Edited version of your written advice

Authorisation Number: 1012810478634

Ruling

Subject: Assignment of Partnership Interest

Questions and Answers

1. Will capital gains tax (CGT) event E1 apply when you assign a portion of your interest in the Partnership to the Trustee of the Trust (the Trust)?

No

2. Will capital gains tax (CGT) event E1 apply when you assign a portion of your interest in the Partnership to the Company?

Yes

3. Will CGT event E2 apply when you assign your interest in the Partnership to the Trust?

Yes

4. Will CGT event A1 apply when you assign your interest in the Partnership to the Company?

No

5. Will CGT event D1 apply when you assign your interest in the Partnership?

No

6. Will CGT event E9 apply when you assign your interest in the Partnership to the Company and/or the Trust?

No

7. Will the capital gain made by you on entering the assignment qualify for the small business 50% reduction provided by Subdivision 152-C of the ITAA 1997?

Yes

8. Will the 50% discount provided by Division 115 of the ITAA 1997 apply to the capital gain which arises on entering into the assignment?

No

9. Can you elect CGT rollover under subdivision 122-A in respect of a capital gain arising as a result of entering into the Assignment Deed?

No

10. Will the Commissioner administer the disposal of Partnership interests, which are held legally and beneficially by you, in a manner consistent with the principles in Taxation Ruling IT 2540 such that the deemed market value consideration under subsection 116-30(1) of the ITAA 1997 will equal the actual consideration, being nil?

Yes

11. Will the Commissioner administer the acquisition of Partnership interests which are held legally and beneficially by you, in a manner consistent with the principles in IT 2540 such that the deemed market value cost base under subsection 112-20(1) of the ITAA 1997 will be equal to the actual consideration paid, being nil?

Yes

12. Will the Commissioner administer the disposal of Partnership interests which are held by the Trust and/or the Company, in a manner consistent with the principles in IT 2540 such that the deemed market value consideration under subsection 116-30(1) of the ITAA 1997 will equal the actual consideration, being nil?

Yes

13. Will the Commissioner administer the acquisition of Partnership interests on 1 January 2014, which are held by the Trust and/or the Company, in a manner consistent with the principles in IT 2540 such that the deemed market value cost base under subsection 112-20(1) of the ITAA 1997 will be equal to the actual consideration paid, being nil?

Yes

14. Will your assessable income include that share of the partnership income which has been assigned to the Trust and/or the Company?

No

15. 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 and/or the Company?

No

This ruling applies for the following period

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on

1 July 20XX

Relevant facts

You are an equity partner in the Partnership.

The Partnership carries on a business of providing professional services in Australia.

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.

The partners in the Partnership are all natural persons who hold a fractional interest in the Partnership. The acquisition or disposal of an interest in the Partnership is reflective of that person's status as an active practitioner in the practice and held by that person both legally and beneficially. This includes managing partners who do not undertake client work and non-practitioner consultants (for example legal counsel).

The Partnership has capital which reflects merely a nil or immaterial value for goodwill.

The Partnership has adopted an agreement that regulates the basis for admission and exit of partners and the amount that is paid for it. The Partnership agreement provides that no or an immaterial payment is to be made for acquiring a partnership interest, disposing of a partnership interest or any change to the profit distribution entitlements attached to an interest in the Partnership, in respect of goodwill.

You intend to enter into an agreement under which a portion of your interest in the Partnership will be assigned to either or both of the Trust, which is an existing trust, and the Company. The portion of interest to be assigned will be 60%.

You will continue to be the legal owner of the Partnership interest.

The assignment will be irrevocable.

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

• The trustee of a Family Trust

• The Company

• Your existing family members

The trustee of the Trust is the Company; you legally and beneficially own all the shares in the Company.

The Family Trust is a discretionary trust of which you are the trustee. You, your existing and future family members are potential beneficiaries of this trust.

The trustee of the Family Trust and family members will contribute additional share capital to the Company through subscribing to new shares during the 20XX-XX financial year and subsequent financial years.

There is no existing relationship between you and the Trust or Company in respect of the Partnership interest.

You will not have been a member of the Partnership for more than 12 months prior to effecting the assignment. You will have signed the Partnership agreement more than 12 months prior to assignment, but as a matter of membership, you will not have actually been a member of the Partnership for 12 months.

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] HCA 6; (1980) 143 CLR 440 (Everett) and Federal Commissioner of Taxation v. Galland [1986] HCA 83; (1986) 162 CLR 408 (Galland). Documentation is yet to be completed at the time of the application.

On 1 July 20XX a yet to be determined number of new partners will be admitted to the Partnership, these Partners will not be required to pay any consideration for goodwill.

On 1 July 20XX a yet to be determined number of existing partners will exit the Partnership, these partners will not be entitled to any consideration in respect of goodwill.

The admission and exit of partners on 1 July 20XX will occur as part of the normal ebb and flow of carrying on business as a large partnership.

The basic conditions for relief in section 152-10 of the ITAA 1997 are satisfied.

The cost base will be worked out without reference to indexation.

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 subsection 106-5(3)

Income Tax Assessment Act 1997 subsection 106-5(4)

Income Tax Assessment Act 1997 subsection 112-20(1)

Income Tax Assessment Act 1997 subsection 116-30(1)

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

Summary

CGT event E1 will apply if or when you assign your partnership interest to the Company.

CGT event E2 will apply if or when you assign your partnership interest to the Trust.

CGT events E9, A1 and D1 will not apply.

The small business 50% reduction will be available as will the 50% CGT discount.

You cannot elect CGT rollover under subdivision 122-A in respect of a capital gain arising as a result of entering into the Assignment Deed.

The Commissioner will administer the disposal and acquisition of Partnership interests held by you on 1 July 20XX in a manner consistent with the principles in Taxation Ruling IT 2540 Income tax: capital gains: application to disposals of partnership assets and partnership interests (IT 2540), such that the Commissioner will accept that the market value of the capital proceeds and the cost base will be nil.

The Commissioner will administer the disposal and acquisition of partnership interests held by the Trust and/or the Company on 1 July 20XX in a manner consistent with the principles in IT 2540 such that the Commissioner will accept that the market value of the capital proceeds and the cost base will be nil.

On the assumption that the assignment agreement will have the same legal effect and be prepared in a manner consistent with the assignments considered by the High Court in Everett and Galland, your assessable income will not include that share of the net partnership income which has been assigned to the Trust and/or the Company and the Commissioner will not apply Part IVA to deny any tax benefit obtained as a result of assigning an interest in the Partnership to the Trust and/or the Company.

Detailed reasoning

CGT and assignment of a partnership interest

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. 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. Tax Ruling IT 2608 provides:¹

'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

CGT event E1 will happen if or when you assign an interest in the Partnership to the Company.

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 order for CGT event E1 to happen, two requirements must be satisfied. These are:

• you must create a trust over the asset by declaration or settlement and

• the exceptions within subsection 104-55(5) must not apply.

No trust relationship exists between you and the Company before entering into the Everett assignment. Based on the views of the High Court in Everett's case, it is clear that entering into an assignment will involve the creation of a trust of which the partner (in this case, you) will be trustee and the Company is the sole beneficiary. As none of the exceptions in subsection 104-55(5) apply, the second condition will be satisfied.

Furthermore, it is considered that the trust would be created by declaration or settlement as required by subsection 104-55(1).

When a statute speaks of a 'declaration' of trust, it is naturally taken as referring to a declaration or instrument which is effective to create a trust by operating upon property vested in the declarant.² This is what would occur in the present case when you enter into an arrangement to assign your partnership interest to the Company. The effect of such an assignment is to create a trust in respect of the assigned interest.³ A resolution that property is to be held on a separate trust is sufficient to amount to a declaration for the purposes of CGT event E1, even if there is no express declaration.⁴ The manifestation of an intention to create the relevant trust can be inferred from words or conduct, and no formal or technical language is required. Accordingly, it is not essential that you use words such as 'I declare myself a trustee'.⁵

Alternatively it is considered that a trust would be created by way of 'settlement' for the purposes of CGT event E1 in the present case, being an instrument which creates a new beneficial interest in property through the imposition of a trust.⁶

CGT event E2

CGT event E2 will happen if or when you assign an interest in the Partnership to the Trust.

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.

If you assign an interest in the Partnership to the Trustee of the Trust you will transfer that interest to an existing trust and CGT event E2 will happen.

The assignment would also make you the trustee of a trust in respect of the assigned interest; however, CGT event E2 is the more specific event in these circumstances and CGT event E1 would not therefore apply: subsection 102-25(1).

CGT event E9

Section 104-105 of the ITAA 1997 provides that CGT event E9 happens if:

• You agree, for consideration, that when property comes into existence you will hold it on trust; and

• At the time of the agreement, no potential beneficiary under the trust has a beneficial interest in the rights created by the agreement.

CGT event E9 will not happen in the present case, as the assignment will have the same legal effect as the assignments considered in Everett. Accordingly, it will operate in respect of present property, rather than a mere expectancy or future property, and will confer an immediate equitable entitlement upon the assignee.⁷

CGT event A1

Section 104-10 of the ITAA 1997 explains that CGT event A1 happens if you dispose of a CGT asset.

In your case, you will dispose of a part-interest in the Partnership when you assign a part of your partnership interest.

However, CGT events E1 and E2 are more specific to the situation and CGT event A1 will not apply: subsection 102-25(1) of the ITAA 1997.

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.

In your case, the arrangement will result in you creating a right in another entity. However, as the assignment will result in CGT events E1 and E2 happening, CGT event D1 will not apply: subsection 102-25(1) of the ITAA 1997.

The small business 50% reduction

Under section 152-205 of the ITAA 1997, if the basic conditions for the CGT small business concessions are met in relation to a capital gain and the 15 year exemption does not apply, the capital gain will be reduced by 50% under the CGT small business reduction, unless you choose not to apply it.

Assuming you satisfy the basic conditions you are entitled to the small business 50% reduction provided by Subdivision 152-C of the ITAA 1997.

The 50% discount

You will be entitled to 50% discount on a capital gain arising on entering into the assignment if:

• the relevant interest does not have an indexed cost base; and

• you have been a member of the Partnership for more than 12 months.

As you has not been a member of the Partnership for more than 12 months prior to effecting the assignment. You are not entitled to the 50% discount on any capital gain arising on entering into the assignment.

CGT rollover under subdivision 122-A

Where a taxpayer transfers a CGT asset to a wholly-owned company, they are entitled to choose to obtain a roll-over if one of the CGT events listed in the table in section 122-15 applies.

As discussed above, CGT event E1 and/or CGT event E2 apply to the assignment of a portion of your interest in the Partnership. As CGT event E1 and CGT event E2 are not listed in section 122-15 of the ITAA 1997 you are not entitled to choose this roll-over.

Disposal and acquisition of partnership interests on 1 July 20XX

Subsection 106-5(4) of the ITAA 1997 provides that if a new partner is admitted to a partnership:

a) the new partner acquires a share (according to the partnership agreement, or partnership law if there is no agreement) of each partnership asset; and

b) the existing partners are treated as having disposed of part of their interest in each partnership asset to the extent that the new partner has acquired it.

Subsection 106-5(3) of the ITAA 1997 states that if a partner leaves a partnership, a remaining partner acquires a separate CGT asset to the extent that the remaining partner acquires a share of the departing partner's interest in a partnership asset.

In your case, under the terms of the partnership agreement, no consideration is payable in respect of goodwill on the exit or admittance of partners to the partnership. As no consideration will be received by you for your interest in the goodwill of the firm when you dispose of a part of your partnership interest, it will need to be considered whether the market value substitution rules will apply.

Subsection 116-30(1) of the ITAA 1997 provides that if you received no capital proceeds from a CGT event, you are taken to have received the market value of the CGT asset that is the subject of the event (the market value is worked out as at the time of the event).

Subsection 112-20(1) of the ITAA 1997 explains that the first element of your cost base and reduced cost base of a CGT asset you acquire from another entity is its market value (at the time of acquisition) if:

a) you did not incur expenditure to acquire it, except where your acquisition of the asset resulted from:

i. CGT event D1 happening; or

ii. another entity doing something that did not constitute a CGT event happening; or

b) some or all of the expenditure you incurred to acquire it cannot be valued; or

c) you did not deal at arm's length with the other entity in connection with the acquisition.

Taxation Ruling IT 2540 examines the capital gains tax (CGT) implications of a disposal of a partnership interest. Though it is expressed in terms of the former CGT provisions (of the Income Tax Assessment Act 1936), the discussion is still relevant for the purposes of the ITAA 1997. At paragraphs 13 and 14 it states:

…In other cases, it will generally be accepted, provided the evidence reasonably supports the conclusion that the partners are dealing with each other at arm's length. Any consideration paid or received on the acquisition or disposal of an interest in the partnership will be used for Part IIIA (CGT) purposes in determining the cost base or disposal proceeds of the interests in the partnership assets that the partnership interest represents. This will mean that if, for example, the partnership arrangement is such that no amount is payable for the acquisition or disposal of goodwill, it will be accepted for the purposes of Part IIIA (CGT) that the value of the goodwill is nil.

In the case of large professional partnerships, where the partners' dealings with each other are at arm's length, it will only be where consideration is paid by a partner on entering the partnership or where a partner receives a payment on leaving the partnership that Part IIIA (CGT) will have any practical effect. Where consideration is neither paid by a person on entering the partnership, nor received on retirement from the partnership, the partner will not realise a capital gain or incur a capital loss on the disposal of particular assets. However, as noted above, the admission or retirement of a partner may affect the proportionate ownership of the partnership assets by the individual partners and therefore may affect the extent of a continuing partner's interest in the partnership. This would be relevant in the event of a subsequent disposal of the partnership assets for consideration, or where consideration is paid to a partner on retirement from the partnership.

Accordingly, where the evidence demonstrates that such partnership interest dealings are at arm's length, the Commissioner will accept where there is no consideration, that the market value of the partnership interest is nil.

In order for the treatment mentioned in IT 2540 to apply, the Commissioner expects that the following conditions, listed at paragraph 18 of Taxation Determination TD 2011/26 Income tax: capital gains tax: if a share in a 'no goodwill' incorporated professional practice is disposed of for no consideration, will the Commissioner accept, for the purposes of calculating the market value of the share upon a possible application of subsection 116-30(1) of the Income Tax Assessment Act 1997 that the goodwill of the company can be taken to have no value?, (TD 2011/26) must be satisfied. These conditions are:

i. the partners in the partnership are all natural person practitioners who hold a fractional interest in the 'no goodwill' partnership;

ii. the acquisition or disposal of an interest in the partnership must be reflective of that person's status as an active practitioner in the practice and held by that person both legally and beneficially; in this context 'active partner' will include managing partners who do not undertake client work and non-practitioner consultants (for example legal counsel in an accounting firm);

iii. the partnership has capital which reflects merely a nil or immaterial value for goodwill, except in circumstances where the partnership has taken over another practice with goodwill, and such acquired goodwill remains on the partnership's books; in that circumstance, provided the partners cease to recognise that goodwill in dealings between themselves for the admission and exit of partners this condition will be satisfied;

iv. the partnership adopts an agreement that regulates the basis for admission and exit of partners and the amount that is paid for it; and

v. the partnership agreement provides that no or an immaterial payment is to be made for acquiring a partnership interest, disposing of a partnership interest or any change to the profit distribution entitlements attached to an interest in the partnership, in respect of goodwill.

In the present case, the Commissioner accepts your arrangement meets the relevant requirements under IT 2540 and will apply the treatment mentioned in IT 2540 to the acquisition and disposal of partnership interests that occur on 1 July 2015 during the natural ebb and flow of partners into and out of the partnership. This will mean that the Commissioner will accept that the market value of the consideration paid on acquisition of the partnership interest will be nil, and likewise, the consideration received on disposal of the partnership interest will also be nil.

Assessment of partnership net income

Where the assignment of partnership income is in accordance with the Everett or Galland decisions, the tax liability will fall on persons who, at the end of the year of income, have enforceable equitable rights to receive a share of the partnership income.

Therefore, in accordance with section 92 of the ITAA 1936, your assessable income will only include your share of the net income of the partnership that has not been assigned to the Trust and/or the Company.

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)).

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 identified in this Ruling application are assumed 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.

¹ IT 2608 at paragraph 5.

² DKLR Holding Co (No. 2) Pty Ltd v. Commissioner of Stamp Duties (NSW) (1982)149 CLR 431 at 454 and 459.

³ FC of T v. Everett 80 ATC 4076 at 4079-4080.

⁴ Oswal v. FC of T 2013 ATC 20-403 at [44]-[54].

⁵ See Commissioner of Stamp Duties (Qld) v. Jolliffe (1920) 28 CLR 178 at 190-9 per Isaacs J cited with approval in Byrnes v. Kendell (2011) 243 CLR 253; see also, Bahr v Nicolay [No. 2] (1987) 164 CLR 604 at 619; Jacobs' Law of Trusts in Australia 7ed 2006 [at 501].

⁶ Oswal v. FC of T 2013 ATC 20-403 at [56]-[60].

⁷ See FC of T v. Everett 80 ATC 4076 at 4082.

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