What a Law-Firm Service Company Is (and Is Not)
A service company is a separate company that holds a law firm's "back office" and recharges the cost of it to the trading LLP. In practice it does one or more of three things: it employs the support and administrative staff and supplies them to the LLP; it owns or leases the premises and sub-lets to the LLP; or it owns the IT, equipment and library that the firm uses. Whatever the precise mix, the defining feature is the same: the company provides services or assets and is paid a charge for them.
That charge, the recharge, is what makes a service company a cost-recharge entity. It is paid a commercial price for a function. It does not share in the firm's profits, and it is not a member of the LLP. This is the line to hold throughout, because it is the single feature that separates a service company from the structure it is most often confused with.
The contrast is with a corporate member of the LLP. A corporate member is admitted to the partnership and takes a profit share, retained at the corporation-tax rate, and it is policed by the mixed-membership partnership rules. A service company takes a cost recharge for services and assets it provides, and is not a profit-sharing member at all. We cover the corporate-member route separately, in our guide to a corporate member of a law-firm LLP and the mixed-membership rules. This page is about the cost-recharge entity, and it runs along three threads: the VAT on the recharge, the arm's-length pricing requirement, and the mixed-membership boundary.
Why Firms Use a Service Company
It helps to be candid about why firms adopt the structure, because the honest rationale is operational, not a tax trick. There are four common drivers.
The first is limited liability and ring-fencing. Holding staff employment, or premises and asset ownership, in a separate company keeps those liabilities away from the trading entity, which can matter for risk management as a firm grows. The second is pension and benefit planning: where the company employs the support staff it can run occupational or benefit arrangements for them cleanly. The third is cost allocation: where a single back office serves more than one partnership or office, a service company gives a clean, defensible basis for sharing those costs.
The fourth driver is historic. Service companies were once used for employment and NIC structuring, but anti-avoidance has closed most of those angles, so the modern case for a service company is operational and risk-based, not a tax saving. We say that plainly because firms sometimes arrive expecting the structure to cut their tax bill, and it generally will not. What it does well is separate functions, contain risk and tidy up cost-sharing. The tax job is then to run it correctly, not to manufacture a saving from it.
The VAT Headline: a Recharge Is a Standard-Rated Supply
The first pressure point is VAT, and the starting position is straightforward. When the service company recharges the LLP for staff, premises or IT, it is making a supply of services, and a supply of legal-sector overheads carries no VAT exemption. So the recharge is standard-rated at 20%.
That means, without a VAT group, the service company charges 20% VAT on its recharge to the LLP. Because a law firm makes mostly taxable supplies (legal services are standard-rated), the LLP can usually recover that VAT as input tax. So in the ordinary case the VAT is a cash-flow and administration cost rather than an absolute one: it is charged, then recovered. But two qualifications matter. If the LLP has material exempt income it may be partially exempt, restricting recovery on overheads attributable to the exempt activity. And even where it is fully recovered, the VAT adds invoicing, timing and compliance burden to every recharge.
State it plainly: a service company's recharge to the LLP is a standard-rated supply unless the two are VAT-grouped. The staff-supply position has its own detail (VAT is due on the full charge including recharged salary and employer costs, the old staff-hire concession having been withdrawn from 1 April 2009), which we cover in the wave-2 sibling on the secondment of solicitors and the VAT on supply of staff. For the underlying VAT position on the firm's own work, see VAT on legal services.
The VAT Group Solution: Intra-Group Supplies Are Disregarded (VATA 1994 s.43)
The clean answer to the recharge-VAT problem is a VAT group. Where the service company and the LLP form a VAT group, supplies between them are disregarded for VAT. VATA 1994 s.43(1) provides that "any business carried on by a member of the group shall be treated as carried on by the representative member" and that "any supply of goods or services by a member of the group to another member of the group shall be disregarded".
The practical effect is that the recharge carries no VAT and no VAT invoice is issued for it. VAT Notice 700/2 confirms that intra-group supplies are normally disregarded for VAT, that VAT need not be accounted for on them, and that no VAT invoices must be issued in respect of them. The group accounts for VAT as a single taxable person: it files one VAT return through a representative member, who handles the group's external supplies and input tax.
So for a firm that runs a service company, the VAT-group decision is the central one. Inside a group, the staff, premises or IT recharge simply falls away for VAT purposes. Outside a group, the recharge is standard-rated and must be invoiced and (usually) recovered. The group removes the recharge VAT entirely, which is why it is the usual recommendation where the entities are eligible to group.
Who Can Form a VAT Group, and the 2019 Extension to LLPs (VATA 1994 s.43A)
The reason a VAT group works for a law firm at all is a 2019 change to the eligibility rules, and it is worth understanding precisely. Originally a VAT group was confined to bodies corporate under common control, which left an LLP (not a body corporate) unable to group with its service company.
That changed from 1 November 2019, when Finance Act 2019 amended VATA 1994 s.43A to broaden eligibility. The section allows two or more UK bodies corporate to be group members where "(a) one of them controls each of the others, (b) one person (whether a body corporate or an individual) controls all of them, or (c) two or more individuals carrying on a business in partnership control all of them", each being a UK body corporate "established or has a fixed establishment in the United Kingdom". The 2019 extension means non-corporate entities, individuals and partnerships including an LLP, can now join a VAT group where they control the body corporate. VAT Notice 700/2 confirms that individuals and partnerships can join a VAT group if they control the UK body corporate and are established, or have a fixed establishment, in the UK. The detailed control mechanics now sit in s.43AZA.
The practical upshot is the point the structure turns on: an LLP that controls its service company can VAT-group with it, so the recharge is disregarded. Before 1 November 2019 that was impossible for an LLP, because only bodies corporate could group. The post-2019 extension is precisely what lets the LLP-plus-service-company structure remove its recharge VAT through grouping.
The Arm's-Length, Commercial-Recharge Requirement
The second pressure point is pricing, and it does not go away inside a VAT group. The recharge must be at arm's length, a commercial charge, typically cost plus a mark-up, for two reasons.
The first is commercial: the company needs a genuine commercial return on the function it performs, or it is not really a service company at all. The second is statutory: connected-party charges have to be commercial for the tax to work. The transfer-pricing rules in TIOPA 2010 Part 4 apply the arm's-length principle to transactions between connected parties, and the wholly-and-exclusively test (ITTOIA 2005 s.34 for the LLP's deduction, or CTA 2009 for the company) requires the charge to be incurred for the purposes of the trade. A cost-plus mark-up is the typical model that satisfies both.
The warning is that a non-commercial recharge is challengeable from both ends. A recharge set too high (to shift profit into the company) or too low (to strip profit out of it) can be adjusted under transfer pricing, the LLP's deduction can be disallowed on wholly-and-exclusively grounds, and, as the next section explains, profit parked in the company can be reallocated under the mixed-membership rules. Critically, within a VAT group the VAT falls away but the direct-tax arm's-length requirement does not: even when there is no VAT on the recharge, the deduction and the company's income still have to be commercial. Grouping solves the VAT question, not the pricing question.
Service Company Versus Corporate Member: the Mixed-Membership Boundary
This is the boundary that most often trips firms up, and it is the cleanest way to see what a service company is. A corporate member has a profit share in the LLP and is policed by the mixed-membership rules in ITTOIA 2005 ss.850C to 850E (in force from 6 April 2014). Those rules reallocate any profit share above the company's appropriate notional profit (broadly, a genuine return on the capital it contributed plus an arm's-length charge for the services it provides) back to the individual partners who have the power to enjoy it.
A service company earning only a genuine arm's-length recharge for services and assets it really provides is not a profit-sharing member. It is paid a commercial price for a function, not allocated a slice of the firm's profit. So in the ordinary case it falls outside s.850C: there is no profit share to reallocate, because the company is not a member taking profit.
The risk reappears in only one situation: where the firm parks profit in the service company. If the recharge is inflated so that the company holds what is really partner profit, the substance starts to look like profit diversion rather than a commercial recharge. At that point the mixed-membership rules (and the general anti-abuse rule) can bite, and the recharge is exposed on transfer-pricing and wholly-and-exclusively grounds as well. The line is therefore clear: an arm's-length cost recharge is outside the rules; parked profit is at risk. Keep the company a genuine cost-recharge entity, and it stays on the right side of the boundary.
Corporation Tax in the Service Company and Getting Money Out
Whatever profit the service company makes (its mark-up) is taxed at company level, and getting that profit out to the partners costs further tax. This is why a service company is rarely a net tax saving.
The company pays corporation tax on its profit: 19% small-profits rate on profits up to £50,000, 25% main rate above £250,000, with marginal relief in between (FY2025 and FY2026). Extracting the money then triggers a second layer. A dividend is taxed on the recipient at 8.75% (ordinary), 33.75% (upper) or 39.35% (additional) in 2025/26, and from 6 April 2026 at ordinary 10.75% and upper 35.75% (the additional rate of 39.35% is unchanged), with a £500 dividend allowance. A salary triggers employer (secondary Class 1) NIC at 15% on pay above the £5,000 secondary threshold from 6 April 2025. A loan to a participator triggers a s.455 charge, tracking the dividend upper rate at 33.75% on loans made before 6 April 2026 and 35.75% on or after, repayable under s.458.
The conclusion for planning is to keep the company's profit (the mark-up) modest and the structure operational. A service company that tries to accumulate profit invites the mixed-membership rules and the double layer of corporation tax plus extraction tax; one that recharges a genuine commercial cost-plus and pays out little keeps the tax friction low. For the underlying extraction comparison, see the law firm partnership tax guide.
Premises, the Option to Tax and Capital Allowances
Where the service company owns assets, two further points arise. If it owns the premises and charges rent or a recharge to the LLP, the starting position is that supplies of land are VAT-exempt, which blocks recovery of input VAT on buying or refurbishing the building. An option to tax under VATA 1994 Schedule 10 makes the company's supply of that property standard-rated, so the input VAT on the purchase or refurbishment becomes recoverable. The option must be notified to HMRC within 30 days, has a six-month cooling-off period, and otherwise lasts 20 years. Note that if the company and LLP are VAT-grouped the intra-group rent is disregarded, but the option still governs recovery on the third-party spend.
Where a partially exempt entity spends £250,000 or more (VAT-exclusive) on land or a building, the Capital Goods Scheme spreads the input-VAT recovery over a 10-interval adjustment period (5 intervals for a single computer item costing £50,000 or more), recalculating recovery as the taxable-use mix changes.
On fit-out and IT the company can claim the usual capital allowances: the Annual Investment Allowance of £1m, the special-rate pool at 6% (for integral features), and the main-rate writing-down allowance at 18% (reducing to 14% from 1 April 2026 for corporation tax under Finance Act 2026 s.28). Full expensing (100% on new main-rate plant) is available to companies. The detailed mechanics of the option to tax and the allowances sit in our separate VAT and capital-allowances guides.
SRA and Practical Governance
The service company is not itself an SRA-regulated legal entity. It provides services to the firm; it does not deliver regulated legal services, so it is not authorised by the SRA and it does not hold client money. Client money stays in the LLP's client account under the SRA Accounts Rules 2019, ring-fenced from the firm's own money and from the service company entirely.
What the structure must not do is blur the firm's regulatory lines. The recharge should be a real, documented, arm's-length arrangement: a written services or recharge agreement, regular invoicing (or VAT-group accounting where grouped), and proper board governance for the company. If the structure ever gave a non-lawyer control over the legal practice itself, that would raise ABS and licensing questions under Part 5 of the Legal Services Act 2007, with the SRA as licensing authority. A back-office service company that simply supplies staff, premises and IT does not, but the governance should make that distinction obvious.
Worked Examples
These sketches are illustrative only, to show how the threads connect, and are not advice on any particular firm.
Example 1: a staff service company, with and without a VAT group. A service company employs the firm's support staff and recharges the cost to the LLP. Without a VAT group, the recharge is a standard-rated supply at 20%: the company adds VAT, and the LLP recovers it as input tax (assuming it is fully taxable), so it is a cash-flow and administration cost rather than an absolute one. With a VAT group (the LLP controls the company and is eligible to group under s.43A since 1 November 2019), the recharge is disregarded under s.43(1), no VAT and no VAT invoice, and the group files one return through its representative member. The point in a line: the recharge is standard-rated unless you VAT-group, and an LLP can group with its service company since November 2019.
Example 2: an arm's-length recharge versus parked profit. A service company supplies IT and premises and charges the LLP cost plus a commercial mark-up. This is a genuine arm's-length recharge: the company's modest mark-up is taxed at corporation tax, and the mixed-membership rules do not apply because the company is not a profit-sharing member. Contrast a version where the recharge is inflated so the company holds what is really partner profit: now the substance is profit diversion, exposed to the mixed-membership rules (s.850C) and the general anti-abuse rule, and the LLP's deduction is challengeable on transfer-pricing and wholly-and-exclusively grounds. The point in a line: a commercial cost-plus recharge is fine, and parking partner profit in the company is not.
Example 3: a premises-owning service company and the option to tax. The service company buys and refurbishes the firm's premises and recharges rent to the LLP. Land supplies are VAT-exempt, blocking input-VAT recovery on the refurbishment, so the company opts to tax (notifying HMRC within 30 days) to recover the VAT on the spend. The Capital Goods Scheme tracks the recovery over 10 intervals if the spend is £250,000 or more (VAT-exclusive), and the company claims the Annual Investment Allowance and special-rate allowances on the fit-out. If the company and LLP are VAT-grouped, the intra-group rent is disregarded, but the option to tax still governs recovery on the third-party spend. The point in a line: owning premises means thinking about the option to tax and the Capital Goods Scheme, even inside a VAT group.
A Specialist Note
A service company is a legitimate, common structure, but it earns its keep operationally, not as a tax saving. Two points decide whether it is run correctly. The VAT point is whether you VAT-group: outside a group the recharge is standard-rated at 20%, while inside a group, available to an LLP and its service company since 1 November 2019, it is disregarded under VATA 1994 s.43. The direct-tax point is whether the recharge is genuinely arm's-length, a commercial cost-plus that satisfies transfer pricing and wholly-and-exclusively and keeps the company outside the mixed-membership rules. The figures in this guide carry their 2026 dates; rates and thresholds change, so confirm the current position before you act. If your firm runs, or is considering, a service company, we review the VAT-group decision, the recharge pricing and the structure as a whole so that it does what you want without straying onto the wrong side of any of these rules.