Originally published in Private Client Practitioner, Guernsey Report 2011
There is a new trend for family offices to use the private equity model of limited partnerships instead of the traditional trust structure. Tom Carey, Partner at Carey Olsen, examines how this type of structure can be set up and why Guernsey Limited Partnerships offer family offices greater flexibility and control of their assets.
Over recent years a number of measures introduced in the UK have altered the way in which family offices manage their affairs. Traditionally family offices have looked, almost exclusively, to trust structures to look after their assets, estate planning and preserve their wealth for future generations and these structures have served their purposes well.
Trust structures were an easy way of managing the family office affairs. They were considered more flexible and nimble than other structures for the preservation and investment of family wealth. However, as the investments have diversified and the tax implications have increased they have become less attractive.
Guernsey Limited Partnerships are tax transparent for Guernsey tax purposes and provide tax efficient means of achieving the same result as a trust except with the added benefit of allowing the limited partner a greater degree of control over the partnership than would be permitted in the UK.
Disadvantages of a trust
The gloss has definitely been taken off the trust vehicle particularly for a UK domiciled settlor who, when setting up a trust, incurs an immediate 20 percent inheritance tax (IHT) charge on the initial capital above the nil rate band (presently at £325,000). There are also ongoing charges – of around 6 percent on each tenth anniversary of the trust and there are now exit charges that didn't exist in the trust vehicles.
The new tax implications mean family offices are turning to Family Limited Partnerships (FLP) as an alternative. FLPs provide the flexibility of a trust but without the IHT charges and there are additional benefits.
As one would expect, an FLP is a limited partnership in which the contributor puts in assets in return for a limited partnership interest. It is likely that the contributor's interest will allow rights to the majority of the income and capital of the FLP.
Typically the FLP will have a general partner who will manage the FLP but only have a small share in its profits. The limited partners are taxed directly on income and capital gains attributable to their share which means the FLP is transparent from a tax perspective. It provides significant IHT benefits because the limited partner's interest can be transferred as a potentially exempt transfer (the transfer is tax free providing the contributor survives for seven years). So the contributor can gift the limited partner share in a tax efficient way but still have controls built in – not something that can be done with a trust.
Benefits of using the island
Guernsey is firmly in the spotlight when it comes to FLPs. The limited partnership law in Guernsey is flexible and modern and offers a number of advantages over other jurisdictions' limited partnership laws. For instance, capital can be returned to any of the limited partners at any time in the life of the partnership subject to solvency. In the UK you can only return capital at the end of the life of the partnership.
Usually limited partners cannot get involved in the conduct or management of partnerships but under Guernsey law there are a number of safe harbours. Most important is that a limited partner can be a director or a shareholder of the general partner. Limited partners can be consulted and can advise the general partner on the business of the partnership. They can vote in various matters in respect of the assets or business or administration of the partnerships without losing limited liability status. That means that family offices can retain elements of control in the partnership.
Another valuable feature is that typically the Guernsey Financial Services Commission will not treat family limited partnerships as collective investment schemes that would be subject to regulation. Providing the interests in the limited partnership are held by family members, or employees, and there are restrictions in place with regards to transfers to third parties – the commission will not seek to classify the limited partnership as a collective investment scheme which would require their approval.
Regulation costs time and money and there is significant benefit where a workable structure suits the family office, can be set up quickly and does not incur unnecessary costs. There is also the benefit of confidentiality. Family offices are notoriously protective of their privacy and in Guernsey a limited partnership does not need to file an agreement thereby securing a high level of confidentiality.
FLPs have only really come into being in the last couple of years but Guernsey has been at the forefront of the establishment of these vehicles and has the high level of expertise to advise accurately and with experience.
For more information about Guernsey's finance industry please visit www.guernseyfinance.com.
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.