Thursday, 13 September 2018 16:29
Taxation of Partners and Partnerships in Nigeria
Partnerships are not taxed in Nigeria, partners are. Nonetheless, partnership arrangements affect the computation of tax liability of the partners. Taxation of Partners is governed by the Personal Income Tax Act (PITA). Under the Act, partners are taxed as individuals with chargeable incomes derived from the partnership and other sources. To determine partners’ tax liabilities, the partnership income is first computed and then distributed to the partners in whose hands the income is subjected to tax.
Understanding the meaning and nature of partnerships as well as the financial relationship between partners will prepare the ground for understanding how partners are taxed in Nigeria.
What is a Partnership?
A Partnership is a business arrangement where 2 or more individuals or entities pool resources to run a business and agree to share the profits and losses of the business. By the Partnership Act 1890, a partnership is “the relation which subsists between persons carrying on a business in common with a view of profit.”
The nature of Partnerships in Nigeria
Partnership is governed by the Partnership Act 1890–a statute of general application; the Partnership Law of Former Western Region 1958 (now Lagos, Osun, Ogun, Ondo, Oyo, Edo, and Delta); and Partnership Law of Lagos State 2009. The Partnership Law of Former Western Region 1958 “is virtually a reproduction of the English Statute” but for the provisions on limited partnership in the 1958 Law. Lagos State in its Partnership Law 2009 went a step further than the 1958 law by including provisions on Limited Liability Partnerships.
From these laws, three expressions of partnerships are recognized; general partnerships, limited partnerships, and limited liability partnerships. These arrangements are identified by the extent of liability undertaken by partners in the partnership.
1. General Partnerships
General partnerships impute unlimited liability on all the partners. All partners are liable for the debt and obligations of the firm during the partnership, and even after death, a partner’s estate will be liable for any unsatisfied debts. In absence of contrary evidence, all partnerships are deemed to be general partnerships.
2. Limited Partnerships
Limited partnerships allow some partners in a partnership to limit their liabilities to their contribution or agreed contribution to the firm. Under this arrangement, at least one partner must be a general partner with unlimited liability towards the partnership. If a limited partnership doing business in Lagos is not registered it is deemed to be a general partnership. Registered limited partnerships insert “LP” behind their name.
3. Limited Liability Partnerships
Under limited liability Partnerships, the liabilities of partners are limited to the contributions they make or agree to make to the partnership as capital. Limited liability partnerships confer a separate identity different from the partners, so the firm can sue and be sued in its own name. Limited liability partnership is the only partnership arrangement that confers a separate legal identity on the firm. General partnerships and limited partnerships do not have identities separate from the partners.
The nature of a partnership arrangement is recognized from the terms in the Partnership Agreement. In the absence of a Partnership Agreement, the partnership is deemed to be a general partnership.
The Partnership Agreement usually covers: names and addresses of the firm and the partners; business nature; duration of the partnership; capital contribution of each partner; interest rate on capital contributions; sharing ratio of profit and losses; rate of interest on partner’s drawings; salary or commission of partners; interest on loans to partners; mode of admission and retirement of partners; method of calculating goodwill of partners; method of treating premiums on partners’ life insurance; how proceeds are shared among the Partners; arbitration clause; method of dissolution; and so on.
A certified copy of the partnership deed is required to be registered with the tax authority within 30 days of execution.
How do Partners relate financially?
A partnership like any other business arrangement is profit oriented. Necessarily, all partners are concerned with the management of the business, in terms of the income and expenses, as well as profits and losses.
The financial statements for the accounting year are prepared like that of a sole trader with the addition of an Appropriation Account, a Capital Account, and a Current Account. The Statement of profit or loss and other comprehensive income and Statement of Financial Position are the statements prepared for a sole trader. The Appropriation Account shows how profits or losses are shared between the partners, that is, what share each partner is entitled to receive from the partnership in that accounting year. The Capital and Current Accounts on the other hand are used to determine the stake of each partner in the partnership; the balances in these accounts are used in preparing the Statement of Financial position.
1. Statement of Profit or Loss and other Comprehensive Income
The statement of Profit and loss is used to determine the net profit or loss to be shared between the partners.
Format for Statement of Profit and Loss
Sales Revenue x
Less: Cost of Sales (x)
Gross profit X
Other incomes x
Less: Administrative expenses (x)
Distribution costs (x)
Finance Costs (x)
Net profit X
2. The Appropriation Account
The Appropriation Account shows how the net profit or loss is shared between the partners. It shows the share of profit or loss each partner is entitled to receive from the Partnership that accounting year.
Format for Appropriation Account
Net profit x
Add Interest on drawings: Partner A x
Partner B x
Less Salary: Partner A x
Partner B x
Less Interest on capital: Partner A x
Partner B x
Divisible profits X
Share of Profits: Partner A x
Partner B x
3. Capital and Current Accounts
The Capital and Current Accounts are used to determine the stake of each partner in the partnership. The Capital Account contains the capital introduced or withdrawn permanently by the partners. The Current Account contains transactions relating to drawings, interest on capital or drawings, salary or commission to the partners, and share of profit or loss.
Format for Capital Account of the Partners
Particulars A B Particulars A B
Drawings from Capital x x Balance b/d x x
Balance c/d x x Additional capital x x
x x x x
Balance b/d x x
Format for Current Account of the Partners
Particulars A B Particulars A B
Drawings x x Balance b/d x x
Interests on Drawings x x Salary x x
Balance c/d x x Interest on Capital x x
Interest on Loans x x
Share of Profits x x
x x x x
Balance b/d x x
4. Statement of Financial Position
“Statement of Financial Position is prepared to ascertain the financial position of the business entity at the end of the reporting period.”
Format for Statement of Financial Position
Assets Cost Depreciation Net Book Value
Non-current assets x (x) x
Long term investments x
Current Assets x
Total Assets X
Equity and Liabilities
Capital account Partner A x
Partner B x
Current account Partner A x
Partner B x
Non-current liabilities x
Current Liabilities x
How are partners taxed?
A Partner is liable to pay tax in the State the partner was resident during the assessment year. Partners are taxed on a preceding year basis; a partner’s is to file tax returns within 90 days of the end of the fiscal year, that is, by 31 March.
Under tax laws, Partnerships are viewed as a combination of two or more sole traders, and partnership income to be distributed between the partners is determined using principles applicable to sole traders. “The Partners are assessed in their individual names, based on the share of partnership profits allocated to them.”
Because partnerships are based on profit and loss sharing, all income received by a partner are viewed as the partners share of the partnership profit or loss. A partner’s income from the partnership is calculated as the sum of any remuneration; interest on capital; cost of leave or recreation passages to or from Nigeria charged to the Partnership account in respect of that partner; and share of the income left after deducting the 3 items above from the partnership income. In other words, the income of a partner derived from the partnership is calculated by summing up;
1. Salary or commission paid to the partner;
2. Interest on capital invested in the partnership by the partner;
3. Leave or recreational passages enjoyed by the partner and charged to the partnership account; and
4. Share of profit or losses of the partner.
To determine share of profits accruable to a partner, the net profit or loss of the partnership must be adjusted. An Adjustment is made by adding back to the net profit or loss all disallowable expenses and unreported taxable income under PITA while deducting from the net profit or loss all reported non-taxable incomes and allowable expenses under PITA. The adjusted profit or loss of the partnership is then split between the partners according to the agreed ratio.
All expenses disallowed under PITA from being deducted when calculating the net profit are disallowable expenses. They are; domestic or private expenses; capital withdrawn; loss recoverable under insurance; rent or cost of repair of premises not used in producing income; taxes on income or profits levied in Nigeria or elsewhere(with exception); payment to pension, provident, savings, widows, or orphan’s fund not approved by the Joint Tax Board (JTB); depreciation; sum reserved out of profits (except bad and doubtful debts that have become due and payable; expenses incurred to earn management fee without Minister’s approval of the agreement; and expenses incurred as management fee without the Minister’s approval of the agreement.
All incomes chargeable to tax under PITA are taxable incomes, some of which may not have been reported in calculating the net profit. They are; gain or profits from the business; gain, profit or premium arising from business property; interest, dividend, or discount; charge or annuity; any other profit, gain, or payment to the business.
Non-taxable incomes of the Partnership may have been reported in calculating the Partnership Income. They include; profit on disposal of a fixed asset; profit on disposal of an investment; and income received to cover a disallowed expense.
Allowable expenses are expenses that should be deducted before arriving at the net profit of the partnership. They include; interest on loan used for business; interest on loan used to develop residential house for a partner; rent and premiums on land or building used for business; expenses for repair, renewal, or alteration of premises, plant, machinery, or fixtures used for business; bad debts due and payable during the assessment year; contribution, abatement, or pension of a public officer under an approved scheme; pension, provident, or retirement benefit, fund or society approved by the JTB; expenses incurred wholly and exclusively for the business; expenses proved to be incurred for research including levy paid under the National Agency for Science and Engineering Infrastructure Act.
By adding back all disallowable expenses and unreported taxable income and deducting all reported non-taxable incomes and allowable expenses from the net profit determined in the Statement of Profit or Loss and other comprehensive income, the adjusted profit or loss of the partnership is determined.
The adjusted profit is split between the partners, first by distributing all incomes received from the partnership to partners (salaries or commissions, interests on capital, leave allowance, and other expenses charged by the partners to the partnership account) and second, by distributing the remainder of the adjusted profit or loss according to the agreed sharing ratio. Each partner’s total income is then treated for losses and capital allowances to arrive at the assessable partnership income for each partner.
Treatment of losses and capital allowances
“If the Partnership makes a loss, and consequently any of the partners make a loss, the loss can be relieved against the next year.” The loss is carried forward and relieved from the partner’s total partnership income in the next year. “But if the partnership makes a profit and a partner makes a loss, the loss cannot be relieved against the next year.”
Capital allowances are calculated under the PITA. Where a partnership has capital allowance to be claimed, it is usually shared in the profit ratio and relieve against each partners income.
Determining a partner’s tax liability
The partner’s incomes from the partnership is added to the partner’s income from other sources to arrive at the partner’s total income. The partner’s total income is then treated with the reliefs and deductions available under PITA. They are:
1. Consolidated relief allowance: This is the addition of the higher of N200,000 or 1% of partner’s gross income plus 20% of gross income.
2. National Housing Fund contribution
3. National Health Insurance Scheme
4. Life Assurance Premium
5. National Pension Scheme
7. Child allowance: This is “
N2, 500 for each child up to a maximum of four children, provided that none is above 16 years or married. However, a relief can be granted for a child over 16 years if the child is in a recognised school, under artisanship or learning a trade.”
8. Dependent Relative allowance: This is “
N2,000 for each dependent relative up to a maximum of two relatives who are widowed or infirm”
After deducting all applicable reliefs and allowances, the income left is the chargeable income of the partner. The chargeable income is taxed using the tax rates in the 6th schedule of PITA, thus:
N300,000 at 7%
N300,000 at 11%
N500,000 at 15%
N500,000 at 19%
N1,600,000 at 21%
N3,200,000 at 24%
Once the tax rates are applied, a partner’s tax liability for the year is determined.
Steps for computing a partner’s tax liability.
1. Identify net profit or loss of partnership.
2. Add all non-allowable expenses and unreported taxable income.
3. Deduct non-taxable income and allowable expenses not deducted.
4. Step 1-3 would give the adjusted profit or loss.
5. Deduct all private expenses and money given to each partner from the partnership profit and distribute to each partners account as income received from partnership.
6. Share the remaining adjusted profit between the partners in the profit and loss sharing formula.
7. Deduct loss carried over by each partner from the result of steps 5 and 6.
8. Deduct each partner’s share of the capital allowance for the partnership.
9. Result of steps 5 to 8 is the earned income from partnership.
10. Add income from other sources received by each partner.
11. Deduct consolidated relief allowance and other allowable deductions for individuals.
12. The result is the chargeable income per partner
13. Apply the tax rate to this income.
Format for computing partner’s tax liability
Net profit or Loss x
Non-allowable expenses xx
Unreported taxable income xx
Non-taxable income xx
Allowable expenses not deducted xx
Adjusted profit X
Total A B C
Adjusted profit xx
Share of profits: (xx) xx xx xx
(Salaries, Interest on capital
Leave allowance, sharing ratio)
Losses b/f xx
Losses relieved (xx) (x) (x) (x)
Losses c/f xx
Capital Allowance xx
Capital Allowance relieved (xx) (x) (x) (x)
Income from partnership X X X
Other earned income x x x
Total Earned Income x x x
Unearned Income x x x
Statutory total income X X X
Deduct allowances and reliefs (x) (x) (x)
(Consolidated relief Allowance, NHF, Pension etc)
Chargeable Income X X X
Apply tax rate to Chargeable Income.
Although partners and not partnerships are taxed in Nigeria, taxing partners cannot be achieved without identifying the income the partnership brings to the table. Understanding the nature and terms of the partnership is key to determining the tax liability of partners. Once the partnership income is recognized and shared properly, partners are treated similarly with other individuals under PITA.
By Ololade Tinuola Olukowi
By Ololade Tinuola Olukowi
Published in Blog