Edited version of your written advice

Authorisation Number: 1051403101098

Date of advice: 28 August 2018

Ruling

Subject: Capital gains tax consequences of assignment of partnership interest

Question 1

Will CGT event E1 under section 104-55 of the Income Tax Assessment Act 1997 (ITAA 1997) happen when the taxpayer assigns, by way of declaration of trust, a beneficial interest in the Partnership to a family discretionary trust?

Answer

Yes

Question 2

Will CGT event E2 under section 104-60 of the ITAA 1997 happen when the taxpayer assigns, by way of declaration of trust, a beneficial interest in the Partnership to a family discretionary trust?

Answer

No

Question 3

Will CGT event A1 under section 104-10 of the ITAA 1997 happen when the taxpayer assigns, by way of declaration of trust, a beneficial interest in the Partnership to a family discretionary trust?

Answer

No

Question 4

Assuming either CGT event E1, E2 or A1 happens, for CGT purposes, will the capital proceeds for the taxpayer’s disposal of the partnership interest to a family discretionary trust be the consideration received by the taxpayer for the assignment if that consideration is less than market value?

Answer

No

Question 5

Assuming either CGT event E1, E2 or A1 happens, will the capital proceeds (if actual consideration is less than market value) for the taxpayer’s disposal of the partnership interest to a family discretionary trust be the deemed market value consideration under subsection 116-30(1) of the ITAA 1997 for the CGT event, which will equal an amount determined by an independent qualified valuer, if the actual consideration is less than market value.

Answer

Yes

This ruling applies for the following period:

1 July 201X to 30 June 201Y

The scheme commences on:

1 July 201X

Relevant facts and circumstances

The taxpayer is an equity partner of the Partnership.

The Partnership provides professional services to the public, and has an agreement with a service trust to provide the Partnership with administration support services.

The Partnership operates as a 'no-goodwill' partnership. Goodwill is not recognised either in the balance sheet of the Partnership or for any other commercial purpose. When new partners are admitted to the Partnership they do not make any payment to the existing partners to acquire any goodwill. Partners also are not entitled to receive any consideration for the disposal of goodwill when they retire or otherwise exit from the Partnership.

Any loan capital provided by the partners to the Partnership is returned to the partners on retirement.

On admission to the Partnership, the partners become primary beneficiaries of the Services Trust, with their spouse, family members and any associated entities becoming secondary or tertiary beneficiaries of the trust. The Services Trust is a discretionary trust.

The taxpayer is a partner and thus has interest in the “Partnership Group”, which includes the Partnership and the Services Trust.

The Services Trust is the principal operating entity for the support functions to the Partnership, including the employment and operations of the finance, information technology, human resources and marketing teams. There is a service agreement in place between the Services Trust and the Partnership where the Partnership pays arm’s length services fees of cost plus a percentage mark-up to the Services Trust for its services. The percentage mark-up is specified to be no more than the mark-up permitted by the ATO using the ‘indicative rates’ method. The entire profit from the

Services Trust is distributed to the partners or their nominated entity.

The Services Trust currently derives and distributes approximately X% of the total income for the Partnership Group, although this may vary year on year. The Service Trust percentage of total income from the Partnership Group will at all times be less than Y%.

The Partnership intends to allow each partner to assign a portion (up to a maximum of Z%) of his or her partnership interest by way of declaration of trust ('Everett assignment'). The Partnership will approve and review Firm internal rules in regards to Everett Assignments but will not approve individual assignments.

The declaration of trust will be irrevocable.

Under the proposed arrangement, the taxpayer will assign a portion of the taxpayer’s interest in the Partnership to a discretionary family trust (the Trust). The taxpayer has to ensure he directly receives a minimum of 50% of the overall profits from the Partnership Group each year.

Documents 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).

A trust relationship will come into existence consistent with the decision in Everett.

The Partnership has a valuation methodology to determine the market value of the Partnership.

The Trust will pay consideration for the assigned partnership interest, although the consideration may be less than market value.

The assignment will affect the assignment of all beneficial rights associated with the partnership interest, including the right to receive the share of income of the Partnership. The taxpayer will continue to legally be a partner of the Partnership. The trustee of the Trust will not become a member of the Partnership, nor will the trustee be entitled to interfere in the Partnership's business or affairs or to require any account or to inspect the books 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 104-10,

Income Tax Assessment Act 1997 – Section 104-55,

Income Tax Assessment Act 1997 – Section 104-60,

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

Unless otherwise stated, all legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997).

CGT implications of holding a portion of the taxpayer’s partnership interest as trustee

The Commissioner considers that CGT event E1 will happen when the taxpayer commences holding a portion of the taxpayer’s interest in the Partnership as trustee for the Trust.

CGT Event E1

Section 104-55 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.

It is considered that the first condition will be satisfied in the present case.

No trust relationship currently exists between the taxpayer and the Trust in respect of the Partnership interest. However, the taxpayer intends to commence holding a portion of the taxpayer’s 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 the taxpayer commences holding a portion of the taxpayer’s interest in the Partnership as trustee for the Trust. A resolution that the 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.

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

CGT Event E2

Section 104-60 provides that CGT event E2 happens if you transfer a CGT asset to an existing trust.

A distinction is to be drawn between the creation of a trust over an asset and the transfer of an asset to an existing trust: Truesdale v. Federal Commissioner of Taxation (1971) 120 CLR 353; 70 ATC 4056.

In the present case, the taxpayer will commence holding the assigned interest in the Partnership on trust for the trustee of the Trust. Whilst the Trust will exist prior to the assignment being entered into, the entering into of the assignment by declaration of trust will give rise to a new trust which was not in existence before that time. Accordingly, the taxpayer will not transfer an asset to an existing trust and CGT event E2 will not happen.

CGT Event A1

Section 104-10 provides that CGT event A1 happens if you dispose of a CGT asset. Disposal is then defined in subsection 104-10(2) to have happened when there is a change of ownership from you to another entity.

Under the proposed assignment, the taxpayer will retain the legal ownership and continue to be the named partner in the Partnership. The Trust will only acquire the beneficial ownership of the assigned partnership interest. Therefore, the taxpayer will dispose of a part-interest in the Partnership when the taxpayer commences holding it on trust for the trustee of the Trust.

However, in accordance with subsection 102-25(1), CGT event E1 is more specific to the situation, therefore CGT event A1 will not apply.

Capital proceeds for the disposal of the taxpayer’s 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 the taxpayer is proposing to assign, by way of declaration of trust, a proportion of the taxpayer’s partnership interest to the Trust for what may be less than market value, 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), 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’) 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 ITAA 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 (‘Granby’) 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 the taxpayer proposes to assign a proportion of the taxpayer’s partnership interest to the Trust for possibly an amount other than market value 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 dealing with each other at arm’s length. The amount paid by the assignee may not be reflective of a normal bargaining process which was discussed in Granby and the capital proceeds of may not reflect the value which an interest in the Partnership would expect to be valued at.

Paragraph 28 in IT 2540 provides that when determining the market value of an Everett assignment, the valuation should be in accordance with the decision in Reynolds’. Reynolds’ case concerned the valuation of an assigned partnership interest on which ad valorem stamp duty was payable. Despite the other assets of the partnership being held in administration and service entities and goodwill not being recognised by the partnership, Burt CJ held:

‘the assigned partnership interest was of value; its value derived from the value of the right that was attached to the partnership interest to receive a proportionate share of the future income of the partnership.’

Paragraph 28 of IT 2540 further explains that when valuing a partnership interest when entering into an Everett assignment, this will involve 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.