A partnership is a business organisation where two or more persons pool their resources together with a view to making profit. The business is usually conducted in accordance with certain terms and conditions as agreed to by all the partners. However, where no fixed terms are agreed upon for the period of partnership, then the association is a partnership at will.
According to Soyode & Kajola (2006:229), partnership is a relationship subsisting between two or more persons agreeing to carry on business in common with a view to making profit under some arrangement, for the sharing of the resultant profit or loss for tax purposes. Partnership income is computed in the same way as that of sole trader and company income so as to ascertain the taxable profit for a given year of assessment. In computing the adjusted profit of a partnership, allowable income and deductions according to section 20 of PITA, and disallowable income and deductions according to section 2 are all taking into consideration.
In this unit therefore, you will be exposed to admission, retirement/resignation and succession of partnership- so as to understand how to bring out the differences between this form of business and the other forms of businesses.
At the end of this unit, you should be able to:
- define the term partnership
- describe the factors involved in partnership business
- analyse the different structures of partnership and their treatment
- explain the treatment of capital allowances and loss relief
- ascertain the tax liabilities of each partner.
3.0 MAIN CONTENT
3.1 Formation of Partnership
The Partnership act of 1897 and 1907 spelt out the procedures for forming general partnership and limited partnerships, respectively. Usually, a legal document called a “deed of partnership”; that is, if the partnership is not a “partnership at will”, it is drawn up to define the rights, duties and interests of the partners. This legal document is expected to contain clauses relating to:
- capital contribution;
- the interest (if any) to be paid to each partner on his capital or the interest that each partner will pay on loan or takings from the partnership;
- the salaries( if any) to be paid to active partners;
- the agreed division/sharing of profits and losses;
However, where there is no formal agreement or the partnership is at will, the following will be adopted:
- partners share the profits and loss equally;
- partners are not entitled to interest on capital;
- partners will not be entitled to any salary; and
- no interest is received from any partner for loan or takings from the partnership.
SELF-ASSESSMENT EXERCISE 1
Discuss the procedures for the formation of a partnership business?
3.2 Computation of Partnership Income
The income of a partnership, for a period, is computed in accordance with the provisions of PITA 1993- as though the income of an individual were being computed except that the cost of the following is allowed:
- any partner’s salaries;
- any partner’s interest on capital; and
- any partner’s leave or recreational passages.
Partnership expenses referable to a partner which would have been private or domestic expenses, if incurred by the partner himself are not allowed in computing the partnership income.
3.2.1 Income of a Partner
The income arrived at (as shown above) is called the computed income of the partnership. It is not, however, assessed on the partnership, or collectively, on the partners. The partners are individually assessed as though they are working individually. The income of each partner is the addition of:
- his salary( if any), charged in the partnership accounts;
- his interest on capital( if any) charged in the partnership accounts;
- his private passage costs( if any) charged in the partnership accounts; and
- his share of the computed income of the partnership.
The share of a partner in the computed income of a partnership shall be a proportion of the computed income accruing to him, under the provisions of the partnership agreement.
3.2.2 Capital Allowances
The provision of paragraph 23, 5th schedule of PITA, 1993 applies in the computation of the assessable profit of a partnership. The computed profit is then shared amongst the partners.
On the other hand, the computed capital allowances of the partnership are shared between the partners in the profit and loss sharing ratio. A partner’s share is then used to reduce his share of profit in order to ascertain his/her taxable income. Any appeal made by a partner against the amount of partnership income included in his total income assessed is dealt with by the relevant tax authority of the place where the partnership is resident.
3.2.3 Resident and Responsible Tax Authority
A partner’s place of residence is his/her place of abode where he/she must have resided for a period of not less than 180 days in the year of assessment. The tax authority within the territory of his/her residence is responsible for the collection of the tax.
It may happen that the head office of a partnership business is situated in one territory, while some of the partners are resident in other territories. In order to comply with the general provisions of PITA, 1979- as applicable to a place of residence, each partner receives his/her share of the profit and then pays the tax on it to the appropriate tax authority.
3.2.4 Loss Relief
SELF-ASSESSMENT EXERCISE 2
Explain how a partner’s taxable income can be ascertained?
3.3 Registration of Partnership Agreement
A certified copy of the partnership deed or particulars of any partnership agreement must be registered with relevant tax authorities at will or on demand. Any later changes agreed between the partners are to be made known to the tax authority within 30 days of the agreement. The apportionment of income between partners is normally based on the particulars supplied. If particulars are not supplied, then the apportionment is made as the tax authority thinks just and reasonable.
SELF-ASSESSMENT EXERCISE 3
What are the advantages of registering a partnership deed?
3.4 Treatment of Changes in Partnership Structure
The following are some of the changes that may occur in a partnership structure and the treatment for tax purposes.
- Admission of a new partner:A new partner into any partnership is deemed to have commenced a new business and the commencement rule will fully apply in assessing him/her to tax.
- Death, retirement and resignation of an old partner Where an old partner dies, resigns or retires, he/she will be deemed to have ceased business and will, therefore, be assessed to tax based on cessation rules.
- Amalgamation of two or more partnerships :Two or more partnerships can amalgamate to form a new partnership. In this situation, neither commencement nor cessation rules will apply, but the rules for existing businesses will be used for the new business. All the capital expenditures transferred to the new partnership are deemed to have been transferred at their tax written down values (TDWV) and there will be no balancing adjustments.
- Conversion of a partnership into a limited liability company A partnership may decide to convert to a limited liability company in order to take advantage of limited liability. Where this occurs, a new business is deemed to have come into existence and consequently cessation rule will apply for the partnership that has folded up as it has ceased business as a partnership.
The transferring of qualifying capital expenditures of the old partnership into the new company will be at agreed values; therefore, balancing adjustments (that is, balancing allowance or balancing charge) will have to be computed. This is done by comparing the valuation with the tax written down values at the time of transfer. Computation of capital allowances on the transferred qualifying capital expenditure will be undertaken accordingly