Private ruling: Capital gains tax consequences of an assignment of partnership interest
Date of advice: 20 November 2017
Published: April 2018
Ruling period: Income year ending 30 June 2018
Date scheme commenced: 1 July 2017

Ruling: Q1: Will Capital Gains Tax (CGT) event E1 under section 104-55 of the Income Tax Assessment Act 1997 (ITAA 1997) happen when the Partner assigns, by way of a declaration of trust, a beneficial interest in the Partnership to a trust (the Assignee)? | A1: Yes | Q2: Will CGT event E2 under section 104-60 of the ITAA 1997 happen when the Partner assigns, by way of a declaration of trust, a beneficial interest in the Partnership to the Assignee? | A2: No | Q3: Will CGT event A1 under section 104-10 of the ITAA 1997 happen when the Partner assigns, by way of a declaration of trust, a beneficial interest in the Partnership to the Assignee? | A3: No | Q4: For CGT purposes, will the capital proceeds for the Partner’s disposal of the Partnership interest to the Assignee be the consideration received by the Partner for the assignment? | A4: Yes | Q5: In calculating any CGT payable by the Partner on the disposal of the Partnership interest to the Assignee, are other partners in the Partnership affiliates of the Partner, as defined in section 328-130 of the ITAA 1997, for the purposes of the maximum net asset value test under section 152-15 of the ITAA 1997? | A5: No | Q6: In calculating any CGT payable by the Partner on the disposal of the Partnership interest to an Assignee, is the Service Entity an entity “connected with” the Partner as defined in section 328-125 of the ITAA 1997, for the purposes of the maximum net asset value test under section 152-15 of the ITAA 1997? | A6: No | Q7: Will the capital gain that the Partner will otherwise make from the Assignment be reduced by 50% as a consequence of the CGT discount percentage referred to in Division 115 of the ITAA 1997? | A7: Yes | Q8: Will the amount of the capital gain that the Partner will otherwise make from the Assignment that is remaining after applying the discount percentage be reduced by a further 50% as a consequence of Subdivision 152-C of the ITAA 1997? | A8: Yes | Q9: Will the Partner’s Reduced Capital Gain be disregarded as a consequence of Subdivision 152-D? | A9: Yes

Relevant facts and circumstances: You (‘the Partner’) are an equity partner of a general law partnership (‘the Partnership’). Equity partners are entitled to a share of the net profits of the Partnership in accordance with their proportionate Unit Shares. On admission to the Partnership, new partners make a contribution to the capital of the Partnership and agree to progressively make further contributions to the working capital of the Partnership. When a partner exits the Partnership they are entitled to receive the amounts of contributed capital standing to the credit of their capital accounts. The Partnership is operated on a “no goodwill” basis. Goodwill is not recognised on the balance sheet of the Partnership. When a new partner is admitted to the Partnership they are not required to pay an amount which reflects a value for any goodwill of the practice. Further, when a partner exits the Partnership, they are not entitled to receive a payment which reflects a value for any goodwill of the practice. The Partnership has entered into service arrangements with a unit trust (“the Service Entity”). Pursuant to the service arrangements, the Partnership pays arm’s length service fees to the Service Entity as consideration for the provision of certain services. The unit holder in the Service Entity is a discretionary trust (“Trust X”). The potential beneficiaries of Trust X are the partners of the Partnership and/or nominated associates of the partners. The trustee of Trust X is a private company managed by an independent board of directors. The Partner is a director of the trustee, but does not have a controlling vote over decisions of the board of directors. The Partnership Agreement permits a partner to assign a portion of his or her partnership interest (an “Everett assignment”) in certain circumstances, including where approval from the Board of Management has been obtained. In accordance with the Partnership Agreement, the Partner proposes to assign approximately Y% of the Partnership Interest (as defined in the Deed of Assignment) to an associated discretionary family trust (the Assignee) by executing a Deed of Assignment (the Assignment). The Assignment is part of an estate planning and asset protection strategy that is sought to be achieved by diversifying ownership of the rights to income in respect of the Partnership Interest. The Assignee will pay market value consideration of $Z for the assigned Partnership Interest. The Assignment will affect the assignment of all beneficial rights associated with the Partnership Interest, including the right to receive income of the Partnership. The Partner will continue to be legally a partner in the Partnership. The Assignee will not become a member of the Partnership. The Partner has been a partner in the Partnership for more than 12 months prior to the Assignment. The net value of the CGT assets held by the Partner, any entities connected to the Partner, any of the Partner’s affiliates and any entities connected to the Partner’s affiliates, at all relevant times for the purposes of this ruling application, is less than $6 million. The Partner is under 55 years of age. No choices under Subdivision 152-D of the ITAA 1997 have previously been made by, or on behalf of, the Partner. The Partner has no other capital losses from the income year and no previously unapplied net capital losses from earlier income years. The Partner will make a choice to disregard all of the Reduced Capital Gain (the remaining capital gain after applying the 50% general CGT discount concessions and the 50% small business concessions). This choice will be made by the day the Partner lodges their income tax return for the income year the CGT event happened and the choice will be in writing specifying that the Reduced Capital Gain is the “CGT exempt amount”. The Partner will the CGT exempt amount to a complying superannuation fund or Retirement Savings Account within the time required by paragraph 152- 305(1)(c)(ii) of the ITAA 1997.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 102-5, | Income Tax Assessment Act 1997 Section 102-20, | Income Tax Assessment Act 1997 Section 102-25, | Income Tax Assessment Act 1997 Section 104-10, | Income Tax Assessment Act 1997 Section 104-55, | Income Tax Assessment Act 1997 Section 104-60, | Income Tax Assessment Act 1997 Section 108-5, | Income Tax Assessment Act 1997 Subdivision 115-A, | Income Tax Assessment Act 1997 Subdivision 115-B, | Income Tax Assessment Act 1997 Section 116-20, | Income Tax Assessment Act 1997 Section 116-30, | Income Tax Assessment Act 1997 Subdivision 152-A, | Income Tax Assessment Act 1997 Subdivision 152-C, | Income Tax Assessment Act 1997 Subdivision 152-D, | Income Tax Assessment Act 1997 Section 328-125, | Income Tax Assessment Act 1997 Section 328-130 and | Income Tax Assessment Act 1997 Section 995-1.

Reasons for decision: Detailed Reasoning - Relevant CGT event on assigning a beneficial interest in the Partnership to the Assignee: Section 108 - 5 of the ITAA 1997 provides the definition of CGT asset. In your circumstances, your interests in each of the assets of the Partnership are CGT assets, according to paragraph 108-5(2)(c). Furthermore, any interest you may have in the partnership that was not covered by paragraph (c) is also a separate CGT asset according to paragraph 108-5(2)(d). Section 102-20 states that you can make a capital gain or loss if and only if a CGT event happens. Section 102-25 requires you to consider which CGT event happens to your situation. In the present case, you will commence to hold approximately Y% of your interest in the Partnership as a trustee, in a manner consistent with the assignment accepted in Federal Commissioner of Taxation v Everett (1980) 143 CLR 440 (“ Everett ”). | Detailed Reasoning - CGT Event E1: Section 104-55 of the ITAA 1997 provides that CGT event E1 happens if you create a trust over a CGT asset by declaration or settlement. In order 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 subsection 104-55(5) must not apply. It is considered that the first condition will be satisfied in the present case. The effect of the Assignment will be to create a trust over your assigned interest in the Partnership. 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. This is what would occur in the present case when you commence holding a portion of your interest in the Partnership in trust for the benefit of the Assignee via the execution of the Deed of Assignment. A resolution that the property is to be held on a separate trust is sufficient to amount to a declaration for the purposes of CGT event E1, even if there is no express declaration. The manifestation of an intention to create the relevant trust can be inferred from words or conduct, and no formal or technical language is required. Accordingly, it is not essential that you use words such as ‘I declare myself a trustee’. 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. None of the exceptions in subsection 104-55(5) apply in the present case. Accordingly, the second condition is also satisfied. | Detailed Reasoning - CGT Event E2: Section 104-60 of the ITAA 1997 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, you will commence holding your interest in the Partnership in trust for the benefit of 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, you will not transfer an asset to an existing trust and CGT event E2 will not happen. | Detailed Reasoning - CGT Event A1: Section 104-10 of the ITAA 1997 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, you 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 assigned partnership interest. Therefore, you will dispose of a part-interest in the Partnership when you commence holding it as trustee for the Assignee. However, in accordance with subsection 102-25(1) of the ITAA 1997, CGT event E1 is more specific to the situation, therefore CGT event A1 will not apply. | Detailed Reasoning - Capital proceeds for the disposal of your partnership interest: Subsection 104-55(3) of the ITAA 1997 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 of the ITAA 1997 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). In this case, the Assignee will pay market value consideration of $Z for the assigned Partnership Interest, which will therefore be the capital proceeds. | Detailed Reasoning - Other partners of the Partnership as affiliates of yours: To be able to access the small business relief CGT concession in Division 152 of the ITAA 1997, you must satisfy the basic conditions set out in section 152-10. Subparagraph 152-10(1)(c)(ii) refers to the maximum net asset value test in section 152-15. For the purposes of the maximum net asset value test set out in section 152-15, paragraph (c) of this section requires you to include in the calculation the net value of CGT assets of any affiliates of yours or entities connected with your affiliates. The term ‘affiliate’ is defined by section 995-1 to have the meaning described in section 328-130 of the ITAA 1997. Subsection 328-130(1) provides the criteria to be considered when assessing if an individual or a company is your affiliate. Subsection 328-130(2) then provides an exemption where an entity is not your affiliate merely because of the business relationship between you and that entity. Furthermore an example is provided in section 328-130 in relation to partners in a partnership not being affiliates of each other by acting in concert with each other in relation to the affairs of the partnership. As you and other partners in the Partnership share and have the common business relationship in the partnership, the exemption provided in subsection 328-130(2) is applicable to you, in relation to the affairs of the Partnership. The Commissioner does not consider the other partners in the Partnership to be your affiliates for the purposes of section 152-15. | Detailed Reasoning - The Service Entity as an entity connected with you: For the purposes of the maximum net asset value test set out in section 152-15, paragraph 152-15(b) requires you to consider, for the purpose of the maximum net asset value test, not only the net value of CGT assets of yours but also any entities connected to you. The question that was raised in your request for a private ruling is whether the Service Entity is an entity connected with you or not. The term “connected with” is defined in section 995-1 of the Act to have the meaning described in section 328-125. Subsection 328-125(1) considers an entity is connected with another entity if either entity controls the other entity or both entities are controlled by a third entity. As the Service Entity is a fixed trust the concept of control is determined under subsection 328-125(2). As the sole unit holder of the Service Entity, Trust X has the right to receive 100% of the income of the Service Entity. On this basis it will have direct control of the Service Entity under paragraph 328-125(2)(a). You do not have direct control of the Service entity as you do not have the right to receive any of the income of the Service Entity. Subsection 328-125(7) describes the concept of indirect control. It provides that section 328-125 applies to an entity (the first entity) that directly controls another entity (the second entity) as if the first entity also controlled any other entity that is directly, or indirectly by any other application or applications of this section, controlled by the second entity. Pursuant to subsection 328-125(7), if you are taken to control Trust X, you will be taken to also control the Service Entity. As Trust X is a discretionary trust, control of the trust should be considered with reference to subsections 328-125(3) and (4). The trustee of Trust X is a private company managed by an independent board of directors. Although you are a director of the trustee, you do not have a controlling vote over decisions of the board of directors. As a partner of the Partnership, you and/or your nominated associates are potential beneficiaries of the Trust X. While you may recommend to the trustee of Trust X distribution be directed to your associates, the Trustee has absolute discretion over distribution of the trust’s income. Therefore it is accepted that Trust X does not act, or could reasonably be expected to act, in accordance with your directions or wishes as described in subsection 328-125(3). As a matter of practice, the income of Trust X has been distributed to partners and/or their nominated associates in accordance with the partners’ percentage profit share of the Partnership, as determined by their proportionate Unit Shares. Having regard to the number of partners in the Partnership to whom the trustee of Trust A distributes income, it is unlikely that 40% of the income or capital of Trust X will be distributed to you. As such, you are not considered to control Trust X under subsection 328-125(4). As you are not considered to control Trust X, the Commissioner does not regard the Service Entity as being an entity connected with you for the purposes of section 152-15. | Detailed Reasoning - Discount Capital Gain: On the basis that you have been a partner of the Partnership for at least 12 months prior to the time that the Deed of Assignment takes effect, the 50% CGT discount applies to any capital gain arising as a result of the Assignment pursuant to Subdivision 115-A of the ITAA 1997. | Detailed Reasoning - Partnership interest as an active asset: Section 152-40 of the ITAA 1997 provides the meaning of ‘active asset’. A CGT asset will be an active asset at a time if, at that time, you own the asset and the asset was used or held ready for use by you, an affiliate of yours, or by another entity that is ‘connected with’ you, in the course of carrying on a business. Subsection 152-40(1) of the ITAA 1997 provides that an asset is an active asset if the asset is an intangible asset you own and is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or an entity connected with you. In your case, your interest in the Partnership is an intangible asset. It was through this interest that you carried on a business in partnership with others. Your interest in the Partnership is inseparable from the business (and therefore inherently connected with the business) that you carried on. As such, your Partnership interest is considered an active asset. | Detailed Reasoning - Small business 50% reduction: Section 152-205 of the ITAA 1997 (in Subdivision 152-C of the ITAA 1997) states that the amount of a capital gain remaining after applying step three of the method statement in subsection 102-5(1) of the ITAA 1997 is reduced by 50%, if the basic conditions in Subdivision 152-A are satisfied for the gain. Section 152-10 of the ITAA 1997 contains the basic conditions to be satisfied. These conditions are: (a) a CGT event happens in relation to a CGT asset of yours in an income year; (b) the event would (apart from Division 152 of the ITAA 1997) have resulted in the gain; (c) at least one of the following applies: (i) you are a small business entity for the income year; (ii) you satisfy the maximum net asset value test (see section 152-15 of the ITAA 1997); (iii) you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership; or (iv) the conditions mentioned in subsection 152-10(1A) or 152-10(1B) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year. (d) the CGT asset satisfies the active asset test (see section 152-35 of the ITAA 1997). In your case, you will satisfy the basic conditions in section 152-10 of the 1997 because: ● CGT event E1 will happen as a consequence of the Assignment; ● a capital gain would have resulted from this event; ● you satisfy the maximum net asset value test as the net value of the CGT assets held by you, your connected entities, your affiliates and any entities connected to your affiliates is less than $6 million; and ● your Partnership interest is an active asset and you satisfy the active asset test. Accordingly, you are eligible to apply the CGT small business 50% active asset reduction under Subdivision 152-C of the ITAA 1997 to the capital gain made from the assignment of your Partnership interest. | Detailed Reasoning - Question 9: If you are an individual, you can choose to disregard all or part of a capital gain, under the small business retirement exemption in Subdivision 152-D of the ITAA 1997, if: ● you satisfy the basic conditions in Subdivision 152-A of the ITAA 1997; ● if you are under 55 years old just before you choose to use the retirement exemption, you make a personal contribution equal to the CGT exempt amount to a complying superannuation fund or retirement savings account. You must make the contribution when you made the choice to use the retirement exemption, or when you received the proceeds (whichever is later). Section 103-25 states that you must make the choice by the day you lodge your income tax return for the income year in which the CGT event happened. Further, the CGT exempt amount must be specified in writing. The amount of the capital gain that you choose to disregard (that is, the CGT exempt amount) must not exceed your ‘CGT retirement exemption limit’. An individual’s lifetime CGT retirement exemption limit is $500,000, reduced by any previous CGT exempt amounts the individual has disregarded under the retirement exemption. This includes amounts disregarded under former (repealed) retirement exemption provisions. In your circumstances, as previously noted, you will satisfy the basic conditions in Subdivision 152-A of the ITAA 1997 in respect of the assignment of your Partnership interest. You will also be under 55 years of age at the time the choice is made to apply the retirement exemption and will contribute the relevant amount (an amount equal to the ‘CGT exempt amount’) to a complying superannuation fund. Also, you will choose to apply the retirement exemption by the day you lodge your income tax return for the income year the CGT event happened and the choice will be made in writing. You have stated that no choices under Subdivision 152-D of the ITAA 1997 have previously been made by, or on behalf of, you and that the amount of the Reduced Capital Gain will be less than $500,000. Therefore, under Subdivision 152-D, you will be able to choose to disregard all of the Reduced Capital Gain in respect of the capital gain you make from CGT event E1 happening in respect of the Assignment.