Private ruling: Capital Gains Tax - Capital Proceeds
Date of advice: 22 September 2017
Published: February 2018
Ruling period: Year ending 30 June 2017
Date scheme commenced: 1 July 2016

Ruling: Q1: Will the consideration received by the trustee of the Trust on the disposal of a portion of its interests in partnership assets constitute its capital proceeds for the purposes of Division 116 of the Income Tax Assessment Act 1997? | A1: Yes.

Relevant facts and circumstances: The Partnership was established pursuant to a partnership agreement (the “Agreement”). All partners in the Partnership are discretionary trusts, and each trust is controlled by an individual (”Principal”) who is employed by the Partnership. Other than their interest in the Partnership, all partners and Principals are unrelated. A Pty Ltd (“Manager”) acts as Manager of the Partnership and each Principal is also a director of Manager. The Partnership carries on business as an accounting firm providing professional accounting, financial, tax and other services to clients. The partners have passed a Special Resolution pursuant to a clause of the Agreement that the financial statements of the Partnership record the goodwill of the business at a director’s valuation of $B million. The valuation was based on a range of factors. The Trust is a partner of the Partnership and currently has a controlling interest in the assets of the Partnership. One of the Principals is the appointer of the Trust, the sole director and sole shareholder of the trustee of the Trust, and is employed by the Partnership. It is proposed that changes will be made to Partnership interests to increase the interests of the existing minority partners, and to admit new partners to the Partnership. As a result, the Trust proposes to transfer a proportion of its interest in the assets of the Partnership to the new and existing partners for an amount equal to the percentage transferred multiplied by the goodwill of $B million. All of the proposed new partners and associated Principals are unrelated to the Trust.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 104-10 | Income Tax Assessment Act 1997 Section 116-20 and | Income Tax Assessment Act 1997 Section 116-30

Reasons for decision: Summary: Under the general rules provided in section 116-20 of the Income Tax Assessment Act 1997 (ITAA 1997), the capital proceeds from a CGT event are the total of: (a) the money you have received, or are entitled to receive, in respect of the event happening; and (b) the market value of any other property you have received, or are entitled to receive, in respect of the event happening (subsection 116-20(1) of the ITAA 1997). Subsection 116-30(2) of the ITAA 1997, however, modifies the general rules replacing the capital proceeds with the market value of the CGT asset (worked out as at the time of the event) if: (a) some or all of those proceeds cannot be valued; or (b) those capital proceeds are more or less than the market value of the asset and: (i) you and the entity that acquired the asset from you did not deal with each other at arm's length in connection with the event; or (ii) the CGT event is CGT event C2 (about cancellation, surrender and similar endings). Section 108-5 of the ITAA 1997 states that a CGT asset is: ● any kind of property, or ● a legal or equitable right that is not property. The section specifically recognises that an interest in an asset of a partnership, and any other interests in a partnership are CGT assets. Taxation Ruling TR 1999/16 discusses goodwill of a business and explains that for the purposes of section 108-5 (ITAA 1997), goodwill takes the legal definition as explained by the High Court in FC of T v. Murry 98 ATC 4585; (1998) 39 ATR 129 rather than its accounting and business definitions (paragraph 9). The ruling explains that: ‘… goodwill is the product of combining and using the tangible, intangible and human assets of a business for such purposes and in such ways that custom is drawn to it… It is an indivisible item of property that is legally distinct from the sources from which it emanates. It is something that attaches to a business and is inseparable from the conduct of a business. It cannot be dealt with separately from the business with which it is associated’ (TR 1999/16 paragraph 12). Goodwill exists in connection with the conduct of a business, even though it may not necessarily appear in the financial statements of the business (TR 1999/16 paragraph 15). As such, where a business is being carried on in partnership, the goodwill is intangible property of the business. The partners’ interests in the partnership assets include an interest in the business goodwill equal to their interest in the partnership, whether or not the goodwill is recognised on the financial statements of the business. In the situation outlined, money will be received in consideration for the interest in question, which is to be sold triggering CGT event A1. As such, the market value substitution rule can only apply if you and the entity that acquires the asset are not dealing at arm’s length in connection with the event. In determining whether taxpayers are dealing at arm's length in transacting the sale all relevant circumstances are taken into account. We have reviewed the circumstances outlined in your ruling request, and consider that the parties to the acquisition are dealing at arm’s length. Therefore, the consideration received by the trustee of the Trust on the disposal of a portion of its interests in partnership assets will constitute its capital proceeds for the purposes of Division 116 of the Income Tax Assessment Act 1997 .