Why create a FLP?
Many parents wish to pass down wealth to their children for inheritance tax ('IHT') planning and to maximise younger generations' lower marginal rates of income tax and capital gains tax ('CGT') exemptions. However, parents are often reluctant to make outright gifts, wish to protect assets from their children's possible divorce or bankruptcy, want to retain significant control and hold assets through a coherent, flexible and tax efficient structure. FLPs can provide for just this. In particular, FLPs can be a good estate planning option where the use of a trust is not possible and this is even more the case now following the recent changes to the taxation of excluded property trusts.
What is a FLP?
A FLP is a limited partnership used as a vehicle for holding family assets, whose partners are family members or entities. Its structure separates the ownership of wealth from its control, allowing the senior generation to give away value from his/her estate, without control passing to the younger generation.
A limited partnership involves two types of partners:
- general partners ('GPs') who are responsible for the management and control of the FLP. The GP has, in principle, unlimited liability vis-à-vis partnership creditors, but, in practice, a limited liability company often acts as the GP to limit such liability (though this is not required). The GP would usually have only a nominal economic interest; and
- limited partners ('LPs') who do not manage the partnership and have limited liability status. This limited liability status will be lost if these 'silent' partners take part in the management of the FLP. LP interests would usually carry the majority of economic rights but cannot have management rights.
How it works as control structure
The control mechanism provided by a FLP is predicated on the senior generation who are, or own, the GP which retains full management and control over of the FLP, whilst they pass on wealth (in the form of the partnership assets) to the younger generations, represented by LP interests.
Since the senior generation will have designed the terms of the partnership agreement they will, in effect, determine the how the LPs may benefit from the assets held by the FLP. As the partnership agreement is essentially a contract, it may be amended from time to time if the circumstances of the family fundamentally change.
Funding and passing value to the next generation LPs
The FLP provides a 'wrapper' in which assets of the senior generation are contributed to the FLP and then gifted, in the form of LP interests, to the next generation LPs. Very basically, this means that the senior generation fund the FLP and in so doing become the GP and the initial LP(s), and then gift some or all of their LP interests to the next generation, as incoming LPs.
Ongoing taxation for the partners
FLPs are transparent for tax purposes. As such, the partners are treated as owning the share of underlying assets underpinning their partnership interest and they are entitled to the profit generated from such interest according to the terms of the partnership agreement. Depending on the assets in which the FLP is invested, the profit generated will be income and/or capital gains and since the partners are entitled to that profit they are taxed on an arising basis in line with their marginal rates (and making use of their personal allowances).
There are particular complexities regarding IHT, stamp duty land tax and annual tax on enveloped dwellings, which we can advise on.
Is a FLP an appropriate structuring choice?
If the senior generation is keen to mitigate IHT by transferring value from their estate to the next generation, then a FLP provides a control mechanism in which to do this. But the tax benefit is predicated on the GP operating the FLP in a way that reflects the senior generation having fully given up any benefit from the assets underpinning the LP interests transferred to the next generation.
Because a FLP is tax transparent, unless it invests in assets that defer income tax and CGT, the partners will be exposed to arising basis taxation, which will need to be funded. That said, in suffering arising basis taxation, the partners are in no worse position than if they had received the assets outright.
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.
