Incorporation of an Unincorporated Business and Partnership (WS16)

Cessation of membership and its consequences

" A person may cease to be a member of an LLP by giving reasonable notice to the other members (LLPA 2000, s 4(3)). There is no equivalent provision to this in a traditional partnership. The bankruptcy of a member does not automatically cause a termination of membership of the LLP, unless the LLP agreement so provides. Also, a member cannot be expelled or be required to retire, unless the LLP agreement deals with this (default rule 8, which adopts s 25 of the PA 1890). " If a person ceases to be a member, the LLP must notify the Registrar within 14 days.

Advantages and Disadvantages of an LLP

" Advantages o (a) limited liability and separate legal personality (like a company); o (b) a flexible organisational structure: the members can decide what they want; o (c) the ability to grant fixed and floating charges over its assets; security needs to be registered with the Registrar of Companies; o (d) the ability to appoint an administrator. " Disadvantages o (a) the requirement to file accounts with the Registrar of Companies, which will then be public documents; o (b) the potential 'clawback' provisions in the event of an insolvency; o (c) the transfer of a personal interest in an LLP is more complex than transferring shares (but a transfer can be less problematic with an LLP that with an ordinary partnership structure as LLP membership can be assigned); o (d) an LLP cannot convert into a limited company.

Owning property and the granting of charges

" An LLP can issue debentures and grant fixed or floating charges. Every LLP must keep a register of charges and a copy of every charge requiring registration at its registered office (CA 2006, ss 869-873). The register must include all charges affecting property of the LLP and all floating charges. The register must be open for inspection by any creditor or member of the LLP without payment of a fee. " The LLP is required to register charges with the Registrar in the same way that a company is so required. An amended version of the form for companies is used for registration of charges for an LLP. As with companies, there is a power of the court to rectify omission of registration of a charge (CA 2006, s 873).

Designated Members

" At least two of the members of the LLP must be 'designated members' (LLPA 2000, ss 2(1)(a), 8(2)). The original two designated members will be the subscribers to the incorporation document. One possibility is that all members of the LLP will be designated members. Alternatively, the LLP may specify named members as the designated members in addition to, or in place of, the original subscribers (LLPA 2000, s 8(4)(b)). " The responsibilities of the designated members are contained in the LLPA 2000, the CA 2006 and the IA 1986. Broadly, designated members have powers equivalent to directors in a company. However, they also have the duties and responsibilities of being a member of the LLP. " Designated members must: o (a) sign and file the annual accounts with the Registrar (CA 2006, s 444(6)); o (b) appoint, remove and remunerate auditors (CA 2006, s 485(4)); o (c) file the confirmation statement (CA 2006, s 854); o (d) send notices to the Registrar, for example concerning a member leaving or joining the LLP (LLPA 2000, s 9(1)); o (e) send a statement of release of a charge to the Registrar (CA 2006, s 872); o (f) apply for a change of name of the LLP (LLPA 2000, Sch, para 5(2)(b)); o (g) apply to strike off the LLP from the register (CA 2006, s 1003); or o (h) wind up the LLP or apply for a voluntary arrangement (IA 1986, s 89(1)). " All the functions of a designated member must be carried out consistent with the core fiduciary obligation owed by every member to the LLP itself, ie an obligation of loyalty and promoting the best interests of the LLP. The designated members will also owe a duty to the LLP of reasonable care and skill.

Management and decision making

" Default rules 3 and 4 provide that every member may take part in the management of the LLP, and that no member is entitled to remuneration for doing so. These rules are adapted from s 24(5) and (6) of the PA 1890. The LLP agreement can depart from these rules and the members can create any management structure that is desired. " Default rule 6 is adapted from s 24(8) of the PA 1890 and provides that ordinary matters of the LLP are to be decided by a majority of the members. No change in the nature of the business of the LLP can be made without the consent of all members.

Authority of a member to bind the LLP

" Every member of an LLP is the agent of the LLP (LLPA 2000, s 6(1)). Section 6(2) provides for limitations to be placed on a member's actual authority. So, an LLP is not bound if the member has no authority to act for the LLP in that matter and the third party in question knows that fact. The LLP agreement, if there is one, should provide for limits on the authority of members. However, this still leaves open the question of apparent authority. The extent of the apparent authority will be determined by the nature of the business concerned, and therefore what constitutes the 'normal course' of that business. Apparent authority is dependent upon the representations which the LLP makes to the third party or, more likely, the mistaken impressions which the LLP fails to correct " The member will cease to be the agent of the LLP whenever he ceases to be a member of that LLP.

Capital and Profits

" Funding for a business comes either from debt or equity, ie borrowing or shares. With an LLP, the equity is the members' capital which they have contributed to the business. Default rule 1 provides that members are entitled to share equally in the capital and profits of the LLP, in the absence of contrary agreement. The default rules do not deal with losses, as it is the LLP itself which bears any losses, just as a company does. In other words, this is where limited liability applies and benefits the members of the LLP. The only thing that the member has at risk is the contributions he has made to the LLP's finances, ie his capital and any profits due to him, and loans from him which the LLP cannot repay

Effect of limited liability

" If the LLP becomes insolvent, both the LLP and the members will be subject to the IA 1986 regime with regard to the liquidation of companies. Thus, there is the possibility of the member being found liable for misfeasance, fraudulent trading or wrongful trading . The member may therefore be required to contribute to the assets of the insolvent LLP in the same way that a company director can be, under the equivalent provisions for companies. The Company Directors Disqualification Act 1986 also applies to members of an LLP.

Limited partnerships (compare)

" LPA 1907 " Different from limited liability partnerships o Must have the words 'Limited Partnership/LP' in name o Failure to register the firm (s5 and s8B LPA)(otherwise = general partnership- with no benefits of limited liability) Defining characteristics " Two types of partner General Partners: o manage the business o (s6(1), unlimited personal liability for debts (s4(2)) o Can wind up on dissolution unless court disagrees (s6(3) o S6(5)(a) - decide ordinary matters on simple majority basis o Not required to make contribution to capital Limited Partners o contribute to capital but limited liability (there are exceptions: o Loss of limited liability if: 1.Participation in management (s6(1)LPA) - they become liable (therefore they should not hold allow their names to appear on business letters or in the name of the firm in case they are held out as general partners) 2. Return of capital investment during continuance of partnership (s4(3) LPA) (will be liable to the extent that partner is repaid for their contribution) o Body corporate may be limited partner (s4(4) o S5(b) - limited partner may retire by assigning its share with consent of general partners o Must contribute capital (4(2A) Characteristics: o Need at least one of each type of partner (s4(2) o No limit of number of partners o No separate legal personality o Partnership Act 1980- rules apply - unless inconsistent with LPA 1907 (s7) o Therefore, definition of s1 Partnerships Act 1980 must be satisfied o Termination = same rules except limited partner cannot dissolve by notice (s6(5)(e)) and death/bankruptcy of limited partner does not dissolve (s6(2))(but does for general partner) o Provisions may be modified (e.g. s24 Partnership act 1980)

Limited Liability Partnerships [summary] (compare to company)

" Limited liability partnerships (LLPs) were created by the Limited Liability Partnerships Act 2000 (LLPA 2000) in response to pressure from professional firms for more protection from liability than was possible with existing partnership law. " Partners in an LLP ('members') have full limited liability. " An LLP is required by s 8 of the LLPA 2000 to have at least two 'designated members' who are responsible for sending documents to Companies House. " An LLP is registered by sending two forms to Companies House, but there is no need to send a copy of any partnership agreement or other constitutional document. The main form is generally equivalent to that used for a company and is called the 'incorporation document', which must contain (LLPA 2000, s 2(2)): o (a) name of the LLP; o (b) country where the registered office is situated; o (c) address of the registered office; o (d) name and address of each member of the LLP; and o (e) identities of the designated members. " An incorporation form equivalent to that used for companies is also lodged, that is containing a statement that the requirements of s 2(1)(a) have been complied with, including that two or more of the partners must have subscribed their names to the incorporation form. A statutory declaration is not required. " Companies House will issue a certificate of registration. The name of an LLP has to end with the words 'limited liability partnership' or 'LLP', or their Welsh equivalents. The rules on registration of names are similar to those for companies " There is no management structure imposed on an LLP, that is, there is no equivalent of the model articles for a company. Implied terms which would apply in the absence of contrary agreement are provided by regulations. " Members will owe a duty to the LLP as a body corporate in common law, but it seems unclear whether they owe a duty of good faith to each other. " Members are agents of the LLP, under s 6 of the LLPA 2000 which is equivalent to s 5 of the PA 1890 . " The relationship between the members is set out in s 5 of the LLPA 2000, which is equivalent to s 24 of the PA 1890. " An LLP has no share capital and therefore there are no requirements to maintain share capital. There are no directors and shareholders. There are just 'members'. The members are free to decide upon management and decision processes. " There is no restriction on membership numbers, though there have to be at least two members to constitute an LLP. The LLP structure is open to any type of business (LPPA 2000, s 2(1)(a)). " The LLP itself can be liable for, eg, torts and debts, but the members have limited liability. " An LLP has to file annual accounts, which are then a public document. " The provisions relating to wrongful and fraudulent trading also apply to the members of an LLP (Limited Liability Partnerships Regulations 2001, SI 2001/1090 ('LLP Regulations 2001'), reg 5). " An LLP cannot convert into a limited company directly, but the business itself could be incorporated. " For tax purposes, an LLP is to be treated as an ordinary partnership, that is, the partners will be liable to income tax under the ITTOIA 2005 for their share of profits, and to capital gains tax on gains made on the disposal of partnership assets. " The limited liability partnership has a legal personality separate from that of its members. Thus, it is the limited liability partnership that carries the duties and liabilities of the business which are owed to outsiders. Unlike the position with a partnership, the existence of the LLP is separate from that of its members. So, a partnership will cease to exist if there are not two or more members, ie partners. This is not the case with an LLP. It continues to exist as a separate legal entity until it is dissolved.

The Duties and Responsibilities of Members

" Many LLPs will have a written agreement. However, this will not be the only source of the duties and responsibilities of the members. As a member is in the position of agent with the LLP as principal, the member will owe a fiduciary duty to the LLP. There are also the default rules to be considered. " The member's duties to the LLP will include: o (a) a duty to account for any money received on behalf of the LLP; o (b) a duty not to apply LLP monies improperly; o (c) fiduciary duties, for example a duty of good faith towards the LLP; o (d) duties on members as a whole, for example to prepare financial accounts which give a true and fair view of the LLP's financial position; o (e) duties on individual members, for example to give the auditors such information as they require from him; and o (f) duties to his co-members, for example a duty to render true accounts and full information on matters concerning the LLP.

Use of limited partnerships

" Often used as investment vehicle " Pool large sums of capital for investment " Partners who do not run the business are not required to contribute more money if strategy fails " May not trade but merely invest " Satisfies definition of business in s45 PA 1890- every trade, occupation or profession' " Collective investment scheme (specified investment activity - regulated activity - so need exclusion- conduct - usual to delegate to authorised advisor Benefits of limited partnerships for collective investment schemes " Limited partners can only lose their original investment " All of the profits, and losses, accrue to the partners in their (potentially flexible) profit sharing ratios " 'Tax transparency'; the LP is not a separate legal entity so investors are taxed on any gains or income and can claim reliefs according to their own tax regime " General partners arrange for expert fund managers to manage the investment portfolio " Limited partners do not get involved in the investment decision making process

The LLP Agreement

" Section 5(1) of the LLPA 2000 provides that the mutual rights and duties of an LLP and its members are governed by an agreement between the members, or in the absence of an agreement by the provisions of the LLP Regulations 2001. The Regulations provide a set of 'default rules'. These rules adopt some of the provisions contained in ss 24-30 of the PA 1890, with appropriate modifications. " The matters covered by the default rules are as follows, with references to the PA 1890 for comparison: o (a) sharing in capital and profits (PA 1890, s 24(1)); o (b) indemnity to members (s 24(2)); o (c) right to take part in management (s 24(5)); o (d) no entitlement to remuneration (s 24(6)); o (e) introduction of a new member and voluntary assignment of a member's interest (s 24(7)); o (f) ordinary matters connected with the business to be decided by majority (s 24(8)); o (g) books and records to be available for inspection by any member (s 24(9)); o (h) each member to render true accounts and full information to any member (s 28); o (i) obligation to account to the LLP for any profits made from a competing business without consent (s 30); o (j) obligation to account to the LLP for any private benefit derived without consent from use of LLP property (s 29(1)); and o (k) no majority power to expel without express agreement as to such power (s 25).

New members

" The LLP is incorporated with its first members. Thereafter, any person may become a member with the agreement of the existing members. As with a traditional partnership, being a member of an LLP is a matter of contract. Any LLP agreement therefore needs to make provision for new members joining the LLP.

Formalities

" The LLP must have its name on the outside of its place of business. Similarly, its business stationery must mention its name, its place of registration and its registration number, and the address of the registered office (CA 2006, s 82(1), (2)). It must always have a registered office, as it is an address for service of official documents (LLPA 2000, Sch, para 6). " Entering into contracts and executing other documents is much the same for LLPs as for companies. Thus, a contract may be made on behalf of an LLP by anyone acting with express or implied authority. So, a document is executed on behalf of an LLP by that document being signed by two members of the LLP, or by applying the common seal of the LLP, if it has one. " An LLP can change its name at any time. There is no procedure prescribed in legislation for doing so. This should be a matter addressed in the LLP partnership agreement. If it is not then the default rules apply , and the consent of all the members is needed (LLP Regulations 2001, regs 7 and 8). " Every LLP must send to the Registrar an annual confirmation statement (CA 2006, ss 854, 855). This covers the following items: o (a) the address of the registered office; o (b) the names and addresses of the members of the LLP; o (c) the identity of the designated members, if not all members are designated; and o (d) the address where the register of debenture holders is kept, if it is not the registered off ice. " The appropriate form is a variation of the standard form for companies. It must be signed by a designated member who certifies that the return is accurate. " Changes to the membership of an LLP must be notified to the Registrar of Companies as they occur (LLPA 2000, s 9(1)(a)).

Applications of an LLP

" The LLP structure has been primarily of interest to professional partnerships, eg solicitors, accountants and engineers. An LLP could also be used in the context of joint ventures or in project finance.

Outcomes

1. Advise on the procedural aspects of converting an unincorporated business into a business run through the medium of a private limited company. 2. Explain the difference between a LP and a LLP. 3. Identify the main features of a general partnership and a LLP and explain how these differ from and are similar to the features of a company.

Converting from Sole Trader to Partnership

Formalities " In law, the creation of a partnership is simply a question of whether or not the statutory definition of partnership under s 1 of the PA 1890 is satisfied. It follows that there is no necessary formality to be observed in converting from sole trader to partnership. Nevertheless, certain questions should be considered. To whom will the business assets belong? " It is inevitable that certain assets, particularly stock-in-trade and goodwill, will belong to the partners jointly. In relation to other assets, it will be necessary for the partners to reach agreement as to ownership of assets. Ownership of assets can simply be dealt with by means of a clause in the partnership agreement which declares which assets are partnership assets and which assets used by the partnership belong to a partner individually. In relation to premises, for example, this clause would operate as a declaration of trust, where legal title is to remain in the name of one partner alone but the beneficial ownership is to be shared by all the partners. The partners may prefer a formal transfer of title from the original owner to the partners jointly, in which case a conveyance or transfer of the title will be required. Will there be a formal partnership agreement? " Partners should always have a formal partnership agreement prepared, not only to deal with the question of ownership of assets but also to deal with all other aspects of the relationship. Will the CA 2006, ss1192-1208 apply? " If the name of the business is to differ from those of the partners, it will be necessary to set out the names of the partners, together with an address for each partner for service of documents, on all business stationery and on the business premises. Income tax implications " The incoming person will be assessed to income tax under the rules described chapter 25. Capital gains tax implications " Where the sole trader agrees to share ownership of the business assets with his new partner, he will be disposing of a share in those assets. If the assets are chargeable assets for CGT purposes (such as premises and goodwill), there will be a possible charge to CGT on the disponer. Reliefs and exemptions that might be available include: o (a) hold-over relief if the disposal is by way of gift to the incoming partner; o (b) entrepreneurs' relief; o (c) the annual exemption. Stamp Duty Land Tax " The FA 2004 introduced provisions to charge stamp duty land tax on certain transfers into and out of partnerships. Employees " Since the former sole trader continues as an employer, there are no necessary implications so far as the positions of employees are concerned.

Converting from Unincorporated Business to Limited Company

Formalities " Because the conversion from unincorporated business to limited company involves a sale of the business by the present owners (partners or sole trader) to a new owner (the company), there are many more formalities attached to this conversion. o (a) The present owners will need to form, or purchase off the shelf, a company of which they will be the sole directors and shareholders and to which they will sell the business. The consideration for the sale will normally consist exclusively of shares in the company but some of the consideration may be in the form of debentures (under which part of the agreed price is left outstanding as a loan to the company) or cash. o (b) Once the company is ready, it will buy the business from the present owners and it will be necessary for the company to observe the usual formalities on decision-making within the company, on filing returns with the Registrar of Companies and on maintaining the company's own records. o (c) The sale of the business will be effected under the terms of a contract (a sale agreement); typically this will: " (i) describe the assets being sold to the company; " (ii) describe the price and the way in which it will be paid by the company, normally wholly in shares; " (iii) apportion the price to show the value attributed to the various assets or groups of assets comprised in the business and being sold to the company; " (iv) contain covenants on the part of the company designed to indemnify the sellers in respect of any liability for the existing debts, liabilities and obligations connected with the business; " (v) contain the company's acceptance of the seller's title to the premises, for example, to ensure that no claim could be brought by the company against the sellers for a defective title (this might otherwise have been a possibility should the company eventually change hands, eg in liquidation); and " (vi) contain the company's acceptance of the equipment and stock in its current condition so that no claim can be brought by the company against the sellers on the basis of these items being defective or in poor condition. " In pursuance of the sale agreement, title to certain assets (notably the business premises) will, if appropriate, be transferred to the company by separate document, whilst the title to other assets may pass under the sale agreement (eg goodwill) or by physical delivery (eg stock). " If, as is common, the company takes over the previous name of the business and this is not the same as the company's name, it will be necessary for the company's stationery and a notice at the company's place of business to state the company's name and address (CA 2006, ss 1202, 1204).

Converting from Unincorporated Business to Limited Company [tax implications]

Income tax implications General " When the unincorporated business is sold to the company, this is a discontinuance of the business so far as the partnership (or sole trader) is concerned. The individual partners (or sole trader) will be assessed to income tax under the rules for the closing tax year of a business up to the date of the transfer of the business. The company must pay corporation tax on profits thereafter. Capital allowances " In so far as the partnership (or sole trader) sells to the company assets on which capital allowances have been claimed (eg machinery and plant), there may be a balancing charge to income tax on any profit identified by comparing the sale proceeds with the assets' written- down value. Suppose, for example, that some machinery cost £50,000 when purchased three and a half years ago and capital allowances have been claimed totalling £22,432, so that the written-down value is £27,568. If the value attributed to this machinery on the sale was £30,000, there could be a balancing charge to income tax on the £2,432 'profit'. In other words, this 'profit' would be taxed as part of the trading income in the closing tax year. Conversely, if there is a loss calculated on the same basis, there will be a deduction from profits for the final year for income tax purposes, known as a balancing allowance. If the company is controlled by the sellers of the business, the company and the sellers can elect within two years that the company shall take over the position of the sellers so that no balancing charge occurs (CAA 2001, ss 266 and 267). Trading losses " If the unincorporated business has made trading losses which have not been relieved when the business is transferred to the company, these losses can be carried forward and deducted from income which the former partners (or sole trader) receive from the company, such as a salary as director or dividends as shareholder. This relief is available only if the business is transferred to the company wholly or mainly in return for the issue of shares in the company Interest on a qualifying loan- income tax relief for partners " Details of this relief are given at 25.2.4. If a partnership is incorporated as a close company and the loan remains outstanding following incorporation, relief will continue to be given if the conditions for the relief that apply to close companies are met. Capital gains implications " When the business is transferred to the company there will be a disposal to the company by the individual partners (or sole trader) of any of the assets of the business which do not remain in their personal ownership. In so far as these assets are chargeable assets for CGT purposes, there may be a charge to CGT. Reliefs which may be available include the following. Roll-over relief on incorporation of a business (TCGA 1992, s162) " The conditions for the relief to apply include the condition that the business must be sold to the company as a going concern with all of its assets (although cash may be ignored for this purpose). Transferring all the assets may present certain disadvantages, including: o (a) possible SDLT on the transfer of land; o (b) various other expenses incurred in transferring assets, such as professional fees; o (c) possible double charge to taxation in relation to future gains on those assets transferred o (d) availability of those assets transferred for payment of the company creditors. Other reliefs " The taxpayer may not wish to roll over his gain on incorporation of the business. This may be the case if the taxpayer wishes to use one or more of the following (if available - see): o (a) EIS deferral relief; o (b) entrepreneurs' relief; o (c) the annual exemption. Stamp duty land tax " Stamp duty land tax is chargeable on a 'land transaction' in accordance with Part 4 of the FA 2003, and this would include the acquisition by a company of land included as part of a business. The amount of the charge (if any) will depend on the value of the (usually non- residential) land. VAT implications " If the company is not registered for VAT purposes before the sale to the company takes place, the sellers must charge VAT on the transaction. This is avoided by ensuring that the company is registered for VAT before the sale takes place (under the Transfer of Going Concern (TOGC) Rules). Employees " As a result of the sale of the business, the owner of the business and therefore the employer will change. Under the Transfer of Undertakings (Protection of Employment) Regulations 2006 (SI 2006/246), the new employer (the company) is taken to stand in the shoes of the old employer and the rights of the employees are automatically transferred. If no change is made affecting the employees, then there will be no immediate implications of the change of employer.

Limited Partnership Issues

Limited Partnership Issues " LP is a collective investment scheme - establishment, operation and winding up will constitute a regulated activity " Liability is limited to capital contribution, but loss relief has not been similarly limited " Limited partner cannot withdraw capital without losing limited liability, but can assign share for consideration " Exclude the application of statute o Default provisions are inappropriate o Need doc to refer to

Converting from Private to Public Limited Company

Procedural requirement " For information on the re-registration of a private company as a public company. See chapter 12 Implications " Since the company remains the same person, there are no implications for the company in terms of taxation or in terms of the employees. The real implications for the company lie in the realm of the company's ability to raise finance by inviting the public to purchase its shares and by applying to have its shares dealt in on the London Stock Exchange. " For the shareholders in the company there may be implications as to the availability or otherwise of capital tax reliefs. For example, some IHT reliefs (such as BPR and the instalment option) operate less favourably for shareholdings in quoted companies than for shareholdings in unquoted companies. Some CGT reliefs (such as entrepreneurs' relief ) are dependent on the company being a 'personal trading company', which is less likely to be established in a company whose shares are quoted on the London Stock Exchange.

OUTCOME 1: Advise on the procedural aspects of converting an unincorporated business into a business run through the medium of a private limited company.

SEE BELOW

OUTCOME 2 + 3

see below