A limited partnership created under the Limited Partnerships Act 1907 (the 1907 Act) has unlimited legal capacity and can be used to carry on any form of lawful business including dealing with the development of, and investment in, UK real estate.

Its most attractive feature as a vehicle for the holding of UK real estate is its ability to combine the flexibility and tax transparency of a partnership with limited liability for its investors.

Key features

  • Investors (limited partners) have limited liability.
  • A limited partnership is transparent for tax purposes - attractive to "tax-privileged" investors.

Introduction

  • Limited partnerships are simply a special sort of partnership. All the normal rules applicable to ordinary partnerships apply to limited partnerships, except as modified by the 1907 Act.
  • The main rules applicable to partnerships generally are contained in the Partnership Act 1890 (the 1890 Act) and a large volume of associated case law.
  • For a partnership to exist, two or more persons (a "person" includes a company) must be "carrying on a business in common with a view of profit"[1] . Simple joint ownership of assets does not, of itself, create a partnership, whether the owners share profits from the use of the common asset or not.
  • A partnership (including a limited partnership formed under the 1907 Act) is not a separate legal entity in the same way, as for example, a company[2]. In law, when action is taken by or against a partnership, it is being taken by or against the underlying partners collectively.
  • If a partnership exists, then the partners collectively are known as a "firm"[3]. Any act of any partner which is done for the purposes of "carrying on in the usual way business of the kind carried on by the firm" [4] will generally bind the firm collectively and each partner. Consequently, each partner is liable jointly with all others for all debts and obligations of the firm incurred while the person is a partner. This extends to liability for any loss or injury to third parties caused by any partner acting in the ordinary course of the business of the firm, or for misapplication of a third party's money by the firm or a partner.
  • Partnership property is held on trust for the partners, to be held and applied exclusively for the purposes of the partnership and in accordance with the partnership agreement.
  • The partners owe a general duty of good faith to each other in relation to the business of the partnership.
  • Modification of the normal rules for limited partnerships
  • The 1907 Act provides for the creation of limited partnerships. The essential distinctive feature of a limited partnership is that it has two categories of partners - limited partners and general partners. There must be at least one partner of each category to make up a limited partnership.
  • The general partner(s) are liable without limit for all debts and obligations of the firm in the usual way. The limited partners must, at the time of entering into the partnership, contribute (in cash or in kind) partnership capital. However, they have no liability for the debts or obligations of the partnership beyond the amount so contributed. A limited partner may not withdraw its capital from the partnership during the life of the partnership, on pain of being liable for the firm's obligations up to the amount withdrawn.
  • For this reason, it is common for limited partners to inject a nominal amount of capital, with the bulk of their contribution to the assets of the partnership being by way of loan.
  • A limited partner is prohibited from taking part in the management of the partnership business, on pain of becoming automatically liable for all debts and obligations of the firm while it does so. It is permitted to inspect the firm's books, "examine into the state and prospects of the partnership business, and may advise with the partners thereon" [5]. It has no power to bind the firm.
  • A limited partnership must be formally registered as such at Companies House, in default of which the limited liability of the limited partners is lost.
  • There is no restriction on the number of partners who can participate in a limited partnership.
  • There are certain obligations to publish accounts of a partnership where all the partners (or, in the case of a limited partnership, all the general partners) are (directly or indirectly) limited companies[6].

Key benefits of limited partnerships

  • Limited partnerships provide a means of potentially delivering a combination of tax transparency and limited liability.
  • While the tax rules are fairly complex, their essence is that each partner is taxed separately on its share of the income and capital gains of the partnership. If a partner is also a member of a group of companies, then there is the potential for using the group relief provisions to shelter partnership profits from tax using other group losses, and vice versa.
  • In some circumstances it may be possible to avoid having to show any partnership debt on the balance sheet of investors in the partnership.
  • The obvious use of a limited partnership is to permit a "sleeping partner" to inject finance into a project without becoming involved in its management. However, it can also be used either as a joint venture vehicle for two or more parties who wish to be actively involved in a project, or as a syndication vehicle.
  • There is a great deal of flexibility in how a limited partnership can be constituted. The partners can set whatever rules they like on matters such as sharing of profits (where capital and revenue profits can be treated differently), dealing with shares in the partnership and how the partnership business is to be conducted.
  • A limited partner may be able to borrow against the security of its share in the partnership, although it remains true that few banks are familiar or comfortable with this type of lending.

Limited partnerships and the Financial Services and Markets Act 2000 (FSMA)

  • If each partner in a limited partnership carries on a business other than an "investment business" (within the meaning of FSMA) and it becomes a partner for commercial purposes related to that business, then the limited partnership will not be a "collective investment scheme" (CIS) for the purposes of FSMA. In any other case, it is extremely likely that the partnership will amount to a CIS.
  • The significance of this is that FSMA requires anyone who establishes, operates or winds up a CIS to be appropriately authorised under FSMA. Failure to obtain authorisation may result in criminal sanctions and the unenforceability of agreements made by that person. The presumption is that the general partner(s) of a limited partnership are "operating" the partnership for these purposes. However, by way of an appropriate agreement with a person authorised by the Financial Services Authority it is possible to delegate responsibility for much of the management of the partnership, thereby rebutting that presumption. This avoids the need to obtain and maintain a separate FSMA authorisation for the general partner(s), which is a fairly onerous process.
  • There are companies in the market, authorised by the Financial Services Authority (generally associated with the large firms of chartered surveyors), who are prepared to provide this service - for a fee.

Context for use of limited partnerships

Apart from the straight commercial joint venture structure mentioned above, typical situations in which a limited partnership might be used in relation to UK real estate include the following:

  • A joint venture between a developer and an institution which holds property ripe for major redevelopment. The institution wishes to retain a significant interest in the property, and the developer is prepared to put up some cash and also its development expertise to acquire an equity stake in the project and carry through the redevelopment to enhance its value. Once the redevelopment is completed, the parties may contemplate selling down part of their investment to other investors.
  • A situation where the institutional owner of a large property or real estate portfolio wishes to release some of its cash investment and reduce (but not eliminate) its equity stake in that real estate. The real estate can be placed in a limited partnership structure with part of the acquisition cost funded by bank borrowing and part by contributions from other investors who become limited partners.
  • A vehicle for the creation of a portfolio of UK real estate investment, where non-UK resident limited partners want to retain the advantages of falling outside the UK tax net but do not want to exclude UK resident investors from participation in the venture.

There are many other possible variations on the theme.

Taxation

  • One of the principal attractions of a limited partnership is that it is generally transparent for tax purposes[7]. Each partner can participate in the limited partnership in such a way that the tax charge is no higher than if it had carried out the business itself.
  • This does not mean, however, that the profits arising to him/it from a limited partnership will be exempt. Profits are taxed as if the business was carried on by the partners. There is no special tax treatment or relief available to limited partnerships beyond those available to partners in partnership.
  • A limited partnership is required to submit an annual tax return (although it does not pay any tax).

Taxes on income

  • The profits of a limited partnership are calculated in accordance with the tax rules applying to partners. Where a partner is subject to income tax, tax is calculated by reference to the income tax rules. Where a partner is subject to corporation tax, those rules apply to the calculation of profit.
  • An income tax payer will be liable for profits arising for the accounting period ending in the relevant tax year. The partners are taxed under self-assessment directly as partners in partnership. Partners who are corporation tax payers have their profit arising from the limited partnership calculated under the corporation tax rules and will be taxed according to the accounting period of the relevant partner.
  • Individuals are subject to income tax, as are foreign companies (unless they are carrying on a trade in the UK through a branch or agency, in which case they are also subject to corporation tax) and foreign individuals. It should be possible to arrange matters so that the non-UK resident partner's liability to tax on income is limited to basic rate income tax. UK-resident companies are subject to corporation tax on their profits derived from the business of the partnership.

Taxes on capital gains

  • Each partner is treated as owning an appropriate share of the underlying limited partnership assets. Any transaction by a limited partnership involving one of its assets is treated as a transaction by each of the partners in relation to its share of the overall asset(s)[8].
  • Upon a disposal of real estate by a limited partnership, each partner is treated as making a disposal of its fractional share of that real estate. Any capital gain (subject to usual allowances and reliefs) crystallising on that disposal is charged to tax in the hands of the partner, dependant upon its particular tax position. A non-UK resident partner will not suffer UK tax on any such gain unless it is carrying on a trade in the United Kingdom through a branch or agency. Investment in real estate is not a trade for these purposes.
  • There are anti-avoidance provisions designed to re-categorise as income any capital gains arising on a disposal of real estate acquired or developed with the sole or main aim of realising a capital gain on disposal [9]. These rules should not apply where the objective of acquiring or developing the real estate is to create a source of income and to achieve medium-to-long term capital appreciation.

Value added tax (VAT)

  • While a partnership is generally treated as a VAT-able entity [10], HM Revenue & Customs regard only the general partner(s) of a limited partnership to be carrying on its business[11]. Accordingly HM Revenue & Customs require the general partner(s) only to register for VAT (in its own name if it is the sole general partner or in the firm's name if there is more than one general partner) if the general partner is treated as making taxable supplies in excess of the registration threshold. Where it is only making supplies of UK real estate and has exercised the option to tax[12], a general partner should recover all input VAT incurred by it.

Stamp duty land tax (SDLT)

  • A limited partnership will be liable to SDLT (at a rate up to 4%[13]) where: the limited partnership acquires land for chargeable consideration (in money or "money's worth"); land is transferred to (or from) the limited partnership by (or to) a partner (or person becoming or ceasing to be a partner) of the limited partnership; or there is a transfer of a partner's interest in the limited partnership where the limited partnership is a property-investment partnership[14]. The limited partnership would be a property-investment partnership if its sole or main activity is investing or dealing in interests in land[15]. Where a limited partnership acquires real estate, the partners of the limited partnership are jointly and severally liable for any SDLT liability.

Stamp duty

  • Following the introduction of SDLT, stamp duty will only be due (at a rate of 0.5%) in respect of transfers of an interest in a limited partnership to the extent (if at all) that the limited partnership holds stock or marketable securities[16].