Edited version of your written advice

Authorisation Number: 1012514194273

Ruling

Subject: Capital gains tax - assigning partnership interest

Question 1

Will the Commissioner administer the disposal of Partnership interests on 1 January 2014, which are held legally and beneficially by Mr A, in a manner consistent with the principles in Taxation Ruling IT 2540 such that the deemed market value consideration under subsection 116-30(1) of the Income Tax Assessment Act 1997 (ITAA 1997) will equal the actual consideration, being nil?

Answer: Yes

Question 2

Will the Commissioner administer the acquisition of Partnership interests on 1 January 2014, which are held legally and beneficially by Mr A, in a manner consistent with the principles in IT 2540 such that the deemed market value cost base under subsection 112-20(1) of the ITAA 1997 will be equal to the actual consideration paid, being nil?

Answer: Yes

Question 3

Will the Commissioner administer the disposal of Partnership interests on 1 January 2014, which are held by Trust A, in a manner consistent with the principles in IT 2540 such that the deemed market value consideration under subsection 116-30(1) of the ITAA 1997 will equal the actual consideration, being nil?

Answer: Yes

Question 4

Will the Commissioner administer the acquisition of Partnership interests on 1 January 2014, which are held by Trust A, in a manner consistent with the principles in IT 2540 such that the deemed market value cost base under subsection 112-20(1) of the ITAA 1997 will be equal to the actual consideration paid, being nil?

Answer: Yes

This ruling applies for the following period

Year ending 30 June 2013

Year ending 30 June 2014

The scheme commenced on

1 July 2012

Relevant facts and circumstances

Mr A is an equity partner in a partnership (the Partnership).

The Partnership carries on a business.

The Partnership operates on a 'no goodwill' basis. This means that incoming partners are not required to pay any amount in relation to goodwill being acquired and exiting partners are not entitled to receive any payment in recognition of goodwill.

Mr A intends to enter into an agreement under which a portion of his interest in the Partnership will be assigned to Trust A (the Trust), which is a existing trust. The agreement giving effect to the assignment will amount to a declaration of trust by Mr A in respect of the Partnership interest.

Mr A is the existing owner of the property that will be subject to the trust, and will continue to be the legal owner of the Partnership interest after the Trust becomes the beneficial owner.

The Trust is a discretionary trust established for the benefit of Mr A's family. Mr A is not a potential beneficiary of the Trust.

The trust relationship will be irrevocable.

Mr A intends to engage the services of an expert valuer to ascertain the market value of your interest in the Partnership.

You state that there is no existing trust relationship between Mr A and the Trust in respect of the Partnership interest. The trust relationship will be created as a consequence of the Partnership interest.

Assumptions

Documentation giving effect to the assignment will be prepared in a manner which is consistent with and which provides the same legal effect as the assignments considered in Federal Commissioner of Taxation v. Everett (1980) 143 CLR 440 (Everett) and Federal Commissioner of Taxation v. Galland (1986) 162 CLR 408 (Galland). Documentation is yet to be completed at the time of the application.

On 1 January 2014, a yet to be determined number of new partners will be admitted to the Partnership. As set out in the Partnership Agreement, these partners will not be required to pay any consideration in respect of the goodwill of the Partnership.

On 1 January 2014, a yet to be determined number of existing partners will exit the Partnership. As set out in the Partnership agreement, these partners will not be entitled to receive any consideration in respect of the goodwill of the Partnership.

The admission and exit of partners on 1 January 2014 will occur as part of the normal ebb and flow of carrying on a business as a large professional services partnership. It is common practice for the Partnership to admit and exit partners on this date each year.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 106-5(4)

Income Tax Assessment Act 1997 Subsection 106-5(3)

Income Tax Assessment Act 1997 Subsection 116-30(1)

Income Tax Assessment Act 1997 Subsection 112-20(1)

Reasons for decision

Summary

The Commissioner will administer the disposal and acquisition of Partnership interests on 1 January 2014, held by Mr A, in a manner consistent with the principles in Taxation Ruling IT 2540 Income tax: capital gains: application to disposals of partnership assets and partnership interests (IT 2540), such that the Commissioner will accept that the market value of the capital proceeds and the cost base will be nil.

The Commissioner will administer the disposal and acquisition of partnership interests on 1 January 2014, held by the trustee for the Trust, in a manner consistent with the principles in IT 2540 such that the Commissioner will accept that the market value of the capital proceeds and the cost base will be nil.

Detailed reasoning

Partnership interests and no goodwill partnerships

Subsection 106-5(4) of the ITAA 1997 provides that if a new partner is admitted to a partnership:

a) the new partner acquires a share (according to the partnership agreement, or partnership law if there is no agreement) of each partnership asset; and

b) the existing partners are treated as having disposed of part of their interest in each partnership asset to the extent that the new partner has acquired it.

Subsection 106-5(3) of the ITAA 1997 states that 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.

In your case, under the terms of the partnership agreement, no consideration is payable in respect of goodwill on the exit or admittance of partner's to the partnership. As no consideration will be received by you for your interest in the goodwill of the firm when you dispose of a part of your partnership interest to the Trust, it will need to be considered whether the market value substitution rules will apply.

Subsection 116-30(1) of the ITAA 1997 provides that if you received no capital proceeds from a CGT event, you are taken to have received the market value of the CGT asset that is the subject of the event (the market value is worked out as at the time of the event).

Subsection 112-20(1) of the ITAA 1997 explains that the first element of your cost base and reduced cost base of a CGT asset you acquire from another entity is its market value (at the time of acquisition) if:

a) you did not incur expenditure to acquire it, except where your acquisition of the asset resulted from:

i. CGT event D1 happening; or

ii. another entity doing something that did not constitute a CGT event happening; or

b) some or all of the expenditure you incurred to acquire it cannot be valued; or

c) you did not deal at arm's length with the other entity in connection with the acquisition.

Capital gains tax implications on the acquisition and disposal of partnership interests

Taxation Ruling IT 2540 examines the capital gains tax (CGT) implications of a disposal of a partnership interest. Though it is expressed in terms of the former CGT provisions (of the Income Tax Assessment Act 1936) the discussion is still relevant for the purposes of the ITAA 1997. At paragraphs 13 and 14 it states:

…In other cases, it will generally be accepted, provided the evidence reasonably supports the conclusion that the partners are dealing with each other at arm's length. Any consideration paid or received on the acquisition or disposal of an interest in the partnership will be used for Part IIIA (CGT) purposes in determining the cost base or disposal proceeds of the interests in the partnership assets that the partnership interest represents. This will mean that if, for example, 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 Part IIIA (CGT) that the value of the goodwill is nil.

In the case of large professional partnerships, where the partners' dealings with each other are at arm's length, it will only be where consideration is paid by a partner on entering the partnership or where a partner receives a payment on leaving the partnership that Part IIIA (CGT) will have any practical effect. Where consideration is neither paid by a person on entering the partnership, nor received on retirement from the partnership, the partner will not realise a capital gain or incur a capital loss on the disposal of particular assets. However, as noted above, the admission or retirement of a partner may affect the proportionate ownership of the partnership assets by the individual partners and therefore may affect the extent of a continuing partner's interest in the partnership. This would be relevant in the event of a subsequent disposal of the partnership assets for consideration, or where consideration is paid to a partner on retirement from the partnership.

Accordingly, where the evidence demonstrates that such partnership interest dealings are at arm's length, the Commissioner will accept where there is no consideration, that the market value of the partnership interest is nil.

In order for the treatment mentioned in IT 2540 to apply, the Commissioner expects that the following conditions, listed at paragraph 18 of Taxation Determination TD 2011/26 Income tax: capital gains tax: if a share in a 'no goodwill' incorporated professional practice is disposed of for no consideration, will the Commissioner accept, for the purposes of calculating the market value of the share upon a possible application of subsection 116-30(1) of the Income Tax Assessment Act 1997 that the goodwill of the company can be taken to have no value?, (TD 2011/26) must be satisfied. These conditions are:

i. the partners in the partnership are all natural person practitioners who hold a fractional interest in the 'no goodwill' partnership;

ii. the acquisition or disposal of an interest in the partnership must be reflective of that person's status as an active practitioner in the practice and held by that person both legally and beneficially; in this context 'active partner' will include managing partners who do not undertake client work and non-practitioner consultants (for example legal counsel in an accounting firm);

iii. the partnership has capital which reflects merely a nil or immaterial value for goodwill, except in circumstances where the partnership has taken over another practice with goodwill, and such acquired goodwill remains on the partnership's books; in that circumstance, provided the partners cease to recognise that goodwill in dealings between themselves for the admission and exit of partners this condition will be satisfied;

iv. the partnership adopts an agreement that regulates the basis for admission and exit of partners and the amount that is paid for it; and

v. the partnership agreement provides that no or an immaterial payment is to be made for acquiring a partnership interest, disposing of a partnership interest or any change to the profit distribution entitlements attached to an interest in the partnership, in respect of goodwill.

Application to partnership interest held by Mr A

In this instance, the Commissioner accepts your arrangement meets the relevant requirements under IT 2540 and will apply the treatment mentioned in IT 2540 to the acquisition and disposal of partnership interests. This will mean that the Commissioner will accept that the market value of the consideration paid on acquisition of the partnership interest will be nil, and likewise, the consideration received on disposal of the partnership interest will also be nil.