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Edited version of your private ruling
Authorisation Number: 1012595772097
Ruling
Subject: Income tax consequences of a sale of a partnership interest
Issue 1
Taxation of trading stock when there is change in partnership interests
Question 1
Whether the Taxpayers can make the election in subsection 70-100(4) of the Income Tax Assessment Act 1997 (ITAA 1997) in respect of the trading stock held by the Former Partnership?
Answer
Yes
Question 2
Will the Former Partnership include the Election Value in its assessable income pursuant to subsection 70-100(5) of the ITAA 1997 in the income year that includes the day of the Proposed Transaction?
Answer
Yes
Question 3
Will the transferee (the New Partnership) be treated as having bought the trading stock that was held by the Former Partnership for the Election Value on the day of the Proposed Transaction pursuant to subsection 70-100(5) of the ITAA 1997?
Answer
Yes
Question 4
Will the New Partnership be entitled to a deduction under section 8-1 of the ITAA 1997 for the amount of the Election Value?
Answer
Yes
Issue 2
Taxation of depreciating assets when there is a change in partnership interests
Question 5
Can the Taxpayers make the election in subsection 40-340(3) of the ITAA 1997 in respect of the depreciating assets held by the Former Partnership (the Capital Allowance Rollover Relief Election)?
Answer
Yes
Question 6
Will any amount be included in the Former Partnership's assessable income under section 40-285 of the ITAA 1997 if the Capital Allowance Rollover Relief Election is made?
Answer
No
Question 7
Will the New Partnership, pursuant to subsection 40-345(2) of the ITAA 1997 deduct the decline in value of the depreciating assets using the same method and effective life that the Former Partnership was using?
Answer
Yes
Issue 3
Assessability of payment made for share of partnership interest.
Question 8
Will any amount of the Proposed Consideration be included in the exiting partner's assessable income under section 6-5 of the ITAA 1997?
Answer
No
Question 9
Will any amount of the Proposed Consideration be included in the exiting partner's assessable income under Part 3-1 of the ITAA 1997?
Answer
No
Issue 4
Deductibility of payment made for share of partnership interest
Question 10
Will the New Partnership be entitled to claim an income tax deduction for any part of the Proposed Consideration under sections 8-1 of the 1997 Act?
Answer
No
Question 11
Will the New Partnership be entitled to claim a deduction for any part of the Proposed Consideration under section 40-880 of the ITAA 1997?
Answer
No
This ruling applies for the following period(s)
The year ended 30 June 2014
The scheme commences on
The day that the Proposed Transaction occurs.
Relevant facts and circumstances
A partnership carries out a business.
The following partnership interests are held in the partnership:
• Partner A as to X%;
• Partner B as to Y%; and
• Partner C as to Z%.
Each of the partners of the partnership is a resident of Australia for the purposes of the Income Tax Assessment Act 1936 (ITAA 1936) and the ITAA 1997.
There have been no changes to the partners of the partnership or their interests in the partnership since establishment.
The partnership's financial statements show that trading stock makes up most of the balance sheet value of the partnership assets. The partnership assets also include some depreciating assets as defined in subsection 40-30 of the ITAA 1997. The other assets included on the financial statements are cash, prepayments and receivables.
Legal title to the trading stock and other partnership assets is held by nominee companies. These nominees act as agent for the partnership. Each partner in the partnership has a beneficial interest in the assets of the partnership to the extent of their interest in the partnership.
The liabilities of the partnership include loans from the partners of the partnership.
There is no other intellectual property or goodwill, sales contracts or other rights held by the partnership.
The trading stock is held as trading stock on hand for the purposes of section 70-10 of the ITAA 1997.
Proposed Transaction
It is proposed that Partner A will dispose of its interest in the partnership (the Former Partnership) to Partner D (an entity associated with Partner B) as to V% and Partners C as to W% (Proposed Transaction).
Following the Proposed Transaction, the partnership (the New Partnership) will be constituted as follows:
• Partner B as to a Y% interest;
• Partner C as to Z% interest; and
• Partner D as to a V% interest (referred to as the "New Partners")
Partner A will receive a payment for its interest in the Former Partnership (the Proposed Consideration) inclusive of the following amounts:
• repayment of the outstanding partner loan;
• payment of unpaid partnership drawings. This include amounts that have previously being included in Partner A's assessable income as its share of partnership income and amounts that will be included in Partner A's assessable income for the year ended 30 June 2014 as its share of partnership income from 1 July 2013;
• payment in respect of Partner A's share of the trading stock (revalued) less liabilities. This amount will be derived as follows: trading stock revaluation (as agreed between the parties) less liabilities and partnership equity. The New Partners will assume Partner A's share of the current liabilities of the partnership.
Shares in the nominee companies (the Sale Shares) will also be disposed of to the New Partners or associated entities. The consideration payable for the Sale Shares will be a nominal amount being equal to the issue price for these shares.
The New Partners will continue to conduct the business under the original partnership agreement.
The value of the trading stock on hand at the time of the Proposed Transaction for the purposes of subsection 70-100(4) of the ITAA 1997 will be less than the market value of the trading stock.
The parties to the Proposed Transaction are dealing with each other at arm's length.
Partner A, Partner B, Partner C and Partner D are together referred to as the Taxpayers.
Relevant legislative provisions
ITAA 1997 section 6-5
ITAA 1997 section 8-1
ITAA 1997 section 40-285
ITAA 1997 section 40-295
ITAA 1997 section 40-340
ITAA 1997 section 40-345
ITAA 1997 section 40-880
ITAA 1997 section 70-25
ITAA 1997 section 70-100
ITAA 1997 section 106-5
ITAA 1997 section 108-5
ITAA 1997 section 118-24
ITAA 1997 section 118-25
Reasons for decision
Background to treatment of partnerships under tax law
1 At general law, a partnership is not recognised as an entity distinct from its partners. It is the partners that carry on a business together and not the partnership as an entity separate from the partners.
2 A partnership is treated as a separate entity for some income tax purposes. In determining the amount included in an individual partner assessable income in respect of a business carried on in partnership, section 92 of the ITAA 1936 includes in the assessable income or deductions of a partner so much of their individual interest in the 'net income' or 'partnership loss', respectively. Section 90 of the ITAA 1936 defines the 'net income' and 'partnership loss' to be calculated 'as if the partnership was a taxpayer'.
3 In addition, the term 'entity is defined in section 960-100 of the ITAA 1997 to include a partnership and is relevant to some of the provisions in the ITAA 1997 and ITAA 1936.
4 However, for capital gains tax purposes, subsection 106-5(1) of the ITAA 1997 provides that any capital gain or capital loss from a CGT event happening in relation to a partnership or one of its assets is made by the partners individually. Subsections 106-5(3) and (4) of the ITAA 1997 provides for the consequences for remaining partners and new partners when a partner leaves a partnership or a new partner is admitted to a partnership.
Issue 1
Treatment of trading stock
5 The definition of trading stock in subsection 70-10(1) of the ITAA 1997 states that it:
'includes
(a) anything produced, manufactured or acquired that is held for the purposes of manufacture, sale or exchange in the ordinary course of a business; and
(b) live stock'.
6 Taxation Determination TD 92/124 Income Tax: property development: in what circumstances is land treated as trading stock? states that land is treated as trading stock if it is held for the purposes of resale and a business activity which involves dealing in land has commenced.
7 A business trading in assets generally deducts the cost of acquiring trading stock under section 8-1 of the ITAA 1997 and includes in assessable income the proceeds of sales made in the ordinary course of the business under section 6-5 of the ITAA 1997. Section 70-25 of the ITAA 1997 states that an outgoing incurred in connection with acquiring trading stock is not an outgoing of capital or of a capital nature.
8 The difference between the values of the stock on hand at the start and end of each year is taken into account by including the excess of closing stock over opening stock in assessable income and allowing a deduction for the excess of opening stock over closing stock (section 70-35 of the ITAA 1997). A taxpayer elects to value its trading stock on hand at the end of an income year at cost, market selling value or replacement value and carries over the value to opening stock at the beginning of the next income year (section 70-40 of the ITAA 1997). The value of trading stock is a nil amount if it was not taken into account at the end of the last income year (subsection 70-40(2) of the ITAA 1997).
9 Sections 70-90 and 70-100 of the ITAA 1997 deal with disposals (or deemed disposals) of trading stock outside the ordinary course of the taxpayer's business.
10 Section 70-80 of the ITAA 1997 explains why the rules relating to disposals or items otherwise ceasing to be held as trading stock are necessary. Subsection 70-80(3) of the ITAA 1997 states that an item stops being a taxpayers trading stock if, inter alia, interests in it change. Subsection 70-80(2) of the ITAA 1997 states that if an items stops being a taxpayers trading stock for reasons other than a disposal in the ordinary course of business an amount is generally included in assessable income to balance the reduction in trading stock on hand.
11 The Explanatory Memorandum to the Tax Law Improvement Bill 1997 at chapter 40 explains:
This section provides for what happens if a partial change of interests in trading stock causes that stock to be held by a different entity (eg. if there is a change in the membership of a partnership that has trading stock).
12 Subsection 70-100(1) of the ITAA 1997 provides:
An item of trading stock is treated as having been disposed of outside the ordinary course of business if it stops being trading stock on hand of an entity (the transferor) and, immediately afterwards:
(a) the transferor is not the item's sole owner; but
(b) an entity that owned the item (alone or with others) immediately beforehand still has an interest in the item.
Example:
A grocer decides to take her daughters into partnership with her. Her trading stock becomes part of the partnership assets, owned by the partners equally. As a result, it becomes trading stock on hand of the partnership instead of the grocer. This section treats the grocer as having disposed of the trading stock to the partnership outside the ordinary course of her business.
Note:
If the transferor is the item's sole owner after it stops being trading stock on hand of the transferor, section 70-110 applies instead of this section.
13 Where subsection 70-100(1) of the ITAA 1997 Act applies, subsections 70-100(2) and (3) of the ITAA 1997 provide:
(1) As a result, the transferor's assessable income includes the market value of the item on the day it stops being trading stock on hand of the transferor.
(2) The entity or entities (the transferee) that own the item immediately after it stops being trading stock on hand of the transferor are treated as having bought the item for the same value on that day.
14 However, an election can be made to treat an item of trading stock as having been disposed of for what would have been its value as trading stock of the transferor on hand at the end of an income year ending on the day that it stops being trading stock pursuant to subsection 70-100(4) of the ITAA 1997, provided that the conditions in subsection 70-100(6) of the ITAA 1997 are met.
15 The conditions in subsection 70-100(6) of the 1997 Act are as follows:
(a) immediately after the item stops being trading stock on hand of the transferor, it is an asset of a business carried on by the transferee;
(b) immediately after the item stops being trading stock on hand of the transferor, the entities that owned it immediately beforehand have (between them) interests in the item whose total value is at least 25% of the item's market value on that day; and
(c) the value elected is less than that market value; and
(d) the item is not a thing in action.
16 Where the election in subsection 70-100(4) of the 1997 Act is made, the transferor will include the value elected in its assessable income for the income year. The transferee is taken to have bought the trading stock for that same value on the same day: subsection 70-100(5) of the ITAA 1997.
17 Subsection 70-100(8) provides that the election must be in writing and signed by or on behalf of each of the entities that owned the item immediately before it stops being trading stock on hand of the transferor and signed by or on behalf of the entities that own it immediately after.
18 The election must be made before 1 September following the income year in which the item stops being trading stock on hand of the transferor. However, the Commissioner may allow the election to be made later: subsection 70-100(7) of the ITAA 1997.
19 Pursuant to subsection 70-100(10) of the ITAA 1997 an election is not effective if :
(a) the items stops being trading stock on hand of the transferor outside the course of ordinary family or commercial dealing; and
(b) the consideration receivable by the transferor (or by any of the entities constituting the transferor) substantially exceeds what would reasonably be expected to be the consideration receivable by the entity concerned if the market value of the item immediately before it stops being trading stock on hand of the transferor were the value elected under subsection (4).
20 Consideration receivable means so much of the value of any benefit as is reasonable to expect that that entity will obtain in connection with the item ceasing to be trading stock on hand of transferor (subsection 70-100(11) of the ITAA 1997).
Question 1
Whether the Taxpayers can make the election in subsection 70-100(4) of the ITAA 1997 in respect of the trading stock held by the Former Partnership?
21 Subsection 70-100 of the ITAA 1997 applies to treat the trading stock as having been disposed of outside the ordinary course of business because under the Proposed Transaction:
(a) the trading stock stops being trading stock of the Former Partnership as the partnership is dissolved and the New Partnership is formed (i.e. interests in the trading stock change - subsection 70-80(3) of the ITAA 1997);
(b) immediately before the Proposed Transaction, Partner B and Partner C owned the Trading stock (with Partner A) because they each had a beneficial interest in the trading stock in their respective partnership interests; and
(c) immediately after the Proposed Transaction, Partner B and Partner C still have an interest in the Trading stock (with Partner D).
22 The Taxpayers can elect to treat the trading stock as having been disposed of for what would have been its value as trading stock of the Former Partnership on hand at the end of an income year ending on the date of the Proposed Transaction (Election Value) because each of the conditions in subsection 70-100(6) of the ITAA 1997 will be met as follows:
(a) immediately after the item stops being trading stock of the Former Partnership, the trading stock will be an asset of a business carried on by the New Partnership;
(b) immediately after the item stops being trading stock of the Former Partnership, Partner B and Partner C will hold X% of the interest in the trading stock;
(c) the Election Value will be less than the market value of the trading stock; and
(d) the trading stock is not a thing in action.
23 Subsection 70-100(10) of the ITAA 1997 will not apply to make the election ineffective because the Trading stock stops being trading stock of the Former Partnership in the course of ordinary commercial dealings.
24 Therefore, the Taxpayers can make the election in subsection 70-100(4) of the ITAA 1997 in respect of the trading stock of the Former Partnership.
Question 2
Will the Former Partnership include the Election Value in its assessable income pursuant to subsection 70-100(5) of the ITAA 1997 in the income year that includes the day of the Proposed Transaction?
25 Pursuant to subsection 70-100(1) of the ITAA 1997 the Former Partnership is deemed to have disposed of the trading stock.
26 Where an election is made pursuant to subsection 70-100(4) of the ITAA 1997, the Former Partnership's net income for the purposes of section 90 of the ITAA 1936 includes the Election Value for the income year that includes the day of the Proposed Transaction (subsection 70-100(5) of the ITAA 1997).
Question 3
Will the transferee (the New Partnership) be treated as having bought the trading stock that was held by the Former Partnership for the Election Value on the day of the Proposed Transaction pursuant to subsection 70-100(5) of the ITAA 1997?
27 Where an election is made pursuant to subsection 70-100(4) of the ITAA 1997, the partners in the New Partnership are treated as having bought the trading stock for the Election Value of the day of the Proposed Transaction pursuant to subsection 70-100(5) of the ITAA 1997.
Question 4
Will the New Partnership be entitled to a deduction under section 8-1 of the ITAA 1997 for the amount of the Election Value?
28 As the New Partnership is treated as having bought the trading stock for the Election Value on the day of the Proposed Transaction, the New Partnership is treated as having incurred an amount equal to the Election Value in respect of the acquisition of the Trading stock.
29 The purchase of trading stock is on revenue account (refer section 70-5 of the ITAA 1997) as expenditure incurred in gaining or producing assessable income, and therefore is deductible under section 8-1 of the ITAA 1997. Section 70-25 of the ITAA 1997 states that an outgoing you incur in connection with acquiring trading stock is not capital or of a capital nature.
30 Therefore, the New Partnership is entitled to a deduction under section 8-1 of the ITAA 1997 in the amount of the Election Value.
Issue 2
Capital allowance rollover relief
31 Pursuant to subsection 40-285(1) of the ITAA 1997 an amount is included in a taxpayer's assessable income if:
(a) a *balancing adjustment event occurs for a *depreciating asset you *held and:
i. whose decline in value you worked out under Subdivision 40-B; or
i. whose decline in value you would have worked out under that Subdivision if you had used the asset; and
(b) the asset's *termination value is more than its *adjustable value just before the event occurred.
32 The amount included under subsection 40-285(1) of the ITAA 1997 is the difference between the termination value and the adjustable value just before the event occurred.
33 Subsection 40-285(2) of the ITAA 1997 explains when you can deduct an amount for a balancing adjustment event.
34 Subsection 40-295(2) of the 1997 Act provides that:
(a) A balancing adjustment event occurs for a depreciating asset if:
(b) for any reason, a change occurs in the holding of, or in the interests of the entities in, the asset; and
(c) the entity or one of the entities that had an interest in the asset before the change has an interest in it after the change; and
(d) the asset was a partnership asset before the change or becomes one as a result of the change.
35 Item 5 of the table in subsection 40-300(2) of the ITAA 1997 provides that the termination value of a depreciating asset for a balancing adjustment event referred to in subsection 40-295(2) of the ITAA 1997 occurring will be the market value of the asset when the balancing adjustment event occurred.
36 Rollover relief for a balancing adjustment event covered in subsection 40-295(2) of the 1997 Act is provided under subsection 40-340(3) of the ITAA 1997 as follows:
There is rollover relief if:
(a) there is a balancing adjustment event for a depreciating asset because of subsection 40-295(2) (about a change in the holding of, or in interests in, the asset); and
(b) the entity or entities that had an interest in the asset before the change (also the transferor) and the entity or entities that have an interest in the asset after the change (also the transferee) jointly choose the roll-over relief.
37 Section 40-345 of the ITAA 1997 provides:
(1) Section 40-285 does not apply to the *balancing adjustment event for the transferor.
(2) The transferee can deduct the decline in value of the *depreciating asset using the same method and *effective life (or *remaining effective life if that method is the *prime cost method) that the transferor was using.
Question 5
Can the Taxpayers make the election in subsection 40-340(3) of the ITAA 1997 in respect of the depreciating assets held by the Former Partnership (the Capital Allowance Rollover Relief Election)?
38 The Proposed Transaction would trigger a balancing adjustment event under subsection 40-295(2) of the ITAA 1997 because:
(a) there is a change in the interests in the depreciating assets as a result of the Proposed Transaction;
(b) Partner B and Partner C had an interest in the assets before the change and after the change; and
(c) the depreciating assets were assets of the Former Partnership before the Proposed Transaction.
39 The Taxpayers can make the election (jointly choose to apply the roll-over relief) under subsection 40-340(3) of the ITAA 1997, as there would be a balancing adjustment event under subsection 40-295(2) of the ITAA 1997 and the Taxpayers are the entities that had an interest in the depreciating assets before and after the Proposed Transaction.
Question 6
Will any amount be included in the Former Partnership's assessable income under section 40-285 of the ITAA 1997 if the Capital Allowance Rollover Relief Election is made?
40 Pursuant to subsection 40-345(1) of the ITAA 1997, where the Taxpayers jointly choose the roll-over relief, section 40-285 of the ITAA 1997 will not apply to the balancing adjustment event for the Former Partnership, and therefore, it will not include any amount in its assessable income because of the balancing adjustment event occurring.
Question 7
Will the New Partnership, pursuant to section 40-345(2) of the ITAA 1997 deduct the decline in value of the Depreciating Assets using the same method and effective life that the Former Partnership was using?
41 Pursuant to subsection 40-345(2) of the ITAA 1997, where the Taxpayers jointly choose the roll-over relief, the New Partnership will use the same method and effective life when deducting the amount of the decline in value of the depreciating assets that was used by the Former Partnership before the Proposed Transaction occurred.
Issue 3
Assessability of payment made for share of partnership interest.
Question 8
Will any amount of the Proposed Consideration be included in the exiting partner's assessable income under section 6-5 of the ITAA 1997?
42 A taxpayer's assessable income includes income according to ordinary concepts: Section 6-5 of the ITAA 1997
43 The Proposed Consideration is attributable to the following:
(a) repayment of the outstanding partner loan;
(b) payment of unpaid partnership drawings; and
(c) payment in respect of Partner A's share of the trading stock (revalued) less liabilities and partnership equity and assumption of Partner A's share of the liabilities.
44 The repayment of the outstanding partner loan will not be included in Partner A's assessable income as it is a capital receipt.
45 The repayment of Partner A's unpaid partnership drawings is a return of capital invested in the Former Partnership and is a capital receipt.
46 Pursuant to subsection 70-100(1) of the ITAA 1997, the Former Partnership is deemed to have disposed of the trading stock. This deeming occurs irrespective of the actual consideration changing hands in respect of the partial change of ownership. By virtue of an election having been made under subsection 70-100(4) of the ITAA 1997, the Former Partnership includes the Election Value in its net income under section 90 of the ITAA 1936.
47 As stated in subsection 70-80(2) of the ITAA 1997, the amount included in assessable income when an items stops being a taxpayer's trading stock for reasons other than a disposal in the ordinary course of business is generally included in assessable income to balance the reduction in trading stock on hand. The effect of the election made under subsection 700-100(4) of the ITAA 1997 is that the amount deemed to be included in assessable income is equal to what would have been the closing value of Trading stock for the Former Partnership on the day of the Proposed Transaction (had there not been a deemed disposal), and therefore, matches the reduction in trading stock on hand which is accounted for under subsection 70-35(3) of the ITAA 1936 as a deduction. The tax liability in respect of the difference between the value for tax purposes and market value is deferred until there is an actual disposal of the trading stock and the profit is realised by the New Partners.
48 There is no amount in respect of the Proposed Consideration attributable to trading stock that Partner A will include in its assessable income under section 6-5 of the ITAA 1997.
Question 9
Will any amount of the Proposed Consideration be included in the exiting partner's assessable income under Part 3-1 of the ITAA 1997?
49 A 'CGT asset' for the purposes of Part 3-1 of the ITAA 1997 is defined in section 108-5 to mean:
(a) any kind of property; or
(b) a legal or equitable right that is not property.
50 Subsection 108-5(2) of the ITAA 1997 expands on this definition to provide some examples for the avoidance of doubt. Included in these are:
(a) …
(b) …
(c) an interest in an asset of a partnership;
(d) an interest in a partnership that is not covered by paragraph (c).
51 Subsection 106-5(1) of the ITAA 1997 provides that any capital gain or capital loss from a CGT event happening in relation to a partnership or one of its assets is made by the partners individually. Subsections 106-5(3) and (4) of the ITAA 1997 provides for the consequences for the remaining partners and new partners when a partner leaves or a new partner is admitted.
52 Taxation Ruling No. IT 2540 Income Tax: Capital Gains: Application to disposals of partnership assets and partnership interests explains at paragraph 9 that in order to determine any capital gain or loss to the partner in respect of the disposal of their interest in each of the partnership assets it is necessary to determine the portion of the disposal proceeds attributable to each of those interests. Paragraph 13 provides that where parties are dealing with each other at arm's length and the dealings take place in an ordinary commercial context it will generally be accepted, provided that the evidence reasonably supports the conclusion, that any consideration paid or received on disposal of an interest in the partnership will be used for Part IIIA purposes in determining the cost base or disposal proceeds of the interests in the partnership assets that the partnership interest represents.
53 Subsection 118-25(1) of the ITAA 1997 states:
A capital gain or capital loss you may make from a CGT asset is disregarded if, at the time of the CGT event, the asset is:
(a) …;
(b) if you are a partner, trading stock of the partnership; or
(c) … .
54 In respect of depreciating assets, section 118-24 of the 1997 Act provides:
118-24(1) A capital gain or capital loss you make from a CGT event (that is also a balancing adjustment event) that happens to a depreciating asset is disregarded if the asset was:
(a) …; or
(b) if you are a partner, an asset of the partnership; or
(c) …;
where the decline in value of the asset was worked out under Division 40 (including that Division as it applies under Division 355), or the deduction for the asset was calculated under Division 328, or would have been if the asset had been used.
118-24(2) However, subsection (1) does not apply to:
(a) a capital gain or capital loss you make from CGT event J2 or CGT event K7 happening; or
(b) a depreciating asset for which you or another entity has deducted or can deduct amounts under Subdivision 40-F or 40-G.
Application to your circumstances
55 The Former Partnership's assets are mainly comprised of trading stock and the depreciating assets. The other assets are cash, receivables, prepayments, and intellectual property (nominal value). No part of the Proposed Consideration is attributable to the depreciating assets or other assets.
56 The trading stock and the depreciating assets are CGT assets. Partner A's interest in each of the assets of the Former Partnership is also a CGT asset as is its interest in the Former Partnership (to the extent that such an interest is not covered by its interests in the assets of the Partnership).
57 Applying the process explained in paragraph 9 of IT 2540, insofar as the Proposed Consideration is attributable to Partner A's interest in the Former Partnership's assets it is attributable to the trading stock. Therefore, it is necessary to consider if any capital gain is made in respect of Partner A's disposal of its interest in the Former Partnership to the extent that it is a disposal of its individual interest in the trading stock.
58 In relation to Partner A's interest in the trading stock, subsection 118-25(1) of the ITAA 1997 provides that a capital gain or loss made by a partner in a partnership from trading stock of the partnership is disregarded.
59 Although no part of the Proposed Consideration is attributable to the depreciating assets, it is noted that any capital gain or loss is disregarded when made from a CGT event that is a balancing adjustment event that happens to a depreciating asset of a partnership where the decline in value was worked out under Division 40 of Part III of the ITAA 1997 and subsection 118-24 of the ITAA 1997 does not apply.
Issue 4
Deductibility of payment made for share of partnership interest
Question 10
Will the New Partnership be entitled to claim an income tax deduction for any part of the Proposed Consideration under sections 8-1 of the 1997 Act?
60 Subsection 8-1(1) of the ITAA 1997 allows a deduction for any loss or outgoing to the extent that:
(a) it is incurred in gaining or producing your assessable income; or
(b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.
61 However, subsection 8-1(2) of the ITAA 1997 provides that a loss or outgoing is not deductible to the extent that:
(a) it is a loss or outgoing of capital, or of a capital nature;
(b) it is a loss or outgoing of a private or domestic nature;
(c) it is incurred in relation to gaining or producing your exempt income or your non-assessable non-exempt income; or
(d) a provision of [the ITAA 1997 or the ITAA 1936] prevents you from deducting it.
Application to your circumstances
62 The Proposed Consideration is attributable to the following:
(a) repayment of the outstanding partner loan;
(b) payment of unpaid partnership drawings; and
(c) payment in respect of Partner A's share of the trading stock (revalued) less liabilities and partnership equity and assumption of Partner A's share of the liabilities of the Former Partnership.
63 The repayment of the outstanding partner loan will not be deductible as it is capital expenditure.
64 The repayment of Partner A's unpaid partnership drawings is a return of capital invested in the Former Partnership and is capital expenditure.
65 The purchase of trading stock is on revenue account (refer section 70-5 of the ITAA 1997) as expenditure incurred in gaining or producing assessable income and therefore is deductible under section 8-1 of the ITAA 1997. Section 70-25 of the ITAA 1997 states that an outgoing you incur in connection with acquiring trading stock is not capital.
66 However, as explained earlier in these reasons, where an election is made pursuant to subsection 70-100(4) of the ITAA 1997, the partners in the New Partnership are treated as having bought the Trading stock for the Election Value pursuant to subsection 70-100(5) of the ITAA 1997. This deeming occurs irrespective of the actual consideration changing hands in respect of the partial change of ownership of the trading stock.
67 Therefore, the New Partnership is treated as having incurred an amount equal to the Election Value in respect of the acquisition of trading stock for the purposes of section 8-1 of the ITAA 1997.
68 Therefore, no further amount is deductible under section 8-1 of the ITAA 1997 in respect of the Proposed Consideration that is attributable to trading stock.
Question 12
Will the New Partnership be entitled to claim a deduction for any part of the Proposed Consideration under section 40-880 of the ITAA 1997?
69 Subsection 40-880(2) of the ITAA 1997 provides for a deduction in equal portions over five years for, inter alia capital expenditure incurred in relation to a taxpayer's business (including for a former business or proposed business) or in winding up a business partnership.
70 Subsection 40-880(1) of the ITAA 1997 explains that the object of the section is to make certain business expenditure deductible where it is not otherwise taken into account, not otherwise denied deductibility, and the business is (was or proposed to be) carried on for a taxable purpose.
71 Subsection 40-880(9) of the ITAA 1997 provides that the taxpayer cannot deduct anything under the section for an amount of expenditure incurred:
(a) by way of returning an amount they have received (except to the extent that the amount was included in their assessable income or taken into account in working out an amount so included); or
(b) to the extent that, for another entity, the amount is a return on or of:
i. an equity interest; or
ii. a debt interest that is an obligation of theirs.
72 Taxation Ruling TR 2011/6 Income tax: business related capital expenditure - section 40-880 of the Income Tax Assessment Act 1997 core issues in paragraph 306 explains that amounts that comprise the transfer or distribution of or on funds, that comprise repayments or that comprise amounts that do not otherwise give rise to any income tax consequences are not deductible under section 40-880. Such amounts do not represent an economic loss to the taxpayer.
73 Paragraph 40-880(9)(a) excludes from deductibility expenditure incurred by the taxpayer which returns an amount the taxpayer has received and that has not been included in the taxpayer's assessable income or in working out an amount included in that assessable income, for example, the repayment of loan principal.
74 For the purpose of paragraph 40-880(9)(b), 'equity interest' takes its meaning from section 820-930 in the case of a partnership. Equity interest is defined in subsection 995-1(1) of the ITAA 1997 with reference to subsection 820-930(2) of the ITAA 1997, which provides, in the case of a partnership, an interest as a partner in the partnership. 'Debt interest' takes its meaning from Subdivision 974-B.
75 To the extent that the taxpayer's capital expenditure is a return on or of an equity interest of another entity it is excluded from deductibility under subparagraph 40-880(9)(b)(i) of the ITAA 1997.
Application to your circumstances
76 The Proposed Consideration is attributable to the following:
(a) repayment of the outstanding partner loan;
(b) payment of unpaid partnership drawings; and
(c) payment in respect of Partner A's share of the trading stock (revalued) less liabilities and partnership equity and assumption of Partner A's share of the Former Partnership's liabilities.
77 Subsection 40-880 of the ITAA 1997 only applies to capital expenditure incurred. The purchase of trading stock is on revenue account (refer section 70-5 of the ITAA 1997). Section 70-25 of the ITAA 1997 states that an outgoing you incur in connection with acquiring trading stock is not capital or of a capital nature.
78 It is noted that where an election is made pursuant to subsection 70-100(4) of the ITAA 1997, the partners in the New Partnership are treated as having bought the Trading stock for the Election Value pursuant to subsection 70-100(5) of the ITAA 1997, and therefore, as having incurred an amount equal to the Election Value in respect of the acquisition of trading stock. A deduction in respect of the deemed disposal of trading stock is already taken into account for the New Partnership under section 8-1 of the ITAA 1997 in the amount of the Election Value.
79 Therefore, the amount of the Proposed Consideration attributable to trading stock is not deductible under section 40-880 of the ITAA 1997.
80 The repayment of the outstanding partner loan is not deductible under section 40-880 of the ITAA 1997 as the amounts are excluded pursuant to subsection 40-880(9) of the ITAA 1997 as being the return of amounts received that were not included in assessable income or taken into account in working out an amount so included.
81 The repayment of unpaid partnership drawings is not deductible under section 40-880 of the ITAA 1997 as the amounts are excluded pursuant to subsection 40-880(9) of the ITAA 1997 as the return on or of an equity interest or the return of amounts received that were not included in assessable income or taken into account in working out an amount so included.
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