Partnership Tax- Everything you need to know!
May 30, 2023
WHAT IS PARTNERSHIP?
Partnerships are one of the most popular forms of business structure that allows two or more (up to 20) people to come together and share in the profits and losses of a business venture. That said, please don’t just go and register your own Partnership - even though it seems free and easy to do so, you are creating a new business with new tax obligations and partnership rules that you might not be aware of. It is always best to speak to an accountant (or lawyer), especially about the liability/risk, and tax implications.
A Partnership is a recognition of two or more, doing business together. It is not its own legal entity like a company, but it must still have a Tax File Number (TFN) and Australian Business Number (ABN), and it must lodge a partnership tax return with the Australian Taxation Office (ATO) each year. The Partnership lodges a tax return to tell the ATO everything, but then it’s the Partners who pay the tax in the end.
3 Main types of Partnerships:
- General partnership: a partnership where each partner is equally liable for the management of the business and each has unlimited liability for any debts or obligations it may incur.
- Limited partnership: composed of general partners, each of whom has liability set at the amount they have invested in the partnership. Typically, limited partners are passive investors who don't participate in day-to-day operations of the business.
- Incorporated Limited Partnership: partners in this type of partnership may only be held liable in part for the obligations of the business. Nevertheless, a minimum of one general partner with unlimited responsibility is required for an ILP. The general partner (or partners) are personally responsible for any unpaid obligations if the business is unable to pay them.
Specific tax regulations:
- Taxation of Partnership Income: Rather than being taxed at the partnership level, partnership income is taxed at the individual partner level. As a result, each partner is required to report their share of partnership income on their individual tax returns. Each partner must receive a statement from the partnership detailing their portion of the partnership's earnings, expenses, and credits for the financial year.
Keep in mind, there are rules around how the partner’s ‘share’ is calculated. It is not as simple or nice as saying “oh, I will pay Sam this much and Kim this much”.
- Partnership Return: While the partnership as a whole is exempt from income tax (doesn’t pay tax), it is nevertheless required to file a Partnership Return each year. This return shows the partnership's income, deductions, and credits for the financial year. The partnership return is used to allocate the partnership's income and deductions among the partners.
The allocation of income and deductions is based on the partnership agreement and can be different for each partner. Usually, it is default set to an equal split and the amount of hours or work or prepayments made to the partners is less relevant!!
Just like any other type of business, a partnership must be registered for goods and services tax if the annual income turnover is $75,000 or more. Read more about GST in our blog here.
Calculating Partnership income or loss
Even though a Partnership does not pay income tax in its own right, it is required to complete an
income tax return showing the ‘net income’ or ‘net loss’ of the partnership sources. The net income or loss of a partnership is essentially calculated like the taxable income of a taxpayer, but with a little bit of difference. This is how you do it.
(-) ALLOWABLE DEDUCTION
(-) EXCEPTIONS (Items directly related to partner’s personal returns)... I.e. Prior year Losses and Personal Superannuation
= NET INCOME OR LOSS
It is the net Partnership income (or loss) that is ultimately reported in the individual partner’s returns.
How to compute Partnership income or loss
A partnership agreement provides that the income will be divided equally among the partners.
Number of Partners: 2
Superannuation Contributions: $10,000
Prior Losses: $7,000
Simplified computation of Partnership Tax Return:
The first step is to allocate the partnership income among the partners based on the partnership agreement. In this case, the income is divided equally among the partners, so each partner will receive $50,000 ($100,000 ÷ 2 partners).
- Allocation of Expenses:
The next step is to allocate the partnership expenses among the partners based on the partnership agreement. In this case, the expenses are also divided equally among the partners, so each partner will receive $23,000 ($46,000 ÷ 2 partners).
- Allocation of Superannuation Contributions:
The next step is to allocate the superannuation contributions among the partners based on the partnership agreement. In this case, the superannuation contributions are also divided equally among the partners, so each partner will receive $5,000 ($10,000 ÷ 2 partners).
- Allocation of Prior Losses:
The next step is to allocate the prior losses among the partners based on the partnership agreement. In this case, the prior losses are also divided equally among the partners, so each partner will receive $3,500 ($7,000 ÷ 2 partners).
- Partner's Share of Income:
The partner's share of income is calculated by subtracting their share of expenses, superannuation contributions, and prior losses from their share of income. In this case the share of income of 2 partners will be $18,500 ($50,000 - $23,000 - $5,000 - $3,500).
Important: the actual money transferred from the Partnership to the partners is not as relevant to the calculation of Partnership distribution.
If Partner A had been doing the bulk of the work, this might seem unfair that Partner B has an equal right to the profits… but that is essentially what the Partnership deal is unfortunately. Also, partners can’t really be employed by the Partnership. If they are, the earnings are deemed to simply be pre-payments of their share of the partnership profits If Partner A had been paid a wage of $10,000 throughout the year, this is considered a pre-payment of the $18,500. So the full $18,500 goes into their tax return, and they are owed the remaining $8,500.
- Partnership Return:
The partnership must then prepare and lodge a Partnership Return, which shows the partnership's income, expenses, superannuation contributions, and allocation of these amounts among the partners. The Partnership Return is used to allocate the partnership's income and deductions among the partners, which will be reflected on each partner's individual tax return.
- Individual Tax Return:
Each partner must then include their share of the partnership income on their individual tax return. They must also include any other income they have earned during the financial year, as well as any deductions and credits they are entitled to claim. Then their individual tax is paid.
This means, one partner might have just the $18,500 Partnership distribution to report (and since this is under the tax free threshold there is essentially no tax to be paid). The other partner might have a second job, paying them $100,000. From this, their employer withheld ~$24,500 in tax. Since overall they have $118,500 of taxable income, their tax bill should be more like $31,349. So, when they lodge, they owe the difference to the ATO: $6,849.
- KEEP RECORDS! It is important for partners to keep accurate records of the partnership's income and expenses, as they will need this information to complete their individual tax returns. They should also keep records of any changes in the partnership, such as the admission or withdrawal of partners.
- SEEK A PROFESSIONAL ADVICE! Partnership tax can be complex, and it is important for partners to seek professional advice from a tax professional or accountant. This will help them to understand their obligations and ensure compliance with the tax laws.
As the partnership is not considered as a separate legal entity, partners are jointly and severally liable for the partnership's debts, and other liabilities. This is another reason to seek professional advice and to have a well-drafted partnership agreement.
It is important to note that the tax laws and regulations related to partnerships can change over time, so it is always recommended to consult with a tax professional or accountant to ensure compliance with the current laws and regulations, and to properly plan the tax implications of a partnership.
Here are the helpful links If you wish to read the partnership laws according to your state
ACT – Partnership Act 1963
NSW – Partnership Act 1892
NT – Partnership Act 1997
QLD – Partnership Act 1891
SA – Partnership Act 1891
TAS – Partnership Act 1891
VIC – Partnership Act 1958
WA – Partnership Act 1895
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Business structures and partnerships