The more immediate issue which firms that are profitable need to address is the 50% income tax rate. To deal with both issues it is probably timely to think again about the structure that you choose to operate for your firm.

Firm’s Structure

Traditional partnerships were always seen as the most tax efficient way of fully distributing profits and most firms have always had a culture of fully distributing profits rather than reinvesting in the business to build up a capital value.

When LLPs were introduced this seemed a more appropriate structure as it was likely to limit the liability of the members without changing the tax position of the firm.

Some firms have decided to incorporate as this too can limit liability on the partners and be a more tax efficient way for the firm to accumulate profits for reinvestment.

More complex structures are beginning to be used which can provide a combination of the benefits described. An example of this would be to have a traditional LLP as the main trading entity but to add in a corporate member in addition to the individual members. Most of the profits could be distributed to the individual members in the usual way but some of the profits can be distributed to the corporate member which can retain the profits at a lower rate of tax than if it were income in the hands of the members. This profit could then be distributed later when income tax rates are lower again.

Using a corporate member

Alternatively the profit received by the Corporate member could be used to invest in the main entity or indeed in any other business. The new businesses in which investment is made could be other legal businesses or any other business which could yield an acceptable return.

In some cases it is possible to sell the goodwill created in the main entity to a corporate entity which can result in a capital gain at 10% being paid on profits that would otherwise be charged at income tax rates of 40 or 50%.

If a firm wants to open itself up to external investment then an investor is more likely to feel comfortable investing through a corporate member than directly in the trading entity.

Be realistic

While the above provides food for thought, it is worth remembering that these alternative structures are of little value if the firm is not efficiently run, attractive to clients and is capable of producing high profits over a long period of time.

© Robert Mowbray - Taylor Mowbray LLP

April 2011

Taylor Mowbray LLP
rmowbray@taylormowbray.com

Telephone: 07979 517221