Edited version of your private ruling

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Ruling

Subject: Income Tax: Deduction - for the purposes of Subsection 24(9) of the Fringe Benefits Tax Assessment Act 1986, are partnership expenses wholly deductible to the partner.

Question 1

For the purposes of advising your employer the extent to which the amount of an expense payment fringe benefit is otherwise deductible to you, as your employer is required to apply subsection 24(9) of the Fringe Benefits Tax Assessment Act 1986 (FBTAA); are the partnership expenses, where those expenses are allocated to you under an attachment to your partnership agreement, deductible to you under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes, however only to the extent of your interest in the partnership.

This ruling applies for the following period:

Year ended 30 June 2012

The scheme commences on:

1 July 2011

Relevant facts and circumstances

You are a partner in a partnership (the partnership), which conducts a primary production business. Your activities include a mix of livestock farming and cropping.

Your primary production activities are carried out on land leased jointly in the names of the partners. In addition to paying rent for this land you also incur costs jointly for the council rates and water rates in respect of that same land.

For the purpose of equity of contributions from each partner, in respect of your labour and financial input into the partnership, you made an agreement specifying individual expenses from the partnership operation and allocating responsibility for payment of those expenses to a particular partner. Under that attachment, you are to pay expenses of the partnership consisting of rent, council rates and water rates.

You are an employee and in no way related to your employer, nor are you a proprietor or principal in your employer's business.

You propose to enter a salary sacrifice arrangement with your employer to pay expenses of the partnership for which you have been allocated under your agreement. Your employer will pay those expenses directly to the Third Party. You state that the payment of these partnership expenses by your employer, are the provision of an expense payment fringe benefit under section 20 of the FBTAA.

Relevant legislative provisions

Fringe Benefits Tax Assessment Act 1986 Section 24

Fringe Benefits Tax Assessment Act 1986 Subsection 24(9)

Fringe Benefits Tax Assessment Act 1986 Subsection 136(1)

Fringe Benefits Tax Assessment Act 1986 Section 138

Fringe Benefits Tax Assessment Act 1986 Subsection 138(3)

Income Tax Assessment Act 1936 Division 5

Income Tax Assessment Act 1936 Division 6A

Income Tax Assessment Act 1936 Section 90

Income Tax Assessment Act 1936 Section 91

Income Tax Assessment Act 1936 Section 92

Income Tax Assessment Act 1936 Subsection 92(1)

Income Tax Assessment Act 1936 Subsection 92(2)

Income Tax Assessment Act 1936 Section 318

Income Tax Assessment Act 1936 Subsection 318(1)

Income Tax Assessment Act 1936 Subsection 318(4)

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 Section 35-10

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

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

Further issues for you to consider

There may be related issues that you should consider including:

· Carrying on a business

· Non-commercial loss rules (application of Division 35 of the ITAA 1997)

· Only one deduction (application of section 51AH of the ITAA 1936)

· Capital Gains Tax

· Assignment of a right to future income (application of section 102B of the ITAA 1936).

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.

Detailed reasoning

General discussion of the law

Partnerships

Partnerships fall under common law in addition to relevant law of the various States and Territories (partnership Acts). 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.

Partnership interests

Acquisitions and disposals

Taxation Ruling IT 2540 sets out the Commissioner's view in relation to the Capital Gains Tax (CGT) issues arising in respect of the disposal of partnership assets or partnership interests.

In discussing certain aspects of Federal Commissioner of Taxation v. Everett (1980) 143 CLR 440; (1980) 54 ALJR 196; (1980) 10 ATR 608; (1980) 28 ALR 179; (1980) 80 ATC 4076 (Everett's case), paragraph 2 of IT 2540 explains that as a partnership is not a separate legal entity and therefore cannot own property, the title to the partnership assets are legally vested in the partners. Drawing on this principle, paragraph 3 of IT 2540 discusses that the partnership agreement may determine the legal ownership of partnership assets.

In addition IT 2540 discusses that where a partner disposes of their interest in a partnership, they also dispose of their interest in the partnership assets. However the Commissioner highlights in paragraph 24 of IT 2540 that, in the case of an assignment of an interest in a partnership as occurred in Everett's case, where that assignment was of an equitable nature (a right to future net income of the partnership), the legal title to the partnership assets remains vested in the partners to the exclusion of the assignee.

However, paragraph 29 of IT 2540 explains that, where the assets of the partnership are held by the partners (as in legal ownership), an assignment of an interest in a partnership will result in a part disposal of the partner's interests in those assets.

Where a partnership agreement does not specify a partner's interest, or is silent on a particular matter, the relevant partnership Act may determine the required treatment. The various partnership Acts typically provide that the net income of a partnership is to be shared equally between the partners.

Assignments

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 Everett's case and Federal Commissioner of Taxation v. Galland (1986) 162 CLR 408; (1986) 61 ALJR 69; (1986) 68 ALR 403; (1986) 18 ATR 33; (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 Everett's and Galland's cases.

Paragraph 3 of IT 2608 discusses that where a partner assigns a share of an interest in a partnership, expenses incurred by the assignor partner in connection with the partnership may have to be apportioned in order to determine the deduction allowable to the assignor.

Further, where the expenditure incurred relates to the partner's proportionate interest in the partnership, a deduction is only allowable to the assignor partner for the share of the partnership interest not assigned. For example, a partner who assigns one-third of his interest in the partnership would only be entitled to a deduction for two-thirds of interest expenditure incurred on borrowings used to purchase the interest in the partnership.

However paragraph 4 of IT 2608 explains that where the expenditure incurred by the assignor partner is unrelated to the partner's proportionate interest in the partnership, a deduction is allowable in full. Examples of such expenditure include subscriptions to professional publications, travel expenses and depreciation of the partner's personal professional library. This type of expenditure would be incurred by a partner irrespective of what share, if any, of the partnership interest is assigned.

Liability of partners in a partnership

In relation to the liabilities of partners, the partnership Acts typically 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.

For example, 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 all 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 these 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. Subsection 8-1(1) 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.

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. However, 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 discusses 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 the Full Federal Court case of Federal Commissioner of Taxation v. Galland (1984) 4 FCR 566; (1984) 56 ALR 468; (1984) 16 ATR 41; (1984) 84 ATC 4890 the judgement of Bowen CJ and Fisher J discusses the operation of section 92 of the ITAA 1936, where they explained that 'The net income of a partnership is gross income less allowable deductions ascertained in accordance with recognised principles of accounting at the end of the particular accounting period'.

Expense Payment Fringe Benefits

Section 20 of the Fringe Benefits Tax Assessment Act 1986 (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. This 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 the 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' (ND).

Subsection 24(9) of the FBTAA provides a modification to how the ND is calculated in certain circumstances and states:

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.

The recipient of an expense payment benefit

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 that an associate includes an employee's partner where they are in a partnership.

Section 138 of the FBTAA defines certain terms to prevent double counting of fringe benefits. In particular, where a benefit is provided jointly to the employee and their associate, subsection 138(3) of the FBTAA provides that the benefit shall be deemed to have been provided to the employee only.

Entitlement 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.

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.

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 an individual's other assessable income in the year the loss is incurred.

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) of the ITAA 1997 does not apply to quarantine a loss for that income year. Testing occurs each income year.

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 of the ITAA 1997. It is the resulting loss that is deferred and cannot be offset against an individual's other assessable income in that income year.

Application of the law

Under your proposed salary sacrifice arrangement, your employer will pay rent, council rates and water rates expenses, which you have identified as expenses of your partnership. You have identified that the payment of these partnership expenses by your employer are an expense payment fringe benefit under section 20 of the FBTAA.

Deductibility to the partner of partnership expenses

In the first instance, as those expenses relate to land that is leased in the names of both partners jointly for the conduct of the partnership's farming activity, it is the partnership that has incurred those expenses.

Further, the immediate liability arises at the time the respective expenses are recognised by the third party that provides the goods or services and are recognised under the name of the partners jointly. The expenses remain expenses of the partnership until such time as your employer makes payment to extinguish the obligation of the partnership.

Partnership law will operate to determine the interest of each partner in the partnership. Neither the partnership agreement, nor the attachment to that agreement, assigns an interest in the income of the partnership or an interest in the partnership itself (including the assets of the partnership).

For taxation purposes, you are entitled to share in the partnership net income based on your partnership interest. Through the operation of section 90 and 92 of the ITAA 1936, the assessable income and allowable deductions applied in calculating that income are also shared in that same proportion.

Further, with regard to the Commissioner's view in IT 2501, IT 2540 and IT 2608, as you have not assigned an interest in the partnership and the expenses remain joint expenses, you cannot deduct the whole amount of those expenses you have been allocated against your share of the assessable income of the partnership. Your share of partnership net income (or partnership loss) includes a share of the partnership's allowable deductions in proportion to your partnership interest, which includes those partnership expenses that you have been assigned to pay.

Therefore, for the purposes of advising your employer the extent to which the amount of an expense payment fringe benefit is otherwise deductible to you, as your employer is required to apply Subsection 24(9) of the FBTAA; it is considered that the partnership expenses, where those expenses are allocated to you under an attachment to your partnership agreement, are deductible in-part to you under section 8-1 of the ITAA 1997. The otherwise deductible rule is limited to the extent of your interest in the partnership.

Non-commercial losses

The non-commercial losses rules of Division 35 of the ITAA 1997 apply to individuals in respect of their share of any net loss from a non-commercial business activity in an income year.

Where your share of the partnership net loss is quarantined under the non-commercial losses rules of Division 35 of the ITAA 1997, the deductible nature of those expenses is not altered. This means that your share of the allowable deductions that form part of that net loss and that are determined to be otherwise deductible for the purposes of the otherwise deductible rule under section 24 of the FBTAA, remain otherwise deductible to you for that income year.

Fringe benefits tax

As it has been determined that the partnership has incurred a deductible expense and that for the purposes of subsection 24(1) of the FBTAA your proportionate share of that expense would be an allowable deduction to you, it is considered that you have, or would have incurred a once only deduction at the time you incurred the expense.

In addition, as the partner of a partnership is included in the definition of 'associate' under subsection 318(1) of the ITAA 1936, it is considered that the benefit has been provided to you and your associate jointly. In your circumstances subsection 138(3) of the FBTAA operates to deem those benefits as being provided to you only.

The Taxable Value of the expense payment fringe benefit provided by your employer, arising from the payment of the partnership expenses under a salary sacrifice arrangement, includes the amount attributable to your associate's share.

Accordingly, for the purposes of the otherwise deductible rule under section 24 of the FBTAA and where all relevant requirements of section 24 are satisfied, in calculating the Taxable Value of the benefit your employer is required to apportion any reduction of that value under subsection 24(9) of the FBTAA.

Therefore, where all relevant requirements under section 24 of the FBTAA are satisfied, your employer may calculate any reduction to the Taxable Value of the benefit provided by the proportion of your interest in the partnership.