1. Advanced Income Tax Law
Chapter 3
Partnerships
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Overview
Definition of a partnership
Tax law defines a partnership as “an association of persons carrying on a business as partners or in receipt of ordinary income or statutory income jointly, but does not include a company”.
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Overview
Creation of partnership
For tax purposes the existence of a partnership is a question of fact determined according to the facts relevant to each particular circumstance.
A formal written partnership agreement is not a pre-requisite for a partnership to be held to exist for tax purposes.
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Overview
Creation of partnership
The following factors are prima facie evidence of a partnership:
joint ownership of business assets
joint bank accounts
registration of a business name
sharing of profits/losses
evidence of capital invested
public recognition of the business as a partnership 4
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Income Splitting
A partnership may be formed between family members as a means to split income and therefore reduce the family's overall tax liability. This is a means of tax minimisation and is a legitimate tax planning technique.
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6. Taxation of a Partnership
A partnership itself does not pay income tax, but it is required to lodge a Partnership tax return.
- a Form P
A partnership tax return is not necessary where persons are not in a partnership carrying on a business and the only income derived jointly (or in common) with another person was:
rent from a jointly owned investment property.
interest from a jointly held account.
dividends from jointly held shares.
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7. Partners Share of Income
Each partner is individually taxed on their share of partnership net income (PNI). It must be included as assessable income in the partner’s individual income tax return. If there is a partnership loss, then each partner's share of the loss is a deduction in their own income tax return.
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8. Partnership Net Income (PNI)
s.90 ITAA36 defines net income as “the balance left after deducting from the partnership assessable income all allowable deductions and allowable losses”. s.90 PNI is divided between the partners in accordance with their profit/loss sharing ratio.
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9. Partnership Net Income (PNI)
A Partnership tax return requires the completion of a Statement of Distribution which shows for each partner:
name
Tax File Number and address
share of s.90 PNI
share of any dividend franking credit
share of TFN amount withheld
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Determination of s.90 PNI
Financial dealings with partners in partnership capacity are not considered in determining s.90 PNI..
The following payments to partners are not deductions for the partnership:
salaries paid to partners
interest on capital
Alternatively, the following receipts from partners are not assessable income for the partnership:
interest on drawings
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Determination of s.90 PNI
Financial dealings with partners not in partnership capacity are considered in determining s.90 PNI.
interest expense on a loan (advance) made by a partner to the partnership is a deduction for the partnership.
interest received from a loan (advance) made by the partnership to a partner is assessable income of the partnership.
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12. Illustration 1: Calculation of s.90PNI/Distribution Statement
The partnership records of Laxmi and Parvati showed accounting net profit for the year of income of $50,000. The partnership agreement provided that profits and losses are to be shared equally after adjusting for the following:
Partners’ salaries - Laxmi $10,000, Parvati $10,000
Interest on Capital - Parvati $2,000
Required:
(a) Calculate s.90 partnership net income.
(b) Prepare a Distribution Statement.
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13. Illustration 1: Calculation of s.90PNI/Distribution Statement
Solution: (a) Net profit = $50,000 = s.90PNI (as no adjustments necessary) (b) Calculate amount to distribute: s.90PNI $ 50,000 less Partners’ salaries $ 20,000 Interest on capital 2,000 22,000 28,000 Therefore: Laxmi: 10,000 + (50% x 28,000) = $24,000 Parvati: 10, ,000 + (50% x 28,000) = $26,000 Distribution Statement Laxmi $ 24,000 Parvati 26,000 50,000
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14. Illustration 2: Calculation of s.90PNI/Distribution Statement
The partnership records of Vishnu and Brahma showed accounting net profit for the year of income of $50,000. The partnership agreement provided that profits and losses are to be shared equally after adjusting for the following:
Partners’ salaries - Vishnu $10,000, Brahma $10,000
Interest on Capital - Brahma $2,000
Interest paid on advance from Vishnu $4,000
Interest on Drawings - Brahma $1,000
Required:
(a) Calculate s.90 partnership net income.
(b) Prepare a Distribution Statement.
(c) Calculate assessable income of each partner.
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15. Illustration 2: Calculation of s.90PNI/Distribution Statement
Solution: (a) s.90PNI is: Net profit $ 50,000 less Interest on advance 4,000 46,000 (b) Calculate amount to distribute: s.90PNI 46,000 less Partners’ salaries $ 20,000 Interest on capital 2,000 22,000 24,000 plus Interest on Drawings 1,000 25,000 Therefore: Vishnu: 10,000 + (50% x 25,000) = $ 22,500 Brahma: 10, , ,000 + (50% x 25,000) = $ 23,500
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Illustration 2 continued: Calculation of s.90PNI/Distribution Statement
Solution: Distribution Statement Vishnu $ 22,500 Brahma 23,500 46,000 (c) Assessable income: Vishnu Brahma s.90PNI share $ 22,500 $ 23,500 Interest on advance 4, ,500 23,500
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Illustration 3: Partners’ Salary Calculation of s.90PNI/Distribution Statement
Sampson and Delila are partners sharing profits and losses equally, after allowing for salaries and interest on partners’ capital accounts.
Accounting net loss from business was $10,000 after paying the following:
Partner’s salary - Sampson $20,000
Interest on Capital - Delila $3,000
Required:
From the following extract of partnership accounts:
(a) Calculate s.90 partnership net income.
(b) Prepare a Distribution Statement.
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Illustration 3: Partners’ Salary Calculation of s.90PNI/Distribution Statement
Solution:
s.90PNI is:
Accounting net loss $ (10,000)
plus Partner’s Salary $ 20,000
Interest on Capital 3,000 23,000
13,000
 (b) Calculate the amount to distribute:
  s.90PNI $ 13,000
less Partner’s salary $ 10,000
Interest on capital 3,000 13,000
Nil
  Therefore:
Sampson: 10, % x (10,000 – 10,000) = $ 10,000
Delila: 3, % x (10,000 – 10,000) = $ 3,000
Distribution Statement
Sampson $ 10,000
Delila 3,000
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Dividend Imputation
Where a partnership receives a franked dividend, the following rules apply:
the partnership's assessable income is "grossed up" to include the amount of the franking credit.
the franking credit is then apportioned between the individual partners in accordance with their s.90 PNI share .
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20. Illustration: Treatment of franking credits
The partnership of Albert and Victoria provide the following information:
Gross profit from trading $ 40,000
Fully franked dividend received 490
Deductible business expenses 8,000
The partnership agreement states that profits and losses are shared in the ratio Albert 60% and Victoria 40%.
Required:
(a) Calculate s.90 partnership net income.
(b) Prepare a Distribution Statement.
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21. Illustration: Treatment of franking credits
Solution: (a) s.90 PNI is: Gross profit $ 40,000 Dividend 490 Franking credit (490 x 30/70) ,700 less deductible business expenses 8,000 32,700 (b) Calculate amount to distribute: Albert: 60% x 32,700 = $ 19,620 Victoria: 40% x 32,700 = $ 13,080 The franking credit is apportioned as follows: Albert: 210 x 19,620/32,700 = $ Victoria: 210 x 13,080/32,700 = $ 84.00
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22. Illustration: Treatment of franking credits
Solution: Distribution Statement
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Partnership Losses
A partnership cannot carry forward a loss for deduction against income in a future year. Losses are distributed to the individual partners in the year in which the loss was incurred.
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Illustration: Partnership Loss and Partners’ Salaries Calculation of s.90PNI/Partner’s Shares
Angela and Bruce are partners sharing profits and losses equally, after allowing for salaries. Partnership records show the following information:
Partner’s Salary – Angela $20,000
Accounting net loss (after paying Angela’s salary) $30,000
Required:
(a) Calculate s.90 partnership net income.
(b) Calculate the s.90 PNI shares.
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Illustration: Partnership Loss and Partners’ Salaries Calculation of s.90PNI/Partner’s Shares
Solution: (a) s.90PNI is: Accounting net loss $ (30,000) plus Partner’s Salary 20,000 (10,000) (b) Calculate amount to distribute: Angela: 50% x (10,000) = $ (5,000) Bruce: 50% x (10,000) = $ (5,000) The $20,000 salary cannot create or increase a partnership loss. It will be met from profits in a future year(s) and be assessable to Angela in that future year(s).
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26. Partnership Capital Gains/Losses
A capital gain or loss is not included in the calculation of s.90 PNI. Instead, the individual partners are assessed on their respective shares of any capital gain/loss.
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27. Miscellaneous Matters
No Deduction Allowed
A partnership is not allowed a deduction for:
contributions made to superannuation funds on behalf of the partners.
premiums paid by the partnership on the life of a partner.
Such payments are instead deductions for the partners individually.
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28. Miscellaneous Matters
Payments to Relatives and Associated Persons
The ATO has the discretion to allow only what they consider “reasonable” as a deduction for payments made to relatives and associated persons and related entities.
Excessive payments which are disallowed need to be added back to net profit so as to determine s.90 PNI.
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29. Uncontrolled Partnership Income (UPI)
s.94 ITAA36 is designed to minimise tax avoidance by imposing a special further tax on any uncontrolled partnership income. It is a penalty tax imposed on partners who do not have real and effective control over their share of s.90 PNI. Partners who are minors are not affected by the UPI provisions.
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30. Uncontrolled Partnership Income (UPI)
Real and effective control
Factors to consider are:
the constitution of the partnership as per the partnership agreement.
the control of the partnership as per the actual facts.
the conduct of the partnership's operations.
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31. Uncontrolled Partnership Income (UPI)
The rate for 2015/16 is 47% reduced by the average rate of ordinary tax (excluding tax offsets and credits) on the taxpayer's taxable income. 31
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32. Uncontrolled Partnership Income (UPI)
Rate of further tax
The rate of further tax is calculated as follows:
47% less (Tax on taxable Y x 100%)
taxable Y
The FCT has the discretionary power not to apply UPI penalty tax where "special circumstances" exist.
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33. Illustration: Uncontrolled partnership net income
In the 2015/16 income year Effie, aged 20, has taxable income of $40,000 which includes $18,000 uncontrolled partnership income.
Required:
(a) Calculate UPI penalty tax
(b) Calculate tax payable
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34. Illustration: Uncontrolled partnership net income
Solution: (a) UPI penalty tax is: (47% less (Gross tax on taxable income x 100%)) x UPI taxable income = (47% – (4,547 x 100%)) x 18,000 40,000 = (47% – 11.37%) x 18,000 = 35.63% x 18,000 = $6, (b) Tax Payable is: Tax on $40,000 $ 4, UPI penalty tax 6, , less Low Income tax offset 445 – 1.5% x (40,000 – 37,000) , Medicare Levy (2% x $40,000) Balance Payable 11,360.40
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35. Structural Changes to Partnerships
Trading Stock
A change in the ownership of a partnership (e.g. due to formation, admission or dissolution) is treated for tax purposes as a notional disposal of the stock by the old owner(s) to the new owner(s).
Under s any profit (loss) upon from revaluation is assessable income (deduction) of the old owner(s).
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36. Illustration: Revaluation of trading stock
On 30 June Partners A, B, and C, decide to admit a new partner D for a 1/4 share. At 30 June the book value of trading stock was $30,000 and its agreed market value was $40,000.
Required:
What are the tax implications of the trading stock revaluation?
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37. Illustration: Revaluation of trading stock
Solution: Under s the old partnership (ABC) will be deemed to have sold (and the new partnership (ABCD) to have purchased) the trading stock for $40,000. Therefore, partners A, B, and C will be assessed on the $10,000 gain on revaluation. This will be reflected as an adjustment to increase the gross profit of the old partnership (ABC). It will be divided among partners A, B, and C in accordance with their profit share ratio.
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38. Structural Changes to Partnerships
Trading Stock Election
As per s (4) an agreement can be made by the old and new owners that s does not apply (i.e. the owners of the new business structure may elect to use the value of trading stock that would have been taken into account if no disposal had occurred.
Under s any profit (loss) upon from revaluation is assessable income (deduction) of the new owner(s).
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39. Structural Changes to Partnerships
Trading Stock
The s (4) agreement can only be made where:
the old owners retain at least a 25% interest in the new business structure.
all new owners agree to the election being made.
the ATO is advised.
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40. Illustration: Effect of s.70-100(4) election
Using A, B, C, and D data as before.
Required:
What are the tax implications of a s (4) election?
Solution:
If partners A, B, C, and D make the s (4) election, the old partnership (ABC) is deemed to have sold, and the new partnership (ABCD) deemed to have purchased the trading stock for $30,000, and there is no assessable profit on the transaction.
Therefore, the assessment of profit is deferred until the stock is sold in the ordinary course of the new partnership business.
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41. Illustration: Market value < closing value
Adam, who was previously a sole trader, and Eve decide to form a partnership.
The closing value of Adam’s trading stock is $12,000. Its agreed value is $14,000, but its fair market value is only $9,000.
Required:
What are the tax implications of the trading stock revaluation?
Solution:
The s (4) election cannot be made as market value $9,000 is less than closing value of trading stock $12,000.
Thus, the trading stock must appear in the books of the partnership as $14,000.
Adam would include a gain of $2,000 in his books of account.
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42. Structural Changes to Partnerships
Depreciable assets
If there is a partial change in the holding of a partnership asset, or where an asset becomes a partnership asset (e.g. where a partnership is created, varied or dissolved) an adjustment may be required under the balancing adjustment rules.
This applies where at least one partner who had an interest before the change has an interest after that change.
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