A Family Limited Partnership (‘FLP') is a potentially tax efficient wealth transfer structure in a number of scenarios including where:
- UK deemed-domiciled US citizens wish to transfer assets to their US citizen children;
- UK deemed domiciled parents transfer assets to the family-at-large where each family member has a different tax residence;
- Families wish to invest collectively to preserve greater purchasing power and provide for centralized asset management.
A typical FLP allows the younger generations to receive gifts of limited partner interest which protect the underlying investment assets from being directly accessed by the younger generations while providing a general partner (or their appointee) to manage the underlying assets and make decisions about the timing of distributions to the limited partners. This is beneficial where there is a desire to assist children in the management of family assets, allowing them to take advantage of a parent's investment experience to grow the family wealth while learning to manage the family assets for themselves in the future.
Persons who are domiciled or deemed domiciled in the UK and who settle trusts for the benefit of their families can find the value of inheritable wealth reduced by punitive upfront charges to UK inheritance tax (‘IHT') – at rates of 20% initially and then of up to 6% every 10 years, and on the extraction of value from the trust. An FLP, on the other hand, is not a ‘settlement' for IHT purposes and is not subject to the upfront and ongoing charges. The transfer of value to family members through an FLP is a potentially exempt transfer and does not trigger an IHT charge so long as the transferor survives the transfer by seven years. For US federal estate and gift tax purposes, the transfer (if structured properly) is respected as a gift and will diminish the transferor's lifetime estate and gift tax exemption, which currently stands at $11.7m in 2021.
Care is needed in relation to the basis of the assets being transferred however. For UK resident individuals who are either not on the remittance basis of taxation or who transfer UK situs assets, the transfer will trigger a UK capital gains tax (‘CGT') charge (to the extent the assets being transferred have built-in gain). The transfer will not cause however, the gain to be taxed (or the basis uplifted) for US tax purposes. This could give rise to a tax mismatch in future years.
While the form of an FLP is quite different to that of a trust, there are significant parallels:
- an FLP separates economics from control;
- the role of the general partner (‘GP') is similar in some respects to that of the trustee of a trust (in that certain decision making rests with the GP); and
- the limited partners (‘LPs') are akin to the beneficiaries of a trust as their ability to receive distributions from the FLP is only at the discretion of the GP or other authorized third party.
The fundamental differences are that the LPs own their LP interest, report their share of underlying FLP income and gains and the LP interests are assets in their estates. Also the GP must have an economic interest in the FLP (although this is generally quite small).
Depending on the family's overall facts and circumstances, it may be possible for the family member funding the partnership and gifting the limited partner interests to also serve as the GP. If the family member funding the FLP is US, the GP powers, if any, must be limited to prevent US federal estate tax inclusion of those assets in the GP's estate. Certain powers (e.g. distribution, liquidation, and amendment of the FLP agreement) may not be solely held with the GP interest in those circumstances. These powers should be held by an independent manager who the GP can remove/appoint and who will hold only the powers that the GP cannot hold.
An FLP is typically transparent for income tax in the US and UK and for UK CGT. The partners would be treated as owning the partnership assets directly in line with their partnership interests and the amount of tax that each partner pays will be dependent on the amount of taxable income or gains allocated to them under the partnership agreement rather than any amount which might be distributed. A partners' tax liability will depend upon the partner's own tax profile however, any income arising to an LP who is the minor child of a UK resident transferor will be taxed in the hands of the transferor (in that situation capital gains continue to be taxed in the hands of the minor child).
It is important to note that US case law has made it clear that it is essential that the formalities of the FLP must be respected at all times, as in the case of any other business arrangement between third parties. The FLP also must have a substantial and legitimate non-tax purpose. As mentioned above, this can include developing an investment philosophy and educating the next generation, in addition to establishing mechanisms of operation in hopes of avoiding family disputes regarding investments (such as regular meetings) and mechanisms to resolve such disputes (i.e. clear rules on how decisions are made).
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.