The government plans to reform one of the real estate industry’s most popular vehicles, UK limited partnerships, over money-laundering concerns. Melville Rodrigues explains
Tax-transparent returns with limited liability are a key attraction of the UK limited partnership (LP) structure to domestic and international investors. It is a structure often used as a fund vehicle for indirect real estate investment – whether the real estate is located in the UK or elsewhere – as well as private equity, infrastructure assets and venture capital. There is no direct tax at the level of the UK LP itself. The investors – designated as limited partners and often including pension funds and other tax-exempt entities – are taxed according to their individual status.
The UK government, reacting to concerns about the illicit use of Scottish LPs for money laundering, has issued a consultation paper which includes proposals for the reform of limited partnership law. The government is inviting responses to the consultation by 23 July 2018.
The essence of the proposals are:
• To require all those seeking to register an LP to be registered with an anti-money laundering supervisory body;
• New annual reporting requirements – the government requests views on whether UK LPs should prepare reports and accounts in line with the requirements for private companies;
• To ensure LPs maintain a meaningful connection with the UK.
To achieve the third objective, two alternatives have been put forward. The first would require an LP’s principal place of business to be in the UK; the second would allow the principal place of business to move outside the UK but would introduce a requirement for a service address to be maintained in the UK.
From a regulatory perspective, UK LPs used for fund structures often fall within the scope of the Alternative Investment Fund Managers Directive (AIFMD) and as a result require the appointment of an alternative investment fund manager. However, a UK LP has the flexibility to fall outside the scope of AIFMD if the general partner/manager is based outside the European Economic Area (EEA) and does not undertake marketing activities in the EEA.
If the government chooses the first option requiring the principal place of business of UK LP to be within the UK, this flexibility would no longer be available – all UK LPs would be brought within the scope of AIFMD. If the government chooses the second option requiring a service address to be maintained in the UK, this flexibility would be retained.
The UK business minister, Andrew Griffiths, says these reforms will improve transparency and subject UK LPs to more stringent checks, “to ensure they can continue to be used as a legitimate way for investors and pension funds to invest in the UK”.
The government in fact enhanced the attraction of UK LPs for investors with legislation that took effect in April 2017. Assuming qualification as a collective investment scheme, the UK LP can opt for a private fund limited partnership (PFLP) status. Limited partners in PFLPs benefit from a ‘white list’ of extensive, although not exhaustive, permissible activities similar to those available in other jurisdictions without forfeiting their limited liability. PFLPs are more flexible. For example, they are not required to make capital contributions, and can withdraw capital.
The UK LP, with the added PFLP option attraction, can operate as a vehicle of choice for real estate investors – including international investors – on the basis that the UK LP does not hold UK real estate directly, or directly holds UK real estate but the investors have no liquidity expectations.
Transaction taxes – stamp duty land tax (SDLT) in England, land and buildings transaction tax (LBTT) in Scotland, and land transaction tax (LTT) in Wales – apply to transfers of LP interests. This makes such interests illiquid, given the 5% SDLT/LTT or 4.5% LBTT charge on the gross underlying asset value of the LP interest transferred. Higher rates may apply to transfers of partnership interests where the underlying assets consist of residential real estate.
The funds industry should respond to the consultation, welcoming the improved transparency proposals, while persuading the government to accept the second option that a UK LP service address be maintained in the UK instead of requiring that its principal place of business remain in the UK.
Melville Rodrigues is a partner at Charles Russell Speechlys