Private ruling: Components of consideration paid to a retiring partner and effect on the reconstituted partnership
Date of advice: 6 June 2016
Published: July 2016
Ruling period: 1 July 2014 to 30 June 2015
Date scheme commenced: 1 July 2014

Ruling: Q1: Does the amount paid to the Retired Partner under the Deed of Retirement form part of the cost base of the assets of the New Partnership formed by the Remaining Partners? | A1: No | Q2: Does part of the debt assumed by the Remaining Partners form part of the consideration for the restraint of trade and is it deductible under section 40-880 of ITAA 1997? | A2: Yes, some of the debt assumed by the Remaining Partners is consideration for the restraint of trade and is deductible under section 40-880. | Q3: Is there an amount paid for the Work In Progress of the Old Partnership that is deductible by the New Partners under section 25-95 of ITAA 1997? | A3: Yes. | Q4: Is there an amount for the Depreciable Plant and Equipment of the Old Partnership, included as consideration paid to the Retiring Partner, which is deductible to the partners of the New Partnership under section 40-25? | A4: Yes. | Q5: Is the collection of debtors of the Old Partnership by the New Partnership assessable income to the New Partnership? | A5: No.

Relevant facts and circumstances: 1. The partnership, during the relevant years was comprised a number of members (Old Partnership). 2. By a Deed of Retirement (The Deed) stated the Retiring Partner retired from the Old Partnership and disposed of their interest in Old Partnership for cash payment and release and indemnity all claims against the Old Partnership including any debts owed. 3. The Retiring Partners share in the Old Partnership was purchased by the Remaining Partners who formed a new partnership together (New Partnership). 4. The Remaining Partners assumed the Retiring Partners share of the Old Partnership debt and reconstituted the partnership and continued trading under a new partnership Australian Business Number (ABN) and Tax File Number (TFN). 5. No Partnership Agreement or Statement of Distribution for the Old Partnership is available 6. A Partnership tax return for the Old Partnership was lodged. The net income for the partnership was $xxx 7. The Retiring Partner's share in the separate net income of the Old Partnership for the year ending is $xxx. 8. The consideration paid was apportioned against the assets held by the partners of the New Partnership. 9. Both the Old and the New Partnership account on an accruals basis for income tax purposes.

Relevant legislative provisions: Section 90 of Income Tax Assessment Act 1936 | Section 92 of Income Tax Assessment Act 1936 | Section 116-20 of Income Tax Assessment Act 1997 | Section 116-55 of Income Tax Assessment Act 1997 | Section 40-880 of Income Tax Assessment Act 1997 | Section 25-95 of Income Tax Assessment Act 1997 | Section 40-25 of Income Tax Assessment Act 1997

Reasons for decision: Summary: Does an amount paid to the Retired Partner under the Deed of Retirement form part of the cost base of the assets of the New Partnership formed by the Remaining Partners? Taxation Determination TD 2015/19, Income tax: if a retiring partner is entitled to an amount representing their individual interest in the net income of the partnership for an income year, will section 92 of the Income Tax Assessment Act 1936 apply?, states that where a retiring partner receives an amount representing their individual interest in the partnership net income, the amount is assessable under section 92 of the ITAA 1936 regardless of how the amount is labelled or described, the timing of the partner's retirement and the timing of any payment. TD 2015/19 specifically states as follows: 16. For income tax purposes a more specific characterisation is required. It is necessary to identify whether (or the extent to which) the amount: • represents the partner's share of partnership net income • is assessable in the partner's hands on revenue account on another basis, or • otherwise relates to the disposal of the partner's interest in partnership assets. 17. It is therefore necessary to characterise the amount by reference to what it represents, relates to or is attributable to. If the amount represents, relates or is attributable to more than one thing it is necessary to apportion the amount between each thing on a reasonable basis and determine a character for each portion of the amount. The separate net income of the Old Partnership for the year ending 30 June 20XX is $xxx. Following TD 2015/19 one fifth of that separate net income represents the Retiring Partner's share of the Old Partnership's separate net income. Therefore all of the amount paid to the Retiring Partner relates to separate net income and cannot form part of the cost base of the New Partnership. Does part of the debt assumed by the Remaining Partners form part of the consideration for the restraint of trade and is it deductible under section 40-880 of ITAA 1997? Yes, some of the debt assumed by the Remaining Partners is consideration for the restraint of trade and is deductible under section 40-880. The cash payment made to the Retiring Partner, together with the assumption of the Retiring Partner's liabilities, forms the Remaining Partner's consideration for the purchase of the Retiring Partner's share of the partnership assets and the restraint of trade. The amount of debt assumed by the Remaining Partners is $xxx. As explained in TD 2015/19 components of any payment that are referable to the distribution of partnership income do not form part of the cost base and are merely the partners share of net income. The balance of consideration paid by the Remaining Partners to the Retiring Partner, after subtracting the Retiring Partner's share of separate net income, is $xxx . The balance of consideration paid by the Remaining Partners to the Retiring Partner, after subtracting the Retiring Partner's share of separate net income, is required to be apportioned over the assets acquired by the Remaining Partners. Accordingly, each category of assets must be separately identified and applied in accordance with the Income Tax Assessment Act 1936 and the Income Tax Assessment Act 1997. As there is no partnership agreement and the deed of retirement does not specify apportionment calculations the amount apportioned to each asset on a reasonable basis as required by paragraph 17 of TD 2015/19. Valuations used to determine the value to be apportioned to an asset should be prepared in accordance with the ATO Guidelines on Market valuation for tax purposes which is available on the ATO's website. The assets acquired by the Remaining Partners are valued at $xxx. The apportionment against each asset is accepted as being on a reasonable basis. Since the balance of the consideration, after subtracting the Retiring Partner's share of the Old Partnerships separate net income, is $xxx there is $xxx unallocated against any of the Retiring Partner's assets. Since the Deed of Retirement contained a restraint of trade it is reasonable to accept this unallocated amount to be paid for the restraint of trade. | Detailed Reasoning - Section 40-880 - Restraint of Trade: The purchase of a restraint of trade by an existing partner to preserve goodwill is able to be claimed by the continuing partners under s40-880 ITAA 1997 if all the requirements are satisfied. Section 40-880 of the ITAA 1997 provides a deduction over 5 years for certain business-related capital costs that are incurred if: • the expenditure is not otherwise taken into account; and • a deduction is not denied by some other provision; and • the business is, was or is proposed to be carried on for a taxable purpose. The ways in which expenditure can be taken into account are listed in subsections 40-880(5) to (8) of the ITAA 1997. Subsection 40-880(2) of the ITAA 1997 allows the taxpayer to deduct, in equal proportions over a period of 5 income years starting in the year in which the taxpayer incurs it, capital expenditure the taxpayer incurs ' in relation to', inter alia , his business. However, any deduction under section 40-880 of the ITAA 1997 is subject to the limitations and exceptions contained in subsections 40-880(3) to 40-880(9) of the ITAA 1997. Subsection 40-880(3) of the ITAA 1997 provides that you can only deduct the expenditure, for a business that you carry on, used to carry on or propose to carry on, to the extent that the business is carried on, was carried on or is proposed to be carried on for a taxable purpose. The relevant business for the purposes of the application of subsection 40-880(3) of the ITAA 1997 is the business to which the relevant paragraph in subsection 40-880(2) of the ITAA 1997 applies. In this case, the relevant business of the taxpayer is a legal firm. The relevant expenditure was incurred In the course of carrying on an existing business pursuant to the requirements in subsection 40-880(2). Section 40-880 requires that expenditure must be incurred in relation to a business carried on by a taxpayer. The partnership is conducting a business of a legal firm such that the relevant expenditure was incurred In the course of carrying on an existing business pursuant to the requirements in subsection 40-880(2). As the partners of the New Partnership are the entities that incurred the relevant expenditure and they are carrying on a business for a taxable purpose, subsections 40-880(3) and 40-880(4) are satisfied. The expenditure does not fall within any of the exclusions contained in s 40-880(5): TR 2011/6 at paragraph 318 provides that s40-880(8) will apply to allow such expenditure to be written off over 5 years where a partner in a partnership secures a restraint from the exiting partner as this will preserve but not enhance goodwill. The partners in the New Partnership will be able to claim a deduction under section 40-880 for their share of the consideration paid to the Retiring Partner to secure a restraint of trade. | Detailed Reasoning - Question 3: Is there an amount paid for the Work In Progress of the Old Partnership that is deductible by the New Partners under section 25-95 of ITAA 1997? | Detailed Reasoning - Answer.: Yes Consideration paid by the partners of the New Partnership for the Work in Progress of the Old Partnership was determined on a reasonable basis. Under section 25-95 of the Income Tax Assessment Act 1997 a deduction for work in progress amounts is allowable as follows: (1) You can deduct a *work in progress amount that you pay for the income year in which you pay it to the extent that, as at the end of that income year: (a) a recoverable debt has arisen in respect of the completion or partial completion of the work to which the amount related; or (b) you reasonably expect a recoverable debt to arise in respect of the completion or partial completion of that work within the period of 12 months after the amount was paid. The partners of the New Partnership have incurred the expenditure to obtain the Retiring Partners share of the work in progress and each partner's expense is deductible under section 25-95 provided that within 12 months of the consideration being paid a recoverable debt has arisen in respect of that work. | Detailed Reasoning - Question 4: Is there an amount for the Depreciable Plant and Equipment of the Old Partnership, included as consideration paid to the Retiring Partner that is deductible to the partners of the New Partnership under section 40-25? | Detailed Reasoning - Answer: Yes. Consideration paid by the partners of the New Partnership for the Depreciable Plant and Equipment of the Old Partnership was determined on a reasonable basis. Section 40-25 of the ITAA 1997 provides a basis for depreciating assets over their estimated effective life where the items are owned by you and either used during the year of income or installed ready for use for the purpose of earning your assessable income. Under section 40-25 an amount can be deducted for the decline in value of a depreciating asset for an income year The New Partner's share of the plant and equipment acquired from the Retiring Partner are depreciating assets under section 40-30 of ITAA 1997. The New Partners can claim a deduction for their share of the decline in value (for the relevant period) of the depreciating assets acquired from the Retiring Partner. An outright deduction for the assets cannot be claimed. | Detailed Reasoning - Question 5: Is the collection of debtors of the Old Partnership by the New Partnership assessable income to the New Partnership? | Detailed Reasoning - Answer: No. Both the Old and the New Partnership account on an accruals basis. Income that was assessable to the Old Partnership but not received by the Old Partnership is not assessable to the New Partnership.