UK TAX
A new era
begins…
Jay F Krause and Sophie Dworetzsky consider the use of Family Limited
Partnerships
O
n 22 March 2006, Gordon Brown,
then Chancellor and now Prime
Minister of the UK, ushered in a
new era. The day, of course, was
Budget Day, and the new era one subjecting
trusts, used in Britain since the middle ages
as a means of protecting family wealth across
generations, to a punitive tax regime.
To recap, notwithstanding that the Budget
Day proposals were significantly modified,
in large part courtesy of vigorous lobbying
by STEP, Finance Act 2006 generally subjects
lifetime transfers into trusts to an immediate
inheritance tax (IHT) charge at 20 per
cent and to six per cent charges every ten
years. These changes apply equally to UK
domiciliaries and deemed domiciliaries. Also
effective from 6 April 2006, holdover relief is
no longer available on transfers into settlor
interested trusts, such that capital gains
tax (CGT) may apply at up to 40 per cent on
transfers into trust. The combined effect
could lead to an effective tax of up to 60 per
cent on an initial transfer into trust.
These new tax charges arise, in large part,
from a misconception that UK domiciled and
deemed domiciled individuals utilised trusts
primarily to effect income and capital gains
tax benefits, rather than to provide a safety
net for younger generations.
In reality, as readers are well aware,
the situation is rather different. Trusts
originated as a means of protecting family
assets while the leader of the family was
unable to attend to such matters, and
tax had no part to play in matters. Their
modern use is more sophisticated, but in
essence not wildly different: the primary
benefit remains sophisticated succession Whether a CGT
planning by enabling the transfer of charge applies
wealth across generations, while to a gift of FLP
conferring asset protection. interests depends
While the tax regime may have changed upon the nature
dramatically, the need for succession of the FLP assets.
planning remains. Inspired by an American No CGT charge
concept, Family Limited Partnerships (FLPs) applies to gifts
offer a tax neutral vehicle for collectivising where the FLP
family investments, transferring family wealth holds cash or
and protecting assets. As FLPs are income assets eligible
and capital gains tax transparent, they do not for business
lend themselves to facilitating the abuses asset taper relief
perceived to be offered by trusts. (BATR) (provided
‘holdover relief is
Overview elected for BATR
While numerous variations abound, a assets). For FLPs
typical FLP structure might involve family comprised of other
members contributing assets to a specially assets, a gift of
tailored limited partnership in exchange for a limited partner
limited partner interests and a family owned interest would trigger CGT on the interest
company subscribing for the general partner transferred; this compares favourably
(GP) interest. The senior generation could with trusts, in which holdover relief is not
then gift as much or as little of their limited available for transfers into settlor interested
partnership interests to younger generations trusts and thus CGT would be triggered on
as and when they see fit. the entirety of the amount transferred into
The gifts are ‘potentially exempt transfers’ trust.
(PETs) and will fall completely outside the With respect to subsequent income
senior generation’s chargeable estates and gains derived by the FLP, the partners
for IHT purposes, provided the transferor are subject to tax on an arising basis
survives seven years from the gift (each on income and gains accruing with
year after the first three, the portion of the respect to their partnership share.
PET subject to IHT reduces by 20 per cent The partnership essentially is a ‘look
annually so real savings are achieved from through’ for UK tax purposes.
the start of year four). Limited partners’ liabilities in terms of
Almost any type of business or investment partnership obligations are limited to the
asset can be transferred to a FLP. No IHT or extent of their capital contribution, provided
CGT arises on the contribution to the FLP. they take no part in the active management
NOVEMBER/DECEMBER 2007 | THE STEP JOURNAL 25

of the partnership. In order to ensure this
liability protection remains in place for
the individual partners, and for reasons of
practicality, the FLP will be managed by the
GP with the limited partners having little,
if any, say in day-to-day management of
partnership affairs.
Comparison to trust structures
Certain opportunities remain for avoiding
the initial 20 per cent IHT charge on
transfers into trust, including transfers of
(i) the nil rate band amount, (ii) ‘normal
expenditures out of income’ and (iii) assets
eligible for business property relief (BPR).
Unfortunately, these opportunities are of
somewhat limited applicability and still
generally result in a six per cent IHT charge
every ten years on assets in trust and/or an
exit charge upon distribution.
Transfers into FLPs do not incur IHT
charges, and assets within FLPs are not
subject to the six per cent, ten-yearly
charge or to exit charges as FLPs are not
‘settlements’ for the purposes of Inheritance
Tax Act 1984 and, therefore, not subject to the
IHT regime for trusts.
Regulatory considerations
FLPs are collective investment schemes (CIS)
for the purposes of the Financial Services and
Markets Act 2000 (FSMA).
Accordingly, initial promotion should
be undertaken by an entity authorised to
promote unregulated collective investment
schemes to private individuals.
On an ongoing basis, almost all
partnership management and investment
activities should either be delegated
to persons with the necessary FSA
authorisations or delegated offshore.
Alternatively, in certain limited
circumstances, the GP itself may wish to
undertake certain of these functions after
obtaining the necessary FSA permissions.
In practice, the primary aspects of the
partnership management role are twofold
– namely (i) investment management
(Investment Advisor) and (ii) day-to-day
management over distributions, redemptions
and all other non-investment matters
(Operator). These roles can be bifurcated
allowing the option of either a single provider
of both investment and management services
or separate providers. The GP retains the
ability to replace both the Operator and
Investment Advisor.
Key provisions
While each FLP should be tailored to address
specific family needs and concerns, a
non-exclusive list of certain key provisions
typically of interest includes:
Eligible investments. FLPs can invest in
any asset class including stocks and bonds,
hedge and private equity funds, derivatives,
real estate, unit trusts, insurance bonds, etc.
and may be of particular interest for family
businesses anticipating a major liquidity
event, such as an IPO or business sale.
As FLPs are entirely ‘look through’ for UK
tax purposes, they provide an ideal umbrella
structure for holding tax efficient structures,
such as OEICs and AUTs, which provide CGT
deferral and insurance wrappers to provide
income tax deferral.
Distributions. FLPs provide significant
flexibility in dealing with partnership income
and gains. Such amounts can either be
re-invested or distributed according to the
needs of the partnership. However, unlike a
trust structure, it would not be appropriate to
look to the individual needs of the partners in
making distribution decisions.
Because of the transparent nature of
limited partnerships for UK tax purposes,
each partner will be subject to income
tax (IT) or CGT, as the case may be, in
line with income or gains arising to their
partnership interest. These tax liabilities
can be met through annual distributions
of an amount equal to the liability being
made to the partners.
Transfer restrictions. Most FLP
agreements would contain customised
restrictions prohibiting transfers of
partnership interests to anyone other than a
specified class of persons.
Redemptions/winding up. Again, a
great deal of flexibility exists in tailoring
provisions governing redemption of a
partner’s interest and the winding up of the
entire partnership itself.
Choice of jurisdiction. FLPs may
be established as English limited
partnerships or as limited partnerships
under another jurisdiction’s limited
partnership law.
English limited partnerships require
registration of the partners’ names and
NOVEMBER/DECEMBER 2007 | THE STEP JOURNAL
UK TAX
contributions along with registration of
transfers of limited partner interests.
These requirements generally can be
satisfied through the use of nominee
arrangements, thereby protecting the
identity of the partners. However, should
additional privacy be preferred, a limited
partnership based in another jurisdiction
without similar disclosure requirements
may be desirable.
Additionally, English limited partnership
law generally prevents a partner from
withdrawing capital contributions prior
to the winding up of the partnership.
While this may be viewed as desirable in
some instances, it also may be viewed as
inflexible in other circumstances. Again,
a limited partnership based in another
jurisdiction without similar withdrawal
limitations may be desirable.
Resident deemed domiciliaries. FLPs
based outside of England and Wales
may be of particular interest to resident
deemed UK domiciliaries, many of whom
have taken a great deal of care to structure
their investments outside the UK. While
in principle an English FLP could work
equally well, use of an ‘offshore’ FLP may
be consistent with maintenance of offshore
investments and investment structures.
Asset protection. We understand that
FLPs offer asset protection at least equal
to that associated with trusts. As noted,
it is not appropriate for the GP to look to
the individual needs of partners in making
decisions. The GPs discretion is narrow
and looks instead to the investment
purpose of the FLP. A disgruntled partner
seeking to force access to all or part of
his share, or to dissolve the FLP, would in
practice most likely need to show abuse
or bad faith by GP. Under the envisaged
bifurcated management structure this
would be most unusual.
A new era begins…
To return to the beginning, 22 March 2006
marked the end of one era and the dawn of a
new one. There is every reason to think that
FLPs may very well come to be a hallmark of
the new era that commenced that day.
Jay F Krause TEP is a principal at Withers Worldwide
and Sophie Dworetzsky is senior assistant in wealth
planning at Withers Worldwide
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