Tax changes for general and limited partnerships
28 June 2006
Proposed tax changes for general and limited partnerships
A government discussion document released today proposes codifying the tax rules on general partnerships and introducing new rules on limited partnerships.
“The changes are designed to bring clarity and certainty to New Zealand’s tax rules on partnership income and bring them into line with world’s best practice,” said Finance Minister Michael Cullen and Revenue Minister Peter Dunne.
“A key impetus of the tax reform for limited partnerships is the planned introduction of modern limited partnership regulatory rules, to be the subject of a future bill.
“Limited partnerships are an internationally preferred vehicle for venture capital investment into foreign countries. Given the importance of attracting venture capital into New Zealand, it makes sense to have tax rules that facilitate this kind of investment by recognising the separate legal entity status of limited partnerships, while ensuring flow-through treatment for tax purposes.
“Having clear tax rules for general partnerships will provide greater certainty for all partnerships, large or small,” they said.
“The new limited partnership rules are investment-friendly and will enable New Zealand to be more competitive with Australia in attracting venture capital,” they said.
The main proposals are:
- Partners will derive income or expenses from each source, in proportion to their profit share (flow-through treatment).
- The entry and exit of partners will not result in the dissolution of the partnership for income tax purposes.
- Exiting partners may recognise gains or losses attributable to underlying partnership assets on disposition subject to a minimum threshold rule. The minimum threshold simplifies tax consequences for exiting or new partners when tax is not an issue.
- New rules will reduce the likelihood of under-taxation and over-taxation of both exiting and incoming partners.
- New rules will allow the same flow-through tax treatment for limited partnerships that have separate legal entity status.
- New loss limitation rules will ensure the tax losses deducted by limited partners reflect the actual level of any economic loss.
- A simple transition from a special partnership to a limited partnership would not generally result in the triggering of income tax provisions for the partners.
The discussion document, “General and limited partnerships – proposed tax changes”, is available at www.taxpolicy.ird.govt.nz. Submissions close on 11 August 2006.
Questions and answers
What's behind the proposed changes?
The government has agreed to the introduction of modern limited partnership rules, with separate legal entity status and partnership tax treatment, in order to encourage the flow of venture capital investment into New Zealand. This discussion document sets out a clear set of tax rules that will apply to the proposed limited partnership form. In addition, the problems associated with the taxation of partnerships generally (as highlighted by the Valabh Committee) may become more acute as the use of limited partnership structures increases. Therefore the discussion document proposes to clarify and improve the tax rules for partnerships generally.
What is the extent of the proposals?
The changes proposed are two-fold. First, the discussion document outlines rules that will apply to all partnership and partners (such as general and limited partners/partnerships). Second, it proposes specific rules for limited partners.
Will the current rules for allocating partnership income and expenditure to partners be changed?
No. The discussion document proposes to clarify and codify the existing law and practice in legislation.
What tax changes are proposed for the entry and exit of partners?
There is currently a great deal of uncertainty about the applicable tax treatment on the entry and exit of partners. Technically, under current law the entry or exit of partners may result in dissolution of the partnership and the creation of a new partnership. This may trigger the operation of tax provisions relating to the disposal of an interest in property of the partnership for all of the partners in the partnership.
The proposals aim to clarify the treatment in future by making it clear that a partnership will continue and will not dissolve for tax purposes. The discussion document proposes that only the exiting partner may be taxed on the taxable gain attributable to the underlying partnership assets. This is subject to a minimum threshold rule – for example, there would be tax consequences for the exiting partner only if the sale proceeds exceed the tax book value of assets by $20,000 or more. These proposed rules will reduce the complexity of the tax rules applying to partnerships and the compliance costs associated with the entry and exit of partners.
How will the proposed changes affect small partnerships (such as. family and farming partnerships)?
The discussion document does not propose any real changes for small partnerships. The proposals contained in the discussion document merely clarify and codify the existing law and practice. The discussion document also proposes that partnerships of fewer than six members may elect to follow the proposed rules for the entry and exit of partners or continue as they are.
How will the proposed changes affect professional partnerships?
The discussion document does not propose any real change to the allocation of income and expenditure to the partners. In relation to the exit and entry of partners, a minimum threshold has been developed, with professional partnerships in mind. Therefore exiting partners of partnerships with few assets will not be taxed on the taxable gain attributable to the underlying partnership assets on disposal.
What is a limited partnership?
partnership is composed of "general" partners who are liable
for the debts and obligations of the partnership and one or
more "limited" partners, whose liability is limited to the
amount of their investment, provided that they do not engage
in the management of the partnership.
Standard features of the proposed limited partnership include: flow-through tax status; limited liability for investing partners; separate legal personality; and the ability for limited partners to participate in management only in prescribed circumstances.
How will limited partners be taxed differently from general partners?
All of the rules proposed for general partnerships in the discussion document will also apply to limited partners. In addition, the discussion document proposes the introduction of loss limitation rules for limited partners. This means that a loss available to a limited partner in any given income year will be limited to the tax value of their investment. This ensures that the net tax losses claimed by a limited partner in relation to a limited partnership interest reflect the actual level of that limited partner’s economic loss.
These rules are consistent with international practise.
How will the new rules affect the venture capital industry?
A new limited partnership rules (with partnership tax treatment) will help encourage the flow of venture capital investment into New Zealand. The limited partnership is the preferred business structure internationally for investing in venture capital.
What are the compliance cost
implications associated with the new rules?
Many of the proposed rules aim to reduce the compliance costs associated with partnerships by providing greater certainty about tax treatment. However, a cost may be associated with the proposed introduction of the “partner’s basis” (basis tracking), which will be required to determine the extent of the application of the loss limitation rules for limited partners.