23 November 2022 Mini Series: Business of Law Firms Taxing Law Firms

Business of Law Firms​

Taxing Law Firms​

What do you need to know this week?

This week marks the 21st article in TCLA’s series on the Business of Law Firms.

The Lawyer ran an interesting article last Friday, 17 November, that explored how reforms to law partners’ tax liability could net the Treasury as much as £871m. More of a thought experiment than indicative of any likely reform, this article does raise important commercial and strategic features of law firms as a business, such as the nature of the partnership and its partners’ tax liability.

LLPs and tax law

With very few exceptions (cough, Slaughter and May), nearly all law firms in the UK are structured as limited liability partnerships (LLPs). Like limited companies, one of the principal benefits of LLPs is that the partnership is a separate legal entity from its owners (the partners). As the name suggests, it is the partnership in an LLP that assumes liabilities such as contractual obligations and debt rather than the partners (which is the case for general partnerships).

However, unlike limited companies, from a tax perspective, LLPs are “tax transparent”. That is, tax law “looks through” the partnership entity and taxes the partners’ share of the earnings directly. This differs from companies, which as body corporates, are directly accountable to HMRC for their profits.



The proposal

In effect, tax law treats equity partners as if they are self-employed. And as a matter of tax law, self-employed earners do not pay towards the National Insurance Contributions (NIC) scheme. Instead, NIC is primarily funded by taxing the income of employees along with employer contributions.

From a tax law perspective, NICs are not classed as a form of income tax. This is for various reasons, the main one being that NICs entitle the payer to future social security benefits like the state pension. (Which is why LLP partners are not eligible to draw a state pension, because they do not pay into the scheme).

However, NIC still functions like an income tax in that it funds ongoing social programmes. In this sense, the thrust of The Lawyer’s proposal is that current tax rules means that partners avoid paying 13.8% of their earnings towards the NIC scheme (which is effectively the portion non-LLP employers contribute towards the NIC scheme).

Were the position to change, HMRC could raise as much as £577.4m from UK law firms and £293.3m from US firms’ UK operations.

Why is this important for your interviews?

Tax mitigation plays a massive role in most business decisions. For partners in LLP, this is no different. Understanding the tax rules underlying LLP business structures is essential to understanding the wider business decisions made by a given law firm’s senior management.

As the article concedes, were the government to change the tax transparency feature of LLPs, law firms may abandon the LLP structure altogether in favour of the limited company.