Partnerships are an unusual animal under the tax law. Under that law, a partnership includes not only an association of people who carry on a business as partners (the general law partnership) but also includes persons in receipt of income jointly (a tax law partnership). This means that owning a rental property or shares jointly causes a partnership to exist.
In the event that an arrangement gives rise to general law or a tax law partnerships, what tax obligations arise as a result?
If a partnership exists under the tax law, a partnership tax return should be lodged. However, in the case of tax law partnerships a partnership return is generally not required where property or shares are jointly owned.
Partnerships do not have taxable income like individuals and companies. Instead, gross assessable income less tax deductions result in net income, which is distributed to the partners of the partnership. That distributed income must then be declared in the partners’ individual tax returns. In a case where tax deductions exceed gross assessable income, a net loss arises. Each partner must show their share of that loss in their individual tax return and can claim a tax deduction for that loss.
In addition to individuals, trusts and companies can be partnership in a partnership and the above rules equally apply to them. Importantly, partnerships do not pay tax; that occurs at the partner level as explained above.
A commercial disadvantage of individuals being in business as a partnership is that their personal assets remain exposed in the event of a law suit arising in respect of a business conducted by the partnership. To avoid this liability exposure, many business people trade as companies or trusts with a corporate trustee. Choosing the correct business structure requires considerable thought.
Where more than one family is involved in a business, a partnership of companies or trusts is becoming more common. In this event, entry into and extraction from the partnership may be easier than, for example, being in a company structure where shares have to be sold or redeemed. Advice from an experienced tax professional should be sought to ensure the correct business structure.
From a capital gains tax perspective, the partnership is not regarded as the owner of the asset. Instead, the partners are deemed under the tax law to own an interest in or proportion of the assets. Therefore, if land owned by the partnership is sold, each of the partners must declare their share of the capital gain or loss in their income tax return. The amount of the gain to be included in the partner’s assessable income may be reduced by the 50% general CGT discount unless the partner is a company.
Finally, the ATO’s recent release of draft guidelines regarding the allocation of profits within professional firms provides cause to take stock of your existing business structure. The guidelines are intended to explain how the ATO will assess tax compliance risks associated with the allocation of profits from the business structure of a professional firm carried on through a partnership, trust or company. Stay tuned for our article discussing these guidelines.