Partnerships and Income Allocation Rules

Introduction
Understanding partnerships and income allocation rules is essential for entrepreneurs, consultants, professionals, real estate investors and family-owned businesses operating as partnerships in Canada. Partnerships offer flexibility, shared ownership, lower administrative burden and the ability to combine expertise and financial resources. However, because partnerships are flow-through entities, the income, losses, deductions and credits do not stay in the partnership—they flow directly to the partners. Canada’s tax rules for partnerships are complex and require proper tracking, documentation and allocation to avoid CRA or Revenu Québec reassessments. This guide explains the legal framework, income-allocation rules, documentation requirements and common issues related to partnerships and income allocation rules.

Legal and Regulatory Framework
Partnerships and income allocation rules are governed by the Income Tax Act, Québec’s Taxation Act, and provincial partnership laws such as Québec’s Civil Code. A partnership:

• is not a separate taxpayer under Canadian law
• files an information return (T5013) if revenues exceed certain thresholds
• allocates all income or losses to partners based on the partnership agreement
• requires each partner to report their share on their personal or corporate tax return

Income allocation depends on the partnership agreement and may include:

• profit-sharing ratios
• capital contributions
• workload or time spent
• special allocations based on services, assets, or investment

Income can be allocated to individual partners, corporations, trusts or holding companies. Québec requires separate RL-15 slips for provincial allocation. Understanding partnerships and income allocation rules ensures compliance with both CRA and Revenu Québec.

Key Court Decisions
Courts have ruled extensively on partnerships and income allocation rules. Key rulings include:

• partnership agreements must clearly outline allocation percentages
• courts reject allocations that are artificial, unreasonable or lack business purpose
• income must be allocated according to the partnership agreement—even if partners disagree
• undocumented partnerships risk reassessment because CRA may impose default rules
• losses allocated to limited partners may be restricted
• income cannot be allocated solely for tax avoidance

In Québec, courts emphasize that a partnership is a contractual relationship requiring clear terms, transparency and consistent reporting. These rulings demonstrate the importance of properly structuring partnerships and income allocation rules.

Why CRA Targets This Issue
CRA and Revenu Québec closely monitor partnerships and income allocation rules because:

• income splitting is common
• partners may allocate losses improperly
• undocumented agreements create tax ambiguity
• partnerships often mix personal and business expenses
• high-risk industries (real estate, professional firms, contractors) use partnerships heavily

Audits are often triggered by:

• large losses allocated to one partner
• sudden changes in allocation ratios
• inconsistent reporting between partners
• missing T5013/RL-15 slips
• partnerships with related-party partners (e.g., spouses)
• GST/HST/QST mismatches

Understanding partnerships and income allocation rules helps businesses avoid audit exposure.

Mackisen Strategy
Mackisen CPA provides a comprehensive strategy for partnerships and income allocation rules:

• drafting or reviewing partnership agreements for tax clarity
• determining accurate profit-sharing ratios
• creating partner schedules (capital accounts, allocation summaries)
• preparing T5013 partnership information returns
• preparing Québec RL-15 allocations
• separating business expenses clearly from personal transactions
• confirming eligibility for loss allocations (especially for limited partners)
• ensuring GST/HST and QST reporting aligns with partnership structure
• advising on corporate partner structures (Opco/Holdco partnerships)
• planning distributions and withdrawals to avoid taxable benefits

Our proactive approach ensures full compliance with federal and Québec partnership taxation.

Real Client Experience
Many clients come to Mackisen after issues arise with partnerships and income allocation rules. One pair of consultants split income 50/50 but had no written partnership agreement. CRA questioned the allocation. Mackisen drafted a formal agreement and corrected prior filings.

A real estate partnership allocated 100% of losses to one partner, causing CRA to disallow deductions. We restructured the allocation and prepared a defensible filing package.

A Québec-based partnership failed to file RL-15 slips for two years. Revenu Québec issued penalties. Mackisen filed all outstanding slips and negotiated reductions.

A family-run partnership misallocated income to a lower-income spouse without respecting labour contributions or business purpose. We corrected allocations and avoided TOSI implications.

These examples show why proper management of partnerships and income allocation rules is essential.

Common Questions
Partnership clients frequently ask:

• Do partnerships pay tax?
No—partners pay tax personally or corporately.

• Is a written partnership agreement required?
Not legally, but strongly recommended to avoid CRA disputes.

• Can partners allocate income however they want?
Only if the allocation matches the partnership agreement and has economic substance.

• Do partnerships need T5013 filings?
Yes, if revenue exceeds $2 million, assets exceed $5 million, or the partnership includes a corporation.

• Do Québec partnerships file differently?
Yes—Québec requires RL-15 slips and provincial allocations.

• Can partners deduct business losses?
Yes, but subject to loss-restriction rules for limited partners.

Understanding these questions helps clarify partnerships and income allocation rules.

Why Mackisen
With more than 35 years of combined CPA experience, Mackisen CPA Montreal helps businesses stay compliant while recovering the taxes they’re entitled to. Whether you're filing your first GST/QST return or optimizing multi-year refunds, our expert team ensures precision, transparency and protection from audit risk. When handling partnerships and income allocation rules, Mackisen provides full agreement drafting, allocation planning, tax compliance, and year-round strategic guidance