4 benefits of written partnership agreements
When recommending a partnership structure for your clients, you are likely to be asked whether a written partnership agreement is necessary. Given that most advisers are aware that a written agreement is not required to establish a partnership at law, this can be difficult question to answer.
It is not simply the legal requirements which should dictate your answer. A well drafted partnership agreement is vitally important at least for taxation, commercial and business succession reasons.
Below are four advantages for your clients in preparing written partnership agreements.
1. Reduce the impact of disputes
The primary legal advantage of a written partnership agreement is that it provides evidence in the event of an internal or external dispute.
When a dispute arises, a written partnership agreement removes conjecture and assumption and can prove, amongst other things:
- The parties’ intention to form a partnership;
- The term of the partnership and the circumstances in which it will continue or be dissolved (see below);
- The joint ownership of assets and joint liability for debts;
- The agreed splits with respect to profits; and
- The dispute resolution methods to be adopted.
Legal disputes, even for small businesses, can be incredibly costly. A partnership agreement evidencing the above may significantly reduce costs and heartache for your client.
2. Avoid unwanted dissolution
There are many ways that a partnership can be dissolved at law, including:
- A partner dies;
- A partner become insolvent or bankrupt;
- The term of the written partnership agreement expires;
- A partner gives written notice to the other partners of their intention to dissolve the partnership;
- One or more partners can no longer legally own a business;
- It is unlawful for the members of the partnership to carry on the business; or
- A partner makes an application to the court and the court makes an order to dissolve the partnership.
In respect of the events in items 5 to 7 above, a dissolution will occur regardless of the agreement made between the parties.
A partnership will not automatically dissolve, however, where the events in items 1 to 4 occur and a partnership agreement provides otherwise.
Partners therefore have the opportunity to control the impact of the above events and make their own decisions in regards to whether or not the partnership should continue under particular circumstances.
3. Ability to reconstitute partnerships
The situation may occur where your client or their business associate wants to leave a partnership and have the continuing partners (as well as any incoming partners) take over the assets and liabilities of that partnership and have the partnership continue.
In partnership law, dissolution occurs in this situation and a new partnership is formed.
From the ATO’s administrative perspective however, a partnership may be “reconstituted” and continue where:
- There is at least one continuing partner who is a member of the partnership prior to and following the reconstitution;
- There is an express or implied continuity clause in a partnership agreement;
- All of the partnership assets remain substantially with the continuing partnership;
- The nature of the enterprise remains substantially unchanged;
- The client or customer base remains substantially unchanged; and
- The business name or name of the firm remains unchanged.
‘Substantially’ in the Commissioner’s view means more than 50%, although each case is assessed on the basis of its particular facts.
The benefits of reconstituting a partnership are that the TFN, GST registration and ABN can be retained. Furthermore, the partnership will only be required to complete one income tax return for the income year in which the reconstitution took place.
4. Flexibility in partner salaries
If your client seeks to have flexibility about the distribution of partnership profits from time to time and pay partner salaries, the ATO looks for evidence of an agreement regarding same.
The ATO has made it clear that any agreement to pay a ‘partnership salary’ to a partner after the end of the income year is not effective for tax purposes.
Although it is possible that the Commissioner will accept written resolutions of the partners or evidence of an oral agreement, our experience indicates that the path of least resistance accepted by the ATO as prima facie evidence that an agreement exists is a written partnership agreement.
A well drafted agreement will offer some flexibility as to whether a partner’s salary is fixed or variable.
For more information on partnership agreements, or any other queries regarding your clients’ business structures, contact us at firstname.lastname@example.org or phone us on 07 3223 6100.