bank Plc or
Barclays International (as appropriate)
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Limited Liability Partnership Operating Agreement
If you wish to proceed with the registrations
immediately, download an Application Form
which you will need to complete and return by email, fax
or post. Upon its return, we will:-
1. register the new company within 24 hours;
2. register the new LLP within 6 working days
(Companies House does not yet permit electronic LLP
registrations);
3. have bank accounts applied for in respect of each
immediately upon incorporation; and
4. provide you with all statutory documentation and the
Operating Agreement within a week of the LLP registration.
The advice given in these notes is correct to the
best of our knowledge and belief but the information
contained therein is for guidance only, and no
responsibility for acting upon or refraining to act upon
these notes can be accepted by A1 Company Services
Limited.
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