Edited version of your written advice

Authorisation Number: 1013107114453

Date of advice: 14 October 2016

Ruling

Subject: Assignment of 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 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

In calculating any CGT payable by you on the disposal of the partnership interest to a family discretionary trust, is the Partnership X Service Trust (the Service 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 (MNAV) test under section 152-15 of the ITAA 1997?

Answer

No

Question 4

In calculating any CGT payable by you on the 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 MNAV test under section 152-15 of the ITAA 1997?

Answer

No

Question 5

If Company Y as trustee for Family Trust Z (being a unit holder in the Service Trust) is an affiliate of you, then are the other partners of the Service Trust connected with Company Y as trustee for Family Trust Z as defined under section 328-125 of the ITAA 1997, for the purposes of the MNAV test under section 152-15 of ITAA 1997?

Answer

No

This ruling applies for the following periods

1 July 2015 to 30 June 20VV

1 July 2016 to 30 June 20WW

1 July 2017 to 30 June 20XX

1 July 2018 to 30 June 20YY

1 July 2019 to 30 June 20ZZ

The scheme commenced on

1 July 20UU

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.

Background

You are an equity partner in Partnership X which operates in Australia through a general law partnership (the Partnership).

Remuneration and capital arrangements

Capital arrangements

There is no entry or exit price for new partners. Equity partners are allocated points by a remuneration committee and each equity partner must contribute capital to the legal partnership proportionate to total points based on the debt to equity working capital requirements of the business.

Upon departure, equity partners are entitled to the remaining balance of their current account (i.e. retained earnings) and any capital they have contributed.

Remuneration arrangements

Equity partners are entitled to a share of the net profit of the relevant partnership in accordance with their proportionate partnership points.

Economic climate

The industry has seen increasing levels of partner turnover in recent years. This is attributed to individual partners seeking to improve their financial wellbeing and reduce their personal risk.

The financial well-being of partners has been one of the key priorities of retaining partners and attracting talent. With this in mind, the Partnership has been considering alternative options to enhance the risk protection of its partners, and improve their family asset protection planning.

The Partnership is working to identify alternatives that may ensure partner retention, attract new talent and reduce the risks attaching to operations and partners that may otherwise inhibit the ability of the Partnership to grow.

The Partnership is aware that other firms offer the ability for partners to assign a proportion of their partnership interest to an 'Everett' trust which provides increased asset protection to partners. In order to remain competitive to attract and retain partners, the Partnership is considering offering equity partners the ability to implement Everett assignments with certain parameters. The proposed arrangement is outlined in further detail below, and would only be available in strict accordance with this arrangement.

The Service Trust

The Partnership engages a unit trust, the Service Trust, to provide various services to the Partnership to undertake its professional services business. These activities include:

● holding leased assets and property, plant and equipment (e.g. rented premises in each office location);

● employing all support staff in roles of administration, finance, and IT.

The unitholders of the Service Trust are generally nominated associates of the partners.

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

Over the past 3 years, each partner and their associates has held a maximum interest of less than 14% of the income and capital of the Service Trust.

Family Trust Z

Family Trust Z is your family trust, and is a beneficiary of the Service Trust. Family Trust Z receives distributions from the Service Trust and further distributes to its beneficiaries. Company Y is the corporate trustee of the Family Trust Z.

The other unitholders in the Service Trust are not beneficiaries of and have not previously received a distribution of income or capital from the Family Trust Z.

Company Y as trustee for Family Trust Z does not receive or have the right to receive any distribution of income or capital from the other unit holders of the Service Trust. There is also no expectation that the other unit holders in the Service Trust will act in accordance with the directions or wishes of Company Y as trustee for Family Trust Z.

Admission of new Partners to the Partnership

New partners become party to the agreement by signing the partnership agreement.

Goodwill is not recognized in the balance sheet of the Partnership or for any other purpose. In addition, new partners, when admitted to the equity Partnership, do not make any payment to existing partners to acquire any goodwill.

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

Proposed Arrangement

As outlined above, the Partnership has been considering alternative options to enhance the risk protection of its partners, improve their family asset protection planning, whilst also responding to the increasing competition for skilled partners to grow the practice.

The partnership agreement already permits a partner to assign a portion of his or her partnership interest by way of declaration of trust (Everett assignment), where specifically approved by resolution of the Equity Partners:

The Partnership wishes to ensure that equity partners of the Partnership comply with Australian Taxation Office (ATO) views on partnership assignments, both now and in the future, by putting in place a mechanism which meets these views and ensures compliance.

The mechanism will take the form of Management Team Policy Guidelines such that any equity partner seeking to make an 'Everett assignment' does it in a way which meets the intention of the published ATO views. The prior written consent of the other parties to the agreement would not be granted without a declaration that the Management Team Policy was met in its entirety. This will reflect partnership governance values.

The equity partners will be permitted to consider the following general assignment.

Under the general assignment arrangement, the Partner is permitted to assign a portion of their interest in the Partnership income to an associated discretionary family trust (the Family Discretionary Trust) through an irrevocable declaration of trust (creating the Declaration Trust) whereby the Partner declares he or she holds a portion of their interest in the Partnership in trust (i.e. as trustee) for the benefit of the Family Discretionary Trust.

The Family Discretionary Trust will be the sole beneficiary of the Declaration Trust. The Declaration Trust will receive income from the Partnership and distribute this in full to the Family Discretionary Trust. The Declaration Trust will undertake no further transactions. A company will act as a corporate trustee for the Family Discretionary Trust. 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 the cases of Federal Commissioner of Taxation v Everett (1980) 143 CLR 440 and Federal Commissioner of Taxation v Galland (1986) 162 CLR 408.

When considered together with distributions from the Service Trust, the Partner will receive in his or her own hand no less than 50% of the overall profits of both the Partnership and the Service Trust in each income year.

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

The assignment, by declaration of trust, will affect the assignment of all beneficial rights associated with the partnership interest, including the right to receive the share of income of the partnership.

The Partner will continue to be legally a partner of the Partnership. The trustee of the Family Discretionary 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 Partner will not be the trustee of the Family Discretionary Trust, or control the corporate trustee of the Family Discretionary Trust.

The potential beneficiaries of the Family Discretionary Trust will be limited to family members or entities associated with the Partner and arm's length charities. While the Partner is a partner of the Partnership, they will not be a beneficiary of the Family Discretionary Trust but may be a shareholder of a corporate beneficiary of this 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 - Division 116,

Income Tax Assessment Act 1997 - Section 116-20,

Income Tax Assessment Act 1997 - Section 116-30,

Income Tax Assessment Act 1997 - Division 152,

Income Tax Assessment Act 1997 - Section 152-10,

Income Tax Assessment Act 1997 - Section 152-15,

Income Tax Assessment Act 1997 - Section 152-20,

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

Question 1

Summary

CGT event E1 will happen when you commence holding a portion of your interest in the Partnership 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 the Partnership 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 the Partnership 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 the Partnership on trust for the Family Discretionary Trust. Whilst the Family Discretionary Trust will exist prior to the assignment being entered into, the entering into 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 the Partnership. The Family Discretionary Trust will only acquire the beneficial ownership of the assigned partnership interest. Therefore, you will dispose of a part-interest in the Partnership 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 (paragraph 116-30(2)(b) of the ITAA 1997).

As you are proposing to assign, by way of declaration of trust, a proportion of your interest in the Partnership 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 Income Tax Assessment Act 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

In calculating any CGT payable by you on the disposal of the Partnership interest to the Family Discretionary Trust, the Service Trust will not be an entity connected with you, as defined under section 328-125 of the ITAA 1997, for the purposes of the MNAV test under section 152-15 of the ITAA 1997.

Detailed Reasoning

Section 152-15 of the ITAA 1997 provides that you will satisfy the MNAV test if, just before the CGT event, the sum of the following amounts does not exceed $6,000,000:

(a) the net value of your CGT assets;

(b) the net value of the CGT assets of any entities connected with you;

(c) the net value of the CGT assets of any affiliates of you or entities connected with your affiliates but only to the extent those assets are used, or held ready for use, in the carrying on of a business by you or another entity connected with you (section 152-20(3) of the ITAA 1997).

An entity is connected with another entity if:

(a) either entity controls the other entity in a way described in section 328-125 of the ITAA 1997; or

(b) both entities are controlled in a way described in section 328-125 of the ITAA 1997 by the same third entity.

Relevant to the current circumstances, subsection 328-125(2) of the ITAA 1997 provides, in part that, an entity controls another entity if it or its affiliate (or all of them together) owns, or has the right to acquire ownership of, interests in the other entity that give the right to receive at least 40% of any distribution of income or capital by the other entity.

In the current circumstances, the partners of the Partnership, and/or their nominated associates, are unit holders of the Service Trust. Over the past 3 years, each partner and their associates have held a maximum interest of less than 40% of the income and capital of the Service Trust. Accordingly, it is considered that you (and/or your associates as your affiliates) would not own, or have the right to acquire the ownership of, interests in the unit trust that carry between them the right to receive at least 40% of any distribution of the income or capital of the Service Trust.

It is therefore considered that, although subject to the issues considered in Questions 4 and 5 below, that the Service Trust is not an entity connected with you for the purposes of section 152-15 of the ITAA 1997.

Question 4

Summary

In calculating any CGT payable by you on the disposal of the Partnership interest to the Family Discretionary Trust, the other partners in the Partnership are not affiliates of you, as defined under section 328-130 of the ITAA 1997, for the purposes of the MNAV test under section 152-15 of the ITAA 1997.

Detailed Reasoning

For the purposes of the MNAV test set out in section 152-15 of the ITAA 1997, paragraph (c) of that section requires you to include in this 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 of the ITAA 1997 to have the meaning described in section 328-130 of the ITAA 1997.

Subsection 328-130(1) of the ITAA 1997 provides that an affiliate is an individual that, in relation to their business affairs, acts or could reasonably be expected to act:

● in accordance with your directions or wishes, or

● in concert with you.

An individual however is not your affiliate merely because of the nature of a business relationship you and the individual share (subsection 328-130(2) of the ITAA 1997). This attribute is highlighted in an example in section 328-130 of the ITAA 1997 which relevantly provides:

A partner in a partnership would not be an affiliate of another partner merely because the first partner acts, or could reasonably be expected to act, in accordance with the directions or wishes of the second partner, or in concert with the second partner, in relation to the affairs of the partnership.

In your circumstances, although you and the other partners in the Partnership share and have a common business relationship, there is no evidence to suggest that the necessary outcomes described in section 328-130 of the ITAA 1997 exist. Consequently the other partners in the Partnership are not considered to be your affiliates for the purposes of the MNAV test in section 152-15 of the ITAA 1997.

Question 5

Summary

While Company Y as trustee for Family Trust Z (being a unit holder in the Service Trust) is an affiliate of you, the other unit holders of the Service Trust are not connected with Company Y as trustee for Family Trust Z as defined under section 328-125 of the ITAA 1997, for the purposes of the MNAV test under section 152-15 of ITAA 1997.

Detailed Reasoning

As previously noted, for the purposes of the MNAV test set out in section 152-15 of the ITAA 1997, paragraph (c) of that section requires the taxpayer to include in the calculation the net value of CGT assets of any affiliates of the taxpayer or entities connected with the taxpayer's affiliates.

On the basis that Company Y as trustee for Family Trust Z is an affiliate of you, it is also necessary to consider whether the other unit holders of the Service Trust are entities connected with Company Y as trustee for Family Trust Z for the purposes of the calculation in section 152-15 of the ITAA 1997

An entity is connected with another entity if:

(a) either entity controls the other entity in a way described in section 328-125 of the ITAA 1997; or

(b) both entities are controlled in a way described in section 328-125 of the ITAA 1997 by the same third entity.

In the current circumstances, based on the information provided, it is considered that neither Company Y as trustee for Family Trust Z nor the other unit holders in the Service Trust satisfy the relevant control tests in respect of each other. In this regard, it is noted that:

● the other unitholders in the Service Trust are not beneficiaries of and have not previously received a distribution of income or capital from Family Trust Z;

● Company Y as trustee for Family Trust Z does not act (nor might reasonably be expected to act) in accordance with the directions or wishes of the other unit holders in the Service Trust;

● Company Y as trustee for Family Trust Z does not receive or have the right to receive any distribution of income or capital from the other unit holders of the Service Trust; and

● the other unit holders in the Service Trust do not act (nor might reasonably be expected to act) in accordance with the directions or wishes of Company Y as trustee for Family Trust Z.

Accordingly the other unit holders of the Service Trust are not connected with Company Y as trustee for Family Trust Z, as defined under section 328-125 of the ITAA 1997, for the purposes of the MNAV test under section 152-15 of the ITAA 1997.

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