Investors should be aware of planned reforms to UK limited partnerships, which could be to their advantage. Melville Rodrigues explains
Tax-transparent returns and limited liability are the key attractions of the UK limited partnership. It is a structure typically used as a vehicle for indirect real estate investment as well as private equity, infrastructure assets and venture capital, particularly when the fund manager is based in the UK. There is no direct tax at the level of the UK limited partnership itself. The investors – designated as limited partners (LPs) and often including pension funds and other tax-exempt entities – are taxed according to their individual status.
LPs enjoy limited liability provided they do not take part in the management of the partnership business. This contrasts with the general partner (GP) – often an associated entity of the fund manager – which has unlimited liability for the debts and other obligations of the limited partnership. In practice, the risk of unlimited liability is ring-fenced by the GP entity being a special-purpose company or other limited liability entity.
One long-standing challenge is whether LPs can monitor and protect their investments without taking part in management and therefore forfeiting their limited liability.
The UK government plans to introduce reforms by March 2017 so that limited partnerships (assumed to be UK collective investment schemes) can opt for the newly-created private fund limited partnership (PFLP) status – subject to complying with administrative requirements.
LPs in PFLPs will then benefit from a ‘white list’ of extensive permissible activities, similar to those available in other jurisdictions, without forfeiting their limited liability.PFLPs can operate more flexibly – for example, LPs will not be required to make capital contributions if the limited partnership were registered after the PFLP reforms are introduced.
As a result, indirect real estate investors may consider the PFLP to be a vehicle of choice on the basis that it does not hold UK real estate directly or if it does, the investors have no liquidity expectations.
Stamp duty land tax (SDLT) or land and buildings transaction tax (LBTT) applies to transfers of PFLP/limited partnership interests (respectively holding real estate in England and Wales or Scotland). This makes such interests illiquid, given the 5% SDLT or 4.5% LBTT charge on the gross underlying asset value of the PFLP/limited partnership interest transferred. Higher rates may apply to transfers of partnership interests where the underlying assets consist of residential real estate.
“As a reaction to the experiences of the previous real estate market downturn, pension funds and other institutional investors have tended to look for greater control over their investments. Investors want to ensure that funds operate within debt and other risk-management parameters and comply with the fund’s strategic objectives”
As a reaction to the experiences of the previous real estate market downturn, pension funds and other institutional investors have tended to look for greater control over their investments. Investors want to ensure that funds operate within debt and other risk-management parameters and comply with the fund’s strategic objectives. They want to be consulted on key strategic decisions and frequently insist on representation within an investor advisory committee (IAC). Consultation is viewed as not taking part in the management of the limited partnership business.
I suggest that the PFLP reform white list will largely address the greater control expectations of LP investors, including:
• Participating in certain investment-related decisions and decisions related to partnership borrowings. This would provide effective control over particular investments and taking on associated debt;
• Taking part in a decision about a change in the nature of the partnership’s business, disposal of the business or dissolution – for example, altering the strategic focus of the fund and/or implementing a restructuring;
• Approving partnership accounts and valuations of underlying partnership assets. This provision would enable limited partners to scrutinise the real estate valuations of the PFLP;
• Acting as a director, member, employee or officer of the GP or fund manager, enabling, for example, the LP to exert influence via the GP entity;
• Taking part in a decision that involves an actual or potential conflict of interest relating to the partnership or its business. This provision may enable the LPs to be involved in approving management fees;
• Appointing a representative to a limited partnership committee, which would extend to membership of an IAC.
LPs in existing UK limited partnerships should engage with the GP over opting for PFLP status when available, and potentially seeking wider powers consistent with the new white-list activities.
In addition, investors in new limited partnerships should formalise similar arrangements with the GP which would apply once the reforms become operational: PFLP opt-in and the LPs being permitted to undertake white-list activities.
The reforms could impact on unit trusts and other feeder funds into UK limited partnerships. The feeder-fund investors may wish the master limited partnership to opt for PFLP status, which might require changes to governance arrangements for the feeder funds, so that they can properly exercise a more active role in the underlying PFLP.
In summary, indirect real estate investors may well look to use the PFLP reforms, which are fully compatible with investors expecting greater control within funds.
Melville Rodrigues is a partner at CMS