In South Africa (SA) a partnership is not a legal person distinct from the partners. Partners are liable for the debts of the partnership equally or as otherwise agreed. In this way, a partnership is different from a company: shareholders of a company are not liable for debts of the company.
Partnerships are also taxed differently to companies. The income and capital gains of a company are taxed in the hands of the company. A company also pays secondary tax on companies when it distributes amounts to shareholders.
But a partnership is not a "person" as defined in the Income Tax Act, No 58 of 1962 (ITA) and is not subject to tax. Instead, the partnership is "tax transparent". For income tax purposes, income and expenses of the partnership are deemed to be those of partners (section 24H of the ITA). For purposes of capital gains tax the proceeds on disposal of a partnership asset are deemed to have accrued to the partners (paragraph 36 of the Eighth Schedule to the ITA).
Some other countries, notably the United Kingdom, have created limited liability partnerships (LLPs) which are partnerships with legal personality separate from that of their members. However, although the LLPs are separate legal entities, the partners are still taxed in their own hands, like in SA.
Because of their legal nature, LLPs may be seen to be companies and not partnerships for purposes of SA tax law, so the partnership (and not the partners) may be subject to tax in SA. This may be lead to unfavourable tax treatment for LLPs who may then choose not to invest in SA.
The Taxation Laws Amendment Bill [B28-2010] (the Bill), when adopted, will change the way that LLPs - and other foreign partnerships - are taxed in SA. The proposed changes are in line with other changes contained in the Bill which seek to make SA more attractive for investors who wish to use SA as a regional base (see, for instance, the Media Statement issued by the National Treasury in relation to the draft Bill on 1 May 2010).
The Bill will introduce a definition of "foreign partnership" in the ITA. Simply put, a foreign partnership will be a partnership which is formed outside SA, the partners of which (and not the partnership) are subject to tax under the laws of the relevant country.
A foreign partnership will also be excluded from the definitions of "company" and "person".
Section 24H of the ITA will also be changed.
Practically, the effects of the proposed changes will be the following:
• Partnerships formed in other countries will not be subject to tax in SA, despite the fact that they may be LLPs.
• The partners of such partnerships will be subject to tax in SA (to the extent that they have taxable income or capital gains in SA).
• As foreign partnerships are no longer defined as companies for purposes of the ITA, they will not, for instance, be controlled foreign companies (CFCs) for purposes of section 9D of the ITA. Simply put, passive income of CFCs - being companies owned by SA tax residents as to more than 50% - is attributed to the SA tax resident shareholders. Compare the Binding Private Ruling (BPR 0061 dated 30 October 2009) in terms of which SARS ruled that a foreign limited partnership, incorporated in a foreign jurisdiction, was a "company" as defined in the ITA and, as such, constituted a CFC for purposes of section 9D of the ITA.
• As foreign partnerships are no longer defined as "persons" for purposes of the ITA, they will not, for instance, be "employers" as defined for purposes of employees' tax under the Fourth Schedule to the ITA.
• As pointed out in the Tax Alert of 27 August 2010, where a partnership (as opposed to the partners) is subject to tax in the foreign country, the partnership could still constitute a "company" and a "person" for purposes of the ITA.
The introduction of the concept of "foreign partnership" opens up interesting planning opportunities.
Written by: Ben Strauss, Director, Tax at Cliffe Dekker Hofmeyr