By Grant Diamond
Partnerships sound like a simple concept, but they can be more complicated than they appear when it comes to taxation.
In fact, they can be downright confusing.
For starters, “partnership” is not defined under the Income Tax Act, although it does acknowledge and define something called a Canadian partnership, in which all members of the partnership must be residents of Canada.
In most cases, we have to look to the courts to establish the official definition of a partnership, which is a relationship that exists between two or more people who carry on a business with the intention of making a profit.
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As well, unlike a corporation, a partnership is not considered a person under the Income Tax Act. Instead, it is considered a person under the Excise Tax Act. It is also a legal entity that can own assets and property, but these do not have legal identity status separate from the partners.
This means that unlike the owners of a corporation, the partners are personally liable for all the actions and debts of the partnership. As well, each partner is liable for the entire partnership. A corporation may be more expensive to set up than a partnership, but the liability issue represents a significant advantage over a partnership.
Partnerships are regulated by provincial law, and although formal registration is not required, it is recommended to avoid later difficulties.
For example, there could be questions about whether the partnership exists if it is not formally registered. In such cases, the courts will look at the actions of the partnership and not at what it owns to determine the validity of the arrangement.
The existence of a partnership agreement will also hold sway with the courts.
In the absence of a formal registration, the Canada Revenue Agency has the right to determine what it believes to be a reasonable allocation of income to each of the partners.
Equal distribution of income be-tween two or more partners is rarely questioned if there is no formal registration and no partnership agreement.
Consistency of what is reported from year to year is always recommended and rarely questioned by the CRA. Inconsistent reporting acts like a beacon to the CRA and will almost always be challenged.
Without a partnership agreement, a partner may also be at risk of losing claims for items such as automobile and entertainment expenses.
Reallocations of income may come under closer scrutiny and anti-tax avoidance rules may be applied when a partnership involves non-arm’s length partners such as spouses.
In any event, we recommend that professional assistance be ob-tained when establishing a partnership.
We also recommend formally registering the partnership and establishing a clear agreement of how the partnership will operate along with a description of the share in the partnership assumed by each member.
