Tag Archives: partnerships

Uneven sharing of the partnership pie – OK for tax?

pie

Anecdotally one hears that many partners of business partnerships, especially husband and wife partnerships, don’t bother with a deed or agreement to record their partnership. These partnerships run some risk that the Commissioner of Taxation won’t accept that a partnership exists and then the onus of proof will be on the “partners” to show that the Commissioner is wrong and that the partnership between them is real.

Demonstrating the partnership

The burden of proof (see our blog post at https://wp.me/p6T4vg-W ) then moves on to the taxpayers asserting their partnership to prove their contribution and involvement in a partnership and their conduct of a business as a partnership. If the supposed partners don’t meet this onus on them, the partnership fails for tax.

The Commissioner usually won’t dismiss a business partnership asserted in a partnership income tax return without a reason for doing so. But lack of a written partnership agreement can be a major driver in cases where the Commissioner does do that.

Income tax effective features of a partnerships accepted for tax

A partner in a tax partnership can broadly offset a loss from the partnership against non-partnership income of the partner for income tax though that capability is now constrained by the non-commercial loss rules in Division 35 of the Income Tax Assessment Act (ITAA) 1997 which apply to both individuals and partnerships.

The ability of partners to share income and losses from a partnership unevenly is both a commercially useful flexibility and a tax effective feature of a partnership.

Uneven shares of tax partnership income and losses

Section 92 of the ITAA 1936 brings to tax a partner’s share of their “individual interest” in the net income of the partnership in an income year. If the agreed split of partnership income and losses between two partners of a partnership is say 75%/25% by agreement between the partners then this can be thus accepted for tax, all else being in order.

In order?

State and Territory partnership legislation provides that:

all partners share equally in the capital and profits of the business, and must contribute equally towards the losses, whether of capital or otherwise, sustained by the partnership

from paragraph 24 of Taxation Ruling TR 2005/7 [footnoting Section 24(I) of the Partnership Act 1892 (NSW); section 28(1) of the Partnership Act 1958 (Vic); section 27(1) of the Partnership Act 1891 (Qld); section 24(I) of the Partnership Act 1891 (SA); section 34(1) of the Partnership Act 1895 (WA); section 29(a) of the Partnership Act 1891 (Tas); section 29(1) of the Partnership Act 1963 (ACT) ]

To achieve an unequal split of income or losses between the partners, the partners must produce an agreement contracting out of this statutory prescribed equal share which applies effectively by default. An obvious instance where this is necessary is when partners have made unequal capital contributions to the partnership and seek to adjust quantum rights to:

  • partnership income and losses; and
  • returns of partnership capital;

accordingly.

Where partners pursuing unequal partnership income/loss entitlements seek:

  • to prove those entitlements to the Commissioner; or
  • to avoid disagreement and dispute with other partners about their share of partnership income or losses;

a written form of the deal setting out the terms of the partnership is essential.

Partner salary

Taxation Ruling TR 2005/7 concerns the taxation implications of ‘partnership salary’. The ruling explains:

 A ‘partnership salary’ is not truly a salary, nor is it an expense of the partnership, but instead is a distribution of partnership profits to the recipient partner. Thus, the payment of a ‘partnership salary’ to a partner, whether or not for personal services provided by the partner, is not taken into account as an allowable deduction under section 8-1 of the Income Tax Assessment Act 1997…

Paragraph 7 of TR 2005/7

At paragraph 10 of TR 2005/7 the Commissioner further states that, to be effective for tax purposes, an agreement to pay a partnership salary must be entered into before the end of the income year in which a claimed partnership salary is drawn.

TR 2005/7 has a number of useful examples of how accounting for a partnership salary can be done in a way that will be acceptable for tax by the Commissioner.

Fights with other partners over entitlements

A partner in receipt of a partnership salary for personal services should thus be mindful that a partnership deed may or will be vital to showing he or she received a partnership salary, as agreed, for those services in fact and that amounts received by the partners were additional, as salary, to and not an advance or drawings of the partner’s statutory equal share of income.

Other problems with partnerships that are not in order for tax

Not partnership salary issues and so not addressed in TR 2005/7 are:

  • where the Commissioner may adjust partnership income of a partner where a partner does not have real or effective control of or of disposal of partnership income using the uncontrolled partnership income provision in section 94 of the ITAA 1936; and
  • where the Commissioner asserts a partnership is a sham: that is, the partnership is without legal effect despite documentation, such as an purported agreement, of it.

Conclusions

It is an imperative that partnerships where a partner or partners:

  • are to receive a partnership salary; or
  • are to participate unequally in income and losses with the other partners for any other reason, including due to disparity in contributions of capital to the partnership of to facilitate partnership salaries;

document the terms of the partnership. A partnership deed or agreement is usually inexpensive and a small price to protect against the above calamities. It is especially important to complete a deed or agreement where there is possibility of dispute between partners as to what their shares of partnership income and losses are to be.

A partnership deed also shows the Commissioner that the partnership is most likely a real structure carrying on a business and that the shares of income and losses partners say they share in and take from the partnership matches what the partners believe them to be and will so return in their partnership income tax returns.

Determining the AAT fee on a tax appeal to the AAT

The applicable fees to appeal

Unless a taxpayer is disadvantaged and qualifies for a concessional $100 fee – see our blog post: Small business now has its own dedicated taxation division of the AAT at https://wp.me/p6T4vg-dx, fees for review of the Commissioner of Taxation’s decisions reviewable by the AAT are now:

  • $952 for review by the Taxation & Commercial Division; and
  • $511 for for review by the Small Business Taxation Division (SBTD).

These fees have gone up since our blog post in March 2019.

Who can appeal to the SBDT?

As explained in our earlier blog post, appeal to the SBTD is available where the appellant is a small business entity under section 328-110 of the Income Tax Assessment Act (ITAA) (C’th) 1997.  A small business entity is an entity (see section 960-100 of the ITAA 1997) carrying on business with an aggregated turnover of less than $10 million in an income year.

Multiple decisions – single fee on an applicant

Where the appeal is against more than one decision that relates to the appellant, the AAT can allow appeals to be dealt with together so only one fee applies. For instance, if a taxpayer is appealing against decisions to disallow a series of objections against multiple assessments of tax across multiple tax periods then the AAT can apply a single fee.

The AAT also allows for a single fee to be imposed on an “organisation” rather than separately on each of the members of the organisation applying to appeal.

Partnership CGT SBDT appeal

We have a client seeking review of objections against multiple assessments of income tax in the SBTD. The client is a partnership under State law (viz. a general law partnership carrying on business) and is a section 328-110 small business entity eligible to appeal to the SBTD.

The appeal concerns decisions by the Commissioner to disallow objections by the partners against income tax assessments seeking reduction in amounts included as assessable net capital gains to the partners in a series of income years.

Net capital gains made on partnership assets are assessed as income to the partners individually in a partnership. That is capital gains on partnership assets are not included in partnership income nor are they included in a partnership’s income tax return.

Soon after the introduction of capital gains tax (CGT) in September 1985 to include capital gains in assessable income it became apparent that it was impractical to assess partnership capital gains as partnership income to partnerships. Not only is a partnership not a legal owner of partnership property, and thus not apparent as the entity against which to assess a gain on a CGT asset, partnership property is often not owned by partners in the same names or proportions as partners share in the income and losses of the partnership.

Should a single fee have applied to the partnership?

The treatment of a partnership as an entity for some purposes, but not for others, can be confusing. It is via the small business entity regime that our client, a partnership, qualifies as a small business entity and this also impacts how the capital gains on partnership assets in dispute are assessed to the partners. The partnership is an “organisation”. Should a single fee apply to appeals by all of the partners of the partnership relating to the partnership asset CGT issues which are in common to all of the partners?

For the moment the AAT Registry say no. The AAT Registry has sought the $511 fee from each of the partners and has raised the appeals as separate cases (at odds with how the Australian Taxation Office dealt with binding private ruling applications and objections from the client in substance). The AAT Registry have raised the prospect that partners can seek to have their cases combined into one case and can seek a refund of the further instances of the $511 fee at a later point in the proceedings.

If the client is successful in obtaining a refund of the additional $511 fees we will update this story with a comment below.