IRD & Partnerships



What the IRD Can Do
Under the Act the Commissioner of Inland Revenue can determine, after perusal of the partnership agreement, whether it is considered that a partnership allocation of profits and other remuneration between the partners is acceptable for tax purposes or not. The commissioner will consider the profit allocation in proportion to each partner’s involvement in the business.

If the commissioner is of the opinion that the remuneration paid or share of profits to the partners, relative to their duties and employment in the business is excessive, he/she may reallocate the share of remuneration or profit in whatever proportion he/she considers reasonable.

To consider whether the payment or share in the profit or loss is reasonable, the IRD looks at all of the following:

  • The nature and extent of the services provided
  • The value of the partners' contributions made by way of services or capital
  • Any other relevant matters.

This section in the Act is designed to counter tax arrangements between partners (such as relatives) where the main purpose is splitting of income to reduce overall tax liability. That would not really be a genuine business arrangement, but merely a vehicle set up to redistribute income with the sole intention of avoiding taxation.

This section, of course, will not apply to bona fide partnership contracts that meet the requirements of the Act. The IRD cannot reallocate a partners' share of income or losses if there is a bona fide contract.


Payment of Partner’s Salaries and Interest
Because a partnership is not separate legal entity (as for a company) the partners cannot strictly be employees of a partnership. Therefore all “salaries” paid really amount to a distribution of the partner’s share of the income, and is not a deduction from the partnership income to arrive at the correct “net income” for tax.

This treatment applies also to interest paid on a partner’s capital or partner’s current account with the partnership. A partner who works for the partnership can be paid a salary or wage providing there is a bona fide contract. The contract must be in writing and agreed to by all partners and PAYE must be deducted.

Salaries or wages paid to partners are a deductible expense in the partnership's Income tax return - partnerships (IR7). The partner must include the salary or wage in their Individual tax return (IR3) along with their share of any profit or loss from the partnership.

Where under a proper agreement a salary is provided for before distribution, this may result in a situation where one partner has a surplus and the other a deficiency.

Generally the IRD will accept for tax such a split and in effect allow “the salary” to be deductible in arriving at the net partnership income or loss.

e.g. Partnership Net Income - $30,000
Partners “A” Salary to be paid - $40,000

Basis

  1. Partner A will receive a loss of $5,000 (50% of $10,000 loss) plus income of $40,000 to arrive at a $35,000 net income
  2. Partner B will receive a loss of $5,000 only