Many features of the Scottish limited partnership are attractive to businesses, from its tax transparency to the partnership’s distinct legal personality. Paul Sutton and Jane McCormick report
Scottish limited partnerships (SLPs) may be suitable vehicles in respect of group structures and investment funds, even where those groups or funds have no other connection to Scotland. This suitability stems from the key features of SLPs: tax-transparency, limited liability and separate legal personality.
Under the Partnership Act 1890, persons who have entered into partnership with one another are collectively called a firm. In Scotland a firm is a legal person distinct from the partners of whom it is composed—Partnership Act 1890, section 4(2). This means Scottish partnerships do not automatically dissolve on any change of partners and that the partnership itself may enter contracts and hold property.
However, partners in a Scottish partnership have the same unlimited liability towards third parties as they would have under English law and they have the same duty of good faith. This combination of tax-transparency, limited liability of limited partners and being a legal person has a particular application in the following circumstances.
Intermediate holding entities in group structures
SLPs may hold property in their own name, which makes them potentially suitable vehicles to act as intermediate holding entities in group structures.
Since SLPs are legal persons, the tax treatment may differ, dependent on the taxing jurisdiction. For instance, SLPs may be treated as taxable entities by certain overseas authorities.
Depending on the jurisdiction, this may allow the SLP to be financially structured to increase the tax efficiency of the international partners and of the group as a whole.
Carried interest partners
Fund managers are often permitted to participate in the fund’s profits through a ‘carried interest’ arrangement. In the case of a fund established as an English limited partnership, the carried interest is frequently structured through a separate carried interest partnership, which is itself a partner in the main fund, and whose partners include the relevant managers.
Because only a “person” can be a member of a limited partnership—Limited Partnerships Act 1907 (LPA), section 4(2)—a Scottish limited partnership is suitable to act as a carried interest partner, whereas an English limited partnership would not be.
Lloyd’s underwriters
Although not further explored in this article, it should be noted that SLPs are also frequently used as vehicles for investment in Lloyd’s, as their separate legal personality enables them to become “names” along with limited companies and individuals (that is, legal persons that carry on a single business of underwriting insurance).
Establishing SLPS
Two cases have held that the legal validity of a partnership is not affected by the motive for which it was created—see Newstead v Frost (1980) and Ensign Tankers (Leasing) v Stokes (1989). However, if a partnership is deemed by the courts not to be an SLP, the ruling will find that it never was an SLP.
It is, therefore, important to ensure that the SLP complies with all administrative requirements and can provide sufficient evidence that it is a bona fide SLP in all respects.
Administrative requirements
To set up an SLP a form (LP5) must be filed with the Registrar of Limited Partnerships in Scotland. This form sets out the basic details of the SLP: name; general nature of business; principal place of business; name of each partner; term of the partnership or, if there is no definite term, the conditions of existence; statement that the partnership is limited; capital contribution of each limited partner; and date of commencement.
There are also ongoing obligations to file a form (LP6) with any change of details in the partnership, including the details of any new partners who join the SLP or the change of general or limited partner status of any particular partner. Unlike limited companies and limited liability partnerships, limited partnerships do not need to file annual accounts with the relevant Registrar.
There is no requirement for any of the partners of an SLP to be British subjects or British companies. Although the issue of a certificate of registration by the Registrar of Limited Partnerships in Scotland constitutes prima facie evidence that the partnership is in fact an SLP, the arrangements may be subject to scrutiny by HMRC or other authorities. The question, therefore, arises as to what circumstances are necessary or desirable to establish that a limited partnership is properly registered in Scotland.
The principal place of business of an SLP must be in Scotland (LPA, section eight). This is not generally interpreted as meaning that any particular business activity or active management needs to be carried out in Scotland, merely that the SLP must have its administrative headquarters there. Accordingly, the administrative headquarters may be little more than a location where records of management decisions and, possibly, accounting records are kept up to date and available for inspection by the partners.
Although it is not strictly necessary for limited partnerships to be governed by written agreements, it is common practice for such written agreements to be entered into by the partners in order to set out their rights and obligations.
In the partnership agreement the jurisdiction clause should refer to the fact that an SLP will be governed by Scottish law and be subject to the jurisdiction of the Court of Session. This should be the case even if all the partners are based in one or more overseas jurisdictions.
It is not generally considered necessary for the limited partnership agreement (if any) constituting or establishing the SLP to be executed in Scotland. Nevertheless, it may help from a presentational perspective for certain documents to be executed in Scotland, even if under a power of attorney.
The profit-sharing arrangement of the partners is usually mapped out in the written agreement of the SLP. In general, limited partnerships are free to implement whatever profit-sharing arrangement is agreeable to the partners at the time. Profit-sharing does not need to be pro rata to capital contributions, and capital contributions do not need to be equal between partners.
There is no minimum capital requirement for a limited partnership. Normally funding is provided by a mixture of capital and debt funding. The reason for the debt element is that limited partners may not withdraw or receive back any part of their capital contribution until the partnership is dissolved—LPA section 4(3).
An SLP may, in certain circumstances, be regarded as a collective investment scheme (Financial Services and Markets Act 2000, section 235). In order to be lawful, a collective investment scheme would need to be operated or managed by an FSA-authorised person.
Under the Companies Act 1985, section 740, a Scottish firm was expressly excluded from the definition of a ‘body corporate’.
The Companies Act 2006, section 1173, states that a partnership is not a ‘body corporate’ for the purposes of the Companies Acts if that partnership ‘is not regarded as a body corporate under the law by which it is governed’. This introduces new uncertainty into the meaning of ‘body corporate’ under company law.
Although there is at least one Scottish case where a Scottish partnership is included in the meaning of body corporate under the Trade Descriptions Act 1968—Douglas v Phoenix Motors 1970 SLT (Sh. Ct.) 57 (Tayside)-—the explanatory note to the Companies Act 2006 adopts the generally accepted view that Scottish partnerships are not bodies corporate (at paragraph 1488): “The definitions of ‘body corporate’ and ‘corporation’, and of ‘firm’, are new in part. They clarify the position of corporations sole and of partnerships that are legal persons but are not regarded as bodies corporate (as under Scots law).”
Change of control
When inserting a partnership into a group structure, it is important to be aware of its potential impact on the change of control provisions affecting subsidiaries.
Such change of control provisions may allow a counterparty to terminate an agreement early when the relevant company is no longer a subsidiary of the same ultimate holding company. These provisions are often found in, for example, loan facilities, supply agreements and joint venture agreements.
The effect of such insertion will largely depend on the particular definition of ‘control’ and/or ‘group’. Where these definitions refer to the Companies Act definitions of ‘subsidiaries’ or ‘holding companies’, the insertion of a partnership may trigger the change of control provisions, since the chain of subsidiary companies may be broken.
However, this may not be the case where the relevant provisions use the Companies Act definitions of ‘subsidiary undertaking’ or ‘parent undertaking’, since the word ‘undertaking’ also encompasses partnerships—Companies Act 2006, section 1161.
Tax treatment
Generally, using an SLP should not raise major tax issues in the UK, since specific legislation has been enacted to preserve equality of treatment betweenScotland and England in respect of, for example, computation of partnership profits (Income and Corporation Taxes Act [ICTA] 1988, section 111[1]); capital gains (TCGA 1992, section 59[1][a]); relevant investments (Income Tax Act [ITA] 2007, section 856); and accrued income [ITA 2007, section 675[3]).
Given that SLPs are distinct from English limited partnerships by virtue of having separate legal personality, the equality of treatment for UK tax purposes (primarily tax-transparency) makes using an SLP particularly attractive. An SLP should not be subject to UK corporation tax, as it is regarded as a transparent entity for UK tax purposes. HMRC’s practice is to treat all partnerships as transparent for UK corporation tax purposes, regardless of whether they are governed under Scottish or English law. (HMRC Business Income Manual 72205 states: “a partnership is not regarded as an entity separate and distinct from the individual persons making up the partnership. This is the case even when the partnership, as in Scotland, does have legal personality.”) The legislation seeks to tax corporate partners on their share of the partnership profits.
ICTA 1988, section 111 provides that where a trade or profession is carried out by persons in partnership, the partnership shall not be treated for UK corporation tax purposes as an entity which is separate and distinct from those persons.
The profits and losses of the ‘trade, profession or business’ of a UK-tax-resident corporate partner in an SLP are computed for UK tax purposes as if the SLP were a company resident in the UK (ICTA 1988, section 114[1]). A UK-resident corporate partner is then chargeable to UK tax on its share of the partnership profits so computed, as if it carried on the partnership trade alone.
For a non-UK-tax-resident corporate partner to be assessable to UK corporation tax on its share of the SLP profits, the SLP must be carrying on a trade in the UK. This is a question of fact, taking into consideration the ‘badges of trade’ as established by case law. Care should be taken to ensure that investment activities (for example, in respect of the control and oversight of a regulated group) do not become trading activities. If the SLP’s activities do represent a trade being carried on in the UK, a non-UK-resident corporate partner will be chargeable to UK tax on its share of the SLP’s profits (ICTA 1988, section 115[4]).
Controlled foreign company rules and Treasury consent
Where the SLP is the top regulated entity of a regulated group, the SLP may have direct and indirect 100% holdings in UK and overseas subsidiary companies. This may raise the issue of Treasury Consent and the controlled foreign company (CFC) rules.
Since an SLP is generally not considered a ‘body corporate’ under Scottish partnership law, and assuming that none of the SLP’s partners is resident in the UK, it is arguable that the provisions of ICTA 1988, section 765 should not be in point to require Treasury consent prior to subsequent refinancing/restructuring.
Broadly, subsequent restructuring would be considered unlawful (and stringent penalties would apply) if a UK body corporate caused or permitted a non UK-resident body corporate over which it has control to issue or transfer shares or debentures, without the prior consent of the Treasury.
The CFC rules (ICTA 1988, section 747) should have no impact, as either no overseas company is controlled by persons resident in the UK (the SLP being treated as transparent for tax purposes) or there is no company resident in the UK to which any profits may be apportioned under the CFC provisions. Again, this assumes that the SLP’s partners are not UK-tax-resident.
Care should be taken, however, in structures where the SLP has one or more UK-resident corporate partners, such that a UK-resident company could be regarded as having control over one of the subsidiaries held beneath the SLP, thereby bringing the Treasury consent and CFC provisions into consideration.
Paul Sutton is a partner at McGrigors and Jane McCormick is the head of KPMG’s financial services tax group. A longer version of this article appeared in Tax Journal on 14 January, 2008.
ScotlandJuly2008
