Taxation of partnership
The partnership is not taxed in its own right because the profits made are distributed to the partners. The partners then pay tax on those profits in their own name. That is, the profit or loss of the partnership will be apportioned between the partners in accordance with the ratio already determined in their agreement.
Partnership are still required to file partnership tax returns, but this will only show the accounts of the partnership and the profits or loss it has made for the tax period. It will then also show how that profit or loss has been divided among the partners.
All members of a partnership are provisional taxpayers, as the income they derive from the partnership is not subject to taxation at the source.
How tax affects a partnership
A partnership is where two or more people join together to run a business and the following criteria apply:
- Partnerships need to apply for a new partnership IRD number.
- Profits and/or losses are usually shared equally between partners unless a partnership agreement states otherwise.
- Each partner is personally responsible for any partnership debt.
- They can trade under a trade name, employ staff and register for GST. It’s important before a partnership registers for GST or as an employer that they seek advice from us, an accountant or a tax advisor about whether or not they need to register. There may be financial implications if they need to de-register at a future date.
Partnerships and their tax obligations
Partnerships are required to file a tax return form IR7 which shows all the income derived by a partnership or joint owners. Although a return of income must be filed by each partnership business, a partnership as such is not liable for taxation. The income or profit from the partnership business is split amongst the partners, according to the partnership agreement and then each partner will be assessed upon his/her share of the profits, together with the other income that each may earn from other sources.
The income or loss of the partnership for taxation purposes is calculated in the same way as for an individual business taxpayer with a few exceptions. All the members of a partnership are provisional taxpayers, as the income which they derive from the partnership is not subject to taxation at the source.
Tax returns required to be filed therefore, in respect of a partnership are:
- A joint partnership return showing the total partnership profit and the allocation of the profit amongst the partners (IR7)
- Separate individual tax returns for each partner showing his/her share of income from the partnership together with any other income which he/she has derived (IR3)
In any partnership, it is desirable to have a formal agreement which sets out the rights of the respective partners, and even though many partnerships are recognised as such for taxation purposes without any written agreement, a written agreement in the form of a deed of partnership is necessary where a husband and wife are involved.
How partnerships administer their affairs for tax purposes
The partnership itself does not pay income tax. Instead it distributes the partnership income to the partners. The partners then pay tax on their own share. It completes a Partnership income tax return (IR7) showing the allocation of the net profit/loss to the partners. Income, tax credits, rebates, gains, expenditure or losses allocated to a partner in an income year will generally be allocated in proportion to each partner’s share in the partnership’s income under the partnership agreement.
Partners then complete their own Individual income return (IR3), declaring their allocated profit/loss from the partnership and any additional income they have (rent, interest, salary/wage income, etc) and pay their tax using the individual tax rates. Partners can be paid a wage with PAYE deducted – in this case, the partnership needs to be registered as an employer and send us employer monthly schedules.
Partners are personally liable for any debts of the partnership, including PAYE and GST, and any personal income tax liability arising out of income received from the partnership.
How does a partnership income share distribution work?
You can prepare a formal partnership agreement and operate according to that agreement. If you are looking at a Limited Partnership, you will need to register such a limited partnership with the Companies Office. Partners share responsibility for running the business and share the profits and losses equally, unless an agreement says otherwise.
The partnership distributes its income to the partners who each pay tax on their own share. The partnership itself does not pay income tax on its profits. Instead:
- at the end of each year the net profit (without taking into account partners’ drawings) is distributed between each partner, and
- each partner then pays income tax on their share of the profit in their individual tax return, along with any other income they may have received
Tax returns for partnerships
Taxation returns are required to be filed, in respect of the partnership.
- A partnership tax return showing the total partnership profit and the allocation of that profit among the various partners.
- Separate individual tax returns for each partner, showing their income from the partnership together with any other income they derive from other sources.
If a partnership makes a profit, the partners will pay tax on the share of profit they receive. If the partnership makes a loss, then each partner will receive a share of the loss and they can claim it against any other income in their tax return.
Paying a salary or wage to a partner
If there is a bona fide contract in writing and agreed to by all partners you can pay a salary or wage to a partner and deduct PAYE.
The partners must:
- include the salary or wage in their Individual tax return (IR3) along with their share of any profit or loss from the partnership, and
- claim the salary or wage as a deductible expense in the Income tax return: partnerships and look-through companies (LTCs)(IR7)
Reallocating payments for tax purposes
Inland Revenue can reallocate payments for tax purposes if they consider that any:
- salary or wage
- share of profit or loss, or
- other income paid to a relative or associated person
……………..is unreasonable or excessive.
To determine this, they look at:
- the nature and extent of the services provided
- the value of the partners’ contributions made by way of services or capital, and
- any other relevant matters
IRD can’t reallocate a partners’ share of income or losses if there is a bona fide contract.
Filing a partnership and look-through company income tax return (IR7)
A partnership or look-through company (LTC) must file a Income tax return: partnerships and look-through companies (LTCs)(IR7) every year. The partnership or LTC is not assessed for tax, but each partner or owner is liable for tax on their share of the income from the partnership or LTC.
Partnership and partner’s returns
A partnership must file an IR7 return, attaching the Partnership details (IR7P), until the partnership ceases and we are advised. An IR7 return must be filed for the year in which the partnership ceased.Each partner in a partnership must file an Individual income tax return (IR3) showing their share of any income, expenses and tax credits from the partnership, as shown on the IR7P.
Partnership and Look-through companies (LTCs)
A look-through company (LTC) must file an IR7 return, for every year that it is registered with the Companies Office unless it has completed a Non-active company declaration (IR433). It must attach the Look-through company (LTC) income/loss allocation (IR7L) for each owner of the LTC. An IR7 return must be filed for the year in which the LTC ceased.
Each look-through owner in a LTC must file their relevant income tax return showing their share of any income, expenses and tax credits from the company, as well as any non-allowable deductions, as shown on the IR7L.