Private ruling: Partnerships and corporate limited partnerships
Date of advice: 20 February 2018
Published: June 2018
Ruling period: Year ending 30 June 2018 | Year ending 30 June 2019 | Year ending 30 June 2020 | Year ending 30 June 2021 | Year ending 30 June 2022
Date scheme commenced: 22 November 2017

Ruling: Q1: Will Trust A, Company B and Limited Partnership C, associated in partnership (the Initial Partnership) be entitled to make an election under subsection 70-100(4) of the Income Tax Assessment Act 1997 (ITAA 1997), in respect of items of trading stock acquired in purchasing the business, if the book values of the items are less than the market values of the items on the day of purchase? | A1: Yes | Q2: Can Trust A (as Transferor) and the partners in the Initial Partnership (as Transferee) choose to apply roll-over relief under subsection 40-340(3) of the ITAA 1997 in respect of the items of depreciable plant acquired in purchasing the business? | A2: Yes. So long as the choice is made jointly by the Transferor and the Transferee. | Q3: Will CGT event A1, under section 104-10 of the ITAA 1997, happen to any assets of the Initial Partnership when it converts to a limited partnership (LP) that is a corporate limited partnership (CLP) under section 94D of the Income Tax Assessment Act 1936 (ITAA 1936) | A3: No | Q4: Will items of trading stock held by the Initial Partnership be deemed to be disposed of to the LP/CLP, pursuant to section 70-100 of the ITAA 1997, when it converts to a LP/CLP? | A4: No | Q5: Will converting to the LP/CLP result in a balancing adjustment event occurring in respect of depreciating assets of the Initial Partnership pursuant to subsection 40-295(2) of the ITAA 1997? | A5: Yes. The roll-over relief provided in subsection 40-340(3) of the ITAA 1997 can be chosen by the Transferor and Transferee at the time of the balancing adjustment event. | Q6: Will the first element of the cost base of the goodwill, after the Initial Partnership coverts to the LP/CLP, be the amounts paid by Limited Partnership C and Company B for their respective interests in the goodwill, under section 110-25 of the ITAA 1997? | A6: Yes | Q7: Will the first element of the cost base of the goodwill, after the Initial Partnership converts to the LP/CLP, be the market value of the goodwill at the date of conversion to the CLP under section 112-20 of the ITAA 1997? | A7: No

Relevant facts and circumstances: Trust A operates a business manufacturing and installing architectural systems. Trust A has agreed to sell a X% interest in the goodwill and net assets of the business (excluding cash at bank and debtors) to Company B and Limited Partnership C. Company B was incorporated on DDMMYY. Limited Partnership C will be the name of a Limited Liability Partnership that will be registered in State A prior to the sale taking place. Trust A proposes to take the following steps: (a) Trust A will sell a X% interest in certain assets including trading stock, goodwill, and depreciating assets of the Business to Company B for market value. (b) Trust A will sell a X% interest in trading stock, goodwill, and depreciating assets of the business to Limited Partnership C for market value. (c) Trust A will retain X% interest. (d) Trust A, Company B and Limited Partnership C will then own the business assets and operate the business in their joint names, which means that the relationship between them will be a partnership within the meaning of section 995-1 of the ITAA 1997 (the Initial Partnership). (e) The Initial Partnership will later register as a limited partnership (LP) under section 50 of the Partnership Act 1891 (State A) (the State A Partnership Act) under which, (i) Company B will be the general partner, and (ii) Trust A and Limited Partnership C will each be limited partners. The parties have agreed on a value of goodwill. This price was negotiated between the parties based on their own view of the value of the business. The price has not been based on a valuation. The remaining net assets (including depreciable plant and equipment and trading stock) will be transferred at book value for the purpose of the transaction. Limited Partnership C will pay X% of the agreed goodwill value to Trust A for the acquisition of its interest in the goodwill and X% of the book value of remaining assets. Company B will pay X% of the agreed goodwill value to Trust A for the acquisition of its interest in goodwill and X% of the book value of remaining assets. Trust A currently has a nominal cost base for the goodwill in the business. The contract for sale has not been finalised and is still under negotiation. Partnership Agreements have not yet been prepared for either the Initial partnership or the subsequent limited partnership.

Relevant legislative provisions: Income Tax Assessment Act 1936 Division 5A | Section 94A | Section 94D | Paragraph 94D(1)(a) | Section 94J | Section 94K | Section 94L | Section 94V | Income Tax Assessment Act 1997 Section 40-40 | Subsection 40-295(2) | Paragraph 40-295(2)(a) | Paragraph 40-295(2)(b) | Subsection 40-340(3) | Section 70-100 | Subsection 70-100(1) | Subsection 70-100(4) | Subsection 70-100(6) | Section 104-10 | Subsection 104-10(1) | Subsection 104-10(2) | Subdivision 106A | Section 106-5 | Section 110-25 | Subsection 110-25(2) | Paragraph 110-25(2)(a) | Subsection 110-55(2) | Section 112-20 | Section 995-1 | Partnership Act 1891 (State A) | Subsection 23(1) | Section 50

Reasons for decision: Detailed Reasoning - Detailed reasoning: Under subsection 70-100(1) of the ITAA 1997 an item of trading stock is treated as having been disposed of outside the ordinary course of business if it stops being trading stock on hand (TSOH) of an entity (the transferor ) and, immediately afterwards: (a) the transferor is not the item's sole owner; but (b) an entity that owned the item (alone or with others) immediately beforehand still has an interest in the item. Ordinarily: ● the transferor's assessable income includes the market value of the items of trading stock on the day it stops being TSOH of the transferor, and ● the transferee’s (the entity or entities that own the trading stock after the sale) are treated as having bought the trading stock on that day for the same value. However, subsection 70-100(4) of the ITAA 1997 provides that an election can be made to treat the items of trading stock as having been disposed of for the value that would have been its value as TSOH of the transferor (the book value) at the end of an income year ending on the day it stops being TSOH of the transferor. If an election is made, the book value is included in the transferor’s assessable income for the income year that includes that day, and the transferee is treated as having bought the item for the same value on that day. Under subsection 70-100(6) of the ITAA 1997 this election can only be made if: (a) immediately after the item stops being TSOH of the transferor, it is an asset of a business carried on by the transferee; and (b) immediately after the item stops being TSOH 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. The term “interest in” an asset is not defined in the ITAA 1997 or ITAA 1936 as such it takes its ordinary meaning, which the Macquarie Dictionary includes, among other things, to mean: ● a share in the ownership of property, in a commercial or financial undertaking, or the like. ● any right of ownership in property, commercial undertakings, etc. Taxation Ruling IT 2540 Income tax: capital gains: application to disposals of partnership assets and partnership interests (IT 2540), at paragraph 2, explains that the title to partnership assets is legally vested in the partners. This view accords with the opinion expressed by the majority (Barwick CJ., Stephen, Mason and Wilson JJ.) of the Full High Court of Australia in F.C.T v Everett (1980) 143 CLR 440 (Everett) at page 446: “Although a partner has no title to specific property owned by the partnership, he has a beneficial interest in the partnership assets, indeed in each and every asset of the partnership.” Under the proposed sale of the business currently owned solely by Trust A, Trust A will retain X% of the trading stock in the business, whilst Limited Partnership C and Company B will own X% and 1% respectively. This arrangement satisfies the requirements of subsection 70-100(1) as Trust A will no longer be the item’s sole owner, but will have an interest in the trading stock following the sale. Under the proposed sale, the business will continue to operate so that immediately after the trading stock stops being solely owned by Trust A, it will be an asset of a business carried on by the transferee, the Initial Partnership. Also, at this time Trust A will retain an interest greater than X% of the trading stock’s market value on that day. As such, so long as the book values of the items of trading stock are less than their market values on the day of the change of ownership, the Initial Partnership can make an election under subsection 70-100(4) of the ITAA 1997 in relation to the items of trading stock. NOTE: Where an item of trading stock is a “thing in action”, an election cannot be made in respect of that item. | Detailed Reasoning - Question 2: Can Trust A (as Transferor) and the partners in the Initial Partnership (as Transferee) choose to apply roll-over relief under subsection 40-340(3) of the ITAA 1997 in respect of the items of depreciable plant acquired in purchasing the business? | Summary: Yes. Trust A and the partners of the Initial Partnership can choose the roll-over relief in subsection 40-340(3) of the ITAA 1997 in respect of the items of depreciable plant acquired in purchasing the business, so long as the choice is jointly made by the Transferor and the Transferee. | Detailed Reasoning - Detailed reasoning: Subsection 40-340(3) of the ITAA 1997 provides roll-over relief if: (a) there is a balancing adjustment event for a depreciating asset because of subsection 40-295(2); and (b) the entity or entities that had an interest in the asset before the change (the transferor) and the entity or entities that have an interest in the asset after the change (the transferee) jointly choose the roll-over relief. Subsection 40-295(2) of the ITAA 1997 establishes that a balancing adjustment event occurs for a depreciating asset if: (a) for any reason, a change occurs in the holding of the asset, or in the interests of entities in the asset; and (b) the entity or one of the entities that had an interest in the asset before the change has an interest in it after the change; and (c) the asset was a partnership asset before the change or becomes one as a result of the change. Section 40-40 of the ITAA 1997 provides assistance in working out who ‘holds’ a depreciating asset, which at: ● Item 7 says that a depreciating asset that is a partnership asset is held by the partnership and not any particular partner, and ● Item 10 says that any depreciating asset is held by its owner, or the legal owner if there is both a legal and equitable owner. As discussed in question 1, the term “interest in” an asset is not defined for tax purposes and as such takes its ordinary meaning. Trust A currently has holds the depreciating assets of the business. As a result of the proposed sale: ● The Initial Partnership will ‘hold’ the depreciating assets (section 40-40 item 7), and ● Trust A will retain an interest in the depreciating assets. As such, paragraphs 40-295(2)(a) and (b) are satisfied. The term ‘partnership asset’ is not defined for tax purposes however subsection 23(1) the Partnership Act 1891 (State A) (the State A Partnership Act) provides the following definition of ‘partnership property’: (1) All property and rights and interests in property originally brought into the partnership stock or acquired, whether by purchase or otherwise, on account of the firm, or for the purposes and in the course of the partnership business ( partnership property ) must be held and applied by the partners exclusively for the purposes of the partnership and in accordance with the partnership agreement. Although, various modifications to the general laws of partnership are made under Part 3 of Chapter 3 of the State A Partnership Act makes in respect of LPs, however, no changes are made in relation to subsection 23(1) of that Act. Further explanation regarding partnership property was provided in O’Brien v. Komesaroff 150 CLR 310; 41 ALR 255, in which Mason J clarified that: "... not all the property of each partner used for the purposes of the partnership business can be said to be brought into the partnership. It may in some circumstances remain the separate property of one partner... Whether the property of a partner becomes partnership property depends on the agreement of the parties... The acts and intentions of the parties, not the operation of s 24 [the Victorian equivalent of s 23 of the State A Partnership Act], determine finally and ultimately the question whether property owned by a partner becomes partnership property." From the words of Mason J it can be seen that the agreement between the partners, together with actions and intentions of the partners, will finally and ultimately determine the question of what property is ‘partnership property’. As proposed, the business will be run by the Initial Partnership, and the depreciating assets of the business that were purchased from Trust A will be exclusively used to generate income under the partnership agreement. As such, the Commissioner accepts that the depreciating assets will be brought into the partnership exclusively for the purposes of the partnership and will be ‘partnership assets’ as a result of the change; and that paragraph 40-295(2)(c) is satisfied. Under the proposed sale, a balancing adjustment event under subsection 40-295(2) of the ITAA 1997 would occur for the depreciating assets of the business at the time of the sale of the assets. As such, Trust A (as Transferor) and the partners of the Initial Partnership (as Transferee) will be entitled to choose the roll-over relief in subsection 40-340(3) of the ITAA 1997 in respect of the items of depreciable plant acquired in purchasing the business under the proposed sale, so long as the choice is jointly made by the Transferor and the Transferee. | Detailed Reasoning - Question 3: Will CGT event A1, under section 104-10 of the ITAA 1997, happen to the assets of the Initial Partnership when it converts to a LP that is a CLP (the LP/CLP) under section 94D of the Income Tax Assessment Act 1936 (ITAA 1936) Summary No. As there has been no change in ownership of the assets, CGT event A1 does not happen when the Initial Partnership converts to the LP/CLP. Detailed reasoning For tax purposes, the term ‘limited partnership’ means an association of persons (that is not itself 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 (section 995-1 of the ITAA 1997). You advise that after a time as a general law partnership, the partners will enter an agreement whereby the liability of Trust A and Limited Partnership C will be limited (Company B will be the general partner). At this time, the partners will register as a LP under section 50 of the State A Partnership Act. As the partners will be carrying on business, and will be in receipt of ordinary and statutory income jointly, the definition of a LP will be satisfied. For the 1995/96 and later years, a LP is known as a CLP, in relation to a year of income, for the purposes of Division 5A of the ITAA 1936 (paragraph 94D(1)(a)). The object of Division 5A is to treat CLPs as companies for tax purposes (section 94A of the ITAA 1936). The Division modifies definitions in the tax law by deeming, amongst other things, that: ● references to companies include CLPs (section 94J), ● references to partnerships exclude CLPs (section 94K), and ● references to dividends include distributions of a CLP to partners in a partnership (section 94L). As proposed, at the time the LP satisfies the tax law definition of a LP: ● The LP will be a CLP under Division 5A of the ITAA 1997. ● Division 5A will apply to the LP/CLP. ● The income tax law will apply to the LP/CLP as though it is a company. Subsection 104-10(1) of the ITAA 1997 provides that 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 because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner (subsection 104-10(2) of the ITAA 1997). Although section 106-5 of the ITAA 1997 provides that any capital gains or losses from a CGT event happening in relation to a partnership or one of its CGT assets is made by the partners individually, as a consequence of section 94K of the ITAA 1936, this does not apply to CLPs. ATO ID 2010/210 Income Tax CGT event A1: partnership becomes corporate limited partnership (ATO ID 2010/210) refers to the relevant state legislation to determine whether, upon converting to a LP, a change in ownership occurs in relation to the partnership or the partnership assets. The ATO ID explains that converting to a LP does not cause the original partnership to cease, it merely varies the mutual rights and duties that exist between the partners. Although, under Division 5A of the ITAA 1936, the LP/CLP is treated as a company for income tax purposes, this does not convert the LP/CLP into a company. Further, Division 5A of the ITAA 1936 does not modify the operation of section 104-10 of the ITAA 1997 such that a CGT event happens on converting to a LP/CLP. As there would be no change in ownership of the assets when the Initial Partnership converts to the LP/CLP under the proposed arrangement, CGT event A1 would not happen. | Detailed Reasoning - Question 4: Will items of trading stock held by the Initial Partnership be deemed to be disposed of to the LP/CLP, pursuant to section 70-100 of the ITAA 1997, when it converts to a LP/CLP? | Summary: No. As the trading stock will remain ‘partnership property’, held by the partners and applied exclusively for partnership purposes by the partners, there is no deemed disposal of the trading stock. | Detailed Reasoning - Detailed reasoning: As discussed in question 1, an item of trading stock is treated as having been disposed of outside the ordinary course of business if it stops being trading stock on hand of an entity (the transferor ) and, immediately afterwards: (a) the transferor is not the item's sole owner; but (b) an entity that owned the item (alone or with others) immediately beforehand still has an interest in the item (subsection 70-100(1) of the ITAA 1997). As discussed in question 3, ATO ID 2010/210 considers whether a change in ownership occurs in relation to the partnership or the partnership assets on converting to a LP. Converting to a LP does not cause the original partnership to cease it merely varies the mutual rights and duties that exist between the partners. Treatment of a CLP as a company for the purposes of the ITAA 1997 and ITAA 1936 does not deem there to be a transfer of the ownership of partnership assets to a new company nor does it change the ownership of partnership assets under general law. Section 70-100 of the ITAA 1997 only applies where the owner of the trading stock ceases to be the sole owner, but retains an interest in the trading stock. As proposed, when the partners in the Initial Partnership convert to a LP and treatment as a CLP begins, there is no change of ownership of the trading stock – Trust A, Company B and Limited Partnership C will remain the owners of the trading stock both before and after the conversion. As such, there is no deemed disposal of the trading stock when the Initial Partnership converts to a LP and begins treatment as a CLP (which is subsequently taxed as a company). | Detailed Reasoning - Question 5: Will converting to the LP/CLP result in a balancing adjustment event occurring in respect of depreciating assets of the Initial Partnership pursuant to section 40-295(2) of the ITAA 1997? | Summary: Yes. The conversion to a LP/CLP will result in a balancing adjustment event occurring in respect of depreciating assets pursuant to section 40-295(2) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Subsection 40-295(2) of the ITAA 1997 establishes that a balancing adjustment event occurs for a depreciating asset if: (a) for any reason, a change occurs in the holding of the asset, or in the interests of entities in the asset; and (b) the entity or one of the entities that had an interest in the asset before the change has an interest in it after the change; and (c) the asset was a partnership asset before the change or becomes one as a result of the change. As a consequence of Division 5A of the ITAA 1936, item 7 of section 40-40 of the ITAA 1997 no longer applies to the CLP. As such, whereas before converting to a CLP the depreciating assets would be held by the partnership, after converting they are held by their owner, or the legal owner if there is both a legal and an equitable owner’. Under the proposed arrangement, whilst it is clear there is no underlying change in the ownership of the partnership asset on converting to a limited partnership, as a consequence of applying Division 5A of the ITAA 1936 a change does occur in the ‘holding of the asset’ as defined, and a balancing adjustment event occurs under subsection 40-295(2) of the ITAA 1997. | Detailed Reasoning - Question 6: Will the first element of the cost base of the goodwill, after the Initial Partnership coverts to the LP/CLP, be the amounts paid by Limited Partnership C and Company B for their respective interests in the goodwill, under section 110-25 of the ITAA 1997? | Summary: Yes. The first element of the goodwill’s cost base will be the amounts paid by Limited Partnership C and Company B to acquire the goodwill at the date of formation of the Initial Partnership. | Detailed Reasoning - Detailed reasoning: The first element of the cost base of a CGT asset (and, in relation to capital losses, the reduced cost base of a CGT asset) is the total of: (a) the money you paid, or are required to pay, in respect of acquiring it; and (b) the market value of any other property you gave, or are required to give, in respect of acquiring it (worked out as at the time of the acquisition) (subsections 110-25(2) and 110-55(2) of the ITAA 1997). Subdivision 106A of the ITAA 1997 sets out how the CGT provisions apply to partnerships, but it is not relevant to determining the cost base following formation of the CLP. This is because Division 5A of the ITAA 1936 requires that any reference to the term ‘partnership’ in the income tax law be read as not including a reference to a CLP. A CLP is taken to be a separate entity for the purposes of calculating tax payable ( Resource Capital Fund IV LP v Commissioner of Taxation [2018] FCA 41 ( RCF IV ) at [15] ). This means that for the purposes of calculating whether a capital gain arises on the disposal of a partnership asset, and the amount of any such gain, the CLP is taken to be the relevant entity. However, the partners will be jointly and severally liable for any tax payable (section 94V of the ITAA 1936). Goodwill, as an asset, is inseparable from the conduct of a business and cannot be dealt with separately from the business with which it is associated (Taxation Ruling TR 1999/16 Income tax: capital gains: goodwill of a business (TR 1999/16)). A partner who owns an interest in goodwill of a partnership business cannot sell the asset independently from the business. As such, goodwill of a business operated by a partnership is a partnership asset. The capital gain on any disposal of the goodwill is determined by subtracting the CLP’s cost base from its capital proceeds. Under paragraph 110-25(2)(a) of the ITAA 1997, the first element of a taxpayer’s cost base consists of the amount the taxpayer paid to acquire the asset. If an asset was acquired by partners prior to the formation of a CLP, we consider first element of the cost base for the CLP will be equal to the amount paid by the partners to acquire the asset. This is because, although the CLP is treated as an entity (for tax purposes), the “factual and legal reality” ( RCF IV at [14]) remains that it is merely a relationship between persons. And, having regard to context (including the policy intent of the CGT provisions), we consider it correct to view the price paid by these persons to acquire an asset as the first element of the CLP’s cost base for that asset. The alternative view is that the first element of the CLP’s cost base is zero on the basis that it, as a separate tax entity, did not acquire the assets (as against the partners). However, we consider this view fails to have proper regard to context and the factual and legal reality. As a LP/CLP, corporate tax rates apply to work out tax payable on any capital gains from CGT events happening to the goodwill of the business (for example, if a new partner joins the partnership and acquires an interest in the goodwill, or if the partnership sells part of the business together with a portion of the goodwill that can be attributed to that part of the business). Under the proposed arrangement, Limited Partnership C and Company B will pay money in respect of acquiring an interest in the goodwill of the business that is operated by the partnership. In line with the intent of the CGT provisions, the partners in association as the LP/CLP are entitled to: ● reduce any capital proceeds from a CGT event happening to the goodwill (whilst the partnership continues) by the cost base of the goodwill, or ● subtract the capital proceeds from the reduced cost base of the goodwill, to determine the amount of the capital gain or loss. The first element of the cost base of the goodwill will be the amounts paid by Limited Partnership C and Company B to acquire the goodwill. As Trust A did not pay any amount to acquire the goodwill, the cost base of the goodwill in respect of Trust A is zero. Note: where a partner exits a LP/CLP and receives capital proceeds which include an amount they paid for their interest in the partnership’s goodwill, the partner is entitled to reduce their capital proceeds by the cost base of their interest in the goodwill. At this time, the amount paid by the exiting partner in originally acquiring the goodwill of the partnership is no longer included in the cost base of the goodwill owned by the remaining partners in association as the LP/CLP. | Detailed Reasoning - Question 7: Will the first element of the CLP’s cost base for the goodwill of the business be equal to the market value of the goodwill at the date of formation of the CLP under section 112-20 of the ITAA 1997? | Summary: No. The first element of the cost base for the goodwill will be the amounts paid by Limited Partnership C and Company B to acquire the goodwill at the date of formation of the Initial Partnership. | Detailed Reasoning - Detailed reasoning: Section 112-20 of the ITAA 1997 provides that the first element of your cost base and reduced cost base of a CGT asset you acquire from another entity is its market value (at the time of acquisition) if: (a) you did not incur expenditure to acquire it, except where your acquisition of the asset resulted from: (i) CGT event D1 happening; or (ii) another entity doing something that did not constitute a CGT event happening; or (b) some or all of the expenditure you incurred to acquire it cannot be valued; or (c) you did not deal at arm's length with the other entity in connection with the acquisition. Under the proposed arrangement, Limited Partnership C and Company B will incur expenditure to purchase an interest in the goodwill of the Initial Partnership. Section 112-20 would only apply to work out the cost base if when initially purchasing their interest in the goodwill Limited Partnership C and Company B do not incur any expenditure or do not deal at arm’s length with Trust A when acquiring the assets. This is not the case under the proposed arrangement. When the Initial Partnership converts to a LP, and treatment as a CLP begins to apply, no CGT event occurs and the CLP does not acquire the goodwill. Section 112-20 cannot apply at this point as an acquisition does not occur.

The Initial Partnership will be entitled to make an election under subsection 70-100(4) of the ITAA 1997 in respect of the items of trading stock acquired if the book values of the items are less than the market values on the day of purchase.