Edited version of your written advice

Authorisation Number: 1013111469125

Date of advice: 1 November 2016

Ruling

Subject: Proposed Business Restructure

Issue 1: Disposal of Interest in the Assets

Question 1

Does a balancing adjustment event arise under subsection 40-295(2) of the Income Tax Assessment Act 1997 (ITAA 1997) specifically, or under section 40-295 generally, in relation to the disposal by A and B - as partners in the A and B Partnership - of a x-percent fractional interest in the Assets that they hold in the A and B Partnership to New Co?

Answer

Yes.

Question 2

If the answer to Issue 1 Question 1 is in the negative, what are the tax consequences in relation to the disposal by A and B as partners in the A and B Partnership of a x-percent fractional interest in the Assets to New Co?

Answer

Not applicable.

Question 3

If the answer to Issue 1 Question 1 is in the positive, can A and B as partners in the A and B Partnership (the transferor) and A and B and New Co as partners in the new General Law Partnership (New GLP) and subsequently the new Limited Liability Partnership (New LLP) (collectively the transferee) elect to apply rollover relief under subsection 40-340(3) of the ITAA 1997 in relation to the formation of New GLP and subsequently New LLP?

Answer

Yes.

Question 4

If the answer to Issue 1 Question 3 is in the positive, is the nature of the rollover relief as prescribed in section 40-345 of the ITAA 1997?

Answer

Yes.

Question 5

If the answer to Issue 1 Question 3 is in the positive, do the relevant entities - being A and B as partners in the A and B Partnership (the transferor) and A and B and New Co as partners in New GLP and subsequently New LLP (the transferee) - choose rollover relief in a manner according to the requirements prescribed in subsection 40-340(4) of the ITAA 1997?

Answer

Yes.

Question 6

Would the cost of the Assets (depreciating assets) for A and B and New Co as partners of New GLP and subsequently New LLP (the transferee) be the 'adjustable value' of the Assets to A and B as partners of the A and B Partnership (the transferor) just before the balancing adjustment event occurs pursuant to Item 6 in subsection 40-180(2) of the ITAA 1997?

Answer

Yes.

Question 7

If the answer to Issue 1 Question 3 is in the negative, what are the tax consequences in relation to the said disposal?

Answer

Not applicable.

This ruling applies for the following period:

1 July 20XX to 30 June 20YY

The scheme commences on:

1 July 20XX

Issue 2: Limited Liability Partnership (LLP) Carrying on a Business

Question 1

Does the Commissioner accept that New LLP will be carrying on a business?

Answer

Yes.

This ruling applies for the following period:

1 July 20XX to 30 June 20YY

The scheme commences on:

1 July 20XX

Issue 3: Capital Gains Tax (CGT)

Question 1

Will there be a CGT event or other taxing event that arises in relation to the registration of the new General Law Partnership (New GLP) as a LLP under the provisions of the relevant State Partnership Act?

Answer

No.

This ruling applies for the following period:

1 July 20XX to 30 June 20YY

The scheme commences on:

1 July 20XX

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.

General Information

1. The A and B Business Group (the Group) provides services under a contract with a State Government agency.

2. Presently, the Group holds X assets, of which the majority (hereafter referred to as 'the Assets') are owned by the A and B Partnership, and the remainder of the X assets are owned by Company B.

3. The current operational structure of the Group is as follows:

a. A and B Partnership

b. Company A, and

c. Company B.

4. The A and B Partnership has entered into a contract with a State Government agency for the provision of services.

A and B Partnership

5. The A and B Partnership is a General Law Partnership (GLP) with the following partners:

a. A (XX%), and

b. B (XX%).

6. The A and B Partnership holds the following assets:

a. the Assets and the associated finance debt

b. the contract with the State Government agency to provide services, and

c. the business premises.

7. The current operations of the A and B Partnership include:

a. rental of the Assets to Company A

b. receipt of revenues in respect of the contract with the State Government agency, and

c. subcontract of the contract (with the State Government agency) to Company A.

8. The turnover that the A and B Partnership receives from the rent of the Assets to Company A has historically been profitable, and this is expected to continue in future years.

9. With specific regard to the rental of the Assets to Company A, the activity is managed as a business and detailed business records are kept in a professional manner. This includes maintenance of financial statements, the preparation and review of quarterly accounts, the preparation of annual financial statements by an external accounting firm and the maintenance of a detailed fixed asset register.

Company A

10. The shares in Company A are owned 100% by Company C.

11. The shares in Company C are 100% owned by A and B as trustees for The A and B Family Trust.

12. Company A provides services on a subcontract basis to the A and B Partnership pursuant to the contract with the State Government agency. The activities of Company A include:

a. operating the Assets (which are rented from the A and B Partnership, with other assets rented from Company B)

b. employment of staff

c. maintenance of the Assets (owned by the A and B Partnership), as well as the assets owned by Company B, and

d. security at and maintenance of the business premises.

13. Pursuant to the Subcontractors Agreement between the A and B Partnership and Company A (in respect of the A and B Partnership's contract with the State Government agency), Company A is required to - at its own expense - supply all necessary plant, equipment and staff to comply with its obligations under this Agreement. Given that Company A does not own the relevant assets in its own right, it rents these assets (including the Assets) from the A and B Partnership (and Company B) for a commercial rental.

14. There is no written rental agreement in place between the A and B Partnership and Company A in respect of Company A renting the Assets owned by the A and B Partnership.

Company B

15. The shares in Company B are owned XX% by A and XX% by B.

16. Company B owns a small number of relevant assets held by the Group. These assets were purchased by Company B rather than the A and B Partnership as an interim asset protection measure for A and B.

17. Company B rents this small number of assets to Company A.

Proposed Restructure

18. A and B currently hold significant assets in their individual names, including:

a. their family home

b. the business premises

c. multiple other properties, and

d. the shares in Company B.

19. A and B have obtained legal advice that, in order to limit their individual liability in respect of their overall business, they should form a Limited Liability Partnership (LLP) to carry on only the rental component of the business owned by the existing partnership (the A and B Partnership), with A and B as the limited partners, and a new company created, with A and B as the shareholders and directors, managing the business as the general partner.

20. In other words, for the purpose of asset protection, it is proposed that the A and B Partnership will transfer only one percent of its interest in the Assets it owns (along with the associated finance debt) to a new company (New Co), where New Co will be a partner in a new GLP (New GLP), which will subsequently be registered as a LLP (New LLP). In this way, claims and liabilities that may arise in respect of the ownership of the Assets will be quarantined to New LLP, and the liability of A and B will be limited to a nominal amount that will be shown on the limited partnership register.

21. The relevant steps of the proposed restructure are as follows:

a. Step 1: A new Australian resident private company (New Co) is registered with the Australian Securities and Investments Commission. The shareholders and directors of New Co will be A (XX%) and B (XX%).

b. Step 2: A and B, as partners in the A and B Partnership, will each transfer a X% interest in the Assets held in the A and B Partnership - along with the associated finance debt - to New Co (x percent in total), and in so doing, will create a new GLP (New GLP).

c. Step 3: New GLP will register as a LLP under the relevant State Partnership Act and will conduct the business of commercial rental of the Assets (New LLP). Within New LLP, A and B will be limited partners with a XX% interest in the partnership (i.e. XX% each) and New Co will be a general partner with a x percent interest in the partnership and will also manage the partnership business.

22. No interest in the ownership of the assets owned by Company B will be transferred.

23. The proposed restructure will limit A's and B's personal exposure to the risks of owning the assets of the Group as, akin to a company structure, the liability of a limited partner is limited to their capital contribution to the partnership pursuant to subsection 53(1) of the relevant State Partnership Act.

24. In particular, A and B wish to undertake this particular restructure for the following reasons:

a. It achieves a significant level of asset protection for A's and B's personally owned assets pursuant to the operation of the relevant State Partnership Act through separating the risk to A and B of owning the Assets through the existing partnership (the A and B Partnership) and thus reducing/limiting the associated risk to A's and B's personal assets in the event of any claim/liability.

b. The restructure is simple in its implementation and operation.

c. The transaction costs in implementing the restructure are low, including but not limited to, stamp duty, as there is effectively only a transfer of x percent of the Assets in the A and B Partnership to New Co.

25. The general partner, New Co - which will be the manager of New LLP (via A and B as directors) - will have significant commercial knowledge and skill and will dedicate significant time to managing the business.

26. New Co will receive a commercial fee from New LLP for its management activities as the general partner operating the business of New LLP.

27. Under the proposed new structure, the terms of the Subcontractors Agreement between the A and B Partnership and Company A (where the A and B Partnership sub-contracts its obligations under the contract with the State Government agency to Company A) will remain the same.

28. The current unwritten rental agreement in place between the A and B Partnership and Company A in respect of Company A renting the Assets owned by the A and B Partnership will be terminated under the proposed new structure, and a new (written) rental agreement will be entered into between New LLP and Company A. The cost base of this agreement is considered to be nil.

29. In relation to the formation of New GLP (and, upon registration as a LLP under the relevant State Partnership Act, New LLP), both the partners that held an interest in the Assets before the proposed disposal of a x-percent fractional interest in the Assets (i.e. A and B as partners in the A and B Partnership) and the partners that will have an interest in the Assets after the proposed fractional interest transfer (i.e. A and B and New Co as partners in New GLP and subsequently New LLP) will jointly choose rollover relief pursuant to section 40-340 of the Income Tax Assessment Act 1997.

30. Detailed cash flow projections and business plans will be produced by New LLP.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 94D

Income Tax Assessment Act 1936 Subdivision C of Division 5A in Part III

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1997 Section 40-30

Income Tax Assessment Act 1997 Section 40-40

Income Tax Assessment Act 1997 Section 40-85

Income Tax Assessment Act 1997 Subsection 40-180(2)

Income Tax Assessment Act 1997 Section 40-285

Income Tax Assessment Act 1997 Subsection 40-295(2)

Income Tax Assessment Act 1997 Subsection 40-340(3)

Income Tax Assessment Act 1997 Subsection 40-340(4)

Income Tax Assessment Act 1997 Section 40-345

Income Tax Assessment Act 1997 Subsection 104-10(1)

Income Tax Assessment Act 1997 Subsection 104-10(2)

Income Tax Assessment Act 1997 Subsection 104-25(1)

Income Tax Assessment Act 1997 Subsection 104-25(2)

Income Tax Assessment Act 1997 Subsection 104-25(3)

Income Tax Assessment Act 1997 Section 116-20

Income Tax Assessment Act 1997 Section 116-30

Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision

Issue 1 Question 1

Summary

The disposal by A and B of a x-percent fractional interest in the Assets that they hold as partners in the A and B Partnership will trigger a balancing adjustment event pursuant to subsection 40-295(2) of the Income Tax Assessment Act 1997 (ITAA 1997), as a relevant change in the holding of, or in the interests of entities in, the assets in question occurs at the time of the relevant disposition.

Detailed reasoning

Subsection 40-295(2) of the ITAA 1997 states:

A balancing adjustment event occurs for a depreciating asset if:

(a) for any reason, a change occurs in the holding of, or in the interests of entities in, the asset; and

(b) the entity or one of the entities that had an interest in the asset before the change has an interest in it after the change; and

(c) the asset was a partnership asset before the change or becomes one as a result of the change.

The Assets that are to be the subject of the fractional interest transfer from A and B as partners in the A and B Partnership to New Co are 'depreciating assets' as that term is defined in sections 995-1 and 40-30 of the ITAA 1997. In particular, pursuant to section 40-30 of the ITAA 1997, the Assets are depreciating assets as they have a limited effective life and can reasonably be expected to decline in value over the time that they are used. Hence, the Assets are 'depreciating assets' for tax and accounting purposes in the hands of the A and B Partnership, with such treatment continuing in the hands of the new General Law Partnership (New GLP) which, upon registration, will become a limited liability partnership (New LLP).

In terms of the meaning of 'holding' an asset, section 40-40 of the ITAA 1997 provides that while a partnership is the holder of partnership assets, individual partners have an interest in such assets.

Subsection 40-295(2) of the ITAA 1997 applies if the change in the holding of the asset, or in the interests of entities in the asset, occurs for any reason. The Commissioner considers that the following events would satisfy this subsection:

● the formation of a partnership

● the dissolution of a partnership

● a variation in the constitution of a partnership, and

● a variation in the interests of the partners in a partnership.

The proposed transfer by A and B as partners in the A and B Partnership of a x-percent undivided fractional interest in the Assets to New Co constitutes a change in the 'holding of, or in the interests of entities' in that the disposal of an undivided fractional interest in a partnership asset (the Assets) does not represent a disposal of the Assets per se, but instead constitutes a change in the interests in the Assets. In other words, prior to the intended disposal of the x-percent undivided fractional interest in the Assets, the Assets were owned by A and B as partners in the A and B Partnership, and post-disposal will be owned by A and B and New Co in their agreed percentages as tenants in common and as partners in New GLP (and upon registration as a LLP under the relevant State Partnership Act, New LLP). Post disposal, two partnerships will exist, being the A and B Partnership and New GLP/New LLP.

As a corollary of this, it follows that one or more entities that had an interest in the Assets before the disposal will have an interest post-disposal, being A and B. That is, the Assets were partnership assets of the A and B Partnership prior to the disposal of the fractional interests therein, and remain partnership assets post the disposal of the fractional interests therein to New Co, leading to the formation of New GLP and subsequently New LLP.

Therefore, the Assets that are to be the subject of the fractional interest transfer from the existing partnership (the A and B Partnership) to New Co (as a partner of New GLP/New LLP) were partnership assets both pre-disposal and post-disposal. It is noted that, as a matter of construction, if an asset was both a partnership asset pre and post the relevant change in holding, there is no requirement that the partnership that 'holds' the asset or assets both pre and post disposal be the same partnership for the purposes of paragraph 40-295(2)(c) of the ITAA 1997. All that is required for the purposes of that subsection is that the asset(s) in question be “a” partnership asset.

Hence, paragraph 40-295(2)(c) of the ITAA 1997 is satisfied, as the asset in question - the x-percent interest in the Assets - was a partnership asset of the A and B Partnership pre-disposal, and a partnership asset of New GLP post-disposal (and then of New LLP upon registration of New GLP as a LLP). There is direct High Court authority supporting this position in Rose v. FC of T (1951) 84 CLR 118; 9 ATD 334 (which concerned the trading stock provisions of the Income Tax Assessment Act 1936), where it was held that the disposal of an undivided fractional interest in an asset was not a disposal of the asset, and that such a transfer is treated as a balancing adjustment event under subsection 40-295(2) of the ITAA 1997 because there is a change in the interests in the asset.

Issue 1 Question 2

Summary

Not applicable.

Issue 1 Question 3

Summary

Upon formation of the proposed new partnership (New GLP, and upon registration as a LLP under the relevant State Partnership Act, New LLP), A and B as partners in the A and B Partnership (the transferor) and A and B and New Co as partners in New GLP/New LLP (the transferee) can jointly elect to apply rollover relief pursuant to subsection 40-340(3) of the ITAA 1997.

Detailed reasoning

Subsection 40-340(3) of the ITAA 1997 states:

There is also roll-over relief if:

(a) there is a *balancing adjustment event for a *depreciating asset because of subsection 40-295(2) (about a change in the holding of, or in interests in, the asset); and

(b) the entity or entities that had an interest in the asset before the change (also the transferor) and the entity or entities that have an interest in the asset after the change (also the transferee) jointly choose the roll-over relief.

Example:

The change could be a variation in the constitution of a partnership or in the interests of the partners.

Note 1:

Section 40-345 sets out what the relief is.

According to the response to Issue 1 Question 1, a balancing adjustment event pursuant to subsection 40-295(2) of the ITAA 1997 will arise as there will be a change in the holding of, or in interests in, the Assets upon the proposed transfer by A and B (as partners of the A and B Partnership) of one percent of their interest in the Assets to New Co, thus forming New GLP and subsequently New LLP.

As per the facts, both the partners that held an interest in the Assets before the proposed disposal of a x-percent fractional interest in the Assets (i.e. A and B as partners in the A and B Partnership) and the partners that will have an interest in the Assets after the proposed fractional interest transfer (i.e. A and B and New Co as partners in New GLP/New LLP) will jointly choose the rollover relief.

Therefore, the partners in both the existing partnership (the A and B Partnership) and the proposed new partnership (New GLP, and subsequently New LLP) can elect to apply rollover relief pursuant to subsection 40-340(3) of the ITAA 1997 upon formation of the proposed new partnership.

Issue 1 Question 4

Summary

Section 40-345 of the ITAA 1997 specifies the consequences of section 40-340 of the ITAA 1997 applying to provide rollover relief for a balancing adjustment event relating to a depreciating asset. Where a balancing adjustment event occurs for a depreciating asset, a balancing adjustment amount may be assessed or deducted under section 40-285 of the ITAA 1997 if the termination value of the asset differs from its adjustable value.

Pursuant to section 40-345 of the ITAA 1997, the nature of the rollover relief is as follows:

● section 40-285 of the ITAA 1997 does not apply to the balancing adjustment event for the transferor (being A and B as partners of the A and B Partnership), and

● the transferee of the x-percent fractional interest in the Assets (being A and B and New Co as partners of New GLP, and subsequently New LLP) can deduct the decline in value of the associated depreciating assets (the Assets) using the same method and effective life (or remaining effective life if that method is the prime cost method) that the transferor (i.e. A and B as partners of the A and B Partnership) was using.

Issue 1 Question 5

Summary

Subsection 40-340(4) of the ITAA 1997 prescribes the requirements for choosing rollover relief under subsection 40-340(3) of the ITAA 1997, by requiring the choice to be:

(a) in writing; and

(b) contain enough information about the transferor's holding of the property for the transferee to work out how this Division or Subdivision 328-D applies to the transferee's holding of the depreciating asset; and

(c) be made within 6 months after the end of the transferee's income year in which the balancing adjustment event occurred, or within a longer period allowed by the Commissioner.

As per the responses to Issue 1 Questions 3 and 4, the partners of both the existing partnership (the A and B Partnership) and the proposed new partnership (New GLP/New LLP) can elect to apply rollover relief under subsection 40-340(3) of the ITAA 1997, with the nature of the rollover relief being as prescribed in section 40-345 of the ITAA 1997.

Therefore, as subsection 40-340(3) of the ITAA 1997 applies, the relevant entities - being A and B as partners of the A and B Partnership (the transferor), and A and B and New Co as partners of New GLP and subsequently New LLP (the transferee) - can choose rollover relief in a manner according to the requirements of subsection 40-340(4) of the ITAA 1997, as stipulated above.

Issue 1 Question 6

Summary

The cost of the applicable depreciating asset (the Assets) for A and B and New Co as partners of New GLP/New LLP (the transferee) will be the 'adjustable value' of the asset to A and B as partners of the A and B Partnership (the transferor) just before the balancing adjustment event occurs pursuant to Item 6 in subsection 40-180(2) of the ITAA 1997.

Detailed reasoning

The cost of the applicable depreciating asset (i.e. the x-percent interest in the Assets) in the hands of A and B and New Co as partners of New GLP and subsequently New LLP (the transferee) will be governed by Subdivision 40-C of the ITAA 1997.

In the case of effective rollover relief under subsection 40-340(3) of the ITAA 1997, the Commissioner considers that both Items 5 and 6 of the cost table in subsection 40-180(2) of the ITAA 1997 - as extracted below - could apply to determine the cost of the relevant depreciating assets (i.e. the x-percent interest in the Assets) to A and B and New Co as partners of New GLP/New LLP (the transferee).

If more than one item in this table covers the asset, apply the last item that covers it.

First element of the cost of a depreciating asset
Item	In this case:	The cost is:
….
5	A partnership asset that was held, just before it became a partnership asset, by one or more partners (whether or not any other entity was a joint holder) or a partnership asset to which subsection 40-295(2) applies	The market value of the asset when the partnership started to hold it or when the change referred to in subsection 40-295(2) occurred
6	There is roll-over relief under section 40-340 for a balancing adjustment event happening to a depreciating asset	The adjustable value of the asset to the transferor just before the balancing adjustment event occurred
….

Subsection 995-1(1) of the ITAA 1997 provides that the 'adjustable value' of a depreciating asset has the meaning given by section 40-85 of the ITAA 1997. Subsection 40-85(1) of the ITAA 1997 defines the adjustable value of a depreciating asset at a particular time as follows:

(a) if you have not yet used it or had it installed ready for use for any purpose - its cost; or

(b) for a time in the income year in which you first use it, or have it installed ready for use, for any purpose - its cost less its decline in value up to that time; or

(c) for a time in a later income year - the sum of its opening adjustable value for that year and any amount included in the second element of its cost for that year up to that time, less its decline in value for that year up to that time.

The 'opening adjustable value' of a depreciating asset for an income year is defined in subsection 40-85(2) of the ITAA 1997 as the asset's adjustable value at the end of the previous income year.

Pursuant to subsection 40-180(2) of the ITAA 1997, if more than one item in the cost table applies, the last applicable item - in this case, Item 6 - determines the cost of the depreciating asset (i.e. the x-percent interest in the Assets). Therefore, as Item 6 of the cost table in subsection 40-180(2) of the ITAA 1997 is the operative Item, the cost of the depreciating asset in the hands of the transferee (being A and B and New Co as partners in New GLP and subsequently New LLP) would be the adjustable value of the asset to the transferor (being A and B as partners in the A and B Partnership) just before the balancing adjustment event occurs.

Issue 1 Question 7

Summary

Not applicable.

Issue 2 Question 1

Summary

The Commissioner is of the view that New GLP will be carrying on a business (a commercial rental business) for the purpose of profit-making, and as such is eligible for registration as a LLP (which would also meet the definition of a Corporate Limited Partnership (CLP)).

Detailed reasoning

As per the facts, the proposed restructure of the Group will entail the creation of a new GLP (New GLP), which is intended to subsequently be registered as a LLP (New LLP) - which will also be a 'corporate limited partnership' (CLP) such that New LLP will be taxed as a company pursuant to the tax modifications contained in Subdivision C of Division 5A in Part III of the Income Tax Assessment Act 1936 (ITAA 1936).

A 'partnership' is defined in subsection 995-1(1) of the ITAA 1997 as an association of persons (other than a company or a limited partnership) carrying on business as partners or in receipt of ordinary income or statutory income jointly; or a limited partnership. Similarly, the meaning of a 'partnership' in section 5 of the relevant State Partnership Act is 'the relation which subsists between persons carrying on a business in common with a view of profit.'

Subsection 995-1(1) of the ITAA 1997 provides that a 'limited partnership' is an association of persons (other than a company) carrying on a business as partners or in receipt of ordinary income or statutory income jointly, where the liability of at least one of those persons is limited. A 'limited partnership' is defined in section 49 of the relevant State Partnership Act to mean a partnership (as defined above) that exists between two or more persons of whom one or more is/are a general partner/s, and one or more is/are a limited partner/s. In order for at least one partner's liability to be limited in the relevant sense, that partner must be a 'limited partner' as defined in the Schedule to the relevant State Partnership Act to mean 'a partner in a limited partnership whose liability to contribute is limited under Chapter 3 [Limited Partnerships]'.

A CLP is defined in section 94D of the ITAA 1936 to mean, inter alia, a limited partnership (or LLP).

Therefore, before New GLP is able to be registered as a LLP/CLP under the relevant State Partnership Act, New GLP must firstly be carrying on a business with a view to profit. This position has recently been confirmed by the Full Court of the Federal Court in D Marks Partnership by its General Partner Quintaste Pty Ltd and Ors v. FCT [2016] FCAFC 86.

Is New GLP carrying on a business with a view to profit?

Whether a business is being carried on is a question of fact and degree. The Courts have developed a series of indicators that are applied to determine the matter on the particular facts.

Taxation Ruling 97/11 entitled 'Income tax: am I carrying on a business of primary production?'

(TR 97/11) discusses the Commissioner's view on whether a taxpayer is carrying on a business.

Ultimately, the question of whether the activities of a taxpayer amount to a business is decided on the facts of each case. The Commissioner and the Courts consider that the following matters (listed at paragraph 13 of TR 97/11) are relevant in determining whether a taxpayer is conducting a business of acquiring property for the purpose of making a profit on its subsequent sale:

● whether the activity has a significant commercial purpose or character

● whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

● whether there is repetition and regularity of the activity

● whether the activity is of the same kind and carried on in a similar manner to that of theordinary trade in that line of business

● the volume of the operations and the amount of capital employed

● whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit, and

● the size, scale and permanency of the activity.

In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impressions gained from looking at all the indicators and whether these indicators provide the operations with a commercial profile.

Having regard to the factors highlighted in paragraph 13 of TR 97/11, the Commissioner is of the view that New GLP will be carrying on a business - specifically a commercial rental business - for the purpose of profit-making.

Issue 3 Question 1

Summary

No capital gains tax (CGT) event will arise upon the conversion of New GLP to New LLP (which will meet the definition of a CLP pursuant to section 94D of the ITAA 1936) under the proposed restructure.

However, the termination of the current (unwritten) rental agreement between the A and B Partnership, and Company A will trigger CGT Event C2, and the market value substitution rule will apply in respect of capital proceeds involving the termination of that agreement. The Commissioner accepts that no capital gain or loss will arise from the termination of this agreement as it is acknowledged that the capital proceeds from the termination will be nil and that the current rental agreement does not have any cost base.

Detailed reasoning

Conversion of New GLP to New LLP

As per the facts provided, A and B (as partners in the A and B Partnership) will each transfer a X% interest in the Assets held in the A and B Partnership - along with the associated finance debt - to New Co (one percent in total) under the proposed restructure, and in so doing, will create New GLP, which will conduct the business of commercial rental of the Assets. New GLP will subsequently be registered as a LLP under the relevant State Partnership Act, thus becoming New LLP.

ATO Interpretative Decision 2010/210 CGT event A1: partnership becomes corporate limited partnership (ATO ID 2010/210) considers whether CGT Event A1 in subsection 104-10(1) of the ITAA 1997 happens to a partnership asset when a partnership converts to a limited partnership that satisfies the definition of a CLP in section 94D of the ITAA 1936.

Subsection 104-10(1) of the ITAA 1997 states that CGT Event A1 occurs when a taxpayer disposes of a CGT asset. According to subsection 104-10(2) of the ITAA 1997, a taxpayer disposes of a CGT asset if a change in ownership occurs from that taxpayer to another entity, whether because of some act or event or by operation of law.

Section 94D of the ITAA 1936 provides that, for the 1994/95 and later income tax years, a limited partnership is treated as a CLP.

ATO ID 2010/210 relevantly states the following:

Under the scheme of the relevant State legislation governing limited partnerships, there is no change of ownership of the partnership asset on the registration of a limited partnership. Generally, a partnership converts to a limited partnership, with the consent of all the partners, by varying the terms of the existing partnership agreement to limit the liability of one or more partners and registering the limited partnership under the relevant Australian State laws. This conversion does not cause the original partnership to cease; it merely varies the mutual rights and duties that exist between the partners.

Under the operation of Division 5A of the ITAA 1936, a limited partnership that satisfies the definition of corporate limited partnership in section 94D of the ITAA 1936 is treated as a company for certain income tax purposes. Division 5A of the ITAA 1936 does not modify the operation of CGT event A1 in section 104-10 of the ITAA 1997 such that an event happens to the partnership assets on the commencement of corporate limited partnership status.

Section 94J of the ITAA 1936 provides that a reference in the income tax law to a company or to a body corporate includes a reference to a partnership.

The Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 6) of 1992 which introduced Division 5A into the ITAA 1936 advised that, while corporate limited partnerships are generally treated as companies for the purposes of the income tax law, this does not convert them into companies for other purposes, including criminal law, monetary claims, and so on.

This is consistent with the view that the treatment of a corporate limited partnership as a company for the purposes of the ITAA 1997 and ITAA 1936 does not deem there to be a transfer of the ownership of partnership assets to the company nor does it change the ownership of partnership assets under general law.

As per the Commissioner's response to Issue 2 Question 1, New LLP (upon New GLP's registration as a LLP under the relevant State Partnership Act) would satisfy the meaning of a 'limited partnership' as defined in subsection 995-1(1) of the ITAA 1997. New LLP would thus be treated as a CLP as it meets the definition of a CLP (as defined in section 94D of the ITAA 1936).

Therefore, having regard to the principles encapsulated in ATO ID 2010/210, as there will be no change of ownership of the applicable partnership asset (i.e. the x-percent interest in the Assets) upon conversion of New GLP to New LLP under the proposed restructure described in the facts, CGT Event A1 will not happen.

Termination of Current Rental Agreement between the A and B Partnership and Company A

However, a CGT event will be triggered in respect of the termination of the current unwritten rental agreement in place between the A and B Partnership and Company A. As per the facts, the current unwritten rental agreement in place between the A and B Partnership and Company A in respect of Company A renting the Assets owned by the A and B Partnership will be terminated for the purpose of the proposed restructure, and a new (written) rental agreement will be entered into between New LLP/the CLP and Company A.

Subsection 104-25(1) of the ITAA 1997 provides that CGT Event C2 happens if ownership of an intangible CGT asset ends by the asset:

(a) being redeemed or cancelled; or

(b) being released, discharged or satisfied; or

(c) expiring; or

(d) being abandoned, surrendered or forfeited; or

(e) if the asset is an option - being exercised; or

(f) if the asset is a convertible interest - being converted.

The current rental agreement between the A and B Partnership and Company A is an intangible CGT asset, which will be terminated/cancelled/abandoned for the purpose of the proposed restructure.

Therefore, pursuant to subsection 104-25(1) of the ITAA 1997, the termination of the rental agreement between the A and B Partnership and Company A will give rise to CGT Event C2.

Subsection 104-25(2) provides that the timing of a CGT Event C2 will be when a contract is entered into that results in the relevant asset (in this case, the existing rental agreement between the A and B Partnership and Company A) ending, or if there is no contract, when the asset ends.

Pursuant to subsection 104-25(3), a capital gain is made if the capital proceeds from the termination of the existing rental agreement between the A and B Partnership and Company A are more than its cost base, and that a capital loss is made if those capital proceeds are less than the asset's reduced cost base. This correlates with the general rules in section 116-20 of the ITAA 1997 pertaining to capital proceeds received by a taxpayer when a CGT event happens to a CGT asset. However, such general rules are modified by the market value substitution rule in section 116-30 of the ITAA 1997.

Under section 116-30 of the ITAA 1997:

● Where a taxpayer receives no capital proceeds for a CGT event, the taxpayer is taken to have received the market value of the CGT asset that is the subject of the CGT event. (Subsection 116-30(1) of the ITAA 1997)

● Where a taxpayer does receive capital proceeds for a CGT event, the capital proceeds from the CGT event are replaced with the market value of the CGT asset that is the subject of the event if: (Subsection 116-30(2) of the ITAA 1997)

(a) some or all of those capital proceeds cannot be valued

(b) those capital proceeds are more or less than the market value of the asset and either:

(i) the taxpayer and the entity that acquired the asset did not deal with each other at arm's length in connection with the event, or

(ii) the CGT event is CGT event C2 (about cancellation, surrender and similar endings).

Exceptions to subsection 116-30(1) of the ITAA 1997 are provided in subsection 116-30(3) of the ITAA 1997, which include instances involving CGT Event C2 where a CGT asset expires, or a statutory licence held by the taxpayer is cancelled. It is considered that the exceptions in subsection 116-30(3) do not apply in the current circumstances.

Therefore, the termination of the current (unwritten) rental agreement between the A and B Partnership and Company A will trigger CGT Event C2, and the market value substitution rule will apply in respect of capital proceeds involving the termination of that agreement. The Commissioner acknowledges that the capital proceeds from the termination will be nil as, in an open market, a knowledgeable, willing but not anxious buyer acting at arm's length would not pay anything to acquire the agreement as:

● it is for a commercial rental only as opposed to providing a premium rental, and so has no greater value than entering into a new agreement in relation to the Assets, and

● it is an agreement at will that is not in writing, and so does not provide security to a purchaser as it could be terminated by the A and B Partnership at any time.

As per the facts, it is considered that the current rental agreement does not have any cost base.

Consequently, it is accepted that no capital gain or loss will arise from the termination of this agreement.

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