How partnerships are taxed
General rules for computing partnership income
Section 96 establishes the "flow-through" treatment of partnerships — partnerships compute income as if they were a separate person, then allocate each partner's share of income, losses, and tax credits to the partner's individual return.
Plain-language explanation
Section 96 governs the tax treatment of partnerships. Unlike corporations, partnerships are not themselves taxpayers — they are "flow-through" entities. The partnership computes its income as if it were a separate person, then the income (or loss) flows through to each partner.
Flow-through principle: The partnership files an information return (T5013) showing each partner's share of income, losses, capital gains, and tax credits. Each partner then includes their allocated share on their personal or corporate tax return. The character of income (business, capital, foreign) is determined at the partnership level and flows through unchanged.
Partners' share (s.96(1)): Each partner's income or loss from the partnership is their proportionate share based on the partnership agreement. Partners may have different ratios for different types of income.
Loss allocation: Partnership losses flow through to partners and can offset income from other sources (within the "at-risk" limits under s.96(2.1)). Tax shelters using partnership losses are restricted by the at-risk rules and REOP limitations.
Adjusted cost base of partnership interest (s.53): When you join a partnership, your ACB is your initial contribution. It increases with income allocations and additional contributions, and decreases with distributions and loss allocations. The ACB tracking is essential to avoid double taxation.
Example
Alice and Bob are 50/50 partners in a catering business. The partnership earns $120,000 in business income and has $20,000 in CCA. Net partnership income: $100,000. Alice and Bob each include $50,000 on their personal T1s as business income. They each report this on their T5013 slip.
Amendment history
Significant changes to this provision. Older versions help you understand rules that applied in prior tax years.
Character conversion rules and partnership straddle rules introduced to prevent financial institution partnerships from converting ordinary income to capital gains through loss-shifting strategies.
Common questions
Does a partnership pay income tax? +
No. A partnership is not a taxpayer and does not pay income tax directly. It files an information return (T5013). Each partner pays tax on their allocated share of partnership income. This is the key difference from a corporation.
What are the at-risk rules for limited partners? +
Under s.96(2.1)-(2.7), a limited partner can only deduct losses from the partnership up to their "at-risk amount" — essentially the amount they have actually invested (capital contributions minus distributions and guaranteed amounts). Losses above the at-risk amount are suspended and can only be used in future years against partnership income.
Key terms
Related sections
Source: Income Tax Act, RSC 1985, c. 1 (5th Supp.), section 96. — Read the official text on Justice Canada
These summaries are for educational purposes only and do not constitute legal or tax advice. Speak with a CPA for advice on your specific situation.