Taxation of a Partnership – The Basics
June 18, 2018
By Vivian Esper
Barrett Tax Law
TAXATION OF A PARTNERSHIP – THE BASICS
The Canadian common law of all provinces defines a partnership as the relation that subsists between or amongst persons carrying on a business in common with a view of profit.
Subsection 102(1) of the Income Tax Act defines a Canadian partnership as a partnership all of the members of which were, at any time in respect of which the expression is relevant, resident in Canada.
Under Canadian law, a partnership is not considered a separate legal entity. However, for income tax purposes the partnership is a hybrid. Subsection 96 of the Income Tax Act provides that a partnership is a separate person for the purposes of computing income, but not for the computation of tax.
Each partner holds a divided interest in the partnership as opposed to the partnership’s underlying assets. The partnership interest has a cost that can be increased or decreased according to Section 53 of the Income Tax Act and such interest can be disposed of by the partners resulting in a disposition of capital interest that can give rise to capital gains or losses.
Income is calculated at the partnership level and subsequently allocated to the partners at the end of the fiscal period of the partnership in accordance with the partnership agreement. Each item of income retains its character in the hands of the partners.
Thus, in computing income or loss for income tax purposes, partners are required to take into account their share of the partnership’s income or loss for a certain fiscal period regardless of whether any distributions from the partnership have been received or will be received.
If the partnership earns income or has losses from more than one source, the income or loss from each source must be determined separately. Similarly, capital gains, capital losses and capital cost allowance (“CCA”) are also claimed at the partnership level.
Although a partnership is able to choose a fiscal year that does not coincide with the calendar year if the partnership has an individual or professional corporation as a member it must choose a calendar year for tax purposes.
With respect to limited partnerships, Subsection 96(2.1) of the Income Tax Act determines that a limited partner may be entitled to a loss in the partnership only to the extent of the partner’s “at-risk” amount, corresponding to the partner’s adjusted cost base of the partnership interest increased by the partner’s share of current year’s income and reduced by amounts owed by the partner to the partnership and any benefit that the partner is entitled to protected him/her against losses from amounts invested (Subsection 96(2.2) of the Income Tax Act).
The unused losses that exceed the “at-risk” amount become the partnership’s losses and can be carried forward indefinitely to be deductible in future years to the extent that the partner’s “at-risk” amount increases.
The treatment of partnerships as flow-through or conduit vehicles, allowing partners to offset losses as against income from other sources has made such business structure very attractive, especially in the early years of business operations.
If you would like to learn more about the advantages associated with establishing a partnership, our team of professional lawyers will be happy to help!