Hazlewoods research reveals more than half of all law firms are now limited companies

A new study by Hazlewoods Chartered Accountants and Business Advisers has revealed that more than half (53 per cent) of law firms in England and Wales are now limited companies. The number of incorporated law firms has risen 88 per cent to 5,137 in the past decade.

Hazlewoods said many law firms have changed their structures from traditional partnerships and LLPs to limited companies over the last ten years as lower taxation made incorporation more attractive. There are now only 2,792 law firms structured as LLPs and partnerships in the UK, a fall of 41 per cent from 4,764 in 2012.

Over the last decade, corporation tax in the UK has reduced substantially, falling from 24 per cent in 2012 to just 19 per cent from 2017 onward. In addition, the tax rate on dividends paid out to shareholders in limited companies was lower than that paid on profits of LLP or partnership members.

Shareholders in many limited company law firms have therefore benefitted from a noticeable tax advantage over recent years. This has allowed them to enjoy a greater share of their firms’ profits than partners in traditional partnerships or LLPs.

Hazlewoods warned this tax advantage is set to end for many firms from April 2023, with the UK set to raise corporation tax to 25 per cent for companies with profits over £250,000. That means the number of incorporated law firms is likely to level off as incorporation becomes much less attractive for partners in law firms.

Firms that have incorporated for tax reasons in the last decade are likely to find it quite difficult and potentially expensive to change back to being partnerships, said Andy Harris, a partner at Hazlewoods who advises law firms on their structures. He explained that while there are tax reliefs for partners moving to limited company status, the same is not true for firms looking to go the other way.

Changing from a limited company to an LLP will require the consent of any bank that has made a loan to the company. The bank is likely to require personal guarantees from partners for outstanding loans in order to agree to it.

Harris commented: "The limited company has become the structure of choice for UK law firms over the past decade after more than 200 years of partnerships.

“We always advise lawyers not to let tax alone decide how they structure their firms. However, the low levels of corporation tax in the last ten years have made incorporating very attractive for many law firm partners.

“That is now changing and we’re likely to see fewer firms becoming limited companies. 25% corporation tax is much less appealing than 19%, and dividend tax rates are going up, so the case for incorporating is far less compelling than it used to be.

“Those firms considering switching back to an LLP structure need to consider the consequences. Banks are likely to want personal guarantees from the firm’s partners for any loans the firm has outstanding. There’s a good chance that not all of them will be happy to agree to that, especially those individuals who have never been the owners in a partnership.”