Edited version of private advice

Authorisation Number: 1052178957890

Date of advice: 25 October 2023

Ruling

Subject: CGT - consequence of an assignment

Question 1

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

Answer

Yes

Question 2

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

Answer

No

Question 3

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

Answer

Yes. However, the happening of CGT event A1 may be ignored as CGT event E1 is the most specific CGT event that happens.

Question 4

Assuming either CGT event E1, E2 or A1 happens, for CGT purposes, will the capital proceeds for the Assignor's disposal of the Relevant Interest to the Assignee be the nil consideration received by the Assignor for the Assignment?

Answer

No

Question 5

Assuming either CGT event E1, E2 or A1 happens, will the capital proceeds for the Assignor's disposal of the Relevant Interest to the Assignee be the deemed market value consideration under subsection 116-30(1) of the ITAA 1997 for the CGT event, which will be equal to the market value as determined using the Individual Valuation which is determined by reference to the Valuation Methodology?

Answer

Yes

Question 6

Assuming either CGT event E1, E2 or A1 happens, will the 50% CGT discount apply in accordance with Division 115 of the ITAA 1997 to the capital gain the Assignor otherwise makes from the Assignment?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 202Y

Relevant facts and circumstances

The Assignor is an equity partner in the Partnership.

The Partnership is a general law partnership which is formed under and pursuant to the Australian partnership agreement (Partnership Agreement). The Partnership was first formed in 20XY.

The partners of the Partnership are natural persons who hold a beneficial fractional interest in the Partnership (Partners).

The Partnership operates as a 'no-goodwill' professional partnership. Goodwill is not recognised either in the balance sheet of the Partnership or for any other purpose. When new Partners are admitted to the Partnership, they do not make any payment to the existing Partners to acquire any goodwill. Similarly, they 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.

The partners of the Partnership:

(a)           May be directed to contribute capital to the Partnership from time to time.

(b)           Are entitled to be repaid capital contributions by the Partnership where they cease to be a Partner or on winding-up on the terms set out in the Global Partnership Agreement.

(c)           Have equal voting rights in the management of the Partnership.

(d)           Receive their profit distributions by way of variable entitlements.

(e)           Have an interest in the property of the Partnership and a right to participate in the distribution of the net assets in the event of a wind up of the Partnership.

(f)            Would not be indemnified by other Partners against any professional liability in respect of actions against the Partnership.

(g)           Upon retirement or otherwise ceasing to be a Partner, are entitled to the remaining balance of their current account (i.e. retained earnings) and any capital loans they have contributed.

The Assignor is a resident of Australia for tax purposes.

Proposed transaction

The Partnership Agreement permits a Partner to assign a portion of their partnership interest in the Partnership under an Everett assignment in certain circumstances, including where certain approvals have been obtained.

In accordance with the Partnership Agreement, the Assignor proposes to irrevocably assign a portion of their interest (Relevant Interest) to the Assignee by executing the Deed of Assignment (the Assignment).

The Assignee will pay nil consideration for the assigned Partnership Interest (i.e. the Relevant Interest is assigned by way of gift).

The market value of the Relevant Interest is $X, being 40% of the Assignor's interest in the Partnership as at XX XX 20XX.

The market value of the Relevant Interest has been obtained from an independent accredited valuer and determined having regard to the price that a hypothetical buyer would pay for the assigned Relevant Interest having regard to the value of the right to future income of the Partnership which is attached to the interest.

The Assignment will affect the assignment of all beneficial rights associated with the Relevant Interest, including the right to receive income of the Partnership. Pursuant to the terms of the Assignment, the Assignor and the Assignee agree that its effect, from the date of the Assignment, is that the Assignor will hold the Relevant Interest on trust for the absolute benefit of the Assignee.

The Assignor will continue to be a Partner in the Partnership.

The Assignee will not become a Partner of the Partnership and will have no entitlement to share in the underlying assets or participate in the management or administration of the Partnership.

The Assignment will not give the Assignee any right or entitlement to any part of any salary or other remuneration paid by the Partnership to the Assignor in respect of their employment with the Partnership.

The Assignor has been a Partner in the Partnership for more than 12 months and their Assignment of the Relevant Interest will not occur under an agreement they make within 12 months of acquiring the Relevant Interest.

The Assignment will relate to the Assignor's interest in the Partnership only. The Assignment will not involve the assignment of the Assignor's interest in any other entities.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 102-25

Income Tax Assessment Act 1997 subsection 102-25(1)

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 subsection 104-10(2)

Income Tax Assessment Act 1997 section 104-55

Income Tax Assessment Act 1997 subsection 104-55(3)

Income Tax Assessment Act 1997 subsection 104-55(5)

Income Tax Assessment Act 1997 subsection 104-55(6)

Income Tax Assessment Act 1997 section 104-60

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 paragraph 108-5(2)(c)

Income Tax Assessment Act 1997 paragraph 108-5(2)(d)

Income Tax Assessment Act 1997 Division 115

Income Tax Assessment Act 1997 Subdivision 115-A

Income Tax Assessment Act 1997 paragraph 115-100(a)

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 subsection 116-30(1)

Reasons for decision

All subsequent legislative references are to the ITAA 1997.

CGT implications of holding a portion of the Assignor's Relevant Interest as trustee

Section 102-20 states that you can make a capital gain or capital loss if and only if a CGT event happens.

Section 102-25 requires you to consider which CGT event happens to your situation. If more than one CGT event happens, the one used is the one that is most specific to your situation.

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

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. 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 subsections 104-55(5) and (6) must not apply.

A CGT asset is defined in section 108-5 to include (at paragraphs 108-5(2)(c) and (d)) both an interest in an asset of a partnership and an interest in a partnership that is not an interest in an asset of a partnership.

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

No trust relationship currently exists between the Assignor and the Assignee in respect of the Partnership interest. However, the Assignor intends to commence holding a portion of the Assignor's interest in the Partnership (the Relevant Interest) as trustee for the Assignee. 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.[1] This is what would occur in the present case when the Assignor commences holding the Relevant Interest as trustee for the Assignee.

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.[2]

None of the exceptions in subsections 104-55(5) or (6) 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 Assignor will commence holding the Relevant Interest in the Partnership on trust for the Assignee. Whilst the Assignee 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 Assignor 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 Assignor will retain the legal ownership and continue to be the named Partner in the Partnership. The Assignee will only acquire the beneficial ownership of the Relevant Interest. Therefore, the Assignor will dispose of a part-interest in the Partnership when the Assignor commences holding it on trust for the Assignee.

However, in accordance with subsection 102-25(1), CGT event E1 is more specific to the situation, therefore CGT event A1 is to be ignored.

Capital proceeds for the disposal of the Assignor's Relevant 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 no capital proceeds are received from the CGT event (subsection 116-30(1)).

As the Assignor is proposing to assign, by way of declaration of trust, the Relevant Interest to the Assignee for nil consideration, the market value substitution rule under subsection 116-30(1) needs to be considered such that the Assignor will be taken to have received the market value of the Relevant Interest.

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 28 of IT 2540 provides that when determining the market value of an Everett assignment, the valuation should be in accordance with the decision of the Supreme Court of Western Australia in Reynolds v Commissioner of State Taxation (WA) 86 ATC 4528 (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.

The Commissioner is satisfied that the market value of the Relevant Interest set out in the Individual Valuation, determined by reference to the Valuation Methodology, will, for the purposes of subsection 116- 30(1), be the capital proceeds from the creation of the trust by the Assignor.

Discount Capital Gain

On the basis that the Assignor (an individual) has been a Partner of the Partnership for at least 12 months prior to the time that the Deed of Assignment takes effect and none of the rules under Subdivision 115-A which prevent a capital gain from being a discount capital gain apply, the 50% CGT discount under paragraph 115-100(a) applies to any capital gain arising as a result of the Assignment.

[1] DKLR Holding Co (No. 2) Pty Ltd v. Commissioner of Stamp Duties (NSW) (1982)149 CLR 431 at [454] and [459].

[2]Oswal v. FC of T 2013 ATC 20-403 at [56-60].