What the division of profits and losses turns on
A partnership is the relationship that exists between people carrying on a business in common with a view to profit, which is the definition used in s 1 of the Partnership Act 1892 (NSW). Unlike a company, a partnership is not a separate legal entity: the partners themselves are the business. When the business makes a profit, someone has to decide who keeps it. When it makes a loss, someone has to wear it, and that happens at two levels, between the partners themselves and against the outside world.
Two layers of rules answer those questions. The first is the partnership agreement, which can set whatever allocation of profits and losses the partners agree to. The second is the Partnership Act of your state or territory, which supplies default rules that fill any gap in the agreement. The defaults are blunt. If your agreement is silent, profits and losses are shared equally, no matter how much capital or effort each partner contributed.
This article walks through how that machinery operates: who the players are, what the statutory defaults say, how an agreement overrides them, how losses are actually borne, what happens on dissolution, and how the ATO taxes the result. It matters if you are in a partnership now, about to form one, or wondering whether the way profits and losses are currently split is what you actually agreed to.
The players and their stakes
Four groups have a direct stake in how the division works:
- The partners: each contributes capital, skill or labour, and each holds a share of the profits and a share of the losses.
- The firm: the collective name for the partners. It can hold assets, contract and be sued in its firm name, but it is not a separate legal person that absorbs the risk.
- Creditors and third parties: suppliers, lenders, employees and customers with claims against the firm. They can pursue partners personally.
- The ATO: taxes each partner on their share of the partnership's net income rather than taxing the partnership itself.
Agreement first, the Act second
Every state and territory has a Partnership Act, and the rules trace back to the same English model. New South Wales has the Partnership Act 1892, Victoria the Partnership Act 1958, and the other states and territories have equivalent legislation with near-identical provisions. The key structural feature is that the default rules operate only subject to any agreement expressed or implied between the partners. Section 24 of the NSW Act opens with exactly that phrase.
The practical consequence is a hierarchy. Where the partnership agreement deals with an issue, the agreement wins. Where it is silent, the Act supplies the rule. This is why the same statutory text produces very different outcomes in different partnerships: two partners who signed a 60/40 agreement split profits 60/40, while two partners who never signed anything split them 50/50 under the same Act.
The trap is that most of the Act's rules cover the things people forget to write down. A partnership agreement that sets out the name, the business and the bank account, but says nothing about how profits and losses are shared, leaves the division to the defaults. That is usually the point at which an equal split surprises the partner who invested more.
The default: equal shares, equal losses
The foundational default is s 24(1) of the Partnership Act 1892 (NSW):
All the partners are entitled to share equally in the capital and profits of the business, and must contribute equally towards the losses whether of capital or otherwise sustained by the firm.
Two obligations in one sentence. On the profit side, every partner gets an equal share of the profits. On the loss side, every partner must contribute equally to make good the firm's losses, whether the loss is an operating loss or a loss of capital.
Example: Priya and Tom form a partnership with no written agreement. Priya contributes $200,000, Tom contributes $20,000, and both work in the business. In a $100,000 profit year, each receives $50,000. In a $60,000 loss year, each must contribute $30,000 to cover it. Priya's larger capital contribution earns her no larger share of profit and no smaller share of loss, because the default rule takes no account of contributions.
The other defaults that come with equal shares
Section 24 bundles a set of related rules that apply unless the agreement says otherwise:
- No partner is entitled to remuneration for acting in the partnership business, under s 24(6). Working partners get no salary by default; their reward is the profit share.
- No partner earns interest on capital subscribed before profits are ascertained, under s 24(4), but a partner who advances money beyond the agreed capital is entitled to interest at 7% per annum from the date of the advance, under s 24(3).
- Every partner may take part in the management of the business, under s 24(5), and the partnership books must be kept at the place of business and open to all partners, under s 24(9).
- No new partner can be introduced without the consent of all existing partners, under s 24(7), and while ordinary matters can be decided by majority, no change can be made to the nature of the business without everyone's consent, under s 24(8).
Most of these read as common sense, but they produce the classic disputes: the working partner who wants a salary, the silent partner who wants interest on capital, and the two partners who want to bring in a third over the objection of the fourth.
Contracting out: allocating profits and losses by agreement
Partners are free to agree to almost any allocation, which is why the agreement is the primary document. The usual structures are:
- Percentage splits: profits and losses divided in fixed proportions, such as 60/40 or 70/30, typically reflecting capital contributed or expected effort.
- Salaries and special allocations: the agreement can give one partner a fixed amount out of the profits before the balance is split, commonly used to reward a partner who manages the business day to day or brings skills the others lack. A new partner who owns 20% but runs the operation might be allocated a salary first, with the remaining profit split 80/20.
- Tiered arrangements: different ratios for different profit bands, or a ratio that changes over time as partners vest.
Capital and current accounts: how the shares are tracked
Partnership accounting tracks each partner's position through two running balances. The capital account records each partner's permanent contribution, the money and assets they put into the business. The current account records their share of profits, their drawings and their share of losses. When the business makes a profit, each partner's current account is credited with their share. When they draw money out, the current account is debited. When the business makes a loss, the loss is debited against the current accounts first and then the capital accounts, and if a partner's accounts go negative, that partner owes the firm, and through the firm the creditors, the shortfall.
The point of keeping these accounts is that they convert an abstract profit share into a specific dollar entitlement that can be paid out, offset against drawings or carried forward. The agreement should state the ratio, whether losses are borne in the same ratio as profits, and what happens to a partner's account on exit.
A tax note on partner salaries
A salary paid to a partner is not wages in the usual sense. There is no PAYG withholding and no employee entitlements, because partners are not employees of their own firm. For tax purposes the salary is part of the partner's share of the partnership's net income, taxed in the partner's hands at their own marginal rate. The ATO makes the flow-through point directly: a partnership does not pay income tax itself, and each partner includes their share of the net income in their own return whether or not they actually received the money.
When losses bite: liability to outsiders
So far the discussion has been about how losses are divided between the partners. There is a second, harder question: how losses are borne as against the outside world. Here the default rules are unforgiving.
Section 9(1) provides that every partner is liable jointly with the other partners for all debts and obligations of the firm incurred while they are a partner. Section 12 goes further for wrongs such as negligence: liability is joint and several, meaning each partner can be pursued for the whole amount. A creditor does not have to chase each partner for their share. If the firm owes $200,000 and one partner can pay while the other cannot, the creditor can recover the full $200,000 from the solvent partner, who is then left to seek contribution from the other under the internal loss-sharing rules.
This is what it means to say partners have unlimited personal liability. A general partnership does not give its partners the limited liability shield a company gives its shareholders, and the partnership's losses can reach personal assets such as the family home.
The Act softens the edges in a few ways. The firm must indemnify a partner for payments made and liabilities incurred in the ordinary and proper conduct of the business, under s 24(2), though an indemnity from an insolvent firm is only worth what the other partners can pay. A person admitted to an existing firm is not liable for debts incurred before they joined, under s 17(1), and a retiring partner remains liable for debts incurred before retirement, under s 17(3). Exit therefore needs to be managed: the agreement, and arrangements with creditors, should address what happens to pre-existing liabilities when a partner leaves.
Losses on dissolution: the statutory order
When a partnership ends, s 44 sets the order in which losses are absorbed on the final settlement of accounts. Losses, including losses and deficiencies of capital, are paid first out of profits, next out of capital, and lastly, if necessary, by the partners individually in the proportion in which they were entitled to share profits.
Example: Aisha and Ben have equal profit shares but unequal capital accounts, $100,000 and $20,000. The firm winds up with a $150,000 loss. Profits are nil, so the loss is applied against capital: both capital accounts are wiped out, absorbing $120,000, and the remaining $30,000 is contributed by Aisha and Ben equally, $15,000 each. The partner who put in more capital has already lost more through the capital account, and the final contribution follows the profit-sharing ratio, not the capital ratio.
The lesson for drafting is that the profit-sharing ratio does double duty. It determines not only how profits are divided but also how the final shortfall is shared, so an agreement that sets a ratio only for profits should be checked for what it implies for losses and capital.
Tax: profits and losses flow through to the partners
Partnerships are flow-through vehicles for tax. The ATO's position is that a partnership does not pay income tax but must lodge a partnership tax return each income year. The partnership distributes its net income or loss to each partner, and each partner includes their share of the net income in their assessable income. Where the partnership makes a net loss, each partner may claim a deduction for their share of the loss in their own return.
Two consequences follow. First, a partner can owe tax on profits they never drew, because the share is taxed whether or not it was actually received. Second, losses do not disappear at the partnership level; they flow through and become the partners' losses.
For individual partners, the ability to offset a share of partnership losses against other income is subject to the non-commercial loss rules. The ATO explains that you may offset your share of a partnership loss against other income if you meet the income requirement and pass one of four tests: the assessable income test, which requires the activity to have at least $20,000 of assessable income; the profits test, which requires the activity to have been profitable in at least three of the past five years; the real property test, which requires at least $500,000 of real property used in the activity; and the other assets test, which requires at least $100,000 of other assets used in the activity. Where the tests are not met, the loss cannot simply be used against salary or other income that year, and tax advice is needed on how the loss can ultimately be used.
Where a commercial lawyer adds value
A commercial lawyer's main contribution is at the front end: translating the partners' intentions about money into an agreement that actually controls the outcome. That means setting the profit and loss ratio expressly, deciding whether losses are borne in the same ratio as profits, drafting the salary and drawing arrangements, specifying how capital and current accounts are maintained, and covering the unanimous-consent matters such as new partners, changes to the nature of the business and exit.
A lawyer is also the person to call when the agreement is silent on something that now matters. That happens at predictable moments: a partner wants to be paid for working in the business; a partner wants to bring in a family member; one partner's capital account has gone negative and the others want to know who owes what; a partner wants to leave and the remaining partners want to stop being liable for the departing partner's share of the old debts. In each case the lawyer's job is to identify which rule applies, agreement or Act, and to convert the situation into a written amendment.
The silence that decides your share
Every allocation dispute in a partnership traces back to a gap in the agreement, and the gap is always filled by the same default: equal shares of profit, equal contribution to losses, no salary, no interest on capital, and unanimous consent for the big changes. If you have a written agreement, the question worth asking is whether the profit and loss ratio is actually in it, or whether you are relying on an understanding the Act does not recognise. If you have no agreement, the Act is already deciding how your profits and losses are divided, and it may not match anyone's expectation.
The cheapest point of leverage is early review. A conversation with a commercial lawyer about your current allocation, or about a draft agreement before you sign, costs a fraction of a dispute over who bears the losses, and it is the one step that converts the statutory default into the arrangement you actually want.