Edited version of your private ruling

Authorisation Number: 1012514031526

Ruling

Subject: capital gains tax - assigning a partnership interest

Question 1

Will capital gains tax (CGT) event E1 happen when you assign your interest in the Partnership to a Trust?

Answer: No

Question 2

Will CGT event E2 happen when you assign your interest in the Partnership to a Trust?

Answer: Yes

Question 3

Will CGT event A1 happen when you assign your interest in the Partnership to a Trust?

Answer: No

Question 4

Will CGT event D1 happen when you assign your interest in the Partnership to a Trust?

Answer: No

Question 5

Will the CGT event happen in relation to an active asset owned by you, for the purposes of section 152-40 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer: Yes

Question 6

Will the Commissioner apply Part IVA to deny any tax benefit obtained as a result of assigning an interest in the Partnership to the Trust?

Answer: No

This ruling applies for the following period

Year ending 30 June 2013

Year ending 30 June 2014

The scheme commenced on

1 July 2012

Relevant facts and circumstances

You are an equity partner in a partnership (the Partnership).

The Partnership carries on a business.

The Partnership operates on a 'no goodwill' basis. This means that incoming partners are not required to pay any amount in relation to goodwill being acquired and exiting partners are not entitled to receive any payment in recognition of goodwill.

You intend to enter into an agreement under which a portion of your interest in the Partnership will be assigned to a trust (the Trust), which is an existing trust. The agreement giving effect to the assignment will amount to a declaration of trust by you in respect of the Partnership interest.

You are the existing owner of the property that will be subject to the trust, and you will continue to be the legal owner of the Partnership interest after the Trust becomes the beneficial owner.

The Trust is a discretionary trust established for the benefit of your family. You are not a potential beneficiary of the Trust.

The trust relationship will be irrevocable.

You intend to engage the services of an expert valuer to ascertain the market value of your interest in the Partnership.

You state that there is no existing trust relationship between you and the Trust in respect of the Partnership interest.

Assumptions

Documentation giving effect to the assignment will be prepared in a manner which is consistent with and which provides the same legal effect as the assignments considered in Federal Commissioner of Taxation v. Everett (1980) 143 CLR 440 (Everett) and Federal Commissioner of Taxation v. Galland (1986) 162 CLR 408 (Galland). Documentation is yet to be completed at the time of the application.

A trust relationship will come into existence consistent with the decision in Everett.

The valuation will be completed consistent with the decision of the Supreme Court of Western Australia in Reynolds v. Commissioner of State Taxation (WA) 86 ATC 4528 (Reynolds). The valuation will be prepared on this basis to comply with the Commissioner's statement at paragraph 28 of Taxation Ruling IT 2540 Income tax: capital gains: application to disposals of partnership assets and partnership interests as follows:

Where an Everett assignment is not made at arm's length, the valuation method adopted in Reynolds' case will usually be the appropriate method for determining the market value of the assigned partnership interest for the purposes of Part IIIA. Broadly, this will involve the determination of the price that a "hypothetical buyer" would pay for the assigned partnership interest having regard to the value of the right to the future income of the partnership which is attached to the interest.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104-55

Income Tax Assessment Act 1997 Section 104-60

Income Tax Assessment Act 1997 Subsection 102-25(1)

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 104-35

Income Tax Assessment Act 1997 Subsection 104-35(5)

Income Tax Assessment Act 1997 Section 152-40

Income Tax Assessment Act 1997 Section 152-35

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1936 Section 177F

Income Tax Assessment Act 1936 Section 177A

Income Tax Assessment Act 1936 Section 177C

Income Tax Assessment Act 1936 Section 177D

Reasons for decision

Detailed reasoning

CGT and assignment of a partnership interest

Subsection 102-5(1) of the ITAA 1997 provides that a taxpayer's assessable income includes net capital gains made by them (if any) during that financial year. Section 102-20 of the ITAA 1997 provides that CGT will apply to produce a capital gain or a capital loss to a taxpayer if, and only if, a CGT event happens. With respect to an Everett assignment, the proper CGT treatment depends on the nature of the assignment.

IT 2540 addresses the CGT implications of entering into an Everett assignment. Paragraph 24 provides that the effect of an Everett assignment is that the partner disposes of part of his or her partnership interest, notwithstanding that the assignee only has an equitable interest in the assignor's partnership interest and that legal title to the partnership assets continues to vest in the partners to the exclusion of the assignee. However, IT 2540 was written prior to the rewriting of the CGT provisions into the ITAA 1997. The language of IT 2540 provides that an Everett assignment will constitute a disposal of an asset but this was written in accordance with section 160M of the ITAA 1936 CGT provisions, under which all transactions were deemed to be a 'disposal'. Under the CGT provisions in the ITAA 1997, a transaction must fall within one of the specified CGT events in order for the CGT provisions to apply.

Under a valid Everett assignment a partner assigns part of their equitable interest in a partnership to an associated entity (such as a discretionary trust). The assignor retains legal ownership and the assignee acquires equitable ownership in the assigned part. The assignee is entitled to receive part of the assignor's share of the partnership income, but with limited or no entitlement to a transfer of the legal ownership of the assigned interest or to participate in the management of the partnership.

The High Court in Everett rejected the Commissioner's argument that the right of a partner to receive a proportion of partnership profits was a right separate and severable from their share in a partnership. In reaching this conclusion, the Court made several statements about the nature of an interest in a partnership and the consequences of an assignment of such an interest (or part thereof). Critically, the Court explained the nature of the relationship between the assignee and assignor:

Ordinarily the effect of an equitable assignment of an equitable interest is to entitle the assignee to all equitable remedies applicable to the subject matter of the assignment and to give a good discharge (Meagher Gummow and Lehane [606]. By virtue of the assignment the assignee stands in the shoes of the assignor so that there is no necessity to regard the assignor as a trustee for the assignee.

However the assignment of a partner's equitable interest in a partnership produces rather different consequences. A contract for the sale of such an interest is of course a contract capable of specific performance and in an action for specific performance the Court will direct the execution of an assignment (Dodson v Downey [1901] 2 Ch 620).

Before the introduction of the Partnership Acts it was well settled that "a person who agreed to buy a portion of the interest of a partner in a partnership did not become a partner, but that his vendor, while remaining a member of the partnership exactly as before, became a trustee for him of the interest agreed to be sold" Hocking at 743-744 per Griffith CJ; see also p 749. In that case the Court considered that the counterpart of sec 31 of Partnership Act 1892 NSW did not alter the law relating to the assignment of part of a partner's interest in a partnership.

Does this trust relationship come to an end when the contract of sale is completed and a formal equitable assignment is executed? The question must, we think, be answered in the negative, though the nature of the trust changes once the vendor receives payment under the contract. Our reason for saying that a trust continues is that the assignment does not constitute the assignee a partner or pass to him the powers of management, administration and inspection of books and accounts which repose in the assignor as a partner. What is more, legal title to the assets of the partnership continues to vest in the partners to the exclusion of the assignee and he has no access to the assets. The extent of the assignee's equitable interest is ascertainable only on dissolution. These considerations lead us to the conclusion that the assigning partner continues to stand in the relationship of a trustee to the assignee, notwithstanding that the assignee may be entitled to receive payments from partnership profits direct from the partnership.

The Commissioner has followed this trust analysis. At paragraph 5 of IT 2608: 'It is clear from the decisions of the High Court that income flowing from the assigned interest in the partnership is income of a trust estate - comprising the assigned interest - for the purposes of Division 6 of the Income Tax Assessment Act 1936'. References to disposal of an assigned interest (such as paragraph 24 of IT 2540) must be read in that light.

CGT event E1

Section 104-55 of the ITAA 1997 provides that CGT event E1 happens if you create a trust over a CGT asset by declaration or settlement.

In your case, you intend to assign your partnership interest to the Trust. As the Trust is an existing trust, CGT event E1 will not apply.

CGT event E2

Section 104-60 of the ITAA 1997 provides that CGT event E2 happens if you transfer a CGT asset to an existing trust. In order for CGT event E2 to apply there are three requirements that must be satisfied. These are:

· Somebody must 'transfer' an asset into an 'existing trust';

· That somebody, 'you' must be identifiable; and

· The exceptions within subsection 104-60(5) of the ITAA 1997 must not apply

A distinction is to be drawn between the creation of a trust over an asset and the transfer of an asset to an existing trust: Truesdale v. Federal Commissioner of Taxation (1971) 120 CLR 353; 70 ATC 4056.

In the present case, you will be assigning your partnership interest to the Trust. The trust will have been in existence prior to the assignment. Accordingly, you will transfer an asset to an existing trust and CGT event E2 will happen.

CGT event A1

As the effect of an Everett assignment is that the partner retains legal ownership and the assignee acquires the equitable ownership of the assignor's share in the partnership income there has been a change in ownership by operation of the law. This is on the basis that on the commencement of the trust that comes into existence on an Everett assignment, there has been a change in ownership from each partner in their individual capacity, to each partner in their capacity as trustee: see also ATOID 2010/72.

A change in beneficial ownership, otherwise known as a disposal of a CGT asset will trigger CGT event A1. Subsection 104-10(2) of the ITAA 1997 explains when a disposal of a CGT asset occurs. The provision states that:

You dispose of a *CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner.

Note:

A change in the trustee of a trust does not constitute a change in the entity that is the trustee of the trust (see subsection 960-100(2)). This means that CGT event A1 will not happen merely because of a change in the trustee.

In your case, when you assign a part of your partnership interest to the Trust, you will have disposed of a part-interest in the partnership.

The time of the event is when you enter into the contract for the disposal; or if there is no contract - when the change of ownership occurs.

However, in accordance with subsection 102-25(1) of the ITAA 1997, while CGT event A1 happens, CGT event E2 is more specific to the situation, therefore CGT event A1 will not apply.

CGT event D1

Section 104-35 of ITAA 1997 explains that CGT event D1 happens if you create a contractual right or other legal or equitable right in another entity. The time of the event is when you enter into the contract or create the other right. You make a capital gain if the capital proceeds from creating the right are more than the incidental costs you incurred that relate to the event. You make a capital loss if those capital proceeds are less.

Importantly, subsection 104-35(5) of the ITAA 1997 provides that CGT event D1 does not happen if (among other things), the right requires you to do something that is another CGT event that happens to you.

In your case, the agreement entered into to effect the Everett assignment will result in you creating a contractual right in the Trust, however, as we have already established that the assignment will result in CGT event E2 happening, CGT event D1 will not happen by virtue of subsection 104-35(5) of the ITAA 1997.

Active asset test

Section 152-40 of the ITAA 1997 provides the meaning of 'active asset'. A CGT asset will be an active asset at a time if, at that time, you own the asset and the asset was used or held ready for use by you, an affiliate of yours, or by another entity that is 'connected with' you, in the course of carrying on a business.

Subsection 152-35(1) of the ITAA 1997 states that a CGT asset satisfies the active asset test if:

· you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the period of ownership, or

· you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7 and a half years.

Subsection 152-40(1) of the ITAA 1997 provides that an asset is an active asset if the asset is an intangible asset you own and is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or an entity connected with you.

In your case, your interest in the Partnership is an intangible asset. It was through this interest that you carried on a business in partnership with others. Your interest in the Partnership is inseparable from the business (and therefore inherently connected with the business) that you carried on. As such, the interest is considered an active asset.

As your partnership interest was necessarily employed as an active asset throughout the whole period that you held it, the active asset test is satisfied.

Application of Part IVA

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance provision that can apply in certain circumstances. Part IVA gives the Commissioner the power to cancel a 'tax benefit' (or part of a 'tax benefit') that has been obtained, or would, but for section 177F of the ITAA 1936, be obtained, by a taxpayer in connection with a scheme to which Part IVA applies.

In broad terms, Part IVA will apply where the following requirements are satisfied:

· there is a scheme (see section 177A);

· a taxpayer has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme (see section 177C); and

· the dominant purpose of a person who entered into or carried out the scheme, or any part of the scheme, was to enable the relevant taxpayer to obtain a tax benefit in connection with the scheme, or to enable the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (paragraph 177D(b)).

The application of Part IVA depends on a careful weighing of all the relevant facts and surrounding circumstances of each case.

In considering whether Part IVA would specifically apply to an assignment of a partnership interest, Taxation Ruling IT 2501, at paragraph 9, states:

Valid assignments on all fours with the Everett or Galland decisions will be accepted for tax purposes and will not be regarded as caught by section 260 or Part IVA.

The facts relating to the 2014 income year identified in this Ruling application are considered to be 'on all fours' with the facts considered by the Court in the income year considered in Everett. Accordingly, the Commissioner will not apply Part IVA, in the year to which this ruling applies, to deny any tax benefit arising as a result of the assignment.

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