II. Partnerships

15.41. The scheme of Division 5 of Part III of the Act involves calculating the ‘net income’ of the partnership (in general, net income in the sense of those words in Chapter 7) of a year of income and the allocation of that net income, for the purpose of determining the incidence of tax on it, between the partners. The allocations are made in terms of the ‘individual interests’ of the partners in the net income. A partner has an individual interest in partnership profits. It is only as a term of speech that he can be said to have an individual interest in net income. Net income is, after all, merely a figure used in determining the liability to tax on partnership profits.

15.42. All the net income is allocated to the partners and taxed in their hands. While the partnership is an intermediary recognised for the purpose of tax accounting, it is not in any circumstances a taxable entity.

15.43. From the judicial opinion that Division 6 has no application to income of a trust derived from a foreign source, it seems a proper inference that Division 5, too, has no application to foreign-source income. The discussion in this section of the chapter assumes that no foreign-source element is involved: in other words, that the income has an Australian source and the partners are Australian residents.

Net Income of a Partnership and Partnership Profits

15.44. The profits of the partnership as determined by partnership law and the partnership agreement will not necessarily be the same as the net income of the partnership. In some situations the partnership profits will be greater than the net income: special tax concessions by way of accelerated depreciation and investment allowances may be available to the business carried on by the partnership. More probably, partnership profits will be less than the net income. The partnership agreement may

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require that provision be made for contingent liabilities and higher depreciation charged than is allowable in calculating net income. Whatever the amount of partnership profits, only the amount of the net income will be brought to tax in the hands of the partners. The scheme of Division 5 thus ensures that no greater tax is imposed than would have been the case had the income not moved through the intermediary.

15.45. The amount of partnership profits is not, however, irrelevant. It is necessary in many cases to know the amount in order to fix the individual interests of the partners, on the basis of which the net income is allocated to the partners. Where the interests of the partners are simply expressed as fractions of profits, there will be no need to look to the amount of partnership profits. But where the interests of the partners are to some extent expressed as, say, salary or interest on capital contributed, the determination of an individual interest will require a calculation of the amount of profit in order to determine the proportion of the profits of the partnership to which the partner is entitled.

15.46. Division 5 determines exclusively how a partner is to be taxed on the net income of the partnership. Actual distribution to a partner, whenever it occurs, does not involve any derivation of income by the partner.

15.47. The allocation of net income to a partner carries through to the partner the quality of exempt income that may attach to that income. There is an express provision in Division 5 to this effect. Presumably the individual interest of a partner, for this purpose, must depend on the taking of the partnership accounts and any appropriation of profits that distinguishes the income appropriated by reference to its source. It may be necessary to ensure, by express provision, that the quality of being a dividend is carried through in order that the tax credit in respect of dividend income proposed by the Committee in Chapter 16 be available to a partner.

15.48. Where expenditure is incurred by a partnership engaged in prospecting for minerals or in mining development, deductions may be available if there is income from mining or, in some circumstances, any other income to absorb them. The Act does not at present appear to make the deductions available against non-partnership income of the partners. It may be appropriate to remove the doubt by specific provisions for the carrying through of the deductions to the individual partners.

Treatment of Losses

15.49. The treatment of partnership tax losses differs from the treatment of tax losses of a trust. A tax loss is not carried forward by the partnership in determining the net income of the partnership in a subsequent year. It is distributed to the partners in accordance with the individual interests of the partners. ‘Individual interests’, for this purpose, refers to the liability of a partner to share in losses.

15.50. A partnership agreement may provide for the payment of a salary to a partner. The salary in a particular year may be greater than the net income of the partnership or may be payable though a tax loss has been incurred by the partnership. The application of the individual interests of the partners to determine the allocation of the net income or of the tax loss becomes, in these circumstances, a difficult exercise. The present practice of the Commissioner in accepting an allocation agreed to by the partners, where there is no suggestion that a tax advantage is the objective of the allocation, seems to be satisfactory. The practice may involve a result which, curiously, taxes one partner on an amount of net income and allows the other a loss. However, the principle is preserved that, when the tax consequences for the partners

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are combined, no more is taxed than the net income of the partnership or no greater loss is allowed than the tax loss.

Payments by Surviving Partners to Retired Partner or to Estate of Deceased Partner

15.51. A professional partnership agreement may provide that payments be made to a retired partner or to the estate of a deceased partner out of fees received after the retirement or death, the amounts of the payments being determined by reference to the individual interest of the former partner in work in progress at the date of his retirement or death. In the Committee's view there should be express provisions making the amounts income of the retired partner or net income of the estate. At the same time it should be made clear that these amounts are not net income of the partnership of the remaining partners.

15.52. Where the partnership agreement or a new agreement provides for payments to a retired partner or to the estate of the deceased partner which amount to a share of profits derived after the date of retirement or death, the share of profits may be taxed twice. It may be taxed as income of the retired partner, or of the estate, as a series of periodical receipts. It will be taxed also as net income of the partnership of the remaining partners. There is a contrast with the consequences that flow where payments of a similar kind are made by a company to a retired executive or to the dependants of a deceased executive. They will be income of the retired executive or the dependants but may be deductible by the company. They will be deductible as a business expense or under section 78(1)(c), in the latter case to the extent to which, in the opinion of the Commissioner, they are sums paid in good faith in consideration of the past services of the employee in business operation carried on by the company. It may appear anomalous that the company is differentially treated. The company may be no more than a partnership that has adopted a different legal form. It will be anomalous if a company is so treated and a company elects, in accordance with the proposals in Chapter 16, to be taxed as a partnership. In the Committee's view there should be a provision under which a deduction will be allowable to a partnership for payments made to a retired partner. A number of conditions ought to be imposed. One condition would follow the model of section 78(1)(c) and require that the Commissioner form the opinion that the payment was made in good faith in consideration of past services to the partnership. Another would require that the payment be in a form making it income of the person receiving it: in this respect the condition would be more restrictive than that imposed by section 78(1)(c).

15.53. Alternatively, provisions might be adopted that would follow the United States law, whereby the retiring partner continues to be a partner for income tax purposes until all payments to which he is entitled have been received. In this event, there would need to be some provision requiring a re-allocation of partnership income where the payment is excessive having regard to past services.