Please note that the information provided herein is not legal advice and is provided for informational and educational purposes only. If you need legal advice with respect to drafting, reviewing, interpreting or resolving disputes concerning partnership and limited partnership agreements, you should seek professional assistance (e.g. make a post on Dynamic Legal Forms). We have Toronto, Ottawa, Hamilton, Mississauga, Brampton, and other Ontario business lawyers registered on the website who can answer your questions or help you with your partnership and limited partnership agreements. I should know – I’m one of them and you can contact me directly.
This is the first of a series of blog posts about the taxation of partnerships and limited partnerships. Now, tax laws can be quite heavy, so you’ll have to bear with me as I take you through them. I’ll try to simplify as much as possible, but I can’t guarantee that you’ll understand it. That’s why it’s best to consult with an expert if you’re thinking about forming a partnership or limited partnership.
Now, before we start, I just want to say that I’m assuming that you already understand (1) what a partnership is, (2) what a limited partnership is, and (3) how they are different from individuals and corporations. I’ve written about these topics quite extensively on DL Blog, so you can do some keyword searches or scroll through the “business” category to understand these things in greater detail. Now onto business.
Partnerships are Flow-Through Entities
Partnerships and limited partnerships are flow through entities. They are not legal persons. They don’t pay tax. Their income or losses flow through to the partners and are attributed to them. It is the partners who pay taxes, not the partnership or limited partnership. They are disregarded business vehicles. This differs from a corporation, which is considered to be a legal person separate from its owners and managers. Corporations are required to pay income taxes at both the provincial and federal levels.
How are they Taxed?
A partnership or limited partnership is taxes in the following process. First, the parties involved have to recognize that they are operating as a partnership and not some other structure (e.g. joint venture, co-owning property, corporation, franchise, etc.). Then, the parties have to determine the income, losses, and tax credits at the PARTNERSHIP LEVEL. This requires a temporary assumption that the partnership is a separate person resident in Canada. Finally, once you figure out the income, losses, and tax credits, you ALLOCATE them to the partners. It is the individual partners who have to report (and, if applicable, pay taxes on) income, losses, and tax credits.
Annual Information Returns
As per the Canada Income Tax Act, partnerships do not file separate tax returns. They file annual “information returns” setting out their income and details of the partners who are entitled to that income.
So to recap: the net income of the partners (for income tax purposes) of a limited partnership is determined by figuring out the net income of the limited partnership. To figure out the net income of the limited partnership, the Act says that you look at it as if it were a separate legal person: s. 96(1)(a). So you include income and deduct allowable expenses and other credits. Then, the partnership’s income will be attributed to the partners (usually as per the limited partnership agreement). Each partner must report their income or losses from the partnership and pay taxes accordingly: s. 96(1)(f).
Fiscal Year End
For tax purposes (remember that partnerships must file an annual partnership information return after their fiscal period), the combined effects of ss. 96(1) and 249.1 of the Canada Income Tax Act make it clear that the fiscal period will be determined by the type of taxpayers (e.g. individuals, corporations, etc.) that make up the partnership group. If any member of the partnership is an individual, then the fiscal year end must generally be the calendar year end (with certain limited exceptions). If all of the members of the partnership are corporations, the the fiscal year end can be anywhere, so long as the fiscal period does not exceed 53 weeks: s. 249.1(1)(a).
In the next blog, I’ll continue my discussion of the taxation of partnerships…