STRUCTURES – THE PARTNERSHIP
Not simply the domain of hotshot lawyers, a partnership is a simple and effective tax structure to operate a business with one or more other people.
A partnership is not a separate legal entity, rather it is simply an arrangement between people to earn income jointly. The tax legislation defines a partnership as either (a) as an association of persons carrying on a business with a view to profit, or (b) a situation where two or more people are in receipt of income jointly. This second definition would include jointly owned bank accounts, shares, and real property, however there is an ATO administrative concession which means these types of partnerships don’t need to lodge a separate tax return, rather the income is dealt with at an individual tax return level.
Is it generally a good idea to get a legal document drawn up (known as a partnership agreement) that outlines the relationship you will have with your business partner/s in case of any legal dramas further down the track. With such an agreement in place your partnership would be considered a ‘general law partnership’ (i.e. a partnership under the relevant state Partnership Act) and you can have a bit of flexibility when it comes to splitting income between the partners, rather than it having to be split equally as with most partnerships without formal agreements.
What are the advantages of using a partnership?
- Free to establish – just need to register with the ATO (TFN, ABN, GST, etc.).
- Simplicity – income and expenses are pooled, the net profit is then passed out to the individuals and they pay their respective taxes.
- Ongoing fees – typically accounting fees for a partnership are less than those for a company or a trust for example.
- Income splitting between the partners.
- Partnership agreement can provide some degree of flexibility with regards to the income splits between the partners.
Sounds great, but what are the negatives?
- Partners are jointly and severally liable – this means that any single partner can enter into a deal or incur debt on behalf of the partnership, and therefore, on behalf of other partners. An example of this sort of situation going bad would be partner A entering into an expensive lease agreement for the business and then going bankrupt, leaving partner B wholly liable to meet the payments.
- A partnership structure, generally speaking, provides no asset protection.
- Tax can be higher than under a company because there is no way of sheltering income – the entire net profit must be distributed to the partners each year which can result in the partners paying tax rates above 30%, something that can be avoided if a company structure is used.
- Partner joins or leaves? This will mean the old/existing partnership ends and a new one forms which can throw up legal as well as tax issues to consider. I note there is ATO administrative relief available under limited circumstances meaning the original partnership details (e.g. ABN, TFN, requirements to lodge tax returns) can be adjusted to allow for the changed line-up rather than closed – this is handy as it saves having to wrap everything up and start anew every time someone joins or leaves the partnership.
What is a joint venture? Be careful not to confuse a partnership with a joint venture, or JV. If you are in a partnership you must share the income jointly, whereas in a JV the income and deductions are accounted for separately by each of the JV partners. There is no useful definition of JV available, but they are typically project and/or output based (e.g. a mining company forms a JV with a farmer who has land they want to mine for a particular mineral for a particular length of time).
As always, the above is intended as a general guide only and does not constitute advice. Anyone considering establishing a partnership should speak with their lawyer and their accountant.
If you’re keen to explore the best business structure for your situation please get in touch today, we’d love to help.