 This is Waylon Chow and welcome to Forms of Business Organization, Module 5, Part C. In this part, we will continue our examination of the partnership by looking at how a partnership is financed, the taxation of a partnership, and how a partnership is dissolved. Financing of a partnership comes from each of the partners. Each partner contributes capital, which can be cash or property that they already own. A partner to fund their capital contribution may draw from their personal assets or obtain a personal loan to fund their capital contribution. How is a general partnership tax? So remember the basic key legal aspect is that the owners and the business are one and the same. Or another way of saying it is that the partners and the partnership are not separate. They are one and the same. So because of that basic concept for tax purposes, what the way it works is that we first calculate the net income or net loss of the partnership. And then we allocate that net income or net loss to each partner based on their share of the net income or loss. What the amount of that share or the percent amount rather of that share is will be determined either under the Default Rules of the Partnerships Act or under some other split that's agreed to in a partnership agreement. And then, so the profit or loss is allocated to each partner. Each partner must report their share of the partnership income or loss as personal income in the year it is earned or incurred. So that has to be reported regardless of whether or not, let's say there was a net profit. If the profits are actually kept and reinvested in the partnership, it doesn't matter because remember the partnership and the partners are one and the same. So if the partnership had a profit that legally means that the partners personally earned and received that profit. So even if that profit is reinvested in the partnership, the individual partners still have to report their share of the profit in the year that the profit was earned. Lucy's lemonade in its first year, the lemonade stand made a profit of $200. And that profit was not paid out to the partners but was reinvested into the business. How is that profit taxed? Please pause the video at this point so you can consider that question. Even though the profit is not paid out to the partners, the profit is still allocated to Lucy and Marcy. So that means that Lucy must report business income of $150 on her personal income tax return and Marcy must report $50 of business income on her personal tax return. So remember that the partners in the partnership are considered to be one and the same for tax purposes. So even though the $200 profit was not paid out to the partners, it was kept within the partnership, within the business, it still has to be reported by each individual partner. Now what if the Lucy's lemonade partnership had a net loss of $200 instead of a net profit? How would that be reported? Please take a moment to pause this video so you can consider the question. So just as with a net profit, a net loss has to be allocated to each of the partners, Lucy and Marcy. And it has to be allocated based on their agreed split of the profits and losses, which was $75-25. So Lucy must report a business loss of $150 on her personal tax return. Marcy must report a business loss of $50 on her personal tax return. So the tax advantage of that is that those losses can be deducted against any other income that Lucy and Marcy have in that taxation year. So the net result could be that they pay less personal tax because of those business losses. When and how is a general partnership dissolved? A dissolved or dissolution is another way of saying killing the general partnership or getting rid of it or removing it. So under the default rules in the Partnerships Act, a partnership is automatically dissolved upon notice of one partner wanting dissolution. So what that means is that any one partner in a partnership, if the default rule applies, any one partner can say, I want to dissolve this partnership. That would be enough to trigger the dissolution of the partnership. Another trigger could be the death or bankruptcy of any one partner in a partnership. That could also trigger the dissolution of a partnership. Also, if a partnership was created for the purposes of completing just one project or there was a set expiry time for the partnership to end, then either the completion or expiry could trigger the dissolution. So these default rules can be overridden by a partnership agreement. So usually a partnership agreement would set out some different rules for the dissolution of the partnership because obviously you don't want giving one partner the power to dissolve the whole partnership. Also, you don't want the death of just one partner or the bankruptcy of just one partner to trigger the dissolution of the partnership. Now, if a dissolution is required, there are a number of steps that need to be taken. So essentially we are taking the assets of the partnership and we are liquidating them. We're selling them for cash. So we take whatever cash that we have from selling all the assets and we first apply them to pay the debts owed by the partnership to non-partners. So that could include suppliers and other debtors or creditors like a bank. Now the next people who get paid, if there's still money left over after paying the non-partners, is that we pay any debts owed to partners. So if the partners had loaned money to the partnership, then those loans would be repaid in that second step. Now if there's still money left over after steps one and two, then we can return any capital that was contributed by the partners. And then after that third step, if we still have money left over, we can pay any remaining assets to the partners based on whatever split they had agreed to in the partnership agreement. And if there was no, if the partnership agreement did not deal with that, then the default rule under the Partnerships Act is that capital is shared equally. So it would be split up equally between the partners. Now if under that first step where we have to pay the debts owed to non-partners, if the partnership assets are not enough to pay these non-partners, the partners are personally liable to pay the remaining debts and liabilities. Because remember, the big basic concept is that the owners and the business are one and the same, or the partners and the partnership are one and the same. So if the partnership assets are not enough to pay the debts of the partnership, then the partners themselves are personally liable to pay whatever debts and liabilities remain. Back at Lucy's lemonade, Lucy is very unhappy about working with Marcy. Lucy wants out of the partnership. Marcy and Lucy never discussed how the partnership could be terminated or dissolved. So what can Lucy do? Please pause the video so you can consider this question. What Lucy can do is that she can give notice to Marcy that she wants the partnership dissolved. There was no agreement on partnership dissolution, so therefore under the default rule in the Partnerships Act, any one partner can give notice to require the dissolution of the partnership. At Lucy's lemonade, Lucy decides not to dissolve the general partnership and work things out with Marcy. From then on, their business runs smoothly and becomes very successful. However, they need more capital to expand the business by adding another lemonade stand. You know, Mom is willing to invest in the business but does not have any time to get involved in the management. As well, Mom does not want to be exposed to any lawsuits like the one by Charlie. Remember, Charlie was the poor guy who drank the poisonous lemonade and had to be hospitalized. So what should Lucy and Marcy do? Please pause the video to take a moment to consider this question. So Lucy and Marcy can convert their general partnership into a limited partnership. The partnership would need to be registered under the Limited Partnerships Act in order to get that limited partnership status. The general partners of this new limited partnership would be Lucy and Marcy and Mom would be a limited partner. As a limited partner, Mom would be entitled to a share in the profits but cannot be involved in managing the business. So that's exactly what Mom wanted. Mom would also have limited liability in that all she can lose is the amount that she invests in the partnership. She would not be personally exposed to any of the liabilities of the partnership.