Published: March 24, 2025
Last Updated: March 24, 2025
Introduction to a Limited Partnership
In Canada, a limited partnership (LP) offers a unique business structure for ventures involving two or more persons aiming to generate profit. Formed under provincial legislation such as Ontario’s Limited Partnerships Act, an LP combines the managerial role of a general partner with the passive investment of one or more limited partners, governed by a detailed limited partnership agreement. While LPs are not as common as corporations, their tax treatment as a flow-through entity makes them an attractive option for certain business scenarios, particularly those expecting early losses or seeking tax flexibility.
An LP requires at least one general partner, who oversees the business and assumes unlimited liability for its debts, and at least one limited partner, whose liability is capped at his or her contribution—provided one refrains from managing the business.
Typically, the general partner is a corporation that shields its shareholders from personal liability, while limited partners, either individuals or corporations, act as investors. The limited partnership agreement outlines the rights, responsibilities, required capital contributions and profit and loss-sharing amongst partners, making it a critical document for clarity and legal protection.
The general partner’s unlimited liability contrasts with the limited partner’s protection, which hinges on non-involvement in management. Provincial laws define this boundary differently:
- In Ontario, Alberta, and Saskatchewan, a limited partner loses liability protection if one takes “control” of the business.
- In British Columbia, the threshold is “taking part in the management.”
- Manitoba offers more leeway, permitting limited partners to “advise” on management without jeopardizing their status.
Crossing these lines transforms a limited partner into a general partner, exposing him or her to unlimited personal liability.
Unlike corporations, which are separate legal entities, LPs are not distinct taxpayers for tax purposes. This flow-through nature distinguishes them from corporate structures and drives their appeal in specific contexts.
Tax Treatment: The Flow-Through Advantage
The defining tax feature of an LP is that it does not pay income tax at the entity level. Instead, its income, losses, capital or losses gains, or other tax attributes “flow through” to the partners, who report these on their personal or corporate tax returns. This contrasts sharply with a corporation, where profits are taxed at the corporate level, and shareholders only report income upon receipt of dividends and realize losses upon selling shares or winding up the company.
- Income Character Preservation: The type of income—whether business income, interest, dividends, or capital gains—retains its character as it passes to the partners. For instance, a capital gain earned by the LP remains a capital gain for the partner, potentially qualifying for the lifetime capital gains exemption.
- Loss Utilization: Losses flow through annually, allowing partners to offset them against other income sources (e.g., employment income or investment gains). This is particularly advantageous for ventures anticipating initial losses, such as startups or real estate developments, where investors can use these losses to reduce their tax liability elsewhere—something unavailable to corporate shareholders.
- Restrictions for Limited Partners: The Income Tax Act (Canada) imposes “at-risk” rules (Sections 96(2.1)-(2.2)), limiting the losses a limited partner can claim to their “at-risk amount” (essentially, their investment minus prior losses claimed). Excess losses are deferred until the partner’s at-risk amount increases to prevent taxpayers from claiming losses in excess of their investment.
Tax Filing and Non-Resident Considerations
An LP may not need to file a Canadian information return if it has no Canadian-source income, no Canadian-resident partners, does not solicit business in Canada, and is managed outside Canada. An LP that carries on a business in Canada, or a Canadian LP with Canadian or foreign operations or investments, has to file Form T5013 Statement of Partnership Income for each of the fiscal periods of the partnership where one of the following occurs:
- At the end of the fiscal period, the partnership has an absolute value of revenues plus an absolute value of expenses of more than $2 million, or has more than $5 million in assets;
- At any time during the fiscal period:
- The partnership is a tiered partnership (has another partnership as a partner or is itself a partner in another partnership);
- The partnership has a corporation or a trust as a partner;
- The partnership invested in flow-through shares of a principal-business corporation that incurred Canadian resource expenses and renounced those expenses to the partnership;
- The Minister of National Revenue asked in writing for a completed Form T5013, Statement of Partnership Income.
Non-resident limited partners receiving Canadian-source income may face Part XIII withholding tax (typically 25%, reducible by treaty), complicating tax planning. The partnership can be liable for any unremitted withholding tax that should have been remitted to the CRA. If your partnership involved a non-resident partner, it is advisable to contact an expert Canadian tax lawyer to ensure the partnership is meeting all of its tax obligations and is withholding the proper amounts.
Because income flows through regardless of distribution, limited partners face tax liability on their share of LP income even if no cash is distributed. This “phantom income” risk underscores the importance of aligning income allocation and cash distribution policies in the limited partnership agreement to avoid unexpected tax burdens on income earned by the LP and attributed to the partner, even if the partner has not actually received it.
Pro Tax Tips: Why Choose a Limited Partnership?
LPs are not a default choice; their use is often driven by compelling tax reasons. The ability to flow losses to investors makes them ideal for ventures expecting early deficits, such as resource exploration or film/software production. Unlike corporations, where losses are trapped within the entity, LPs offer immediate tax relief to partners, enhancing cash flow for reinvestment or personal tax planning. Additionally, avoiding corporate-level tax eliminates the double taxation inherent in dividend distributions, a significant advantage for high-income investors.
However, this structure isn’t without drawbacks. The general partner’s unlimited liability (mitigated by using a corporation) and the potential for limited partners to face tax without cash distributions require meticulous planning. The complexity of tax rules, especially for non-residents or those under the at-risk limitations, may also deter some investors.
A well-drafted limited partnership agreement and a thorough understanding of provincial and tax laws are essential to maximizing benefits while minimizing risks. It is highly advisable to consult with a top Canadian tax lawyer to understand the tax consequences and obligations involved in a partnership.
FAQ
What are the risks associated with a limited partnership?
One of the risks is the CRA denying partnership losses on the basis that the partnership is a tax shelter. Tax shelters are generally investments that have as a main or secondary purpose the reduction of taxes, and are often challenged by CRA.
The CRA announced that they have launched criminal investigations into a number of tax shelter promoters. Due to the flow-through nature of partnerships and the fact that they allow the partners to deduct partnership losses on their business/capital accounts, the CRA carefully scrutinizes partnership arrangements. It is best to screen for the risk of your partnership being characterized as a tax shelter early on by consulting an expert Canadian tax lawyer, as, if the CRA denies partnership losses down the road, it will lead to additional expenses such as legal fees, interest, and penalties.
How does GST/HST apply to limited partnerships?
Limited Partnerships are treated as separate “persons” for GST/HST under the Excise Tax Act. If taxable supplies in the course of a commercial activity exceed $30,000 annually, they must:
- Register for GST/HST.
- File GST34 returns (monthly, quarterly, or annually, based on revenue).
Disclaimer: This article just provides broad information. It is only up to date as of the posting date. It has not been updated and may be out of date. It does not give legal advice and should not be relied on. Every tax scenario is unique to its circumstances and will differ from the instances described in the article. If you have specific legal questions, you should seek the advice of a Canadian tax lawyer.
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