Computation of income or loss for partner
A partnership is a relationship between persons (i.e., partners) carrying on business in common. A partnership is not a person under the Income tax Act and therefore does not pay tax. Instead, the income or loss of the partnership is computed on a notional basis, and each partner then includes their share of the income or loss of the partnership.
In general terms, the amount and character of the income or loss (e.g. business income, royalties, taxable capital gains) flows out to each partner. The partner’s share of the income is normally determined under the applicable partnership agreement or other legal instrument that sets out the rights of the partners. Each partner then reports the income or loss on the partner’s individual tax return for the year.
The partnership does not claim tax credits. Again, since the partners report the income on their tax returns, they simply claim the various credits that apply to them in the circumstances.
For certain credits, like charitable donations and political donations credits, and the investment tax credit in respect of the partnership’s business, a notional calculation of the credit is made for the partnership and is then allocated to the partners according to their respective shares.
Adjustment to adjusted cost base of interest
Each partner’s share of the partnership income is added to the adjusted cost base of the partner’s interest in the partnership. This treatment ensures that, if the interest is sold and some or all of that income is retained in the partnership, any capital gain on the sale of the interest will not result in double taxation. That is, the addition to the cost base reflecting the income inclusion will reduce the subsequent capital gain accordingly.
Conversely, the partner’s share of any loss of the partnership is deducted from the adjusted cost base of the interest in the partnership.
Since the partner’s share of the partnership is included in income each year as it earned, cash withdrawals are not subject to further tax. However, the cash withdrawals reduce the adjusted cost base of the partner’s interest.
In 2015, John was a member of a partnership and his share of the income for the year was $200,000. During the year, he withdrew $150,000. On a net basis, $50,000 would be added to his adjusted cost base of his interest at the end of 2015 ($200,000 addition for the income inclusion, $150,000 reduction for the cash withdrawal).
Note that John still has to pay income tax on $200,000 of partnership income, even though only $150,000 of that was paid out to him in the year.
Partnership information return
Although a partnership is not a person or a taxpayer, in some cases a T5013 information return must be filed with the Canada Revenue Agency (CRA). The return will contain information such as the identity of the partners, the head office, the type of business, the partners’ shares of the partnership income, and various related items.
The Income Tax Regulations require Canadian partnerships and partnerships that carry on business in Canada to file a partnership information return. A Canadian partnership is one in which all the partners are resident in Canada. However, the CRA has an administrative policy (cra.gc.ca/partnership) under which some of these partnerships are not required to file the information return.
The CRA requires a partnership to file the T5013 for a fiscal period if:
- at the end of the fiscal period, the partnership has an absolute value of revenues plus an absolute value of expenses of more than $2 million, or has more than $5 million in assets; or
- at any time during the fiscal period: the partnership was part of a “tiered partnership”, e.g. where it was a partner in another partnership or vice versa;
- the partnership had a corporation or a trust as a partner;
- the partnership invested in flow-through shares of a principal-business corporation that incurred Canadian resource expenses and renounced those expenses to the partnership; or
- the CRA requests that a return be filed.
Otherwise, a partnership is not normally required to file the T5013. For example, a partnership with only individuals as partners does not need to file the return unless the $2 million or $5 million thresholds above are exceeded. Furthermore, the CRA states that farm partnerships that are made up of only individual partners do not have to file a T5013 return for the 2015 fiscal year. The CRA has not yet indicated whether the farm partnership exception will continue to apply for 2016.
For the above purposes, the absolute value of a number is the value without regard to its positive or negative sign. Therefore, the $2 million threshold revenue and expense threshold is determined by adding total worldwide expenses to total worldwide revenues.