US law firms are an increasingly important force in the London market. On 26 February The Lawyer revealed that revenue earned by the 10 US firms in the UK with the highest UK revenues was in excess of £680m in 2006. Meanwhile, a report on 2 April highlighted that 26 US firms in London had achieved a turnover in the UK of more than £20m.
As the scale of the London operations grows and the City’s importance to global business increases, firms have been considering the structures through which their UK offices should practise.
While a number of US law firms have decided to operate as UK LLPs, there is as yet no consensus as to the best vehicle through which to practise, and many US firms continue to be attracted to practising in the UK through US LLPs.
At present the decision as to whether or not to use the UK or US LLP model often comes down to an assessment of the comparative risk protection afforded and the implications of public disclosure.
In terms of protection, while the UK LLP does not offer complete protection because there remains a potential risk for members to lose capital and other amounts already distributed, and furthermore an individual member found to be negligent faces even greater exposure, it does provide relatively clear protection for the majority of its members against an Armageddon scenario. By contrast, the measure of protection that a US LLP might provide (at least in an English court) is argued by some to be less well defined.
In the context of disclosure, the main downside in currently opting for the UK LLP route is perceived to be that the firm’s financial statements need to be filed at Companies House and are therefore in the public domain. As well as the disclosure of how the firm as a whole is performing, other disclosures, including that of the highest-paid member, are seen by some firms as being particularly undesirable.
While the decision as to which structure to adopt is often based on the weighing up of these two factors, other considerations around the added costs of the UK LLP and the tax consequences may also help to tip the balance.
With regards to costs, there will be extra outflows associated with the UK LLP, with an annual requirement for an audit to be performed by a registered auditor. In addition, there will be one-off costs at the time of conversion, including legal fees (or the loss of chargeable time if done in-house), accounting advice, rebranding etc.
In regard to tax matters, a firm will want to establish the impact that any potential change will have on the existing basis of taxation, any additional taxes that might arise on conversion and the longer-term consequences.
In many cases US firms will already operate in the UK through separate partnerships and all the various tax benefits associated with this approach ought to be capable of being maintained under either LLP model.
Actual conversion to an LLP is a little less straightforward, particularly if the entity is to operate beyond UK borders. In general, outside the confines of the UK, a tax-free or neutral conversion has been considered to be more straightforward for a US LLP, although increasingly those adopting the UK model are now enjoying success in securing tax-free rulings.
This just leaves the future; and with both LLP models now likely to gain wide recognition as tax-transparent entities, it is difficult to predict which is likely to shade the other as the future model of choice from the tax perspective.
So what are the potential changes that might make the choice between the two vehicles more straightforward?As part of the implementation of the Companies Act 2006, the Department of Trade & Industry (as it was then still called) issued a consultation document inviting comments on a number of areas. One such area relates to UK LLPs and how the 2006 act should be applied to LLPs, the provisions of which are based largely on the Companies Act 1985.
Although unconnected to any of the specific questions, the following, relating to overseas LLPs, appears in the consultation document: “LLPs formed in Great Britain and Northern continued #+ continuedIreland are required to register with the Registrar of Companies and to disclose specific information. However, there is at present no regulation requiring overseas LLPs with branches in the UK to register or disclose information (unlike overseas companies with branches here who have both registration and disclosure requirements placed upon them). We will consider the position of overseas LLPs as part of the broader consideration of how to apply the 2006 Act to LLPs.”
So what are the provisions that relate to overseas companies with branches in the UK? And what would be the implications if these were mirrored for overseas LLPs?
The requirements in relation to oversea (the term ‘oversea’ rather than ‘overseas’ is used in the legislation) companies are complex. This stems from the fact that there are two separate regimes under which a company may be registered. These are the ‘branch regime’ and the ‘place of business regime’. The majority of US firms practising in the UK that are not practising as UK LLPs will be set up either as branches of US LLPs or, more typically, as separate US LLPs.
If the functions in the UK are not ‘ancillary or incidental to the company’s business as a whole’ they are likely to fall under the ‘branch regime’. As a result, and in the absence of a requirement in the US to “prepare, have audited and disclose” financial statements, it will be necessary for US LLPs to file Section 700 financial statements.
While the basic rule is that these financial statements must contain the same information as would be required if the entity had been formed and registered under the 1985 act, there are exemptions from some requirements, such as no audit being required.
What is crucial about the financial statements is that they must in certain instances be those of the overseas company and not merely those of its branch or place of business in the UK.
For a US firm operating in the UK through a branch of a US LLP that includes the US business, the financial statements would need to include the results of the whole of the firm’s US and UK business. Clearly this would leave the firm at a potential competitive disadvantage to its US peers, which is something the vast majority of firms would want to avoid.
Where a US firm’s UK operations are operated through a separate US LLP that excludes the US business, the financial statements would only need to report the results of the UK business (and any other operations included in the LLP), with the information then given being broadly similar to that reported by a business incorporated as a UK LLP.
It would therefore appear that, if the UK legislation is changed to align US LLP reporting requirements with those of companies’, one of the current clear distinctions between the two models will be eradicated. The only significant differentiator remaining could then be the quality and scope of liability protection afforded by each of the two models.
Martin Moore is a partner and Jeremy Black is an associate partner at Deloitte