Limited partnerships - liability of limited partners for partnership tax liabilities

Executive summary

A recent court decision has made clear that limited partners of a limited partnership (LP) are liable for certain tax liabilities of the LP. This article briefly discusses the decision and implications for limited partners.

In summary:

• Liability of limited partners in respect of partnership tax liabilities applies only to liabilities under Schedule 1 to the Taxation Administration Act 1953 (Cth) (TAA) (e.g. PAYG withholding liabilities), indirect tax liabilities (e.g. GST) and liabilities for minerals resource rent tax (MRRT).
• Limited partners of an LP that is taxed as a company for income tax purposes are not liable for income tax liabilities of the LP or PAYG instalment liabilities in respect such income tax (but partners of a partnership that is treated as a flow-through entity for income tax purposes are subject to income tax in respect of their share of the partnership income and gains).

The recent decision in DCT v McGuire

On 11 March 2013 the Supreme Court of NSW (Gzell J) handed down its decision in Deputy Commissioner of Taxation v McGuire [2013] NSWSC 184 (McGuire), holding that the 2 defendants (Taxpayers), being individuals who were limited partners of a limited partnership (LP), were personally liable for certain tax liabilities of the LP, which was an unincorporated LP under the Partnership Act 1892 (NSW) (Partnership Act). The relevant liabilities related to:

• unremitted pay-as-you-go (PAYG) withholding amounts from wages etc. paid to employees of the LP under Schedule 1 to the TAA (Schedule 1);
• goods and services tax (GST); and
• general interest charge (GIC) in respect of the above.

The Commissioner of Taxation (Commissioner) had allocated the liabilities to the running balance account (RBA) of each Taxpayer under s 8AAZC of the TAA and sought judgement against each of the Taxpayers for the resulting RBA debts.

The Taxpayers submitted that the liabilities were liabilities of the LP under s 60 of the Partnership Act and, as limited partners, they were only liable to contribute to that liability to the extent of the amount shown against their names in the partnership register (i.e. $5 each).

Gzell J rejected this submission and held that each partner was jointly and severally liable for the obligations of the LP in relation to PAYG withholding amounts imposed under Schedule 1 to the TAA and in relation to GST imposed under the GST Act, pursuant to s 444-30 of Schedule 1 to the TAA.

Subsection 444-30(1) provides that obligations imposed on a 'partnership' under Schedule 1, the 'MRRT law' or an 'indirect tax law' (i.e. GST, wine tax, luxury car tax and fuel tax) are imposed on each partner and may be discharged by any of the partners, while s 444-30(2) provides that the partners are jointly and severally liable to pay any amount that is payable under Schedule 1, the MRRT law or an indirect tax law. 'Partnership' is defined to include both a general law partnership and persons in receipt of income jointly, as well as a 'limited partnership', which in turn is defined as a partnership where the liability of at least one of the partners is limited, as well as certain venture capital entities (namely a VCLP, ESVCLP, AFOF or a VCMP).¹ Under current law, any entity (other than a VCLP, ESVCLP, AFOF or VCMP) that is legally a body corporate would be a 'company' under the ITAA and would not be a 'limited partnership'.²

His Honour held that s 444-30 creates liabilities directly upon the partners and their liability is not to contribute to liabilities already incurred by any or all of the partners to which they are called upon to contribute under s 60 of the Partnership Act.

Thus, his Honour held that the liabilities in question were not imposed upon the general partner of the LP, with a right to call on the Taxpayers as limited partners but rather were, by force of s 444-30, imposed upon them directly.  Accordingly, s 60(1) of the Partnership Act did not limit the liability of the Taxpayers in relation to the RBA deficit amount and GIC and the Taxpayers' defence to the Deputy Commissioner's claim therefore failed.

Can limited partners be liable for income tax of the LP?

Under Division 5A of Part III of the ITAA 1936, a 'corporate limited partnership' (i.e. an LP other than a VCLP, ESVCLP, AFOF, VCMP or certain LPs formed before 19 August 1992) is treated (under s 94J) as if it were a company for the purposes of the 'income tax law', which is defined in s 94B to mean the ITAA, any Act that imposes any tax payable under the ITAA, any provision of the TAA relating to the ITAA and any provision of other Acts, and any Regulations, that relate to any of the foregoing Acts.

In short, under Division 5A, a limited partnership is treated for income tax purposes as if it were a company rather than a partnership and the partners are treated as if they were shareholders rather than as partners.  Thus, income tax is a liability of the LP (as if it were a corporate taxpayer) and not of the partners.

Under s 94K, a reference in the income tax law to a 'partnership' does not include a reference to a limited partnership to which Division 5A applies.

As noted above, s 444-30 of Schedule 1 to the TAA (on which the decision in McGuire was based) applies only in relation to liabilities arising under Schedule 1, the MRRT law or an indirect tax law and therefore does not apply to income tax payable under the ITAA.  Further, notwithstanding that s 444-30 applies to liabilities under Schedule 1, it does not apply to PAYG instalment liabilities under Division 45 of Schedule 1, on the basis that, pursuant to s 94K of the ITAA, the reference to a 'partnership' in s 444-30 excludes a limited partnership for the purpose of applying s 440-30 to PAYG instalments of income tax (on the basis that Division 45 is an 'income tax law' as defined in s 94B).

Accordingly, while limited partners can (as confirmed by McGuire) be liable for certain tax liabilities of the partnership, such as PAYG withholding amounts and GST (as in McGuire), other indirect taxes, other liabilities under Schedule 1 and MRRT, they will not be liable for the partnership's liabilities for income tax or PAYG instalments in relation to income tax.

However, it should be noted that, in the case of a partnership that is not a corporate limited partnership under Division 5A and is therefore subject to 'flow-through taxation' (such as a non-limited partnership or a VCLP, ESVCLP, AFOF or VCMP³), the partnership itself is not liable for income tax in respect of the income and gains of the partnership.  Rather, each partner is taxable on their share of such partnership income and gains (and is entitled to deduct their share of any partnership loss), in accordance with the partner's own tax status.⁴ Some partners may be entitled to tax exemptions in respect of their share of the partnership income or gains (e.g. certain foreign investors in respect of 'eligible venture capital investments' through a VCLP, ESVCLP or AFOF or, in some cases, made directly).

Further, non-residents are not subject to Australian tax on capital gains in respect of assets that are not 'taxable Australian property' (essentially, Australian real property and mining interests, non-portfolio interests in entities that the majority of whose assets are Australian real property and mining interests and assets used in carrying on business at or through a permanent establishment in Australia).