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Ruling

Subject: Fringe benefits tax - expense payment fringe benefits, otherwise deductible rule.

Question 1

Is the Taxable Value of an expense payment fringe benefit arising from the payment of an employee's partnership expenses, where you pay those expenses under a salary sacrifice arrangement with your employee; reduced to the extent that those expenses are otherwise deductible under section 24 of the Fringe Benefits Tax Assessment Act 1986 (FBTAA)?

Answer

Yes.

Question 2

Is the Taxable Value of an expense payment fringe benefit arising from the payment of an employee's partnership expenses, where you pay those expenses under a salary sacrifice arrangement with your employee; worked out using a notional deduction calculated in accordance with subsection 24(9) of the FBTAA?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 2012.

The scheme commences on:

1 July 2011.

Relevant facts and circumstances

The Family Trust employ an individual (your employee), who is in no way related to the family trust, nor is he a proprietor in any business associated with the trust.

Your employee is a partner in a partnership (the partnership), which carries on a business. An attachment has been prepared to the partnership agreement specifying individual expenses from the partnership operation and assigning those expenses to be paid by particular partners.

It is proposed that you enter a salary sacrifice arrangement with your employee. Under that arrangement you intend to pay expenses of the partnership, for which your employee is assigned under the additional agreement made by the partners. You intend to make payment of those expenses directly to the Third Party.

Assumptions

The expenses outlined within the scheme of this ruling are expenses of the partnership. The nature of, and liability in respect of, those expenses is not altered in any way by the agreement between partners to assign the responsibility for the payment of those expenses to an individual partner.

The proposed salary sacrifice arrangement is an effective salary sacrifice arrangement for the purposes of determining that an amount is a benefit provided to an employee such that the FBTAA will apply in respect of that amount.

For the relevant year of tax, in respect of the benefit provided to your employee that are the subject of this ruling, your employee has:

· provided documentary evidence in respect of their expenditure; and

· provided declarations in respect of their expenditure, in the form approved by the Commissioner, before the declaration date; and

· satisfied any other evidentiary or declaration requirement; under subsection 24(1) of the FBTAA.

Relevant legislative provisions

Fringe Benefits Tax Assessment Act 1986 Section 20

Fringe Benefits Tax Assessment Act 1986 Section 24

Fringe Benefits Tax Assessment Act 1986 Subsection 24(1)

Fringe Benefits Tax Assessment Act 1986 Paragraph 24(1)(l)

Fringe Benefits Tax Assessment Act 1986 Subsection 24(9)

Fringe Benefits Tax Assessment Act 1986 Subsection 136(1)

Fringe Benefits Tax Assessment Act 1986 Subsection 138(3)

Income Tax Assessment Act 1936 Section 318

Income Tax Assessment Act 1936 Division 5

Income Tax Assessment Act 1936 Section 90

Income Tax Assessment Act 1936 Subsection 92(1)

Income Tax Assessment Act 1936 Subsection 92(2)

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Subsection 8-1(1)

Income Tax Assessment Act 1997 Subsection 8-1(2)

Income Tax Assessment Act 1997 Division 35

Income Tax Assessment Act 1997 Subsection 35-10(1)

Income Tax Assessment Act 1997 Subsection 35-10(2).

Reasons for decision

These reasons for decision accompany the Notice of private ruling.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Question 1

Detailed reasoning

General discussion of the law

Partnerships

Partnerships fall under common law in addition to relevant state law (Partnership Act). The legal principles that apply to partnerships are not modified for the purposes of taxation law. Generally, a partnership is an association of separate persons who, with a view to profit:

· carry on business as partners, or

· receive income jointly.

In common law it has been established that a partnership is not a separate and distinct legal entity from the persons who comprise it. A partnership is merely a relationship between separate persons, the partners. The nature of that relationship is contractual and, therefore, much of the law relevant to the formation of a contract is also relevant to the formation of a partnership.

Due to the contractual nature of partnerships, a partner's interest in a partnership is largely dependant on the agreement between the partners. The courts have determined in FC of T v. Everett (1980) 143 CLR 440; 80 ATC 4076 (Everett's case) and FC of T v. Galland (1986) 162CLR 408; (1986) 86 ATC 4885 (Galland's case) that in certain circumstances the net partnership income and the interest of a partner in that partnership may be determined under such agreements.

The Commissioner has discussed these cases and their application for income tax purposes in Taxation Ruling IT 2501 and Taxation Ruling IT 2608. Generally the Commissioner will treat such agreements as applying for income tax purposes, however any such agreement must be on all-fours with the facts of the Everett and Galland cases.

However, where a partnership agreement does not specify a partner's interest, or is silent on a particular matter, the relevant Partnership Act of the States and Territories may determine the required treatment.

In relation to the liabilities of partners, the Partnership Acts of the States and Territories make every partner in a partnership liable jointly with the other partners for all debts and contractual obligations of the partnership incurred while the partner is a partner of that partnership.

In particular, section 13 of the Partnership Act 1958 (VIC) provides that every partner in a partnership (other than an incorporated limited partnership) is liable jointly for the debts and obligations of the partnership. Joint liability is a joint obligation of two or more persons (the partners) irrespective of the individual contributions between those people.

This means if the partnership incurs a debt, each partner is personally liable to meet the full extent of that debt or obligation. If the assets of the business are not sufficient to satisfy the debt, the personal assets of the individual partners can be called upon in satisfaction of that debt. In other words, the partnership may have incurred the expenses but ultimately every partner is liable jointly or severally for the partnership debts and obligations.

Deductibility of partnership expenses

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) deals with general deductions. Where subsection 8-1(1) of the ITAA 1997 allows a taxpayer to deduct from their assessable income any loss or outgoing to the extent that it is incurred in gaining or producing their assessable income, or it is necessarily incurred in carrying on a business for the purpose of gaining or producing their assessable income.

However subsection 8-1(2) of the ITAA 1997 provides that you cannot deduct a loss or outgoing to the extent that the expenditure is private, domestic or capital in nature.

Taxation Ruling TR 97/7 sets out the Commissioner's views on the meaning of incurred. Generally, a taxpayer incurs an expense at the time they owe a present money debt that they cannot escape.

The courts have developed a set of rules that help to determine if an expense has been incurred;

· there must be a presently existing liability to pay a pecuniary sum

· the taxpayer's liability may be defeasible by others

· the liability must be a sum certain or capable of reasonable estimation

· presently existing liability is determined on the circumstances of the case, and

· an expense is incurred when actually paid if there was no presently existing liability.

Additionally, paragraph 6 of Taxation Ruling TR 94/26 also provides the following interpretation of the word 'incurred':

The determination of whether an outgoing is incurred depends on whether there is a presently existing pecuniary liability, having regard to the terms of the contract and other arrangements giving rise to that liability.

Division 5 of the Income Tax Assessment Act 1936 (ITAA 1936) deals with the liability to taxation of partnerships. It also sets out the ordinary rules for the treatment of income and allowable deductions of partnerships.

Section 90 of the ITAA 1936 defines the 'net income' of the partnership broadly as all the assessable income less all the allowable deductions of the partnership, calculated as if it were a resident taxpayer. Similarly, the partnership loss of a partnership is defined as the excess of all the allowable deductions over all the assessable income of the partnership, calculated as if it were a resident taxpayer.

Subsection 92(1) of the ITAA 1936 then includes in the assessable income of each partner their interest in the net income of the partnership. Where a loss has been incurred, subsection 92(2) of the ITAA 1936 provides that there is an allowable deduction to each partner for their interest in that partnership loss.

In Galland's case, Mason and Wilson stated that:

…by virtue of s.92, a partner's assessable income is ascertained by reference to the net income, not the gross income of the partnership for the year of income. Therefore it matters not that the partner derives gross income when the partnership earns recoverable fees during the year of income. The point is that, in general, the partner's assessable income for the year of income can only be ascertained at the end of that year when the net income of the partnership is ascertained. Accounts for that purpose cannot be taken until the expiration of the year of income, unless there is some independent reason for taking accounts at an earlier date, as, for example, a dissolution of the partnership.

As a result of Galland's case it is clear that a partner of a partnership does not derive assessable income nor incur allowable deductions until such time as the partnership accounts are prepared and the net income of the partnership is determined at the conclusion of the relevant financial year.

Impact of the non-commercial losses provisions

The purpose of Division 35 of the ITAA 1997 is to prevent losses of individuals from non-commercial business activities being offset against other assessable income in the year the loss is incurred. The loss is deferred. The division sets out an income requirement and a series of tests to determine whether a business activity is treated as being non-commercial.

However the deferred losses may be offset in later years against profits from the activity. The losses may also be offset against other income if the income requirement and one of the other tests are satisfied, or if the Commissioner exercises his discretion.

Subsection 35-10(1) of the ITAA 1997 sets out the circumstances where subsection 35-10(2) of the ITAA 1997 will apply and includes a list of tests. Where other relevant criteria are met and any of those tests are satisfied, subsection 35-10(2) does not apply to quarantine a loss for that income year.

Subsection 35-10(2) of the ITAA 1997 provides that:

If the amounts attributable to the *business activity for that income year that you could otherwise deduct under this Act for that year exceed your assessable income (if any) from the business activity for that year, or your share of it, this Act applies to you as if the excess:

(a) were not incurred in that income year; and

(b) were an amount attributable to the activity that you can deduct from assessable income from the activity for the next income year in which the activity is carried on.

Taxation Ruling TR 2001/14 sets out the Commissioner's view on the application of Division 35 of the ITAA 1997. TR 2001/14 discusses, among other things, that the deductibility of an expense incurred in the course of carrying on a business is not altered by the application of the provisions under Division 35. Instead, where the relevant conditions and tests are not satisfied, such that the loss is to be quarantined, it is the loss created by the excess of those deductions over the assessable income of that business that is considered not to be incurred in that income year.

What this means is that Division 35 of the ITAA 1997 applies in respect of the excess (the loss), it does not apply in such a way as to alter the underlying fact that those expenses were incurred in the carrying on of that business and are deductible under a provision of an Income Tax Act in that income year.

Expense Payment Fringe Benefits

Section 20 of the FBTAA deals with Expense Payment Benefits and provides:

Where a person (in this section referred to as the "provider"):

(a) makes a payment in discharge, in whole or in part, of an obligation of another person (in this section referred to as the "recipient") to pay an amount to a third person in respect of expenditure incurred by the recipient; or

(b) reimburses another person (in this section also referred to as the "recipient"), in whole or in part, in respect of an amount of expenditure incurred by the recipient;

the making of the payment referred to in paragraph (a), or the reimbursement referred to in paragraph (b), shall be taken to constitute the provision of a benefit by the provider to the recipient.

Section 24 of the FBTAA sets out the circumstances allowing a reduction of the taxable value of a benefit, where that benefit would otherwise be deductible to the recipient, commonly known as the 'Otherwise Deductible' rule.

That section sets out circumstances in which expenditure is an allowable deduction to employee. Generally an expense payment fringe benefit will be considered an allowable deduction to the employee where:

· the recipient of the expense payment fringe benefit is an employee of the employer for that year of tax

· if at the time the recipient had incurred the expenditure, the recipient had incurred and paid unreimbursed expenditure, that expenditure would ordinarily be allowed as a once only deduction

· the employee has provided sufficient documentation to the employer in relation to the relevant expenses

· the employee has provided the employer with the required declaration in respect of the deductibility of those expenses in time.

Section 24 of the FBTAA also provides relevant formula with which to determine the taxable value of the expense payment fringe benefit. The taxable value is determined with regard to the amount that is considered to be otherwise deductible to the recipient, referred to as the 'notional deduction'.

The notional deduction is calculated with regard to the nature of the expense payment fringe benefit and the proportion of that expense that relates to business use.

However where the expense payment fringe benefit is deemed to have been provided to the recipient by subsection 138(3) of the FBTAA, paragraph 24(1)(l) of the FBTAA requires the notional deduction amount to be calculated in accordance with subsection 24(9) of the FBTAA.

Subsection 24(9) of the FBTAA provides that:

For the purposes of paragraph (1)(l) (which applies to an expense payment fringe benefit that, under subsection 138(3), is deemed to have been provided to an employee only), the amount is calculated in accordance with the formula:

Unadjusted ND × Employee's percentage of interest

Where:

employee's percentage of interest

(a) is the percentage of the interest held by the employee, during a period (in this subsection called the holding period) in the year of tax, in the asset or other thing that:

(i) relates to the matter in respect of which the expense payment fringe benefit is provided; and

(ii) is applied or used for the purpose of producing assessable income of the employee; and

(b) does not include the percentage of the interest held in that asset or other thing by the employee's associate or associates during the holding period.

unadjusted ND is the amount that would be ascertained as representing the component ND in the formula in subsection (1) if paragraph (1)(l) did not apply in relation to the expense payment fringe benefit.

Is the recipient of the expense payment benefits an employee?

Subsection 136(1) of the FBTAA provides certain definitions which apply for the purposes of that act. This subsection states that the term 'associate' has the meaning given by section 318 of the ITAA 1936, which provides:

318(1) [Associates of a natural person]

For the purposes of this Part, the following are associates of an entity (in this subsection called the "primary entity") that is a natural person (otherwise than in the capacity of trustee):

(a) a relative of the primary entity;

(b) a partner of the primary entity or a partnership in which the primary entity is a partner;

(c) if a partner of the primary entity is a natural person otherwise than in the capacity of trustee - the spouse or a child of that partner;

(d) a trustee of a trust where the primary entity, or another entity that is an associate of the primary entity because of another paragraph of this subsection, benefits under the trust;

(e) a company where:

(i) the company is sufficiently influenced by:

(A) the primary entity; or

(B) another entity that is an associate of the primary entity because of another paragraph of this subsection; or

(C) another company that is an associate of the primary entity because of another application of this paragraph; or

(D) 2 or more entities covered by the preceding sub-subparagraphs; or

(ii) a majority voting interest in the company is held by:

(A) the primary entity; or

(B) the entities that are associates of the primary entity because of subparagraph (i) of this paragraph and the preceding paragraphs of this subsection; or

(C) the primary entity and the entities that are associates of the primary entity because of subparagraph (i) of this paragraph and because of the preceding paragraphs of this subsection.

318(4) [Associates of a partnership]

For the purposes of this Part, the following are associates of a partnership (in this subsection called the "primary entity"):

(a) a partner in the partnership;

(b) if a partner in the partnership is a natural person - any entity that, if that natural person were the primary entity, would be an associate of that natural person because of subsection (1) or (3);

(c) if a partner in the partnership is a company - any entity that, if the company were the primary entity, would be an associate of the company because of subsection (2) or (3).

Section 138 of the FBTAA defines certain terms to prevent double counting of fringe benefits. Generally this section is designed to prevent an employer becoming liable to fringe benefits tax for provision of a benefit more than once for the same benefit or multiple employers becoming liable for the provision of a single benefit. In particular, this section provides:

138(3) [Benefit to employee and associate]

For the purposes of this Act, where a benefit in respect of the employment of an employee is provided jointly to the employee and one or more associates of the employee, the benefit shall be deemed to have been provided to the employee only.

The application of subsection 138(3) of the FBTAA was considered in National Australia Bank v. Federal Commissioner of Taxation (1993) 46 FCR 252; 26 ATR 503; 93 ATC 4914, (NAB Case). Ryan J in discussing the application of the otherwise deductible rule to a loan taken out by an employee and their spouse said at ATC 4922:

The scheme of Division 5 of Part III of the Income Tax Assessment Act is to treat a partnership as a separate entity up to the point where its receipts and outgoings have been ascertained for the purpose of determining whether it has made a profit or a loss. Only then is the resultant net profit or loss apportioned rateably between the partners and carried into the hands of each of them as an addition to, or deduction from, his or her assessable income.

On this analysis, the Commissioner contends, the recipient of the Heskett loan within the meaning of s. 19(1)(a) of the Act was the partnership between Mr and Mrs Heskett and neither of them individually would have been entitled, as required by s. 19(1)(b), to a once- only deduction in respect of the loan.

For that submission to succeed, it is necessary to deny to s. 138(3) of the Act any application to a loan fringe benefit received by a partnership subsisting between an employee and one or more associates of the employee. Such a denial imposes a limitation on the introductory words of s. 138(3) "For the purposes of this Act'' by reading down their wide general import to exclude the purposes of s. 19. I can discern no warrant for such a limitation in either the language of the provisions or in general principle.

It was argued for the Commissioner that s. 138 as a whole is designed to prevent the double taxation of benefits. That much may be conceded in the sense that sub-ss. (1) and (2) are designed to avoid two or more employers being liable to tax in respect of the same single benefit. Similarly, sub-ss. (3) and (4) are designed to avoid a single employer being liable to tax twice in respect of the same single benefit provided jointly to an employee and two or more associates or two or more associates but not to the employee. However, the mechanism chosen by the draftsman to avoid that result in the circumstances of a single benefit provided jointly is to deem it for all the purposes of the Act to have been provided to a single recipient.

Thus, the loan provided jointly to Mr and Mrs Heskett is deemed to have been provided to Mr Heskett alone.

Would the employee have been entitled to a once-only deduction?

Once-only deduction is defined in subsection 136(1) of the FBTAA to mean:

a deduction in a year of income in respect of a percentage of the expenditure where no deduction is allowable in respect of a percentage of the expenditure in any other year of income.

Within this definition are two conditions that need to be satisfied, being:

· that there is an amount which is allowable as a deduction in a year of income, in respect of the relevant expenditure.

· that there is no deduction allowable in respect of a percentage of the expenditure in another year of income.

In other words, once-only deduction means a deduction that is wholly or partly allowable in one year for the expenditure, and not in any other year. A deduction spread over more than one year, such as depreciation on equipment with a life of more than one year or borrowing expenses on a loan lasting more than one year, would not be a once-only deduction.

Application of the law

Deductibility of partnership expenses

Subsection 8-1(1) of the ITAA 1997 provides that deductions are allowed where the loss or outgoing is necessarily incurred in gaining or producing assessable income in the course of carrying on a business. In applying this provision it is important to identify who has incurred that loss or outgoing.

Under partnership law (state law) partners are jointly liable for the debts of the partnership irrespective of their individual contributions made between them. Where expenses are paid by a partner on behalf of the partnership, this represents a contribution to the partnership by that partner.

Where a partner pays partnership expenses, it is the partnership that has incurred those expenses. This is because the immediate liability arises at the time the third party provides the goods or services to the partnership.

Under partnership law, the responsibility for payment of those expenses is incumbent upon each of the partners in a partnership, irrespective of an agreement between partners as to who may pay those expenses. The expenses assigned to your employee under the separate agreement remain expenses of the partnership.

For income tax purposes, an individual partner's share of allowable deductions in respect of partnership expenses, are incurred at the end of the income year at the time the net income of the partnership is determined. As a partnership is a legal relationship between the individual partners, those allowable deductions are attributable to each partner to the extent of their respective interest in the partnership. Therefore those expenses are deductible to the each partner in that proportion.

Expense payment fringe benefits

Under the proposed salary sacrifice arrangement with your employee, you will pay certain expenses, which have been identified as expenses of the partnership within the attachment to the partnership agreement.

As you are making a payment to a third party, to discharge wholly or in part, your employee's obligation in respect of expenses incurred by your employee as a partner in a partnership, it is considered that in making those payments you are providing an expense payment fringe benefit under section 20 of the FBTAA.

Are the expenses paid by the employer otherwise deductible by the employee

Subsection 24(1) of the FBTAA requires that an exempt benefit can be an allowable deduction to the employee where that employee has, or would have, incurred a once only deduction at the time they incurred the expense.

As it has been determined that the employee, as a partner in a partnership, has for income tax purposes incurred a deductible expense at the conclusion of the relevant income year, and that expense is an allowable deduction to the partner for that income year; it is considered that the employee has, or would have incurred, a once only deduction for the purposes of subsection 24(1) of the FBTAA.

Therefore, the taxable value of an expense payment fringe benefit arising from the payment of an employee's partnership expenses, where you pay those expenses under a salary sacrifice arrangement with your employee; is reduced under section 24 of the FBTAA.

Question 2

Detailed reasoning

Application of the law

Ordinarily, where an expense payment fringe benefit is provided jointly to an employee and their associate, subsection 138(3) of the FBTAA applies to deem that benefit to have been provided to the employee only.

As the partner in a partnership is jointly liable to the expenses of the partnership and a partner in a partnership is included in the definition of 'associate' under subsection 318(1) of the ITAA 1936; it is considered that the benefit has effectively been provided to the employee and his associate jointly. In this case subsection 138(3) of the FBTAA operates to deem those benefits as being provided to the employee only.

Therefore the taxable value of an expense payment fringe benefit arising from the payment of an employee's partnership expenses, where you pay those expenses under a salary sacrifice arrangement with your employee; is worked out using a notional deduction calculated in accordance with subsection 24(9) of the FBTAA.