Edited version of private advice

Authorisation Number: 1051596811732

Date of advice: 21 October 2019

Ruling

Subject: Partnerships

Question

Does Company A, Company B and Company C constitute a partnership?

Answer

No.

This ruling applies for the following period:

1 January 2019 to 31 December 2020

The scheme commences on:

October 2013

Relevant facts and circumstances

The ownership structure

Company D is owned by:

·         Company E; and

·         Company B acting in the capacity as trustee for Trust 1.

Company F is the trustee of Trust 2. The units in Trust 2 are owned by:

·         Company A; and

·         Trust 1.

Company D contracted to purchase real estate. At the time of acquisition, Company D intended to hold this real estate as a long term investment.

Trust 2 contracted to purchase real estate.

The two properties are contiguous.

Proposed development and joint venture

Company D and Trust 2 decided to pursue a development approval for the redevelopment of the properties with a view to constructing, tenanting and eventually selling the completed structure (the Project). Company D and Trust 2 agreed to share any profits and losses equally.

Trust 2 would take more of a lead role in the project. To reflect this, the parties decided to enter into a more formal agreement. The following parties entered into an agreement setting out their roles and obligations in relation to the proposed development (Joint Venture Agreement - as supplied with the Ruling Application):

·         Company A;

·         Company C;

·         Company D;

·         Company E;

·         Trust 1;

·         Trust 2; and

·         Company A, Company C, and Trust 1 jointly (Development Managers).

The Joint Venture Agreement provides for the payment of a fee to the Development Managers, and further provides that the Joint Venture may be terminated either by:

·         mutual agreement of the parties; or

·         written notice following an event of default which is not rectified by the defaulting party. The events of default, as defined in the dictionary, relate to acts of insolvency, repudiation of the agreement, failure to discharge debt agreements and fraudulent conduct.

Activities of Company C

Company C in its capacity as one of the Development Managers has planned to hire specialist staff to work on the project, for example, a specialist project manager, a specialist construction manager and various development consultants.

The Development Managers collectively, as opposed to any one of them acting in their own individual capacities, do not carry on any other activity other than that related to the Project. That is, the Project is the only expected source of revenue for the Development Managers.

Status of the project

A development approval has been obtained for the Project. The Development Managers are in the process of securing a tenant for the Project.

Offers to purchase:

(i)    Trust 2 received an unsolicited offer to purchase their property.

(ii)   Company E and Trust 1 received an unsolicited offer to purchase their shares in Company D.

Neither of the unsolicited offers described in the preceding paragraph ultimately resulted in a sale and the Project has proceeded on the basis that it will be completed by parties to the Joint Venture Agreement. However, due to commercial interest in the site, the parties to the Joint Venture Agreement anticipate that further offers will be received in the future.

Should Trust 1, Trust 2, and Company E accept an offer of the type described above, the prospective purchaser will likely carry out a redevelopment and will not require the services of the Development Managers.

Apart from any offers of the type described above, the parties to the Joint Venture Agreement may seek to terminate it for other commercial reasons. For example, if a less expensive Development Manager can be appointed.

Should they seek to terminate the Joint Venture Agreement, the parties to the Joint Venture Agreement (excluding the Development Mangers), will offer to pay the Development Managers a "break fee" in return for the Development Managers agreeing to terminate the Joint Venture Agreement.

Should the Development Mangers agree to terminate the Joint Venture Agreement in return for payment of a break fee, they will be required to enter into a deed of release. Under the terms of the deed of release:

·         the Development Mangers would accept the break fee in full and final satisfaction of the other parties' obligations under the Joint Venture Agreement; and

·         the Development Mangers would give up any further claims arising from termination of the Joint Venture Agreement.

In any event, the offer to sell the Properties was not accepted and the directors have since continued with their original intention to develop the Properties. In doing so, a letter of intent has been executed with a third party, and the directors hold an optimistic view of proceeding with this party towards an agreement for lease. As a consequence, the JVA is no longer intended to be terminated and as a consequence no break fee will be required to be accurately calculated or paid.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Reasons for decision

Question 1

Summary

Company A, Company B, and Company C do not constitute a partnership.

Detailed reasoning

Subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) states that 'partnership' has the same meaning as in the Income Tax Assessment Act 1997 (ITAA 1997).

Section 995-1 of the ITAA 1997 states:

partnership means:

(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.

This definition of partnership has three limbs:

·         an association of persons (other than a company or limited partnership) carrying on a business as partners (a general law partnership);

·         an association of persons (other than a company or limited partnership) in receipt of ordinary or statutory income jointly (a "tax law partnership" - also called a statutory partnership); or

·         a limited partnership.

The possible distinction between a partnership at general law and for taxation purposes is important because where there is a partnership at general law, it is possible for the partners to enter into an agreement that determines the proportional share of profits and losses that will apply. On the other hand, where a partnership is deemed to exist for taxation purposes only, such as where income is jointly received, it is not possible to make an agreement varying distribution of profit and losses. The partners will be required to return their share of profits and losses in accordance with their respective legal or equitable interests.

Whether a partnership exists is a question of fact. A taxpayer alleging that there is a partnership (and consequent division of income) bears the onus of proving its existence.

The Tax Office considers that the intent and conduct of the parties indicates the existence of a partnership and, in TR 94/8, outlines the following non-exhaustive factors that should be taken into account in deciding whether a partnership exists:

·         the mutual assent and intention of the parties;

·         joint ownership of business assets;

·         registration of a business name;

·         joint business account and the power to operate it;

·         the extent to which the parties are involved in the conduct of the business;

·         the extent of the capital contributions;

·         entitlements to a share of net profits;

·         business records; and

·         trading in joint names and public recognition of the partnership.

No single factor is decisive and the weight to be given to each factor varies with individual circumstances, although entitlement to a share of net profits is essential.

Intention

Mutual assent and intention to act as partners is the essential element in demonstrating the existence of a partnership between two or more persons. The Commissioner accepts a written or an oral agreement as prima facie evidence of such an intention.

However, a stated intention of a partnership is not, of itself, sufficient to establish a partnership, as the intention must be manifested by conduct (Re Megevand; Ex Parte Dalhasse (1878) 7 Ch. D 511). The parties must understand what the partnership relationship entails, which requires more than a general understanding between them that they are in business as partners (I.R. Commrs v. Williamson (1928) 14 TC 335) (Williamson).

The Commissioner acknowledges the "Heads of Agreement" entered into by Company C along with Company A and Company B. The Commissioner further acknowledges that these three entities have other business interests and would therefore understand the content of that document and the relationship they entered into at the time of signing.

Company D and Trust 2 own the assets but do not have any employees, therefore they rely on the "Heads of Agreement" agreement with the three entities to do the actions necessary to progress the project.

Over the past few years the three entities, collectively have undertaken all the planning aspects and administrative duties as per their Development Manager role under the Joint Venture Agreement.

Therefore, the Commissioner considers the three entities have demonstrated their mutual assent and intention to work together for the progression of the project.

Conduct

Mutual assent and intention must be demonstrated, but do not stand alone and must be assessed with all relevant circumstances, including the conduct of the parties (Jolley v. FC of T 89 ATC 4197). This conduct is explored in greater detail below.

Joint ownership of business assets

The Commissioner views the joint ownership of business assets, together with a joint liability to business debt, as indicative of a business partnership. All partners must be liable for the partnership's debts not only to the extent of the partnership property, but also to the extent of their personal resources.

On the facts provided by you, including the Joint Venture Agreement and Heads of Agreement, it is evidentiary that the capital and business assets are provided by the Joint Venture. Further, the full liability is also borne by the Joint Venture. The alleged partnership has not extended any assets nor is it liable for any debts in relation to its business activities.

Registration of a business name

The Commissioner considers the registration of a business name by the parties to be a positive factor in determining the existence of a partnership. The use of a business name, or the names of the parties trading in joint names, can be an external sign of the existence of a partnership to third parties.

The alleged partnership is not registered and does not have a business name. You note that the parties to the alleged partnership are also parties to the Joint Venture. Therefore it was not necessary to register a business in order to build brand recognition or for promotional purpose as the parties are already known.

Joint business account and power to operate the account

The existence of a joint bank account, specifically named and used as a business account, is another positive factor in establishing that business is being carried on in partnership. The Commissioner gives this factor greater weight where:

·         the bank at which the account is held is aware the parties are acting in partnership; and

·         all parties have the power to operate the account.

You state the alleged partnership does not have any bank accounts. You further state that a bank account would only be opened to receive the management fees at the end of the Project.

Extent to which parties are involved in the conduct of the business

While it is not essential all partners actively participate in a partnership, such participation supports the existence of a partnership.

Exclusive performance of all the work or activities of a business by one party will not, of itself, negate the conclusion that a partnership exists.

The Commissioner acknowledges this point is satisfied on the basis the work is being undertaken collectively to complete the Project.

Extent of capital contributions

When the Commissioner examines relationships between parties to determine whether they are in partnership, the Commissioner assess the relative capital contributions of the parties to the relationship. Contributions may be made at the start of, or during, a partnership.

The sharing by the parties of contributions to assets and capital weighs in favour of the existence of a partnership.

It is the Commissioner's view the assets and capital have been contributed by the Joint Venture and not from the alleged partnership.

Entitlement to a share of net profits

Partners share between them the profits and losses of the partnership activity (Williamson). The Commissioner looks at the rights of the parties to a share of the net income or loss of the partnership. A situation in which profits are shared in line with clearly stated rights and entitlements in the partnership agreement is prima facie evidence of the existence of a partnership.

The 'Heads of Agreement' outlines the 'fees' the alleged partnership will charge the Joint Venture for services. The alleged partnership will never sustain losses. It is the Joint Venture that will actually share the profits and losses between its partners.

Business records

The existence of a partnership is supported when business activities are entered in records that are separate and distinct from those kept for other business and private activities. Business records include:

·         books of account (with accounts for each partner's capital contribution, drawings, and share of profit or loss);

·         minutes of partnership meetings; and

·         memoranda of decisions reached, especially regarding shares of income and losses.

All records are held for the Joint Venture. Further, as the alleged partnership has not generated any income, it is not required to lodge a tax return. Therefore it has not prepared any formal financial statements.

There are minutes of the alleged partnership meetings which were provided as part of the private ruling application. Major decisions are also minuted but no separate memoranda of decisions are prepared.

Trading in joint names and public recognition of the partnership

The conclusion that a partnership exists is supported if the parties, by trading in joint names, make it clear to persons dealing with them that they are in partnership. Banks, suppliers, and customers dealing with a partnership should be aware they are trading with a partnership, as opposed to dealing with an individual. It is important that creditors of a partnership, as partners are obliged, jointly and severally to meet the debts to the full extent of their own resources.

The alleged partnership does not trade at all in its own capacity as its sole purpose is to manage the development of the Joint Venture.

Conclusion

The Joint Venture contributed all capital, bears the losses (if any) and carries all the risk.

The alleged partnership's sole purpose is to manage the development of the Joint Venture. The parties to it signed a "Heads of Agreement' which states how they will act, how they will resolve conflict, and what they will be paid for their services as Development Managers.

The Joint Venture Agreement refers to the alleged partnership as 'Development Managers' and does not refer to them as being in a partnership. Rather, it appears to be a contractual arrangement whereby the Development Managers undertake the Project for a set percentage fee, thereby none of the three entities have an entitlement to a share of the net profits directly. Their conduct is the satisfying of the contract rather than the actions of partners in a partnership.

On the balance of the factors as outlined above from TR 94/8, the Commissioner considers it is more probable the alleged partnership does not constitute a partnership. Even though there is a "Heads of Agreement" which states they are a partnership, they still fail several of the factors.

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