Edited version of private advice

Authorisation Number: 1052198586251

Date of advice: 29 November 2023

Ruling

Subject: CGT -disposal of an interest

Question 1

Will capital gains tax (CGT) event E1 under section 104-55 happen when the taxpayer assigns, by way of declaration of trust, a beneficial interest in the partnership to the trustee of a discretionary trust?

Answer

Yes.

Question 2

Assuming CGT event E1 happens, the Commissioner is requested to confirm that, for CGT purposes, the capital proceeds from the disposal of an interest in the partnership by the taxpayer to the trustee will, under subsection 116-30(2), be the deemed market value consideration of the CGT asset, which will equal an amount determined by an independent qualified valuer.

Answer

The capital proceeds will be the market value of the assigned 39% share of the taxpayer's interest in the Partnership. We can't rule on whether an amount arrived at by a valuer would equal market value when we don't have the valuation. If the taxpayer had a valuation he wanted us to incorporate into a private ruling, then we may look to have that valuation reviewed and may charge the taxpayer for the cost of this review.

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

1.    The taxpayer is an equity partner in a law firm established as a general law partnership.

2.    The partnership currently has both equity partners and fixed profit share partners.

3.    Some of the equity partners currently have an arrangement known as an 'Everett Assignment' in place.[1]

4.    <Paragraph removed for privacy reasons.>

5.    <Paragraph removed for privacy reasons.>

6.    The partnership is a 'no-goodwill partnership'. In other words, goodwill isn't recognised in the partnership's balance sheet. When partners are admitted to the partnership, they don't make any payment to existing partners, and they aren't entitled to receive consideration for disposing of any goodwill when they retire from the partnership. Equity partners contribute $A to the partnership's working capital. On retirement, they are entitled to a return of their capital contribution and the balance of their share of undistributed profits up to retirement and any other amounts owed on retirement. No sum is payable or taken into account for goodwill or other assets of the partnership.

7.    The partnership has a service trust. This service trust is a discretionary trust that provides various services (such as procuring office premises and recruiting employees) to the partnership to allow it to undertake its legal services business. The service trust's potential beneficiaries are the partnership's partners and their nominated associates.

8.    The partnership's chargeable hours for the partners typically represent about B% of the firm's total annual charged hours, and about C% of the firm's total annual revenue.

9.    Since XXXX, the partnership has allowed each equity partner to assign D% (D being less than 50%) of his or her partnership interest by a declaration of trust. The partnership set this D% portion so that the assigning partner would receive (and be taxable in respect of) no less than 50% of the income from the firm (being the share of the partnership and the service trust).

10.  Each assignment was an equitable assignment of the legal rights associated with the assigned portion of an interest in the partnership.

11.  For each Everett Assignment, the equitable assignment of legal rights associated with an equity partner's interest in the partnership occurred this way.

•         By grant of written consent of the partnership's council in accordance with the partnership's constitution, equity partners of the partnership were provided the opportunity to assign D% of their interest in the partnership to the trustee of Trust B. Following Everett, this assignment had effect as an equitable assignment only.

•         The assignment of the partnership interest to the trustee of Trust B occurred by declaration of trust which effected the assignment of all the beneficial rights (not legal rights) associated with the partnership interest, including the right to receive an appropriate share of profits of the partnership to which the discretionary trust was entitled by virtue of the equitable interest obtained as a result of the equitable assignment, following Everett.

•         The declaration of trust by the Assignor Partner created a first trust (Trust A), of which the Assignor Partner was trustee.

•         The discretionary trust (Trust B) was a pre-existing trust established by a person other than the Assignor Partner (or a potential beneficiary of Trust B) and had a trustee other than the Assignor Partner.

•         Trust B paid consideration of $E (a nominal sum) for the assigned partnership interest.

•         The Assignor Partner continued to legally be the partner in the partnership. The trustee of Trust B didn't become a partner of the partnership nor did the trustee of Trust B become entitled to interfere in the partnership's business or affairs or to require any accounts or to inspect the books of the partnership.

•         The potential beneficiaries of Trust B were limited to family members or entities associated with the Assignor Partner. The Assignor Partner was not a beneficiary of Trust B during the period in which the Assignor Partner was a partner of the partnership. But the Assignor Partner may be a shareholder of the trustee of Trust B, or a corporate beneficiary of Trust B.

•         The declaration of trust was irrevocable.

Assumption

The taxpayer will enter an Everett Assignment under an arrangement identical to the existing Everett Assignments described in paragraphs 9 to 11 (which partners in the partnership have entered into since XXXX).

Relevant legislative provisions

Income Tax Assessment Act 1997

•  Section 104-10

•  Section 104-55

•  Section 108-5

•  Section 116-20

•  Section 116-30

Reasons for decision

Question 1: Will capital gains tax (CGT) event E1 under section 104-55 happen when the taxpayer assigns, by way of declaration of trust, a beneficial interest in the partnership to the trustee of a discretionary trust?

Answer

Yes.

Summary

12.  CGT event E1 will happen when the taxpayer enters this Everett Assignment. He or she will create a trust over the CGT asset represented by his or her D% share in the partnership.

Detailed reasoning

13.  Section 104-10 says CGT event A1 happens if you dispose of a CGT asset. You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether by some act or event or by operation of law. However, a change of ownership doesn't occur if you stop being the legal owner but continue to be the beneficial owner.

14.  Subsection 104-55(1) says CGT event E1 happens if:

•                you create a trust

•                over a CGT asset

•                by declaration or settlement.

15.  Subsection 104-55(5) says CGT event E1 doesn't happen if you are the sole beneficiary of the trust, and you are absolutely entitled to the asset as against the trustee (and it isn't a unit trust).

16.  Subsection 108-5(1) says a CGT asset is any kind of property, or a legal or equitable right that isn't property.

17.  Subsection 108-5(2) supplements that meaning, saying that 'to avoid doubt' some other things are CGT assets. The listed items include:

•                part of, or interests in, assets covered by subsection 108-5(1)

•                interests in partnership assets, and

•                other interests in partnerships.

18.  TD 2019/14 at paragraphs 57-58 says a trust is created by 'declaration' when it's created by words or conduct demonstrating an intention to create an express trust over property, and by 'settlement' when property is vested in a trustee for the benefit of others.

19.  Very broadly, a beneficiary is absolutely entitled if it can call for the asset to be transferred to them or be transferred at their direction. See TR 2004/D25 at paragraph 10.

20.  The elements of CGT event E1 in subsection 104-55(1) are met.

•                The asset is the bundle of rights comprising D% of the taxpayer's interest in the partnership.

•                That bundle of rights is a CGT asset because it's at least a legal or equitable right (we don't need to determine whether it's also 'property').

•                The taxpayer will create a trust over this CGT asset because there's a trustee (the taxpayer) holding trust property (the bundle of rights attaching to the D% interest) on trust for a beneficiary (Trust B).

•                That trust will be created by declaration or settlement - there's an intention to create an express trust, and the trust property is vested in the taxpayer for the benefit of Trust B.

21.  The exception in subsection 104-55(5) isn't relevant. Trust A has one beneficiary - the trustee of Trust B, and it isn't a unit trust. But in this context, the 'you' creating the trust is the taxpayer, not Trust B. We don't need to determine if Trust B is absolutely entitled. It's enough to say that the taxpayer isn't absolutely entitled.

22.  We don't need to consider whether other CGT events could happen. Creating a trust over a CGT asset might also be a disposal under CGT event A1. If more than one CGT event happens, you apply the CGT event that's most specific to your circumstances: see section 102-25. Regardless of which CGT event is applied, the capital gains and losses are calculated the same way for CGT events A1 and E1: compare subsections 104-10(4) and 104-55(3).

Question 2: Assuming CGT event E1 happens, the Commissioner is requested to confirm that, for CGT purposes, the capital proceeds from the disposal of an interest in the partnership by the taxpayer to the trustee will, under subsection 116-30(2), be the deemed market value consideration of the CGT asset, which will equal an amount determined by an independent qualified valuer.

Answer

The capital proceeds will be the market value of the assigned D% share of the taxpayer's interest in the partnership. We can't rule on whether an amount arrived at by a valuer would equal market value when we don't have the valuation. If the taxpayer had a valuation he or she wanted us to incorporate into a private ruling, then we may look to have that valuation reviewed and may charge the taxpayer for the cost of this review.

Summary

23.  The market value substitution rule will apply to the CGT event occurring on the Everett Assignment. The taxpayer will be deemed to have received the market value of his or her D% interest in the partnership.

Detailed reasoning

24.  Subsection 104-55(3) explains when you make a capital gain or capital loss from CGT event E1. You make a capital gain if the capital proceeds from the creation are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base.

25.  Subsection 116-20(1) says the capital proceeds from a CGT event are the total of the money and the market value of any other property you have received (or are entitled to receive), in respect of the event happening. (The market value of any property is worked out as at the time of the event.)

26.  There's a market value substitution rule applying to capital proceeds. This market value substitution rule (in section 116-30) can apply to CGT event E1: see the table in section 116-25 at event number E1. Subsection 116-30(1) applies where you receive no capital proceeds from a CGT event. Subsection 116-30(2) applies where the capital proceeds either can't be valued or are more or less than the asset's market value. Under both subsections, the market value is worked out as at the time of the event.

27.  Where the capital proceeds are more or less than the asset's market value, subsection 116-30(2) only applies if either:

•                you and the entity that acquired the asset from you didn't deal with each other at arm's length in connection with the event, or

•                the CGT event is CGT event C2.

28.  ATO guidance suggests that determining whether parties are dealing with each other at arm's length involves considering the way parties conduct their dealing. The dealing must be consistent with how independent third parties would act, applying their minds and wills to the transaction. There must be real bargaining, and the dealing itself is critical, rather than the relationship between the parties. See TR 2014/5[2] at paragraphs 97 through 104 and TR 2006/7[3] at paragraphs 76 through 78.

29.  The ATO has guidance about what market value means in the tax context. The ATO website[4] says that market value is an asset's estimated monetary worth on the open market at a particular time. It's based on the most valuable use of the asset, based on the amount that a willing buyer and seller would agree to in an arm's length transaction. Any valuation must be objective, accurate, and supported by appropriate evidence. Valuations are usually more credible if they're undertaken by professional valuers who are independent. You are responsible for ensuring the valuer is suitably knowledgeable and experienced, remains objective, their work isn't inhibited, and they provide a reasonable market value supported by an appropriate recognised valuation methodology.[5]

30.  The taxpayer's capital proceeds under subsection 116-20(1) will be the $100 Trust B pays as consideration for the assigned partnership interest.

31.  Subsection 116-30(2) applies here. We think it's evident that the taxpayer's capital proceeds of $E (a nominal sum) would be less than the market value of the D% interest in the partnership which he or she will assign to Trust B. We also think it's evident that the taxpayer won't be dealing at arm's length with Trust B. The taxpayer would demand a higher purchase price for his or her D% interest if he or she was bargaining or dealing with the trustee (of Trust B) as an independent 3^rd party.

32.  This means the market substitution rule will apply. The taxpayer will be taken to have received the market value of the CGT asset (in this case, the D% share of his or her partnership interest) worked out at the time of the event.

33.  An independent qualified valuer would generally be expected to provide a reliable assessment of market value, but it would depend on the facts and circumstances. Those circumstances could include whether the valuer has been properly briefed, applied a reasonable methodology, had enough data or evidence to form an opinion and was experienced in the relevant field. The ATO might question a valuation by a qualified valuer if it seemed unreasonable or produced an unusual result under the circumstances.

[1] An 'Everett Assignment' means where a partner in a general law partnership assigns part of their share in a partnership to another entity. This is treated as alienating rights to the income from the partner to the assignee. In Federal Commissioner of Taxation v Everett (1980) 143 CLR 440 the taxpayer sought to assign 6/13ths of his interest in a partnership to his wife. The High Court of Australia ruled that the taxpayer wasn't assessable on income relating to that 6/13ths share, as the assignment gave the wife an immediate equitable entitlement to the income enforceable against the husband and the other partners. See Taxation Ruling IT 2540 Income tax: capital gains: application of disposals of partnership assets and partnership interests at paragraphs 22 to 24.

[2] Taxation Ruling TR 2014/5 Income tax: matrimonial property proceedings and payments of money or transfers of property by a private company to a shareholder (or their associate).

[3] Taxation Ruling TR 2006/7 Income tax: special income derived by a complying superannuation fund, a complying approved deposit fund, or a pooled superannuation trust in relation to the year of income.

[4] ATO (2023) 'Market valuation of assets' QC 66067 (last modified 30 June 2023) accessed at https://www.ato.gov.au on 8 November 2023.

[5] ATO (2023) 'Market valuation for tax purposes' accessed at https://www.ato.gov.au on 8 November 2023.