Edited version of your private ruling

Authorisation Number: 1012478294041

Ruling

Subject: Capital Gains Tax concessions for small business

Question 1

Does the Commissioner determine that you do not control the partnership under subsection 328-125(6) of the Income Tax Assessment Act 1997 (ITAA 1997) despite holding 40% of the interest in the partnership?

Answer: Yes

Question 2

When calculating whether you satisfy the maximum net asset value (MNAV) test, is it only your interest in the partnership (and not the assets of the partnership as a whole) that will be included in the calculation?

Answer: Yes

This ruling applies for the following period

Year ended 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts and circumstances

You acquired a 20% interest in a professional partnership.

The partnership has the following partner entitlements:

· B Trust - 60%

· C Trust - 20%

· You - 20%

The partnership continued under this structure for approximately 4 years.

Then, you progressively bought 20% of C Trust's partnership entitlement (4% of total partnership) over a 5 year period. This resulted in your entitlement increasing 4% each year and C Trust reducing 4% each year.

At the end of the 5 year period, the partnership had the following partners entitlements:

· B Trust - 60%

· You - 40%

Later, the partnership entered into an agreement to sell the partnership business, with the sale being finalised in the 2011-12 financial year.

During your time in the partnership, your entitlement was less than 40%, except for the period 1 July 2011 to 1 June 2012 when it was 40%.

The majority partner, B Trust, maintained a 60% partnership entitlement at all times.

The partners are not connected or related to each other.

An associate of B Trust was the managing director/partner of the business and the partnership business operations.

The partnership engaged an office manager who worked closely with the managing director to deal with the day to day operations of the partnership. The managing director made all the final decisions in relation to the running of the partnership business and also worked with clients.

Associates of you and the C Trust were employees of the partnership and worked in the business dealing with client matters.

Partners meeting would generally be held quarterly where the officer manager and managing director would provide an update on operational decisions and discuss financial statements and reports.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 152-15

Income Tax Assessment Act 1997 Subsection 328-125(1)

Income Tax Assessment Act 1997 Subsection 328-125(2)

Income Tax Assessment Act 1997 Subsection 328-125(6)

Reasons for decision

Maximum net asset value (MNAV) test

Section 152-15 of the ITAA 1997 explains that you satisfy the MNAV test if, just before the CGT event, the sum of the following amounts does not exceed $6,000,000:

the net value of the CGT assets of yours;

the net value of the CGT assets of any entities connected with you;

the net value of the CGT assets of any affiliates of yours or entities connected with your affiliates (not counting any assets already counted under paragraph (b)).

If you are a partner in a partnership and the CGT event happens in relation to an asset of yours or a CGT asset of the partnership (for example, disposal of a partnership asset), the maximum net asset value test would include:

· all the assets of the partnership if you are connected with it, and you would exclude the value of your interest in the partnership, or

· only your interest in the partnership if you are not connected with it, you would not count the assets of the partnership as a whole.

Entity 'connected with' you

Subsection 328-125(1) of the ITAA 1997 explains that an entity is connected with another entity if:

either entity controls the other entity in a way described in this section; or

both entities are controlled in a way described in this section by the same third entity.

Subsection 328-125(2) of the ITAA 1997 provides that an entity (the first entity) controls another entity if the first entity, its affiliates, or the first entity together with its affiliates: beneficially owns, or has the right to acquire beneficial ownership of, interest in the other entity that give the right to receive at least 40% (the control percentage) of any distribution of income or capital by the other entity.

Section 328-125(6) of the ITAA 1997 provides that if the control percentage referred to in subsection (2)…is at least 40%, but less than 50%, the Commissioner may determine that the first entity does not control the other entity if the Commissioner thinks that the other entity is controlled by an entity other than, or by entities that do not include, the first entity or any of its affiliates (a third entity).

For an entity to be controlled by a third entity, the third entity must also have a control percentage of at least 40% in the entity. That is, it must control the entity in the way described above. In working out the third entity's control percentage, the interests of any affiliates of the third entity are taken into account.

In other words, for the Commissioner to be able to determine that an entity does not control another entity (despite holding at least 40% interest in it), there must be a third entity that has a control percentage (including the interests of any affiliates) of at least 40% in the other entity.

Alternatively, it is possible that both of the entities with a control percentage of at least 40% may control the company if such responsibilities are shared.

The following example taken from the Advanced guide to capital gains tax concessions for small business 2011-12 provides a situation in which the Commissioner may be satisfied that a third entity controlled a company:

Lachlan owns 48% of the shares in Ayoubi Art Supplies. He plays no part in the day-to-day or strategic decision making of the business. Daniel owns 42% of the shares in the company. The remaining 10% of shares are beneficially owned by a third shareholder who does not take part in the management of the business. All shares carry the same voting rights and Daniel makes all day-to-day and strategic decisions for the company. Even though Lachlan owns 48% of the shares in Ayoubi Art Supplies, he would not be taken to control the company if the Commissioner was satisfied that the company is controlled by Daniel.

Application to your circumstances

In your case, you acquired a 20% interest in the partnership, at this time, B Trust held a 60% interest in the partnership and C Trust held the remaining 20%. You have stated that none of the partners in the partnership are related entities.

You initially held a 20% interest in the partnership and you progressively acquired a further 4% interest in the partnership each year until your partnership interest totalled 40%, with the remaining 60% interest held by B Trust. These holdings remained the same until the partnership business was sold. Therefore, you have held less than a 40% interest in the partnership for approximately 7 years and 11 months and have held a 40% interest for 11 months.

You have stated that an associate of B Trust was the managing director/partner of the business and the partnership business operations. The partnership engaged an office manager who worked closely with the managing director to deal with the day to day operations of the partnership. The managing director made all final decisions in relation to the partnership business and also worked with clients.

You state that your associate, and an associate of C Trust, were employees of the partnership and worked in the business dealing with client matters. They were not involved in the day to day running or decision making of the partnership business.

Partners meeting would generally be held quarterly where the officer manager and managing director would provide an update on operational decisions and discuss financial statements and reports.

Based on the information provided, the Commissioner is prepared to make a determination under subsection 328-125(6) of the ITAA 1997 that the control percentage attributed to you of 40% does not allow you to exercise control over the partnership. This control is considered to be held by another entity (B Trust) who holds a 60% interest.

Accordingly, as the partnership is not an entity 'connected with' you, it is only the value of your interest in the partnership that will need to be included in the calculation of the maximum net asset value test and not the assets of the partnership as a whole.