A partnership is a common and relatively inexpensive way to set up a business in which more than one person has control and ownerships. It involves two or more owners (the partners) operating a business together with the intention of making (and sharing) a profit. While a Partnership can be a great way to bring additional capital and knowledge to the business issues can quickly develop where the parties are each moving in different directions and don’t effectively communicate with each. You need to work as a team rather than multiple, independent business owners.
Why is the intention to make a profit important when looking at Partnerships?
The focus on making profit is the key difference between a Partnership and a Joint Venture (JV). Partners in a Partnership operate a business and share in the profits generated whereas parties in a Joint Venture share in the knowledge or products produced by the JV and generate profits independently. A common example of a JV we see in Australia is when two or more mining companies enter a JV to develop a new coal mine. The JV pools resources from the mining companies and operates the mine. However, the companies don’t share in ‘profits’ from the mine. They each receive an amount of coal from the site, sell this to their own customers and keep all of the profit achieved from those sales.
Should there be a Partnership agreement?
While it is not compulsory to have a formal agreement when establishing a business under a partnership structure, a formalised partnership agreement spelling out the rights, responsibilities and obligations of each partner can be a great communication and planning tool. Setting expectations up front saves unnecessary arguments later on. Maybe we need formal marriage agreements as well? I’ll leave that up to you to decide!
A partnership can exist with no formal agreement between the parties at all. In the absence of a partnership agreement The Partnership Act of 1891 sets out the various rules that govern the conduct of partners in a partnership. The act places joint liability on all partners for debts and obligations incurred by the business during their involvement in the partnership. Partners are obligated to keep their co-owners properly informed.
Who Pays the Tax?
While a partnership is a separate business operation to the partners involved, having its own Australian Business Number (ABN) and Tax File Number (TFN), all the business profits are taxed in the hands of the partners at their respective marginal tax rates.
Pro’s and Con’s of Partnerships as a Business Structure
Advantages of a Partnership:
• Easy and inexpensive to establish and maintain;
• Fewer reporting requirements;
• Any losses incurred by the business may be offset against other income earned (such as investment income or wages) by each partner subject to satisfying certain conditions;
• Partners are not considered an employee of their own business – no payroll related expenses need to be paid on their profit share (Superannuation, Workcover Insurance etc).
• Relatively easy to change your legal structure if the business grows, or if you wish to wind things up.
Disadvantages of a Partnership:
• Unlimited liability which means all personal assets are at risk if the business operation gets into trouble;
• Some of your control over the business assets and decisions needs to be relinquished;
• Business debts and losses cannot be shared with anyone except the partners;
• Requirements to pay preliminary tax on business income which may not have been earned;
• Limited access to additional capital;
The main item to watch out for with partnerships is shared liability, particularly where the partnership is between multiple individuals (rather than multiple companies or trusts). Unless your business partner steps well outside what would be consider acceptable conduct under the partnership agreement or the Partnerships Act you are mutually liable for everything they do and all debts the business accumulates. This can place your own personal assets at considerable risk.
What do we think of Partnerships?
We recommend business owners avoid operating partnerships where the partners are individuals and carefully consider whether or not a partnership is necessarily the way to go even if the agreement is between companies or trusts. If you are currently considering a partnership as a business structuring option we recommend you read our later articles in this series that look at companies and trusts, or contact us for assistance if needed.
Where Do You Go from Here?
This article is the third in a series. To learn more about a particular structure option I would recommend reading further in series as each article is published.
For some professional advice on Business Structuring Contact Us.
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