(upbeat music)
-: We often hear about people being partners in partnerships.
There are big partnerships
like the big accounting and law firms.
There are also much smaller partnerships
such as two people running a small marketing firm together.
But what exactly is a partnership?
Firstly, let's look at what a partnership is not.
Unlike a company, a partnership
is not a separate legal entity.
So technically speaking when a partnership owns an asset
or owes a debt it is the partners of that partnership
that own the asset or are subject to the liability.
Furthermore, if the partnership has a debt
and one of the partners cannot pay
the other partners are personally liable
to pay for all of the unpaid amount,
even if it means having to sell their personal assets.
The tax definition of partnership in section 995-1
has two limbs.
And tax payers that come under either of them
for tax purposes will be considered
to be carrying on a partnership.
The first limb captures those
that are carrying on a partnership at general law.
Case law, which has been codified in most states'
partnership acts determines what
a general law partnership is.
Basically, it is when two or more persons
carry on a business together
with an intention to share their profit.
Peggy and Sue are two accountants
that work in the same office premises,
under the same business name, and who share their profits.
They are very likely to be running
a general law partnership.
Such a partnership, like most general law partnerships,
is likely to have a partnership agreement.
This agreement gives details about
when the partnership commences,
how it is to run, how profits are to be split,
and other relevant information
about the conduct of the partnership.
However, it is possible for there to be
a general law partnership
in the absence of such an agreement
if the requirements of a general law partnership
are still fulfilled.
So in this scenario,
even if Peggy and Sue do not have a partnership agreement,
it is highly likely that they would be regarded
as carrying on a general law partnership.
The second limb of the tax law definition of partnership
is persons in receipt of income jointly.
This covers a situation such as when two people
own a rental property in joint names and collect rent on it.
Such persons are not carrying on
a partnership at general law since
they are not carrying on a business together.
However, since they are receiving income jointly
they come under the second limb
of the tax law definition of a partnership.
Now that we know what a partnership is,
the next question we need to think about is
what are the tax implications of carrying on a partnership?
If there is a general law partnership
then there are two steps involved
regarding the tax implications.
The first one under section 91
of the 1936 Income Tax Assessment Act
is for the partnership to lodge a partnership tax return.
This return will state the partnership's
income and deductions.
And so calculate the net income of the partnership.
However, the partnership itself will not pay tax on this,
because it is not a separate legal entity.
The second step under section 92 of the ITAA 1936
is for each partner to account
for their share of the partnership income
or loss in their own personal tax return.
So, if the partnership made a profit,
each partner's share of the net income will constitute
assessable income in their tax return.
And they will individually pay tax
on their share of the profit.
If the partnership instead made a loss
each partner's share of the loss
will be a deduction in their personal tax return.
This is one advantage of a partnership
over a company or trust,
because it means that the partner can offset
their share of the partnership loss
against their non-partnership income.
If an individual partner does not have sufficient
non-partnership income to offset such a deduction
then they will have an individual tax loss,
which can be carried forward
and offset against future income.
If there is a partnership under tax law
only due to it coming under this
second limb of the definition.
Then in practise each partner's share of the income
goes straight to their individual income
without having to go through this two-step process.
Another important distinction is that
if there is a partnership at general law,
the partners can decide between them
how to split up the partnership profit.
But if there is a partnership only because
it comes under the second limb of the tax law definition
then the profit must be split up proportionately
to the interests in the jointly owned asset.