Edited version of your written advice

Authorisation Number: 1013066740415

Date of advice: 2 September 2016

Ruling

Subject: Retiring partner income

Question 1

Is a lump sum payment made by a partnership to you under a retirement deed considered a receipt of capital which will be assessed under the capital gains tax (CGT) provisions of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Are you eligible to reduce the capital gain made on the surrender of your partnership interest under the CGT concessions for small business in Division 152 of the ITAA 1997?

Answer

Not necessary to answer given our answer to Question 1.

Question 3

Is a lump sum payment made by a service trust to the family trust under a retirement deed considered a receipt of capital which will be assessed under the CGT provisions of the ITAA 1997?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20YY

The scheme commences on:

The scheme has commenced

Relevant facts and circumstances

You became a partner of a professional services partnership.

On entering the partnership, you acquired an interest in the partnership, including assets of the partnership which belong to the partners and involving the sharing of losses and liabilities between the partners.

The partnership does not recognise goodwill, and therefore there was no consideration paid by you upon you entering the partnership.

The administration, management entitlements and obligations of the partners are governed by a partnership agreement.

A family trust was a beneficiary of a service trust, by virtue of you being a partner of the partnership and therefore eligible as a general beneficiary under the service trust's trust deed. Both the family trust and the service trust are discretionary trusts.

The partnership agreement provides, among other things, in relation to the disposal of the partnership interest upon retirement,

• detail related to the calculation of the retirement entitlement

• that the partnership and the retiring partner release each other from all claims on account of the partnership, and

• imposition of certain restrictions with respect to future activities of the former partner.

Subject to the CEO discretion, the partnership expects a partner to retire on the earlier of the 30 June or 31 December next following the partner attaining 58 years of age.

You entered into a retirement deed to retire from the partnership, which states that you will cease to be a partner of the partnership on and from the retirement date. The retirement date is 1 July 20XX. Upon your retirement, the family trust also ceased being eligible as a general beneficiary of the service trust.

At the time of your retirement, you were 58 years of age.

The pertinent clauses of the retirement deed include:

• clarification that you will cease to be a partner of the partnership on and from the retirement date

• certain restrictions and continuing obligations under the partnership agreement you have post retirement, and

• the relinquishing of any claims you may have against the partnership.

The retirement schedule provided records an amount of $X under the title of 'retirement allocations FY20YY'.

Upon retirement as a partner a lump sum consideration of $X was allocated to you, comprising your retirement allowances and annual leave entitlements.

With respect to the calculation of retirement allocation of $X:

a) part comprises amounts calculated to be equal to unused annual leave accruals; and

b) part comprises a retirement allowance based on the average income, being "the distributable profit of the partnership and/or its associated entities allocated to the partner", for the 5 financial years preceding your retirement, calculated in accordance with the partnership agreement.

The lump sum consideration being the amount of $X allocated to you on your retirement was paid to you by the partnership and to the family trust by the service trust on a 73% (being an amount of $Y) to 27% (being an amount of $Z) split.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 92

Income Tax Assessment Act 1936 Subsection 92(1)

Income Tax Assessment Act 1936 Section 97

Income Tax Assessment Act 1936 Section 101

Income Tax Assessment Act 1997 Division 152

Reasons for decision

Question 1

Summary

The payment you received as a retiring partner is not considered to be a receipt of capital but represents a share in the net income of the partnership and is assessable under section 92 of the Income Tax Assessment Act 1936 (ITAA 1936).

Detailed reasoning

Subsection 92(1) of the ITAA 1936 requires each partner to include their interest in the net income of the partnership in their income tax return.

Taxation Determination TD 2015/19 is relevant in your circumstances. 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 how the amount is labelled or described, the timing of the partner's retirement and the timing of any payment.

In your case, you have advised that you ceased to be a partner in the partnership with effect on and from 1 July 20XX and that you received an amount under the retirement deed being $Y. As you were a partner, pursuant to the partnership agreement, the amount of $Y you received was in respect of your individual interest in the net income of the partnership. The character of the amount of $Y you have received will not alter regardless of the date of your retirement or the timing of when you received this payment.

Paragraph 23 of TD 2015/19 states that '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'.

Therefore the amount of $Y you received is your entitlement as an equity partner in the share of the profits of the partnership. The amount represents your individual interest in the net income of the partnership and is assessable under section 92 of the ITAA 1936.

Further, in characterising the amount of $Y with regard to the terms of the partnership agreement and the retirement deed, this amount would be assessable on revenue account as it is referrable to your services, performance and annual leave (see paragraphs 29 to 30 of TD 2015/19).

Question 2

It is not necessary to answer this question as the lump sum payment you received on retirement from the partnership is included in your assessable income under section 92 of the ITAA 1936 and is not considered to be capital in nature.

Question 3

Summary

The payment the family trust received is not considered to be a receipt of capital.

Detailed reasoning

The beneficiaries of a discretionary trust do not have a fixed entitlement or interest in the trust funds. The trustee has the discretion to determine which of the beneficiaries are to receive the capital and income of the trust and how much each beneficiary is to receive.

The beneficiaries of a discretionary trust do not have an interest in the assets of the trust. They merely have a right to be considered or a mere expectancy until such time as the trustee exercises its discretion to make a distribution.

A further essential feature of a discretionary trust is that no beneficiary has any valuable interest in any of the assets held by the trustee on behalf of the trust fund. The interest of a beneficiary is said to be a "mere expectancy" of receiving a benefit.

In your circumstances the trustee of the service trust paid an amount of $Z, which was income of the service trust, to the family trust.

Section 101 of the ITAA 1936 provides a beneficiary shall be presently entitled where a trustee exercises their discretion to apply income of a trust estate for the benefit of the beneficiary.

As the family trust is not under a legal disability, the family trust is liable to be assessed and to pay tax pursuance to section 97 of the ITAA 1936.

The amount of $Z, received by the family trust from the service trust is not considered a receipt of capital but rather income from the service trust.