Is incorporating the right choice for your practice?

Hot on the heels of the Budget, the questions being asked by many partners at solicitor practices across the country are, “Should we consider incorporation to obtain limitation to liability or not?” and “What are the consequences now?”

The majority of the legal practices that we see are partnerships and partners who are looking at how to best structure their practice in order to attract and obtain potential future partners. The big question often is, what is the most tax efficient way of extracting funds from the business?

Limited Company

One solution could be to set up a limited company with an alphabet share structure so that different dividends can be declared for each of the different shareholders to replicate the profit sharing ratios of the partnership. This makes full use of the shareholders’ tax-free allowances.

Prior to the change in taxation of dividends, a significant tax saving could be made this way, as no national insurance was payable and due to the tax credit received on dividends. However, the Chancellor is, in effect, closing this route off and getting people to pay more income tax.

Limited Liability Partnership

Another avenue that could be explored is setting up a Limited Liability Partnership (LLP). At a glance, an LLP offers similar protection and, in addition, enables members to register charges over their loans to a Limited Company (Ltd). However, they are taxed very differently.

Even though an LLP is a separate entity and does not pay tax itself, the LLP members are taxed as if they are self-employed, subject to certain HMRC criteria, as if they were a member of a partnership. A Ltd pays corporation tax on profits and the shareholders pay income tax on the dividends.

The Chancellor backtracked on his proposal to increase national insurance contributions for the self-employed. Originally, the Chancellor proposed the change on the basis that the difference in national insurance rates between employed and self-employed undermined the fairness of the UK tax system. So will he seek to redress this in a future Budget?

In addition, in the Spring Budget, it was announced that the tax-free dividend allowance will be reduced from £5,000 to £2,000 from April 2018. What this means is that only the first £2,000 will be declared tax free and any dividends beyond this will be taxed according to your income tax banding for 2017/18 tax year:

  • Tax-free up to £2,000
  • 7.5% within the basic rate band (£2,001 – £33,500)
  • 32.5% on higher rate (£33,501 – £150,000)
  • 38.1% on additional rate band (over £150,001)

In summary

Taxation of profits should not be the influencing factor when deciding the structure of the practice, as there are many commercial decisions to be made. In addition, entry to and departure from the entities need to be considered due to the potential tax consequences.

If you would like to discuss incorporating in more detail or you would like to speak with a member of our Solicitors team, please call 01903 234094.

A version of this blog originally appeared on the website of one of our MHA Association member firms, Larking Gowen.