If you have entered into a business partnership or are interested in entering into a partnership, this Legal Kitz blog post will provide you with a basic outline of the advantages and disadvantages of partnership taxes. Setting up a business does not have to be done alone; entering into a written partnership agreement can be a safe and effective way of dividing incomes and losses to ensure the business is set up for success.
What is a business partnership?
A business partnership is made up of a group of a minimum of two people or an association of people who collectively carry on a business and distribute profits and losses between themselves. There is a maximum of 20 people to a partnership, however there can be exceptions. Overall, establishing a partnership can be cost effective and easy to establish and it also has low compliance and accounting costs.
There are three main partnerships:
- General Partnership – this form of partnership is where all partners are equally responsible for the management of the business.
- Limited Partnership – this partnership is comprised of general partnerships, however, the liability here is limited to the individual contributions by each partner. This partnership is often for investors who are not involved in the day-to-day management of the business.
- Incorporated Limited Partnership – this form of partnership incurs a limited liability of the debts of the business. However, under this form of partnership there must be at least one general partner that has unlimited liability of the business. In the circumstance that the business is unable to meet its obligations, then the general partner(s) will become personally liable.
Is a partnership made in writing?
A partnership does not have to be made in writing, but it is recommended. Having a written partnership ensures that there is a physical outline of the distributions of the income and losses and an outline on how the business will be controlled.
Having a written partnership will also prevent any misunderstandings or disputes within partners to the business. Entitlements would also be addressed in writing and this would allow partners to see what entitlements they have in regards to the business’s income. This is especially important for tax purposes, in the circumstance where the profits and losses are not equally distributed.
Partnership tax requirements
Entering into a partnership, the partner is not its own legal entity, such as a company. However, the partnership must have a Tax File Number (TFN) and an Australian Business Number (ABN).
When entering into a partnership, the partnership is not a separate taxable entity. This is because a share from a partnership is to be treated as personal income and therefore is to be identified as such on the tax return. In this case, partnerships do not pay tax on the income. Therefore, incorporation can be a great way to reduce tax burdens because companies are taxed lower and at a fixed rate.
Each partner must lodge a partnership tax return. This declares:
- the income the partnership earns;
- deductible expenses; and
- the distribution of the net income or loss between partners.
What are the disadvantages to a partnership tax?
- Drawings: A partnership will not be able to claim a deduction for the money a partner removes from their business. When amounts are regularly taken from a partnership business and are then regarded as a ‘wage’, it is not considered a ‘wage’ for tax purposes and will not be tax deductible.
- Superannuation: When entering into a partnership, each partner will be responsible for their own superannuation arrangements, because they are not an employee of the partnership business.
- Payment of income tax: It is a requirement to lodge an annual partnership income tax return. This ensures that all income earned in the partnership and all the deductions that are claimed for expenses are proved to carry on the business.
Legal advice
If you would like to know information about partnership taxes, or would like to speak to one of our experienced lawyers about your own partnership agreement click here for a FREE 30-minute legal consultation. If you would like to read more blogs, have a look at our knowledge centre – here!