CHAPTER 15:

Partnerships

Prepared by

Kristie Dewald
University of Alberta
Electronic Presentations in Microsoft PowerPoint

Copyright 2016 McGraw-Hill Education Limited

Partnerships
I.
II.
III.

The Standard Partnership Definition and Format

Taxation of Partnership Operations
Partnership Structure Impact on Decision Making

Partnerships
Different alternative structures for a business activity
includes:
Partnerships
Useful for individuals who practice together in a profession
and small business enterprise
Also used to form part of a business structure of large public
and private corporations.
Limited partnerships (Chapter 16)
Joint Venture (Chapter 16)
These are non-taxable entities
The entity itself is not directly liable for tax on its earned
income
3

I. The Standard Partnership

A. Definition and Format
A relationship that exists between entities carrying on
a business in common with a view to profit.
Created when two or more entities jointly conduct ongoing
business
Scope is defined by mutual agreement
Partners share in final net results in an agreed ratio

Partnerships
A partnership is a self-contained entity holding assets,
liabilities, and partners equity.

Partner 1

Partner 2

Partner 3

Partner 4

Partnership

B. Partnership Agreement

A partnership venture consists of the partnership

entity, which conducts its affairs as a separate
organization, and a particular number of partners
A partnership is created by the execution of a
partnership agreement.
The partnership agreement outlines:
1. Each partners required contributions to the entity.
2. The format and rules for decision making and the
management of the partnerships business affairs.
3. How profits or losses are to be shared by the participating
partners.

B. Partnership Agreement
1. Partners Contribution
. A partner can participate by contributing capital or effort
or a combination of the two.
. Financial resources contributed can include cash and
specific assets such as land, buildings, equipment,
patents, and franchises.
. The cash or the value of the specific assets contributed
constitutes the partnerships equity base.

B. Partnership Agreement
2. Management
Usually all partners participate in the management of the
enterprise,
By agreement specific partners may be excluded from
this process
Procedures for decision making can be tailored to the
wishes of the participating partners.
Management decision making is completely flexible and
can be as democratic or as autocratic.

B. Partnership Agreement
3. Sharing of Operating Results:
Profits or losses are usually shared:
as a function of capital contributions, or
the degree of effort or participation in the business process, or
Both of the above.

The sharing of profits and losses is a function of the

partnership agreement.

C. Partner Liability
Standard partnership is a separate functioning entity for
management purposes.
It is not a protected legal entity that is separate from
the affairs of the partners.
All obligations and debts incurred are the responsibility of each
partner
All negligent activities performed by them, are the full
responsibility of each partner.

Each partner is jointly and severally liable for all

partnership activities.
Can be limited under certain circumstances.

10

C. Partner Liability
Most provinces have introduced a Limited Liability
Partnership (LLP)
Each partner is not responsible or liable for the negligence
of another partner
If partnership is sued only particular partners may be held
liable for their own negligence; other partners are protected
Normally only permitted for regulated professions such as
lawyers and accountings

11

II. Taxation of Partnership Operations

Not a taxable entity.
Income earned or losses incurred by the partnership are
allocated to the partners:
in accordance with the agreed sharing ratio,
for inclusion in each partners income for tax purposes.

Income is allocated for tax purposes regardless of

whether actually distributed to the partners.

12

II. Taxation of Partnership Operations

Advantage is that losses can be offset against partners
other income
Utilizing losses can:
Increase cash available to strengthen the new venture

13

II. Taxation of Partnership Operations

A. Partnership Income and Losses
Income earned or losses incurred is determined as if the
partnership were a separate taxable entity.
Can earn business income, property income, and capital
gains;
all of these are determined according to the normal rules.

Income allocated retains its source and characteristics

when included in the partners income.

14

Income Allocation an example

Type of Activity

60%
partner

40%
partner

$500,000
(100,000)

$300,000
(60,000)

$200,000
(40,000)

10,000
40,000
100,000

6,000
24,000
60,000

4,000
16,000
40,000

20,000

12,000

8,000

$570,000

$342,000

$228,000

Partnership

Business:
Retail
Manufacturing loss
Property:
Interest income
Eligible dividend Income
Rental income
Net Capital Gains

15

A. Partnership Income and Losses

Profits retained in the partnership form part of each
partners capital or equity
Available for distribution when partners so decide
When distributed, constitutes a return of capital and not subject to
further taxation

Amount of tax paid on partnership profits depends on the nature

of the given partner:
(a) Whether the partners are individuals or corporations;
(b) The rates of tax applicable to the various partners; and
(c) Other sources of income of each partner.

16

B. The Partnership Interest

A partner is considered to own a partnership interest
whenever that partner has rights and obligations created
by being party to a partnership agreement.
The partnership interest is a tradable asset
can be bought and sold.

Usually treated as capital property for tax purposes;

disposition results in a capital gain or loss.

17

B. The Partnership Interest

Usually a partnership is created when the participants

contribute capital in the form of cash or assets in return
for a partnership interest.
Can become a partner by:
a) Purchasing a departing partners interest, or acquiring a
portion of the interest of each remaining partner; or,
b) Contributing cash or assets to the partnership in return
for a new partnership interest.

18

B. The Partnership Interest

Existing partners can depart or diminish their

percentage of participation by:
a) Selling all or a portion of their partnership interest to a
new partner or existing partner(s); or,
b) Withdrawing their capital directly from the partnership
treasury.

19

Acquiring a Partnership Interest

A

$50,000

$50,000

Partnership
Net worth
$100,000

Partners A and B want to admit a third partner, C

Can purchase a portion of A and B partnership interest, or
Can purchase net partnership interestthereby increasing the
partnership net worth
20

Acquiring a Partnership Interest

Acquiring from Partners

Acquiring new interest

$33,333

$33,333

$33,333

$50,000

$50,000

$50,000

Partnership
Net worth
$100,000

Partnership
Net worth
$150,000

21

Disposing of a partnership interest

Normally results in a capital gain or loss
If interests value has increased or decreased in relation to
its cost

A partnership interest will increase or decrease in value

as a result of:
Accumulation of undistributed profits or occurrence of
operating losses; and
Increase or decrease in the value of the assets owned by
the partnership

22

Disposing of a partnership interest

Any change in value resulting from profits retained or
losses incurred does not create a capital gain or capital
loss when disposed of.
Capital gains or losses only to the extent that the
individual assets owned by the partnership have changed
in value.
This results from an arbitrary adjustment to the cost
base, for tax purposes, of the partnership interest.

23

Adjusted Cost Base (ACB)

of Partnership Interest
Original investment
$100,000
Allocation of partnership income
ACB after allocation $120,000
Fair value (120,000)
Capital gain if sold nil

20,000

24

Partnership Interest - ACB

Additions to the ACB (most common)
Partner's contribution of capital
Partners share of income from the partnership Partners share
of Capital Dividends received by the partnership
Partners share of the net proceeds of life insurance

Deductions from ACB ( most common)

Partners share of loss
Partners share of charitable gifts or political contributions
Partners drawings

25

C. Transactions with Partners and

Reorganizations
Partner
Sold
At FMV
Or
Elect at
Cost

Sold
At
FMV

Partnership
Asset FMV $25,000

26

C. Transactions with Partners and

Reorganizations
A partnership is considered to be a separate entity for
purposes of holding assets.
Transactions between partners and the partnership are
automatically taken place at FMV.
A partner can elect to transfer property into a partnership
at cost.
Partnership transfers its assets to a partner, considered
sold at FMV.
27

C. Transactions with Partners and

Reorganizations
The choice of a partnership form of organization is not
binding on the participants.
A partnership can be converted into a corporation in
which the former partners are shareholders.
A partnership can elect to convert itself into a corporation
without immediate tax consequences.

28

D. Small Business Deduction and Private

Corporate Partners
Active Income earned by a partnership can be entitled to
use the small business deduction (SBD) by a CCPC
partner.
The active business income earned by the partnership
that is eligible for the SBD is limited to $500,000 annually.

29

D. SBD and
Private Corporate Partners
Partnership earns $600,000 in ABI. Structure of
partnership is:
Corporate Partner
1

Corporate Partner
2

ABC Partnership

Each owns 50% How is the partnership income taxed?

30

D. SBD and
Private Corporate Partners
Allocation
Partnership
Eligible for SBD if
partners qualify
Not eligible for
SBD

Total

CP # 1

CP #2

$500,000

$250,000

$250,000

100,000

50,000

50,000

$600,000

$ 300,000

$300,000
31

E. Partnership Information Return

Partnerships do not file income tax returns

Required to file information returns (T5013) reporting income or

loss of the partnership and the share earned by each partner

32

III.Partnership Structure Impact on

Decision Making
Must consider these four fundamental tax issues:
1. What will be the tax cost on the annual operating profits
generated from the new venture?
2. If operating losses are expected during the start-up phase,
how and when can such losses be utilized against other
sources of income of the venture itself or of the participating
parties?
3. What will the tax implications be if the venture fails and is
either terminated or sold off at a loss?
4. How will the capital invested and the accumulated profits be
returned to the investor?

33