We continue to see a significant number of individuals retiring, or otherwise exiting from their partnerships and neglecting their own tax obligations. Whether employed or retired, our expectation of all taxpayers is that they'll remain up to date by lodging accurately and on time.
If you're an individual professional practitioner (IPP), you must record, as assessable income in your individual tax return, any assessable distributions derived during an income year that are related to the net income of your partnership.
As a former partner in a professional services firm, your tax obligations don’t end when your role in the partnership finishes. There are a range of common reporting issues among retired or exited partners that can lead to compliance risks if not addressed early.
Omissions of final partnership income or distributions
Many partnership agreements continue to pay the IPP for a set period after they leave the firm. These payments are considered assessable income in the income year from which they’re derived. We’re concerned that former partners incorrectly report these distributions as capital revenue and not income or, in some cases, omit the amounts completely.
You can still receive assessable partnership distributions after retiring or exiting the partnership, depending on the governing documents and agreements for your firm.
Incorrect treatment of retirement payments or deferred entitlements
Concerningly, we’re seeing that some retired partners don’t understand their partnership agreement, or their final partnership statements, and are incorrectly categorising these distributions as ‘pension’ type payments. Based on the arrangements identified to date, these distributions are the allocation of profits or income from professional firms and must be reported as assessable income by the IPP.
Misreporting of capital account adjustments
The capital account measures the partner's equity investment in the partnership and may hold shares or other investments. Changes to a capital account may result in losses. However, not all losses will be deductible or give rise to a capital loss.
Accurate record keeping and reporting is essential to determine whether losses can only be applied against current or future year capital gains and whether any gains may be eligible for the capital gains tax discount.
Overlooking of obligations related to service trusts or related entities
While service arrangements may vary widely in the precise steps used, in essence they involve a taxpayer incurring a deduction for fees and charges in the conduct of its business for the acquisition of staff, clerical and administrative services, premises, plant or equipment from an associated entity. These arrangements are sometimes called Phillips arrangements. Our concerns are detailed in TR 2006/2 Income tax: deductibility of service fees paid to associated service entities: Phillips arrangements.
If you’re planning to leave, or have recently left, a professional firm
Our reviews found that the key drivers of this behaviour included IPPs not understanding the terms of either their agreements or any retirement deeds. There was also often uncertainty around final year entitlements or a delay or incomplete information from their firm. Finally, changing financial advisers or record-keeping practices, or the misunderstanding of how retirement payments are taxed, also contributed to the number of errors we observed.
If you’re planning to leave, or have recently left, a professional firm, we recommend that you:
- review your agreement and final statements
- seek advice early from a tax professional who's familiar with professional firm structures
- use updated guidance from us, or your firm’s finance team
- keep records of all communications and payments post-exit
- accurately report all income and distributions received – this includes all income derived, including amounts that may not be physically received but are applied or dealt with on your behalf
- include any capital gains or adjustments related to your exit
- ensure retirement payments are correctly classified.
If you're still uncertain about to how to treat payments, you may seek a private ruling from us in relation to your circumstances.
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