Everybody in the wealth management industry seems to be talking about family investment partnerships at the moment. You might be forgiven for thinking that they are the latest fashion, the ‘must have’ accessory for wealthy families.
In the UK, there is a clear reason for looking closely at the opportunities offered by family partnerships, and that is the changes that were made in 2006 to the UK inheritance tax rules. These changes make it very unattractive for a wealthy UK individual to contribute assets to a trust.
This domestic UK interest in family investment partnerships has sparked a more international debate about the relative merits of partnerships as compared with other, more commonly used asset holding structures, such as trusts, companies, foundations, etc.
Use of partnerships
Partnerships originally came into being as a way for individuals to come together to carry on a business activity, usually a trading venture. In England, a partnership is defined as ‘the relationship which exists between persons carrying on a business in common with a view to profit.’ Mere co-ownership of assets does not amount to a partnership. There must be a business and there must be an intention to make a profit from that business.
Whilst trading partnerships have been common for hundreds of years, the use of partnerships for investment activities is a much more recent phenomenon. It is, however, one which has seen an explosion in the last 20 or 30 years as a result of the emergence and growth of the private equity and real estate fund industries.
With some notable exceptions, the use of partnerships in the wealth management industry is still relatively rare. This may be because the view that has generally been taken is that there are other vehicles which are more suitable when looking at a combination of estate, succession and tax planning issues.
Different types of partnership
Discussions about partnerships in the wealth planning context normally focus on limited partnerships.
This preference is not usually the attraction of limited liability. In the context of the management of a portfolio of investments, this is not usually important. What is attractive is the ability to separate the economic benefits (held by the limited partners) from control (which rests in the hands of the general partner). In this way, the general partner can be seen in a similar way to the trustee of a trust, with the limited partners being analogous to the beneficiaries of a trust.
A limited partnership is not the only option. On the basis that limited liability is not important, there is no reason why a general partnership should not be used. Often a general partnership can be created with less formality and is subject to less regulation than a limited partnership. It is perfectly possible for a general partnership to be created in such a way that one particular partner, or group of partners, has control over the partnership and so much the same effect can be achieved in terms of the split between ownership and control as with a limited partnership.
One potential advantage of a limited partnership over a general partnership is that, in some jurisdictions, it is possible to set up a limited partnership which has separate legal personality. Whether this is important may depend on the purpose for which the partnership is being used, and particular issues relevant to the home jurisdiction of the family that is creating the partnership.
Typical partnership structure
Possible features of the partnership agreement might include the following:
- One or more partners have control over partnership decisions and day-to-day management of the partnership assets, with other partners only playing a passive role
- The passive partners will not be able to require distributions
- The controlling partners may have the right to change profit sharing ratios, rather like the ability of the trustee of a discretionary trust to decide on distributions between the class of beneficiaries
- There may be provision for the interest of a partner to be forfeited in certain circumstances, for example: bankruptcy, divorce or any attempt to sell or borrow on the security of the partnership interest
- Provisions will be needed to deal with what happens on the death of a partner. These provisions can protect against a partner leaving his interest in the partnership to somebody who the other partners would not want to become a partner. If relevant, they can also be drafted in such a way as to bolster any argument that an individual’s interest in the partnership is worth significantly less than his proportionate share of the underlying assets.
Common pitfalls with partnerships
- Regulation – as mentioned above, in some jurisdictions (including the UK), partnerships may fall within the definition of a ‘collective investment scheme’ and the management of the partnership may therefore be a regulated activity. There may be ways of structuring the partnership so as to avoid this. Alternatively, it may be that the partnership can be established in a jurisdiction where this problem does not arise.
- Tax – the tax implications of contributions to, and distributions from, the partnership, as well as the tax treatment of partnership profits, will need to be considered. If the intention is to use the partnership to make gifts (for example, from parents to children), the precise way in which the gift is made may be important in determining the tax consequences.
- Involvement of minors – generally, a minor cannot be a partner in a partnership, or at least it would be unwise for a minor to become a partner. It may be possible to solve this problem by having another person as the partner in the partnership and for that person to hold his partnership share as nominee or bare trustee for the minor. There are, however, differing views as to the consequences and, in particular, whether the principles of repudiation would apply so as to enable the minor to require that his share of the partnership assets is distributed to him on reaching majority.
Comparison with trusts
Alternatively, it may be that the partnership can be established in a jurisdiction where this problem does not arise.
- Tax – the tax implications of contributions to, and distributions from, the partnership, as well as the tax treatment of partnership profits, will need to be considered. If the intention is to use the partnership to make gifts (for example, from parents to children), the precise way in which the gift is made may be important in determining the tax consequences.
- Involvement of minors – generally, a minor cannot be a partner in a partnership, or at least it would be unwise for a minor to become a partner. It may be possible to solve this problem by having another person as the partner in the partnership and for that person to hold his partnership share as nominee or bare trustee for the minor. There are, however, differing views as to the consequences and, in particular, whether the principles of repudiation would apply so as to enable the minor to require that his share of the partnership assets
Conclusion
Trusts and foundations are, generally speaking, likely to have more to offer as tools for wealth planning for wealthy international families.
However, partnerships do have a role to play and may be appropriate in situations where the use of a trust or foundation is either not necessary or gives rise to particular problems, such as tax issues.
Other structures, such as: contractual co-ownership arrangements, family investment companies and life insurance based arrangements, should also be considered.
Where a partnership makes sense, it is worth considering both general partnerships (which have less formality) and limited partnerships which, by their nature, have a clearer segregation between control and ownership.
Like any good fashion, a family partnership will not suit everybody, but if you have got what it takes, it is worth the money.