Tax Planning for a Partnership

By Nizam Shajani, CPA, CA, MBA
November 9, 2020

Under the common law a partnership exists when two or more persons carry on business in common with a view to profit. The rules governing the creation and legal existence of a partnership are found in the provincial Partnership Act.

A partnership differs from a joint venture which is an arrangement in which two or more persons work together in a defined business undertaking. In determining the relevant tax implications, the circumstances of the relationship between the parties should be ascertained to determine whether the particular relationship is a joint venture or a partnership.

A partnership is not a corporation. As such it has no specific statutory rules or protections. Unlike a corporation a partnership is quite flexible in terms of its governance and changing partner rights and interests. Limited partnerships and limited liability partnerships (LLP’s – only professions can use them) are artificial creatures that are created under provincial partnership legislation.

For tax purposes a partnership is a conduit or flow through vehicle. Tax motivation does not affect the determination of whether a partnership exists.

There are several advantages (or opportunities) to a partnership including:

• Easy to set up and very flexible with limited regulation
• Partners provide sources of additional capital and skills
• There is the ability to defer tax on the rollover of real estate and other property
• There are tax deferred rollovers available when a partner leaves or enters the partnership, or the partnership becomes a proprietorship carried on by one of the former partners
• Normally a partnership interest is regarded as capital property and CRA should not look through the partnership to the underlying property
• Various employment issues can be avoided as members are partners and not employees
• There are no solvency tests
• An opportunity for income splitting with family members through partnership income allocation
• Partnership income allocation is generally set out in the partnership agreement however there is no requirement that the partnership agreement be in writing or registered (unless limited)
• You can claim your share of partnership losses against other sources of income unless you’re a member of a limited partnership
• Expenses incurred outside the partnership may be deductible for tax purposes (ex. interest on borrowed money, use of a vehicle in the business etc.)
• Partnerships with individual partners and modest financial activity are not required to file a partnership return (T5013)
• Subject to subsection 103(1), there are estate planning opportunities with partnerships including estate freezes
• With proper planning a partner of a professional partnership may be able to access the Small Business Deduction by creating a professional corporation through which professional services will be provided to the partnership

The primary challenges (or risks) of a partnership are:

• Partners have unlimited liability for the debts and obligations incurred by the other partners
• Each partner is responsible for the actions of the other partners
• If disagreements arise, the business can suffer
• There is more complex record keeping and tax return filings
• Salaries or wages paid by a partnership to a partner are non-deductible
• Since 2011 there is no longer a tax deferral for corporate partners that hold a significant interest in the partnership who are now forced to a calendar year end reporting basis
• There is a need to file a partnership return if there if there are six or more partners or, one of the members of the partnership is a corporation or, another partnership or, if certain revenue, expense and asset thresholds are exceeded
• There are “at-risk” rules that limit the deductibility of losses by a limited partner in certain circumstances
• Partnerships that promote tax shelters and tax shelter investments are often targeted by the CRA
• Partnership income allocation can be challenged by the CRA under subsection 103(1) to be an amount that is “reasonable in the circumstances”

Your professional accounting and tax advisors can help you determine which structure best facilitates your goals for your business. They can also develop strategies based on your particular circumstances to eliminate or mitigate some of the potential risks that are apparent when planning or reorganizing a partnership.

This information is for discussion purposes only and should not be considered professional advice. There is no guarantee or warrant of information on this site and it should be noted that rules and laws change regularly. You should consult a professional before considering implementing or taking any action based on information on this site. Call our team for a consultation before taking any action. © 2020 Shajani LLP