INSIGHT

The beginning of the end of the unit trust's monopoly? A look at limited partnerships

By Marc Kemp, James Kanabar
Financial Services Funds

In brief

Written by Partners Marc Kemp and Charles Armitage and Senior Overseas Practitioner James Kanabar

In July's edition of Unravelled, we reported on the Board of Taxation's report on tax arrangements applying to collective investment vehicles, released by the Federal Government on 4 June. Consistent with the 2009 Johnson Report, the report considers that offshore investors are dissuaded from investing in Australian funds because they do not understand unit trusts, and that access to a broader range of collective investment vehicles would help Australian fund managers to compete for capital with their offshore counterparts.

The Board of Taxation report advocates extending tax neutrality to three additional collective investment vehicles: corporates (modelled on the Luxembourg SICAV), limited partnerships and common contractual funds. In the August edition of Unravelled, we examined corporate collective investment vehicles, with a focus on Luxembourg SICAVs, English OEICs, and protected cell companies. In this issue, it is the turn of limited partnerships, with which you may have some familiarity but are not commonly used as collective investment vehicles in Australia (more on that below).

Limited partnerships in an Australian context: existing regime and usage

Under Australian tax law, partnerships are, essentially, treated as flow-through structures for tax purposes. However, in 1992, the tax legislation was amended to treat most limited partnerships as companies for tax purposes. Consequently, during the period that limited partnerships have flourished overseas, limited partnerships have not been seen as attractive vehicles for collective investment in Australia . While concessions were introduced in 2002 to, among other things, restore flow-through tax treatment for certain venture capital limited partnerships, the eligibility criteria have been so restricted that most limited partnerships (eg those that invest in infrastructure assets) cannot qualify. Therefore, as a general proposition, limited partnerships are not currently seen as viable collective investment vehicles outside the venture capital space.

Key features of limited partnerships globally

Limited partnerships are used as collective investment vehicles in a number of jurisdictions, including England and Wales, the Cayman Islands, the Channel Islands and Scotland, and are particularly popular in the context of closed-ended alternative investment funds, such as private equity funds.

A limited partnership must have at least one general partner and one limited partner, and the rules by which it is governed typically comprise specific statute (as is the case in Australia, where state-based legislation provides for limited partnerships), and derogations from the statutory rules in the form of a partnership agreement between its partners.

Arguably, the key feature of a limited partnership is the distinction between its general and limited partners. A general partner is, in all material respects, in the same legal position as partners in a conventional partnership: ie it is responsible for managing the partnership, has a right to use partnership assets, shares the profits in agreed proportions, and has unlimited liability for the partnership's debts. By contrast, a limited partner's liability is limited to the amount of its agreed contribution to the partnership, provided it does not take part in management. What constitutes 'taking part in management' of the partnership differs from jurisdiction to jurisdiction, but a limited partner will typically be able to assume limited consultation, approval and veto rights (eg for changes to the partnership agreement) without losing its limited liability. It is for this reason that limited partnerships are the vehicle of choice for overseas private equity funds, allowing investors that would typically assume a more passive role anyway to enjoy limited liability.

English and Welsh limited partnerships do not have distinct legal personality, and act only by their general partner or partners. By contrast, Scottish limited partnerships always have separate legal personality, and Guernsey and Jersey limited partnerships have the flexibility to follow either course.

While the precise tax treatment of limited partnerships differs from jurisdiction to jurisdiction (eg regarding the income received by the general partner), limited partnerships are generally transparent for tax purposes.

Limited partnerships in an Australian context: possible future regime and usage

Although all limited partnerships share certain core features irrespective of jurisdiction, there are points of difference and, given the Board of Taxation's stated purpose in offering favourable tax treatment to a range of collective investment vehicles (namely, to make Australian funds more attractive to overseas investors), consideration needs to be given to whether (and how) to amend the existing statutory framework for limited partnerships in Australia.

Australia's limited partnership acts are State-based rather than Federal, but there is a strong argument for adopting a single Federal statute, so that overseas investors looking to acquaint themselves with the vehicle need only look to a single Act, rather than a range of similar, yet different, State laws. It may therefore make sense in the long term to consolidate the State Acts into a single piece of Federal law (in much the same way as happened with the Corporations Act), and the creation of a single bespoke act would also allow for the creation of a regime that is broad enough to facilitate the adoption of a mixed bag of limited partnership features chosen from the various jurisdictions. This would then give Australian fund managers maximum flexibility to design investment vehicles that appeal to the particular needs and experience of an individual investor or group of investors.

That said, the existing statutory framework already offers a degree of flexibility (eg by providing for both incorporated and unincorporated limited partnerships). Subject to the required amendments to the tax regime, we think this represents an opportunity to make the limited partnership available as a tax neutral collective investment vehicle in a relatively quick and painless way in the short term, with scope to create bespoke Federal legislation in the future, and with the benefit of feedback from overseas investors that have invested in Australian limited partnerships under the new tax regime.

Given the precedent of venture capital limited partnerships, it should not be structurally difficult to amend the current tax legislation to restore flow-through treatment for specified limited partnerships. There are suggestions in the Board of Taxation's report that the ability for limited partners to benefit from losses flowing through a limited partnership should be limited. There is a precedent for a cap on losses in the foreign hybrid rules in the tax legislation. The key issue will be for the Australian Treasury to avoid being overly prescriptive as to which limited partnerships can qualify for the concessional tax treatment.

In next month's edition of Unravelled, we will consider the common investment fund in more detail.