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A partnership is an association of individuals or entities for the purpose of carrying on a business venture or business activity in common with a view to profit. Each partner is entitled to take part in the management of the partnership. For tax purposes, a partnership is an association of people who carry on business as partners or receive income jointly.
Partnership agreements provide evidence that suggests that the parties intend to be in a partnership. Such evidence can include the joint ownership of assets and joint liability for debts, jointly registered business name, and appropriate profit distribution amongst the parties according to the partnership agreement. Also, unlike joint ventures, parties who operate as a partnership share income jointly as opposed to separately.
The maximum number of partners in a partnership is usually 20 but there are exceptions.
- Splitting Income:
The advantages of a partnership are the same as for a sole trader where the partners are treated as individuals for income tax purposes. The one major difference between a sole trader and a partnership is that income may be more easily ‘split’ between the partners in the partnership.
A partnership is not a separate legal entity and doesn’t pay income tax on income earned by the partnership. Instead, each partner pays tax on their share of net partnership income. As with sole traders, any losses from the partnership business will be available to the partner to reduce other income. Accordingly, profits and losses of the partnership are “brought back” into the individual partner’s tax returns.
The structure of a partnership also allows tax preferred amounts (such as tax incentives and tax free capital gains) to be passed through the partners.
- CGT Discount:
Partners are able to access the 50% CGT discounts as they hold an interest in each partnership asset as an individual.
The partners own and operate the business so this means they can make all the decisions. This control is sometimes difficult to manage because some decisions may require unanimous or joint consent from partners.
- Capita Variations:
Unless otherwise stated in the partnership agreement, the capital of each of the partners can be increased or withdrawn from the partnership without restriction. It is possible for capital contributions to be made in the form of money or property.
- Structural Flexibility:
With appropriate drafting it is possible to structure a partnership agreement that allows flexibility for varying profits/losses between the partners on an annual basis.
- strong> Sharing of burdens:
There are a greater number of people to share the workload, losses and legal responsibilities.
Partnerships are relatively simple and easy to run. They are also less costly to establish than a company or trust.
Partnerships allow for flexibility in the partnership agreement.
The most significant commercial disadvantage of a partnership is the joint and several liability of partners. In other words, if any of the partners do not have enough money or assets to pay their share of the debt, the other partners may be personally liable. This arises from the fact that the partnership is not a distinct legal entity.
- ther consequence of the partnership not being a separate legal entity is that partnerships as such cannot own property. Moreover, whilst the partnership cannot be convicted of a crime or be subject to other liabilities, individual members of the partnership may be personally liable in crime, tort or contract.
- Asset Exposure:
There is generally no asset protection, meaning that the partners’ personal assets may need to be used to repay the business’ debts.
- CGT Disadvantages:
There are some CGT disadvantages; in particular the law treats an individual partner’s share in the partnership as representing a direct fractional interest in each and every asset of the partnership.
- Continuity of Business:
If there is a change in the membership of partners this will usually alter the partnership agreement unless the agreement stipulates otherwise, affecting the continuity of the business.
- Selling the Partnership:
It is difficult to transfer an interest in a partnership as compared to transferring shares in a company. The main reason for this is because there is a small market for advertising the sale of a partnership interest besides advertisements in solicitors’ journals.
- Limitations to Partners Admitted: As mentioned above, because a partnership cannot have more than 20 partners. Note also that some qualified professionals, including doctors and lawyers, are in certain circumstances not allowed to enter into a partnership agreement with an unqualified person.
- Tax Return: Whilst the partnership doesn’t pay tax, it has to lodge an annual partnership tax return to show all income the partnership earned and deductions it claimed for expenses incurred in carrying on the partnership business.
Tax File Number:
A partnership needs its own tax file number and uses it when lodging its annual income tax return. This can be applied for on the ABN application form.
If the partnership is carrying on an enterprise in Australia, it may apply for an ABN and use this number for all the partnership’s business dealings.
Who pays Income Tax:
While the partnership doesn’t pay tax, it does have to lodge an annual partnership income tax return to show all income earned by the partnership and deductions claimed for expenses incurred in carrying on the partnership business. The Tax return also shows each partners share of new partnership income. Partnerships are not liable to pay PAYG instalments. Instead, individual partners may be liable to pay PAYG instalments on their share of income from each partnership they are a member of.
Partnerships cannot claim a deduction for money partners ‘draw’ from their business. Amounts taken regularly from a partnership business, and regarded by some as their ‘wages’, are not wages for tax purposes and are not tax-deductible.
Partners may apply for GST registration for the partnership if it is carrying on an enterprise. This can be applied for on the ABN application form. A partnership is required to be registered for GST if its annual turnover is $75,000 or more ($50,000 or more prior to 1 July 2007).
Partners in a partnership are responsible for their own superannuation arrangements as they are not employees of the partnership. But a partnership needs to pay superannuation contributions for other employees of the partnership.
It is important to make sure that the partnership agreement sets out how partnership capital is treated and accounted for throughout the partnership. The partnership agreement should also cover how profit will be split. Only general law partnerships deriving income are able to split profits in different proportions to the partner’s underlying interest in the partnership. Individuals who have jointly invested in shares or jointly own property will be liable for tax on their share of profits, based on their respective ownership interest in the asset.
New and Retiring Partners:
When a new partner is added or an existing partner retires, the current partnership ceases and a new one is created. The ATO does not always require the new partnership to register for a new Tax File Number or ABN. This will depend upon your business circumstances. It is wise to seek professional accounting advice if you are unsure of how a change in your partnership may affect your ATO tax obligations.
Changing the Partnership Agreement:
Partnership agreements can be changed if all partners involved sign the document once changes have been made. Generally speaking, unless partner interest in the partnership changes, no adverse tax consequences will occur.
If you would like more information on how to set your business up as a partnership, please complete and submit an express enquiry form or call us on 1300 QUINNS (1300 784 667) or on +61 2 9223 9166 to arrange an appointment.
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