Use of service companies in partnerships

By Tolley

The following Owner-Managed Businesses guidance note by Tolley provides comprehensive and up to date tax information covering:

  • Use of service companies in partnerships
  • What is a service company?
  • Why use a service company?
  • Utilising a service company
  • Establishing a profit margin uplift
  • Application of accumulated profits of service company
  • Profit extraction
  • VAT considerations
  • Anti-avoidance and other considerations
  • Administration and compliance costs

The use of service companies alongside partnerships / LLPs has become increasingly popular in recent years. This is largely due to the difference between personal income tax rates and corporation tax rates.

What is a service company?

Typically, a service company will be a limited company run alongside a partnership. The share capital may be owned by the partners personally or as a partnership asset. There may be some advantages to holding share capital within the partnership, for example, an advantageous CGT treatment if there is a change in partnership sharing ratios. See the Capital gains of a partnership guidance note.

The service company typically provides a number of services to the partnership. This may include:

  • employing staff
  • owning or renting premises and dealing with property related outgoings
  • owning equipment such as plant and machinery, motor cars etc
  • providing administrative services, and
  • other back office functions

In return, the service company will be paid a fee by the partnership equal to the costs incurred plus an appropriate profit margin uplift, although this may well be affected by the transfer pricing legislation ― see below.

Alternatively, the service company could be a partner in the partnership. In this case, the fee would be paid by way of a priority profit share.

Why use a service company?
Obtaining cash flow benefits from tax deferral

Cash flow is improved through the accumulation of profits at a lower rate of corporation tax. These accumulated profits can then be used to fund working capital or for future re-investment. See Example 1 for the potential benefits in this respect.

The level of benefit will depend upon the profit margin uplift and relevant tax

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