Explanatory Memorandum
(Circulated by the authority of the Treasurer,the Hon. John Dawkins, M.P.)Taxation of limited partnerships as companies
Summary of proposed amendments
Purpose of amendment: To treat limited partnerships formed on or after 19 August 1992 as companies for taxation purposes. Limited partnerships formed prior to 19 August 1992 will be taxed as companies from the 1995-96 year of income; they must satisfy both a continuity of business test and a continuity of ownership test until then, and if they fail they will be taxed as companies from the year of income in which they first fail.
Date of Effect: 19 August 1992.
Under the existing law, limited partnerships are treated as partnerships for taxation purposes. However, the structure of a limited partnership is comparable to that of a limited liability company in that there are "limited partners" who are similar to shareholders in a company; they do not take part in the management of the business, and their liability generally is limited to the extent of their investment.
Limited partners are not at risk beyond the limit of their liability. Generally, their liability is limited to their investment. They are not required to make good losses of their partnership, nor are they liable to meet the obligations of the partnership. If limited partners are treated in the same way as partners in any other partnership, however, they may benefit from distributions of losses that exceed their limited liability. Those losses could be used to reduce taxable income, and so tax paid, even though the loss is not one that exposes the partner to any risk of having to meet obligations or make good losses.
State legislation enabling the formation of limited partnerships currently exists in New South Wales, Victoria, Western Australia, Queensland and Tasmania.
Explanation of proposed amendments
The Bill will amend the Principal Act to introduce taxation arrangements in new Division 5A of Part III of the Act for taxing limited partnerships [Clause 8] .
The object of this new Division is to ensure that limited partnerships will be treated as companies for taxation purposes. This is not confined to the payment of income tax by limited partnerships, but includes all other purposes under income tax law, including the payment of tax by partners in limited partnerships; for instance, imputation and the taxation of dividends to shareholders [new section 94A] .
What is a limited partnership?
A limited partnership is any partnership in which the liability of at least one partner is limited. This definition is needed, because limited partnerships formed in Australia also include a general partner or partners, whose liability is not limited. The new Division is not confined to limited partnerships formed in Australia, so the definition is sufficiently general to apply to limited partnerships as formed under many legal systems, although the States with limited partnership legislation have so far enacted in similar terms to one another [new section 94B] .
In working out whether a limited partnership is subject to the new Division, limited partnerships are treated as continuous even though there may be changes in the membership of the limited partnership. This avoids the need to treat a limited partnership as ending, and a fresh partnership commencing, on every change in the membership of the partnership [new section 94C] .
So, for example, where a limited partnership was formed before 19 August 1992 and a partner leaves or another partner joins the partnership after that date, the new arrangements will not apply automatically to the partnership and it will continue to be treated as a partnership formed prior to 19 August 1992, rather than as a new partnership. It may still be treated as a company for tax purposes, but only when it fails the continuity of business test, the continuity of ownership test, or from the 1995-96 year of income.
Which limited partnerships are affected?
Partnerships that qualify as corporate limited partnerships will be affected by the new arrangements and subject to the same taxation provisions as companies.
Limited partnerships can be corporate limited partnerships first in the year of income in which 19 August 1992 occurred; generally, that will be the 1992-93 year of income, but it could be a different year of income for limited partnerships with a substituted accounting period [new definition of year of income, in new section 94B] .
Limited partnerships formed on or after 19 August 1992 will be corporate limited partnerships [new paragraph 94D(b)] .
All limited partnerships are corporate limited partnerships in the 1995-96 year of income and subsequent years [new paragraph 94D(a)] .
Until then, limited partnerships formed prior to 19 August 1992 may continue to be treated as partnerships for taxation purposes.
However, if a limited partnership formed prior to 19 August 1992 does not satisfy a continuity of business test, it will be a corporate limited partnership in the year of income in which it fails to satisfy the test and subsequent years [new paragraph 94D(c)] .
Where a limited partnership is formed prior to 19 August 1992 and there is a change in the composition of a limited partnership after that date, the partnership will be deemed to be a corporate limited partnership unless the partners elect that the partnership is not to be treated as a corporate limited partnership [new paragraph 94D(d)] .
The partners will not be able to elect not to be treated as a corporate limited partnership unless the partnership passes a continuity of ownership test [new paragraph 94F(a)] .
The partners must also make the election within six months after the end of the year of income to which the election relates, or the year of income in which the amendments receive the Royal Assent, whichever is the later; the Commissioner of Taxation may allow further time for the making of an election [new paragraph 94F(b)] .
This test is relevant in determining whether the new arrangements will apply to a limited partnership formed prior to 19 August 1992 during the transition period (until the 1995-96 year of income). To satisfy this test, the limited partnership must carry on the same business that it carried on before 19 August 1992 until the end of the period. As well, the limited partnership must not, during the transition period, derive any income from a different kind of business, or from a different kind of transaction in its business, to those it engaged in before 19 August 1992 [new section 94E] .
If a limited partnership stops carrying on the same business it carried on before 19 August 1992, or begins to derive income from a new business or new business transactions, it will be a corporate limited partnership for the whole of that year of income under new paragraph 94D(c). As such, it will be treated as a company for taxation purposes for that year. In any later year, it will be treated also as a company - once the continuity of business test has been failed, it can never be passed again.
The importance of the continuity of business test is that it prevents limited partnerships formed prior to 19 August 1992 from exploiting their partnership taxation status by embarking on new businesses or new business transactions.
The continuity of business test is in similar terms to the tests applied in sections 63C (used to limit availability of deductions for bad debts), 80E (used to limit access to losses of previous years), and 160Z and 160ZP (used to limit access to capital losses, and transfer of capital losses, respectively).
This test is relevant in determining whether the new arrangements will apply to a limited partnership formed before 19 August 1992 during the transition period (until the 1995-96 year of income). The partnership will pass the continuity of ownership test in a particular year of income only if, at all times from 19 August 1992 to the end of the year, more than half the interests in the partnership were held by persons who held more than half the interests in the partnership immediately before 19 August 1992. "Interests" are not defined, but the term is appropriate to compare the various interests of general and limited partners, and is meant to cover the range of interests possible in a limited partnership [new paragraph 94G(a)] .
However, the partnership will not fail the continuity of ownership test only because interests in the partnership are acquired before 1 July 1993, if the interests are acquired in response to and in accordance with the terms of a prospectus, offer or invitation issued before 19 August 1992, as those terms stood immediately before that day.
A prospectus, offer or invitation to acquire interests in a limited partnership, while not defined, certainly will include the kinds of prospectus, offer and invitation subject to regulation by the securities law.
This will ensure that a limited partnership formed before 19 August 1992 may continue to sell shares or interests in the limited partnership, up to the maximum number of shares or interests offered for sale to the public before 19 August 1992. However, this concession will apply only until 30 June 1993 [new paragraph 94G(b)] .
This modification of the continuity of ownership test ensures that limited partnerships already in the course of marketing interests in their operations before 19 August 1992 will be able to continue to market those interests, knowing that they will not be treated as companies for tax purposes even though substantial interests are sold after that date. Their business operations will continue to be dealt with in the same way. It allows such acquisitions of interests in limited partnerships until 30 June 1993, because this is the end of the main selling period for interests in limited partnerships and other tax-effective investments, regardless of any substituted accounting period of the limited partnership or of any particular investor.
As with the continuity of business test, the continuity of ownership test precludes abuse of the continuing tax treatment of existing limited partnerships. Without such a test, new partners could buy out existing limited partners for the sake of the possible losses in excess of investment that could be available.
Corporate Taxation Modifications
Broadly, limited partnerships to which these provisions apply - corporate limited partnerships - are treated as companies for the purposes of the income tax law. They are not treated as partnerships. Because of this approach, most provisions of the income tax law do not need changes to deal with limited partnerships; the existing provisions generally apply without modification. However, in some areas changes are needed.
Subdivision C of Division 5A sets out certain modifications to the existing provisions of the income tax law.
If a limited partnership is a corporate limited partnership in respect of a year of income, the income tax law has effect, subject to the changes set out in the provisions of the new Subdivision C [new section 94H] .
Income tax law is defined to include the Income Tax Assessment Act 1936 , any Act imposing a tax payable under that Act, the Income Tax Rates Act 1986 , the parts of the Taxation Administration Act 1953 that relate to any of those Acts, and any related parts of any other Acts. It also includes any related regulations. However, it does not include a number of other taxing laws, which already deal with limited partnerships and other partnerships effectively. For instance, the Fringe Benefits Tax Assessment Act 1986 treats all partnerships as individuals in their own right, in subsection 165(1) [definition, "income tax law", new section 94B] .
"Company" includes corporate limited partnership
A reference in the income tax law, other than in respect of the definition of "resident" or "resident of Australia" in section 6 of the Act, to a company or body corporate shall include a reference to a limited partnership. (There is no need to refer to the definitions of resident or resident of Australia, as the residence of corporate limited partnerships is specifically dealt with.) [new section 94J] .
"Partnership" does not include corporate limited partnership
A reference in the income tax law to a partnership does not include a reference to a corporate limited partnership. So the provisions in this Act that apply to other partnerships will not apply to a corporate limited partnership. Key provisions include Division 5 of Part III of the Act, but many other areas of the income tax law have special provisions to deal with the tax treatment of partnerships, which will not apply to corporate limited partnerships [new section 94K] .
"Dividend" includes distribution of corporate limited partnership
A reference in the income tax law to a dividend includes a reference to any distribution made to a partner by a corporate limited partnership, whether the distribution is in money or in other property. This extends the ordinary meaning of "dividend" to create consistency between corporate limited partnerships and companies [new paragraph 94L(a)] .
However, any distribution that is attributable to profits or gains arising during a year of income when the partnership was not deemed to be a corporate limited partnership will not be regarded as a dividend. This will ensure that a partner's share in the net income of a limited partnership in a year of income in which it is not a corporate limited partnership for taxation purposes will not be regarded as a dividend, even if it is paid to the partner in a year of income in which the limited partnership is treated as a company for taxation purposes. It will ensure also that no franking credits will arise as a result of the payment of tax in respect of a year of income for which the partnership was not a corporate limited partnership [new paragraph 94L(b)] .
What distributions are paid out of profits?
If a corporate limited partnership pays or credits an amount to a partner in the partnership from profits or anticipated profits, or in anticipation of profits, the amount paid or credited will be deemed to be a dividend paid by the partnership to the partner out of profits derived by the partnership. Assessable income of shareholders includes certain dividends paid out of profits, under subsection 44(1); companies generally pay dividends only out of profits, as a matter of corporations law, but limited partnerships could pay dividends from other sources more readily. Moreover, one view of partnership law as it applies to corporate limited partnerships suggests that their income only arises when accounts are taken, despite their treatment as companies for taxation purposes. It could also be argued that profits don't arise until their amount can be finally ascertained. As corporate limited partnerships can make distributions before the taking of accounts, out of anticipated profits or in anticipation of profits, the provision ensures that such distributions will be taken to be made out of profits [new subsection 94M(1)] .
If the partnership makes a subsequent distribution of profits which includes an amount paid or credited in anticipation of profits, the Commissioner of Taxation is required to take such steps, if any, as are necessary to ensure that a partner is not subject to double taxation. This ensures that, if a partner has already been taxed on a distribution when it was credited, the partner will not face income tax again when the distribution is actually paid [new subsection 94M(2)] .
"Private Company" does not include corporate limited partnership
The provisions in the income tax law which apply only to private companies rather than to companies generally have no application to corporate limited partnerships [new section 94N] .
"Share" includes interest in corporate limited partnership
A reference in the income tax law to a share shall include a reference to an interest in a corporate limited partnership [new section 94P] .
"Shareholder" includes partner in corporate limited partnership
A reference in the income tax law to a shareholder includes a reference to a partner in a corporate limited partnership. This, combined with the extended meaning of "dividend" and "company", ensures that many key provisions for the taxation of companies and shareholders apply correctly to corporate limited partnerships and their partners [new section 94Q] .
"Liquidator" may include partner in corporate limited partnership
In relation to the application of section 47 of the Act, in the event of a winding-up of a corporate limited partnership, whoever is responsible for the taking of accounts and making payments does so as a liquidator within the extended meaning of 'liquidator' in the Act. This is so, even if several persons do different things in the winding-up; each will be a 'liquidator'.
For the purposes of the income tax law, a reference to a liquidator includes a partner in a corporate limited partnership who carries out the winding-up of the partnership [new paragraph 94R(a)] .
Also for the purposes of the income tax law, a reference to distributions made by a liquidator in the course of winding-up a corporate limited partnership includes a reference to distributions made by the partner who carries out the winding-up to himself or herself in the course of winding-up the partnership [new paragraph 94R(b)] .
Together, these provisions ensure that payments by a partner in the course of the taking of accounts and winding up of a corporate limited partnership are treated in the same way as payments by any other liquidator of the partnership, or as payments by the liquidator of a company. All such payments generally will be dividends out of profits or income, to the extent to which they are made from profits or income.
Continuity of corporate limited partnership not affected by changes in composition
For the purposes of the income tax law, a change in the composition of a corporate limited partnership does not affect the continuity of the partnership. So a new corporate limited partnership is not created, or a former partnership extinguished, on the retirement, substitution or addition of a partner to a corporate limited partnership [new section 94S] .
Residence of corporate limited partnership
For the purposes of the income tax law, a corporate limited partnership is a resident of Australia if, and only if, the partnership was formed in Australia, or it either carries on business in Australia or has its central management and control in Australia. This gives a test of residence for corporate limited partnerships that is closely comparable to the test of residence for companies. Partnerships generally did not need to be considered as having a place of residence, under the provisions applicable to other partnerships; as their net income, loss, exempt income and so on were attributed to the partners, it was the residence of the particular partner that mattered [new section 94T] .
For the purposes of the income tax law, a corporate limited partnership is taken to have been incorporated in the place where it was formed and under a law in force in that place. This rule is needed to clarify the operation of several provisions relating to companies, as they apply to corporate limited partnerships [new section 94U] .
Obligations and offences of limited partnerships
Broadly, obligations and offences of limited partnerships are taken to be those of the individual partners, with certain joint and several liabilities. The reason for this approach is that, while corporate limited partnerships are generally treated as companies for the purposes of the income tax law, this does not convert them into companies for other purposes, including criminal law, monetary claims, and so on. So the obligations and offences of limited partnerships continue to be dealt with broadly as before these amendments. The law will provide for limited partnerships in much the same way as for other partnerships.
Where, as an entity, a corporate limited partnership is subject to an obligation under the income tax law, that obligation is imposed on each of the partners, but it may be discharged by any one of them [new paragraph 94V(1)(a)] .
Where, as an entity, any amount is payable under the income tax law by a corporate limited partnership, the partners are jointly and severally liable to pay that amount [new paragraph 94V(1)(b)] .
Where, as an entity, any offence against the income tax law would have been committed by a corporate limited partnership, each partner will be deemed to have committed the offence [new paragraph 94V(1)(c)] .
However, it will be a defence against a prosecution of a partner for such an offence if the person proves that he or she did not aid, abet, counsel or procure the particular act or omission, and was not in any way knowingly concerned in, or party to, that act or omission (whether directly or indirectly or by act or omission of the person). Limited partners will generally be able to establish that defence with ease; limited partnerships established in Australia preclude limited partners from taking part in the management of their partnerships, although cases can be imagined where a limited partner would be denied the defence by aiding, abetting, counselling or procuring the offence [new subsection 94V(2)] .
The general liability of partners for offences of their partnership is in accord with the accepted law. However, the statutory defence allows an innocent partner to rebut the presumption. The matters to be proved, to establish the defence on the balance of probabilities, will be peculiarly within the knowledge of the partner and extremely difficult for the prosecution to negative. So what might be thought a reverse onus of proof for partners charged with offences is justified.
This proposed onus of proof for a partner defending proceedings for an offence of the partnership is similar to that in other taxation laws. Sections 102AAZG, 221YHZN and 468 of this Act, sections 165 and 166 Fringe Benefits Tax Assessment Act 1986 , and sections 12 and 13 Petroleum Resource Rent Tax Assessment Act 1987 all operate similarly.
Pre-1995-96 years of income - certain corporate obligations do not arise
Where a limited partnership is formed before 19 August 1992, and an event occurs whereby the partnership becomes a corporate limited partnership for a year of income prior to the 1995-96 year of income, certain obligations may be imposed under the income tax law on the partnership in its capacity as a company. However, it is not intended that a corporate limited partnership should be liable for any obligations to act as a company before the event which results in the partnership being a corporate limited partnership for that year of income.
Accordingly, where, in a year of income prior to the 1995-96 year of income, a limited partnership is deemed to be a corporate limited partnership because it failed either the continuity of business test or the continuity of ownership test, the income tax law has effect as if any obligation imposed on corporate limited partnerships because they are taxed as companies which arose before the corporate limited partnership first failed to meet either of those tests had never arisen [new section 94W] .
The provision applies only in respect of any obligations arising between the beginning of the relevant year of income and the time at which the first event occurs.
Modification of loss provisions
In determining whether a disqualifying event has occurred for the purposes of section 50H or whether the continuity of ownership test for the purposes of section 80A has been satisfied, the parts of those provisions relating to voting power will not be taken into account [new section 94X] .
Modification of provisions relating to the collection of company tax
Irrespective of anything in Division 1B of Part VI, relating to the collection of company tax, the notional tax of a limited partnership will be nil in respect of the first year of income for which it is taxed as a corporate limited partnership. The notional tax is nil if the year of income is the one in which 19 August 1992 occurred, or if the partnership was not a corporate limited partnership in the year of income before the particular year [new section 94Y] .
Because of the definition of a "year of income", the first possible year of income for a corporate limited partnership is the year of income in which 19 August 1992 occurred. In effect, a limited partnership will be treated as a new entity in the year of income in which it first becomes assessable as a company under these provisions [definition, "year of income", new section 94B] .
Clause 9 provides that any act or omission on the part of any person before Royal Assent to this provision will not result in a person being guilty of any offence under the income tax law, merely because of the changes made here. In effect, before Royal Assent, no offences arise from a limited partnership failing to discharge obligations imposed on it as a corporate limited partner. The only relevant actions or omissions will be in relation to the law affected by the changes - that is, the areas of income tax law to which the treatment of certain limited partnerships as companies is relevant [Clause 9] .