Edited version of your private ruling

Authorisation Number: 1012549378474

Ruling

Subject: Partnership income and deductions

Question 1

Does a partnership exist for tax purposes and is it carrying on a business?

Answer

Yes

Question 2

Are you entitled to treat your income from the partnership as passive income?

Answer

No

Question 3

Are you entitled to claim a deduction for interest incurred on a loan used to invest in the partnership?

Answer

Yes

This ruling applies for the following period

Year ended 30 June 2013

The scheme commenced on

1 July 2012

Relevant facts

You were involved in a business activity involving an entity.

This activity was called a joint venture and a joint venture agreement was drafted.

The Joint Venture Agreement contained the following clause:

· The joint venture assets shall be distributed in the following manner and priority:

· In payment of any costs and expenses payable by the joint venture in respect of that sale

· In repaying loans made to the joint venturers for the purpose of the joint venture

· In repayment of other costs and expenses of the joint venture

· In repaying advances made by the joint venturers

· In repayment of an specified amount of money to the joint venturers in the specified proportions

· The balance remaining is to be divided between the joint venturers in the specified proportions.

The decision was made to sell off the assets and this was completed over a number of years, up to and including the 2011-12 financial year.

At the conclusion of the sale process a single asset remained.

The asset was unsaleable in its existing form and the decision was taken by the entity to carry out a business undertaking.

The activity was managed by a related taxpayer. The project was funded by you.

Other than providing the funding and receiving distributions out of the profit you were not involved with the activity carried out by the entity.

The funds provided by you were treated as either loans or capital contributions in the entity's financial statements.

You took out loans and incurred interest on those loans. The loans were used to loan the funds to the entity or as a capital contribution to the entity.

The entity has been lodging partnership tax returns from the day it commenced its activities.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision

Question 1

The term partnership is defined in subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997) as an association of persons (other than a company or a limited partnership) carrying on business as partners or in receipt of ordinary income or statutory income jointly.

The distinction between a joint venture and a partnership is that a joint venture is, broadly, the relationship that subsists between parties carrying on an undertaking in common for their individual gain. It is usually a relationship between two or more parties formed for a particular commercial transaction or transactions, the product of which will be taken by the joint venturers in such shares as is mutually agreed between them and disposed of by them individually at such times as the venturers may individually determine.

Notwithstanding the expanded statutory definition of partnership, a joint venture is not a partnership for income tax purposes. The distinguishing factor between a joint venture and a partnership for income tax purposes is that, for a tax partnership there must be a joint receipt of income but, in the case of a joint venture, each venturer derives separate income and there is no joint derivation of income.

In your case the entity was carrying out a business activity. The agreement outlined that upon sale the joint venture assets would be distributed to pay costs and expenses, advances then the balance divided between the joint venturers.

The entity is an association of persons carrying on business as partners therefore the entity is a partnership for tax purposes. It is not a joint venture because there is joint receipt of income as outlined in the Joint Venture agreement. A partnership exists and it carries on business.

Question 2

The term "partnership" is defined in subsection 995-1(1) of the ITAA 1997 to include an association of persons carrying on a business as partners. This aspect of the definition imports the common law meaning of partnership, being the relationship which exists between persons carrying on business in common with a view to profit.

A partnership is not a separate legal identity. Each partner of a partnership is carrying on the partnership business. It follows that, where a partnership is carrying on a business, each partner of that partnership is considered to be carrying on business.

In your case the partnership was in business. As the partnership was in business each of the partners are also considered to be carrying on a business. The income you receive from the partnership is not passive income as you are in business.

Question 3

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature.

A number of significant court decisions have determined that for an expense to be an allowable deduction:

· it must have the essential character of an outgoing incurred in gaining

assessable income or, in other words, of an income-producing expense

(Lunney v. FC of T; (1958) 100 CLR 478,

· there must be a nexus between the outgoing and the assessable income so

that the outgoing is incidental and relevant to the gaining of assessable

income (Ronpibon Tin NL v. FC of T, (1949) 78 CLR 47, and

· it is necessary to determine the connection between the particular outgoing

and the operations or activities by which the taxpayer most directly gains or

produces his or her assessable income (Charles Moore Co (WA) Pty Ltd v.

FC of T, (1956) 95 CLR 344; FC of T v. Hatchett, 71 ATC 4184).

Taxation Ruling TR 95/25 provides the Commissioner's view regarding the deductibility of interest expenses. As outlined in TR 95/25, there must be a sufficient connection between the interest expense and the activities which produce assessable income. TR 95/25 specifies that to determine whether the associated interest expenses are deductible, it is necessary to examine the purpose of the borrowing and the use to which the borrowed funds are put.

The 'use' test, established in the High Court case Federal Commissioner of Taxation v. Munro (1926) 38 CLR 153, (1926) 32 ALR 339 is the basic test for the deductibility of interest, and looks at the application of the borrowed funds as the main criterion.

Accordingly, it follows that if a loan is used for investment purposes from which assessable income is to be derived, the interest incurred on the loan will generally be deductible. 

In your case, you have invested in the entity by injecting funds from a third party loan. You have incurred interest on that loan. The loan was used to invest in the entity which in turn carried out a business activity. You received the proceeds from the sale. Therefore a deduction is allowable under section 8-1 of the ITAA 1997.

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