Overview of the Limited Partnership
It is quite common for businesses to be carried on though corporations. However, there are various other structures through which to carry on a business, including the often overlooked limited partnership. When starting a business with someone else, don’t just assume that incorporation is the way to go; consider whether a limited partnership would be better suited to your business investment. One key advantage of a partnership structure, for example, is that income and losses of the business are attributed to the partners for tax purposes, thereby avoiding double taxation of the profits of the business. Additionally, use of a limited partnership can provide limited liability to the partners, similar to the protection of shareholders in a corporate structure.
So What is a Limited Partnership?
Generally speaking, a partnership is a relationship between at least two persons carrying on a business in common with a view to profit. Each of the partners are fully responsible for all of the partnership’s liabilities. The terms of the relationship are usually set out in a partnership agreement.
A limited partnership is a special type of partnership governed by the Limited Partnership Act, which is comprised of one or more general partners and one or more limited partners.
The general partner of a limited partnership is charged with the management and operation of the business of the partnership, and has unlimited liability for all of the liabilities of the partnership. As such, usually the general partner has a very nominal partnership interest and has no other assets, so as to minimize the exposure to creditors.
Limited partners on the other hand do not take part in the management and operation of the business of the partnership and are only liable for the partnership’s liabilities to the extent of their contributions to the limited partnership and amounts they agree to contribute from time to time (including any partnership assets that they contribute). A limited partner who takes part in the control, management or operation of the business of the limited partnership, including signing any documents on behalf of the partnership in its capacity as a limited partner, is potentially exposed to unlimited liability.
How is a Limited Partnership Created?
Since the limited partnership is a statutory creation it is formed when a declaration is filed with the Registrar. The declaration must be signed by the general partner(s) desiring to form a limited partnership.
Every declaration expires five years after its date of filing unless the declaration is cancelled by filing a declaration of dissolution, or the declaration is replaced by filing a new declaration before the expiry date. It is therefore important for the general partner to be sure to refile the declaration before it expires.
While not mandatory, limited partnerships usually have agreements which govern the relationships between the partners.
Capital Contributions and Distributions of Income
The income and losses of the partnership are allocated to the partners pro rata to their partnership interests unless the partners otherwise agree. The partners’ respective responsibility to make capital contributions and their interests in the capital of the partnership are pro rata to their partnership interests unless the partners otherwise agree. It is usually agreed that the capital interest of a general partner is usually very nominal; for example, a small fraction of one percent (1%) of the partnership.
Partners only have the right to demand and receive distributions of income after all liabilities of the partnership have been paid.
Ownership of Property
Since a partnership is a contractual relationship rather than a separate legal entity, a partnership is not a taxpayer and so the partnership, per se, does not own the property of the partnership. Generally, the property of the limited partnership is owned by the general partner on behalf of the limited partnership and is registered as follows:
ABC as General Partner for the XYZ Limited Partnership
If a limited partner takes title to an asset of the partnership (for example real estate of the partnership) in its name, such partner risks exposure to unlimited liability.
Some Tax Considerations
There are multiple tax benefits to the partnership arrangement, including:
- property of the partners can be rolled into the partnership on a tax free basis by filing an election in accordance with the Income Tax Act of Canada;
- there is no taxation at the partnership level. Instead, the taxable income is calculated by the partnership and is allocated to the partners to be declared by them individually; and
- losses of the partnership flow through to the partners to be claimed against their individual taxable income and are not trapped in the partnership.
There are, however, limits on the amount of partnership losses that can be allocated to the partners; a limited partner cannot claim more than the aggregate of (i) the amount paid for its partnership interests (ii) the income received by such partner, and (iii) the amount of the liabilities of the partnership assumed by such partner.
Any losses which are not deducted by the limited partners may be carried forward to successive taxation years of the partners. The partnership year end must be December 31st.
As income is calculated on a partnership level, capital cost allowances can only be deducted at the rate determined by the partnership.
The limited partnership may incur indebtedness and borrow money from time to time. In that regard, subject to the partnership agreement, the general partner of the limited partnership has the authority to borrow and issue security on the property of the limited partnership and unless otherwise agreed, in the event of default the creditor can only look to the assets of the limited partnership, in addition to all of the assets of the general partner.
Dissolution of the Limited Partnership
There are certain events which trigger an automatic dissolution of the partnership, unless the parties agree otherwise. As such, it is best to set out in the partnership agreement how and when a partnership will be dissolved.
Should the partners wish to dissolve the limited partnership or should an event triggering the dissolution of the partnership occur, subject to the agreement, the general partner will be required to dispose of all of the assets of the limited partnership on commercially reasonable terms and pay all creditors before the dissolution of the partnership.
After all of liabilities have been paid and the remaining assets of the partnership have been distributed or after all of the limited partners cease to be limited partners, the limited partnership will be dissolved upon the filing of a declaration of dissolution with the Registrar.
Many business owners are uncomfortable with the sole proprietorship and partnership forms of business, because of the unlimited personal liability to which they can be exposed. However, use of a limited partnership may provide the answer to this problem. Properly operated by the general partner, a limited partnership offers limited liability for its limited partners, and numerous tax benefits. Allocations of profits and losses, and contributions of the partners can all be determined by agreement of the partners. As such, the limited partnership also provides economic flexibility. The protections, tax benefits and flexibilities of the limited partnership, may be sound reasons for you to use a limited partnership structure though which to operate, and, at the very least, should be considered when structuring the form of business ownership that’s right for your business.
© Morrison Brown Sosnovitch LLP, 2014. All rights reserved.