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Know your Structures (Part 1) - Partnerships

Disclaimer: The content of this Bulletin is general information only. It is not legal advice. Law Central Legal recommends you seek professional advice before taking any action based on the content of this Bulletin.

12/04/2018

By Law Central Legal

This is the first Bulletin in a series which will look at different business structures.

Partnerships are a basic business structure which can be traced back as far as medieval Europe. A partnership is defined by Australian Law as the relationship which subsists between persons carrying on a business in common with a view of profit. A partnership will form when two or more people decide to carry out ongoing business together without incorporating. The law allows partnerships to have up to 20 partners before they are required to incorporate (with limited exceptions).

The two main types of partnerships 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’s day-to-day operations and is personally liable for business debts, and passive partners called limited partners. Each state in Australia has its own legislation which sets out the law relating to partnerships. Some states have separate acts for general partnerships and limited partnerships.  

Partners may have different equity shares in the partnership. 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’s 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. 

The law will recognise a partnership even when the parties have no written partnership agreement. The partnership comes into existence when agreement is reach 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. So a written partnership agreement is especially important if the partners do not wish to distribute losses and profits equally between themselves.

The ATO states that 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 its 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’s income in their own personal tax return.

This bulletin will now outline some of the advantages and disadvantages of a partnership business structure.

Advantages of a Partnership:

The major advantage of a partnership is the ease and low cost of setting it up. As mentioned above, a partnership does not even require the preparation of documentation. This means partnerships will often be attractive to those who have limited corporate knowledge or limited funds to set up the 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 as flexible or as controlling as the 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 much more prescriptive. It could set out the expectations of each partner, the procedure for adding/removing partners, the equity share of the partners, 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’s tax loss on their own personal tax returns.

Disadvantages:

The major 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 liability for the debt of the partnership. This means that any single partner can be held liable for the entire debt. As an example, if Lachlan and Alexandra have a partnership that owes Sam $10,000. Sam can either sue Lachlan for $10,000 or sue Alexandra for $10,000. Once Sam has recovered his money, it is up to Lachlan and Alexandra to attribute the loss between them. A partnership agreement may prescribe the amount of responsibility each partner has for the partnership loss.

A practical solution to the issue of liability is to have a partnership between 2 companies. The liability is then generally limited to the company structures as opposed to the individuals.

Partnerships can also experience difficulty resolving disagreements between partners. There is the potential for a stalemate when there is an equal number of voting partners. This issue is often worsened when the partnership agreement does not set out the procedure for when the partnership is equally divided by an issue.

Putting it in Writing – the Importance of a Partnership Deed:

Although not a requirement under the law, the affairs and running of the partnership should be governed by a partnership deed. The partnership deed would set out the partners rights and obligations, succession issues, loans and advances by the partners, the partners rights to income and capital and such other issues including voting procedures and matters relating to the business enterprise being run by the partnership. A partnership deed would also address the settlement of accounts in the case of the dissolution of the partnership. Not having a deed that addresses the issues regulating the partnership may result in unnecessary and expensive litigation on matters that could have been clearly set out in the partnership deed.

A case in point is that of Fletcher Nominees Pty Ltd v SGMC Pty Ltd [2004] WASC 279. The case relates to a partnership involved in a gold mining operation in WA. A dispute arose as to how the losses where to be divided amongst the partners upon dissolution of the partnership.

Master Sanderson in paragraph 6 of his judgement states “In fact, whatever the terms of the partnership may have been, is largely irrelevant for the purposes of these proceedings. Really, all that is of interest is the terms of the agreement relating to the way in which any losses sustained by the partnership were to be distributed on winding-up. It is also clear that the partners never discussed this particular issue. Not surprisingly, they all expected that the venture would be profitable. That means, of course, that the way in which the losses are to be distributed and winding-up is dependent upon terms which can be implied in the partnership either as a consequence of the terms expressly agreed by the partners, or by operation of law under the Partnership Act.”

In paragraph 21 of the decision it was noted that the partners “did not reach any agreement as to what should happen on dissolution of the partnership”. Accordingly the provisions of Partnership Act 1895 (WA) were applied.

The decision held, in this particular case (due to the absence of an agreement to the contrary), “that all payments made by the partners which are properly characterised as made on behalf of the partnership, are to be totalled up and borne equally” between the partners.

The above case demonstrates the importance of a properly documented partnership agreement.

Gold and Platinum members read on for a distinction between partnerships and joint ventures.

Platinum Members, click here to view content

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