In Deputy Commissioner of Taxation v O'Donoghue  WASC 153, the WA Supreme Court was tasked with determining whether a partnership existed between the defendant and his former business associate - and, if it did, whether the ATO could pursue the defendant for the partnership's tax debts.
Definition of "partnership"
The rules governing partnerships are found in state-specific legislation and a large body of case law.
Put simply, a "general law partnership" exists when people agree to carry on a business together. This agreement may be express or implied, formal or informal. The conduct of the parties after the date of the agreement will also help determine whether the parties came to a binding agreement.
On the other hand, a "tax law partnership" has a slightly broader definition and includes an association of persons in receipt of income jointly. Therefore, a tax law partnership could exist where, for example, two or more persons are the joint owners of an investment property.
Under Australia's tax regime, a partnership will include both a general law partnership and a tax law partnership.
As partners will be jointly and severally liable to pay any amount of income tax or indirect tax owed by the partnership, disputes as to the existence of said partnership can arise when one or both partners prove reluctant to pay the bill. In such disputes, whether a partnership ever existed can become a point of contention, with high-stakes consequences.
What happened in O'Donoghue?
In O'Donoghue, the ATO held a judgment against Mr Jacobs for a running balance account (RBA) debt recorded against an alleged partnership with the defendant. The ATO pursued the defendant for those debts. The defendant argued that he was an employee of Mr Jacob's business, and not his business partner, so wasn't liable for the RBA debt (or alternatively, that the partnership had been dissolved).
Ultimately, the Court found that a partnership had existed between the defendant and Mr Jacobs noting:
- the fact that Mr Jacobs attended to the management of the business, with Mr O'Donoghue contributing his labour, and there was a profit split of 60/40 in Mr Jacobs' favour;
- an ABN application form which indicated Mr Jacobs and the defendant were in a partnership;
- that the defendant and Mr Jacobs had an oral agreement to start a business and operate it as partners;
- admissions by Mr Jacobs in a pleading that he was carrying on business in partnership;
- that the defendant and Mr Jacobs had seen a business adviser together and had both signed the bank account authority cards;
- business records which indicated the business paid its employees in a different manner to the defendant; and
- the defendant's personal income tax return, which declared partnership distributions but not employment income.
The absence of a partnership agreement and the defendant's lack of financial contribution to the business were not sufficient to displace the existence of the partnership.
The Court dismissed an argument by the defendant that he could not be pursued for the RBA debt because the judgment against Mr Jacobs had converted it to a "secondary tax debt" within the meaning of section 8AAZA of the Taxation Administration Act 1953 (Cth). The Court found that the defendant's liability to pay the RBA debt arose directly under a taxation law and was therefore a primary tax debt for which the defendant was also liable.
Partnership or not: determining factors
While partnerships are useful and efficient vehicles for conducting a business, when set up or maintained incorrectly, the tax consequences can be significant. Where parties come under the scrutiny of the courts, they may find it difficult to prove the existence or absence of a partnership.
When establishing or maintaining a partnership arrangement, it is important for parties to be aware of the following indicators of whether a partnership exists at law or not:
- the mutual assent and intention of the parties
- joint ownership of business assets
- registration of a business name
- joint business account and the power to operate it
- involvement in the conduct of the business
- extent of capital contributions
- entitlements to a share of net profits
- business records
- where one party has sole power to operate the bank account, and assets are all in one name
- vague agreements, or agreements which make no provision for the contribution of capital or rendering of services
- lack of partnership correspondence, records of meetings of income tax returns
- where the business is not conducted consistently with the deed of partnership