Edited version of your written advice

Authorisation Number: 1051259768078

Date of advice: 18 August 2017

Ruling

Subject: Business – partnership – related parties – affiliate

Question

Does your joint ownership of real property constitute a partnership within the meaning of the terms contained under subparagraph 328-125(2)(a)(ii) of the Income Tax Assessment Act 1997?

Answer

Yes.

Question

Are you connected entities for the purposes of subsection 328-125(1) of the ITAA1997?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2018

Year ended 30 June 2017

The scheme commences on

1 July 2016.

Relevant facts and circumstances

You are a married couple.

You own a number of investment properties.

You each hold a 50% ownership interest in each property.

You earn rental income from each property.

The properties are not your main residence.

There is no written or verbal partnership agreement between you.

You do not conduct any business either in your own names or in partnership with each other.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-47

Income Tax Assessment Act 1997 section 328-125

Income Tax Assessment Act 1997 subsection 328-125(2)

Income Tax Assessment Act 1997 subparagraph 328-125(2)(a)(ii)

Income Tax Assessment Act 1997 subsection 328-130(1)

Income Tax Assessment Act 1997 section 960-100

Income Tax Assessment Act 1997 section 995-1

Further issues for you to consider

Additional information

This ruling has not considered your eligibility for the small business rollover concession. You should ensure that you satisfy the basic conditions and the active asset test. More information is available from our website as follows:

Small business entity concessions

Basic conditions for the small business CGT concessions

Reasons for decision

Detailed reasoning

Partnership

The term 'partnership' is defined in subsection 995-1(1) of the ITAA 1997 to mean:

(a) 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

(b) a limited partnership.

The first limb of paragraph (a) reflects both the general law definition of a partnership, which is the relationship which subsists between persons carrying on a business in common with a view of profit, as well as the concept of tax law partnership where property joint owners are in receipt of ordinary income (in this case, rent), jointly. That is to say, subsection 995-1(1) of the ITAA 1997 captures both common law, and tax law partnerships in the definition of partnership.

Connected entities

Subparagraph 328-125(2)(a)(ii) of the ITAA 1997 provides that:

An entity (the first entity) controls another entity if the first entity, its *affiliates, or the first entity together with its affiliates:

(a) except if the other entity is a discretionary trust – own, or have the right to acquire the ownership of, interests in the other entity that carry between them the right to receive a percentage (a control percentage) that is at least 40% of:

(i)…; or

(ii) if the other entity is a partnership – the net income of the partnership; …

In your case you are a member of a tax law partnership by way of your joint ownership of your rental property. As joint owners you are each entitled to 50% of the net income of the partnership, which satisfies the requirement of Subparagraph 328-125(2)(a) of the ITAA 1997 that you have a right to receive at least 40% of the partnership interests.

Therefore, each member of your partnership is considered to be connected entities of the other by virtue of your partnership relationship.

You have raised in your ruling application that the Explanatory Memorandum of the Tax Laws Amendment (Small Business) Act 2007 does not specify which type of partnership this law applies to. However, as 'Partnership’ is a defined term in the ITAA 1997, no reference is required to be made to the type of partnership, and it is considered that the use of the word partnership at paragraph 2.44 of the Explanatory Memorandum includes any partnership as defined under section 997-1(1) of the ITAA 1997.

You have also raised that 'partnership asset’ is an undefined term in section 997-1(1) of the ITAA 1997, and that there may be cause to consider that the term 'partnership asset’ may not be applied to a tax law partnership. However, this in itself does not support that entities in a tax law partnership are not connected.

Maximum net asset value test

To qualify for the capital gains tax concessions for small business you need to pass either an income or an asset test. The asset test is the Maximum net asset value (MNAV) test. To pass the test, the CGT assets owned by you and certain entities must not exceed $6 million just before the CGT event for which the concessions are sought.

When calculating the MNAV, you include the net value of assets owned by you, any entities connected with you, any affiliates, or entities connected with your affiliates.

As you are in a tax law partnership, each partnership member is a connected entity, and you would accordingly need to include the value of the partnership assets of each partner in the calculation of any MNAV.

Although you have raised in your private ruling request that you consider that the MNAV test is not meant to capture passively held assets held by partnerships, we would contend the opposite, and believe that the assets of a tax law partnership should be included in the view of a single economic unit.

Further, section 152-47(2) and (3) of the ITAA 1997 states:

152-47(2)

For the purposes of this Subdivision, in determining whether the business entity is an *affiliate of, or is *connected with, the asset owner, take the following to be affiliates of an individual:

(a) a *spouse of the individual;

(b) a *child of the individual, being a child who is under 18 years.

152-47(3)

If an entity is an *affiliate of, or *connected with, another entity as a result of subsection (2), then the *spouse or *child mentioned in that subsection is, in addition, taken to be an affiliate of the individual for the purposes of this Subdivision, and for the purposes of sections 328-110 to 328-125 to the extent that they relate to this Subdivision.

Under the operation of 152-47 of the ITAA 1997 as you are members of a tax law partnership and also in a spousal relationship, any assets that you hold passively would be included in any MNAV test as either connected entities or affiliates.

Conclusion

As partners in a partnership, you are connected entities as you satisfy Subparagraph 328-125(2)(a) of the ITAA 1997, and each partner is entitled to 50% of the net income of the partnership. This applies regardless of whether your partnership is a common law or a tax law partnership.

In the alternative, as each partner is the spouse of the other, you are considered to be affiliates under section 152-47(2) of the ITAA 1997.

Under either scenario the value of the assets held jointly in your tax law partnership would be included in any calculation of MNAV for any small business operated by either partner.

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