Technical amendments to the partnership rules
2009 amendments to the tax rules for partnerships correct technical problems with general partnership legislation, particularly for primary sector partnerships.
Sections EB 26B, HG 3, HG 4, HG 5, HG 6(6), HG 7(6), HG 8(6), HG 9, HG 10 and HG 11(8) of the Income Tax Act 2007
Several remedial amendments have been made to the tax rules for partnerships to correct several technical problems with the general partnership legislation, particularly for primary sector partnerships.
The Taxation (Limited Partnerships) Act 2008 came into force on 1 April 2008. The legislation updated the tax rules relating to general partnerships, as well as providing for flow-through tax treatment for the new "limited partnership" vehicle created by the Limited Partnerships Act 2008. The amendments were added at the Committee stage of the legislation and apply from the 2008-09 tax year.
One of the amendments applies for the 2008-09 and later income years. This amendment ensures that the death of one of the spouses in a husband and wife partnership where the other spouse inherits does not give rise to immediate tax consequences for the surviving spouse. This also applies when dissolution relates to the settlement of relationship property.
All other changes apply for the 2009-10 and later income years.
Tax consequences upon the death of a spouse or relationship property settlement
Section HG 4 has been amended for the 2008-09 and later income years to ensure that the death of one of the spouses in a husband and wife partnership does not give rise to immediate tax consequences when the surviving partner inherits from the deceased. In the absence of these rules, the partnership is treated as being dissolved where the partners are married, in a civil union or in a de facto relationship, and one partner dies leaving his or her interests to the other partner. Where the surviving partner inherits the deceased partner’s partnership interests there is a tax base rollover in respect of the deceased’s interests. However the partnership cessation rule treats the surviving partner as having disposed of and reacquired his or her partnership interests at market value for tax purposes. The amendment ensures that the rules that apply on the cessation of a partnership will not apply to a two-person partnership when the partners are married, in a civil union or in a de facto relationship, and one partner dies. A similar exemption has been provided in section HG 4 when the dissolution relates to the settlement of relationship property (for example, in the event of a divorce).
Disposal of partnership interests
Remedial amendments have been made to the general rollover relief formula. The definition of "gross tax value" in section HG 5(2)(c) has been amended by including assets whose sale or disposal does not have taxation consequences at their market value. Further, the treatment of assets, such as forestry, that have no carrying value for the purposes of the Income Tax Act 2007 has been clarified.
Section HG 3 has been amended to clarify the rules around the application of the $50,000 exemption in section HG 5 and its relationship with the exemptions in sections HG 6 to HG 10. Section HG 3 clarifies that when HG 5 applies, sections HG 6 to HG 10 cannot apply.
Section HG 4(2) and (3) has also been amended to remove the need to have all partnership disposals treated as being at market value.
Section HG 6(1) has been amended to clarify that "quantum of turnover" is measured for the immediately preceding partnership income year.
Amended section HG 10 provides that an incoming partner may elect to spread any difference between the price he or she paid for specified livestock that the partnership is valuing at cost when the partnership has breeding livestock.
The details for this spread are contained in new section EB 26B, which times the incoming partner’s valuation adjustment.
Section EB 26B provides that where an incoming partner has elected to spread the difference between the price he or she paid for the specified livestock and the partnership’s cost base carrying value of that livestock, then the spread shall be calculated as follows:
At the end of the income year that the incoming partner acquired the livestock:
- The partnership will perform its specified livestock cost calculations as if the partnership had not changed.
- To the extent the partnership is using a cost basis, the incoming partner will also calculate the value of specified livestock based on the price he or she paid.
- At the end of the next x years, the incoming partner may amortise on a straight line basis the difference between his or her calculation of the cost of livestock and share of the partnership calculation. (NB: x is 4 when the partnership change occurred before 2 July; x is 5 when the partnership change occurred on or after 2 July.)
- This applies only when the partnership continues to value the relevant specified livestock at cost.
Minor drafting and cross-referencing corrections
The reference to section HG 4 in section HG 4(4) has been replaced with section HG 5.
References to "small partnerships" in sections HG 5 to HG 9 have been deleted because sections HG 5 to HG 9 are elective under section HG 3(2).
References to "short-term agreements for the sale and purchase of property or services" in section HG 9 have been replaced by "short-term agreements for sale and purchase", to be consistent with the definition in section YA 1.
Sections CB 27B and DO 11B have been consequentially repealed.
Clarification of policy intent of aspects of the new partnership rules
Further clarification on the policy intent of aspects of the new partnership rules introduced by the Taxation (Limited Partnerships) Act 2008 are discussed below.
Variable profit sharing clauses
Some partnerships contain a "variable profit sharing clause". This allows one partner’s proportionate entitlement to income from the partnership to be different to his or her share in the partnership’s assets.
It is common in professional services firms such as accounting or law firms for each partner’s rights to the profit from the partnership to fluctuate from year to year based on their individual performance, but for each partner’s share of the partnership assets remains the same. For example, 10 partners in a firm each have a share of 10% in the assets of the firm. However, the partnership agreement may provide that their right to income from the partnership is partly dependent on an individual partner’s performance during that year. Therefore, a partner who performs particularly well may be allocated 12% of the partnership’s profits from that year and a partner who performs less well may be allocated 8% of the profits.
The intent of the partnership legislation is to allow a partner’s share in the income to be different from the partner’s share in the assets for tax purposes. The definition of "partnership share" in section YA 1 accordingly refers to the "relevant share that a partner has in the rights and obligations and other property…in a partnership".
Section HG 2(2) does not prevent this outcome. Rather, section HG 2(2) prevents streaming of income, tax credits, rebates, gains, expenditure or loss of the partnership to specific partners.
Non-resident partner’s partnership income
A question has been raised regarding whether a non-resident partner deriving what would otherwise be treated as foreign-sourced income through a New Zealand partnership would be brought within the New Zealand tax net merely because:
- the partnership is a New Zealand limited partnership formed and registered in New Zealand; or
- the general partner is a New Zealand tax resident or has a fixed establishment in New Zealand.
Partnerships, including limited partnerships, are transparent for the purposes of the Income Tax Act by virtue of subpart HG. Therefore, as has always been the case for general partnerships, the relevant question under the residence rules (sections YD 1 to YD 3) for a person who is a partner in a partnership, is whether the individual is New Zealand-resident. Likewise, under the source rules (sections YD 4 to YD 8), the question (when it arises) is whether that person carries on business through a fixed establishment in New Zealand. The answer to either question would depend on the facts of the particular case.
Definition of a person - income equalisation schemes
A question has been raised regarding whether partnerships are included for the purposes of the income equalisation scheme in sections EH 3 and EH 37, as those sections refer to a "person".
Under section OB 1 of the Income Tax Act 1994, it was clear that a person includes an unincorporated body of persons (which includes a partnership). Given that section 29 of the Interpretation Act 1999 provides the rule that a reference to "person" in legislation includes an unincorporated body, this was removed from section OB 1 as part of the rewrite of the Income Tax Act.