A partnership is not considered a “person” or a “taxpayer” for most purposes of the Income Tax Act. As a result, a partnership does not file an income tax return or pay income tax.
Instead, the partners include their shares of the partnership’s income or loss for the year (specifically, their taxation year in which the partnership’s fiscal period ends). The percentages are usually determined under the partnership agreement.
In addition, the type of income (business income, income from property, etc.) generally flows through and is taxed as such to the partner. A partnership is therefore considered a flow-through entity (in contrast to a corporation, which is a taxpayer and pays tax on its income, and its after-tax income paid out as dividends to the shareholders is also subject to tax, with a dividend tax credit intended to offset the corporate tax).
The income (or loss) is included in the partner’s income regardless of whether it remains in the partnership or is withdrawn as a partnership “draw”. When the partner withdraws the income, there is no further income inclusion.
For each year in which there is an income inclusion, the amount so included is added to the partner’s adjusted cost base of his or her interest in the partnership. This addition ensures that, where the income stays in the partnership and the partner sells his or her interest, there will not be double taxation. When the partner withdraws the income, the amount of the withdrawal is subtracted from the adjusted cost base of the interest.
In year 1, a partner’s share of the partnership income is $100,000. During the year, she withdraws $80,000 of this amount.
In year 2, her share of the income is again $100,000. During year 2, she withdraws $120,000.
In year 1, the partner will include in income the full $100,000 amount, even though she has not received the entire amount. The adjusted cost base of her interest in the partnership will increase by $20,000 ($100,000 inclusion net of $80,000 withdrawal).
In year 2, she will again include $100,000 in income. The $120,000 withdrawal will not be included in income. The adjusted cost base of her interest in the partnership will decrease by $20,000 (due to the $100,000 inclusion and $120,000 withdrawal).
Since the partnership is not a taxpayer and does not pay tax, it obviously cannot claim tax credits. Again, each partner will claim the credits that are available to the partner.
In some cases, the credit will relate to the actions of or donations made by the partnership. For example, if a partnership makes a charitable donation or political donation, each individual partner will claim a credit based on their share of the donation (again, the share will normally be determined by the partnership agreement or otherwise by the partners). The partner’s share of the credit will reduce the adjusted cost base of his or her interest in the partnership.
Special rules apply to limited partners of a partnership. In general terms, a “limited partner” under the Act includes a person whose liability as a partner is limited by operation of any law governing the partnership agreement (the definition is actually quite broad and can catch certain other partners). A limited partner for the purposes of these special rules does not include a member of a professional limited liability partnership (LPP), which include many law and accounting partnerships.
A limited partner’s share of a loss from the partnership is limited to the partner’s “at-risk amount” in respect of the partnership. As the name of the term implies, this amount is meant to reflect how much the partner actually has at risk in terms of the partner’s investment in the partnership.
In basic terms, the at-risk amount at any time equals the partner’s adjusted cost base in the interest plus the partner’s share of the partnership income for the year accruing to that time, net of amounts owing by the partner to the partnership and any amount or benefit that the partner may receive for the purpose of reducing the impact of a loss of the partner’s investment in the partnership.
The limited partner’s share of the loss for the year in excess of the at-risk amount is not deductible in computing the partner’s income for the year. The excess becomes a “limited partnership loss”, which can be carried forward indefinitely and deducted in future years, but again only to the extent of the partner’s at-risk amount in those future years.