General and limited partnerships – proposed tax changes: a government discussion document
In June, the government published a discussion document proposing important reforms to the taxation of partnerships and the codification of some existing practices. The proposals have been released in anticipation of the introduction of a limited partnership regime. Rather than devising new laws which will apply exclusively to limited partnerships, the government has taken the initiative to clarify and modernise the tax treatment of partnerships generally.

The new rules will apply to general partnerships, limited partnerships and New Zealand resident partners of foreign general partnerships and certain foreign limited partnerships.

Existing special partnerships will be able to choose to apply the new rules or continue to apply the existing rules until their expiry or dissolution. It is expected that a special partnership will be able to register as a limited partnership, at which time the new tax rules will apply. The new rules will not apply to joint ventures.

Limited partnerships
The proposed limited partnership regime is intended to update the law applying to special partnerships and offer an internationally recognised investment vehicle that will encourage venture capital investment into New Zealand. A limited partnership will be a separate legal entity with the benefit of flow-through tax treatment. A limited partnership must have at least one general partner, who will have unlimited liability and will be responsible for management of the partnership, and at least one limited partner, whose liability will be capped at the amount of their capital contribution. Limited partners will be able to contribute to decisions of the partnership within set parameters without being regarded as taking part in the management of the business and losing their limited liability. The existing tax rules will need to be amended to ensure that the separate legal entity nature of a limited partnership does not result in it being taxed as a company.
A hybrid approach to taxation
The proposed reforms apply a hybrid approach to the taxation of partnerships, with the partnership being recognised as a separate entity for some purposes, such as the entry and exit of partners, and being ignored for others, such as the passing through of income or expenditure to the partners.

Income and expenditure will be treated as being derived by each partner from each source in proportion to their profit share. This proportionate allocation of income and costs prevents partnerships from streaming particular types of income to those partners who are best placed to receive it. For example, a partnership will not be able to allocate all of its foreign sourced income to a non-resident partner in order to escape taxation on that income in New Zealand.

It is proposed that partnership losses incurred by limited partners will be limited to ensure that the net tax losses claimed reflect the actual level of that limited partner’s economic loss in relation to the limited partnership interest. This will be achieved by limiting the tax loss available to the limited partner to the partner’s “basis” in the limited partnership. Two different formulae for calculating partner’s basis have been proposed, one which includes the partner’s share of realised capital gains and losses previously recognised and one that does not.

In summary, the partner’s basis will be equal to all contributions made to the partnership, including the value of guarantees and indemnities provided, plus the share of limited partnership income previously recognised, less the share of limited partnership loss previously recognised and less prior distributions. Any amount of loss that exceeds the limited partner’s basis will be disallowed in the income year and will be carried forward to future years. It is not clear how, if at all, this treatment of partnership losses fits in with the existing deferred deduction rule.

Exiting the partnership
The calculation of income and expenditure for new and exiting partners is considered in depth. In terms of taxing a partner on exit of a partnership, current practice has shown that in many cases an entity approach is adopted when there is no basis in law to do so. When a partner leaves a partnership, that departure legally constitutes the winding up of the partnership and the creation of a new partnership between the remaining partners. If the existing tax laws were applied to this legal form, the remaining partners would be deemed to have sold their interest in the partnership assets and reacquired them, with the result that a tax liability may be triggered for depreciation recovery or gains on revenue account property.

In practice, many partnerships ignore these rules and behave as if the partnership had continued. The proposals aim to clarify the appropriate tax treatment in order to regularise the prevailing practice and halt the widespread non-compliance that currently persists. Legal partnerships will need to review the proposals carefully – especially those partnerships which provide for a partner to be paid only capital contributed upon exit from the partnership.

Abolishing the QC and LAQC regimes
As part of these proposals, the government has floated the idea of abolishing the qualifying company (QC) and loss attributing qualifying company (LAQC) regimes. The government suggests that these entities will no longer be required when the limited partnership laws come into effect on the basis that limited partnerships provide limited liability and flow through tax treatment in a similar manner as qualifying companies.

This proposal will have ramifications for the large number of investors who currently hold their assets in a LAQC. In particular, in order to achieve limited liability, an investor will need to be a limited partner, in which case losses incurred through the partnership in excess of the capital contribution to the partnership will be ring-fenced against the income derived from the partnership and will not be available to offset against other income as is presently the case. Furthermore, the vast majority of investors who currently hold assets in a LAQC are unlikely to welcome the complex “partner’s basis” calculations that will be required annually under the limited partnership rules.

This article was written by Amber Vink, a senior associate in the tax team at Buddle Findlay in Auckland. Amber can be contacted by phone: +64-9-358 7026 or email: