Edited version of private advice

Authorisation Number: 1051970854039

Date of advice: 4 May 2022

Ruling

Subject: Corporate limited partnership - disposal of real property

Question 1

Were Person A and Company B carrying on a 'partnership' as defined in section 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997) for the financial years ended 30 June 20XX to 30 June 20XX?

Answer

Yes.

Question 2

Was the partnership a 'limited partnership' as defined in section 995-1(1) of the ITAA 1997 for the financial years ended 30 June 20XX to 30 June 20XX?

Answer

Yes.

Question 3

Was the property legally and beneficially owned by Person A and Company B as at 30 June 2021?

Answer

Yes.

Question 4

Will Person A and Company B be liable to pay income tax on the capital gain from the sale of the property according to their proportionate interests?

Answer

Yes.

Question 5

If no, will the Partnership be liable to pay tax on the capital gain on the sale of the property?

Answer

Not applicable.

Question 6

If no, will the cost base of the property be its market value as at the date the partnership agreement was entered into?

Answer

Not applicable.

This ruling applies for the following period:

Financial year ended 30 June 20XX

The scheme commences on:

1 July 202X

Relevant facts and circumstances

Person A acquired the property after 19 September 1985.

The property was leased to Company B who operated a farming business on the property.

Company B was incorporated before 20 September 1985. Person A and their adult child, C are the directors of B Pty Ltd. The majority of the ordinary shares issued in Company B are held by Person A, most of the rest by C, and a very small percentage held by another relation.

Company B acquired a small interest in the property from Person A for a purchase price of $X. The capital gain on the disposal of the X% interest in the property was declared in Person A's tax return for that financial year.

The partnership was established under the relevant state Partnership Act to take over the operation of the primary production business from the company.

The partnership has a limited liability partner.

The partner's share of income and capital of the partnership is as follows:

Under the partnership agreement:

1.    the initial capital will be $x and will be contributed by the capital partners. The capital partners shall beneficially own the capital of the partnership in the proportions in which initial capital is contributed and if further capital contributions occur on the varied proportions subsequent to the change (clause X)

2.    general partners have the sole responsibility for the management of the partnership business (clause X)

3.    limited partners take no part in the conduct of the partnership business and have no right or authority to act for or bind the partnership (clause X)

4.    voting power in the partnership is determined by reference to the percentage of partnership capital of the partner (clause X).

The partnership is to carry on business as a Limited Partnership (clause X).

At all relevant times the partnership lodged a company tax return.

Person A declared the receipt of rental income from the lease of the property in their tax returns.

At no time was the property legally transferred from Person A and the company to the partnership.

On 30 June 20XX the property was sold by Person A and Company B to a third party for $X.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 subsection 106-5(2)

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

Income Tax Assessment Act 1936 subsection 94D(1)

Income Tax Assessment Act 1936 subsection 94D(2)

Income Tax Assessment Act 1936 section 94J

Income Tax Assessment Act 1936 section 94L

Income Tax Assessment Act 1936 section 94M

Income Tax Assessment Act 1936 section 94P

Income Tax Assessment Act 1936 section 94Q

Reasons for decision

Partnership

'Partnership' is defined in subsection 995-1(1) of the ITAA 1997 to mean 'an association of persons carrying on business as partners or in receipt of ordinary income or statutory income jointly', or 'a limited partnership' (paragraph 7 of Taxation Ruling TR 94/8). It does not include a company or a corporate limited partnership.

The first limb of this definition covers partnerships formed under the general law, which are defined in the State Partnership Acts as the relation which subsists between persons carrying on a business with a view to a profit.

The second limb refers to an association of persons that is not in business, but that is nevertheless in receipt of ordinary income or statutory income jointly. This type of partnership is referred to as a tax law partnership. The term 'association' is not defined in the ITAA 1997 and takes its ordinary meaning of 'connection or combination' with a common purpose or a body of persons associated together for a common purpose. For the purposes of the second limb of the definition of a partnership, co-owners of property are an association of persons.

The existence of a partnership for income tax purposes is determined based on the facts of each case. The existence of a partnership is evidenced by the actual conduct of the parties towards one another and towards third parties during the course of carrying on business.

Taxation Ruling TR 94/8 Income tax: whether business is carried on in partnershipsets out factors that will be considered in determining the existence of a business partnership. No one factor is conclusive, and each case will depend on its facts and surrounding circumstances.

The mutual assent and intention of the parties, together with conduct supporting that intention need to be considered. Mutual assent and intention to act as partners is considered essential in demonstrating the existence of a partnership, with a written or oral agreement accepted as prima facie evidence of such an intention.

Beyond intention, all relevant circumstances including the conduct of the parties will also be assessed. The factors considered include (from paragraph 4 of TR 94/8):

a) joint ownership of business assets;

b) registration of business name;

c) joint business account and the power to operate it;

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

e) extent of capital contributions;

f) entitlements to a share of net profits;

g) business records; and

h) trading in joint names and public recognition of the partnership.

In this case:

•         Person A and Company B own all business assets

•         Person A and Company B have registered the partnership

•         Person A and Company B have contributed capital to the business

•         Person A and Company B are entitled to net profits and losses of the partnership in agreed proportions

•         Person A and Company B shall beneficially own the capital of the partnership in the proportions in which capital is contributed.

•         Company B have the sole responsibility for the management of the partnership business (clause X). Although Person A as an individual partner takes no part in the conduct of the partnership business (clause X of the partnership agreement), Person A, being one of the directors of Company B and also being the main shareholder who holds X% share of B Pty Ltd, is considered to be involved in the management of the partnership business.

•         The partnership lodged the income tax returns and prepared the financial statements as an entity. They own the business assets, registered the partnership, have contributed capital, and are entitled to the net profits and losses of the partnership.

It is considered that Person A and Company B were intended to conduct a partnership business and in receipt of profits or losses of the business jointly. The business structure comes within the definition of partnership for income tax purposes.

Limited partnership

The partnership is a limited partnership for tax purposes under paragraph (a) of the definition of limited partnership in subsection 995-1(1) of the ITAA 1997. The partnership is a corporate limited partnership for tax purposes under subsection 94D(1) of the Income Tax Assessment Act 1936 (ITAA 1936). This is on the basis that it is a limited partnership; does not satisfy the exclusions in subsection 94D(2) of the ITAA 1936, and is not a foreign hybrid limited partnership.

A 'corporate limited partnership' is treated as a company for income tax purposes under section 94J of the ITAA 1936. Further, the partnership interests in the fund will be treated as shares (section 94P of the ITAA 1936), the partners (general partner and LP) will be treated as shareholders in the fund (section 94Q of the ITAA 1936) and distributions of profits or anticipated profits from the fund will be treated as dividends (sections 94L and 94M of the ITAA 1936).

The partnership contains at least one limited partner whose liability in relation to the partnership is limited, and meets the other criterion, so it is a limited partnership.

Ownership of the property

Taxation Ruling TR 93/32 explains that the net loss or income from a rental property must be shared according to the legal interest of the owners, except in those very limited circumstances where there is sufficient evidence to establish that the equitable interest is different from the legal title. A capital gain or loss is apportioned on the same basis. An example of where the equitable interest may differ from the legal interest is when an owner is holding their share as trustee for the other owner.

Capital gains tax (CGT) event A1 occurs when you dispose of a CGT asset. You are considered to have disposed of a CGT asset if a change of ownership occurs from you to another entity because of some act or event or by operation of law. The capital gain or capital loss is made at the time of the event.

It is the beneficial owner of a CGT asset that is liable for capital gains tax upon sale of the assets. A change of ownership does not occur if you stop being the legal owner. The beneficial owner of a CGT asset is also required to cease to be liable for tax on the capital gain on the sale of the assets.

In this case, it is accepted that Person A and Company B were the owners of the property as at 30 June 202X. Any income derived from renting the property and any capital gain or loss that occurs in relation to the sale of the property should be declared by both entities accord to their ownership interest in the property.

CGT consequences of disposal of real property by a limited partnership

The term 'partnership asset' is not defined for tax purposes however section XX of the Partnership Act (the relevant State Partnership Act) provides the following definition of 'partnership property':

(1) All property, and rights and interests in property, originally brought into the partnership stock or acquired, whether by purchase or otherwise, on account of the firm, or for the purposes and in the course of the partnership business, are called in this Act partnership property, and must be held and applied by the partners exclusively for the purposes of the partnership and in accordance with the partnership agreement.

Although, various modifications to the general laws of partnership are made under X of the Partnership Act makes in respect of LPs, however, no changes are made in relation to section XX of that Act.

Further explanation regarding partnership property was provided in O'Brien v Komesaroff 150 CLR 310; 41 ALR 255, in which Mason J clarified that:

... not all the property of each partner used for the purposes of the partnership business can be said to be brought into the partnership. It may in some circumstances remain the separate property of one partner... Whether the property of a partner becomes partnership property depends on the agreement of the parties...

The acts and intentions of the parties, not the operation of s 24 [the Victorian equivalent of s 23 of the State Partnership Act], determine finally and ultimately the question whether property owned by a partner becomes partnership property.

From the words of Mason J it can be seen that the agreement between the partners, together with actions and intentions of the partners, will finally and ultimately determine the question of what property is 'partnership property'.

On formation of a partnership, each partner has a separate cost base and reduced cost base for the partner's interest in each CGT asset of the partnership (subsection 106-5(2) of the ITAA 1997).

CGT event A1 (section 104-10 of the ITAA 1997) will happen to that part of the taxpayer's interest in the land at the time they enter the contract to dispose of the property. Each partner will use their portion of the sale price in the calculation of their capital gain for the financial year ended 30 June 202X.

Conclusion

Based on the facts you provided, we consider Person A and Company B were carrying on a 'partnership' and meet the definition of 'limited partnership' as defined in section 995-1(1) of the ITAA 1997 for the financial years ended 30 June 20XX to 30 June 20XX.

The property was legally and beneficially owned by Person A and Company B as at 30 June 20XX. Person A and Company B will be liable to pay tax on the capital gain from the sale of the property according to their proportionate interests.

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