Case Study: Characterisation of partnership payments

Business greeting

The ATO has recently issued Tax Determination TD 2015/19 which deals with payments made to partners retiring from a partnership. The Commissioner is concerned that many of these payments are not being appropriately dealt with in accordance with section 92 of the Income Tax Assessment Act 1936 (ITAA). Specific characterisation of any payment received is required.


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.

Outcome

There are two major implications for Xavier in this scenario:

  1. 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.
  2. 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.

For any advice relating to partnership payments please contact Brian Richards of our office at tax@redchip.com.au, or phone us on +617 3223 6100.

Back to Articles
Redchip

Recent Articles

empty hall
Major change to the Commercial Building Disclosure Program

From 1 July 2017, expansion of the CBD Program will require most sellers and lessors of office space 1,000 square metres or more to obtain a Building Energy Efficiency Certificate before the building goes on the market.

Read more
With House Model And Stack Of Coins On Desk
GST and new property sales

From 1 July 2018, purchasers of new residential premises (new homes or apartments) and subdivided residential lots will need to pay any applicable GST on the sale directly to the ATO.

Read more
aircraft Wing
Investors lose depreciation and travel deductions

From 1 July 2017, Australian Residential Property Investors will lose two long-standing tax deductions for residential properties as a result of the Federal Budget 2017.

Read more