Edited version of your written advice

Authorisation Number: 1013085165921

Date of advice: 7 September 2016

Ruling

Subject: Capital gains tax consequence of assignment of your partnership interest

Question 1

Will CGT event E1 under section 104-55 of the Income Tax Assessment Act 1997 (ITAA 1997) happen when you assign, by way of declaration of trust, a beneficial interest in the Partnership to a family discretionary trust?

Answer

Yes

Question 2

Will CGT event E2 under section 104-60 of the ITAA 1997 happen when you assign, by way of declaration of trust, a beneficial interest in the Partnership to a family discretionary trust?

Answer

No

Question 3

Will CGT event A1 under section 104-10 of the ITAA 1997 happen when you assign, by way of declaration of trust, a beneficial interest in the Partnership to a family discretionary trust?

Answer

No

Question 4

Assuming either CGT event E1, E2 or A1 happens, for CGT purposes, will the capital proceeds for your disposal of the partnership interest to a family discretionary trust be the consideration received by you for the assignment if that consideration is less than market value?

Answer

No

Question 5

Assuming either CGT event E1, E2 or A1 happens, will the capital proceeds (if actual consideration is less than market value) for your disposal of the partnership interest to a family discretionary trust be the deemed market value consideration under subsection 116-30(1) of the ITAA 1997 for the CGT event, which will equal an amount determined by an independent qualified valuer, if the actual consideration is less than market value.

Answer

Yes

Question 6

Will the CGT event happen in relation to an active asset owned by you for the purposes of section 152-40 of the ITAA 1997?

Answer

Yes

Question 7

In calculating any CGT payable by you on your disposal of the partnership interest to a family discretionary trust, is the Service Trust or Finance Trust an entity 'connected with' you as defined under section 328-125 of the ITAA 1997 for the purposes of the maximum net asset value test under section 152-15 of the ITAA 1997?

Answer

No

Question 8

In calculating any CGT payable by you on your disposal of the Partnership interest to a family discretionary trust, are the other partners in the Partnership 'affiliates' of you as defined under section 328-130 of the ITAA 1997 for the purposes of the maximum net asset value test under section 152-15 of the ITAA 1997?

Answer

No

This ruling applies for the following periods:

1 July 201X to 30 June 201Y

The scheme commences on:

1 July 201X

Relevant facts and circumstances

You are an equity partner of the Partnership.

The Partnership provides professional services.

The Partnership operates as a 'no-goodwill' partnership. Goodwill is not recognised either in the balance sheet of the Partnership or for any other purpose.

New partners, when admitted to the partnership, do not make any payment to existing partners to acquire any goodwill. Partners also are not entitled to receive any consideration for the disposal of goodwill when they retire or otherwise exit from the partnership.

On admission to the partnership, partners make a fixed contribution to the working capital of the firm. This capital contribution is returned to the partner on retirement from the partnership.

The "Partnership Group" consists of the Partnership, the Service Trust and the Finance Trust.

The Service Trust is a discretionary trust that provides various services to the Partnership to undertake its professional services business. The potential beneficiaries of the Service Trust are the partners of the Partnership and nominated associates of the partners.

The Partnership pays arm's length service fees to the Service Trust.

The Finance Trust is the vehicle through which equity partners are required to subscribe Loan Equity Capital to the Partnership through an entity related to them (generally a trust). It is a unit trust with units having a value of $x.xx on subscription and $x.xx on redemption. The units receive and pay interest at commercial rates with the unit holder earning a small margin. No partner holds an interest of X% or more in the income and capital of the trust.

For the purpose of enhanced family asset planning and protection, the Partnership intends to amend the partnership deed allowing each partner to assign a portion of his or her partnership interest by way of declaration of trust ('Everett assignment'), where specifically approved by the Board of the Partnership.

The declaration of trust will be irrevocable.

In your arrangement, you propose to assign a portion of your interest in the Partnership (X%) to a discretionary family trust ('the Trust'). When considered together with the distribution from the Service Trust and the Finance Trust, you will receive in your own hand no less than X% of the overall profits of the Partnership Group each income year.

The Trust will pay consideration for the assigned partnership interest, although the consideration may be less than market value.

The assignment will effect the assignment of all beneficial rights associated with the partnership interest, including the right to receive the share of income of the partnership. You will continue to be a legal partner of the Partnership. The trustee of the Trust will not become a member of the Partnership, nor will the trustee be entitled to interfere in the partnership's business or affairs or to require any account or to inspect the books of the Partnership.

The potential beneficiaries of the Trust will be limited to family members or entities associated with you. While you are a partner of the Partnership, you will also be a beneficiary of the Trust.

Assumptions

You are a capital or full equity partner of the Partnership and this response is based on the facts and arrangements pertaining to capital or full equity partners. Therefore, the questions answered in this advice are intended to only cover issues for capital or full equity partners. This advice is not intended to apply to fixed draw partners, non-equity partners or limited equity partners.

Documents 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).

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

A market valuation will be obtained from an accredited valuer in relation to the assigned partnership interest. 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). This valuation will 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.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Section 102-5,

Income Tax Assessment Act 1997 - Section 102-20,

Income Tax Assessment Act 1997 - Section 102-25,

Income Tax Assessment Act 1997 - Section 104-10,

Income Tax Assessment Act 1997 - Section 104-55,

Income Tax Assessment Act 1997 - Section 104-60,

Income Tax Assessment Act 1997 - Section 108-5,

Income Tax Assessment Act 1997 - Section 116-20,

Income Tax Assessment Act 1997 - Section 116-30,

Income Tax Assessment Act 1997 - Section 152-10,

Income Tax Assessment Act 1997 - Section 152-15,

Income Tax Assessment Act 1997 - Section 328-125,

Income Tax Assessment Act 1997 - Section 328-130, and

Income Tax Assessment Act 1997 - Section 995-1.

Reasons for decision

CGT implications of holding a portion of your partnership interest as trustee

The Commissioner considers that CGT event E1 will happen when you commence holding a portion of your interest in the Partnership as trustee for the Trust.

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

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

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

It is considered that the first condition will be satisfied in the present case.

No trust relationship currently exists between you and the Trust. However, you intend to commence holding a portion of your interest in the Partnership as trustee for the Trust. Accordingly, it is clear that the proposed arrangement will involve the creation of a trust.

Furthermore, it is considered that this trust would be created by declaration or settlement.

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. This is what would occur in the present case when you commence holding a portion of your interest in the Partnership as trustee for the Trust. A resolution that the 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. 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'.

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.

None of the exceptions in subsection 104-55(5) apply in the present case. Accordingly, the second condition is also satisfied.

CGT Event E2

Section 104- 60 provides that CGT event E2 happens if you transfer a CGT asset to an existing trust.

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 commence holding the assigned interest in the Partnership on trust for the trustee of the Trust. Whilst the Trust will exist prior to the assignment being entered into, the entering into of the assignment by declaration of trust will give rise to a new trust which was not in existence before that time. Accordingly, you will not transfer an asset to an existing trust and CGT event E2 will not happen.

CGT Event A1

Section 104-10 provides that CGT event A1 happens if you dispose of a CGT asset. Disposal is then defined in subsection 104-10(2) to have happened when there is a change of ownership from you to another entity.

Under the proposed assignment, you will retain the legal ownership and continue to be the named partner in the Partnership. The Trust will only acquire the beneficial ownership of the assigned partnership interest. Therefore, you will dispose of a part-interest in the Partnership (excluding management and control rights) when you commence holding it on trust for the trustee of the Trust.

However, in accordance with subsection 102-25(1) of the ITAA 1997, CGT event E1 is more specific to the situation, therefore CGT event A1 will not apply.

Capital proceeds for the disposal of your partnership interest

Subsection 104-55(3) provides the method to calculate any capital gain or loss when CGT event E1 happens to a CGT asset. It provides that:

• you make a capital gain if the capital proceeds from the creation of the trust are more than the asset's cost base; and

• you make a capital loss if the capital proceeds from the creation of the trust are less than the asset's reduced cost base.

When calculating the capital proceeds, the general rules in Division 116 need to be applied. The capital proceeds from a CGT event are the total of the amount of money a taxpayer has received, or is entitled to receive, in respect of the event happening, and the market value of any other property the taxpayer has received, or is entitled to receive, in respect of the event happening (worked out as at the time of the event - section 116-20). However, the general rules are modified by the market value substitution rules in section 116-30 where the capital proceeds received are more or less than the market value of the asset and the asset was disposed of in a non-arm's length dealing (subparagraph 116-30(2)(b)(i)).

As you are proposing to assign, by way of declaration of trust, a proportion of your partnership interest to the Trust for what may be less than market value, the market value substitution rule under section 116-30 needs to be considered.

Whether parties have dealt at arm's length is a question of fact that must be determined in any particular case. Subsection 995-1(1) of the ITAA 1997, in respect of the term 'arm's length' states that in determining whether parties deal at arm's length, consider any connection between them and any other relevant circumstance.

Taxation Ruling IT 2540 Income Tax: Capital Gains: Application to disposals of partnership assets and partnership interests ('IT 2540') provides the Commissioner's view on the CGT consequences of entering into an Everett assignment. Paragraph 24 provides the Commissioner's view that an Everett assignment will be treated as a part disposal of the partner's interest in the assets of the partnership for CGT purposes.

The implication of this treatment was that an Everett assignment could give rise to a capital gain (or capital loss) in the hands of the assignor. As explained earlier in this ruling, the same outcome now arises under the re-written CGT provisions in Part 3-1 of the ITAA 1997. The Commissioner has stated at paragraph 25 that 'it would be very unusual for an Everett assignment to be made on an arm's length basis'. Therefore, the market value modification rule in section 116-30 will apply to determine the capital proceeds.

The case of Granby v. FC of T 95 ATC 4240 ('Granby') considered whether the cost base of certain plant and equipment for CGT purposes was the actual residual value paid or the market value at the time of purchase, in circumstances where plant and equipment was purchased at its residual value on the expiration of a lease. The question turned on whether the lessor of the plant and equipment and the taxpayer's partnership were dealing with each other at arm's length for the purposes of the CGT provisions.

In that case Lee J stated at ATC 4244 that the provision 'dealing with each other at arm's length' invited an analysis of the manner in which the parties conduct themselves in forming the transaction. The question is whether the parties behaved in the manner in which parties at arm's length would be expected to behave in conducting their affairs and the expression means, at least, that the parties have acted severally and independently in forming their bargain.

Further, Lee J stated at ATC 4244 that:

'If the parties to the transaction are at arm's length it will follow, usually, that the parties will have dealt with each other at arm's length. That is, the separate minds and wills of the parties will be applied to the bargaining process whatever the outcome of the bargain may be.'

However this will not be the case where the parties collude to achieve a particular result, or where one of the parties submits the exercise of its will to the discretion of the other. In such a case the lack of the exercise of an independent will in the formation of the transaction would indicate a lack of real bargaining.

The way you propose to assign a proportion of your partnership interest to the Trust for possibly an amount other than market value evidences that the parties will not behave in a manner in which arm's length parties would be expected to behave. That is, in line with the Commissioner's view in paragraph 25 of IT 2540, the facts indicate that the parties will not be dealing with each other at arm's length. The amount paid by the assignee may not be reflective of a normal bargaining process which was discussed in Granby and the capital proceeds of may not reflect the value which an interest in the Partnership would expect to be valued at.

Paragraph 28 in IT 2540 provides that when determining the market value of an Everett assignment, the valuation should be in accordance with the decision in Reynolds'. Reynolds' case concerned the valuation of an assigned partnership interest on which ad valorem stamp duty was payable. Despite the other assets of the partnership being held in administration and service entities and goodwill not being recognised by the partnership, Burt CJ held:

'the assigned partnership interest was of value; its value derived from the value of the right that was attached to the partnership interest to receive a proportionate share of the future income of the partnership.'

Paragraph 28 of IT 2540 further explains that when valuing a partnership interest when entering into an Everett assignment, 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.

Partnership interest as an active asset

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 152-40(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, your partnership interest is considered an active asset.

The Service Trust and Finance Trust as entities connected with you

For the purposes of the maximum net asset value test set out in section 152-15, paragraphs (b) and (c) of this section requires you to include in the calculation the net value of CGT assets of any affiliates of yours or entities connected with your affiliates. It is necessary for the calculation in section 152-15 to consider if the Service Trust or the Finance Trust is an entity connected with you.

The term "connected with" is defined in section 995-1 of the ITAA 1997 to have the meaning described in section 328-125.

Subsection 328-125(1) considers an entity is connected with another entity if either entity controls the other entity or both entities are controlled by a third entity.

As the Service Trust is a discretionary trust, it is necessary to consider any control that you may have over the trustee of the Service Trust. In the context of a discretionary trust, control of the trust should be considered with reference to subsections 328-125(3), (4) and (5).

You have stated in your private ruling request that the Service Trust operates as a separate commercial business. It provides services to the Partnership in return for arm's length fees paid to it by the Partnership. Commercial decisions of the Service Trust are made by the Trustee's management team and/or the Board of the Trustee.

As a partner of the Partnership, you and your nominated associates are potential beneficiaries of the Service Trust. While you may recommend to the trustee of the Service Trust that distributions be directed to your associates, the Trustee has absolute discretion over distributions of the trust's income.

Therefore the Commissioner accepts that the Service Trust does not act, or could reasonably be expected to act, in accordance with your directions or wishes as described in subsection 328-125(3).

As the Partnership is a large partnership, with each partner and their nominated associates being potential beneficiaries of the Service Trust and Finance Trust, each partner and their associates are likely to only have a small percentage of interest in the income and capital of the Service Trust and Finance Trust. It is unlikely you or your associates will receive at least X% of the income or capital of the Service Trust in any income year.

As the Finance Trust is a fixed trust the concept of control is determined under subsection 328-125(2). You have stated in your private ruling request you do not have a right to receive at least X% of the income or capital of the Finance Trust.

Accordingly, the Commissioner does not consider the Service Trust and Finance Trust to be entities that are connected to you for the purposes of section 152-15.

Other partners of the Partnership as affiliates of yours

For the purposes of the maximum net asset value test set out in section 152-15, paragraph (c) of this section requires you to include in the calculation the net value of CGT assets of any affiliates of yours or entities connected with your affiliates.

The term 'affiliate' is defined by section 995-1 to have the meaning described in section 328-130.

Subsection 328-130(1) provides the criteria to be considered when assessing if an individual or a company is your affiliate. Subsection 328-130(2) then provides an exemption where an entity is not your affiliate merely because of the business relationship between you and that entity.

Furthermore an example is provided in section 328-130 in relation to partners in a partnership not being affiliates of each other by acting in concert with each other in relation to the affairs of the partnership.

As you and other partners of the Partnership share and have the common business relationship in the partnership, the exemption provided in subsection 328-130(2) is applicable to you, in relation to the affairs of the Partnership.

The Commissioner does not consider the other partners in the Partnership to be your affiliates for the purposes of section 152-15.

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