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 rates but that benefit does come at the expense of the partners taking out income as drawings and an accumulation of profits in the service company.

Minimising the cost of expenses which do not qualify for tax relief

Such expenses would be disallowable for both corporate and income tax

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