Area of Law: Business Law
Answer # 211
What is a partnership?Region: Ontario Answer # 211
A partnership is an unincorporated business that is carried on by two or more people who intend to share the business profits. Partnerships have at least six important features:
- A partnership can be created by an express agreement or it can be created if the people are simply acting in a way that seems like a partnership.
- The partners can be held responsible for the actions and business debts of the other partners.
- All the assets of the business are personally owned by the partners.
- There are two main types of partnerships: general partnerships, where all the partners share the profits and losses of the business; and limited partnerships, where the limited partners are not involved in the daily operations and are only responsible for losses up to the amount they contributed to the business.
- Partners are not considered employees of the business. Because of this, partners are not eligible for Employment Insurance if the business fails.
- Partners are not paid a salary, but they can take money from the business through personal drawings.
It is a good idea to have a written partnership agreement because it will outline issues such as how the profits or losses will be divided among the partners, and it will describe any limits to the legal responsibility of the partners.
Being a partner in a partnership has several advantages and disadvantages, including important tax implications.
There are three main advantages to forming a partnership:
- A partnership allows two or more people to work together and bring different skills and resources to the business.
- A partnership is fairly easy to establish. The actual registration of a partnership is not expensive or complicated. However, it is a good idea to decide how the partnership will be run and put it into a partnership agreement, and
- If the partnership suffers a loss but the partners have other employment income, the loss can be used to reduce their taxable income, thereby lowering the income tax payable by the partner.
There are also disadvantages to forming a partnership. These include:
- The partners are personally responsible for liabilities of the partnership because the partnership is not considered to be separate from its owners. If the business fails, the partners will be personally responsible to pay all the debts and obligations of the partnership.
- Each partner is personally responsible for the actions of the other partners because each partner is an agent for the business and for the other partners. Consequently, if one of the partners makes a bad business decision, or acts negligently which results in the partnership owing a debt, all the other partners are personally responsible to pay it back.
- If one of the partners dies, the partnership ends because a partnership is based on the individual partners, and it is not a separate legal entity. This means that the remaining partners have to re-establish the partnership.
- It is difficult to buy or sell a partnership interest because a partnership is not a separate legal entity. Buying or selling a partnership interest will involve rewriting the partnership agreement and determining exactly how the partnership will change.
- Although the resolution of disagreements among partners is generally covered under a partnership agreement or case law, it can be very difficult. There is no act that exists which sets out rules for settling partnership disputes. If the disagreements are not resolved by the partners themselves, they will usually have to turn to outside help which can be time consuming and costly.
There are four main tax implications to owning a partnership interest. They are:
- The business income of a partnership is divided between the partners and included on each partners’ personal income tax form; the partnership does not file a separate tax return.
- If the business has suffered a loss, the partners can deduct the loss from any other employment income they receive. This will lower the overall income of an individual partner and reduce the amount of income tax he or she must pay.
- If the business has made a profit, the profits are taxed at each partners’ personal income tax rate.
- Because the partnership is not a separate legal entity, the partners cannot take advantage of tax deferral opportunities available with corporations.
You may be eligible to apply to use a fiscal period other than a calendar year for calculating and paying taxes, but you will not usually be able to defer taxes this way. More information about starting and operating a business in Ontario can be found from ServiceOntario, or Canada Business Ontario. Visit Canada Revenue Agency for information regarding the tax implications of owning your own business.
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