What’s Your Tax Issue: “So-called” Partnership Income

The Tax Issue:

As a technical salesperson, I was part of a so-called partnership and I received distributions that I was told were not taxable because the partnership was operating at a loss. After a few months, I left the company because the so-called distributions were way below the so-called commissions I was supposed to be getting. In fact they barely covered my sales costs. The fast line is that I was assessed by CRA for unreported income which included penalties and interest. I had no idea of how the accounting was done and I have no history of not reporting my earnings. I am willing to pay the taxes on income but is there anyway to have penalties reduced.

The Answer:

This question raises a number of interesting issues. First, the taxation of partnerships. Without going into a 12-page dissertation, if you were, in truth, a member of a partnership, you would be taxed based on the partnership’s income, not on the distributions made to you.

When you add the words “so-called” to the partnership, it leads me to my next point. Documentation. If you enter into any business relationship, it must be properly documented and accounted for.  If the intention was to enter into a partnership, you should have signed an agreement, and you should have received annual statements indicating your share of the partnership income or loss for tax purposes.

If no partnership existed, then your earnings probably should should have been included in income based on what you received. If the CRA is including these amounts, and you have sales costs that you haven’t claimed, then you should indicate to the CRA that expenses should be deductible to reduce your income.

Finally, let’s talk about these so-called penalties. Unreported income in many cases indicates some level of negligence on the part of the taxpayer. However, in order to apply penalties, the CRA has the burden of proof to show than you were “grossly negligent”. Gross negligence involves intentional acting or an indifference as to whether the law followed. Your story seems to indicate a degree of naiveté, perhaps some negligence, but not necessarily gross negligence. You will have to show that you are credible, and if possible, some evidence that you at least had some reasonable cause to believe that this so-called partnership actually existed.

I would have a discussion with the CRA official and go over these issues, show your side of the story, indicating that you have expenses to claim against the income and show that you were not negligent in believing that you were a member of a partnership.

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