Edited version of your written advice

Authorisation Number: 1013041950313

Date of advice: 5 July 2016

Ruling

Subject: Assessable income-net income of partnership

Question:

Is the amount paid to you on your retirement from the partnership assessable under section 92 of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer:

Yes

This ruling applies for the following period:

Year ended 30 June 20cc

The scheme commenced on

1 July 20bb

Relevant facts

You were an equity partner with a partnership until recently when you retired as a partner during the 20bb/cc financial year.

You held XX units in the partnership as an equity partner.

Shortly before your retirement you entered into a series of discussions and negotiations with the managing partner in relation to the terms upon which you would be prepared to retire from the partnership.

You provided a Memorandum document dated XX/XX/XXXX which states:

• You will cease to be an equity partner on XX/XX/XXXX

• You will leave the firm on or before XX/XX/XXXX

• You will receive your full entitlement as an XX unit equity partner for the 20aa-bb financial year. This will be paid in the usual way.

• You will be paid $XXX,XXX in the 20bb-cc financial year.

You left the firm on XX/XX/XXXX, the period in the office between your official retirement date of XX/XX/XXXX and XX/XX/XXXX, being made available to you to finalise matters pertaining to your prior equity interest in the partnership.

You received the $XXX,XXX in the 20bb-cc financial year as per the Memorandum.

The partnership provided you with a statement of distribution of taxable profits of the partnership for the year ended 30 June 20cc which states that you had the sum of $XXX,XXX distributed to you as a taxable distribution of firm profits for the year ended 30 June 20cc.

You also received a further payment of $XXX,XXX in respect of your share of the partnership's work in progress balance at 1 July 20bb and accept that this forms part of your assessable income.

The total taxable distribution to you disclosed in the partnership's income tax return for the year ended 30 June 20cc comprises both amounts totalling $XXX,XXX.

You have also received your full capital entitlements in respect of the XX units you held as an equity partner.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 6-10

Income Tax Assessment Act 1936 Section 92

Reasons for decision

Section 92 of the Income Tax Assessment Act 1936 (ITAA 1936) requires each partner to include their interest in the net income of the partnership for an income year, in their assessable income.

TD 2015/19 states that where a retiring partner receives an amount representing their individual interest in the partnership net income, the amount is assessable under section 92 of the ITAA 1936. It also states at paragraph 2 that:

This is the case regardless of:

• how the amount the partner is entitled to is labelled or described (including whether it is expressed to be consideration for something provided or given up by the partner)

• the timing of the partner's retirement (including whether they retire before the end of the income year), and

• the timing of any payment.

TD 2015/19 states at paragraph 23:

The partner's individual interest in partnership net income is essentially a question of fact in each case, to be determined by reference to the partnership agreement; the partnership's accounting records and any other relevant documents. However, it cannot be concluded that a person has no such interest merely because they cease to be a partner before the partnership's profit or net income has been calculated.

In your case, the partnership provided you with a statement of distribution of taxable profits of the firm for the year ended 30 June 20cc which states that you had the sum of $XXX,XXX distributed to you as a taxable distribution of partnership profits for the year ended 30 June 20cc.

This shows that the partnership considered that you did have an interest in the partnership's net income for the 20bb-cc financial year and the amount of that interest was $XXX,XXX.

There is nothing in the Memorandum or the partnership agreement that conclusively shows that this is not correct. Therefore, based on the information supplied we can only conclude that the $XXX,XXX represents your individual interest in the net income of the partnership for the 20bb-cc financial year. Consequently the $XXX,XXX is included in your assessable income under section 92 of the ITAA 1936.

Your contentions

You argue that the treatment of the amount in the accounts of the partnership is not relevant to the characterisation of the amount you received. However, the Commissioner disagrees. As stated in paragraph 23 of TD 2015/19, the Commissioner considers that the partnership's accounting records are relevant in determining a partner's individual interest in partnership net income.

You contend that as you officially ceased being an equity partner on XX/XX/XXXX, you did not have an entitlement to the income of the partnership for the 20bb-cc financial year. However, although it was for a short time, you were a partner during that income year and therefore it would be expected that you would be entitled to some portion of the partnership's net income for the year. The partnership agreement appears consist with this and nothing in any of the documents provided contradicts this. The partnership has determined that your entitlement to the partnership's net income for the 20bb-cc financial year amounted to $XXX,XXX. As mentioned previously, TD 2015/19 states that where a retiring partner receives an amount representing their individual interest in the partnership net income, the amount is assessable under section 92 of the ITAA 1936, regardless of the timing of the partner's retirement.

You refer to the $XXX,XXX as an ex gratia payment and argue that it is compensation for your agreement to leave the partnership early without requiring the notice period set out in the partnership agreement. However, TD 2015/19 states that once it is concluded that an amount represents a partner's individual interest in partnership net income, the amount is assessable under section 92 of the ITAA 1936 and 'It is unnecessary to further characterise that amount by reference to how it is otherwise labelled by the parties or what it is expressed to be consideration for' (McNally v. Federal Commissioner of Taxation; FC of T v. McNally 2007 ATC 4150 at [42], [47], [59] and [60]). In the McNally Case, the Federal Court highlighted that the issue was whether the amount represented the taxpayer's share of the partnership's net income, and not its character in the taxpayer's hands.

Please note that if the $XXX,XXX were to also represent capital proceeds from a CGT event, any capital gain which would otherwise arise is reduced by $XXX,XXX, that is, to the extent that the amount is assessable under section 92 of the ITAA 1936.