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
N N
Sales Revenue
x
Less: Cost of Sales
(x)
Gross profit
X
Other incomes x
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
N N
Net profit
x
Add Interest on drawings: Partner A x
Partner
B x
x
x
Less Salary: Partner A x
Partner
B x
(x)
x
Less Interest on capital: Partner A x
Partner B x
(x)
Divisible profits X
Share of Profits: Partner A x
Partner B x
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
N N N N
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
N N N N
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
N N N
Assets Cost Depreciation Net Book Value
Non-current assets x (x) x
Long term investments x
Current Assets x
x
Total Assets X
Equity and
Liabilities
Capital
account Partner A x
Partner B x
x
Current
account
Partner A x
Partner B x
x
Non-current
liabilities x
Current
Liabilities x
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
6. Gratuities
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:
1st
N300,000 at 7%
Next
N300,000 at 11%
Next
N500,000 at 15%
Next
N500,000 at 19%
Next
N1,600,000 at 21%
Above
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
N N
Net profit or Loss
x
Add:
Non-allowable expenses xx
Unreported taxable income xx
x
Deduct:
Non-taxable income xx
Allowable expenses not
deducted xx
(x)
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.
Conclusion
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
