Partnerships

Partnerships are widely used in Canada for professional firms, real estate and resource ventures, joint ventures between corporations, and investment funds structured as limited partnerships. The tax treatment rests on a simple idea: a partnership is not a taxpayer, but its income is computed as though it were a separate person and then allocated to the partners. That idea produces a body of rules about computing partnership income, allocating it, tracking each partner's adjusted cost base, limiting losses, moving property into and out of partnerships, and reporting. This lesson works through them using SkyGrid Data, the general partnership that Leah and Dev Mehta formed in 2027 to process aerial survey data.

What is a partnership?

The Act does not define a partnership, so the courts look to provincial partnership law: in Manitoba, as elsewhere, a partnership is the relation that subsists between persons carrying on a business in common with a view to profit. The Supreme Court of Canada in Backman v. Canada (2001) and Spire Freezers Ltd. v. Canada (2001) confirmed that all three elements, a business, carried on in common and with a view to profit, must be present, and that a partnership agreement alone does not create one. Co-ownership of property, for example two people jointly owning a rental building, is not by itself a partnership, and a joint venture, in which parties cooperate on a specific project but each reports its own share of revenue and expenses, is treated differently. A general partnership exposes each partner to unlimited, joint liability; a limited partnership, registered under provincial law, limits the liability of limited partners who take no part in management; and a limited liability partnership protects professional partners from liability for each other's negligence.

Computing and allocating partnership income

Subsection 96(1) computes the partnership's income as if the partnership were a separate person resident in Canada and its fiscal period were its taxation year. Revenues and expenses are determined at the partnership level, the partnership claims CCA on its depreciable property, and capital gains, dividends, foreign income and other items keep their character as they pass to the partners. Each partner then includes its share of the income for the fiscal period ending in its taxation year. A partnership with any individual partners generally must use a 31 December fiscal year-end. The partnership agreement normally determines the shares, and it can allocate different items in different proportions, but subsection 103(1) lets the CRA reallocate income where the principal reason for an allocation was to reduce tax, and subsection 103(1.1) where an allocation is not reasonable having regard to the partners' capital, work and other factors. Salaries or draws paid to partners are not expenses of the partnership: they are simply a way of allocating income. Donations and political contributions made by the partnership flow out to the partners, who claim the credits or deductions.

The adjusted cost base of a partnership interest

A partner's interest in a partnership is capital property with an adjusted cost base that changes every year. Under section 53, the ACB is increased by contributions of capital and by the partner's share of income, including the full amount of capital gains (both halves), at the end of the fiscal period; it is reduced by drawings and by the partner's share of losses. Unlike the US rules, a partner's share of partnership debt is not added to the ACB. When a partner sells the interest, the capital gain is the proceeds minus the ACB at that time; to avoid double counting, income allocated to the partner for a fiscal period that has not yet ended is added to the ACB just before the sale. If the ACB of a limited partner, or of a partner who is not actively engaged in the business, becomes negative at the end of a fiscal period, subsection 40(3.1) deems the negative amount to be a capital gain immediately; a general partner who is actively engaged pays tax on a negative ACB only when the interest is disposed of.

Limited partners and losses

Limited partnerships have long been used as tax shelters, because partnership losses flow through to the partners. Subsection 96(2.1) limits the losses a limited partner can deduct to its 'at-risk amount', which is broadly the ACB of its interest plus its share of current income, minus amounts owed to the partnership and any guarantees or protections against loss. Losses denied by the at-risk rule become limited partnership losses that can be carried forward indefinitely and deducted when the at-risk amount increases. A general partner who is actively engaged is not subject to the at-risk rules and can deduct its share of losses against other income, but bears unlimited liability. Corporate partners face one more limit, from lesson 3: the small business deduction on income earned through a partnership is limited to the corporation's share of a single business limit for the partnership.

SkyGrid Data's 2027 income

Leah contributes $30,000 of cash to SkyGrid Data. Dev contributes servers and software with a fair market value of $30,000 and a cost of $12,000, and the partners jointly elect under subsection 97(2) to transfer them at $12,000, so Dev defers his $18,000 gain. The partnership agreement gives Dev a priority allocation of the first $24,000 of income each year in recognition of his full-time work and splits the rest equally. In 2027 the partnership earns $140,000 of revenue and has $70,000 of expenses, including CCA. Leah draws $8,000 and Dev $24,000. The partnership also borrows $20,000 from a bank.

# SkyGrid Data, a Manitoba general partnership of Leah and Dev Mehta, 2027 (illustrative)
contrib = {"Leah": {"cash": 30_000, "fmv": 30_000, "acb": 30_000},
           # Dev's servers and software: FMV 30,000, cost 12,000, s. 97(2) election at 12,000
           "Dev":  {"cash": 0, "fmv": 30_000, "acb": 12_000}}
revenue, expenses = 140_000, 70_000          # expenses include CCA; partners' draws excluded
income = revenue - expenses                  # computed as if the partnership were a person
priority_to_dev = 24_000                     # agreement: first 24,000 to Dev for his full-time work
residual = income - priority_to_dev
shares = {"Leah": residual / 2, "Dev": priority_to_dev + residual / 2}
draws = {"Leah": 8_000, "Dev": 24_000}
loan = 20_000                                # bank loan to the partnership: not part of ACB
print(f"Partnership income for the fiscal period ending 31 December 2027: {income:,}")
for p in ("Leah", "Dev"):
    acb = contrib[p]["acb"] + shares[p] - draws[p]
    print(f"{p:<5} share of income {shares[p]:>9,.0f}  drawings {draws[p]:>7,}  ACB at year end {acb:>9,.0f}")
print(f"Deferred gain on Dev's property (FMV 30,000 - elected 12,000): {30_000 - 12_000:,}")
info_return_needed = (revenue + expenses) > 2_000_000
print(f"T5013 partnership information return required by the $2 million test: {info_return_needed}")

Partnership income for the fiscal period ending 31 December 2027: 70,000
Leah  share of income    23,000  drawings   8,000  ACB at year end    45,000
Dev   share of income    47,000  drawings  24,000  ACB at year end    35,000
Deferred gain on Dev's property (FMV 30,000 - elected 12,000): 18,000
T5013 partnership information return required by the $2 million test: False

SkyGrid Data's income of $70,000 is computed at the partnership level. Dev's share is $47,000: his $24,000 priority allocation plus half of the remaining $46,000; Leah's is $23,000. Both include their shares in their 2027 returns, whatever they drew. Leah's ACB rises from $30,000 to $45,000, net of her $8,000 of drawings; Dev's rises from $12,000 to $35,000 after he draws his $24,000. The $20,000 bank loan does not affect either ACB. Dev's $18,000 deferred gain remains in the partnership property: because the partnership acquired it at $12,000, a later sale at $30,000 would produce a gain at the partnership level, allocated under the agreement, which is why partnership agreements often allocate such pre-contribution gains back to the contributor. Finally, because the partnership's revenue and expenses total only $210,000, its assets are well under $5 million and its partners are individuals, it is not required to file a T5013 partnership information return unless the CRA asks for one, though it must still give its partners the information to report their shares.

Property transfers into and out of partnerships

A transfer of property to a partnership is a disposition at fair market value under subsection 97(1) unless the partners elect under subsection 97(2), which works much like section 85: a Canadian partnership and all of its members can jointly elect an amount between the property's tax value and its fair market value, provided the transferor receives an interest in the partnership. Withdrawing property from a partnership, or winding it up, is a disposition at fair market value by the partnership, with the gain allocated to the partners, unless section 98 provides a rollover. Subsection 98(3) allows a partnership that ceases to exist to distribute its property to the partners in proportion to their interests on a rollover basis, and subsection 98(5) allows one partner to continue the business as a proprietor. Section 85(2) and subsection 85(3) allow a partnership to transfer its property to a corporation on a rollover basis and then wind up, a common route when a partnership business incorporates. A partner who sells an interest has a capital gain or loss, but section 100 converts part of the gain to full inclusion if the interest is sold to a tax-exempt or non-resident person.

Reporting and filing

A partnership must file a T5013 partnership information return for a fiscal period if at the end of the period the total of the absolute values of its revenues and expenses exceeds $2 million, or its assets exceed $5 million; or if at any time during the period it is a tiered partnership, has a corporation or trust as a partner, has invested in flow-through shares or has incurred resource expenses renounced to it; or if the CRA requests it. The return is due by 31 March after the calendar year for partnerships whose members are all individuals, five months after the fiscal period ends if all members are corporations, and the earlier of the two dates otherwise. Each partner receives a T5013 slip. A partnership is also a person for GST/HST purposes, so it registers and files GST returns in its own name, as SkyGrid Data must once its taxable supplies exceed $30,000.

Partnerships are common when two corporations or professionals combine their efforts, and corporate partners face special issues. Specified partnership income rules, from lesson 3, limit the small business deduction a corporate partner can claim on its share of partnership income to its share of a single $500,000 business limit for the partnership, unless another partner assigns part of its limit. A partnership with corporate partners must file a T5013 regardless of size. When a business carried on in partnership grows, partners often incorporate, either each partner transferring its interest to its own corporation, or the partnership transferring its assets to a new corporation under subsection 85(2) and winding up under subsection 85(3). SkyGrid Data could later follow that route if Leah and Dev want to keep profits in a corporation at the small business rate.