Partnership Tax Basics

A partnership lodges a tax return every year but never pays tax on it. That sounds like a loophole; it is really just plumbing. The return exists to tell the ATO how the profit was split, and the tax lands with each partner personally. Most partnership problems we see are not about tax law — they are about records that don't match what the partners think was agreed.

How the flow-through works

The partnership works out its net income — assessable income less deductions — at the entity level, then allocates it between the partners according to the partnership agreement. If the agreement is silent, the default is equal shares. Each partner then includes their share in their own return: an individual partner pays tax at their marginal rates, a corporate partner at the company rate.

Losses flow through too, which is a genuine difference from trusts and companies: if the partnership makes a loss, each partner generally takes their share into their own return in the same year, though individuals may need to satisfy the non-commercial loss rules before using it against other income.

What the partnership return reports

The return shows the business income and deductions, and — critically — a statement of distribution: each partner's name and TFN, their share of net income or loss, and their share of items that keep their character on the way through, such as franking credits on dividends the partnership received. One quirk worth knowing: capital gains are not reported in the partnership return at all. Each partner accounts for their own share of any CGT event directly in their own return.

Record traps we see often

• Partner salaries are not wages. A partner cannot be an employee of their own partnership; a so-called partner salary is really an allocation of profit and is not a deduction to the partnership.
• Drawings are not what you are taxed on. Each partner is taxed on their share of net income for the year, even if the cash stayed in the business — and even if one partner drew far more than the other.
• Jointly owned rental property is usually not a partnership business. Co-owners of an investment property generally split income according to legal ownership, and cannot re-split it by agreement the way a genuine business partnership can.
• Family partnerships attract attention. Splitting business profit with a spouse who does little in the business is an area the ATO actively reviews; the split needs to reflect reality.

When to get advice

Get advice before changing profit-sharing ratios, admitting or exiting a partner, or moving the business into a company or trust — each of those can trigger CGT and GST consequences that are far easier to manage in advance. And if there is no written partnership agreement, putting one in place is cheaper than the argument it prevents.

Does the partnership itself pay tax?

No. It lodges an information return showing its net income and how it was distributed; each partner then pays tax on their share in their own return.

Are we taxed on what we each drew out?

No — you are taxed on your share of the partnership's net income for the year, whether or not it was drawn. Drawings and taxable shares often differ, which is why partner accounts need to be kept properly.

Can a partnership distribute a loss to the partners?

Yes, unlike a trust. Each partner takes their share of the loss into their own return, though individuals may need to pass the non-commercial loss rules to offset it against other income.