Introduction to Joint Ventures
One of the first decisions to make in establishing a business is what organizational structure will be used. This article is part of our Website series on business organizations and discusses the use of the joint venture structure to carry on a business.
A joint venture is an association of two or more persons who contractually agree to contribute to a specific venture which is usually limited to a specific task or a period of time. Joint ventures are commonly used organizational structures for real estate development or business ventures between First Nations members and non-natives. The joint venturers contribute certain items such as: real property; money; labour; technology; experience and other resources; in the furtherance of a particular project or undertaking. In addition, the joint venturers agree to share the venture’s expenses, what degree of control each venturer will have over the venture, all in return for an interest in the venture’s revenues.
While similiar in structure to a partnership, there are some very clear differences between the two structures, which should be clearly understood by the venturers before choosing this structure as a vehicle to carry on business. Of the many considerations involved in choosing the form of organization, the concern usually falls into the general categories of income taxation, administration and cost, and limitations on liability.
Under the Income Tax Act a joint venture, like a partnership, is not recognized as a separate taxable entity. A joint venture arrangement is effectively treated as a co-ownership for tax purposes and each joint venturer independently reports their own share of the joint venture’s gross revenues and expenses. This means that each of the joint venturers may treat the individual items of revenues and expenses on their own income tax returns differently from the other joint venturers. This allows significant flexibility for income tax planning within the group of joint venturers.
Some additional tax advantages arise from the use of a joint venture, wherein each joint venturer may:
(i) offset the profits and losses from their other businesses against the profits and losses as derived from the joint venture; and
(ii) deduct interest on money borrowed, reflecting the surplus of their interest in joint venture assets where that money was used by the joint venturer for other business purposes.
Joint ventures are well suited as aboriginal business vehicles which involve taxable venturers or non-native venturers in co-ownership with First Nations members who may be tax exempt. The flexibility to classify ownership of certain joint venture property to the non-native venturer may enhance the tax deductions available to the taxable joint venturer, subject to re-allocation and anti-avoidance rules contained in the Income Tax Act (i.e. the non-native investor’s ownership interest in the leasehold interest in Indian Reserve Lands could be increased to allow the non-native investor enhanced capital cost allowance claims in respect of those assets). Such tax deductions are effectively wasted when available to the aboriginal joint venturer.
One of the tax disadvantages of joint ventures is that a joint venture is not as flexible as a corporation for tax planning purposes because of the inability of a single joint venturer to transfer property on an “income tax-deferred rollover” basis to the joint venture.
Administration and Cost
Like a partnership, it is usually recommended that a joint venture set out their business intentions in a written agreement, thereby setting the clear agreement on business methods, sharing of revenues and expenses, and the terms upon which the venture will cease. While this may end up incurring legal fees, the certainty that is created by a clear agreement and the lack of misunderstandings is a prudent cost at the start of business.
One common characteristic used to assert the proposition that a joint venture exists instead of a partnership is the “two-tiered structure” under which joint venture assets are usually leased from one of the venturers to the joint venture, which then uses those assets in the operation of the joint venture business.
Joint ventures have no requirements for annual legislative filings and the costs for maintaining their status are minimal.
The absence of legislative rules for joint ventures allows the venturers significant freedom of contract to create their own rules of conduct for the internal running of the business.
Limitations on Liability
Joint venturers are not jointly and severally liable for the business venture’s debts, unlike a partnership. Each of the venturers is liable for the debts of the joint venture in proportion to their ownership interest in the joint venture. Over the long term, the tax advantages that may be obtained, may offset the venturers’ exposure to liability.
If the circumstances are right, then the choice of a joint venture structure may create an incremental benefit to the venturers over the other organizational structures that are available. Ultimately the choice of which structure to use to carry on a business involves a careful understanding of how the business will operate in the future, the various risks that the business will face, and what benefits each structure will provide to the operator of the business. We recommend you speak with our business law lawyers to discuss the relative merits of the different structures before you commence carrying on business.
The opinions set out in this article reflect generally on this area of law. The impact of the law on any given situation depends upon each individual’s circumstances and the opinions contained in this article should not be relied on for assessing anyone’s legal position. Advice should be obtained directly from our business law lawyers regarding your particular situation.