Offshore opportunities for family limited partnerships
Alicia Lewis, a senior manager in Volaw's Wealth Structuring Group and Tom Amy, head of funds & SPV Group look at the growing interest in an alternative vehicle to trusts for those wishing to mitigate inheritance tax."
Family Limited Partnerships (FLPs), where a senior family member (the donor) contributes capital into a limited partnership and then makes lifetime gifts of limited partnership interests to their younger family members, were identified as an alternative to trusts following the Finance Act 2006. In a similar mechanism to trusts, they allow wealth to be passed on to younger generations in a tax neutral manner without limited partners being able to engage in the management of the FLP.
From March 2006, in the United Kingdom, contributions to a trust generally carried an upfront 20% inheritance tax charge (on value) as well as a 6% inheritance tax charge (on value) every 10 years. FLPs provide an opportunity to avoid such UK tax charges under the following circumstances:
- As long as the donor does not die within seven years of gifting assets to the FLP, such gifts will be free of Inheritance tax; and
- The transfer/gift of assets such as investment portfolios into a partnership would normally trigger a charge to capital gains tax on unrealised latent gains unless holdover relief applies. If a transferred asset had an unrealised loss, there is no inheritance tax or capital gains tax cost.
In addition to these tax benefits, which would apply to all FLPs, further benefits may be available if the FLP is established and managed offshore (such as in Jersey) as a result of the island’s regulatory environment.
A limited partnership must consist of one or more persons who are general partners (who are liable for all debts and obligations of the partnership) (the GP) and one or more persons who are limited partners (who have no liability for the debts or obligations of the partnership beyond the amount which they have agreed to contribute to the partnership). Both general partners and limited partners may be limited liability companies.
A limited partnership will be "fiscally transparent" whereby each of the partners will be separately assessed to tax and the limited partnership will not be dealt with as a separate legal entity. For a Jersey limited partnership, partners who are not resident in Jersey will only be liable to Jersey income tax on the partnership profits and gains if either (1) they arise from investment income (other than bank deposit interest) sourced in Jersey; or (2) they arise from a trade undertaken in Jersey.
Ultimately a limited partnership agreement is a contract, and so the drafting of the agreement can be very flexible. It is possible to ensure that no limited partner can withdraw their capital without the prior consent of all other partners, and/or to draft the partnership agreement so that it cannot be dissolved until after a certain future date. Care must particularly be taken to address the issue of what rights a child has when holding a limited partnership interest upon attaining the age of 18. Clearly it is undesirable for a child to be able to rebut the partnership and simply withdraw his/her share of the partnership capital.
Onshore versus offshore
Whilst FSA regulation is not applicable for a UK limited partnership if it is established as a private structure and therefore not marketed to the public as a collective investment fund (“CIF”), the activity of the GP may require it to obtain FSA approval. Such regulated activities in the UK are likely to be applicable to the FLP structure and include managing, dealing and advising in investments.
Similarly to the UK FLP, where interests in a Jersey limited partnership are offered to a small number of persons (i.e. such as a family group), the limited partnership would not comprise a CIF but instead be a private arrangement. As a result, the Jersey GP would not require specific regulation as a Fund Service Business under the Financial Services (Jersey) Law, 1988 resulting in a straightforward incorporation process with few or no ongoing regulatory obligations.
Further, following the introduction of Unregulated Funds in February 2008, eligible funds (including CIFs) merely need to notify the Jersey Financial Services Commission of their establishment, rather than going through any authorisation process. In relation to a FLP structure, an Eligible Investor Unregulated Fund could be established if investors commit USD1million or more into the limited partnership, or the investor is deemed to be sophisticated. There is no requirement for an Unregulated Eligible Investor Fund to have a Jersey-based administrator or custodian, nor for it to have any Jersey resident directors. There is also no need for Jersey-based auditors to be appointed to the partnership.
Jersey also, for example, prohibits the enforcement of judgements against a limited partnership’s assets, unless the judgement is granted against the GP acting in its capacity as GP. Further, creditors will have no claim against the assets unless the claim relates to the limited partner in his capacity as limited partner.
Finally, an English law limited partnership will also be subject to public disclosure requirements at Companies House and families may not want to disclose the FLP activity.
The cost of establishing, managing and administrating Jersey limited partnerships (including a corporate GP) is generally comparative to that of a trust. Ongoing costs will depend significantly on the underlying asset portfolio, the volume of transactions and the frequency and detail of reporting to partners.
The senior family member donating assets into the FLP will often desire some element of control over the management of the FLP. This can be achieved through ownership of the GP’s shares, although for a Jersey GP a primary concern will be to ensure the mind and management of the structure is demonstrated to be offshore. On the donor’s death, shares could be passed to a trust set up for the benefit of the family bloodline. Were the shares to be passed on to a limited partner, this may jeopardise their limited liability protection and weaken the asset protection served by the FLP.
FLPs should not be designed to hold all the assets of family members, nor to make distributions to support them, as a trust might do. Indeed, any distributions are generally controlled by the general partner and should be made pro rata to all partners. If partnership interests are given to minors, the parents will continue to pay tax on income paid out. Capital gains tax should not be applicable to the parents if the FLP restricts any capital distributions to partners who are minors.
Capital withdrawals will normally be dictated by the limited partnership agreement. It is common for FLP agreements to prevent capital withdrawals until a fixed date or until a limited partner reaches a prescribed age, unless unanimous consent of all partners is provided.
Volaw Trust & Corporate Services Limited
An important element of Volaw's business is the establishment and administration of trusts, companies, limited partnerships and other entities to assist high net worth individuals and their families in estate planning and protecting their wealth. Coupled with this, Volaw has over 20 years of experience of acting as the administrator of investment funds. For any further information on Jersey limited partnerships or investment funds, please contact Tom Amy, Head of Funds & SPV Group (email@example.com) or Alicia Lewis, Senior Manager, Wealth Structuring Group (firstname.lastname@example.org).