What is a Partnership?
A partnership is defined by Australian law as a relationship which subsists between persons carrying on a business in common with a view of profit. A partnership will be formed when two or more people decide to carry on ongoing business together without incorporating. The law allows partnerships to have up to 20 partners before they are required to incorporate (with limited exceptions).
Each state in Australia has its own legislation which sets out the law relating to partnerships.
In New South Wales it is the Partnership Act 1892 (NSW).
What types of Partnerships are there?
The two main types of partnership are general partnerships and limited partnerships. A general partnership is where all partners participate to some extent in the day-to-day management of the business. A limited partnership has at least one general partner who controls the business day-to-day operations and is personally liable for business debts and passive partners called limited partners.
Partners may have different equity shares in the partnership. For example, one partner may have a 60% interest while the other has a 40% interest. A different equity share in a partnership can affect the income received by the partner as well as their share of the partnership’s assets. If multiple people receive a share of the profits of a business, it will be strong evidence that a partnership exists. However, it should be noted that a share of the business profits is not enough by itself to show the existence of a partnership. When the Court is ruling on the existence of a partnership, the Court is required to consider the whole of the facts and the actual agreement between the individuals.
What are the features or requirements for a Partnership?
The law will recognise a partnership even when the parties have no written partnership agreement. The partnership comes into existence when an agreement is reached by the partners, even if this is not written down or formally recorded. Despite this, a written partnership agreement is strongly recommended. A written partnership agreement can help to prevent misunderstandings and disputes which may arise in the future. By default, the losses and profit of the partnership will be split equally between the partners. Such a written partnership agreement is especially important if the partners do not wish to distribute losses and profits equally among themselves.
The ATO states that the key features of the partnership business structure include that ‘the partnership must apply for an ABN and use it for all business dealings’ and ‘the partnership must be registered for GST, if it’s annual GST turnover is $75,000 or more’. A partnership is also required to have its own tax file number and lodge an annual partnership return to the ATO. The partnership itself does not pay any income tax on profits. Each partner is required to report their individual share of the partnership income in their own personal tax return.
Advantages of a Partnership
The major advantage of a partnership is the ease and low cost of setting it up. As stated above, a partnership does not even require the preparation of documentation. This means that partnerships will often be attractive to those who have limited corporate knowledge or limited funds to set up a business.
Once set up, partnerships are also relatively simple to run and account for. The administration of a partnership will often be simpler and less onerous than the administration of an incorporated company.
Another advantage is that a partnership agreement can be flexible or as controlling as partners require. A partnership agreement may simply state who the partners are and the method of splitting the profits. This allows a lot of flexibility in the daily running of the partnership. If necessary, a partnership agreement can be more prescriptive which we strongly urge. Thus it should set out the expectations of each partner, the procedure for adding/removing partners, the equity share of the partners, dispute resolution provisions and/or any other term deemed necessary.
Partnerships also allow the partners to directly access tax losses. If a company or a trust has a tax loss, those losses can be carried forward and used, but only by the company or trust. Tax losses in a partnership are not quarantined to the partnership. The partners may use their portion of the partnership tax loss on their own personal tax returns.
Disadvantages of a Partnership
The main disadvantage with general partnerships is that the partners have unlimited personal liability. A partnership is not a separate legal entity. It is simply an agreement between two or more people. As a consequence, the partners will have personal liability for any debts or obligations the partnership accrues. This means those attempting to recover funds from the partnership can go after the partner’s personal assets in order to satisfy the outstanding debt.
Partners in a general partnership also have joint and several liabilities for the debt of the partnership. This means that any single partner can be held liable for the entire debt. As an example, if X and Y have a partnership that owes Z $100,000, Z can either sue X and Y or sue just X for the $100,000. Once Z has recovered the money from X, it is up to X and Y to attribute the loss between them. A partnership agreement may prescribe the amount of responsibility each partner has for the partnership debts or loss.
A practical solution to the issue of liability, is to have a partnership between two companies, which may limit the liability to the company structures as opposed to the individuals.
Various reported judgments of the Courts, clearly demonstrate the importance of a properly documented partnership agreement.
Author: Stephen Rockliff
If you are thinking of entering into a partnership and would like a partnership agreement drafted, or need advice on other business structures, contact Rockliffs Lawyers today.