Edited version of your written advice

Authorisation Number: 1051419393855

Date of advice: 31 August 2018

Ruling

Subject: Election under section 70-100 of the Income Tax Assessment Act 1997 (ITAA 1997) and Part IVA.

Question 1

Will the Commissioner apply Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) when a second election is made under section 70-100 of the ITAA 1997 in respect of a transfer of trading stock (livestock), more than XX months after an earlier election was made?

Answer

No.

This ruling applies for the following period:

01/07/20XX – 30/06/20YY

Relevant facts and circumstances

Taxpayers

1. The taxpayers for the private ruling application are the partners in Partnership 1.

Trading Stock

2. Partnership 1 operated a family livestock farming business. Partnership 1 had owned 100% of the interests in the livestock that was an asset of the livestock farming business.

3. MN PQ Company Pty Ltd (MN PQ) was registered on the XX/YY/YYYY and has acted as the manager of Partnership 1 since that time.

4. Each partner obtained shares in MN PQ based on their fractional interest in Partnership 1.

Restructure

5. The livestock farming business is being restructured for succession planning reasons and to take advantage of the benefits of a company structure.

First Transfer

6. On XX/YY/ZZZZ, the partners in Partnership 1 each transferred an equal interest of A% in the trading stock to MN QP such that a new partnership was formed.

7. An election was made to treat the transferred interests in the livestock as having been disposed of at closing value for taxation purposes under subsection 70-100(4) of the ITAA 1997, the conditions in subsection 70-100(6) having been satisfied.

Business of Partnership 2

8. From the date of the first transfer, a new partnership (Partnership 2) commenced a primary production business of farming and maintaining livestock for the purpose of selling those livestock or their bodily produce including natural increase with a view to making a profit.

9. The partners obtained a registered business name for the new business from ASIC along with obtaining an Australian Business Number and Tax File Number and registering for GST.

10. Partnership 2 established a new bank account which has been used to transact and conduct the business.

Second Transfer

11. It is XX months since the first transfer. The partners in Partnership 2 now intend to transfer their interests in the livestock, held within the partnership, to MN QP, with the result that MN QP will hold 100% of the interest in the livestock.

12. All the parties to the transfer then intend to make a second election under section 70-100(4). Partnership 2 intends to elect a value for the second transfer that is less than the market value of the trading stock.

13. From the date of the second transfer, MN PQ will then commence in its own capacity a primary production business of maintaining the livestock with the purpose of selling the livestock including its natural increase with a view to generate a profit in accordance with the current operating procedures, protocols and systems that exist in the business of Partnership 2.

14. Partnership 2 will cease to exist.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 177A

Income Tax Assessment Act 1936 Section 177C

Income Tax Assessment Act 1936 Section 177D

Income Tax Assessment Act 1997 Section 70-90

Income Tax Assessment Act 1997 Section 70-100

Reasons for decision

Issue 1

Question 1

Summary

The Commissioner will not apply Part IVA of the Income Tax Assessment Act 1936 when a second election is made under section 70-100 of the Income Tax Assessment Act 1997 in respect of a transfer of trading stock (livestock), more than XX months after an earlier election was made.

Detailed reasoning

Assessable Income Arising from Disposal of Trading Stock

Under subsection 70-90, where an item of trading stock is disposed of outside the ordinary course of a business carried on by the transferor, of which the trading stock is an asset, then the transferor’s assessable income includes the market value of the trading stock on the day of disposal.

The same result is achieved under subsection 70-100(2) of the ITAA 1997 when there is a partial change in the ownership of trading stock outside the ordinary course of business, with the transfer treated as a disposal of the trading stock at market value. A partial change of ownership under subsection 70-100(1) of the ITAA 1997 occurs if, after the change, the transferor is not the sole owner of the trading stock, and one or more previous owners of the trading stock still have an interest in the trading stock. Section 70-100 is particularly relevant if there is a change in the composition of a partnership.

However, under subsection 70-100(4) of the ITAA 1997, the old owners and new owners may agree that the trading stock is to be taken to have been disposed of for what would have been its value as trading stock of the transferor on hand at the end of an income year ending on the day that it stops being trading stock, not at its market value. Under subsection 70-100(5), if this election is made, this value is included in the transferor's assessable income for the income year that includes that day. The transferee is treated as having bought the item for the same value on that day.

This result can only occur if the transferor and transferee make an election. Under subsection 70-100(6) of the ITAA 1997 an election can only be made if:

(a) immediately after the item stops being trading stock on hand of the transferor, it is an asset of a business carried on by the transferee; and

(b) immediately after the item stops being trading stock on hand of the transferor, the entities that owned it immediately beforehand have (between them) interests in the item whose total value is at least 25% of the item's market value on that day; and

(c) the value elected is less than that market value; and

(d) the item is not a thing in action.

Application to Circumstances

The owner of the trading stock (livestock) at the present time is Partnership 2, which consists of the family-owned MN PQ, and the partners in Partnership 1. This ownership structure came into place after a transfer by each of the partners in Partnership 1 of A% of their interest in the trading stock to MN PQ, and the creation of Partnership 2. An election under subsection 70-100(4) of the ITAA 1997 was made after the transfer. The partners in Partnership 1 collectively retained a (100-A)% interest in the trading stock, that was greater than 25%.

It is the intention of the partners in Partnership 1 to transfer their remaining interest in the trading stock, currently held within Partnership 2, to MN PQ.

MN PQ will ultimately own 100% of the taxpayers’ trading stock.

After the second transfer, a second election will be made under subsection 70-100(4) of the ITAA 1997 to treat the livestock as having been disposed of for what would have been their value as trading stock of Partnership 2 on hand at the date of transfer.

An election can only be made if the conditions of subsection 70-100(6) are satisfied, as set out above. These conditions are addressed below:

(a) Immediately after the item stops being trading stock on hand of the transferor, it is an asset of a business carried on by the transferee

The livestock were trading stock of Partnership 1 and ceased to be so when each partner of that partnership transferred an A% interest to MN PQ and established a new partnership, Partnership 2. The livestock then commenced to be trading stock of Partnership 2 which has continued to conduct a primary production business of livestock trading.

It is now proposed that the livestock stop being trading stock of Partnership 2, and will become solely the trading stock of MN PQ with an identical primary production business of trading in livestock being commenced by MN PQ immediately after the proposed second transfer occurs.

Therefore, the condition in paragraph 70-100(6)(a) is satisfied for the Second Transfer.

(b) Immediately after the item stops being trading stock on hand of the transferor, the entities that owned it immediately beforehand have (between them) interests in the item whose value is at least 25% of the item's market value on that day

Immediately before the second transfer, Partnership 2 will hold 100% of the trading stock, with MN PQ and the partners in Partnership 1 respectively holding an A% interest and a (100-A)% interest in the trading stock within Partnership 2.

After the second transfer, MN PQ will hold a 100% interest in the trading stock, and the partners in Partnership 1 will no longer hold any interest in the trading stock.

Thus, immediately after the livestock stop being the trading stock of Partnership 2, MN PQ, a member of Partnership 2 which had an A% interest in that trading stock, will hold a 100% interest.

Paragraph 70-100(6)(b) of the ITAA 1997 is therefore satisfied for the second transfer.

(c) The value elected is less than the market value

Partnership 2 intends to elect a value for the second transfer that is less than the market value.

Paragraph 70-100(6)(c) of the ITAA 1997 is therefore satisfied.

(d) The item is not a thing in action

The livestock is not a chose in action. Paragraph 70-100(6)(d) is accordingly satisfied.

As such, all the conditions of subsection 70-100(6) of the ITAA 1997 will be satisfied for the second transfer.

Part IVA

Part IVA of the ITAA 1936 is a general anti-avoidance rule that can apply in certain circumstances if a taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained by the taxpayer. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

In broad terms, Part IVA will apply where the following requirements are satisfied:

● there is a scheme, per section 177A;

● a taxpayer has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme, per section 177C; and

● the dominant purpose of a person who entered into or carried out the scheme, or any part of the scheme, was to enable the relevant taxpayer to obtain a tax benefit in connection with the scheme, or to enable the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme, per subsection 177D(1).

The application of Part IVA depends on a careful weighing of all the relevant facts and surrounding circumstances of each case.

Scheme

Subsection 177A(1) of the ITAA 1936 defines a scheme broadly as follows:

(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

(b) any scheme, plan, proposal, action, course of action or course of conduct.

Tax Benefit

Paragraph 177C(1)(a) states that a ‘tax benefit’, for the purposes of Part IVA, includes an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out.

Making of an election

Paragraph 177C(2)(a) of the ITAA 1936 provides for an exclusion to obtaining a tax benefit where it relates to the non-inclusion of an amount in assessable income where such non-inclusion is attributable to an election being made as provided for under the ITAA 1936 or ITAA 1997. Per subparagraph 177C(2)(a)(ii), the exclusion will only apply where the scheme was not entered into or carried out for the purpose of creating any circumstance or state of affairs to enable such an election to be made.

Application to circumstances

The taxpayers’ proposed course of action is to make a second transfer of trading stock, this time from Partnership 2 to MN PQ. For the purposes of this ruling the scheme (as defined in subsection 177A(1)) to which Part IVA potentially applies comprises both the first transfer and, more than XX months later, the second transfer, with the making of an election under subsection 70-100(4) in respect of each transfer.

As a result of the scheme, the trading stock (livestock) will be deemed to have been transferred to MN PQ at its closing tax value in the hands of the partners in Partnership 2, rather than at market value. As such, only the tax value of the trading stock will be included in the assessable income of the partners, rather than the market value. Specifically as to the second transfer, the difference between the market value and the tax value of the trading stock transferred by Partnership 2 would be the amount not included in the assessable income of the partners in Partnership 2 in the income year in which the relevant transfer will take place.

This non-included amount would normally constitute a tax benefit under subsection 177C(1). However, as stated above, paragraph 177C(2)(a) of the ITAA 1936 provides for an exclusion to obtaining a tax benefit where it relates to the non-inclusion of an amount in assessable income where it is attributable to an election being made as provided for under the ITAA 1936 or ITAA 1997.

Having considered the particular facts applicable in the present case, the Commissioner does not consider that the scheme in relation to the first and second transfers is one to which the exclusion in paragraph 177C2(a) should be prevented from applying by virtue of subparagraph 177C2(a)(ii).

The restructure is being undertaken for family planning and succession purposes, and to take advantage of the benefits of a company structure. MN PQ is a company under the control of the Family.

Therefore, paragraph 177C(2)(a) will apply such that the non-inclusion of the difference between the market value and the tax value of the trading stock transferred by the taxpayers is not considered a ‘tax benefit’ under subsection 177C(1), on the basis that the non-inclusion is attributable to the making of an election under subsection 70-100(4).

As there is no ‘tax benefit’ under subsection 177C(1) in connection with the scheme, subsection 177D(1) will not be satisfied and Part IVA will not apply to the scheme.

Conclusion

The Commissioner will not apply Part IVA of the Income Tax Assessment Act 1936 when a second election is made under section 70-100 of the Income Tax Assessment Act 1997 in respect of a transfer of trading stock (livestock), more than XX months after an earlier election was made.