A family partnership, when structured appropriately, may be an effective tool to enable assets to transfer from one generation to the next and to manage the tax costs arising.
Family partnerships can be used for numerous purposes. For example, it can allow you to pass a business, farm or investment assets on while effectively controlling the future of those assets for an indefinite period. It helps to alleviate concerns parents may have around children holding assets in their own names, as the parents retain control of the assets. The primary benefit of this structure is that future value can accrue to the next generation, while the managing partner (such as a parent) makes the decisions and controls the assets.
Partnerships can be particularly effective if one of the partners qualifies as a “young trained farmer”. A recent change introduced in Finance Act 2015 means that where a partnership is set up between at least two partners, with provision for profit-sharing between the partners and for the transfer of the farm to the younger farmer within a 10-year period, an income tax credit of up to €5,000 per annum for five years will be allocated to the partnership and split in accordance with a profit-sharing arrangement between the partners. The sharing of the farming profits between a parent and child would normally result in an overall reduction in the liability. There are numerous other financial benefits that registered farm partnerships can avail of such as:
For farmers, additional steps will need to be taken to obtain these tax benefits. They will need to: register the partnership with Revenue and the Department of Agriculture, Food and Marine (“DAFM”); enter a farm agreement; enter a partnership agreement that complies with the new legislation; add the new entrant’s name to the herd number; and open up a partnership bank account.
When the farm assets are transferred to the next generation they should benefit from the stamp duty exemption for Young Trained Farmers, which has also been extended to 31 December 2018, and 90 per cent agricultural relief from Capital Acquisitions Tax.
In order to qualify for agricultural relief, the recipient must be considered a “farmer”; this means that at least 80 per cent of the market value of the beneficiary’s assets after taking the gift consists of agricultural property. In addition the beneficiary must be an “active farmer”. In order to be an active farmer, the beneficiary must either farm the land as an active farmer; be a qualified farmer (by holding a specific farming qualification) and farm the land, or lease the land to an active farmer or to a qualified farmer in order for the agricultural property to be farmed on a commercial basis and with a view to the realisation of profits.
In the event that agricultural relief does not apply (for example if the child does not qualify as a “farmer”) it is possible that an alternative relief – i.e. business relief from Capital Acquisitions Tax – may apply.
Business relief is applicable when a beneficiary receives a gift or inheritance of “relevant business property”. The relief reduces the taxable value of a benefit by 90 per cent. The farming business could be considered “relevant business property” as defined in the Capital Acquisitions Tax Consolidation Act, 2003 and therefore qualify for the relief. “Relevant business property” includes property consisting of a business; shares in a company that the beneficiary controls and land or buildings, machinery or plant used wholly or mainly for the purposes of a business controlled by the disponer. If business relief is claimed, the beneficiary must ensure the assets continue to qualify as business assets (i.e. must continue to trade and farm). If not, a claw-back of the relief will occur. Unlike agricultural relief, there is no restriction on what is done with the land after the benefit is taken other than it cannot be disposed of within six years from the date it is acquired.
An additional difference between business relief and agricultural relief is that business relief would not be available in respect of a farm house, as it is unlikely to be considered relevant business property.
We have detailed the basic components that should be incorporated into a partnership agreement; however, depending on the purpose of the partnership, the clauses should be amended as necessary.
Generally, the structure of the partnership is that each family member is a partner and this can include minor children. An additional layer of protection is required for minor children, as they do not have the capacity to hold assets directly and a bare trust must be put in place to hold their share until they reach the age of 18.
The managing partner will have control over all decisions relating to the partnership, including when any income/gains are paid out to the partners. Usually, one or both of the parents act as the managing partner(s). It is imperative when setting up a family partnership to ensure that the terms are recorded in a carefully drafted partnership agreement.
The partnership agreement shall regulate the terms upon which the partnership will be carried on. The rights, duties and obligations of each individual shall be governed by the partnership agreement. It also sets out the manner in which the partners can participate in the income and gains of the partnership. In order to ensure that the partnership meets the needs of the family, it is essential to consider the following matters:
Profits/losses
Quite often, the partnership agreement provides that the net profits of the partnership belong to the partners in proportion to their individual partnership shares and any losses of the partnership are also borne by the partners in line with their partnership shares. The profits of the partnership can be accumulated while giving the managing partner discretion regarding when a distribution is made. Thus, a managing partner has huge flexibility around if and when appointments are made out to the partners.
Income tax
The partnership is a ‘look-through’ entity. Once the partnership obtains an income source, income tax returns will need to be filed for each partner where income arises, and funds can be released from the partnership structure to settle any income tax (or capital gains tax) liabilities of the partners. Any income that arises while the children are minors shall be taxed in their parents’ hands.
Managing partner
The managing partner will be delegated such powers as may be required to suit the circumstances. In particular, he or she will have control over when distributions should be paid out to any partner.
Voting
In family situations, the partnership agreement typically provides that voting rights are weighted in favour of the parent(s) to ensure that all decisions of the partnership can effectively be controlled by them.
Dissolution
Unless otherwise provided, the retirement of one partner can dissolve the partnership; therefore, the partnership agreement should adequately cover a situation where a partner retires, dies or wishes to wind up the partnership.
Capital contribution and tax consequences
Each of the partners contribute a capital sum to the partnership. The capital contributed by each partner will determine their respective partnership shares.
• It is worthwhile considering utilising the gift tax-free thresholds of the children and either gifting children cash or appointing assets into the partnership up to the value of the appropriate gift-tax thresholds.
• It is possible to structure the capital contributions in such a way as to allow the children to have a higher partnership share.
• It is also possible to include a differentiation between partners as to rights to capital/income depending on the level of value that is to accrue to the children.
• The children’s partnership shares can entitle them to a majority of the capital return and consequently all, if not the majority of the future value or return in respect of the assets held by the partnership, will accrue to them, thus avoiding future capital acquisitions tax liabilities that would otherwise arise if you were to gift the assets to them in the future.
• It is also possible to stipulate that children would be entitled to the potential capital growth in the assets over and above a certain value and on the basis that the children are initially not entitled to any immediate partnership assets, it could be argued that such an entitlement has a relatively low value.
It is important that all parties provide full value or consideration for their entitlement on day one (i.e. the capital sums gifted by them initially should be such that they provide for them to fully purchase all their rights or entitlements that accrue to them under their partnership share).
In order for the financial and commercial benefits outlined above to apply, the partnership must be properly constituted and suited to the circumstances – be it family investment or farming. This is why it is essential that an agreement is drafted correctly and specific provisions are defined accurately in order to avoid any ambiguity or potential conflict amongst the partners.
If you would like us to assist with the drafting of a partnership agreement or farming partnership, please do not hesitate to contact our Private Clients team.
For more articles, see the full edition of Deloitte Private Matters - March 2016.