NATURE AND FORMATION OF A PARTNERSHIP

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CHAPTER 3 OPERATION OF A PARTNERSHIP

Introduction

The following transactions are typically encountered in the operation of a partnership:
Supplies from a partner to the partnership, whether as a contribution of capital, or as a third-party supplier.424
Supplies by the partnership, including supplies made by a partner acting on behalf of the partnership, to a third party.
Acquisitions by the partnership.
Distributions to partners, including profit and in specie distributions.
Private or domestic use of partnership property.
The supply of partners’ shares.425
The VAT implications of these transactions, which are not expressly provided for in the VAT Act, are discussed in this chapter, save for the supply of partners’ shares.

Supplies from a partner to the partnership

The nature of a partner’s supply

As stated above,426 a partner’s supply can be a contribution to the capital of the partnership. After the formation of the partnership, the agreed capital can, with the consent of all the partners, be added to or withdrawn at any time.427 The partner, on the basis of the partnership agreement,428 makes the contribution in his capacity as a partner. Where the partner, instead, makes the supply as a third-party
A partner acts as a third-party supplier where he makes a supply to the partnership, also referred to as a third-party supply, as part of a transaction that does not involve a capital contribution. See  supplier (eg, as an independent contractor) he acts in a non-partner capacity, as the supply is not made in terms of the partnership agreement.429 Strictly speaking, these supplies do not fall within the ambit of the partnership business as envisaged in the partnership agreement.430
I concluded in Chapter Two,431 that a partner’s contribution to the partnership may simultaneously serve as a supply as agent on behalf of the partnership, to a third party, and by carrying out that task, as an in-kind contribution of labour to the partnership. As an agent, the partner contracts an obligation in the name of the partnership.432 Where the partner acts as a third-party supplier, he is not an agent of the partnership, but incurs an obligation in his personal capacity. The partner’s actions would, consequently, not render the partnership liable.433
In my view, when a partner who is a vendor makes a contribution or a supply to the partnership as a third-party supplier, the supply will be subject to VAT at fifteen per cent, provided that all the requirements of section 7(1)(a) have been met.434 Most important, here, is that the supply must be made for a consideration.435 Should the partner act as an agent for the partnership, the partner is liable for any VAT on his supply of ‘agency’ or ‘representation’ services to the partnership, whilst the partnership is liable, through the partner as agent, for any VAT on the supply made to the third party.

The consideration for the partner’s supply

The value of a partner’s supply to the partnership is the amount of the consideration for such supply.436 Where the supply is made for no consideration, or for a consideration which is less than the open-market value of the supply, and the partnership is not exclusively involved in the making of taxable A supply by a partner to a partnership may also be zero-rated or exempt. A supply by a partner, who is a vendor, of an enterprise or of a part of an enterprise, which is capable of separate operation, is zero-rated subject to compliance with s 11(1)(e). A loan made by a registered partner to a partnership, which constitutes a ‘financial service’ as defined in s 2(1)(f), is exempt under s
supplies, section 10(4) could come into play and deem the consideration for the supply to be its open-market value.
Should the partnership make taxable supplies only, the value of the supplies made to the partnership is not really important. This is because the VAT levied on such supplies is, in any case, deductible as input tax. Where, however, the partnership does not make taxable supplies only, the value of the partners’ supplies matters as the VAT on those supplies is not fully deductible by the partnership.437

The distinction between consideration for a supply and profit distributions

In my opinion, it is important to distinguish between a payment made as consideration for a partner’s supply, and a distributive share in profits, whether the supply is a capital contribution or a third-party supply. If the payment is consideration, the supply will be subject to VAT if it is made in the course or furtherance of the partner’s enterprise. If, however, the payment is a profit distribution, it does not constitute consideration since, as I argue above,438 a partner’s share and any resultant profit distributions, are not reciprocally connected to a partner’s contribution. A profit distribution would also not be consideration for a third-party supply because that distribution is clearly the result of ownership of a partner’s share439 and not intended to constitute payment for a supply. If section 10(4) – in terms of which the consideration for the contribution is deemed to be its open-market value – does not apply, the value of the supply will, in terms of section 10(23), be deemed to be nil.
Even though the partnership is entitled to deduct any VAT levied as input tax where it applies the contribution or other acquisition for a taxable purpose, it is clearly administratively more burdensome for a partner to register for VAT and to account for output tax on the transaction. Consequently, a partner would be in a more favourable position if the payment for the supply were classified as a profit distribution, as a profit distribution would not constitute consideration for either a capital contribution or a third-party supply. I argue that the partners could be disposed to claim that a payment is a profit distribution, and not a consideration, in order to ‘shelter’ the supply from VAT.440 partner’s profit share in the partnership agreement, and the formula used to determine the respective shares may be complex or unusual.442
The next issue is how the nature of a payment to a partner can be determined where it is unclear from the terms of the partnership agreement whether the payment is a profit distribution or consideration. The fundamental object of interpreting a contact is to establish and give effect to the common intention of the parties. To do this, a court will have regard to the language used in the contract and the surrounding circumstances.443
In my view, the following indicators could be useful in determining the nature of a payment made to a partner.
A specific payment made by a partnership to a partner, in return for a supply to the partnership, is required to be made to the partner after the payment of partnership creditors, but before the division of net profits.444 I argue that if the payment is prioritised or sequenced in this way, it is indicative of the amount being a payment of consideration for the partner’s supply, rather than a profit distribution. A payment made for a supply, consequently, reduces the profits available for distribution.445
An obligation of a partnership to make payment with respect to a liability that is certain, irrespective whether there are profits or not,446 is, according to Burke, difficult to reconcile with the concept of a distributive share of partnership profits.447 These may take the form of fixed, periodical payments that do not fluctuate depending on the partnership’s net profits (eg, a fixed salary, although a partner cannot be employed by the partnership, or fixed interest payments).
The liability could well exceed the partnership’s profits at the end of an accounting year – for example, when profits are required to be distributed as agreed to in the partnership contract. If the amount or the fact of payment is, instead, contingent upon the entrepreneurial risks of the partnership business, and, accordingly, dependent on the partnership’s net profits, the payment, in all likelihood, constitutes profit share.448
Payments made to a partner in addition to his profit share, and which are based on the partner’s normal hourly rate for those types of service – or as Burke puts it, resemble the manner in which third parties compensate the partner – point to the payment of consideration.449 This reasoning would also apply to supplies of property in return for a related payment, without regard to the success of the partnership business. This type of transaction would more closely resemble a sale or an exchange, than a capital contribution that is placed at the disposal of the partnership and subjected to the risks of the business.450
The relative proximity in time between the supply and the payment, instead of the partner receiving payment when profit distributions are normally made, suggests a payment of consideration.451
In the case of a third-party supply, the partnership may withhold payment if the partner has not yet rendered performance, or if his performance is defective, by raising the defence of exceptio non adimpleti contractus against the partner.452 A partner, however, is entitled to his share in the profits whether or not his contribution is defective. If his contribution is not forthcoming or is defective, the partner can, by means of the pro socio, only be compelled to contribute what he has agreed to the partnership.453 The nature of the action available to the partnership against the partner is, therefore, a relevant consideration.
I believe that if the supply is a contribution, then it is more likely that the payment to the partner is a distribution of profits, since, as stated above,454 it is a naturale of the partnership agreement that a partner is not entitled to compensation for his contribution. As a result, save where the partners otherwise agree, a partner is not rewarded for his contribution. A partner is, therefore, not normally paid a consideration for his contribution, but rather receives payment in the nature of profit distributions.
If, however, as stated,455 a partner has performed special work beyond that performed by the other partners, and which was not envisaged as part of his duties under the partnership agreement, he is
Ibid at Location 2888. See also CRA GST/HST Policy Statement P-244 – Application of Sub-s 272.1(1) of the Excise Tax Act available at https://www.canada.ca/en/revenue- entitled to claim remuneration for his services. Consequently, a partner is normally paid a consideration for a third-party supply.
The partnership agreement might, however, not be clear on the nature of the supply.456 In my view, the following indicators could be useful in determining the nature of a partner’s supply, which could, in turn, be indicative of the nature of the partnership’s payment to the partner.
If the partner’s supply relates to the purpose of the partnership business, as specified in the partnership agreement, or, as Burke submits, the services are closely related to the partnership’s activities,457 it is more likely that the supply is a contribution and the payment a distributive share in the profits.458 The argument, in my view, is that the partner’s supply is intended to achieve the partnership’s objective, as opposed to the partner’s personal business objective.
That the partner is performing the activity not only for the partnership, but also for an enterprise which he carries on separately from the partnership, is indicative of a third-party supply.459
A partner is entitled to be reimbursed for expenses which he has incurred in connection with partnership affairs.460 Therefore, where a partner is reimbursed by the partnership for necessary expenses he has incurred in order to make the supply to the partnership, this suggests a contribution.461 As stated,462 when making a contribution of labour to the partnership, that contribution may simultaneously serve as a supply by the partner as agent on behalf of the partnership to a third party. In terms of the law of agency, a principal must reimburse the agent for all expenses reasonably and properly incurred in carrying out his mandate.463
A partner has the right to be indemnified for losses which he personally suffers whilst carrying on the partnership business. The risk of such losses must, however, be directly and inseparably linked to the carrying on of the partnership business.464 In accordance with agency law, a principal must, similarly, indemnify an agent for losses or liability incurred in the execution of his mandate.465 The partnership is, therefore, liable for the actions of the partner carried out within the course and scope of the partnership business.466 I argue that the existence of an obligation to indemnify a partner for losses resulting from his supply, points to the supply being a contribution.
A transaction effected by a partner with a third party as agent for the partnership, is binding as between the partnership, as principal, and the third party. The partnership is liable under the contract, and may consequently be sued by the third party, whilst no liability attaches to the partner under the transaction.467 I argue, therefore, that if the partnership, rather than the partner, can be sued under the contract with the third party, the partner’s supply is likely to be a contribution, in that he acted as agent for the partnership.
Clearly, the above indicators would not, singly, be decisive of the nature of a supply or payment. They must, however, be weighed together with all other relevant factors when determining the true intention of the parties.
There is no requirement that partners’ contributions must take the same form, be of equal value, or of the same quantity.468 Partners are also free to determine the amount of each partner’s share.469 Partners are, therefore, not required to share equally in the partnership profits. I stated470 that in the absence of an agreement regarding profit share, the profits are shared in proportion to the value of the partners’ respective contributions. Where the value of the individual contributions cannot be established, the profits are shared equally. In my opinion, inequalities in contributions or in profit sharing do not, in themselves, imply that the supply is in fact a third-party supply, or that the payment is a consideration in that such inequalities are perfectly normal in a partnership agreement.471

Supplies made by a partnership to third parties

The partnership’s supply of partnership property

I argue472 that a partnership can make supplies and acquisitions in view of its status as a person for VAT purposes. The property that will generally be supplied by the partnership, is property that forms part of, or is used in, its enterprise. A partner’s contribution, for example, must be placed at the disposal of the partnership473 and will, therefore, be used in the partnership’s enterprise.
All property used in the partnership is deemed to be partnership property if it is necessary for the proper functioning of the partnership business that the property should be a partnership asset.474 Whether property made available to the partnership constitutes partnership property, depends on the intention of the partners as established from the partnership agreement and the surrounding circumstances.475 Property can, therefore, be partnership property regardless of whether or not it is jointly owned by the partners.476 As stated,477 the establishment of a jointly-owned partnership fund is only a naturale of a partnership agreement. The question is, however, whether all partnership property, despite ownership, can be the subject of a supply made by the partnership.
In the New Zealand decision in Case S83,478 the objector – a father-and-son farming partnership – used farmland separately owned by each partner. A family company purchased the farmland from each partner. The Commissioner for Inland Revenue considered that the land had been sold in the course of the partnership’s taxable activity, and assessed the partnership for GST output tax on the respective sales by the partners to the family company.
The dispute in this case turned on the correct interpretation of section 57(2)(b) of the New Zealand GST Act, which provides that, “any supply of goods and services made in the course of carrying on that taxable activity shall be deemed for the purposes of this Act to be supplied by that body, and shall be deemed not to be made by any member of that body.”479
The Commissioner submitted that because the land formed part of the taxable activity of the partnership, the sale is deemed by section 57(2)(b) to have been made by the partnership rather than by the individual partners, and that this is so irrespective of whether the land is also partnership property under general law. It was submitted for the Commissioner, in the alternative, that if section 57(2)(b) cannot apply unless the land is partnership property, then the land in question was partnership property.480
The court held that section 57(2)(b) requires not only that the land be supplied in the course of carrying on the partnership’s taxable activity, but also that it be partnership property. According to the court, there was no compelling evidence that the partners supplied ownership of the land to the partnership.481 As a result, the court held that the land could not have been sold by the partnership because it did not own it. The land was, therefore, not sold in the course of carrying on the partnership’s taxable activity of farming.482 The court determined that in making the objector partnership’s GST assessment, the Commissioner had acted incorrectly by concluding both that the land was the objector partnership’s property used in its taxable activity, and that the supply of the land was made by the objector partnership. The objector partnership, accordingly, succeeded.483
In explaining the reason for its decision, the court stated that section 57(2)(b) cannot be taken to mean that the sale of land made in the course of a partnership’s taxable activity of farming, is deemed to be made by the partnership. The flaw, according to the court, is that in the absence of some clear deeming legislative provision, a person or partnership cannot supply what that person or partnership does not own. A supply which is not made by the partners, as partners, or for them, cannot be made in the course of carrying on the partnership’s taxable activity or as part of its termination.484 In my view, the collection of individuals constituting the partnership and acting in the course and scope of the partnership’s common purpose, must be supplying the ownership of the property in order for the partnership, as the deemed person, to be the supplier of such ownership. The interpretation of section 57(2)(b) in Case S83 was confirmed in Case S84485 and in CIR v Dormer and Anor.486
Considering that section 51(1)(a) deems the partnership to be carrying on the partnership’s enterprise, it is in my view similar to section 57(2)(b), as this provision in effect deems any supply of goods or services made in the course of carrying on that enterprise, to have been made by the partnership. That being so, I argue that the above New Zealand cases can provide guidance on the interpretation of section 51(1). As the two provisions have the same effect, section 51(1)(a) cannot also be taken to mean that the supply of property used in the partnership’s taxable activity, is necessarily deemed to be made by the partnership. As was held in the New Zealand cases, a partnership can only supply what it owns – subject, however, to section 18(4)(b), which is considered below.487
In Lewkowitz v Commissioner for Inland Revenue,488 the court referred to the following general principle489 to be applied when interpreting deeming provisions:
When a statute enacts that something shall be deemed to have been done, which in fact and in truth was not done, the Court is entitled and bound to ascertain for what purposes and between what persons the statutory fiction is to be resorted to.490
Considering, in addition, the purpose of section 51(1) of the VAT Act, in Case S84491 the court expressed the view that section 57(2) of the New Zealand GST Act was intended to apply to the day-to-day supplies to or from an unincorporated group (eg, a partnership) by making it clear that, where partners make or receive supplies, they are deemed to be doing so on behalf of the partnership. The court suggested that the aim of section 57(2) is to clarify that where people operate a partnership, they can register the partnership for GST purposes, and do not need to register each partner. Supplies in the course of the partnership’s activity, made by one or more partners, are deemed to have been made by the partnership and not by the partner. The same applies to inputs regarding supplies to a partner for the partnership. In the light of the meaning and purpose of section 57(2), it appeared to the court to be stretching the concept to submit that land owned by a partner is supplied by the partnership, just because the partnership was conducting an activity on it.492

CHAPTER 1: INTRODUCTION
1.1 INTRODUCTION
1.2 RESEARCH APPROACH
CHAPTER 2: NATURE AND FORMATION OF A PARTNERSHIP
2.1 INTRODUCTION
2.2 THE LEGAL NATURE OF PARTNERSHIP
2.3 THE EFFECT OF DEEMING A PARTNERSHIP TO BE A PERSON
2.4 THE IMPACT OF SECTION
2.5 DATE A PARTNERSHIP IS LIABLE TO REGISTER FOR VAT
2.6 THE VAT CONSEQUENCES OF A CONTRIBUTION TO A PARTNERSHIP
2.7 DEDUCTIONS RELATING TO CONTRIBUTIONS MADE TO THE PARTNERSHIP
2.8 THE ACQUSITION OF PARTNERS’ SHARES
2.9 THE DEDUCTIBILITY OF VAT ON PRE-FORMATION AND PRE-BUSINESS EXPENSES
2.10 SINGLE ENTITY SELLING A SHARE OF ITS BUSINESS
2.11 CONCLUSION
CHAPTER 3: OPERATION OF A PARTNERSHIP
3.1 INTRODUCTION
3.2 SUPPLIES FROM A PARTNER TO THE PARTNERSHIP
3.3 SUPPLIES MADE BY A PARTNERSHIP TO THIRD PARTIES
3.4 ACQUSITIONS MADE BY A PARTNERSHIP
3.5 DISTRIBUTIONS TO PARTNERS
3.6 PRIVATE OR DOMESTIC USE OF PARTNERSHIP PROPERTY
3.7 CONCLUSION
CHAPTER 4: THE TECHNICAL DISSOLUTION OF A PARTNERSHIP
4.1 INTRODUCTION
4.2 CAUSES OF DISSOLUTION
4.3 THE FORMATION OF A NEW PARTNERSHIP
4.4 THE TRANSFER AND ACQUISITION OF A PARTNER’S SHARE
4.5 THE ADMISSION OF A NEW PARTNER
4.6 THE DISSOLVED PARTNERSHIP CEASING TO BE A ‘PERSON’
4.7 THE DISSOLVED AND NEW PARTNERSHIP DEEMED TO BE ONE PERSON
4.8 THE SUPPLY OF A PARTNER’S SHARE
4.9 THE SUPPLY OF THE PARTNERSHIP ENTERPRISE AS A GOING CONCERN
4.10 THE TRANSFER OF LIABILITIES TO THE NEW PARTNERSHIP
4.11 THE DEDUCTION OF VAT ON COSTS INCURRED IN THE TRANSITION FROM THE DISSOLVED TO THE NEW PARTNERSHIP
4.12 GROUP RELIEF MEASURES
4.13 CONCLUSION
CHAPTER 5: GENERAL DISSOLUTION, LIQUIDATION, AND DISTRIBUTION
5.1 INTRODUCTION
5.2 GENERAL DISSOLUTION
5.3 LIQUIDATION AND DISTRIBUTION OF ASSETS
5.4 CONCLUSION
CHAPTER 6: PROPOSED AMENDMENTS
6.1 INTRODUCTION
6.2 GUIDING PRINCIPLES
6.3 THE VAT CONSEQUENCES OF PARTNER CONTRIBUTIONS
6.4 DEFINITION OF A PARTNER’S SHARE
6.5 GOODS OR SERVICES “APPLIED” BY THE PARTNERSHIP
6.6 PARTNERSHIP REIMBURSING PARTNER’S EXPENSES
6.7 DISTRIBUTIONS TO PARTNERS
6.8 TECHNICAL DISSOLUTION OF A PARTNERSHIP
6.9 THE DISSOLVED AND NEW PARTNERSHIP DEEMED TO BE ONE PERSON
6.10 THE DEDUCTION OF VAT PRE-FORMATION AND PRE-BUSINESS EXPENSES
6.11 CONCLUSION
CHAPTER 7: CONCLUSION
BIBLIOGRAPHY
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