SHROPSHIRE FUTURE PARTNERS

ARTICLE

SHROPSHIRE FUTURE PARTNERS

I was really pleased to be joined by Mark Turner from Aaron and Partners, Lucy Speed from Lanyon Bowdlers, Graham Fuller from FBC and Tom Davies from WR Partners who all gave their time to share their knowledge and experience of being partners and in Tom Davies’ case the financial and tax implications of becoming a partner. All of their contributions was received with great thanks from all attendees at the event.

Tom Davies’ lecture of the financial and tax implications was really engaging and I even think some of the partners in the room learned a thing or two.

The panel were able to answer a lot of those questions that are not usually asked of partners within their firms. It was a great event attended by upcoming talent of Shropshire and I have no doubt I will see many of you around partnership in the future.

Thank you to all that attended and I have included Tom Davies’ power point presentation which has some really helpful information about the financial tax implications of becoming a partner. 

FINANCIAL AND TAX IMPLICATIONS OF BECOMING A LEGAL PRACTICE

What am I going to talk to you about?

Points & risks to consider before buying in 

‘Buy-in’ models and valuations 

Different business structures and associated considerations 

Questions

POINTS TO CONSIDER BEFORE ‘BUYING IN’ – MUST BE SCEPTICAL

Are there any ongoing claims against the firm?

Any potential future liabilities payable by the firm?

Suitable insurance in place?

Reputation damage – lead to less future profits?

Unlikely to be disclosed in the accounts unless very late in proceedings

Are the current partners transparent about the claims position of the firm?

Access to prior year SRA Accountant Reports and internal breach register

Is the profit share fair?

Doesn’t necessarily have to be equal

Representative of work done or capital introduced?

Interest on capital mechanism – could be structured in a way that some partners, who have larger capital balances, benefit from unfair interest rates and mechanisms

Clearly definable – not able to be distorted by nonspecific non-financial matters

 Will you be ‘worse off’ post appointment? (Loss of employment benefits, pension etc. vs potential tax savings & increased earnings(?))

Will you be liable for personal fines?

 Do certain types of work carry personal fines?

 Audit partners associated with Carillion collapse fined £250k, audit managers £30k+

 Is there support available from senior partners, departmental heads, Law Society etc.?

 Are systems and workflows in your team sufficient to mitigate risk?

 Is the team suitably skilled to avoid this?

 Additional remuneration or profit for additional risk?

‘BUY-IN’ MODELS AND VALUATIONS – NO RIGHT APPROACH OR ANSWER

Introduce ‘full’ capital balance on day one

 From personal funds or bank/ professional loan - personal wealth & circumstances dependent. May be worth a loan even if cash available?

 Fully capitalised on day one, so all profits achieved are yours to draw until capitalisation levels next reviewed (usually done annually or bi-annually)

Pros

 Interest paid should be tax relievable in any structure

 No distortions in capital account balances, less room for unfair interest on capital mechanisms

 Loan often secured against current/ capital account in business

 Supporting business’ cash reserves on day 1

 Firms often have relationships with banks

Cons

 Interest payable on loans (risk vs. return)

 Another loan to consider on top of mortgage, car loans etc.

 Can be hard to plan in times of economic/interest rate uncertainty

No capital introduction on day one, expectation to ‘leave’ profits in business

 Capital account is built up over time by not drawing profits in full

 Formal agreements, plans and timescales required in advance of buying in

 Requires business to be profitable enough to cover drawings and leave a proportion

Pros

Don’t have to find large sums in order to become a partner

Allows younger team members to become partners – less personal wealth required 

Effectively been ‘gifted’ share of net assets of business by current and outgoing partners 

No interest payable 

No additional personal borrowing

Cons

Lack of commitment shown(?) 

Relies on vacating partners to leave their current accounts in the business whilst incoming partners build theirs up 

Requires business to be profitable (not too much of an issue with established practices, but can be something to consider with startup firms or firms that rely heavily on work that thrives in strong economy) 

Can lead to a reduction in balance sheet position if incoming partners cannot leave profits in as fast as vacating partners draw theirs out 

Tax paid on profits without access to cash

Hybrid of models one and two

Proportion of capital account is introduced on day one, then remainder built up over time by not drawing profits in full 

Formal agreements, plans and timescales required in advance of buying in 

Requires business to be profitable

Pros

Don’t have to find large sums in order to become a partner 

Allows younger team members to become a partner – less personal wealth required 

Shows commitment on day one 

Supporting business’ cash reserves on day 1

Cons

Interest payable on loans 

Vacating partners (which will be you one day!) can perhaps have a larger proportion of their current account on retirement 

Needs business to be profitable (but not as key as in model two)

Another loan to consider on top of mortgage, car loans etc.

Can be hard to plan in times of economic/ interest rate uncertainty 

What to look out for when considering buying in

 No structure around buying in model/ approach and when cash & profits are to be introduced or allocated

 No calculations around capitalisation levels prepared – don’t necessarily need to be formal (it’s an art, not a science!), but something should be in place

 Current owners not forthcoming with timescales, expectations etc.

 Disparity between what payments to the business represent. Are they purchasing a share of the business or loaning to the business? (limited companies structure only)

 Lack of clarity on drawings/remuneration post acceptance

Different business structures – again, no correct answer

 Unincorporated partnership

 Limited Liability Partnership (LLP)

 Limited company – individual director/shareholders

 Limited company – corporate director/shareholders

 Corporate partnership or corporate LLP

DIFFERENT BUSINESS STRUCTURES – AGAIN, NO CORRECT ANSWER

Unincorporated partnership – non tax matters

 2 or more individuals in partnership – no upper limit

 Owners called ‘partners’

 Simple

 Registered at HMRC only, no registration at Companies House – accounts not publicly available

 Profits/ capital of business belong to the partners and this is clearly defined as such in the annual accounts

 No limited liability, if partner’s capital in business is not sufficient to cover any liabilities, claimant can pursue partner’s personal assets

 Very simple SRA registration

Unincorporated partnership – tax matters

 Profits of partnership are declared to HMRC on partnership tax return

 Profits of partnership taxed on the partner’s individual tax returns in the year they are achieved – irrespective of whether or not they have been drawn

 Profits subject to income tax and class 2 & 4 National Insurance contributions

 Little scope for tax planning

 Post-tax profits are available for partners to draw, subject to capitalisation considerations

 Different income streams subject to slightly different allowances, rates etc.

 No capital gains tax considerations

 Partner’s current and capital accounts form part of their estate for inheritance tax purposes but qualify for ‘business property relief’

Limited Liability Partnership – non tax matters

2 or more individuals in partnership – no upper limit 

Owners called members or designated members 

Slightly more complex than an unincorporated partnership, but still simple 

Registered at HMRC and Companies House – accounts are publicly available 

Profits/ capital of business belong to the members and is clearly defined as such in the annual accounts 

Limited liability, if partner’s capital in business is not sufficient to cover any liabilities, claimant cannot pursue partner’s personal assets 

Very simple SRA registration

Limited Liability Partnership – tax matters (identical to a partnership)

Profits of partnership are declared to HMRC on partnership tax return 

Profits of partnership taxed on the member’s in the year they are achieved – irrespective of if they are drawn 

Profits subject to income tax and class 2 & 4 National Insurance contributions 

Little scope for tax planning 

Post-tax profits are available for members to draw, subject to capitalisation considerations 

Different revenue streams subject to slightly different allowances, rates etc. (bank interest has additional allowances, rental income not subject to National Insurance) 

Minimal capital gains tax considerations 

Partner’s current and capital accounts form part of their estate for inheritance tax purposes but qualify for ‘business property relief’

Limited company – individual and corporate ownership

Limited company – individual director/ shareholders –non-tax matters

 A limited company is a type of business structure considered a legally distinct entity, registered at Companies House

 1 or more individuals own shares in, or a share of, a limited company

 Owners called shareholders

 People who run the company called directors – often the same people as the shareholders in owner managed companies

 Annual accounts are submitted to Companies House

 Relatively straight forward to understand

 Profits/capital of a company belong to the company until they are distributed to the shareholders

 Personal liability limited to amount of share capital subscribed or guarantee given 

Simple SRA registration and requirements

Limited company – individual director/ shareholders – tax matters

 Profits of a limited company are subject to corporation tax at the company’s marginal rate – 19% up to £50k, marginal rate between £50k & £250k, 25% above £250k (from1 April 2023)

 Much more scope to reduce profits of a company than a partnership or LLP

 Shareholders are then subject to income tax on declarations made to them

 Small salary which avoids any Ee’s NI being paid, but director still gets NI qualifying year

 Dividends taxed at 8.75%/ 33.75%/ 39.35% - drawings can be staggered to maximise efficiency

 Interest charged on director’s loans subject to 20%/ 40%/ 45% income tax, but qualify for corporation tax relief in the company. Very tax efficient means of withdrawing funds

 When a shareholder leaves a limited company, the sale of their shares is deemed as a market value transaction and subject to capital gains tax. Will often qualify for ‘Business Asset Disposal Relief’ and be taxed at 10% (on gains up to £1m, 20% thereafter)

 If a shareholder dies in office, the market value of their shares form part of their estate for IHT purposes, but again qualifies for inheritance tax relief

Limited company – corporate shareholders – non tax matters

Trading business is a limited company 

Directors of the trading company are the ultimate business owners 

Shareholders of the trading company are the individual’s companies 

Retained profits/ capital of the trading company belong to the trading company 

Therefore, an off balance sheet document is required where profits are directly attributable to the individuals who own the business 

A robust shareholders agreement is required, outlining what the profit distribution method is and what happens when shareholders leave or retire

Limited company – corporate shareholders – tax matters

Trading company profits subject to corporation tax in the same way as if individual shareholders in place 

Distribution of profits from trading company to holding company are tax free due to intercompany dividend rules 

Allows for the different owners to then make their own decision on their personal drawings 

Some shareholders can choose to leave their cash in their own limited company to reduce dividend tax payable, whereas others can draw all their cash if they wish to or need to 

Allows for spouses and/or adult children to own a minority stake in the holding companies, allowing distributions to be made to them to utilise tax bands and allowances. No dilution of the trading company’s ownership 

On leaving the business, the shareholders final distribution is tax free, as above 

The holding companies in which the individuals own their shares do not qualify for BADR for CGT or BPR for IHT due to these companies being classed as investment companies rather than trading companies

Corporate partnership or LLP

Corporate partnership or Corporate Limited Liability Partnership – non tax matters

 2 or more companies in partnership – no upper limit

 Unincorporated partnership or LLP as outlined, where partners/ members are limited companies

 Owners called ‘corporate partners’ or ‘corporate members’  Seen as complex and difficult to understand for nonaccountants and tax professionals

 Profits/ capital of trading partnership/ LLP belongs to the CPs/ CMs and are clearly defined as such in the annual accounts

 Limited liability in both structures, ‘double layer’ of protection in corporate LLP

 Complex SRA registration and requirements

Corporate partnership or Corporate Limited Liability Partnership – tax matters

 Profits of partnership/ LLP are declared to HMRC on partnership tax return

Profits of partnership taxed on the corporate member’s corporation tax returns in the year they are achieved – irrespective of if they are drawn 

Profits subject to corporation tax at the company’s marginal rate

 Much greater scope for tax planning due to corporation tax regime

 Allows for spouses and/or adult children to own a minority stake in the holding companies, allowing distributions to be made to them to utilise tax bands and allowances. No dilution of the trading company’s ownership

 Partnership/ LLP post-tax profits are available for corporate members to draw, subject to capitalisation considerations

 No capital gains tax considerations in partnership/ LLP, but each individuals company subject to CGT as referred to in limited company slides 

Individuals limited company ownership form part of their estate for inheritance tax purposes but qualify for ‘business property relief’ – as in limited company slides

My advice

Look to gain some understanding of each of the topics discussed appropriate to the firm you have been offered ownership of 

Get advice!

Tom Davies

Commercial Manager

WR Partners