A partnership can be a practical way to run a business with another person, share responsibilities and combine skills. However, the tax return process is often misunderstood because the partnership itself generally lodges a return, while the partners are taxed on their respective shares of the partnership’s income.
Getting the return right matters because the figures reported by the partnership flow through to each partner’s own tax position. Clear records, a sound partnership agreement and consistent treatment of income, expenses and drawings can help avoid disputes between partners and reduce problems at lodgment time.
What is a partnership for Australian tax purposes?
For income tax purposes, a partnership has a broad meaning. It includes people carrying on a business as partners, and can also include people who receive ordinary or statutory income jointly. A company is excluded from that definition.
In practical small business terms, a partnership commonly involves two or more people operating a business together. This might include a trade business, professional practice, retail operation, hospitality venture or consulting business.
A written partnership agreement is not essential for a partnership to exist. However, it is strongly advisable. The ATO notes that an agreement can help clarify what each person contributes, how income and losses are shared, and how the business is managed.
A well-prepared agreement should address matters such as:
- the partners’ ownership interests and capital contributions;
- how profits and losses are to be shared;
- each partner’s responsibilities and authority;
- how business decisions will be made;
- how drawings, loans and reimbursements are recorded;
- what happens if a partner retires, dies or wishes to sell their interest; and
- how disputes will be resolved.
The agreement should be reflected in the partnership’s accounting records and tax reporting. It is much harder to support a particular allocation of income if the records, financial statements and conduct of the partners point in a different direction.
It is also important not to assume that jointly owning an asset automatically means you are running a business partnership. For example, joint owners of an investment property or joint bank account may have income to report individually without carrying on a partnership business. The facts, purpose, level of activity and legal arrangements all matter. (ato.gov.au)
How partnership tax works
A partnership must furnish an income tax return, but it is generally not liable to pay income tax on the partnership’s net income. Instead, each partner includes their individual interest in the partnership’s net income in their own tax return. If the partnership makes a tax loss, each partner may generally be entitled to their relevant share of that loss, subject to the applicable tax rules.
This creates a two-part reporting process:
- The partnership tax return reports the partnership’s income, deductions, assets, liabilities and the allocation of relevant amounts between partners.
- Each partner lodges their own return and reports their share of partnership income, losses, capital gains, tax offsets and credits as applicable.
The partnership tax return is therefore not simply an administrative formality. It is the document that supports the amounts reported by each partner.
The partnership should have its own tax file number and, where it carries on a business, an Australian Business Number. The partnership may also need to register for GST, lodge BASs, withhold PAYG amounts from employees or contractors where required, and meet superannuation obligations for eligible workers. The partners themselves are not employees merely because they work in the partnership business.
A partnership carrying on an enterprise is required to register for GST if its GST turnover meets the registration turnover threshold. For most businesses, the threshold prescribed by the GST regulations is $75,000.
Preparing the partnership tax return
The starting point for a reliable partnership tax return is complete and well-organised bookkeeping. The partnership’s accounting records should explain all transactions relevant to its tax affairs, including income received, expenses paid, assets purchased, finance arrangements and amounts withdrawn by partners. The income tax law requires business records to be kept and generally retained for at least five years, with the exact retention period depending on the circumstances.
Before preparing the return, it is useful to finalise a set of year-end accounts. These usually include a profit and loss statement, balance sheet, debtor and creditor records, bank reconciliations and partner capital or loan account balances.
Key records often needed include:
- bank statements and loan statements;
- sales records, invoices and merchant facility reports;
- expense invoices, receipts and supplier statements;
- payroll records, superannuation records and PAYG withholding information, where relevant;
- asset registers and documents for equipment, vehicles or property;
- lease agreements, finance contracts and insurance documents;
- GST and BAS records;
- details of income from investments, trusts or other partnerships; and
- the current partnership agreement and any amendments.
The tax calculation does not always match the accounting profit shown in the financial statements. Some accounting expenses may not be deductible immediately for tax purposes, while some tax deductions may be calculated differently from the accounting treatment.
The general deduction rule allows deductions for losses or outgoings incurred in gaining or producing assessable income, or necessarily incurred in carrying on a business for that purpose. However, an amount is not deductible under that general rule to the extent it is capital, private or domestic in nature, relates to exempt income, or is denied by another provision.
For a partnership, this means the bookkeeping should identify private expenditure, capital purchases, entertainment-related costs, partner drawings and other transactions that may need separate tax treatment. Simply paying an amount from the business bank account does not make it deductible.
Drawings are not the same as taxable income
One of the most common sources of confusion is the difference between cash drawings and a partner’s taxable share of profit.
A partner may withdraw money from the business during the year. That withdrawal is usually recorded against the partner’s drawings, capital or loan account. It does not automatically determine how much taxable income that partner must report.
Likewise, calling a payment a “salary” does not necessarily make it wages for tax purposes where the recipient is a partner. The ATO’s public ruling on partnership income explains that an amount drawn by a partner for work in the partnership business does not, by itself, determine that partner’s tax liability. The relevant issue is the partner’s interest in the partnership’s net income or loss.
This distinction is important where one partner takes regular cash withdrawals while another leaves profits in the business. The partners may still be assessed on their agreed shares of taxable income, rather than on the cash each has withdrawn.
Allocating income, losses and other tax amounts
The allocation of partnership income should be based on the partnership agreement or, if there is no effective agreement, the relevant partnership law. Partners should not treat profit shares as something to decide informally after the financial year has ended, particularly where the allocation is inconsistent with the commercial arrangement between them.
The partnership return includes a statement of distribution that communicates relevant amounts to each partner. Depending on the partnership’s activities, this may include business income or loss, interest, dividends, franking credits, foreign income, withholding credits and other tax attributes. Each partner then reports the relevant amounts in their own return.
Capital gains require particular care. Under the income tax law, a capital gain or capital loss from a CGT event involving a partnership or partnership asset is made by the partners individually. Each partner’s gain or loss is worked out by reference to the partnership agreement, or partnership law where there is no agreement.
This can become particularly important when a partnership sells business premises, goodwill, equipment, shares or another asset that may be subject to CGT. It is not enough to record the sale proceeds in the partnership accounts. The transaction needs to be reviewed for the tax consequences that arise for each partner.
A partnership loss also needs careful handling. While the law provides for a partner’s share of a partnership loss to be deductible in appropriate circumstances, other rules can affect whether and when an individual partner can use that loss. For example, the non-commercial loss rules may be relevant to an individual carrying on a business activity through a partnership.
Changes in partners, ownership and business structure
A change in the people involved in a partnership can have consequences beyond updating the business name or bank account. The admission of a new partner, retirement of an existing partner, change in profit-sharing percentages or transfer of a partnership interest can affect income allocations, CGT outcomes, asset ownership and registration details.
The ATO’s partnership return instructions require additional information where a partnership name change results from a reconstitution. This includes details such as the dissolution and reconstitution dates, the partners who are joining, continuing or retiring, and changes to authorised contacts.
This is a useful reminder that partnership changes should be documented as they happen, rather than reconstructed at tax time.
Consider a generic example. Two designers operate a studio in partnership and agree to share profits equally. During the year, one partner contributes more cash to fund a new computer system, while the other takes more drawings to meet personal living expenses. Unless the partnership agreement is formally changed, those differences do not necessarily alter the agreed profit split for tax purposes.
If the partners later decide that one person should take a larger share of future profits, they should document the commercial basis of the new arrangement before applying it. They should also consider whether the change involves a transfer of an interest in partnership assets or other tax consequences.
A growing business may eventually decide that a company or trust structure is more suitable. That decision should not be made solely because a different structure appears to offer a tax advantage. Asset protection, ownership plans, financing, employee arrangements, succession, compliance costs and the tax consequences of transferring the business all need consideration.
A practical partnership tax return checklist
A structured year-end review can make the return process more efficient and reduce the risk of omissions. Before lodging, consider the following checklist.
- Confirm the correct legal names, tax file numbers, ABNs and contact details for the partnership and all partners.
- Review the partnership agreement and check whether it still reflects the actual business arrangement.
- Reconcile business bank accounts, loans, merchant facilities, payroll systems and GST records.
- Check that all sales and other income have been recorded, including interest, investment income and insurance recoveries where relevant.
- Review expenses for private, capital or non-deductible components.
- Update the asset register and identify any assets acquired, sold, scrapped or transferred during the year.
- Reconcile each partner’s capital, loan and drawings account.
- Document any changes in partners, ownership interests or profit-sharing arrangements.
- Prepare the statement of distribution so each partner has accurate information for their own return.
- Check whether the partnership has BAS, PAYG withholding, superannuation or other obligations that need to be finalised separately.
The ATO allows partnership returns to be lodged using Standard Business Reporting-enabled software, through a registered tax agent or by paper. Lodgment timing can depend on the partnership’s circumstances and whether a registered tax agent is acting, so it is sensible to confirm the applicable due date well before it becomes urgent. (ato.gov.au)
Getting the right advice for your partnership
Partnership tax returns work best when the legal agreement, bookkeeping records and tax reporting all tell the same story. The partnership itself reports its activities, but the tax consequences ultimately flow through to the individual partners. That makes accurate allocations, clear records and early planning especially important.
General information in this article is not personal financial or tax advice. Partnership arrangements can produce different outcomes depending on the agreement, the partners involved, the assets held and the transactions completed during the year. Speak with a registered tax agent or accountant, such as Ample Finance, about advice tailored to your circumstances.
If you would like help preparing a partnership tax return, reviewing partner drawings and loan accounts, or planning for a change in your business structure, the team at Ample Finance can help you work through the issues in a practical and considered way.