Edited version of private ruling

Authorisation Number: 1011813189051

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Ruling

Subject: Income Tax: Capital Gains Tax: Managed Investment Trusts

Question 1

In respect of a trust that is a managed investment trust (MIT) that has made a capital election pursuant to section 275-115 of the Income Tax Assessment Act 1997 (ITAA 1997), does section 275-100 of the ITAA1997 apply to make capital gains tax (CGT) the primary code for calculating a MIT's taxable income in respect of its interest, as a limited partner, in the gains and losses from the disposal of CGT assets which qualify as "covered assets" (as defined in section 275-105 of the ITAA 1997), where:

(a) the CGT assets were disposed of by the Venture Capital Limited Partnership (VCLP); and

(b) subsections 275-100(3) - (6) of the ITAA 1997 do not apply to the MIT limited partner in respect of those CGT assets?

Answer

No

Question 2

In particular, should MIT limited partner investors in the VCLP determine the capital gain each made from the disposal by the VCLP of shares in A Co on the basis that:

· no amount is included in their assessable income pursuant to section 92 of the Income Tax Assessment Act 1936 (ITAA 1936) a consequence of the disposal; and

· the provisions set out in subsection 275-100(2) of the ITAA 1997 do not apply?

Answer

No

This ruling applies for the following period

Year ended 30 June 2011

The scheme commenced on

1 July 2010

Description of VCLP

VCLP is an incorporated limited partnership registered under the provisions of the Partnership Act 1892 (NSW).

The VCLP is also unconditionally registered with Innovation Australia as a venture capital limited partnership under section 13-1 of the Venture Capital Act 2002 (Cth).

As an incorporated limited partnership, the VCLP has a legal personality separate from its partners. However, pursuant to subsection 94D(2) of the ITAA 1936, the VCLP is excluded from the operation of Division 5A of the ITAA 1936 which treats corporate limited partnerships as companies for tax purposes.

As such, the VCLP is treated as an ordinary partnership for tax purposes and the provisions of Division 5 of the ITAA 1936 in relation to partnerships are relevant for the purposes of determining the net income of the partnership to be included in the assessable income of its partners. In this regard, the VCLP prepares and lodges a Partnership Tax Return (Form P) annually.

The VCLP carries on the business of long term investment for the purpose of deriving dividends and interest income and it may derive capital gains in the long run. The VCLP does not employ any staff.

The VCLP only holds assets which are shares in companies that quality to be treated as 'eligible venture capital investments' (as defined in section 118-425 of the ITAA 1997) and provides loans which qualify as "permitted loans" (as defined in section 9-10 of the Venture Capital Act 2002 (Cth)).

The VCLP has not made an election to apply the "Fair Value method" or the "Reliance on Financial Reports" method under Division 230 of the ITAA 1997 to any of the partnership's financial arrangements.

Disposal of shares in A Co

The VCLP acquired the shares in A Co in the income year ended 30 June 2009. All of the shares held by the VCLP were sold during the income year 2011 for market value resulting in a gain on disposal.

The investment in A Co met all of the requirements to be treated as eligible venture capital investments (as defined in section 118-425 of the ITAA 1997), including the requirement at subsection 118-425(9) of the ITAA 1997 which requires that the shares must not be debt interests.

At the time of the disposal of the shares, the VCLP has determined that the requirements in section 51-54 and section 118-405 of the ITAA 1997 have been met to treat the gain from the disposal of the shares as being exempt from both income tax and capital gains tax for eligible venture capital partners. For others, the VCLP believes that the gain from the disposal of the shares should be treated as a capital gain and not ordinary income, and the VCLP intends to prepare the partnership income tax return for the year ended 30 June 2011 accordingly.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 5A

Income Tax Assessment Act 1936 section 92

Income Tax Assessment Act 1997 section 106-5

Income Tax Assessment Act 1997 subsection108-5(2)

Income Tax Assessment Act 1997 subsection 275-100 (1)

Income Tax Assessment Act 1997 subsection 275-100(2)

Income Tax Assessment Act 1997 section 275-115

Income Tax Assessment Act 1997 section 275-120

Taxation Administration Act 1953 Schedule 1, section 12-400.

Partnership Act NSW 1892 (NSW) section 20A

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Question 1

Detailed reasoning

Section 275-115 of the ITAA 1997 allows an eligible managed investment trust (MIT) to make an irrevocable choice to apply capital treatment to certain passive investments. The effect of this choice is to make the capital gains tax (CGT) regime the primary taxing code for the disposal of these investments.

Section 995-1 of the ITAA 1997 defines an MIT by reference to section 12-400 of Schedule 1 to the Taxation Administration Act 1953 (TAA). In broad terms an MIT is a public unit trust that is a listed, widely held or publicly offered managed investment scheme.

The assets to which the Subdivision applies are described as 'covered assets' in paragraph 275-100(1)(d) of the ITAA 1997 and are listed in subsection 275-105(1) of the ITAA 1997 as follows:

(a) a share in a company, including a share in a hybrid company;

(b) a non-share equity interest in a company;

(c) a unit in a unit trust;

(d) land (including an interest in land);

(e) a right or option to acquire or dispose of an asset of a kind mentioned in any of (a) - (d) above.

Whilst, paragraph 275-105(1)(a) of the ITAA 1997 states that a covered asset includes 'a share in a company', the provision does not include 'an interest in a share in a company'.

The taxpayer being an MIT, is also a partner in a VCLP, which is the entity that owns the asset to which the CGT event happens. Paragraph 275-100(1)(b) of the ITAA 1997 requires that the asset be owned by the MIT if the election is to have effect. Further, as it does not meet the definition of an 'eligible venture capital partner' as defined under section 118-420 of the ITAA 1997, the MIT is not eligible to have its share of any capital gains or losses disregarded under Subdivision 118-F of the ITAA 1997.

So having determined that the MIT must be the owner of the asset to which the CGT event happens in order for the Subdivision 275-B of the ITAA 1997 choice to have effect, it must be established that as a partner in the VCLP, the MIT is the 'owner' of the relevant asset.

Being a corporate limited partnership, the partners in the VCLP will not have any legal or beneficial interest in the partnership property (subsection 20A(2) of the Partnership Act 1892 (NSW)). Under the scheme as set out in the 'facts', the assets to which the CGT event happens are shares owned by the VCLP in an Australian registered company.

Paragraph 108-5(2)(c) of the ITAA 1997 states that 'an interest in an asset of a partnership' is a CGT asset.

Further, section 106-5 of the ITAA 1997 states that:

Section 106-5 Partnerships

106-5(1) Any capital gain or capital loss from a CGT event happening in relation to a partnership or one of its CGT assets is made by the partners individually.

Each partner's gain or loss is calculated by reference to the partnership agreement, or partnership law if there is no agreement.

106-5(2) Each partner has a separate cost base and reduced cost base for the partner's interest in each *CGT asset of the partnership.

106-5(3) If a partner leaves a partnership, a remaining partner 'acquires a separate CGT asset to the extent that the remaining partner acquires a share of the departing partner's interest in a partnership asset.

However, while for the purposes of the ITAA 1997 the MIT has an interest in the assets of VCLP by virtue of being a partner, this does not amount to the MIT having ownership of the share. As stated in paragraph 11 of Taxation Determination TD 2008/24:

…In Canny Gabriel Castle Jackson Advertising Pty Ltd v. Volume Sales (Finance) Pty Ltd (1974) 131 CLR 321 the High Court described the nature of a partner's interest in a partnership as a beneficial interest in each of the partnership assets. A beneficial interest in the assets does not equate to beneficial ownership of the assets because a partner does not have title to any specific asset owned by the partnership. The beneficial interest is an interest which will not take effect in possession until the partnership is dissolved. That is, whilst the partnership exists, a partner has by virtue of holding a beneficial interest in the assets of the partnership, a right to a proportion of the surplus after the realisation of the assets and payment of the debts and liabilities of the partnership….

The asset held by the MIT for the purposes of the ITAA 1997 is an interest in the share and not the share itself. As a result, the interests in a share held by the trustees of the MIT are not covered assets under section 275-105 of the ITAA 1997.

As explained above a CGT asset includes an interest in a partnership. However, covered assets under subsection 275-105(1) of the ITAA 1997 does not include an interest in a share in a partnership. Therefore, the principles explained in ATO ID 2011/7 which applies for the modifications under subsection 295-85(2) of the ITAA 1997 does not apply for the modifications under section 275-100(2) of the ITAA 1997.

Accordingly, the shares in A Co are not covered assets under subsection 275-105(1) of the ITAA 1997. As explained the MIT 'owns' an interest in shares that are owned by the VCLP.

Therefore, it is considered that section 275-100 of the ITAA 1997 does not apply to make the capital gains tax provisions the primary code for calculating a MIT's taxable income in respect of its interest, as a limited partner, in the gains and losses from the disposal of the shares in A Co. These 'assets' do not qualify as covered asset under section 275-105(1) of the ITAA 1997.

As a result, the capital gain made from the disposal of the shares in A Co by the VCLP will not satisfy the requirement for the modifications rules under section 275-100 of the ITAA 1997.

Question 2

Detailed reasoning

As explained in question one above, the shares that were owned by the VCLP in A Co are not covered assets under subsection 275-105(1) of the ITAA 1997. Therefore, section 275-100 of the ITAA 1997 will not apply to any capital gain made from the CGT event which happens to the shares in A Co. The capital gain will be included in the calculation of net income of the VCLP under section 92 of the ITAA 1936.

Section 92(1) of the ITAA 1936 provides that the assessable income of a partner in a partnership includes:

so much of the individual interest of the partner in the net income of the partnership of the year of income as is attributable to a period when the partner was a resident;

Hence, the assessable income of a resident partner includes the partner's individual interest in the (worldwide) partnership net income that is attributable to the period during which the partner is resident: section 92(1)(a) of the ITAA 1936.

Net income of a partnership is calculated as if the partnership were a taxpayer who was a resident, less all allowable deductions except deductions allowable under section 290-150 or Division 36 of the ITAA1997.

Section 92A of the ITAA 1936 was inserted by the Taxation Laws Amendment (Venture Capital) Act 2002 (Act 163 of 2002) and applies to the 2002-2003 income year and later income years.

Prior to the amendments by the Taxation Laws Amendment (Venture Capital) Act 2002, limited partnerships came within the definition of corporate limited partnerships in section 94D of the ITAA 1936, and were taxed as if they were companies: Division 5A of Part III of the ITAA 1936. The Taxation Laws Amendment (Venture Capital) Act 2002 amended section 94D of the ITAA 1936 to provide that a VCLP cannot be a corporate limited partnership: subsection 94D(2) of the ITAA 1936. VCLPs are therefore treated as ordinary partnerships for taxation purposes.

Capital gains made on assets held by a VCLP 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 will be taxed as capital gains.

Any capital gain or loss on the realisation of assets held by the VCLP will be taxed according to the partner's tax status.

In this case as explained above, the MIT will not satisfy the requirements under subsection 275-100(1) of the ITAA 1997 in respect of its interest in the shares so it is not possible for the trustee to make a choice under section 275-115 of the ITAA 1997. Therefore, any gain or loss flowing from the realisation of those shares owned by the VCLP, will not be affected by Subdivision 275-B of the ITAA 1997.