Edited version of your written advice

Authorisation Number: 1013104456730

Date of advice: 7 October 2016

Ruling

Subject: Tax consequences arising from an assignment of a partnership interest

Question 1

Where you assign 30% of your interest in Partnership X to Family Trust Y for nil consideration, will nil consideration be accepted as the capital proceeds for the Capital Gains Tax (CGT) Event(s) that happen(s) on the assignment of your interest in Partnership X, as defined in Division 116 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Are you eligible to apply the CGT discount of 50% under Division 115 of the ITAA 1997 to the capital gain made from the assignment?

Answer

Yes

Question 3

Is the interest in Partnership X which you assigned an 'active asset' for the purposes of Division 152 of the ITAA 1997 and, in determining whether you meet the maximum net asset value (MNAV) test, are the assets of Partnership X and other Partnership X partners not required to be included?

Answer

Yes

Question 4

Are you eligible to apply the CGT small business 50% active asset reduction under Subdivision 152-C of the ITAA 1997 to the capital gain made from the assignment?

Answer

Yes

Question 5

Will you qualify for the CGT small business retirement exemption under Subdivision 152-D of the ITAA 1997 in respect of the capital gain made from the assignment?

Answer

Yes

This ruling applies for the following periods

1 July 20WW to 30 June 20XX

1 July 20XX to 30 June 20YY

1 July 20YY to 30 June 20ZZ

The scheme commenced on

1 July 20WW

Relevant facts and circumstances

You were admitted as a partner of Partnership X prior to 30 June 20VV.

Insofar as is relevant to this ruling application, in accordance with the partnership agreement for Partnership X, a partner:

• may assign a partnership interest (approval is required except for an Everett assignment to a related party);

• is allocated a profit based on income allocated to partners with respect to the relevant financial year;

• has no entitlement to a payment with respect to goodwill of Partnership X at any time;

• has no entitlement to accrued leave on leaving Partnership X; and

• is required to leave Partnership X by the 30 June following the Partner reaching age 60.

You contributed an amount of capital to Partnership X.

Income Allocation

The method of income allocation to each partner each year is based on a 'specific' system. That is, each partner, based on various benchmarks is allocated a number of units. Based on the firm's overall performance each year, an amount is determined.

The overall distribution in respect of each partner is income from two sources:

(a) From Partnership X. This is derived by you directly.

(b) From the Partnership X Service Trust.

The split as between Partnership X and Partnership X Service Trust is calculated in accordance with the principles set out by the Commissioner of Taxation in Taxation Ruling 2006/2: Income tax: deductibility of service fees paid to associated service entities: Phillips arrangements and the corresponding Guide entitled "Your service entity arrangements".

Everett Assignment

As you are a partner in a partnership and are jointly and severally liable for the debts of the partnership, you assigned part of your right, title and interest in Partnership X to Family Trust Y, a non-fixed trust, for the purposes of asset protection.

In this regard, you specifically:

(a) Established Family Trust Y, a non-fixed trust with discretionary powers conferred on the trustee as to the distribution of income and capital of the trust. This trust is what is commonly referred to as a discretionary trust or a family trust (though it may or may not be the subject of a family trust election). The trustee of Family Trust Y is a company in which your spouse owns all the shares. Your spouse's sibling is the appointor. Potential beneficiaries of Family Trust Y include you, your spouse and children and entities related to you.

(b) Assigned 30% of your right, title and interest in Partnership X (the Fractional Interest) including the entitlement to profits of Partnership X including any capital contributions equal to the Fractional Interest to the Family Trust Y (the Everett Assignment). This was effected by a deed of assignment. The assignor is you and the sole assignee is the Family Trust Y. This assignment occurred on 30 June 20WW.

The net value of the CGT assets held by you, any entities connected to you and any affiliates of entities connected to your affiliates, at all relevant times for the purposes of this ruling application, is less than $6 million.

For the purposes of the CGT small business retirement exemption, you will be under 55 years of age at the time the choice is made to apply the retirement exemption and will contribute the relevant amount (up to $500,000 of the remaining capital gain after applying the 50% general CGT discount concessions and the 50% active asset concessions) to a complying superannuation fund.

You will choose to apply the retirement exemption by the day you lodge your income tax return for the income year the CGT event happened and the choice will be in writing.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Section 104-55,

Income Tax Assessment Act 1997 - Division 115,

Income Tax Assessment Act 1997 - Division 116,

Income Tax Assessment Act 1997 - Section 116-20,

Income Tax Assessment Act 1997 - Section 116-30,

Income Tax Assessment Act 1997 - Division 152,

Income Tax Assessment Act 1997 - Subdivision 152-A,

Income Tax Assessment Act 1997 - Section 152-15,

Income Tax Assessment Act 1997 - Section 152-35,

Income Tax Assessment Act 1997 - Section 152-40,

Income Tax Assessment Act 1997 - Subdivision 152-C,

Income Tax Assessment Act 1997 - Subdivision 152-D, and

Income Tax Assessment Act 1997 - Section 328-130.

Reasons for decision

Question 1

Summary

Where you assign 30% of your interest in the Partnership X to Family Trust Y for nil consideration, the capital proceeds received, for the purposes of CGT event E1, will be replaced with the market value of the assigned interest at the time of the CGT event (as per section 116-30 of the ITAA 1997).

Detailed reasoning

CGT Event E1

CGT Event E1 happens if you create a trust over a CGT asset by declaration or settlement (section 104-55 of the ITAA 1997). In this case, the legal effect of the Everett Assignment is the creation of a trust arrangement between the Trustee (being the partner) and the assignee. The Everett Assignment will give rise to CGT Event E1.

Capital proceeds

Subsection 104-55(3) of the ITAA 1997 provides the method to calculate any capital gain or capital 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 of the ITAA 1997 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 of the ITAA 1997).

However, the general rules are modified by the market value substitution rule in section 116-30 of the ITAA 1997 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 (paragraph 116-30(2)(b) of the ITAA 1997).

Because you have assigned, by way of declaration of trust, your Fractional Interest to Family Trust Y for nil consideration, the market value substitution rule in section 116-30 of the ITAA 1997 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'.

In Granby Pty Ltd v. Federal Commissioner of Taxation (1995) 129 ALR 503 at 506-507; (1995) 95 ATC 4240; (1995) 30 ATR 400 Lee J said that the term 'at arm's length' means at least that the parties to a transaction acted severally and independently in forming their bargain. Both the relationship between the parties and their conduct in forming the transaction are relevant to whether they have dealt with each other at arm's length. If parties are at arm's length then it usually follows that they will have dealt with each other at arm's length.

In the current circumstances, based on the nature of the transaction, the relationship between the parties involved and the lack of consideration payable, it is considered that the parties did not deal with each other at arm's length in respect of this transaction. This conclusion accords with the Commissioner's view in paragraph 25 of Taxation Ruling IT 2540 Income Tax: Capital Gains: Application to disposals of partnership assets and partnership interests (IT 2540) which provides the Commissioner's view on the CGT consequences of entering into an Everett assignment. As a consequence, it is considered that the requirements in paragraph 116-30(2)(b) of the ITAA 1997 are met and therefore the capital proceeds from the CGT event will be replaced with the market value of the CGT asset (the Fractional Interest) at the time of the CGT event.

When valuing the assigned interest, paragraph 28 of IT 2540 is relevant, as it provides that where an Everett assignment is not made at arm's length, the valuation method adopted in Reynolds v Commissioner of State Taxation (WA) 86 ATC 4528 will usually be the appropriate method for determining the market value of the assigned partnership interest for the purposes of Part IIIA of the ITAA 1936. Broadly, this involves the determination of the price that a 'hypothetical buyer' would pay for the assigned partnership interest having regard to the value of the right to the future income of the partnership which is attached to the interest.

In respect of the valuation of your assigned interest in the current circumstances, it is noted that further guidance has been provided to you by the ATO in communications, separate to this ruling.

Question 2

Summary

To the extent that you make a capital gain from the Everett Assignment and CGT event E1 happening, it will be a 'discount capital gain' under Division 115 of the ITAA 1997 and you will be eligible to apply the CGT discount of 50%.

Detailed reasoning

A discount capital gain is a capital gain that meets the requirements of sections 115-10, 115-15, 115-20 and 115-25 of the ITAA 1997.

These provisions specifically require that to qualify as a discount capital gain:

(a) The capital gain must be made by an individual, trust, complying superannuation fund or a life insurance company (in respect of particular assets)- section 115-10 of the ITAA 1997;

(b) The capital gain must result from a CGT event happening after 11.45am (by legal time in the Australian Capital Territory) on 21 September1999- section 115-15 of the ITAA 1997;

(c) The capital gain must have been calculated without reference to indexation at any time;- section 115-20 of the ITAA 1997; and

(d) The capital gain must result from a CGT event happening to a CGT asset that was acquired by the entity making the capital gain at least 12 months before the CGT event- section 115-25 of the ITAA 1997.

In the current circumstances, these conditions will be satisfied as you are an individual who made a capital gain, calculated without reference to indexation, when CGT event E1 happened as result of the Everett Assignment. The relevant CGT asset (the Fractional Interest) was also acquired by you at least 12 months before the CGT event. This capital gain will therefore be a discount capital gain.

Because you are an individual, the discount percentage for the purposes of Step 3 of in subsection 102-5(1) of the ITAA 1997 will be 50% (pursuant to section 115-100 of the ITAA 1997).

Question 3

Summary

For the purposes of Division 152 of the ITAA 1997, your Fractional Interest is an 'active asset' and the assets of Partnership X and the other Partnership X partners will not be required to be included in determining whether you meet the MNAV test.

Detailed reasoning

Active asset

For a CGT asset to be an active asset for the purposes of Division 152 of the ITAA 1997, it must satisfy the requirements in subsection 152-40(1) of the ITAA 1997 which specifically states:

A CGT asset is an active asset at a time if, at that time:

(a) you own the asset (whether the asset is tangible or intangible) and it is used, or held ready for use, in the course of carrying on a *business that is carried on (whether alone or in partnership) by:

(i) you; or

(ii) your *affiliate; or

(iii) another entity that is *connected with you; or

(b) if the asset is an intangible asset - you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you.

In your case, your Fractional Interest is an intangible asset. It was through this interest that you carried on a business of providing professional services to clients in partnership with others. Your interest in Partnership X is inseparable from the business (and therefore inherently connected with the business) that you carried on. As such, it is considered that your Fractional Interest satisfies the requirements in subsection 152-40(1) of the ITAA 1997 and is therefore considered to be an active asset.

MNAV test

Section 152-15 of the ITAA 1997 provides that the MNAV test is satisfied if the sum of the net value of the CGT asset of the taxpayer, the CGT assets of any entities connected with the taxpayer and the CGT assets of any affiliates of the taxpayer entities connected with the taxpayer's affiliates, just before the CGT event does not exceed $6,000,000.

An entity is connected with another entity if:

(a) either entity controls the other entity in a way described in section 328-125 of the ITAA 1997; or

(b) both entities are controlled in a way described in section 328-125 of the ITAA 1997 by the same third entity.

Relevant to the current circumstances, subsection 328-125(2) of the ITAA 1997 provides, in part that, an entity controls another entity if it or its affiliate (or all of them together) owns, or has the right to acquire ownership of, interests in the other entity that give the right to receive at least 40% of:    

(I) any distribution of income or capital by the other entity, or

(II) if the other entity is a partnership, the net income of the partnership.

In your case, you do not own, or have the right to acquire ownership of, interests in Partnership X that give the right to receive at least 40% of the net income of the partnership. Therefore, unless the other Partnership X partners are considered to be your affiliates, you will not be considered to control and/or be connected with Partnership X.

With this in mind, subsection 328-130(1) of the ITAA 1997 provides that an affiliate is an individual that, in relation to their business affairs, acts or could reasonably be expected to act:

• in accordance with your directions or wishes, or

• in concert with you.

An individual however is not your affiliate merely because of the nature of a business relationship you and the individual share (subsection 328-130(2) of the ITAA 1997). This attribute is highlighted in an example in section 328-130 of the ITAA 1997 which relevantly provides:

A partner in a partnership would not be an affiliate of another partner merely because the first partner acts, or could reasonably be expected to act, in accordance with the directions or wishes of the second partner, or in concert with the second partner, in relation to the affairs of the partnership.

In your circumstances, although you and the other Partnership X partners share and have a common business relationship in Partnership X, there is no evidence to suggest that the necessary features described in section 328-130 of the ITAA 1997 exist. Consequently a Partnership X partner would not be considered to be your affiliate.

Accordingly, because you are not considered to be connected to Partnership X and the other Partnership X partners are not considered to be affiliates of you, the CGT assets of Partnership X and the Partnership X partners are not required to be included in the MNAV test in section 152-15 of the ITAA 1997.

Question 4

Summary

You are eligible to apply the CGT small business 50% active asset reduction under Subdivision 152-C of the ITAA 1997 to the capital gain made from the assignment.

Detailed reasoning

Section 152-205 of the ITAA 1997 (in Subdivision 152-C of the ITAA 1997) states that the amount of a capital gain remaining after applying step three of the method statement in subsection 102-5(1) of the ITAA 1997 is reduced by 50%, if the basic conditions in Subdivision 152-A are satisfied for the gain.

Section 152-10 of the ITAA 1997 contains the basic conditions to be satisfied. These conditions are:

(a) a CGT event happens in relation to a CGT asset of yours in an income year [This condition does not apply in the case of CGT event D1];

(b) the event would (apart from Division 152 of the ITAA 1997) have resulted in the gain;

(c) at least one of the following applies:

(i) you are a small business entity for the income year

(ii) you satisfy the maximum net asset value test (see section 152-15 of the ITAA 1997), or

(iii) you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership;

(iv) the conditions mentioned in subsection 152-10(1A) or 152-10(1B) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year

(d) the CGT asset satisfies the active asset test (see section 152-35 of the ITAA 1997).

In your case, you will satisfy the basic conditions in section 152-10 of the 1997 because:

• CGT event E1 happened as a consequence of the assignment of your Fractional Interest;

• A capital gain would have resulted from this event;

• You satisfy the MNAV test; and

• Your Fractional Interest is an active asset and you satisfy the active asset test.

Accordingly, you are eligible to apply the CGT small business 50% active asset reduction under Subdivision 152-C of the ITAA 1997 to the capital gain made from the assignment of your Fractional Interest.

Question 5

Summary

You will qualify for the CGT small business retirement exemption under Subdivision 152-D of the ITAA 1997 in respect of the capital gain made from the assignment.

Detailed reasoning

If you are an individual, you can choose to disregard all or part of a capital gain, under the small business retirement exemption in Subdivision 152-D of the ITAA 1997, if:

• you satisfy the basic conditions in Subdivision 152-A of the ITAA 1997;

• you keep a written record of the amount you chose to disregard (the CGT exempt amount), and

• if you are under 55 years old just before you choose to use the retirement exemption, you make a personal contribution equal to the exempt amount to a complying superannuation fund or retirement savings account.

You must make the contribution when you made the choice to use the retirement exemption, or when you received the proceeds (whichever is later).

The amount of the capital gain that you choose to disregard (that is, the CGT exempt amount) must not exceed your 'CGT retirement exemption limit'. An individual's lifetime CGT retirement exemption limit is $500,000, reduced by any previous CGT exempt amounts the individual has disregarded under the retirement exemption. This includes amounts disregarded under former (repealed) retirement exemption provisions.

In your circumstances, as previously noted, you will satisfy the basic conditions in Subdivision 152-A of the ITAA 1997 in respect of the circumstances relating to the assignment of your Fractional Interest.

You will also be under 55 years of age at the time the choice is made to apply the retirement exemption and will contribute the relevant amount (up to $500,000 of the remaining capital gain after applying the 50% general CGT discount concessions and the 50% active asset concessions) to a complying superannuation fund. Also, you will choose to apply the retirement exemption by the day you lodge your income tax return for the income year the CGT event happened and the choice will be made in writing.

Therefore, providing you have no previous CGT exempt amounts disregarded under the retirement exemption, you will be able to choose to disregard up to $500,000 under the retirement exemption by simply keeping a record of the amount you chose to disregard.