What is a Family Limited Partnership (“FLP”)?

An FLP is a legal entity created by a family to manage assets and minimise tax liabilities. FLPs came into use after the changes to the inheritance tax treatment of trusts in 2006. The goal of an FLP is to have (so far as possible) the advantages offered from a trust (control over assets, taking assets outside of the settlor’s estate for inheritance tax purposes) without the drawbacks of the inheritance tax charges under the relevant property regime.[1]

To create an FLP, one family member or a few family members can pool their assets into a partnership with one or more general partners who manage the partnership with other limited partners who may contribute capital but have no management responsibilities.

The partnership owns the assets and the general partners have control over how the assets are managed and distributed.

What type of partnership is most appropriate?

There are many different types of partnerships which could in principle be used for an FLP. Partnerships generally fall into three categories:

General partnerships;

Limited partnerships (including private fund limited partnerships); and

Limited liability partnerships (LLPs).

I consider LLPs first as they are least likely to be the most appropriate vehicle for an FLP and so can be dismissed relatively quickly.

LLPs

LLPs are partnerships established under the Limited Liability Partnership Act 2000 (“LLPA”). They are used for professional or trading partnerships enabling the members involved in the business of the LLP to limit their liabilities for the LLP’s debts and obligations. They are used for trading partnerships, and as investment partnerships in some hedge fund structures, but they are not the best choice for FLPs.

LLPs have drawbacks in terms of administration and publication which a person looking to use an FLP is unlikely to desire.

LLPs are required to register at Companies House under section 3 LLPA.

The majority of the law applicable to LLPs is modified company law rather than partnership law. An LLP must disclose information about itself on the public register including details of its registered office, its members, its accounts and reports and its charges. All of these regulatory requirements are both time consuming and add further scrutiny.

Limited Partnership

A limited partnership is a partnership registered under and regulated by the Limited Partnerships Act 1907 (“LPA 1907”).

A limited partnership has two types of partners: general partners who manage the business and bear unlimited liability to creditors (section 2 LPA 1907); and limited partners whose liability to creditors is limited and who do not manage the business. Each limited partner will contribute a sum at the start of the partnership (though it can be incredibly small) and shall not be liable for the debts or obligations of the partnership beyond the amount contributed.

If a limited partner takes part in the management of the business, they lose their limited liability (section 6 LPA 1907).

A limited partnership’s duration is governed by the rules for general partnerships and therefore a limited partnership may be:

For a fixed term, in which case it is automatically dissolved at the expiration of the term (section 32(a) of the Partnership Act 1890 (“PA 1890”));

For a single adventure or undertaking which is dissolved at the termination of it (section 32(b) PA 1890); or

A limited partnership at will and so may be terminated at any time by notice given by a general partner (but not a limited partner) (sections 26(1) and 32(c) PA 1890 and section 6(5) LPA 1907).

There are some features of a limited partnership which would make it attractive for the purposes of an FLP including that:

A limited partner may only assign their share to another with the consent of the general partners (section 6(5)(b) LPA 1907). This is important because one of the key aspects of using an FLP is the option to prevent certain beneficiaries from getting immediate access to assets / cash.

A limited partner is not entitled to dissolve the partnership by notice (section 6(5)(e) LPA 1907). A general partner concerned about how a specific limited partner may want to use funds would not want them to be able to dissolve a partnership by notice.

But these advantages can be obtained by a general partnership with appropriate provisions in the partnership deed.

A limited partnership with an individual as the general partner is not required to file annual accounts with Companies House (though it is obviously best practice to ensure that accounts are drawn up). A qualifying partnership, being a partnership with each general partner being a limited company or an unlimited company with members consisting of limited companies, is required to file accounts (regulation 3 of the Partnerships (Accounts) Regulations 2008).

Whilst a limited partnership is likely to be a good option for an FLP, it does not come without any cost:

There will be administrative costs associated with a limited partnership including registration (section 5 LPA 1907) and notification of changes to the partnership.

A limited partnership is likely to be a collective investment scheme (“CIS”) though it may be possible to avoid this. This will be considered in more detail below.

In the event that the limited partnership in question is a CIS, consideration might be given to designating the limited partnership as a private fund limited partnership (“PFLP”). PFLPs are slightly more flexible versions of limited partnerships. In a PFLP, limited partners are able to take on greater roles in the partnership without losing their limited liability status. Dissolution in the event of there being no general partner is easier. They also have a lessened administrative burden when there are changes to the partnership. Ultimately, these changes may not be desirable from the perspective of the person setting up the FLP but it is an option available to them.

General Partnership

A general partnership is a partnership as defined in section 1(1) PA1890:

(1) Partnership is the relation which subsists between persons carrying on a business in common with a view of profit.

A general partnership can be created orally, but that does not mean that it should be. A partnership agreement should be drawn up in writing setting out how the partnership is to work and the rights and obligations of the partners.

In a general partnership, each partner will have unlimited liability. A general partnership does not have to be registered and whilst it should keep accounts, it is not required to publish them unless each member is a limited company (unlikely in the LLP context).

Unlike with limited partnerships, in general partnerships, every partner may take part in the management of the partnership business (section 28(5) PA 1890). Given this, a general partnership should not be a CIS.

The key disadvantages of using a general partnership as opposed to a limited partnership is that you cannot limit the involvement of the partners in the management of the partnership business in the same way that you can with a limited partnership whilst also getting the limited liability. Given that a key concern with using an FLP will be limiting who can manage the assets, it is unlikely that a general partnership will be the preferred route unless the risk of being a CIS is seen as too great or burdensome.

Will there be a Collective Investment Scheme (“CIS”)?

If the vehicle chosen ends up being a CIS, then different regulatory requirements will apply.

A CIS is defined in section 235 of the Financial Services and Markets Act 2000 (“FSMA”):[2]

235 Collective investment schemes

(1) In this Part “collective investment scheme” means any arrangements with respect to property of any description, including money, the purpose or effect of which is to enable persons taking part in the arrangements (whether by becoming owners of the property or any part of it or otherwise) to participate in or receive profits or income arising from the acquisition, holding, management or disposal of the property or sums paid out of such profits or income.

(2) The arrangements must be such that the persons who are to participate (“participants”) do not have day-to-day control over the management of the property, whether or not they have the right to be consulted or to give directions.

(3) The arrangements must also have either or both of the following characteristics—

(a) the contributions of the participants and the profits or income out of which payments are to be made to them are pooled;

(b) the property is managed as a whole by or on behalf of the operator of the scheme.

(4) If arrangements provide for such pooling as is mentioned in subsection (3)(a) in relation to separate parts of the property, the arrangements are not to be regarded as constituting a single collective investment scheme unless the participants are entitled to exchange rights in one part for rights in another.

(5) The Treasury may by order provide that arrangements do not amount to a collective investment scheme—

(a) in specified circumstances; or

(b) if the arrangements fall within a specified category of arrangement.

Given that one goal of an FLP is to avoid all the participants having day to day control over the management of the property, there is a high risk that the vehicle used could amount to an unregulated CIS.

There are certain exemptions from being a CIS. In particular, Paragraph 4 Schedule 1 to the Financial Services and Markets Act 2000 (Collective Investment Schemes) Order 2001/1062 provides that:

Schemes not operated by way of business

Arrangements do not amount to a collective investment scheme if they are operated otherwise than by way of business.

If there is an unregulated CIS, then the operator will be subject to FCA regulation if they are carrying on their activities in relation to the CIS by way of business. This is further elaborated on in Financial Services and Markets Act 2000 (Carrying on Regulated Activities by Way of Business) Order 2001/1177. Article 3 provides that a person is not to be regarded as carrying on by way of business certain activities unless he carries on the business of engaging in one or more of such activities. These activities include dealing in investments as principal (article 14 of the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001/544 (“the Regulated Activities Order”)), dealing in investments as agent (article 21 of the Regulated Activities Order), and managing investments (article 37 of the Regulated Activities Order).

The FCA has provided guidance in the Perimeter Guidance Manual at 14.5 on when a regulated activity is being carried on “by way of business”. Whether or not a particular person will meet the requirements will depend upon their individual circumstances. The factors that need to be taken into account include:

the degree of continuity;

the existence of a commercial element;

the scale of the activity;

the proportion which the activity bears to other activities carried on by the same person but which are not regulated

It is a criminal offence to operate a CIS unless it is properly authorised by the Financial Conduct Authority section 19 FSMA 2000.

To avoid the requirements of CISs, therefore, one can:
- opt to ensure that each partner does have day-to-day control over the management of the property – this could be possible in a general partnership; or
- attempt to come within the exemptions to be authorised.
Alternatively, in a limited partnership, the general partner can properly delegate the day-to-day control over the management of the assets to an FCA authorised investor to operate the CIS. This includes delegating the power to make investment decisions for the FLP and to promote, establish, operate and wind up the FLP. Whilst delegating these aspects will create an additional cost in running the FLP, it can avoid the risk of sanctions from the FCA.

Are there unit trust risks?

Section 237(1) FSMA defines a unit trust scheme as “a collective investment scheme under which the property is held on trust for the participants, except that it does not include a contractual scheme”.

As addressed, there is a risk that a limited partnership can be a CIS. It does not necessarily follow, however, that it is a unit trust scheme.

In the first instance, the property would not be held on trust just for the participants (as defined in section 235(2) FSMA) in circumstances where the general partner(s) also have an interest in the FLP.

Further, it is arguable that the relationship between the general partner(s) and the limited partners is not that of one where the property is properly characterised as held on trust. Partnership property cannot be held by an English partnership directly and therefore it will usually be held by a nominee on trust for the partnership. But this may not constitute a unit trust on the grounds that the trust is a conveyancing device and not part of the scheme.

For tax purposes, the treatment may not ultimately be different if the FLP is both a limited partnership and a unit trust as there is provision made for both income tax purposes (the Income Tax (Definition of Unit Trust Scheme) Regulations 1988 and for capital gains tax (the Capital Gains Tax (Definition of Unit Trust Schemes) Regulations 1988 to treat the unit trusts in such cases as limited partnerships for those taxes.[3]

This exemption would not apply to general partnerships, but general partnerships are unlikely to be CISs given that the partners should have day-to-day control and so therefore they will not be unit trust schemes.

Is there a “business”?

If the intention is for the FLP to be operating as a partnership, then it will be necessary to ensure that it is carrying on a business with a view to profit. FLPs will be operating as investment businesses. This is sufficient to constitute a “business” for the purposes of creating a partnership.

HMRC agree (PM120100):

‘Business’ is defined as including ‘every trade, occupation or profession’. So ‘business’ is a very wide term, embracing almost every commercial activity, and is much wider than trade or profession alone. It includes a business of making investments. Simply making an investment is not enough, there has to be sufficient organisation, continuity to make the activity a business.

Is it fatal to the tax planning if there is a not a “business”?

In the event that the FLP is not in fact carrying on a business, then the assets of the FLP would be owned by the various parties as co-owners rather than as a partnership. Under the assumption that the partnership has been set up primarily for tax purposes, then this will not be a huge difficulty. The primary tax treatment (as laid out below) will be the same. There are some tax differences which should be borne in mind, but these tax differences will not usually have a huge impact on the decisions made by persons who are setting up FLPs for succession planning purposes.

These differences include:
- Different inheritance tax situs rules apply;
- Different remittance rules apply;
- Different rules may apply to income losses; and
- A Spouse partnership falls outside section 836 ITA 2007 which applies to income arising from spouse co-ownership.

Who can be a partner?

Individuals or separate legal entities such as companies can be partners.

Adults may enter into the partnership and become partners. In deciding whether or not to join the partnership, the adults may need to consider taking independent advice.

Minors cannot enter into the partnership agreement themselves. The donor may consider instead establishing a bare trust for the benefit of the child to which a gift can be made and then entering into the partnership as the trustee as a bare trust.

When they are 18, the arrangements can continue or the child can join the partnership as a partner.

The donor and their spouse can be a partner.

Consideration can be given to using a company with limited liability as the general partner with chosen individuals/the donor(s) as directors/shareholders of that company to retain control over how the assets are managed. If a limited partnership is used, care should be taken if limited partners are also going to be shareholders or directors of a corporate general partner.

Can FLPs be dissolved?

The FLP will continue for the life of the partnership. Unlike with trusts, there are no perpetuity periods. The partnership agreement can specify when the partnership will come to an end. The partners can decide to wind up the partnership under the terms of the partnership agreement or they can apply to court to do so. It could last for many years.

A court may order a dissolution of a partnership in various cases including “Whenever in any case circumstances have arisen which, in the opinion of the Court, render it just and equitable that the partnership be dissolved” (section 35(f) PA1890).

Changes to the partnership?

The partners will need to specify what to do in the event of a death of a partner or beneficiary of a bare trust and include it in the partnership agreement.

The partnership agreement can be drafted to provide flexibility in terms of partner resignation and addition.

The partnership deed should provide that a partner cannot assign their interest without the consent of all the partners. This will prevent a family member from being able to sell their share to get access to cash immediately thereby defeating the purpose of the arrangement in the first place.

Can profits be distributed during the lifetime of the partnership?

The general partner / donor can specify whether or not there will be distributions. It will be necessary to distribute enough of the income/gains in any given tax year to ensure that the various partners are able to pay any tax due by them.

One key advantage of an FLP is that the general partner can have some flexibility in determining how to deal with distributions, who should get what share of the income etc. There are numerous scenarios which could play out around distributions which could put the partnership at risk of a petition to dissolve from one or more of the partners.

General partners can also consider lending partnership funds to partners instead of distributing them outright.

Taxation of the partnership

Inheritance tax

The gift of the property to the partnership would in principle be a potentially exempt transfer (section 3A of the Inheritance Tax Act 1984 (“IHTA”)). As such, provided the donor survives seven years, it will fall outside of their inheritance tax estate.

If the donor decides to have a share in the FLP then this will form part of their estate for inheritance tax purposes. Unless otherwise provided for in the partnership deed, the valuation of this interest will be by reference to the value of the appropriate share of each asset (Gray v IRC [1994] STC 360 and section 160 IHTA). If this occurs, the donor will need to consider appropriate planning for their share.

An FLP is not a settlement for inheritance tax purposes. It is therefore not within the relevant property regime.

The reservation of benefit rules (sections 102ff of the Finance Act 1986) need to be watched, though ultimately they are unlikely to cause significant problems.

There will not be a reservation of benefit provided that under the terms of the partnership deed, the donor enjoys no benefit from the gifted partnership share and possession and enjoyment is assumed by the donee:
- The donor will enjoy no benefit from the gifted property provided that any income they receive will be by virtue of the partnership share they have retained.
- The donees will have all the possession and enjoyment that is possible under the partnership arrangement – to that end, it may be helpful to distribute some income in the first year after setting up the partnership.

There is no reservation of benefit merely because the donor retains control over investment policy and the distribution of profits. Strictly speaking, the donor should not take remuneration for managing the partnership (but in practice HMRC do not take the point). This point may also be relevant in determining whether or not there is a CIS.

Capital Gains Tax

A partnership is transparent for capital gains tax purposes (section 59 of the Taxation of Chargeable Gains Act 1992 (“TCGA”)).

The transfer of assets to a partnership is a disposal on which chargeable gains would be subject to capital gains tax in accordance with Statement of Practice D12.

Holdover relief would in principle be available in the case of business or agricultural property. In the event that the property would qualify for either relief, however, it is unlikely that an FLP would be needed (unless there are concerns about the loss of either of those reliefs).

Whilst the FLP is ongoing, partnership gains accrue to the partners individually and are taxed according to their share (Statement of Practice D12).

Where minor children of a donor are partners then gains will be charged on the children not the donor. Where there are many partners (e.g. grandchildren) then the partnership allows efficient use of their annual exemptions. When the capital gains tax annual exempt amount was £12,300 then this was a clear benefit of using an FLP. The annual exempt amount has, however, reduced to £6,000 for the 2023/2024 tax year and will reduce further to £3,000 for the 2024/2025 tax years and beyond. Given this, the capital gains tax advantages have lessened.

In the event that the partnership is wound up, there will be no disposal on the transfer of partnership assets to the partners in specie on the winding up of a partnership.

Income Tax

A partnership is transparent for income tax purposes (section 848 of the Income Tax (Trading and Other Income) Act 2005 (“ITTOIA”)). This means that tax is charged on the partners in accordance with their shares.

Unless the FLP is structured as an LLP (unlikely), then the salaried member rules (sections 863Aff ITTOIA) will not apply. Where these rules do apply, the members of the LLP are treated as employed by the LLP as opposed to as partners of the LLP and are taxed as such.

An FLP will constitute a settlement for the purposes of Chapter 5 Part 5 ITTOIA (the settlement provisions). The creation of a partnership can be regarded as an arrangement. There would be the element of bounty in an FLP as usually there will be a donor or donors giving shares in the FLP (including of the income from the investment business) to others.

The donor/settlor will be subject to income tax on the income arising to the FLP if it arises during their life from property in which they have an interest (section 624 ITTOIA). Given this, the settlor will only be liable for income tax to the extent that they hold a share in the FLP as they would have retained an interest in that property. They will not be subject to income tax on all the income of the FLP.

The donor / settlor will also be subject to income tax on income paid to or for the benefit of an unmarried minor child (section 629 ITTOIA). As such, while the children of the donor are under 18, there would be no income tax advantage.

In contrast, for adult children of the donor, an FLP can offer income tax advantages similar to that offered by interest in possession trusts. A partnership is better for income tax purposes than a discretionary trust as it avoids the complex and expensive provisions relating to the trust rate of tax.

Advantages

There are several potential advantages to using a FLP for tax planning in the UK, including:
- Inheritance tax advantages: The primary benefit of an FLP is that it can reduce inheritance tax as the assets held in the partnership are not considered part of a donor’s estate for inheritance tax purposes, which can result in significant tax savings.
- Flexibility and control: The donor is able to retain an element of control over the assets, while at the same time allowing other partners to benefit from the income generated by those assets. This allows for flexibility in terms of managing and distributing assets.
- Minimal income tax and capital gains tax savings: There may be some income tax or capital gains tax advantage to using an FLP. These advantages are, however, getting less and so are unlikely to be the driving force behind creating an FLP.

Disadvantages

Whilst there are potential advantages to using an FLP, there are also some potential disadvantages to consider:
- Cost: Setting up an FLP needs professional advice. The financial costs associated with setting up an FLP will vary depending upon what type of firm one uses. An FCA authorised individual may be required to operate the FLP and deal with investing the assets. This could be costly. Ultimately, whether or not it is worth setting up an FLP will come down to the individual factors affecting each donor including, but not limited to, the amounts involved, the reasons behind setting up the FLP, the circumstances of the intended beneficiaries, etc.
- Limited usefulness for some assets: Not all assets are suitable for transfer into an FLP. For example, a holiday home used regularly by the family would not be a suitable asset to place in an FLP. An FLP is not necessary for assets which already qualify for business property relief or agricultural property relief. Investment funds are really the only appropriate assets.
- Inheritance tax planning of the other partners: The interests in the FLP will be within the other partners’ estates for UK inheritance tax purposes so they will need to plan accordingly. They may need to take their own tax advice to establish what steps they will want to take bearing in mind the partnership agreement and their own circumstances.

Further Considerations

Any well run partnership will need to ensure that they keep proper accounts. This should not be difficult given that FLPs are not carrying on a trade but instead are carrying on a business investing assets.

It will be important to ensure that the relevant legal requirements are followed depending on what type of partnership is used. Some requirements will be more or less important for tax purposes, but if and to the extent that other requirements need to be complied with (including, for example, the FSMA requirements), then care will need to be taken to ensure that they are complied with.

The partners, and in particular, the general partner, will need to understand the partnership agreement and what their rights and obligations are under it. This will include, for example, understanding precisely what share of the income they are entitled to or what rights they have in relation to any assets which have been given away.

HMRC’s View

This planning is not the sort of planning which HMRC will want to enquire into on the basis of it being egregious tax avoidance.

In relation to FLPs (unlike, say, family investment companies), HMRC has yet to express a particular view. From their manuals all that can be gleaned is:

PM274700 – Family limited partnerships

You may come across Family Limited Partnerships (FLPs). These entities are generally used as an alternative to trusts in inheritance tax planning.

That being said, simply because this may not be the sort of planning that is on HMRC’s radar does not mean that it does not need to be carried out properly. Proper implementation will be important. For example, the donor will need to take appropriate care to ensure that they do not inadvertently create a reservation of benefit problem.

For More

For more information, contact Mary Ashley here.

[1] For more on Family Limited Partnerships, see Chapter 35 of Drafting Trusts and Will Trusts (14^th ed). There is a new edition coming in Autumn 2023.

[2] For more on CISs, see Appendix 7 of Taxation of Non-Residents and Foreign Domiciliaries 22^nd Edition.

[3] For more on the tax treatment of Unit Trusts see Chapter 68 of Taxation of Non-Residents and Foreign Domiciliaries 22^nd Edition.

Family Limited Partnerships