Earlier this year, The Department for Business Review, Energy & Industrial Strategy (BEIS) held a consultation on its Review of Limited Partnership Law: Call for Evidence. But what was the consultation about and why now?
Other than the Joint Law Commission consultation in 2001 and to a limited extent, the introduction of the private fund limited partnership on 6 April 2017, limited partnerships have largely gone unnoticed until now.
The recent interest has certainly been garnered from a number of media reports alleging that limited partnerships registered in Scotland have been used as vehicles for a number of different forms of criminality. Headlines have featured in Scottish papers about Scotland being a 'tax haven' or 'Scottish firms used for money-laundering in former Soviet Union'.
What is a Scottish limited partnership?
First, a back-to-basics refresher as to what is a limited partnership in Scotland may be useful. A limited partnership is a form of partnership under the Limited Partnerships Act 1907. In a limited partnership there are:
- one or more partners (called the General Partners) who are liable for all debts and obligations of the limited partnership but in return they participate in the management of the partnership business and take all decisions; and
- one or more partners (called the Limited Partners) who have limited liability but in return they cannot participate in the management of the partnership business. If a Limited Partner were to take part in the management of the partnership business, then he would be liable for all debts and obligations of the firm during such period as if he were a general partner.
Curiously, it is the Partnership Act 1890 which refers to a Scottish partnership and not the Limited Partnerships Act 1907. The Partnership Act 1890 applies not only to partnerships but also to limited partnerships (because as referred to earlier a limited partnership is simply a specific form of partnership). Section 4(2) of the Partnership Act 1890 is the relevant wording and provides that "In Scotland a firm is a legal person distinct from the partners of whom it is composed…"
These 17 words crucially recognise a Scottish partnership (including a Scottish limited partnership) as a legal person distinct from each partner. This recognition is not afforded to an English partnership which is considered instead to be a collection of its partners with no separate legal personality.
Neither the Partnership Act 1890 nor the Limited Partnerships Act 1907 gives any guidance as to what this means or even mentions Scotland again. However it is widely accepted that this means that a Scottish partnership and a Scottish limited partnership can sue and be sued; be a partner in another partnership or entity; and enter into contracts with its partners, who can be creditors or debtors of the partnership.
What are the attractions of a Scottish Limited Partnership?
A Scottish limited partnership, like any other partnership in the UK, has the benefit of being tax transparent. What this means is that a Scottish limited partnership is not taxed as an entity. Instead one looks through the limited partnership as if it doesn't exist and the partners are instead taxed on the profits arising from the limited partnership's activities. Contrast this with a company which is taxed corporation tax on its profits before its shareholders are further taxed on the income they receive. This is one of the main attractions of a Scottish limited partnership – it has the benefit of separate legal personality but it is tax transparent at the same time.
These attractions have made Scottish limited partnerships particularly attractive as a vehicle for a variety of legitimate uses such as vehicles in investment fund structures. Frequently there will require to be a carried interest vehicle (representing the fund manager's interest) and a feeder and/or a co-investment vehicle (representing the investors' interest) in fund structures. These vehicles will sit above another entity which would own the commercial property or other investment. Such vehicles must be an entity which has separate legal personality and therefore that is why Scottish limited partnerships are a popular choice in such structures. Structurally, a Scottish limited partnership works because it can be a partner in another partnership and taxation wise it is attractive as it means only the partners are taxed.
Why has BEIS been looking at them now?
Unfortunately, what has made Scottish limited partnerships popular for legitimate uses has also apparently made them popular for illegitimate uses. BEIS has picked up on the media reports that Scottish limited partnerships are being used for money laundering, organised crime and tax evasion. BEIS also refers to the aggressive marketing of Scottish limited partnerships by formation agents outside of the UK.
Another apparent attraction for wrongdoers is that a Scottish limited partnership has fewer reporting requirements than other entities. By way of an example, in certain circumstances it doesn’t need to file annual accounts.
Furthermore it is perfectly valid for a corporate vehicle to be a limited partner or general partner and such partner can be offshore, so making it difficult to evaluate who the true owner is. The new persons of significant control ("PSC") requirements which came into effect in April last year did not cover limited partnerships although there was a subsequent consultation in December of this year called the Transposition Article 30: Beneficial Ownership of Corporate and Other Legal Entities. One of the matters under consultation was whether to bring Scottish limited partnerships under the PSC regime, thereby obliging persons exercising significant control, even if offshore, to be notified to Companies House.
BEIS has been speaking to a variety of professionals in this sector and is currently considering the feedback. At present we don't know the extent of the misuse – only the wrongdoers and (hopefully) the enforcement agencies are in a position to know the true extent of the problem. However, what is undisputed is that there is a problem and steps should be considered to address this.
We have made submissions to BEIS already with some suggestions. For example, if the perceived harm is formation agents selling Scottish limited partnerships abroad to wrongdoers with no regard to their use, then action needs to be taken against such formation agents for failing to administer proper Anti Money Laundering ("AML") procedures.
Another suggestion we have made is that only parties who are regulated by a professional body, who in turn must adhere to AML regulations, should be able to file a form LP5 to register a limited partnership and there should be a declaration on the form LP5 signed by such person confirming that he is so regulated – this would help to deter any formation agent from registering a form LP5 if he has not complied with AML.
Our final suggestion to BEIS was to give Companies House a strike off power – if a Scottish limited partnership was registered without proper AML being conducted or the authorities believe it to be used for criminal activities, then Companies House should have the power to strike it off. Again, this would help to deter any criminal enterprise from using a Scottish limited partnership if any ill-gotten gains can be potentially held by a struck off entity.
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Stephen Chan is a partner in the Harper Macleod LLP Corporate team specialising in partnerships and limited partnerships. He has met with BEIS twice in Edinburgh during their consultation exercise and is also currently writing "A Practical Guide to Partnership Law in Scotland" to be published by Thomson Reuters.
This article was originally published in the Association of Partnership Practitioners' Newsletter in June 2017.