Edited version of your written advice

Authorisation Number: 1013094311875

Date of advice: 20 September 2016

Ruling

Subject: Assignment of partnership income

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 Partnership X to the trustee of a family discretionary trust?

Answer

Yes

Question 2

For CGT purposes, will the capital proceeds from the disposal of your interest in Partnership X to the trustee of a family discretionary trust be the deemed market value consideration under section 116-30 of the ITAA 1997 for the CGT event?

Answer

Yes

Question 3

Following the assignment of your beneficial interest in Partnership X, will the Commissioner continue to administer the acquisition and disposal of partnership interests arising from the ordinary 'ebb and flow' of partners in Partnership X, in a manner consistent with the principles outlined in the administrative treatment guidelines dated 4 May 2016 such that the deemed market value of the partnership interests will be equal to the consideration paid or received (including nil)?

Answer

Yes

This ruling applies for the following periods

1 July 2016 to 30 June 201W

1 July 2017 to 30 June 201X

1 July 2018 to 30 June 201Y

1 July 2019 to 30 June 201Z

The scheme commenced on

1 July 201W

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You are an equity partner in Partnership X.

Distributions paid to the partners of Partnership X are paid by Partnership X.

Partnership X is a 'no-goodwill partnership'. That is, goodwill is not recognised in either the balance sheet of Partnership X nor for any other purpose. Consequently, when partners are admitted to Partnership X, they do not make any payment to existing partners to acquire any goodwill, nor are they entitled to receive any consideration for the disposal of any goodwill when they retire or otherwise exit from Partnership X.

At present, Partnership X pays arm's length service fees to a Services Trust. In general, the profit derived on the service fees is limited to a percentage of overall business profits of the Australian firm available for distribution. In practical terms, the balance of the profit distributions from the Australian firm come from the non-Services Trust.

It is the intention of Partnership X to allow each Partnership X equity partner to assign a portion of his or her partnership interest in Partnership X by way of declaration of trust. The declaration of trust will be irrevocable.

The portion to be assigned will be an amount such that the assigning partner would receive (and be taxable in respect of) no less than 50% of the income from the firm (being the share of profits of Partnership X and the Services Trust) each year in their own hands.

Under the arrangement, you propose to assign a percentage of your interest in Partnership X to the trustee of a family discretionary trust (the Family Discretionary Trust).

The assignment of the partnership interest to the trustee of the Family Discretionary Trust will occur by declaration of trust which will effect the assignment of all the beneficial rights (not legal rights) associated with the partnership interest, including the right to receive an appropriate share of profits of Partnership X to which the Family Discretionary Trust will be entitled. This declaration of trust by you will have the effect of creating a trust (the Declaration Trust), of which you will be trustee.

The Family Discretionary Trust will pay nominal consideration for the assigned partnership interest.

You will continue to be legally the partner in Partnership X. The trustee of the Family Discretionary Trust will not become a member of Partnership X nor will the trustee of the Family Discretionary Trust be entitled to interfere in Partnership X's business or affairs or to require any accounts or to inspect the books of Partnership X.

You will not be the trustee of the Family Discretionary Trust. The Family Discretionary Trust will be a pre-existing trust established by a person (other than you or a potential beneficiary of the Family Discretionary Trust). The potential beneficiaries of the Family Discretionary Trust will be limited to family members or entities associated with you. You will not be a beneficiary of the Family Discretionary Trust during the period in which you are a partner of Partnership X but you may be a shareholder of a corporate beneficiary of the Family Discretionary Trust.

Relevant legislative provisions

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 116-30, and

Income Tax Assessment Act 1997 - Section 995-1.

Reasons for decision

Question 1

Summary

CGT event E1 will happen when you commence holding a portion of your interest in Partnership X as trustee for the Family Discretionary Trust.

Detailed Reasoning

CGT Event E1

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

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) of the ITAA 1997 must not apply.

In the present case, it is considered that the first condition will be satisfied because you will create a trust (the Declaration Trust) holding a portion of your interest in Partnership X as trustee for the Family Discretionary Trust, as a consequence of your irrevocable declaration of trust. This trust will be created by declaration or settlement.

In this regard, it is noted that 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 (DKLR Holding Co (No. 2) Pty Ltd v. Commissioner of Stamp Duties (NSW) (1982)149 CLR 431 at 454 and 459). 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 (Oswal v. FC of T 2013 ATC 20-403 at [44]-[54] (Oswal v. FC of T)). 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' (Oswal v. FC of T).

The second condition is also satisfied as the exceptions in subsection 104-55(5) of the ITAA 1997 will not apply to the present case.

CGT Event E2

Section 104-60 of the ITAA 1997 provides that CGT event E2 happens if you transfer a CGT asset to an existing trust.

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 your interest in Partnership X on trust for the Family Discretionary Trust. Whilst the Family Discretionary 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 (the Declaration 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 of the ITAA 1997 provides that CGT event A1 happens if you dispose of a CGT asset. Disposal is then defined in subsection 104-10(2) of the ITAA 1997 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 Partnership X. The Family Discretionary Trust will only acquire the beneficial ownership of the assigned partnership interest. Therefore, you will dispose of a part-interest in Partnership X when you commence holding it as trustee for the Family Discretionary Trust.

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

Question 2

Summary

For the purposes of CGT event E1, the capital proceeds received will be replaced with the market value of the assigned interest at the time of the CGT event (as per section 116-30 of the ITAA 1997).

Detailed Reasoning

Subsection 104-55(3) of the ITAA 1997 provides the method to calculate any capital gain or capital 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 of the ITAA 1997 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 of the ITAA 1997).

However, the general rules are modified by the market value substitution rules in section 116-30 of the ITAA 1997 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) of the ITAA 1997).

As you are proposing to assign, by way of declaration of trust, a proportion of your interest in Partnership X for nominal consideration, the market value substitution rule under section 116-30 of the ITAA 1997 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'.

In Granby Pty Ltd v. Federal Commissioner of Taxation (1995) 129 ALR 503 at 506-507; (1995) 95 ATC 4240; (1995) 30 ATR 400 Lee J said that the term 'at arm's length' means at least that the parties to a transaction acted severally and independently in forming their bargain. Both the relationship between the parties and their conduct in forming the transaction are relevant to whether they have dealt with each other at arm's length. If parties are at arm's length then it usually follows that they will have dealt with each other at arm's length.

In the current circumstances, based on the nature of the transaction, the relationship between the parties involved and the nominal consideration payable, it is considered that the parties will not be dealing with each other at arm's length in respect of this transaction. This conclusion accords with the Commissioner's view in paragraph 25 of Taxation Ruling IT 2540 Income Tax: Capital Gains: Application to disposals of partnership assets and partnership interests (IT 2540) which provides the Commissioner's view on the CGT consequences of entering into an Everett assignment. As a consequence, it is considered that the requirements in paragraph 116-30(2)(b) of the ITAA 1997 will be met and therefore the capital proceeds from the CGT event (CGT event E1) will be replaced with the market value of the CGT asset (the assigned interest) at the time of the CGT event.

When valuing the assigned interest, paragraph 28 of IT 2540 is relevant, as it provides that, where an Everett assignment is not made at arm's length, the valuation method adopted in Reynolds v Commissioner of State Taxation (WA) 86 ATC 4528 will usually be the appropriate method for determining the market value of the assigned partnership interest for the purposes of Part IIIA of the ITAA 1936. Broadly, this will involve the determination of the price that a 'hypothetical buyer' would pay for the assigned partnership interest having regard to the value of the right to the future income of the partnership which is attached to the interest.

Question 3

Summary

Following the assignment of your beneficial interest in Partnership X, the Commissioner will continue to administer the acquisition and disposal of partnership interests arising from the ordinary 'ebb and flow' of partners in Partnership X in accordance with the Administrative treatment: acquisitions and disposals of interests in 'no goodwill' professional partnerships, trusts and incorporated practices ('the Administrative Treatment Guidelines') dated 4 May 2016. Accordingly the deemed market value of the partnership interests at the time of such an acquisition or disposal will be treated as being equal to the consideration paid or received (including nil).

Detailed Reasoning

From 4 May 2016, the administrative treatment in paragraphs 13 and 14 of IT 2540 was replaced by the Administrative Treatment Guidelines. The Administrative Treatment Guidelines explain the Commissioner's administrative treatment of the acquisition and disposal of interests (practice interests) in 'no goodwill' professional partnerships, trusts, and incorporated practices (practices).

In this regard, the Administrative Treatment Guidelines specifically provide that, if certain conditions are satisfied, the Commissioner will accept that, for the purposes of calculating the partner's cost base or reduced cost base in relation to an acquisition of a practice interest or the calculation of the capital proceeds in respect of a CGT event happening to a practice interest, the market value of the partnership interests at the time of an acquisition or disposal will be treated as being equal to the amount the taxpayer pays or receives (including nil).

In order for the administrative treatment to apply, all of the following requirements (as detailed in the Administrative Treatment Guidelines), as applicable to the current circumstances, must be met:

(i) the taxpayer (practitioner entity) must carry on or participate in the carrying on of a professional practice, and be a partner in a partnership carrying on that practice;

(ii) the governing documents of the practice provide that the consideration payable and receivable by a practitioner entity for the acquisition and disposal of a practice interest in goodwill will be nil, or a nominal amount;

(iii) the governing documents have no further provision relating to consideration for practice interests or such documents provide in the case of a partnership - that consideration payable and receivable by a practitioner entity for the acquisition and disposal of a practice interest in assets other than goodwill will be nil or a particular amount;

(iv) an acquisition and/or disposal occurs in the circumstances covered in the Administrative Treatment Guidelines;

(v) the following parties have an arm's length relationship with one another immediately before the acquisition or disposal:

(i) the acquiring entity (if any); and

(ii) each practitioner entity (if any) who disposes of a practice interest which the acquired interest represents or is reasonably attributable to;

(vi) the evidence reasonably supports the conclusion that the following represent arm's length dealings:

(i) the governing documents; and

(ii) the acquisition and/or disposal transaction; and

(vii) the practitioner entity applies the treatment in these guidelines to all acquisitions or disposals covered above.

In the present case, based on the information provided, the Commissioner accepts that your circumstances will meet the requirements outlined in the Administrative Treatment Guidelines and therefore the treatment specified in those guidelines will apply to the acquisition and disposal of partnership interests that occur during the natural 'ebb and flow' of partners into and out of Partnership X. This will mean that the Commissioner will accept that the market value of the partnership interests at the time of such an acquisition or disposal will be treated as being equal to the consideration paid or received (including nil).

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