Edited version of private ruling

Authorisation Number: 1011659556310

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Ruling

Subject: Capital gains tax (CGT) and taxation of superannuation entities

Is the effect of section 295-85 of the Income Tax Assessment Act 1997 (ITAA 1997) that complying superannuation fund, complying approved deposit fund and pooled superannuation trust limited partner investors in a venture capital limited partnership should treat the loss made from the sale by the partnership of shares in a private company as a capital loss regardless of whether the loss is characterised as revenue or capital loss according to ordinary principles?

Yes, but only to extent that the relevant shares are not trading stock or otherwise excluded from the operation of subsection 295-85(2) of the ITAA 1997 by subsections 295-85(3) and (4) of the ITAA 1997.

This ruling applies for the following period:

Year ended 30 June 2008

The scheme commences on:

1 July 2007

Relevant facts and circumstances

Entity A is the general partner (GP) of Entity B.

Entity B was formed in the 2003-04 income year under the provisions of a Partnership Act. In legal form, Entity B is an incorporated limited partnership and is registered as such under the Partnership Act.

Entity B is registered with a statutory body under a section of an Act as a venture capital limited partnership (VCLP).

Whilst Entity B is a corporate limited partnership formed with a legal personality separate from its partners, pursuant to subsection 94D(2) of the Income Tax Assessment Act 1936 (ITAA 1936), Entity B is excluded from the operation of Division 5A of the ITAA 1936 and is taxed as an ordinary partnership under the provisions of Division 5 of the ITAA 1936 for income tax purposes. In this regard, Entity B prepares and lodges a Partnership income tax return annually.

Entity B was established as the primary investing vehicle of Entity C which is a private equity fund.

Entity B carries on the business of long term investment for the purposes of deriving dividends, interest income and ideally capital gains in the long run.

Entity B does not employ any staff and the GP has appointed Entity D as its investment manager.

Various complying superannuation funds are partner in Entity B. There are also partners which are not complying superannuation funds.

Entity B made an investment in a private company (the private company) in the 2005-06 income year.

In the 2007-08 income year, Entity B sold all its shares in the private company at market value resulting in a loss on disposal.

This ruling is given on the basis of the facts stated in the description of the scheme as set out above. Any material variation from these facts (including any matters not stated in the description above and any departure from these facts) will mean that the ruling will have no effect. No entity will then be able to rely on this ruling as the Commissioner will consider that the scheme has been implemented in a way that is materially different from the scheme described.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-5.

Income Tax Assessment Act 1997 Section 8-1.

Income Tax Assessment Act 1997 Section 295-85

Income Tax Assessment Act 1997 Subsection 295-85 (1).

Income Tax Assessment Act 1997 Subsection 295-85(2).

Income Tax Assessment Act 1997 Section 106-5.

Income Tax Assessment Act 1997 Subsection 106-5(1).

Income Tax Assessment Act 1997 Subsection 106-5(2).

Income Tax Assessment Act 1997 Section 108-5.

Income Tax Assessment Act 1997 Subsection 108-5(2).

Income Tax Assessment Act 1936 Section 90.

Income Tax Assessment Act 1936 Subsection 94(2).

Income Tax Assessment Act 1936 Subsection 94D(2).

Income Tax Assessment Act 1936 Section 304.

Reasons for decision

Summary of decision

The complying superannuation fund, complying approved deposit fund and pooled superannuation trust limited partner investors in Entity B should treat the loss made from the sale by the partnership of shares in the private company as a capital loss regardless of whether the loss is characterised as revenue or capital loss according to ordinary principles, but only to the extent that the shares are not trading stock or otherwise excluded from the operation of the provisions relating to the taxation of superannuation entities.

Detailed reasoning

Subsection 295-85(1) of the ITAA 1997 states that the modifications in subsection 295-85(2) apply if a CGT event happens involving a CGT asset that was owned by a complying superannuation fund, complying approved deposit fund (ADF) or a pooled superannuation trust (PST) just before the time of the event. Subsection 295-85(2) states that provisions including sections 6-5 and 8-1 do not apply to the CGT event.

The general application of CGT rules in relation to partnership revenue assets

A CGT asset is defined in section 108-5 of the ITAA 1997. Subsection 108-5(2) states that an interest in an asset of a partnership is a CGT asset.

The treatment of partnership assets is codified in section 106-5 of the ITAA 1997 which states that any capital gain or loss from a CGT event happening in relation to a partnership or one of its CGT assets is made by the partners individually.

Subsection 106-5(1) of the ITAA 1997 provides that any capital gain or capital loss from a CGT event happening in relation to a partnership's CGT asset is made by the partners individually. Subsection 106-5(2) provides that each partner has a separate cost base and reduced cost base for each of the partner's interest in each CGT asset of the partnership. Therefore, in the case of assets of a partnership, the relevant CGT asset is the partner's interest in the asset of the partnership.

As any capital gain or capital loss from a CGT event happening in relation to a partnership's CGT asset is made by the partners individually, a partnership cannot make a capital gain or loss. Therefore, the net income of a partnership under section 90 of the ITAA 1936 does not include any capital gains or losses in relation to the disposal of partnership assets.

In the case of Entity B, CGT events happen to CGT assets, being the interests in the relevant shares attributable to the complying superannuation fund partner. Specifically, the relevant CGT assets are the interests of the complying superannuation fund partner in the shares in the private company. The relevant CGT events are the disposals by the complying superannuation fund partner of its interests in the shares in the private company.

Why the ordinary income/general deduction provisions cannot apply to the disposal of a complying superannuation fund partner's interest in the shares in the partnership, to the extent that the interest is subject to section 295-85 of the ITAA 1997

Section 295-85 of the ITAA 1997 applies where a CGT event happens involving a CGT asset that was owned by a complying superannuation fund, complying ADF or a PST just before the time of the event. The effect of section 295-85 applying is (relevantly) that sections 6-5 and 8-1 do not apply to a CGT event that happens to the relevant CGT asset.

Subsection 295-85(2) of the ITAA 1997 does not explicitly state that its operation is limited to taxpayers referred to in subsection 295-85(1). Rather, it merely lists the modifications to the ITAA 1997 that apply if a CGT event happens to a CGT asset owned by an entity listed in subsection 295-85(1).

These modifications include that sections 6-5 and 8-1 of the ITAA 1997 do not apply 'to the CGT event'. In the present case the CGT events are the disposals of the CGT assets being the interests in the shares in the private company that are held by the complying superannuation fund that is a partner in Entity B.

Accordingly, on a plain reading of subsections 295-85(1) and (2) of the ITAA 1997 it is considered that sections 6-5 and 8-1 would not apply to any taxpayer (including the partnership Entity) in relation to the disposal of the interest in the shares in the private company that are attributable to the complying superannuation fund partner in Entity B.

The view that, by virtue of section 295-85 of the ITAA 1997, sections 6-5 and 8-1 of the ITAA 1997 do not apply to any taxpayer (including the partnership Entity B) in relation to the disposal of the interest in the shares in the private company that are held by the complying superannuation fund partner in Entity B is supported by an examination of the Explanatory Memorandum (EM) to the Taxation Laws Amendment (Superannuation) Bill 1989 which introduced section 304 of the ITAA 1936 (the predecessor provision to section 295-85 of the ITAA 1997) and the EM to Taxation Laws Amendment (Venture Capital) Bill 2002.

The EM to the Taxation Laws Amendment (Superannuation) Bill 1989 states:

This Bill also proposes amendments so that where Part IIIA applies to the disposal of an asset (including one acquired after 30 June 1988) by a complying superannuation fund, complying ADF or a PST then, generally, no amount will be included in the assessable income of the taxpayer under section 25 or section 25A, or allowed as a deduction under section 51 or section 52.

The EM also states in relation to section 304 of the ITAA 1936:

Paragraphs 304(a), 304(b) and 304(c) specify the consequences where section 304 applies.

By paragraph 304(a) an amount is not included in the assessable income of the taxpayer under section 25 of the Principal Act in respect of the disposal of an asset unless the asset is a security or the amount is a gain attributable to currency exchange rate fluctuations. Section 25 is the general provision which includes income derived by a taxpayer in assessable income.

References in the above EM to section 25 are references to the predecessor provision to section 6-5 of the ITAA 1997.

Section 304 of the ITAA 1936 is specifically referred to in the EM to Taxation Laws Amendment (Venture Capital) Bill 2002:

Capital gains

2.20 Capital gains made on assets held by a VCLP, an AFOF or a VCMP will be taxable to a partner in the same way as interests on assets held by an ordinary partnership. For example, as the CGT provisions are the primary code for taxing gains and losses made by superannuation funds, approved deposit funds and pooled superannuation trusts (section 304 of the ITAA 1936), gains flowing to any of these entities as a limited partner in a VCLP or AFOF will be taxed as capital gains.

2.21 Any capital gain or loss on the realisation of assets held by the VCLP or AFOF, including the carried interest distributed by a VCMP, will be taxed according to the partner's tax status. Thus, individuals who are partners in a VCMP will qualify for the CGT discount on the carried interest if they satisfy the other requirements for the discount.

This illustrates that the legislative intent of Parliament was to allow the CGT provisions to apply as the primary code for taxing gains and losses made by complying superannuation funds. Paragraph 2.20 above strongly suggests that there was also a specific intent to apply section 304 of the ITAA 1936 (now section 295-85 of the ITAA 1997) to a partner's interests in a VCLP potentially subject to ordinary income rules. The effect of this is that amounts attributable to the CGT event happening to the CGT asset of the complying superannuation fund partner are excluded from section 6-5 and 8-1 of the ITAA 1997 where the other conditions of section 295-85 of the ITAA 1997 are met.

Accordingly, sections 6-5 and 8-1 of the ITAA 1997 do not apply to any taxpayer (including the partnership Entity B) in relation to the disposal of the interest in the shares in the private ruling that are attributable to the complying superannuation fund partner in Entity B.

The calculation of section 90 of the ITAA 1936 net income involves applying sections 6-5 and 8-1 of the ITAA 1997. However, the effect of section 295-85 of the ITAA 1997 is that sections 6-5 and 8-1 of the ITAA 1997 do not apply to the calculation of section 90 of the ITAA 1936 net income in relation to amounts that are attributable to the CGT event happening to the complying superannuation fund partner.

As section 6-5 of the ITAA 1997 (and therefore also section 8-1 of the ITAA 1997) does not apply to the disposal of the interest in the asset of the partnership, any gain (or loss) will therefore not be included in the net income of the partnership of Entity B that is determined under section 90 of the ITAA 1936 but rather the gain or loss will fall for consideration under the CGT rules in relation to the complying superannuation fund partner.