Edited version of your written advice

Authorisation Number: 1012987434028

Date of advice: 21 March 2016

Ruling

Subject: Capital gains tax consequence of proposed assignment

Question 1

Will the Commissioner accept, for the assignment of a share of partnership interest in a 'no goodwill' partnership for no consideration that the goodwill of the partnership can be taken to have a nil value?

Answer

No.

This ruling applies for the following periods:

1 July 201X to 30 June 201Y.

The scheme commences on:

1 July 201X

Relevant facts and circumstances

You are an equity partner at a Partnership, which carries on a business.

The Partnership operates on a 'no goodwill' basis. You were not required to pay a purchase price for the acquisition of an interest in the partnership goodwill. When you leave the partnership and your interest is sold either to a newly admitted partner or to the remaining partners, you will not be entitled to receive a payment for your share of the partnership goodwill.

The equity participation in the Partnership entitles you to a share of income generated by the Service Trust and profit of the Partnership.

The Service Trust income represents A% of your annual profit distribution.

A family trust ('The Trust') is being established for the benefit of your family. You intend to nominate the Trust as a beneficiary of the Service Trust.

The remaining of your annual distribution results from the profits of the Partnership.

You intend to enter an agreement to assign for no consideration B% of your interest in the partnership to the Trust.

You will not be a potential beneficiary of the Trust. The trust relationship will be irrevocable.

The agreement giving effect to the assignment will amount to a declaration of trust by you in respect of the partnership interest.

You are the existing owner of the partnership interest and will continue to be the legal owner of the partnership interest after the Trust becomes the beneficial owner.

No existing trust relationship currently exists between you and the Trust in respect of the partnership interest. The trust relationship will be created as a consequence of the assignment of the partnership interest.

Following the assignment, you will be entitled to x% of the profit distribution from the Partnership as a partner of the Partnership.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Section 102-5,

Income Tax Assessment Act 1997 - Section 102-20,

Income Tax Assessment Act 1997 - Section 102-25,

Income Tax Assessment Act 1997 - Section 104-55,

Income Tax Assessment Act 1997 - Section 108-5,

Income Tax Assessment Act 1997 - Section 116-20,

Income Tax Assessment Act 1997 - Section 116-30, and

Income Tax Assessment Act 1997 - Section 995-1.

Reasons for decision

Issue 1

Question 1

Summary

CGT event E1 will happen when you assign your partnership interest to an existing trust.

For CGT purposes, the capital proceeds for the assignment of your partnership interest will not be the nominal consideration received by you, but rather the deemed market value under subsection 116-30(1) of ITAA 1997.

Detailed reasoning

CGT asset and relevant CGT event

Section 108-5 of the ITAA 1997 provides the definition of CGT asset.

In your circumstance, your interests in each of the assets of the Partnership are CGT assets, according to paragraph 108-5(2)(c). Furthermore, any interest you may have in the Partnership that was not covered by paragraph (c) is also a CGT asset according to paragraph 108-5(2)(d).

Subsection 102-5(1) of the ITAA 1997 then states that your assessable income includes your net capital gain (if any) for the income year. This subsection also provides the method statement of working out the net capital gain for the income year by reference to capital gains and capital losses that you made during that income year.

Section 102-20 then states that you can make a capital gain or capital loss if and only if a CGT event happens.

Section 102-25 requires you to consider which CGT event happens to your situation.

You proposed to assign a share of the partnership interest to the Trust by a declaration of trust. You will commence to hold a portion of your interest in the Partnership as a trustee in a manner consistent with the assignment.

The Commissioner considers that CGT event E1 will happen when you commence holding a portion of your interest in the Partnership as trustee for the Trust.

Section 104-55 of the ITAA 1997 provides that CGT event E1 happens if you create a trust over a CGT asset by declaration or settlement. In order for CGT event E1 to happen, two requirements must be satisfied. These are:

• you must create a trust over a CGT asset by declaration or settlement; and

• the exceptions in subsection 104-55(5) must not apply.

None of the exceptions in subsection 104-55(5) apply in the present case. Accordingly, the second condition is satisfied.

Further, it is considered that the first condition is satisfied in the present case.

No trust relationship currently exists between you and the Trust. However, you intend to commence holding a portion of your interest in the Partnership as trustee for the Trust. Accordingly, it is clear that the proposed arrangement will involve the creation of a trust.

Furthermore, it is considered that this trust would be created by declaration or settlement.

When a statute speaks of a 'declaration' of trust, it is naturally taken as referring to a declaration or instrument which is effective to create a trust by operating upon property vested in the declarant. This is what would occur in the present case when you commence holding a portion of your interest in the Partnership as trustee for the Trust. A resolution that property is to be held on a separate trust is sufficient to amount to a declaration for the purposes of CGT event E1, even if there is no express declaration. The manifestation of an intention to create the relevant trust can be inferred from words or conduct, and no formal or technical language is required. Accordingly, it is not essential that you use words such as 'I declare myself a trustee'.

Alternatively it is considered that a trust would be created by way of 'settlement' for the purposes of CGT event E1 in the present case, being an instrument which creates a new beneficial interest in property through the imposition of a trust.

Capital proceeds for the disposal of your partnership interest

Subsection 104-55(3) provides the method to calculate any capital gain or loss when CGT event E1 happens to a CGT asset. It provides that:

• you make a capital gain if the capital proceeds from the creation of the trust are more than the asset's cost base; and

• you make a capital loss if the capital proceeds from the creation of the trust are less than the asset's reduced cost base.

When calculating the capital proceeds, the general rules in Division 116 need to be applied. The capital proceeds from a CGT event are the total of the amount of money a taxpayer has received, or is entitled to receive, in respect of the event happening, and the market value of any other property the taxpayer has received, or is entitled to receive, in respect of the event happening (worked out as at the time of the event - section 116-20). However, the general rules are modified by the market value substitution rules in section 116-30 where the capital proceeds received are more or less than the market value of the asset and the asset was disposed of in a non-arm's length dealing (subparagraph 116-30(2)(b)(i)).

As you are proposing to assign, by way of declaration of trust, a proportion of your partnership interest to the Trust for no consideration, the market value substitution rule under section 116-30 needs to be considered.

Whether parties have dealt at arm's length is a question of fact that must be determined in any particular case. Subsection 995-1(1) of the ITAA 1997, in respect of the term 'arm's length' states that in determining whether parties deal at arm's length, consider any connection between them and any other relevant circumstance.

Taxation Ruling IT 2540 Income Tax: Capital Gains: Application to disposals of partnership assets and partnership interests (IT 2540) addresses the disposal and acquisition of partnership interests in the context of 'no goodwill' partnerships where partners neither pay nor receive anything on entry into or exit from the partnership. At paragraphs 13 and 14, the Commissioner accepts that:

13. For large partnerships, which can have memberships numbering in the hundreds (for example, some major legal and accountancy partnerships) the situation is potentially more complex. In some cases, the potential problems are overcome because the ownership of the assets used by the partnership is vested in a service company or trust. 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 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 that the value of the goodwill is nil. This treatment will also apply to partners of smaller partnerships who deal with each other at arm's length, where those dealings take place in an ordinary commercial context.

14. 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 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. [emphasis added]

However, this treatment is only applicable to the retirement or admission of a partner out of or into the partnership. As explained in Everett's case, an assignment does not constitute the assignee a partner or pass to him the powers of management, administration and inspection of books and accounts which repose in the assignor as a partner. Therefore, the administrative treatment provided in IT 2540 is not applicable to you.

IT 2540 also provides the Commissioner's view on the CGT consequences of entering into an Everett assignment. Paragraph 24 provides the Commissioner's view that an Everett assignment will be treated as a part disposal of the partner's interest in the assets of the partnership for CGT purposes.

The implication of this treatment was that an Everett assignment could give rise to a capital gain (or capital loss) in the hands of the assignor. As explained earlier in this ruling, the same outcome now arises under the re-written CGT provisions in Part 3-1 of the Income Tax Assessment Act 1997. The Commissioner has stated at paragraph 25 that 'it would be very unusual for an Everett assignment to be made on an arm's length basis'. Therefore, the market value modification rule in section 116-30 will apply to determine the capital proceeds.

The case of Granby v. FC of T 95 ATC 4240 considered whether the cost base of certain plant and equipment for CGT purposes was the actual residual value paid or the market value at the time of purchase, in circumstances where plant and equipment was purchased at its residual value on the expiration of a lease. The question turned on whether the lessor of the plant and equipment and the taxpayer's partnership were dealing with each other at arm's length for the purposes of the CGT provisions.

In that case, Lee J stated at ATC 4244 that the provision 'dealing with each other at arm's length' invited an analysis of the manner in which the parties conduct themselves in forming the transaction. The question is whether the parties behaved in the manner in which parties at arm's length would be expected to behave in conducting their affairs and the expression means, at least, that the parties have acted severally and independently in forming their bargain.

Further, Lee J stated at ATC 4244 that:

If the parties to the transaction are at arm's length it will follow, usually, that the parties will have dealt with each other at arm's length. That is, the separate minds and wills of the parties will be applied to the bargaining process whatever the outcome of the bargain may be.

However this will not be the case where the parties collude to achieve a particular result, or where one of the parties submits the exercise of its will to the discretion of the other. In such a case the lack of the exercise of an independent will in the formation of the transaction would indicate a lack of real bargaining.

The way that you propose to assign a proportion of your partnership interest to the Trust for no consideration evidences that the parties will not behave in a manner in which arm's length parties would be expected to behave. That is, in line with the Commissioner's view in paragraph 25 of IT 2540, the facts indicate that the parties will not be acting at arm's length. The amount paid by the assignee is not reflective of a normal bargaining process which was discussed in Granby and the capital proceeds of nil do not reflect the true value which an interest in the Partnership would be valued at.