Partnerships and the Tax Man

Partnerships and tax Partnerships can provide a useful structure to conduct a small business but when things go awry and the partners split there may well be tax consequences that may not have been considered.

A recent decision of the NSW Supreme Court has highlighted some of the problems that can arise.

The Court of Appeal dismissed a taxpayer’s appeal and upheld an earlier decision which had affirmed that as a director of a company he was liable to pay monies to the Tax Commissioner that were withheld from employees’ salaries or wages per section 222AOC of the Income Tax Assessment Act 1936.

That section permits the commissioner to recover from directors of a company by way of penalty an amount equal to the unpaid amount of the company’s liability to pay money withheld by it from salaries or wages of an employee in accordance with its obligations under the tax law.

In this case the commissioner was seeking to recover about $159,000.

The taxpayer was the sole director of a company. In November 2005 the company (as trustee of the taxpayer’s family trust) and the trustee of another trust entered into a partnership agreement. The partnership operated a café/bar business at Penrith in NSW and it was understood that the taxpayer managed the day-to-day operations.

The relationship between the partners deteriorated and on February 7, 2007 the taxpayer was “excluded from the operation of the business”. The taxpayer contended that from that date the partnership was terminated and it followed that there could be no withholding by the partnership and accordingly by the company within the relevant provisions of the tax law.

Disputes between the partners were not resolved and on June 4, 2008 orders were made in the Supreme Court by consent that the partnership be dissolved and wound up under the direction of the court and that a receiver and manager be appointed.

Clause 27 of the partnership deed provided that the partnership would be dissolved “if each partner agrees that the partnership will be dissolved”. But the court found that there was no such agreement.

The commissioner alleged that the partnership as the relevant “entity” had withheld amounts from salaries or wages of its employees and as a consequence was liable to pay those amounts under the tax law.

The amounts were alleged to have been withheld during the period June 2006 to February 2008. The company in question (of which the taxpayer was sole director), as a partner, was said to be jointly and severally liable for the payment of those amounts.

If amounts were withheld by the partnership, the director of the company was required by the tax law to ensure the company complied with its obligations to pay those amounts to the commissioner.

The NSW Court of Appeal found that in the circumstances what was done was consistent with a termination of the taxpayer’s involvement in the management of the partnership but was not a termination of the partnership itself. This was an important point.

The court further said that because the partnership was not terminated before June 2008 business activity statements lodged after February 2007 and on behalf of the partnership were evidence from which it could be inferred that a withholding had occurred and that the withholding had been made by the partnership.

Accordingly the court held that the primary judge was correct to conclude that there had been a withholding by the partnership entity and that each of the partners was jointly and severally liable to pay the amounts withheld to the commissioner on or before the required date. The court said the law permitted the commissioner to recover those amounts from the taxpayer.

This case serves as a useful illustration of what can go wrong when a partnership gets into trouble. The wording of the partnership deed is important and the steps taken to act on that deed are equally important.

Terry Hayes is the senior tax writer at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions .