Taxation Determination

TD 2015/19

Income tax: if a retiring partner is entitled to an amount representing their individual interest in the net income of the partnership for an income year, will section 92 of the Income Tax Assessment Act 1936 apply?

  • Please note that the PDF version is the authorised version of this ruling.
    There is a Compendium for this document: TD 2015/19EC .

Preamble

Exclamation This publication provides you with the following level of protection:

This publication (excluding appendixes) is a public ruling for the purposes of the Taxation Administration Act 1953.

A public ruling is an expression of the Commissioner's opinion about the way in which a relevant provision applies, or would apply, to entities generally or to a class of entities in relation to a particular scheme or a class of schemes.

If you rely on this ruling, the Commissioner must apply the law to you in the way set out in the ruling (unless the Commissioner is satisfied that the ruling is incorrect and disadvantages you, in which case the law may be applied to you in a way that is more favourable for you - provided the Commissioner is not prevented from doing so by a time limit imposed by the law). You will be protected from having to pay any underpaid tax, penalty or interest in respect of the matters covered by this ruling if it turns out that it does not correctly state how the relevant provision applies to you.

Ruling

1. Yes. Subject to paragraph 3 of this Determination, the partner's individual interest in the net income of the partnership is included in the partner's assessable income for the income year under section 92 of the Income Tax Assessment Act 1936 (ITAA 1936).[1]

2. This is the case regardless of:

·
how the amount the partner is entitled to is labelled or described (including whether it is expressed to be consideration for something provided or given up by the partner)
·
the timing of the partner's retirement (including whether they retire before the end of the income year), and
·
the timing of any payment.

3. However, the partner's individual interest in the net income of the partnership is not assessable under section 92 to the extent that it is attributable to both:

·
a period when the partner was not a resident of Australia; and
·
sources outside of Australia.

Example

4. ABC is a professional partnership carrying on business in Australia. Paul was a partner in ABC but retired from the partnership with effect from 1 January, year 1. Paul was a resident of Australia throughout year 1.

5. Paul received a payment of $500,000 from ABC on 30 July, year 2.

6. ABC's accounting profit for year 1 was $200,000,000. Of this amount, $500,000 (0.25%) was allocated to Paul. Both the profit and its allocation were determined in accordance with the terms of the ABC partnership agreement.

7. ABC's working papers indicate that Paul's 0.25% interest comprised:

·
Paul's base profit share for year 1, apportioned to reflect his retirement before 30 June
·
an additional amount expressed to be in respect of unused leave, and
·
an additional amount described as a 'retiring allowance', calculated by reference to the number of years Paul served as a partner in the firm.

8. The calculation of these components was consistent with the terms of the ABC partnership agreement.

9. ABC's Statement of Distribution indicates that ABC's net income was $205,000,000, of which $512,500 (0.25%) was allocated to Paul. A review of ABC's operations in year 1 indicates that ABC's net income was correctly calculated.

10. In Paul's Retirement Deed, the $500,000 payment is described as being in respect of Paul disposing of his interest in the partnership.

11. $512,500 is included in Paul's assessable income for year 1 under section 92. This represents Paul's individual interest in the net income of ABC for year 1. It does not matter that the amount Paul is entitled to is expressed to be in respect of Paul disposing of his interest in the partnership or is, in part, calculated by reference to his past service.

12. Any capital gain which Paul might otherwise make as a result of a CGT event happening to his interest in ABC is reduced to the extent that it is reflected in the amount which is assessable under section 92.

Date of effect

13. In a number of private rulings, issued over several years, the Commissioner has accepted that an amount of the kind covered by this Determination is not assessable under section 92 but is taken into account in working out a capital gain under the capital gains tax (CGT) provisions.

14. Therefore, the ATO will not seek to disturb assessments made before 3 June 2015 (the issue date of Draft Tax Determination TD 2015/D2) in relation to the issue covered by this Determination.

Commissioner of Taxation
7 October 2015

Appendix 1 - Explanation

Exclamation This Appendix is provided as information to help you understand how the Commissioner's view has been reached. It does not form part of the binding public ruling.

15. Where a partner becomes entitled to an amount upon their retirement or exit from the partnership, the amount might be described as relating, in a general sense, to the disposal of the partner's interest in the partnership. However, this does not mean that the receipt of the amount (or any part of it) necessarily gives rise to a capital gain (or loss) from such a disposal.

16. For income tax purposes a more specific characterisation is required. It is necessary to identify whether (or the extent to which) the amount:

·
represents the partner's share of partnership net income
·
is assessable in the partner's hands on revenue account on another basis, or
·
otherwise relates to the disposal of the partner's interest in partnership assets.

17. It is therefore necessary to characterise the amount by reference to what it represents, relates to or is attributable to. If the amount represents, relates or is attributable to more than one thing it is necessary to apportion the amount between each thing on a reasonable basis and determine a character for each portion of the amount.

Individual interest in partnership net income

18. To the extent that the amount represents a partner's individual interest in the net income of the partnership and meets the necessary residency and source requirements, it is brought to account as assessable income of the partner under section 92.

19. Section 92 provides:


The assessable income of a partner in a partnership shall include:

(a)
so much of the individual interest of the partner in the net income of the partnership of the year of income as is attributable to a period when the partner was a resident; and
(b)
so much of the individual interest of the partner in the net income of the partnership of the year of income as is attributable to a period when the partner was not a resident and is also attributable to sources in Australia.

20. For resident partners there are therefore 2 basic steps involved in applying section 92:[2]

·
determining the net income of the partnership, and
·
determining the partner's individual interest in that net income.

21. The net income of the partnership is to be determined from the perspective of the partnership, as if the partnership were a taxpayer.[3]

22. The net income of a partnership is determined by reference to the taxation law rather than any act or statement of the partnership.[4] However, once the net income has been determined in accordance with the taxation law, any agreement between the partners as to the allocation of that amount is binding upon the partners for the purposes of section 92.[5]

23. The partner's individual interest in partnership net income is essentially a question of fact in each case, to be determined by reference to the partnership agreement, the partnership's accounting records and any other relevant documents. However, it cannot be concluded that a person has no such interest merely because they cease to be a partner before the partnership's profit or net income has been calculated.

24. At general law, a partner has an individual interest in the net income of a partnership, even though the precise amount of their interest cannot be determined until the accounts are prepared in respect of the relevant period.[6] This interest exists independently of any actual division of profits or net income, reflecting that the collective income earned by the partnership belongs to the partners according to their partnership shares.[7] While there may be practical difficulties associated with calculating the interest of a partner who retires before the end of the income year, this does not affect the legally correct approach.[8] The position of a person with an interest in the net income of a partnership before the end of the income year can be contrasted with that of a person who has no such interest because they have assigned their entitlement to past and future profits to another entity.[9]

25. Once it has been correctly concluded that an amount represents all or part of a partner's individual interest in partnership net income, the amount is assessable under section 92. It is unnecessary to further characterise that amount by reference to how it is otherwise labelled by the parties or what it is expressed to be consideration for.[10]

26. For this reason, the principles which apply to determine the income or capital character of undissected lump sums[11] are not relevant. By definition, a share in the net income of a partnership is capable of separate identification; and, moreover, is assessable without regard to its income or capital character in the hands of the recipient.

27. While each case turns on its facts, including the terms of the relevant partnership agreement, an amount to which a partner is entitled upon retirement from a professional partnership will commonly be brought to account under section 92 only. This reflects the fact that most or all identifiable assets used in the partnership may be held by a service entity; and the partners may agree that nothing will be paid or received in respect of partnership goodwill upon entering or exiting the partnership.[12]

Other matters

28. To the extent that an amount does not represent the partner's individual interest in the net income of the partnership it is necessary to consider what else it represents, relates to or is attributable to.

29. In characterising such an amount it is necessary to have regard to the terms of any agreement between the parties, including the partnership agreement and any retirement deed.

30. Such an amount would be assessable on revenue account, for instance, to the extent that it relates to partially completed work of the exiting partner, or represents consideration for services rendered or a return on the investment of capital.[13]

31. In rare cases, an undissected compensation receipt may be incapable of apportionment, in which case the entire amount may be treated as capital.[14] However, the facts and circumstances surrounding the receipt may enable the apportionment of such a lump sum on a reasonable basis into its constituent elements.[15]

32. An amount representing an individual interest in partnership net income may also represent capital proceeds from a CGT event. However, any capital gain which would otherwise arise is reduced to the extent that it is assessable under other provisions.[16]

33. In this regard, a partner's exit from a professional partnership will commonly have no CGT consequences, by virtue of arrangements for the holding of CGT assets of the firm; see paragraph 27 of this Determination.

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Footnotes


All legislative references in this Determination are to the ITAA 1936, except where otherwise indicated.


McNally v. FC of T; FC of T v. McNally 2007 ATC 4150 at [42].


Section 90.


Stapleton v. FC of T 89 ATC 4818 at 4827; FC of T v. Grant & Ors 91 ATC 4608.


McNally v. FC of T; FC of T v. McNally 2007 ATC 4150 at [47].


FC of T v. Galland 86 ATC 4885 at 4887 and 4893; Rose v. Federal Commissioner of Taxation (1951) 84 CLR 118 at 124.


FC of T v. Galland 86 ATC 4885 per Dawson J at 4893; Rose v. Federal Commissioner of Taxation (1951) 84 CLR 118 at 124; Federal Commissioner of Taxation v. Happ [1952] 9 ATD 447 at 451.


McNally v. FC of T; FC of T v. McNally 2007 ATC 4150 at [54],


See FC of T v. Galland 86 ATC 4885 at 4888.


McNally v. FC of T; FC of T v. McNally 2007 ATC 4150 at [42], [47], [59] and [60].


McLaurin v. Federal Commissioner of Taxation (1961) 104 CLR 381; Allsop v. Federal Commissioner of Taxation (1965) 113 CLR 341; Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts, paragraphs 188-209.


See further, Taxation Ruling IT 2540 Income tax : capital gains: application to disposals of partnership assets and partnership interest.


See sections 15-50 and 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997).


See footnote 11 of this Determination.


See TR 95/35, paragraph 190.


Section 118-20 of the ITAA 1997.

Previously released in draft form as TD 2015/D2

References

ATO references:
NO 1-6SXDR5A

ISSN: 2205-6211

Related Rulings/Determinations:

IT 2540
TR 95/35
TR 2006/10

Subject References:
partnerships

Legislative References:
ITAA 1936
ITAA 1936 90
ITAA 1936 92
ITAA 1997
ITAA 1997 6-5
ITAA 1997 15-50
ITAA 1997 118-20

Case Relied on:
Federal Commissioner of Taxation v. Galland
(1986) 162 CLR 408
[1986] HCA 83
86 ATC 4885
(1986) 18 ATR 33


Federal Commissioner of Taxation v. Grant & Ors
91 ATC 4608
(1991) 22 ATR 237

Federal Commissioner of Taxation v. Happ
[1952] 9 ATD 447
[1952] ALR 382

McNally v. Federal Commissioner of Taxation; Federal Commissioner of Taxation v. McNally
[2007] FCA 51
2007 ATC 4150
(2007) 65 ATR 738

Rose v. Federal Commissioner of Taxation
(1951) 84 CLR 118
[1951] HCA 68

Stapleton v. Federal Commissioner of Taxation
(1989) 88 ALR 606
89 ATC 4818
(1989) 20 ATR 996

Case distinguished:
Federal Commissioner of Taxation v. Galland
(1986) 162 CLR 408
[1986] HCA 83
86 ATC 4885
(1986) 18 ATR 33


McLaurin v. Federal Commissioner of Taxation
(1961) 104 CLR 381

Allsop v. Federal Commissioner of Taxation
(1965) 113 CLR 341