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Ruling

Subject: Retiring partner and CGT consequences

Questions and answers:

1. Is the amount you received for pro-rata entitlement to the profits of the Partnership for the relevant financial year a receipt of ordinary income?

Yes.

2. Is the receipt of the lump sum under the Deed of Retirement wholly a receipt of capital?

Yes.

3. Did CGT event C2 under section 104-25 of the Income Tax Assessment Act 1997 (ITAA 1997) happen upon the execution of the Deed of Retirement?

Yes.

4. Did you make a capital gain from the happening of the CGT event?

Yes.

5. Will you be entitled to the X% discount under subdivision 115-A of the ITAA 1997?

Yes.

6. Do you satisfy the basic conditions of the small business CGT concessions under Division 152 of the ITAA 1997 allowing the capital gain to be reduced?

Yes.

7. Can you apply the small business X% reduction under subdivisions 152-C of the ITAA 1997?

Yes.

8. Can you apply the small business retirement exemption under subdivisions 152-D of the ITAA 1997?

Yes.

This ruling applies for the following period:

Year ended 30 June 2012.

The scheme commenced on: 1 July 2011.

Relevant facts:

You were admitted as a partner of a Partnership before 2000. Thus, you became a partner in the partnership more than 12 months ago.

The affairs of the Partnership and the relationship, entitlements and obligations of the partner are governed by the Partnership Agreement (Appendix A to your PBR application).

You exited the partnership in the relevant year.

Although you did not pay any consideration to enter the partnership, you received a payment upon ceasing to be a partner.

Upon exiting the partnership you received an amount pursuant to the terms of a Deed of Retirement.

The Deed of Retirement provided that in exchange for a lump sum payment and the Partnership agreeing to relinquish any claims against you, you would relinquish any claims against the partnership, relinquish any interest in the partnership's assets to the continuing partners of the partnership and agree to certain restrictions.

In the relevant year a Deed of Retirement was executed and you ceased to be a partner in the partnership from that time.

At the date of termination you were under 55 years of age.

The Deed of Retirement identifies that your pro-rata entitlement to the profits of the partnership up to the date of retirement amounted to $X. Of this a portion had been paid to you before the exit date and $Y as part of the lump sum.

Your interest in the partnership is an intangible asset. It was through this interest that you carried on an accounting and advisory business, albeit with others.

The interest in the partnership is inseparable from the business that you carried on.

You carried on the business for the entire period of holding the partnership interest.

The amount you received, represents an amount received in respect of the cancellation, surrender or ending of your ownership of an intangible asset (namely your interest in the partnership and partnership assets) and the Capital Receipt is received in consequence of the happening of CGT event C2.

You have advised that you satisfied the maximum net asset value test under section 152-15 of the ITAA 1997.

Pursuant to the Deed of Retirement:

You received a payment which comprised:

i) A Retirement Payout of $Z, which was calculated with reference to profits in previous and length of service,

ii) An amount of $Y representing partnership profit entitlements that you had not yet received to the date of your retirement from the partnership,

iii) An amount representing the repayment of Capital contributed by you, the balance of prior year entitlements and the like.

Relevant legislative provisions:

Income Tax Assessment Act 1936 Subsection 25(1).

Income Tax Assessment Act 1997 Section 6-5.

Income Tax Assessment Act 1997 Section 104-25.

Income Tax Assessment Act 1997 Subsection 104-25(3).

Income Tax Assessment Act 1997 Subsection 115-100(1).

Income Tax Assessment Act 1997 Section 115-25.

Income Tax Assessment Act 1997 Section 152-10.

Income Tax Assessment Act 1997 Section 152-15.

Income Tax Assessment Act 1997 Section 152-35.

Income Tax Assessment Act 1997 Section 152-40.

Income Tax Assessment Act 1997 Section 152-105.

Income Tax Assessment Act 1997 Section 152-205.

Income Tax Assessment Act 1997 Section 152-305.

Reasons for decision

Share of profits from the partnership

Taxation Determination (TD) 93/58 states that a lump sum compensation or settlement payment is assessable income under the former subsection 25(1) of the ITAA 1936 (now replaced by section 6-5 of the ITAA 1997) to the extent that a portion of the lump sum payment is identifiable and quantifiable as income.

You have calculated that of the lump sum payment, an amount of $Y represents a payment of income. Your calculations appear to have been performed on a reasonable basis and therefore represent an accurate breakdown of the payment.

Further your identification of the income component of the lump sum has been performed in accordance with the principles contained within TD 93/58.

Retirement Payout

Your retirement from the partnership meant that you gave up your interest in both the partnership itself as well as any of its assets. The nature of a receipt, for the purposes of the ITAA 1997 is determined from the point of view of the recipient rather than that of the payer.

A partner's interest in the net income of a partnership derives from the partner's interest in the partnership. However, a partner will not derive partnership income until he or she has a right to receive a share of that income.

The net income of a partnership is determined at 30 June of each year where that partnership does not apply a substituted accounting period. Thus a partner will only derive his or her share of the net income of a partnership at 30 June of any given year (FCT v. Everett (1980) 143 CLR 440; 80 ATC 4076; 10 ATR 608 & FCT v. Galland 86 ATC 4885; 18 ATR 33).

Taxation Ruling (IT) 2540 examines the capital gains implications of a disposal of partnership interests. Paragraphs 13 and 14 of IT 2540 state the view that for large partnerships that could potentially have hundreds of partners (for example, major legal firms) it will generally be agreed that the partners are dealing with one another at arm's length.

Any consideration paid or received on the acquisition or disposal of a partnership interest will be used for CGT purposes to determine the cost base or disposal proceeds of the interests in the partnership assets that the partnership interest represents.

As a result, if the partnership arrangement is such that no amount is payable for the acquisition or disposal of goodwill, it will be accepted for the purposes of the CGT provisions that the value of the goodwill is nil. Further, the CGT provisions will only have practical effect with respect to large professional partnerships where consideration is paid by a partner on entering the partnership or where a partner receives a payment on leaving the partnership.

In your case, although you did not pay any consideration to enter the partnership, you have received a lump sum payment (in addition to other the pro-rata entitlement and an amount representing the repayment of Capital Contributed by you, the balance of prior year entitlements and the like e.g. leave allowance) upon your exit from the partnership, namely a retirement payout of $Z which was calculated with reference to profits in previous and length of service.

Therefore the lump sum amount you received which although calculated with reference to income amounts is a capital receipt.

Therefore, the balance of your lump sum receipt is a capital amount and accordingly CGT event C2 under section 104-25 of the ITAA 1997 will occur upon you leaving the partnership.

CGT event C2 happens if your ownership of an intangible asset is cancelled, surrendered or ends. Subsection 104-25(3) of the ITAA 1997 provides that the capital gain you make is equal to the difference between the proceeds received from the event happening and the cost base of the asset. You will have made a capital gain from CGT event C2 happening if the capital proceeds are greater than your cost base.

50% discount

Subparagraph 115-100(a)(i) of the ITAA 1997 provides that an individual may apply a 50% discount to a capital gain arising providing that the conditions contained within section 115-5 of the ITAA 1997 are satisfied.

The most important of these conditions is found within section 115-25 of the ITAA 1997 which provides that the relevant CGT asset must have been acquired at least 12 months prior to the CGT event happening.

As you became a partner in the firm more than 12 months ago, you satisfy this condition. Accordingly, you may apply the 50% discount.

Small business CGT concessions

The small business CGT concessions are contained within Division 152 of the ITAA 1997. There are a number of concessions that allow you to either reduce or disregard a capital gain resulting from the disposal of an asset that was predominantly used in the operation of a business. All of the concessions have basic conditions that must be satisfied. Some of the concessions such as the retirement exemption, have additional conditions that must also be satisfied in addition to the basic conditions.

The basic conditions that are relevant to you are contained within section 152-10 of the ITAA 1997 and are:

· a CGT event happens to a CGT asset of yours;

· the CGT event would have ordinarily resulted in a capital gain;

· you satisfy the maximum net asset value test; and

· the CGT asset satisfies the active asset test.

As discussed above, you satisfy the first two conditions in that CGT event C2 has occurred and this would result in a capital gain.

You also advise that you satisfy the maximum net asset value test under section 152-15 of the ITAA 1997.

Section 152-35 of the ITAA 1997 provides that a CGT asset owned for less than 15 years will satisfy the active asset test if it was an active asset for at least half the period of ownership. Section 152-40 of the ITAA 1997 provides that a CGT asset is an active asset at a given time if you own the asset (the asset can be either tangible or intangible) and:

· you use it, or hold it ready for use, in the course of carrying on a business, or

· it is used, or held ready for use, in the course of carrying on a business by your affiliate, or by another entity that is connected with you; or

· for intangible assets only - you own it and it is inherently connected with a business that you, your affiliate, or another entity that is connected with you, carries on.

Your interest in the partnership is an intangible asset. It was through this interest that you carried on a business, albeit with others. Your interest in the partnership is inseparable from the business that you carried on. The interest is therefore an active asset. As you carried on the business for the entire period of holding your partnership interest, over 10 years, you also satisfy the active asset test.

You therefore satisfy the basic conditions for the small business CGT concessions.

50% small business reduction

The small business 50% reduction allows you to reduce your capital gain by a further 50% after applying the 50% discount.

Section 152-205 of the ITAA 1997 only requires that you satisfy the basic conditions in order to apply the small business 50% reduction.

As previously discussed you satisfy the basic conditions at Section 152-10, you may apply this reduction.

Small business retirement exemption

The small business retirement exemption allows you to disregard any remaining capital gain after the application of the 50% discount and 50% small business reduction up to a lifetime limit of $500,000.

Section 152-305 of the ITAA 1997 states that the following conditions must be satisfied in order to apply the small business retirement exemption:

· the basic conditions (which you satisfy); and

· if you are under 55 years of age just before making the choice, you must contribute an amount equal to the asset's CGT exempt amount to a complying superannuation fund or retirement savings account; and

· the contribution must be made at the later of making the choice and when you received the proceeds.

As you satisfy the basic conditions and are under 55 years of age you may apply the small business retirement exemption providing that you contribute the relevant amount to a superannuation fund or retirement savings account within the required timeframes.