The Commissioner believes that:
It cannot be concluded that a person has no interest in the partnership income merely because they cease to be a partner before the partnership’s profit or net income has been calculated.
A scenario to consider
X&Y is a partnership carrying on business in Australia. Xavier, an Australian resident, was a partner in X&Y holding a 50% partnership interest. Xavier retired from the partnership on 1 January 2014.
X&Y derived an accounting profit of $1,000,000 for the year ended 30 June 2014 and Xavier was allocated $500,000 of that accounting profit in reflection of his 50% interest in the partnership.
X&Y recorded the $500,000 payment to Xavier in its books as comprising:
- Xavier’s profit share for the year ended 30 June 2014 (apportioned to reflect his retirement on 1 January 2014);
- An amount in respect of unused leave; and
- An amount described as a “retirement allowance” (calculated by reference to the number of years Xavier was a partner).
The components were calculated in accordance with the terms of the partnership agreement.
Xavier signed a retirement deed, which described the payment as being in respect of Xavier’s disposal of his interest in the partnership.
X&Y’s net income (taxable) for the year was $1,200,000, of which $600,000 was allocated to Xavier.
There are two major implications for Xavier in this scenario:
- Xavier must include the amount of $600,000 in his tax return under s92 ITAA 1936, given that it is his interest in the net income of the partnership for the year ended 30 June 2014.
- Any capital gain that Xavier might otherwise make as a result of a CGT event happening to his interest in X&Y is reduced to the extent it is reflected in the amount assessable under section 92.
It is imperative that payments made to partners in this context are appropriately characterised and apportioned if necessary.
What does this mean for your clients?
If a partner is set to retire, you should consider the nature of any payment made to the retiring partner – that is whether the amount received:
- Represents the partner’s share of partnership net income for the period up to their retirement;
- Is assessable in the partner’s hands on revenue account on another basis; or
- Relates to the disposal of the partner’s interest in partnership assets.
As the TD states:
At general law, a partner has an individual interest in the net income of a partnership, even though the precise amount of their interest cannot be determined until the accounts are prepared in respect of the relevant period. This interest exists independently of any actual division of profits or net income, reflecting that the collective income earned by the partnership belongs to the partners according to their partnership shares.
That being the case, and unless otherwise provided by the partnership agreement, a partner has an entitlement to their share of the net income of the partnership up to the date the partner retires. Note, however, that the partnership agreement might override this general law presumption.
The characterisation of monies received will be influenced by:
- The terms of the partnership agreement;
- Any separate agreement relating to the retirement of the partner;
- How the payment is characterised in the financial accounts of the partnership; and
- Whether the retiring partner is entitled to any other amounts, more particularly relating to the disposal of the partner’s interest in the assets of the partnership.