Private ruling: 'Partnership salaries' and superannuation
Published: January 2012
Ruling period: Year ended 30 June 2011
Date scheme commenced: 1 July 2010

Ruling: Q1: Can a partnership business issue 'salary or wages' to the partners even if it creates a loss in the partnership business? | A1:  | Q2: Are the payments of 'salary or wages' and superannuation expenses for the partners, allowable deductions for the business? | A2:  | Q3: Should payment summaries be issued, and pay as you go withholding tax be remitted, in respect of the 'salary or wages' paid to the partners? | A3: 

Relevant facts and circumstances: You are a partner in a partnership that runs a business. The partners have made an arrangement between themselves to receive additional remuneration as a 'salary' or fixed sum payable. You intend to pay 'salary or wages' to the partners at the hourly market rate on the actual hours worked. You intend to claim a deduction in the partnership business for the 'salary or wages' and superannuation contributions paid for the partners.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 90 | Income Tax Assessment Act 1936 Section 92 | Income Tax Assessment Act 1936 Subsection 92(1) | Income Tax Assessment Act 1997 Section 8-1 | Tax Administration Act 1953 section 12-35 to schedule 1

Reasons for decision: Summary: A partner in a partnership cannot be an employee of the partnership. Accordingly; § a payment of 'salary or wages' made to a partner of a partnership is considered to be a distribution of partnership profits, and not an expense of the partnership, therefore, it is not deductible and cannot result in, or increase, a partnership loss. § a payment made for superannuation contributions by an employer on behalf of a partner is not an allowable deduction. § there is no requirement to withhold an amount from a payment made to a partner or provide a partner with a payment summary. | Detailed Reasoning - Detailed reasoning: 'Partnership salary' Division 5 of Part III of the Income Tax Assessment Act 1936 (ITAA 1936) is concerned with the taxation treatment of partnerships. The general structure of Division 5 is that the net income or partnership loss of a partnership is determined under section 90 of the ITAA 1936. Having determined whether the partnership has a net income or loss, section 92 of the ITAA 1936 provides that the net income is then assessable, or the partnership loss deductible, to each partner by reference to that partner's individual interest in the partnership income or loss. A partnership is not a legal entity separate and distinct from the partners ( Rose v. FC of T [1951] 84 CLR 118; 9 ATD 34; [1951] 5 AITR 197) and neither the ITAA 1936 or the Income Tax Assessment Act 1997 (ITAA 1997) modify this fact for the purposes of the income taxation law. A partner cannot be the employee of their partnership, it being a legal impossibility for the same person to be the employer and the employed ( Ellis v. Joseph Ellis & Co. [1905] 1 KB 324 at 328 and 329 ( Ellis' Case )). Accordingly, if a partner is paid a 'salary' they are receiving, by agreement, a share of the profits of the partnership quantified as the amount of the salary ( Ellis' Case at 339; Watson v. Haggitt [1928] AC 127). Taxation Ruling TR 2005/7 discusses the taxation implications of partnership salary arrangements. Paragraph 7 of TR 2005/7 states: A 'partnership salary' is not truly a salary, nor is it an expense of the partnership, but instead is a distribution of partnership profits to the recipient partner. Thus, the payment of a 'partnership salary' to a partner, whether or not for personal services provided by the partner, is not taken into account as an allowable deduction under section 8-1 of the Income Tax Assessment Act 1997 (the ITAA 1997) in calculating the net income or partnership loss of the partnership under section 90 of the ITAA 1936. Therefore, the payment of a 'partnership salary' cannot result in or increase, a partnership loss. TR 2005/7 explains that usually, a 'partnership salary' is paid out of the profits of the partnership. The 'partnership salary' increases that partner's share in the net income of the partnership before the remaining profits are divided amongst the other partners at the end of the income year. However, in those years where partnership profits are not sufficient to cover the 'partnership salary', the entitlement to a 'partnership salary' affects the partners' interests in the profits of more than one year. In this instance, the excess distribution will be assessable to the recipient partner in the future income year when profits are sufficient. Example The partnership agreement between A and B provides that the partners share profits or losses of the partnership equally. The partnership agreement allowed for payment of a 'salary' of $20,000 to A. The partnership loss for the year after paying A's salary was $30,000. The determination of net income for the partnership is calculated as follows; Partnership net loss (after deducting salary) ($30,000) Plus: A's salary $20,000 Net loss ($10,000) The net loss is then distributed, in accordance with partnership agreement, being 50%, 50% (in this example) as follows; A Interest in partnership net loss: 50% of (-$10,000) ($ 5,000) Distribution - A ($ 5,000) B Interest in partnership net loss: 50% of (-$10,000) ($ 5,000) Distribution - B ($ 5,000) Total distribution ($10,000) The $20,000 'partnership salary' cannot create or increase a partnership loss. The salary was taken by A in advance of profits. The $20,000 distributed in excess of the available profits will be met from profits in future years and be assessable to A under subsection 92(1) of the ITAA 1936 in that future year when sufficient profits are available. In conclusion, a 'partnership salary', paid in any form, is not a true salary, as the partner is not an employee of the partnership. The 'salary' is merely an advance distribution of the partnership profits. Accordingly, you are not entitled to a deduction for the 'partnership salary' when calculating the net income of a partnership under section 90 of the ITAA 1936. Superannuation contributions In addition to 'partnership salary' not being an allowable deduction, Section 90 of the ITAA 1936 provides that in calculating the net income or loss of a partnership, personal superannuation contributions made by a partner are not allowable deductions (these deductions may be claimable in the individual partner's income tax return). The calculation will also not take into account a deduction for superannuation contributions by an employer on behalf of a partner because a partner is not an employee of the partnership, and is therefore not an employee for superannuation guarantee purposes (Superannuation Guarantee Ruling SGR 2005/1). Accordingly, the partnership business is not entitled to a deduction for superannuation contributions made on behalf of the partners when calculating the net income of the partnership under section 90 of the ITAA 1936. Pay as you go withholding tax and payment summaries As discussed above, the 'partnership salary' is not a true salary and the partner receiving the 'salary' is not an employee of the partnership, the recipient partner is merely receiving an advance distribution of the partnership profits. Therefore, as the payment is not salary or wages as defined in section 12-35 in Schedule 1 of the Taxation Administration Act 1953 , the partnership is not required to withhold an amount from the payment nor issue a payment summary for the recipient partner.

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