Limited Partnership and Limited Liability Partnership Explained
- Published: 7 May 2024
- 12 min read
- Starting a Company
Gabi Bellairs-Lombard
Business Writer
Gabi creates content that inspires. She's spent her career writing compelling website copy, and now she specialises in product marketing copy. As the voice of our products and features, Gabi makes complex business finance and accounting topics easy to understand. Her top priority is ensuring that her words impact and inspire her readers.
Choosing between a limited partnership (LP) and a limited liability partnership (LLP) is fundamental for your business’s legal framework, tax situation, and leadership roles. An LP clearly divides actively managing general partners and a limited partner only investing in the business. In contrast, each partner in an LLP has a say in business decisions without assuming full liability.
This guide navigates the features and implications of limited and limited liability partnerships, illuminating your path to your enterprise's most suitable partnership structure.
Key Takeaways
- Limited Partnerships (LPs) have at least one general partner with unlimited liability and limited partners with liability capped at their investment amount. Limited Liability Partnerships (LLPs) only have limited liability partners, all of whom can participate in making business decisions.
- A Limited Partnership divides partner duties. General partners in limited partnerships handle the day-to-day operations, and the limited partners only contribute capital. The limited partnership business structure is popular in real estate and investment funds for its tax advantages and protection over personal assets.
- A professional services small business benefits from establishing an LLP. This structure protects individual partners against other partners’ malpractice or negligence, management flexibility, and shared responsibilities. They can also opt to form a limited liability company.
What Is a Limited Partnership?
In a Limited Partnership (LP), two or more parties come together to conduct business. At least one general partner must bear full liability. Meanwhile, any limited partner is only liable up to their investment amount. The general partner bears the management burden and is personally liable for debts, while limited partners contribute capital without having the power to make business decisions.
This structure facilitates raising capital for financial investment while capping the liability of the limited partners. Limited partnerships are also taxed as a pass-through entity, allowing each member to report company income on their personal tax returns, offering tax advantages to investors. Therefore, it is popular in sectors including real estate and hedge funds.
General partner responsibilities
Significant responsibility rests on the shoulders of general partners in an LP. They have full management control of the business, making all the key decisions and overseeing operations. Yet, with control comes considerable risk. General partners have unlimited liability for the partnership's debts, which means they are directly responsible for any financial obligations the business cannot meet.
In a general partnership, the extent of this responsibility is such that the general partners’ assets could be used to settle the business’s debts. It’s a heavy burden that comes with the power to control and shape the business’s direction.
Limited partner involvement
On the flip side, we have limited partners. Their liability in a limited partnership is capped at their investment amount, protecting them against being personally liable for business debts. Limited partners typically do not participate in the management of the limited partnership. Their lack of involvement preserves their liability protection and enables them to concentrate on their investor role.
Furthermore, income or losses from limited partnerships are classified as passive for tax purposes, reflecting the passive investment role of limited partners. Any limited partnership must also include at least one partner as a general partner and can have multiple limited partners.
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What Is a Limited Liability Partnership?
Unlike limited partnerships, Limited Liability Partnerships (LLPs) provide personal liability protection to all partners involved. Limited partners in limited partnerships are not personally liable for their partner's malpractices or problems, allowing professionals to conduct business collectively while guarding their personal assets from other partners’ actions.
In an LLP, there are no general partners, and all partners enjoy the privilege of limited personal liability for business debts. This means they can engage in business decisions without the risk of unlimited liability, a freedom not typically enjoyed by general partnerships in an LP. For these reasons, limited liability partnerships are particularly suitable for a service-based small business, such as a law or accounting firm.
Limited liability protection for all partners
All partners in an LLP receive personal liability protection. In jurisdictions where LLPs are available, partners are not held accountable for the misconduct or negligence of other partners. Therefore, this structure provides each partner with a shield against liabilities arising from the actions of other partners or the company's employees.
However, limited liability only extends to a partner's involvement. In other words, while an LLP protects the limited partners from their associates' actions, each limited partner is still personally liable for their behaviours.
Popular among professional service providers
LLPs are particularly attractive to licensed professionals, including lawyers, accountants, and others in similar fields, especially if the business entity is a small business. The structure’s suitability to their business needs makes it a popular choice. While any business can form a limited partnership, only certain professions, such as law and accounting firms, can form a limited liability company.
The reason behind their popularity is the limited personal liability LLPs offer, which is essential for risk management within these industries. Furthermore, LLPs have a more flexible management structure. Partners can be appointed or depart with minimal disruption without impacting the business’s capital structure or incurring tax consequences.
Limited Partnerships vs. Limited Liability Partnerships: Key Differences
While limited partnerships and limited liability partnerships may sound similar, they are significantly different. In an LP, general partners have unlimited personal liability, while the liability of a limited partner is capped at their investment. In contrast, LLPs protect all partners from direct liability, including those yielded from another partner's malpractice and the company's debts.
This difference in liability is tied to the roles and responsibilities of the limited partners and general partners in these two structures. Management and control duties in a limited partnership generally belong to the general partner, whereas limited partners serve primarily as sole investors. LLPs, on the other hand, give all partners the potential to participate in management without affecting their liability.
A third difference is taxation. LPs are taxed as pass-through entities by default, meaning they are not subjected to corporate income taxes or any other entity-level tax. Instead, the tax liability is passed to the partners when they file their allocated shares of profits on their personal tax returns as personal income or self employment tax. On the other hand, LLPs have more flexibility in taxation options because they have the option to file as a corporation.
Personal liability distinctions
A key difference between LPs and LLPs is the extent of each partner's personal liability. In a limited partnership, general partners have full management control and are subject to unlimited liability. They are personally responsible for all business debts and obligations. Meanwhile, limited partners have their liability capped at their investment in the company to protect personal assets. In return, limited partners must refrain from active management in exchange for this protection. Engaging in control or operational activities can make them personally liable for the company's actions.
In contrast, all partners in an LLP are granted limited liability protection. This enables them to actively participate in management without risking their personal assets and protects them from being personally liable for the wrongful acts of others in the company.
Management control variations
Another key difference between LPs and LLPs is the distribution of management control. A general partner in limited partnerships has exclusive business management control. They make all the key decisions, oversee operations, and are accountable for the outcomes.
In contrast, LLPs offer shared management responsibilities among all partners. Each limited partner in an LLP usually has the right to manage the business and make business decisions. This shared control allows for more flexibility and collaboration among partners in decision-making.
Tax implications
The tax implications of the two business structures also vary. A limited partnership is not taxed as a legal entity. Instead, business income is reported on each partner's tax returns. General partners in an LP are subject to self-employment taxes on their portion of the partnership’s earnings because they are actively involved in managing the business.
On the other hand, limited partners in an LP typically do not pay self-employment taxes on their share of the earnings, as their income is not considered ‘earned income’ due to their lack of active involvement in the business. However, all LLP partners must pay self-employment taxes on their distributive share of the profits, as the LLP structure does not distinguish between general and limited partners.
To stay compliant, research Hong Kong's internal revenue code and the different requirements for each structure. For example, you may need to pay self-employment tax if you are a limited partner in an LP.
Choosing the Right Structure for Your Business
Choosing the right business structure is crucial and can mould the trajectory of your business journey. When selecting a suitable partnership structure such as an LP or LLP, it is important to consider your investment strategy, industry norms, location, and potential partner roles. The legal structure chosen for a business determines the following:
- Tax obligations
- Liability risks
- Abilities to fundraise for initial investment
- Internal organisation
Altering your business structure at a later stage can be complex, with potential tax implications and even the possibility of business dissolution. Therefore, making an informed decision from the onset is crucial, and it may involve comprehensive research and consultation with an attorney.
Assessing business needs
Evaluating several key factors is imperative when deciding on the most suitable legal structure for your business. These include:
- The flexibility allowed by the structure
- Its complexity
- The liability it imposes on the partners
- How it affects control over the business
- Its ability to raise capital
Another crucial factor in choosing business partners is assessing shared values and common goals. Some key considerations include:
- Defining roles and responsibilities
- Discussing contributions of time, money, and effort
- Conversations about financial management strategies
- Attitudes towards income contributions and debt
These discussions are essential in assessing the needs of a business partnership structure.
The chosen business partnership structure affects various aspects such as resource contributions, profit distribution, personal liability, and responsibilities over the company's day-to-day operations.
Legal and financial advice
Consultation with professional advisors is recommended as you navigate the process of choosing a business structure. These experts can help ensure your chosen structure aligns with your business needs. A small mistake in this critical decision can lead to costly consequences, so it’s worth investing time and resources to get professional advice.
Personalised guidance from a Certified Public Accountant (CPA) and a business law specialist can be invaluable for making informed decisions about your business's legal structure. They can help you navigate the complex legal landscape and ensure your business is set up correctly.
Choose the right company structure with confidence
Unsure which company structure is best for your business? Our team of experienced advisors in Hong Kong is here to guide you through the decision-making process.
Choose the right company structure with confidence
Unsure which company structure is best for your business? Our team of experienced advisors in Hong Kong is here to guide you through the decision-making process.
Steps and Requirements for Forming an LP or LLP
Once you've determined the appropriate business structure, the next step is its establishment. Registering a limited partnership (LP) or limited liability partnership (LLP) in Hong Kong involves filing with the relevant authorities, typically through the Companies Registry. Local regulations and statutes govern LP and LLP formation in Hong Kong.
A comprehensive partnership agreement is essential when setting up an LP or LLP. This document outlines the partnership's operational procedures, decision-making processes, and partner relations.
State registration and filing fees
Registering an LP or LLP in Hong Kong requires submission to the Companies Registry. This entails completing forms detailing the partnership's particulars, such as its name, purpose, registered address, and partners' details.
Additionally, registration fees may apply. The actual fee may based on the partnership's jurisdiction and nature, as well as different partnership business structures. Adhering to the prescribed procedures and timelines is essential to ensure smooth registration and compliance with regulatory requirements.
Need help? Osome's company formation experts can safeguard you through the process.
Drafting a partnership agreement
One of the foundational aspects of setting up an LP or LLP is drafting a comprehensive written partnership agreement. This document outlines the partnership's operational procedures, decision-making processes, and partner relations. The agreement covers various aspects, including partners' rights and obligations, profit-sharing arrangements, management responsibilities, and dispute-resolution procedures.
Limited partnerships require two or more partners. At least one person must serve as the general partner in an LP. Meanwhile, two or more persons can be considered investment-only limited partners. For LLPs, all partners are limited partners and are not personally liable for each other's behaviour.
Finally, seeking legal advice during the drafting process ensures your partnership agreements align with legal requirements and safeguard the interests of all partners.
Obtaining licenses and permits
In addition to registration, limited partnerships must obtain relevant permits and licenses to operate legally in Hong Kong. The specific requirements vary depending on factors such as the business's location, industry sector, and nature of operations. For example, Hong Kong LPs must obtain a Business Registration Certificate from the Inland Revenue Department to comply with local business operation standards. If you prefer to file your LLP taxes as a legal entity, you will also need to incorporate your LLP, which then allows you to file taxes as a business entity.
LPs and LLPs must thoroughly research and understand these requirements to ensure regulatory compliance and avoid potential penalties or legal issues. If you need help navigating the legal waters of the two structures, reach out to Osome's company formation team. Our experts will help you choose the best partnership structure and walk you through the entire process.
Real-World Examples of LPs and LLPs
Looking at some real-world examples can help better understand LPs and LLPs. During the 1970s and 1980s, LPs were commonly used for specific projects such as films. Industries like filmmaking, real estate, and natural resource exploration frequently utilize the LP structure to carry out their operations.
On the other hand, Hong Kong officially introduced the LLP structure in the Legal Practitioners (Amendment) Ordinance in 2012. The ordinance came into operation in March 2016. Up until then, most law firms in Hong Kong were operating either as sole proprietors or general partnerships. In a general partnership, every partner is jointly and personally liable for all business debts, liabilities, and obligations with each other.
Nowadays, many firms opt for the LLP structure to protect themselves from business debts and from being held personally responsible for the actions taken by others. Similarly, wealth management companies often adopt the LLP structure to combine individual expertise and task division with the benefit of reduced partner liability. The LLP structure is also particularly attractive to medical practices which require protection for individual partners against another partner's negligence, a scenario often encountered in malpractice claims.
Summary
The decision to structure a business as an LP or LLP is significant, with far-reaching implications for liability, taxation, and management control. LPs and LLPs offer unique advantages that make them suitable for different business scenarios. While LPs provide an attractive avenue for investors to limit their liability while contributing capital, LLPs offer professionals an opportunity to enjoy limited liability while actively participating in management. By understanding these structures’ nuances, one can make an informed decision that aligns with their business goals and industry norms.
FAQ
What is the main difference between a Limited Partnership and a Limited Liability Partnership?
The main difference between a Limited Partnership and a Limited Liability Partnership is that in an LP, general partners have unlimited liability and full management control. In contrast, limited partners are considered silent partners who do not participate in the day-to-day operations. In return, their liabilities are capped at their investment level. In an LLP, however, all partners have limited liability and shared management control.
Are there tax differences between an LP and an LLP?
Yes, LPs are taxed as pass-through entities, while LLPs have more flexibility in taxation options.
Why are LLPs popular among licensed professionals?
Before the introduction of LLPs, most professional small businesses are formed under the general partnership structure where all partners are equally liable for all business debts and decisions made. Limited partnerships gained popularity once introduced because they provide limited personal liability that general partnerships lacked. Limited partnerships also offer more flexibility within the management structure, which is crucial for risk management within these industries.
What is the role of a partnership agreement in an LP or LLP?
Any LLP or limited partnership requires a partnership agreement. This document establishes terms, roles, partner responsibilities and operational procedures for profit distribution and sharing losses. In an LP, a general partner oversees the actual company operation, whereas limited partners serve as capital sources only. Meanwhile, any limited partner in an LLP has full management control.
What steps are involved in forming an LP or LLP?
To form an LP or LLP, you must register with the state, create a partnership agreement, and acquire the required licenses and permits. These steps are crucial for establishing your business as an LP or LLP. Hong Kong has its own rules for company registration, so be sure to thoroughly research the process or seek professional help before starting the registration.
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