Edited version of your private ruling

Authorisation Number: 1052112813882

Date of advice: 16 May 2023

Ruling

Subject: CGT - contributing shares to partnerships

We use the terms 'Partnership 1' and 'Partnership 2' as a convenient shorthand only. We haven't determined whether either Partnership 1 or Partnership 2 will be treated as partnerships for tax law purposes. We don't mean to imply otherwise by using the terms 'Partnership 1' and 'Partnership 2' throughout this ruling or our explanations.

Question 1

What are the income tax implications for Entity A and Trustee B on contributing their shares in Company C to Partnership 1 and Partnership 2?

Answer

CGT event A1 will happen to the extent Entity A contributes part interests in Entity A's shareholdings in Company C to Trust E.

Similarly event CGT event A1 will happen to the extent that there is an exchange of part interests in Company C shares between Entity A and Trust B.

Question 2

Are Partnership 1 and Partnership 2 'limited partnerships' as defined in section 995-1 of the Income Tax Assessment Act 1997?

Answer

No. Partnership 1 and Partnership 2 will not be limited partnerships.

Question 3

Will the hybrid mismatch rules in Division 832 of the Income Tax Assessment Act 1997 apply to the contribution of the shares by Entity A to Partnership 1 and Partnership 2 or the contribution of the shares by Trustee B to Partnership 2?

Answer

No. The hybrid mismatch rules in Division 832 of the Income Tax Assessment Act 1997 do not apply to the specific proposed transactions described in the facts for this private ruling. These transactions comprise the mere contribution of a part interest in shares by Entity A to Trust E and the exchange of interests in shares between Trust B and Entity A. We aren't able to rule that the hybrid mismatch rules won't apply to broader schemes which include the proposed transactions described in the facts for this private ruling, in combination with other transactions.

Question 4

Does Part IVA (including the diverted profits tax provisions) of the Income Tax Assessment Act 1936 apply?

Answer

No. Part IVA will not apply specifically to the respective transfer of interests in shares between Entity A and Trust E or as between Trust B and Entity A. However, we cannot preclude the respective transfers of interests in shares being part of a broader scheme under Part IVA if other transactions relevant to the transfer of the interests in the shares happen.

Question 5

Will Entity A obtain a transfer pricing benefit from the arrangement under subdivision 815-B of the Income Tax Assessment Act 1997?

Answer

No. The specific questions asked are about the taxation consequences of the transfer of interests in shares between Entity A and Trust E and the transfer of interests in shares between Trust B and Entity A. As noted above CGT event A1 will apply to the respective transfer of interests in shares. There is no transfer pricing benefit that arises on these share transfers alone. We cannot preclude the possibility that the transactions described in this private ruling, in combination with other transactions, could give rise to a transfer pricing benefit.

This ruling applies for the following periods:

Income years ending XXXX and XXXY

The scheme commences on:

1 July XXXX

Relevant facts and circumstances

1.             This private ruling is about the tax consequences for the proposed contribution of interests in shares under two agreements described as partnership deeds. Under each partnership deed, shareholders will contribute shares. Each partnership will have a major partner with a X% interest in each share, and another partner holding a Y% interest in each share. X is a large percentage, and Y is a small percentage.

2.             <Redacted for privacy reasons.>

3.             <Redacted for privacy reasons.>

4.             Entity A is a shareholder and director in Trustee B (which is the corporate trustee of Trust B.) <Partly redacted for privacy reasons.>

5.             <Redacted for privacy reasons.>

6.             Company C is incorporated in Country D.

7.             <Redacted for privacy reasons.>

8.             <Redacted for privacy reasons.>

9.             <Redacted for privacy reasons.>

10.          Entity A and Trustee B hold shares in Company C. <Partly redacted for privacy reasons.>

11.          Entity A currently holds approximately X Company C shares. Some may be on direct registration system ('DRS') account. Some may be held on a brokerage account. <Partly redacted for privacy reasons.>

12.          Entity A and Trustee B are both proposing to enter agreements described as partnership deeds.

13.          Entity A will enter a partnership deed with Trust E. (We'll call the association formed by this agreement 'Partnership 1'.) Entity A and Trust E will be partners. Entity A will have a X% interest in the income and capital of Partnership 1. Trust E will have the remaining Y% interest. Entity A will contribute all Entity A's Company C shares to Partnership 1. Trust E won't contribute any shares.

14.          Trustee B will enter a similar partnership deed with Entity A. (We'll call the association formed by this second agreement 'Partnership 2'.) Trustee B will have a X% interest in the income and capital of Partnership 2. Entity A will have the remaining Y% interest. Trustee B will contribute all its Company C shares to Partnership 2, with Entity A contributing a small number of Company C shares, which will be approximately Y% of the total Company C shares contributed to Partnership 2.

15.          Where Entity A or Trustee B hold Company C shares through a brokerage account, there won't be a change on the share certificates or Company C's share register as a consequence of these transactions.

16.          However, where Entity A or Trustee B are registered as the record holder on the transfer agent's books (as opposed to being held through a brokerage account), Company C's share register will be updated such that (to the extent relevant) the following will show as holders:

•                Partnership 1, of which Trust E's trustee and Entity A are general partners

•                Partnership 2, of which Trustee B and Entity A are general partners.

17.          The contributions to Partnerships 1 and 2 won't require a change in holding between the two accounts. However, it's possible that before the shares are contributed to Partnerships 1 and 2 some of:

•                Entity A's Company C shares may be transferred from Entity A's DRS account to a brokerage account

•                Company C shares held in the brokerage account may be sold in the market.

18.          <Redacted for privacy reasons.>

19.          <Redacted for privacy reasons.>

20.          <Redacted for privacy reasons.>

21.          Neither Partnership 1 nor Partnership 2 will be registered under the Venture Capital Act 2002.

22.          No entities (or Partnerships 1 and 2) covered by this ruling have a permanent establishment outside Australia.

23.          Entity A and Trustee B won't create any tax deductions in any foreign country (for themselves or another entity) by contributing shares to Partnerships 1 and 2.

24.          Entity A, Trustee B, and Trust E are all Australian residents for income tax purposes and aren't tax residents of any other country.

25.          The applicants gave us draft deeds for the agreements forming Partnerships 1 and 2. Both partnership deeds refer to provisions of partnership legislation in Country F. We take those draft deeds as being incorporated in these facts.

Note that the ruling won't protect the client if the draft partnership documents are materially varied before being executed.

26.          None of the partners in Partnerships 1 and 2 intend to change their tax residency as part of the scheme.

27.          The proposed transactions aren't part of, or preliminary to, a broader scheme.

28.          Trustee B's directors will continue to make decisions about Trust B in Australia, after Partnership 2 is established. While there are no current plans to change directors, if Trustee B changes any of its directors, the new directors will be Australian residents for Australian tax purposes.

29.          Country D imposes estate tax. Estate tax is imposed on the fair market value of certain items and interests included in the deceased's estate. Estate tax liability is reduced by a credit amount, which is $X in 2023. Stock of Country D companies may be included in the deceased's estate.

30.          <Redacted for privacy reasons.>

31.          <Redacted for privacy reasons.>

Client's submissions

32.          The applicant has submitted that the primary consequence of the proposed contributions of Company C shares to Partnerships 1 and 2 will be that in the event of a relevant person's death, Entity A and Trustee B won't be subject to Country D estate tax on the value of those Company C shares.

Relevant legislative provisions

Income Tax Assessment Act 1997

Section 104-10

Section 104-35

Section 118-405

Section 118-407

Section 118-410

Section 770-15

Section 815-115

Section 815-120

Section 815-125

Section 815-130

Section 832-105

Section 832-120

Section 832-180

Section 832-185

Section 832-195

Section 832-200

Section 832-205

Section 832-215

Section 832-230

Section 832-285

Section 832-290

Section 832-305

Section 832-310

Section 832-380

Section 832-395

Section 832-400

Section 832-455

Section 832-460

Section 832-470

Section 832-475

Section 832-480

Section 832-485

Section 832-530

Section 832-535

Section 823-545

Section 832-550

Section 832-610

Section 832-615

Section 832-620

Section 832-625

Section 832-725

Section 995-1

Income Tax Assessment Act 1936

Section 92D

Section 177A

Section 177B

Section 177D

Section 177J

Other legislation

Partnership legislation in Country F

Reasons for decision

In this ruling, legislative provisions which don't mention an Act, for:

•                hyphenated provisions (like section 995-1) are in the Income Tax Assessment Act 1997 and

•                un-hyphenated provisions (like section 177D) are in the Income Tax Assessment Act 1936.

References to Part IVA mean Part IVA of the Income Tax Assessment Act 1936.

Question 1

What are the income tax implications for Entity A and Trustee B on contributing their shares in Company C to Partnership 1 and Partnership 2?

Summary

33.          Entity A and Trustee B will have a CGT event happen to them to the extent they contribute a percentage interest in each Company C share to the other partner. A CGT event will happen to:

•                (for Partnership 1) the Y% interest in each share that Entity A contributes to Trust E

•                (for Partnership 2) the Y% interest in each share that Trust B contributes to Entity A

•                (for Partnership 2) the X% interest in each share that Entity A contributes to Trust B.

Explanation

34.          CGT event A1 will happen to Entity A and Trustee B. That event will happen to the extent that the partnership deeds effect a disposal of an interest in each Company C share on the other party to that deed. Specifically:

•                For Partnership 1, Entity A will have CGT event A1 happen to a Y% interest in each Company C share, because the legal and/or beneficial ownership changes to Trust E to that extent.

•                For Partnership 2, CGT event A1 will happen to a Y% interest in every Company C share Trustee B contributes, and an X% interest in every share Entity A contributes. Legal and/or beneficial ownership will change to that extent.

35.          Where there is no change in the legal ownership of the contributed shares (i.e. the recipient entity will not be entered on the share registered in respect of those shares, which we understand will be the case for those shares held via a brokerage account) CGT event E1 may also happen.

36.          Regardless of whether CGT event A1 or CGT event E1 is the most specific to the proposed arrangement, the calculation of the capital gain will be the same.

Question 2

Are Partnership 1 and Partnership 2 'limited partnerships' as defined in section 995-1 of the Income Tax Assessment Act 1997?

Summary

37.          No. Neither Partnership 1 nor 2 will meet the definition of a limited partnership because the liability of each entity isn't limited.

Explanation

38.          The definition of' limited partnership' has two limbs. The first limb covers associations which meet the partnership definition in the tax legislation, where at least one partner's liability is limited. The second limb covers associations treated as legal entities, formed solely for venture capital or similar purposes. Section 995-1 says 'limited partnership' means:

(a) an association of persons (other than a company) carrying on business as partners or in receipt of ^* ordinary income or ^* statutory income jointly, where the liability of at least one of those persons is limited; or

(b) an association of persons (other than one referred to in paragraph (a)) with legal personality separate from those persons that was formed solely for the purpose of becoming a ^* VCLP, an ^* ESVCLP, an ^* AFOF or a ^* VCMP and to carry on activities that are carried on by a body of that kind.

39.          To elaborate on the second limb, VCLP, ESVCLP, AFOF and VCMP are defined terms. Broadly, those definitions cover entities which have an 'in force' registration (for their entity type) under the Venture Capital Act 2002.

•                AFOF means a limited partnership registered as an Australian venture capital fund of funds: section 995-1 read with subsection 118-410(3).

•                ESVCLP means a limited partnership registered as an early stage venture capital limited partnership: section 995-1 read with subsection 118-407(4).

•                VCLP means a limited partnership registered as a venture capital limited partnership: section 995-1 read with subsection 118-405(2).

•                VCMP means a venture capital management partnership. That covers limited partnerships that are general partnersof one or more VCLPs, ESVCLPs and AFOFs. See section 995-1 read with subsection 94D(3).

40.          Partnership legislation in Country F says every partner is liable jointly with the other partners for all firm debts and obligations incurred while they were a partner.

41.          Partnerships 1 and 2 won't meet the first limb of the limited partnership definition. No partner has limited liability. Section X of each partnership deed says the partners are liable for debts and liabilities in accordance with their respective interests. If the partnerships were governed by the partnership law in Country F, a relevant legislative provision would make them jointly liable in any event.

42.          Partnerships 1 and 2 won't meet the second limb either. Neither Partnership 1 nor Partnership 2 will be a separate legal entity. They won't be registered under the Venture Capital Act 2002. Therefore, they can't be formed solely for that purpose.

43.          Partnerships 1 and 2 aren't limited partnerships because they don't meet either limb of the definition.

Question 3

Will the hybrid mismatch rules in Division 832 of the Income Tax Assessment Act 1997 apply to the contribution of the shares by Entity A to Partnership 1 and Partnership 2 or the contribution of the shares by Trustee B to Partnership 2?

Summary

44.          No. The hybrid mismatch rules apply where there's a payment which produces a mismatch in tax outcomes between two jurisdictions. We don't think there'll be a mismatch here because the mere change in ownership of the assets made subject to the agreements (described as partnerships) won't create Australian or foreign income tax deductions.

Explanation

45.          Very broadly, the hybrid mismatch rules deny deductions orinclude payments in assessable income where taxpayers have used international transactions to exploit tax treatment differences between two countries.

46.          Those rules are in Division 832, which contains several subdivisions setting out different types of hybrid mismatch:

•                subdivision 832-C: hybrid financial instrument mismatch

•                subdivision 832-D: hybrid payer mismatch

•                subdivision 832-E: reverse hybrid mismatch

•                subdivision 832-F: branch hybrid mismatch

•                subdivision 832-G: deducting hybrid mismatch

•                subdivision 832-H: imported hybrid mismatch.

47.          While different requirements and definitions apply to each subdivision, broadly, transactions are caught where there's a hybrid mismatch[1] for payments between two countries.

•         The definition of hybrid mismatch varies in each subdivision, but to loosely synthesise, it means a payment deductible to the payer in specified circumstances.

•                The payment must either be between related or collaborating parties.

•                The deduction can be either an Australian income tax deduction or a foreign income tax deduction.

•                Broadly, Australian income tax allows deduction amounts for losses or outgoings incurred in earning assessable income,[2] or in circumstances covered by a specific provision.[3]

•                A foreign income tax deduction is where an entity is entitled to deduct an amount of a loss or outgoing in working out its tax base for foreign income tax[4]: see section 832-120. The Explanatory Memorandum[5] at paragraph 1.86 suggests that an amount will be a foreign income tax deduction if it's applied to reduce the tax payable in the foreign country in any way.

48.          Here, Entity A and Trustee B propose to contribute shares in Company C, which is incorporated in Country D, under agreements described as partnerships, as capital contributions. They each will retain a percentage interest in each share and dispose the remainder to other parties. The transactions won't be deductible under Australian law, but the amounts disposed might create capital gains liabilities. The applicant submits the transactions will be made to reduce or avoid a potential Country D estate tax liability. Broadly, Country D imposes estate tax on the value of Country D located assets. Country D estate tax allows a credit to reduce those potential liabilities. Will the transactions trigger the hybrid mismatch rules?

49.          No. There's no hybrid mismatch because the transactions won't create an Australian or foreign income tax deduction. They won't be deductible in Australia: they aren't incurred in earning assessable income and aren't covered by specific provisions. There's no suggestion that Entity A would be entitled to apply the value of the transaction to reduce the tax payable as a deduction allowable under Country D law. Therefore, they aren't a foreign income tax deduction. Further, the credit (effectively a minimum threshold for Country D estate tax) applies to all potential Country D estate taxpayers and has nothing to do with the proposed transactions. The credit isn't a loss or outgoing, so it can't be a foreign income tax deduction either.

50.          The hybrid mismatch rules won't apply to the scheme. There's no hybrid mismatch because there's no Australian or foreign income tax deduction.

Question 4

Does Part IVA (including the diverted profits tax provisions) of the Income Tax Assessment Act 1936 apply?

Summary

51.          No. The general Part IVA rules apply to schemes entered into for the dominant purpose of obtaining a tax benefit. The extended rules for diverted profits tax also only apply where the scheme obtains a tax benefit. The mere change in ownership of share interests under the contracts described as partnerships, without any other or further steps, will not trigger Part IVA.

Explanation

52.          Broadly, Part IVA applies to deny tax benefits obtained through schemes for the sole or dominant purpose of achieving them. We'll very loosely summarise some of the core provisions.

•                Section 177D says Part IVA applies if an entity entered into or carried out a scheme for the purpose of obtaining a tax benefit.

•                Section 177A says:

•                where an entity has multiple purposes, purpose means dominant purpose

•                scheme is very broadly defined and includes agreements, arrangements, understandings, undertakings, whether express or implied, whether enforceable or not.

•                Subsection 177C(1) says tax benefits mean:

•                amounts not included in assessable income: see paragraph (a)

•                allowable deductions (b)

•                capital losses (ba)

•                foreign income tax offsets (bb)

•                innovation tax offsets (bbaa)

•                exploration credits (bba)

•                not being liable to withholding tax (bc).

•                Subsection 177D(2) lists factors relevant to determining purpose. Broadly, they address the manner, form, substance, time, and tax outcome of the scheme, changes in financial position, and connections between the parties.

•                Section 177F allows the Commissioner to disallow the tax benefit.

53.          The ATO gives guidance to internal staff about Part IVA in PS LA 2005/24.[6] We'll summarise some propositions from this practice statement.

•                The tax benefit must be identified by comparing the tax consequences of the scheme (but for Part IVA), to an alternative scheme. That alternative scheme is sometimes called a hypothesis, postulate, or counterfactual. This is what would have happened, or might reasonably be expected to have happened, if the scheme hadn't happened. [75]

•                Identifying a tax benefit requires identifying reasonable alternatives to the scheme that might reasonably have achieved the same commercial (non-tax) outcomes. Tax consequences can't be considered in determining whether the alternative is reasonable. [83, 93]

•                Relevant factors in determining reasonable counterfactuals include usual ways to achieve the same commercial scheme outcomes, commercial and social norms, and the behaviour of relevant parties before and after the scheme. [109]

54.          Part IVA also includes extended rules known as the 'diverted profits tax' rules in sections 177H through 177R. The diverted profits tax rules apply where conditions in section 177J are met. One of those conditions is that the taxpayer has obtained a tax benefit from the scheme.

55.          Section 177D can't apply because we haven't identified a tax benefit from the mere contribution by Entity A and Trustee B of their shares in Company C to Partnership 1 and Partnership 2. To identify a tax benefit, we need to compare the scheme with a reasonable alternative scheme which would achieve the same non-tax outcomes. The applicant submits the purpose of these arrangements (that is the contribution of shares to the 'partnerships') is to avoid Country D estate tax. The categories of tax benefits listed in section 177C are all relevant to determining Australian tax liabilities. Country D estate tax isn't calculated based on assessable income, allowable deductions, capital losses, foreign income tax offsets or other things identified as tax benefits under Australian income tax legislation. Foreign tax liability isn't a tax benefit as defined. The diverted profits tax rules can't apply either for the same reason.

56.          The contribution of an interest in shares under the scheme through the agreements described as partnerships would not of their own, without other steps, trigger Part IVA (including the diverted profits tax rules) because there's no tax benefit. However, the outcome could change if we later identify other related steps (whether occurring before, during, or after the proposed transactions) which haven't been disclosed in this ruling application. In that case, we would need to consider whether contributing Company C shares to Partnership 1 and Partnership 2 is part of a wider scheme entered for the dominant purpose of achieving a tax benefit.

Question 5

Does Entity A obtain a transfer pricing benefit from the arrangement under subdivision 815-B of the Income Tax Assessment Act 1997?

Summary

57.          No. The mere contribution of an interest in shares under the scheme will not result in a transfer pricing benefit.

Explanation

58.          Broadly, subdivision 815-B modifies cross-border transactions - for Australian tax purposes - to reflect what arm's length third parties would have done. Section 815-115 substitutes arm's length conditions when working out an entity's tax liability if it gets a transfer pricing benefit. Section 815-120 says an entity gets a transfer pricing benefit if:

•                actual conditions differ from arm's length conditions

•                actual conditions meet the cross-border test, and

•                the entity's taxable income would be greater, or its loss would be less, had arm's length conditions operated.

59.          On the fact of this case, without further steps, the contribution of shares under the scheme through the agreements described as partnerships would not of their own result in a transfer pricing benefit.

[1] See sections 832-215 (subdivision 832C - hybrid financial instrument mismatch), 832-310 (832D - hybrid payer mismatch) 832-400 (subdivision 832-E reverse hybrid mismatch), section 832-475 (subdivision 832-F branch hybrid mismatch), section 832-545 (subdivision 832-G deducting hybrid mismatch), and section 832-620 (subdivision 832-H imported hybrid mismatch).

[2] Section 8-1.

[3] Eg, Division 25 (miscellaneous specific deductions including tax related expenses, repairs, borrowing expenses etc), Division 30 (gifts or donations), Division 40 (capital allowances).

[4] Very broadly, foreign income tax means a tax imposed by laws other than Australian law, that taxes income, profits or gains, or any other tax: see section 770-15.

[5] Revised Explanatory Memorandum (Senate) to the Treasury Laws Amendment (Tax Integrity and Other Measures No. 2) Bill 2018.

[6] Law Administration Practice Statement PS LA 2005/24 Application of General Anti-Avoidance Rules.