- Creating a Partnership
A partnership is created by the joining of 2 or more people (to a maximum of 20) to jointly operate a business. In Western Australia, partnerships are governed by the common law as altered by the Partnerships Act 1895 which sets out various provisions which are implied into a partnership.
Generally, the formation of a partnership should be documented in a partnership agreement but this is not essential and can be formed by oral agreement. The key is that the partners intend to act as partners and carry on a business in common. There may be an express declaration by the partners that they are operating in partnership or this intention may be evidenced by things such as joint registration of bank accounts or business name.
- The Pros & Cons of the Partnership Business Structure
The biggest reason to form a partnership is that it is a low cost and simple structure to establish and dissolve. It allows 2 or more people to pool their skills and resources to build a successful business. It also allows the partner to access the 50% CGT discount.
Conversely, it is important to note is that a partnership is that it is not a separate legal entity and the partners are jointly and severally liable for all liabilities, not just their portion of the partnership. This means that each partner is exposed to the full liabilities of the partnership, not just their portion of the partnership, so a creditor is able to access the assets of each individual.
Another important point is that, whilst a partnership is required to lodge a tax return, it does not pay tax, each of the partners pay tax on their share of the profit. In this respect, for businesses that generate significant profits, it can be a very tax inefficient structure as the top marginal tax rate for each individual partner is higher than for a company.
Finally, without a partnership agreement, it can be difficult to ascertain how to deal with partnership assets
- Partnership Agreements
A partnership agreement gives the partners flexibility to vary their respective rights and obligations, particularly where only one partner actually works in the business. A well drafted partnership agreement minimises the risk of disputes in the operation and dissolution of a partnership.
A well drafted partnership agreement will include clauses outlining:
- the expectations of each party, particularly if one of the partners will not be working in the business day to day;
- the purpose of the business;
- how decisions are made;
- how partnership profits will be distributed and whether partners working in the business will be paid a salary before profits are paid out;
- administrative aspects such as drawings by partners, restrictions on authorities and management rights;
- a dispute resolution clause where there is a disagreement over the operation of the business; and
- what will happen when one of the partners wants to leave.
- Partnership Disputes
There are many reasons why there may be a dispute between partners.
One of the most common is a disagreement over the management over the business. Without an adequate dispute resolution clause, the partners may have to dissolve the partnership or make an application to the Court to determine the matter.
It is also very common for partners to disagree about the distribution of profits, particularly where one of the partners receives a wage before the calculation of profits. If the partnership is dissolved, section 57 provides that, subject to any partnership agreement, the partnership assets shall be paid firstly to any debts or liabilities, paying partners any advances made during the partnership, repaying their capital investment and, finally, equally dividing the balance of the profits.
Finally, a partner can sometimes act in their own best interest and not in the interests of the business. The joint and several liability of partners for all liabilities is a common area of dispute, particularly where one partner incurs liabilities in the business without the knowledge of one of the other partners. Sometimes this occurs where a partner decides to walk away without a formal removal or dissolution, potentially leaving them on the hook, despite not being actively involved in the partnership anymore. It is important to understand your rights in these situations and ensure that you are protected.
If you are starting a partnership or for any other business structuring needs, get in contact today.