Private ruling: Partnership ownership of trading stock assets through bare trust
Date of advice: 23 July 2018
Published: October 2018
Ruling period: The period commencing on the change of bare trustee and ending with the admission of new partners
Date scheme commenced: DDMMYY

Ruling: Q1: Will the appointment of a new bare trustee over part of the landholding give rise to a disposal by the partners of their respective share of the partnership assets? | A1: No | Q2: Will the admission of a new partner for one of the two parcels of land so created give rise to a disposal by each partner of all of their respective shares in the partnership assets pursuant to subsection 70-100(1) of the Income Tax Assessment Act 1997 (ITAA 1997)? | A2: No | Q3: Will the admission of a new partner for one of the two parcels of land give rise to a disposal by the old partnership of a fractional interest pursuant to subsection 70-100(1) ITAA 1997 in the partnership assets? | A3: Yes | Q4: If the answer to 3 is yes, can the partners elect to treat the fractional interests in land as having been disposed of at closing value pursuant to subsection 70-100(4) to the new partnership, as long as at least 25% of the interests are held by the existing partners? | A4: Yes

Relevant facts and circumstances: The X Partnership was formed on DDMMYY to acquire and develop a property located in Australia. The land comprises a significant number of proposed residential lots plus an area allocated to form the town centre (“town centre land”). The entire property is held on behalf of the partners in the X Partnership by X Pty Ltd, as bare trustee. The land is held this way purely for administrative reasons, so that each partner’s name is not required to appear on the title deeds for each parcel of land and for ease of dealing with the various authorities, suppliers and customers. The beneficial owner of the land is not the bare trustee company; rather, the beneficial owners are the individual partners in the partnership. In order to attract separate investors for the town centre land development, and to improve the ability to obtain separate debt finance for the commercial land and residential land, the partners wish to appoint a new trustee company to hold the town centre land. The new trustee company will hold the town centre land in the same proportional interests, for the same partners, as the existing trustee company currently owns the entire property, and the existing trustee will also own the balance of the land in those same proportional interests. Following the transfer of town centre land to the new trustee company, the partnership may invite new partners to participate in either the residential land or commercial land at some stage. In mid-2018 you provided us with further information, in particular, that as with most property developments, the lots are created over an extended period of time. In the case of the X partnership, as it is such a large development, the area will be gradually developed over many years at a rate at which demand can absorb the new lots being created. The lots would generally only be subdivided and the individual titles issued once the surrounding infrastructure has been completed, e.g. roads, parks, sewerage, water, electricity, etc. Only stage 1, which is a residential stage, is currently under development. You advised further that part of stage 1 has been subdivided into lots, while the remaining stages have not yet commenced development and therefore have not reached a stage where they have been divided into lots. You also advised that the division of the Town Centre area into lots will be done over an extended period of time depending on demand from potential purchasers, e.g. shopping centre locations. The following conditions for the trading stock election under subsection 70-100(4) ITAA 1936 will be satisfied: a) Immediately after the item stops being trading stock on hand of the X partnership, it is an asset of a business carried on by the new partnership; and b) Immediately after the item stops being trading stock of the X partnership, the partners in the X partnership have interests in the trading stock, valued at least 25% of the market value of all of the stock transferred; and c) the value elected is less than the market value; and d) the item is not a thing in action (subsection 70-100(6)). The election will also be made in writing before 1 September following the year end in which the transfer takes place, as part of a commercial dealing between the parties.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 70-100 | Income Tax Assessment Act 1997 Section 104-10 | Income Tax Assessment Act 1936 Section 91 | Income Tax Assessment Act 1936 Section 92

Reasons for decision: Summary: The mere change in bare trustee to hold legal title to the land underlying the partnership assets does not give rise to a change in beneficial ownership and accordingly does not constitute a disposal by the partners of their interests in the land. | Detailed Reasoning - Detailed reasoning: A partnership, for general law purposes, is the relationship that exists between persons carrying on a business in common with a view to profit. The definition of partnership in section 995-1, extends this to persons in receipt of ordinary income or statutory income jointly, or, a limited partnership. The X Partnership was formed on DDMMYY in order to acquire the property in Australia, with a view to subdividing and developing the property into a town centre and residential development, and then selling the individual lots off for a profit. The X Partnership therefore qualifies as a partnership for both general law and tax law purposes. For ease of administration, the legal owner of the land is X Pty Ltd as bare trustee for the X Partnership (and effectively for each individual partner in their respective right). A bare trust is a term normally used to describe trust relationships where the trustee has no interest in the trust property and few active duties, other than to transfer the trust property to the beneficiary upon direction: Herdegen v Federal Commissioner of Taxation (1988) 84 ALR 271, 281. Under general law in relation to partnerships, a partnership is not a separate legal entity distinct from the individual partners who comprise the partnership. Accordingly, the partnership does not own property in its own right, title to the partnership assets is legally vested in the partners, even though the individual partner may have no separate title to specific partnership assets. 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 FCT v. Everett (1980) 143 CLR 440 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.” Pursuant to section 91 of ITAA 1936 a partnership shall furnish a return of the income of the partnership, but shall not be liable to pay tax thereon. Pursuant to section 92 of ITAA 1936 a partner shall be assessable on their respective share of partnership income or shall be allowed a deduction for their respective share of partnership loss. The X partnership has prepared financial statements and income tax returns annually, disclosing the income and expenditure of the partnership and the partners have disclosed their respective shares thereof in their own income tax returns over the period. Subsection 104-10(1) ITAA 1997 provides that “CGT event A1 happens if you dispose of a CGT asset”. Subsection 104-10(2) states that: 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. Note: A change in the trustee of a trust does not constitute a change in the entity that is the trustee of the trust (see subsection 960-100(2)). This means that CGT event A1 will not happen merely because of a change in the trustee. Importantly, the Note to section 104-10 clarifies that a change in the ownership of a CGT asset does not occur merely because of a change of trustee. For example, if a trustee holds shares for a particular trust and a new trustee is appointed, the legal ownership of the shares changes from one trustee to another but no change of ownership is taken to have occurred for CGT purposes. The change in bare trustee over a portion of the partnership assets, being the town centre land, does not constitute a change in the partnership, nor a disposal by the partners of their respective share of the partnership assets for the purposes of CGT event A1. It is the same partners, holding the same proportionate interests in the same land, just with two bare trustees holding legal title to differing parts of the land. Accordingly, the segregation of the land between that held for a town centre development, and that held for residential development, does not change the ownership nor constitute an underlying disposal of the land. Given that there is no underlying disposal of the land, or the proportionate interests therein, there is no disposal of the trading stock and no requirement for a partnership income tax return to reflect this. | Summary: The admission of a new partner or partners into one of the parcels of land held by a bare trustee on behalf of the partners, being the town centre land, will only impact that portion of land held by that bare trustee, and will not impact the remainder of land held by the second bare trustee. There will be a disposal of that part of the trading stock from the partners in the old X partnership, to a new partnership which includes the old partners and the new partner(s). The old X partnership will exist in respect of the remainder of the land, with the old partners still holding their respective proportionate interests, in that portion of the trading stock. | Detailed Reasoning - Detailed reasoning: Under general law in relation to partnerships, a partnership is not a separate legal entity distinct from the individual partners who comprise the partnership. Accordingly, the partnership does not own property in its own right, title to the partnership assets is legally vested in the partners, even though the individual partner may have no separate title to specific partnership assets. 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 FCT v. Everett (1980) 143 CLR 440 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.” IT 2540 Income tax: Capital Gains: Application to disposals of partnership assets and partnership interests, discusses the operation of the capital gains and losses provisions as they pertain to partnerships. In that ruling it is determined, based on the above legal principles, that where a partnership disposes of an asset, each of the partners in the partnership disposes of his or her fractional interest in the asset. The capital gains or losses accrue to the individual partner in respect of their respective fractional interests in the partnership assets and not to the partnership itself. Section 70-100 ITAA 1997 is concerned with changes in an entity’s interest in an item of trading stock, and the appropriate bringing to account of assessable income on the disposal of trading stock, thus it overlooks the legal principle that it is the partners that own the assets of a partnership and not the partnership itself. As the section deals with “an item of the entity’s trading stock” there is an expectation that the differing items of trading stock can be dealt with separately. As the land that represents the trading stock of the X partnership has effectively been partitioned, in that it is still property of the X partnership, but legally recognised as a beneficial relationship under two separate bare trusteeships, either part can be dealt with separately under the trading stock provisions. If the partners and partnership decide to introduce a new partner or partners to one portion of the land in isolation to the other part of the land, that can be done without affecting the remaining portion of land. Accordingly, with the introduction of a new partner or partners into either of the two parcels of land, there will be a disposal by the X partnership to a new partnership that will include the new partner or partners together with the existing X partners. There is no requirement for the totality of the land to be transferred to a new partnership; the balance can remain with the X partnership. | Summary: The admission of a new partner or partners into one of the parcels of land held by a bare trustee on behalf of the existing partners, being the town centre land, will represent a disposal by the partnership of a fractional interest in its holding of that part of the land and accordingly a disposal of that fractional part of their trading stock. Section 70-100 will operate to deem a notional disposal by the partners in the first partnership, of that portion of the trading stock that new partner/partners have been permitted to acquire, thereby creating a new partnership for that portion of the trading stock. This will essentially create two partnerships, the existing X partnership will remain, but hold less land as trading stock, and a new partnership will be created for the other parcel of land held by the old and new partners as trading stock (the second partnership). | Detailed Reasoning - Detailed reasoning: Under general law in relation to partnerships, a partnership is not a separate legal entity distinct from the individual partners who comprise the partnership. Accordingly, the partnership does not own property in its own right, title to the partnership assets is legally vested in the partners, even though the individual partner may have no separate title to specific partnership assets. 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 FCT v. Everett (1980) 143 CLR 440 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.” IT 2540 discusses the operation of the capital gains and losses provisions as they pertain to partnerships. In that ruling it is determined, based on the above legal principles, that where a partnership disposes of an asset, each of the partners in the partnership disposes of his or her fractional interest in the asset. The capital gains or losses accrue to the individual partner in respect of their respective fractional interests in the partnership assets and not to the partnership itself. Given that the land currently held by the X partnership is held as trading stock, however, we need to look at the provisions of Division 70 ITAA 1997 - Trading stock, to determine whether this impacts the outcome for the partial disposal of trading stock by the partnership. Section 70-100 dictates that an item of trading stock is treated as having been disposed of outside of the ordinary course of business if it stops being trading stock in the hands 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 The consequence of this treatment is that the transferor’s assessable income includes the market value of the item on the day it stops being trading stock on hand of the transferor. Section 70-100 is concerned with changes in an entity’s interest in an item of trading stock, and the appropriate bringing to account of assessable income on the disposal of trading stock, thus it overlooks the legal principle that it is the partners that own the assets of a partnership and not the partnership itself. Accordingly with the introduction of a new partner or partners into either of the two parcels of land, there will be a disposal by the X partnership to a new partnership that will include the new partner or partners together with the existing X partners. | Summary: As stated at question 3, section 70-100 will operate to deem a notional disposal by the partners in the first partnership, of that portion of the trading stock that new partner/partners have been permitted to acquire, thereby creating a new partnership for that portion of the trading stock. This will essentially create two partnerships, the existing X partnership will remain, but hold less land as trading stock, and a new partnership will be created for the other parcel of land held by the old and new partners as trading stock (the second partnership). As the election pursuant to section 70-100(4) will be made on or before 1 September following the year end in which the transfer takes place, and no more than a 75% interest (per market value) in the trading stock is disposed to a new partner/partners, the normal trading stock values may be used, precluding the X partnership being taxed on unrealised profits. | Detailed Reasoning - Detailed reasoning: Section 70-100 dictates that an item of trading stock is treated as having been disposed of outside of the ordinary course of business if it stops being trading stock in the hands 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 The consequence of this treatment is that the transferor’s assessable income includes the market value of the item on the day it stops being trading stock on hand of the transferor. Section 70-100 is concerned with changes in an entity’s interest in an item of trading stock, and the appropriate bringing to account of assessable income on the disposal of trading stock, thus it overlooks the legal principle that it is the partners that own the assets of a partnership and not the partnership itself. Accordingly with the introduction of a new partner or partners into either of the two parcels of land, there will be a disposal by the X partnership to a new partnership that will include the new partner or partners together with the existing X partners. Section 70-100(4) provides that an election can be made to treat the trading stock as having been disposed of for what would have been its value as trading stock of the X partnership on hand at the end of an income year ending on the day that it is transferred. This value is then used by the new partnership as its acquisition cost for the trading stock on the day that it acquired it. The election in section 70-100(4) can only be made if: a) Immediately after the item stops being trading stock on hand of the X partnership, it is an asset of a business carried on by the new partnership; and b) Immediately after the item stops being trading stock of the X partnership, the partners in the X partnership have interests in the trading stock, valued at least 25% of the market value of all of the stock transferred; and c) the value elected is less than the market value; and d) the item is not a thing in action (subsection 70-100(6)). All these conditions will be satisfied. The election will also be made in writing before 1 September following the year end in which the transfer takes place, as part of a commercial dealing between the parties.