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Everything About Partnership Taxation

Partnership taxation

Small, medium, and large businesses and accountants around Perth often use the humble tax partnership.  However, the taxation of partnerships is rarely discussed or explained in detail, even though they are so prevalent.  In this blog, we will explain what a partnership is, how it operates, and how it is taxed.

What is a partnership?

 Partnerships serve as a widely chosen business structure around Perth where two or more people, up to a maximum of 20, join forces to create a profit. They are widely used, from small shopfronts to large infrastructure and property developments.  A partnership can create significant tax opportunities for family businesses around Perth if properly designed by their tax accountants.

However, establishing a partnership isn’t merely a matter of starting up and going; it requires registering a new business entity with the ATO, and operating as a partnership has tax obligations and partnership regulations that may not be clear. Seeking advice from an accountant or lawyer is strongly advised, especially concerning liability, risk, and tax considerations.

A partnership signifies an effort between two or more parties coming together to profit. Unlike a company, a partnership is not an independent legal person. Yet, it must still acquire a Tax File Number (TFN), potentially an Australian Business Number (ABN), and it will likely lodge an annual partnership tax return with the Australian Taxation Office (ATO). While the partnership files the tax return to disclose information to the ATO, ultimately, it’s the partners who assume responsibility for tax payments.

What are the types of partnerships available?

General Partnership: In this structure, each partner enters the relationship to generate a profit.  The profit ratio does not have to be equal, and the partnership deed governs the structure.  

Tax partnership: Partners in a tax partnership do not need to come together to generate profit. Instead, they come together to generate income.  So, two people owning a rental property will be in a tax partnership but not a general partnership. However a general law partnership will become a tax partnership.

Limited Partnership: This type consists of general partners with liability limited to their investment in the partnership. Typically, limited partners act as passive investors, not involved in day-to-day business operations.

Incorporated Limited Partnership (ILP): Partners in an ILP are liable for business obligations only to a certain extent. However, at least one general partner with unlimited liability is necessary. If the business fails to meet its obligations, the general partner(s) assumes responsibility for any outstanding debts.

How are partnerships taxed?

Taxation of Partnership Income: A partnership is a relationship rather than an entity (like a marriage is a relationship), but a partnership does not exist as an entity.  Rather than facing taxation at the partnership level, partnership income is taxed at the partner level. So, each partner is responsible for reporting their respective share of partnership income on their tax returns. Partners must receive a statement from the partnership delineating their portion of the earnings, expenses, and credits for the financial year. Typically, their Perth tax accountant will prepared that statement to simplify the partners tax affairs.

Partnership Return: Although the partnership is exempt from income tax, it must submit a Partnership Return annually. This return outlines the partnership’s income, deductions, and credits for the fiscal year. It distributes the partnership’s income and deductions among the partners based on the partnership agreement. Typically, this allocation defaults to an equal split, with considerations such as hours worked, or prepayments made by partners being less significant in determining the allocation.  The partnership deed will always be necessary when looking at the allocation.

The partnership tax return will be aided using cloud accounting to track the partnership income and expenses.

Does a partnership pay Capital Gains Tax

No.  When you are looking to understand capital gains tax it is worthwhile that the owner of the asset pays capital gains tax.  As a partnership is a relationship it does not own the asset and it does not pay capital gains tax.  This is the case if the capital asset is owned in Perth, Western Australia, nationally or overseas.

Who can be partners in a partnership?

Any person can be a partner in a partnership.  The person does not have to be a natural person.  So, a partner in a partnership can be a company, unit trust, SMSF or hybrid trust.  That person can then enter a partnership with another person – be it a natural person, company, discretionary trust, hybrid trust, company, unit trust or SMSF.

Is a Joint Venture a Tax Partnership?

A joint venture, often called JV, is a business arrangement where multiple parties agree to work together on a specific project. Each participant brings their unique skills and resources to the table in this setup. Joint ventures are especially prevalent in sectors such as mining or property development. Entities in a joint venture often prefer this structure over a traditional partnership to circumvent specific fiduciary responsibilities, constraints, and liabilities that state-level Partnership Acts typically govern.

Typically, a joint venture is where two people come together with a view to output.  A partnership is where two people come together to profit.

A joint venture, which is not recognised as a separate entity, doesn’t file a collective partnership tax return for tax purposes. Instead, each joint venture participant is responsible for filing their individual tax return. In these filings, they report their proportionate share of deductible expenses and are independently taxed on the income from their portion of the venture’s output. Each party to the joint ventures handles their tax obligations separately, leading to distinct tax results for each participant. This scenario markedly differs from the tax treatment in a partnership structure. Additionally, each member must individually manage any Goods and Services Tax (GST) obligations for the taxable supplies they provide and claim any eligible input tax credits, unless the joint venture qualifies as a GST joint venture, in which case specific regulations come into play.

In a typical joint venture setup, each participant contributes resources—such as cash, assets, or expertise—and receives a corresponding share of the final product. This structure allows each joint venturer to own their portion of the assets independently, bear their own expenses, and separately manage and report their income. For instance, each member must independently assess the nature of their income from the joint venture, determining whether it stems from the sale of trading stock, is considered capital, or results from a transaction to generate profit.

How can GST be simplified for joint ventures?

Under Division 51 of the GST Act, if specific criteria are met, joint venture participants can be recognised as a single entity for GST purposes, known as a ‘GST joint venture’ (‘GST JV’). One participant or an external third party is designated as the GST JV operator in this arrangement. This operator is tasked with managing the GST aspects of the joint venture, including handling the supplies or acquisitions made by the GST JV and filing a business activity statement for each tax period. The primary goal of this structure is to streamline the accounting process for internal transactions by having them managed by a single entity, the operator.

So a GST Joint Venture can then prepare a BAS which could be one of the 5 reasons why you should prepare a BAS.

What are the tax advantages of a partnership?

The primary benefit of a partnership for tax purposes is that each partner pays tax personally.  So, if one partner has distinct tax advantages outside of the partnership, like tax losses, they can use those personally held tax advantages only against their share of partnership income.

This is important for Perth tax accountants when structuring independent parties.  One party might not pay tax (like an SMSF), and the other person might incur a high tax rate (like a natural person), so a partnership will allow each party to deal with their tax profiles personally and not engage the other partner in those discussions.

If a partner incurs a tax loss the individual partners can also enjoy tax loss.  This compares to a trust or company structure where the tax loss will be quarantined for future use.

What is the downside of using a partnership?

Every tax accountant in Perth will mention that partners in a partnership have unlimited liability for the partnership costs.  This unlimited liability is a significant deterrent for partners entering into a partnership that cannot be reduced by insurance alone.

Can Two Companies Establish a Partnership?

Yes.  Two companies can join forces and establish a partnership. A partnership can comprise as many as 20 partners, allowing several companies to collaborate in this structure.

Can Two Trusts Establish a Partnership?

Yes.  A partnership between trusts is a recognised practice among Perth tax accountants. A partnership is an arrangement among parties (in this case, trusts) to collectively share the benefits and responsibilities of the partnership’s operations.

So, if discretionary trusts form a partnership, the partnership essentially signifies an agreement in which each partner is the trustee of a discretionary trust. This structure is distinct from a partnership of individuals, where everyone directly participates as a partner.

While the conceptual differences might seem minor, the accounting and tax implications of a partnership involving trusts can be significant.

Can a partnership pay the partners a salary?

No.  The partnership is the relationship between the partners.  And the partners cannot employ themselves.  So, a partnership cannot employ the partners, salary package their remuneration, undertake fringe benefits tax planning for partners or remit PAYG Withholding on the amounts paid to the partners.

The salary paid to a partner is treated as a division of partnership profits and isn’t deductible. Distributing a salary to a partner alters their share of the partnership’s profit and their portion of the partnership’s net income. Below is an example of how a partner’s salary impacts the financial distribution within a partnership.

Illustrative Example:

Consider a business operated as a general law partnership by Partner A and Partner B. The business’s accounting profit for the fiscal year is reported as $100,000, while the partnership’s net income is determined to be $150,000. According to the partnership agreement, Partner A receives a salary of $50,000, and the remaining profit is equally divided between both partners.

Step 1: Compute the partnership’s accounting profit or loss for the financial year

As stated, $100,000.

Step 2: Compute the partnership’s net income or loss for the financial year

As stated, $150,000.

Step 3: Determine the percentage share of each partner in the accounting profit or loss

For Partner A, the share in the partnership’s accounting profit equals 75%.

This is calculated as $50,000 (salary) + (50% of the remaining profit after salary x ($100,000 partnership accounting profit – $50,000 salary)) = $75,000. The percentage share: $75,000 / $100,000 partnership accounting profit = 75%.

For Partner B, the share in the partnership’s accounting profit equals 25%.

This is calculated as 50% of the remaining profit after Partner A’s salary is taken out x ($100,000 partnership accounting profit – $50,000 Partner A salary) = $25,000. The percentage share: $25,000 / $100,000 partnership accounting profit = 25%.

Step 4: Determine each partner’s taxable income

For Partner A, the taxable income amounts to $112,500.

This is calculated as the 75% partnership interest share x ($150,000 net partnership income / $100,000 accounting profit).

For Partner B, the taxable income amounts to $37,500.

This is the 25% partnership interest share x ($150,000 net partnership income / $100,000 accounting profit).

If a partner’s salary surpasses the accounting profits of the partnership, the excess amount is carried over to offset accounting profits in subsequent fiscal years. This carryover, in turn, modifies the partners’ shares in the partnership’s earnings in the same manner as described above for those subsequent years.  The partnership cannot operate, so one partner generates a loss from the partnership, and the other generates a profit.

Importantly, an agreement to vary the partnership’s profits through a partnership salary must happen before the financial year starts.  The partnership agreement needs to document that a partner’s salary is possible.

Does my partnership agreement need to be documented?

No.  Your partnership agreement does not have to be documented in writing.  Western Australia has legislation (The Partnership Act 1895) that will then govern the partnership.

A written agreement is beneficial – even between “Husband and Wife” partnerships. If the agreement is not in writing, a partner’s salary cannot be used.

Are partnerships right for me?

A partnership can be a simple, transparent, and cost-effective tax structure for you.  A partnership can also be a significant part of a tax strategy for a smart family in a business undertaking a significant transaction.  Importantly, talking to a tax advisor like Westcourt, who has a single focus on families in business with a deep global network and a commitment to independent and impartial advice, is crucial to getting you the best long-term financial outlook.  Given our proven technical excellence and upfront pricing structure we are the natural choice when looking at tax structuring advice – so why not given us a call?

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