Question

David and Emma are married and have some investment properties jointly in Sydney. To structurally manage their investment properties, they signed a formal partnership agreement, and agreed that the net profits from their rental properties would be distributed 95% to Emma and 5% to David. They also agreed that David bear the total losses from the investments. Required: With reference to the relevant laws, critically discuss whether David and Emma are in a partnership as investors? Also, discuss whether they are required to lodge a partnership tax return?

Answer 1

A partnership is an association of persons carrying on a business as a partner or receiving income jointly . A partnership is not a taxable entity, but it must lodge a tax return at the end of each income year. Partners are taxed on their share of the profits of the partnership or are entitled to a deduction for their share of the losses incurred by the partnership as disclosed in their own tax returns. Some deductions are not available to the partnership, but may be claimed by the partners A partnership asset is owned by the partners (and not the partnership) in the proportion to which the partners have agreed. A partner’s share of the capital gains or losses relating to CGT (capital gains tax) events occurring for partnership assets must be disclosed on the partner’s tax return

whether business is carried on in partnership (including 'husband and wife' partnerships)

1. This Ruling outlines factors we take into account in deciding whether persons are carrying on business as partners for income tax purposes. It has particular relevance to what are sometimes known as husband and wife partnerships.

2. This Ruling is not to be applied :

(a) to situations where persons are in receipt of income jointly unless that income is derived from carrying on business; and
(b) to limited partnerships.

3. There are no statutory rules in the income tax law for deciding whether persons are carrying on business as partners. The question of whether a partnership exists is one of fact. The existence of a partnership is evidenced by the actual conduct of the parties towards one another and towards third parties during the course of carrying on business.

4. We look at the following factors in deciding whether persons are carrying on business as partners in a given year of income:

-
the mutual assent and intention of the parties
Conduct (a) joint ownership of business assets
(b) registration of business name
(c) joint business account and the power to operate it
(d) extent to which parties are involved in the conduct of the business
(e) extent of capital contributions
(f) entitlements to a share of net profits
(g) business records
(h) trading in joint names and public recognition of the partnership

5. The weight to be given to these factors varies with the individual circumstances. The above list of factors is not exhaustive and no single factor is decisive, although the entitlement to a share of net profits is essential.

6. This Ruling applies to years commencing both before and after its date of issue. However, the Ruling does not apply to taxpayers to the extent that it conflicts with the terms of a settlement of a dispute agreed to before the date of issue of the Ruling

7. The term 'partnership' is defined in subsection 6(1) of the Income Tax Assessment Act 1936 as follows:' "partnership" means an association of persons carrying on business as partners or in receipt of income jointly, but does not include a company.'

8. This definition extends the meaning given to the word 'partnership' in State and Territory partnership law. According to the statutory definitions in State and Territory partnership law, partnership is the relationship between parties carrying on a business in common with a view to profit. Income tax law does not distort the general law of partnership, nor does it disregard it (Jolley v. FC of T 89 ATC 4197, (1989) 21 ATR 3253).

9. Whether a partnership exists is a question of fact and it is up to the person alleging a partnership to prove that fact (Morden Rigg & Co. and RB Eskrigge & Co. v. Monks (1923) 8 TC 450 ). To decide whether or not a partnership exists between parties, we closely examine the relationship between them. We apply objective tests to the facts of each situation to assess the nature of the relationship.

10. The essential element for a partnership to exist is the genuine intention of all the parties to act as partners. This intention must be demonstrated by the conduct of the parties.

11. We consider the matters outlined below in deciding whether persons are carrying on business as partners.

12. Mutual assent and intention to act as partners is the essential element in demonstrating the existence of a partnership between two or more persons. We accept a written or an oral agreement as prima facie evidence of such an intention.

13. A written agreement signed by all parties, although desirable, is not necessary to demonstrate mutual assent and intention. An agreement to act as partners may also be inferred from a course of conduct agreed to by all parties.

14. Generally, a lack of intention to be in partnership means that a partnership does not exist at law. Conversely, a stated intention of partnership is not, of itself, sufficient to establish a partnership, as the intention must be manifested by conduct

15. Mutual assent and intention must be demonstrated, but do not stand alone and must be assessed with all relevant circumstances, including the conduct of the parties

Reconstituted partnerships

Under the law, if the composition of a partnership changes – for example, a partner retires or dies, or a new partner is admitted – the partnership is dissolved and a new partnership is formed.

However, if the change in the composition amounts only to a technical dissolution of the partnership, the partnership may be able to continue as a reconstituted continuing entity. As such, it avoids the need to change its tax file number (TFN) and Australian business number (ABN), and only one partnership tax return is required at the end of the income year.

Generally, the ATO will treat a changed partnership as a reconstituted continuing entity if the original partnership agreement incorporated a provision for a change in membership or shares and the following factors apply:

1.The partnership is a general law partnership

2.At least one of the partners is common to the partnership before and after reconstitution

3. There is no period where there is only one ‘partner’ (that is, in a two-person partnership, there is a direct transfer of interest from the outgoing partner to a new partner)
4. The partnership agreement includes an express or implied continuity clause or, in the absence of a written partnership agreement, the conduct of the partners is consistent with continuity
5. There is no break in the continuity of the enterprise or firm (that is, the partnership’s assets  remain with the continuing partnership and there are no changes to the nature of the business, the client or customer base, the business name or name of the firm).

At the end of the income year, a reconstituted continuing partnership needs to lodge only one partnership tax return covering the full income year. The tax return must include the distributions made to every person who was a partner at any time during the income year, including those who left the partnership during the year.

When lodging the partnership tax return, supply the following details:

-the date of dissolution
-the date of the reconstitution
-the names of the new, continuing and retiring partners
-the TFN or address and date of birth of all new partners
-details of the changes if the persons authorised to act on behalf of the partnership have changed.

If the changes in membership amount to more than a technical dissolution of the partnership, a new partnership is formed. This new partnership needs a new TFN and ABN. Both partnerships will need to lodge a partnership tax return. Lodge one tax return for the old partnership from the beginning of the income year to the date of its dissolution; and lodge another tax return for the new partnership from the date of its formation to the end of the income year.

Lodging a partnership tax return
A partnership tax return is lodged by the resident partner with the most individual interest in the partnership net income or loss. If partners have equal interests, or two partners have the same greatest interest, any of those partners may lodge the return. If there is no resident partner, the agent in Australia lodges the tax return. For information relating to non-residents, see Non-resident partner.

Keep a copy of the partnership tax return and related documents because there may be a charge for obtaining a copy from the ATO.

Do not lodge a partnership tax return where the only income derived jointly (or in common) with another person was:

-rent from a jointly owned property
-interest from a jointly held account
-dividends from jointly held shares
-and you were not in a partnership carrying on a business (in the above three instances each person shows their share of the income and expenses at the appropriate items on their own tax return).

A partnership return is not required if the partnership was a subsidiary member of a consolidated group or Multiple Entry Consolidated (MEC) group for the full income year. Where this is the case, the head company of the group will have the responsibility for reporting any partnership income in its tax return and preparing any necessary schedules.

Where a return is required because the partnership had one or more periods in the income year when it was not a member of a consolidated group or MEC group (a non-membership period) the partnership should prepare a partnership return and prepare any necessary schedules.

Limited partnerships

This does not apply to a limited partnership (including an incorporated limited partnership) that is a venture capital management partnership, or a limited partnership that is unconditionally registered with Innovation Australia as a venture capital limited partnership, an early stage venture capital limited partnership, or an Australian venture capital fund of funds. These limited partnerships are taxed as ordinary partnerships (subject to special rules about the utilisation of their losses) and are not taxed as companies.

In some cases, we need more information about the partnership to raise correct assessments for the individual partners. These are:

-where the partnership attaches an election, notification, request or application when lodging the partnership tax return

-where the partnership has received a bonus or other amount in respect of a short-term life assurance policy issued after 7 December 1983

-where the partnership has paid or credited unfranked dividends or interest to a non-resident of Australia or has received unfranked dividends or interest on behalf of a non-resident of Australia

-reconstituted partnerships where the dissolution of the partnership was only technical and the partnership business carried

Partnerships and capital gains tax
A partnership does not own assets for capital gains tax (CGT) purposes. A partnership asset is owned by the partners in the proportion to which they have agreed. If a CGT event happens to a partnership during the income year, or the partnership received a share of a capital gain from a trust, each partner must include their share of the capital gain or capital loss on their own tax return. For more information about how a partner returns their share of a capital gain or capital loss,