There are two types of partnerships, “general” and “limited”. A general partnership is one in which all of the partners are responsible for the management of the business, and each partner has unlimited liability for the debts and obligations of the business. A limited partnership, on the other hand, is one in which the liability of one or more partners, for the debts and obligations of the business, is limited. This article will look at general partnerships only.
Partnerships can be formed with relative, and at times alarming, ease (this can result in partnerships being inadvertently formed with potentially adverse consequences). There are three necessary elements for there to be a partnership between two or more persons:
- carrying on a business;
- in common; and
- with a view to profit.
“Carrying on business”
Common law principles give guidance as to what constitutes “carrying on business”, including that:
- whether a person is carrying on business is essentially a question of fact, in which all the surrounding circumstances and the person’s activities will be taken into account; and
- the degree to which a person’s activities are conducted with systems, regularity and continuity will ordinarily determine whether the activity is properly characterised as carrying on a business.
For a partnership to exist there will need to be a mutuality of interests, rights and obligations among the partners. In other words, the business must be carried on by, or on behalf of, all of the partners.
“With a view to profit”
Profit in this context essentially means having an improved financial position by gain in the value of assets when compared at two points in time.
A “person” is not limited to natural persons and may include other legal persons or corporate bodies. Aside from individual people, a partnership could be comprised of any combination of the following:
- corporate bodies established by statute or charter;
- other partnerships; and
- trustees of trusts.
There may be taxation and asset protection advantages which flow from a particular configuration of partnership structures. It is important to note that a partnership is not a separate tax entity, but it must still lodge an annual tax return.
Advantages of a Partnership
The following are some advantages of a partnership:
- Allows partners to combine business skills and financial resources.
- Inexpensive to establish.
- Shared control and management with other partners.
- More opportunities for tax planning than that of a sole trader.
- Relatively easy to dissolve the partnership or to resign and recover your share.
- Access to the 50% Capital Gains Tax discount for individuals.
Disadvantages of a Partnership
The following are some disadvantages of a partnership:
- A partnership is not a separate legal entity. Each partner is fully responsible for debts and liabilities incurred on behalf of the business by the other partners (with or without their knowledge). For this reason, partnerships frequently change into company structures as the business grows, to take advantage of their limited liability nature – resulting in a reduced risk of personal liability for the business owners.
- Potential for disputes over profit sharing, control and business decisions / direction.
- Changes of ownership can be difficult and, in some cases, require a new partnership to be established.
- A partnership is not subject to income tax as a taxpayer itself. Instead each partner pays income tax on their share of the taxable profits of the partnership in each financial year.
A partnership agreement should document all of the key aspects of the commercial arrangement between the partners. Before entering into a partnership, it is strongly recommended that a lawyer be engaged to prepare a formal binding agreement outlining (amongst other things):
- each partner’s role and level of authority in the partnership;
- each partner’s financial contribution to the partnership;
- a procedure for making important decisions;
- a procedure for resolving disputes between partners; and
- a procedure for dissolving or resigning from the partnership.
It is important to have a formal agreement particularly because personal liability is unlimited for each partner. Each partner will be held liable for any shortfall if the business fails and realisation of partnership assets is insufficient to pay out all partnership creditors, whether or not a partner can afford to pay. Each partner is also jointly responsible for any debts another partner incurs on behalf of the business, with or without the other partners’ knowledge.
Further, if there is no agreement in place, each partner is deemed to own equal shares in each asset.
Some common sense observations
- It would be a good idea for prospective partners to first draft a detailed business plan together. While this would not be legally binding, and changes in direction will inevitably occur, it could get the partners on the same page and be useful for guiding the business, as well as identifying problems and disagreements early on.
- The prospective partners should achieve a decent understanding of how partnership structures work, what they allow, and their restrictions, to make sure the structure is fit for purpose for each partner.
- Solid accounting advice should obviously be obtained, including regarding the tax consequences of possible future transformations (eg sale of business, a partner leaving, converting into a company structure, attempting a franchise business).
- The legal risk of conducting business via a partnership is high, especially regarding personal liability in the event of litigation. Insurance options should be carefully investigated.
- Consider implementing joint banking authorities, and ensuring all partners have access to, and are aware of, the financial position of the partnership (eg internet banking access).
- Given the high stakes, do not enter into a partnership lightly, and make sure you know the partner well on each of a personal, financial and business level. Build safeguards into your partnership agreement to resolve disputes and problems arising from bad luck or poor judgement.
As with other business structures there are certain registrations required in order to lawfully carry on business. Failure to comply with the registration requirements will not generally affect the validity of a partnership but may result in other consequences, such as penalties for breaches or non-compliance. Typically, these would include:
- registration of a business name;
- obtaining an Australian Business Number (ABN) for the partnership;
- obtaining a Tax File Number for the partnership;
- registering for GST if the partnership annual turnover equals or exceeds the threshold of $75,000; and
- payment of Payroll Tax (if the partnership has a wages bill in excess of the relevant threshold amount in the state or states in which it operates).
We can help
To the extent that you are considering carrying on business in partnership, Fletcher Law’s experienced lawyers can advise on partnership and structure issues and draft appropriate documentation.