Limited partnership: a tax and liability shelter
A limited partnership differs from a traditional partnership structure by limiting the liability (the debts and obligations to third parties) of certain partners beyond the amounts they have contributed.
In most other ways, a limited partnership is very much like a standard partnership. It is not a person in law (unlike a company), and cannot contract or sue or be sued or hold property.
Within the structure, general partners (GPs) are liable for all debts and obligations of the firm; and limited partners (LPs) are not liable for any amount beyond the amount each has contributed. As such, a limited partnership usually comprises of a minority of GPs and a majority remainder of LPs.
Any person in law can be either type of partner. So a partner might be a company or an individual. However, the same person cannot be both types of partner at the same time.
The "price" of limited liability for an LP is that he or she can not draw out or receive back any part of his or her contribution to the partnership during its lifetime, or take part in the management of the business or have power to bind the firm. If he or she does, he or she become liable for all the debts and obligations of the firm up to the amount drawn out or received back or incurred while taking part in the management, as the case may be.
In order to gain some limitation of liability, individuals who manage the partnership often incorporate a company as the general partner, becoming shareholders of the company. The GP remains liable for the debts of the partnership, but in practice could only be persued for the assets of the underlying management company.
Partners are not employees, and money earned in the partnership business is taxed in accordance with the rules for taxation of partnerships.
Most limited partnerships are limited to a maximum of 20 partners. However, under section 717 of the Companies Act 1985 there are a number of exceptions to this rule. They relate almost exclusively to professional partnerships.
The relevant law that sets out how limited partnerships work is the Limited Partnership Act 1907.
There is no legal obligation to have a formal written partnership agreement, but in practice, one is essential to set out the responsibilities of the partners. If there is no agreement, or the agreement is silent on an important point, then the formal default provisions of the Partnership Act 1890 apply. Since that law no longer represents how most modern businesses operate, that is decidedly to be avoided.
Limited partnerships must be registered at the Registrar of Companies (Companies House). Until registered, both types of partners are equally responsible for any debts and obligations incurred. It is usual to register immediately after the partnership agreement has been signed.
The name of the partnership must be acceptable to the Registrar. The rules are the same as for companies. Broadly speaking this means that you should avoid any name that may be confusing or misleading. As a matter of prudence, you should of course also avoid any name which is the same or similar to any other trade name.
The general partners are responsible for the delivery of Forms LP5 and LP6 (for registration and notifying of changes), whether or not the preparation of the documents was delegated to accountants or to anyone else.
The Act provides for the imposition of penalties for various defaults in carrying out the requirements of the Acts and for failing to send to the Registrar the required forms.
Dissolution and changes to structure
In the event of the dissolution, the general partners must wind up its affairs unless the court orders otherwise. Subject to any agreement between the partners, an LP is not entitled to dissolve the partnership by notice, and the other partners are not entitled to dissolve the partnership merely by reason of any LP suffering his share to be charged for his separate debt.
The death or bankruptcy of an LP is not a ground for dissolution. Nor is that one of the partners is a 'person of unsound mind', unless the person's share in the partnership cannot be otherwise ascertained and realised.
The status of partners be switched between general and limited, but it would be unusual for circumstances to require such a change.
Anti-fraud measures require that notice of any arrangement or transaction under which a general partner will become a limited partner in the firm must be advertised in the London, Edinburgh or Belfast Gazette, as the case may be. Notice must also be advertised in the Gazette of any arrangement or transaction under which a limited partner's share in the firm will be assigned to somebody else.
Until this is done these arrangements or transactions have no effect.
Transactions with third parties
The law of "ostensible authority" applies to partner transactions. Every partner is an agent of the limited partnership. The limited partnership is bound by every contract made by any partner, unless first, the partner had no authority to make the contract and second, the third party was aware of that fact.
The limited partnership is bound even by contracts by former partners, unless the other party has been told that the former partner is no longer a member, or the registrar has received a notice to that effect.
When to use a limited partnership
We do not know why limited partnerships have not been used more widely. They provide a simple shelter against liability for one or more partners.
In a limited partnership between Anna, Bob and Cheshire Land Development Limited, only Cheshire Land Development Limited is a general partner. The two individuals are limited partners.
The partnership engages in property development. If it incurs liabilities it cannot meet, only the general partner is liable. It may have no assets. The estates of the two limited partners are safe.
To preserve the limited liability status, neither Anna nor Bob may take any part in the management of the partnership. In a personal capacity, neither of them does so. However, Bob is a director of Cheshire Land Development Limited, the general partner, so he is exceedingly well informed with regard to the business of the limited partnership.
The shares in which profits are divided may be changed from time to time, to suit the taxation obligations of the partners.
Profits are attributable to the partners because there is no corporate entity. Capital losses can be set against capital gains elsewhere.
Comparison with limited liability partnership
The business areas where the use of a limited partnership might be beneficial are similar to those where you may also consider a limited liability partnership.
In choosing between the two types, you should consider:
Whether the corporate structure of a limited liability partnership is more appropriate than the partnership structure of a limited partnership.
Which structure best suits the tax requirements of the proposed partners.
Whether one structure or the other will affect the ability of the partnership to borrow money.
In a limited partnership the LPs are wholly excluded from management - or they risk losing their limited status. Despite the fact that in practice it may be very difficult for any creditor to prove that a limited partner had ever interfered in management, this is a substantial disadvantage as against a limited liability partnership, where all partners have the same status for the application of limited liability and can participate in the management.
In a limited partnership, some party is always liable down to his last penny (even if that person is a limited company). Conversely, in a limited liability partnership, no partner is liable beyond the extent of cash he has contributed.
Further information and documents
Net Lawman provides a template limited partnership agreement that you can edit to suit your business.
You may wish to read about limited liability partnership structures, or whether partnership or company structures are better for your business.
Please note that the information provided on this page:
- Does not provide a complete or authoritative statement of the law;
- Does not constitute legal advice by Net Lawman;
- Does not create a contractual relationship;
- Does not form part of any other advice, whether paid or free.
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