Limited Partnerships – an option for some

Initially envisioned to be the preferred investment vehicle for foreign venture capital investors, the Limited Partnership (LP) was brought to life in NZ with the enactment of the Limited Partnerships Act 2008. LPs have now evolved into the preferred business vehicle for many who benefit from the limited liability of a company while acquiring a look-through entity for tax purposes.

 

The LP structure requires both a limited partner and a ‘general partner’, with the general partner being responsible for the management of the entity. The regime works by requiring that a limited partner must not take part in the management of the LP, otherwise they lose their limited liability protection.

LPs taxed as standard partnerships

Although the LP itself is a separate legal entity, for tax purposes LPs are treated the same as a ‘standard partnership’. Essentially, the partners are deemed to derive the income, incur the expenditure, carry on the activity, and hold the assets of the partnership, in proportion to their partnership share.

Accordingly, the partners are allocated their share of the partnership income on a pre-tax basis, which is then taxed at the respective marginal tax rates. This provides a material advantage to low tax rate entities such as Maori Authorities and charities who might partner up with standard taxpaying entities such as companies that are taxed at 28 percent.

It also allows partners to combine their own expenditure, such as interest deductions, with their allocation of partnership income to have the net result taxed as a single sum. If losses are incurred by the partnership these will also flow out to the respective partners to be offset against other income and carried forward, which is not as easy to accomplish under a standard corporate structure.

On the downside, because the partners in an LP are deemed to own the assets of the partnership in proportion to their partnership share, a percentage change in the ownership of an LP will give rise to a proportionate disposal of the assets. This can give rise to complex calculations and issues when changes in ownership occur. By comparison, a partial change in shareholding in a company is a standard transaction with few tax consequences for the company.

Strict criteria for LTCs

Similar advantages can be offered through the Look Through Company (LTC) regime, which shares common attributes with LPs – both offer legal protection in the form of limited liability and are ‘look through’ for tax purposes.

However, LTCs need to comply with strict criteria, such as a limit on the number of ‘owners’. The criteria to remain an LTC can be inadvertently breached without realising it, resulting in the loss of LTC status.

Limited partnerships are one of the newest entity types for the NZ business environment, and are rising in popularity. In specific situations, they do offer advantages compared to a generic company. However, for more vanilla investments and business ventures, a standard company is still likely to be the better option. Before using a LP ensure there is a specific and material advantage in doing so.

If you would like to discuss whether an LP is the right structure for your business, please give us a call.

Published spring 2017

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