Essay - Case Analysis Final PDF

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Kelly v Federal Commissioner of Taxation Introduction This analysis focuses on issues involved in the formation and operation of a partnership. Particularly, it will explore the implications of dissolution and assignment through the use of various legal instruments. To do this, the legal framework and structure of the partnership involved in Kelly v Federal Commissioner of Taxation1 will be detailed and analysed. Facts The case involves a firm of lawyers assigning partnership interest to various trusts over the period of 1999-2008. The objective of the transactions was to hold the firm’s majority interest on trust. However, this objective was convoluted and not clearly evidenced. The case turned on three transactions beginning in June 1999 when the Bolton Cleary & Kern Partnership (BCK Partnership) had five partners one of which retired (McFadzean) and allegedly assigned his 20% interest in the firm to the BCK Partnership Trust (BCKPT) through the McFadzean Retirement Deed (MRD). By June 2005, the firm, totalling 7 partners, allegedly individually assigned each of their portions of a 30% interest in the firm to the BCKPT. This interest was subsequently transferred back to each partner’s respective holdings trust in 2006. Lastly, in October 2008 Mr Sterling retired and was replaced by Ms Bligh through the Sterling Retirement Deed (SRD) and the Bligh Nomination Deed (BND). It is important to examine these transactions as incorrect assignments of interests or declarations of trust would result in the interest being held by the partnership consequently rendering it assessable as income by the Federal Commissioner of Taxation (FCT). 1999 MRD The primary issue in this transaction was whether the interest transferred to the BCKPT (through the MRD) was ongoing in nature, and carried with it a right to profit despite the dissolution of the partnership. The problems encountered in construing the deed involved a lack of clear intention and purpose, as well as confusion relating to the parties and their respective capacities. Dissolution Generally, any change in the constituents of a partnership triggers a dissolution, upon which a new partnership may be formed.2 Upon McFadzean’s retirement, the partnership dissolved, subsequently creating a new one.3 When executing the MRD, the objective sought was to assign an ongoing interest to the BCKPT. This was not achieved because upon McFadzean’s retirement the partnership dissolved and the interest assigned to the trust only acquired rights to profit in the previous partnership and not the latter formed.4

1Kelly v Federal Commissioner of Taxation [2013] FCAFC 88. (Kelly No.2) 2Hadlee v Commissioner of Inland Revenue [1989] NZLR 447. 3Partnership Act 1891 (Qld) S35(1)(c). 4Federal Commissioner of Taxation v Everett (1980) 28 ALR 179 at [189]. (Everett) 1

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Thus, to successfully retain an ongoing interest and right to profits, McFadzean would have had to remain a trustee of the chose in action.5 Individual capacities The MRD referred to numerous parties in various capacities. The contention by Mr Kelly was that the continuing partners entered into the deed as trustees for the BCKPT. However, (adopting the primary judge’s view) the majority opined that the continuing partners did not enter into the MRD and declare a trust in their individual capacities as trustees for the BCKPT. Rather, that they entered into the deed as the self-described “Purchasers” of the McFadzean interest.6 The primary judge emphasised that the most obvious observation to make about the MRD was that it was not in the form of an assignment or declaration of trust by the remaining partners.7 In further rejection of Mr Kelly’s argument, the primary judge stated; ‘there was no other evidence, which supported the contention that in entering the MRD, [the remaining partners] were individually declaring trusts or assigning interests in the continuing partnership, instead they were collectively assigning an interest which no longer existed.’8 2005’/2006’ 30% assignment The transfer of an ongoing 30% interest succeeded in this transaction because it carried with it a number of evidential components which the MRD lacked. The success rested upon two elements: an objective intention to individually assign interests and the nature of the interest being transferred. Objective intention The FCT contended that there was no assignment by each individual partner, thus resulting in an ineffective collective assignment.9 However, the majority adopted the primary judge’s view that there was objective evidence supporting the partners’ intention to assign individual interests to the BCKPT.10 This finding was evidenced by a number of formalities carried out by the partnership. The intention is crucial to the transfer’s success because there was no written deed as in the 99’ transaction. Despite the lack of writing, the court found that the ledgers, the bank records and the Duties Act11 assessment form demonstrated the relevant intention and the fact that it was achieved.12 In contrast, the MRD displayed a lack of intention on behalf of the continuing partners. It is due to this lack of intent that the court looked to extrinsic evidence, which proved to be non-existent. The objective evidence the court looked to was the consideration paid for the interest received. Because the consideration was provided

5Kelly v Federal Commissioner of Taxation [2012] FCA 423 at [174]. (Kelly No.1) 6Above n 1 at [39]. 7Ibid at [30]. 8Ibid. 9Ibid at [59]. 1 0Ibid at [60]. 1 1Duties Act 2001 (Qld) 1 2Above n 10. 2

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by a third party, the court could not do in equity what ought to be done (transfer the interest).13

Nature of interest The nature of the interest here is substantially different from that of the 99’ transaction as the interest transferred is of an ongoing nature and not conditionally attributed to an outgoing partner as it was in the MRD. The consequence of this is that the continuing partners can validly assign the ongoing interest to a trust individually,14 rather than collectively, as done in the 99’ transaction. 2008 SRD & BND The main issues surrounding this transaction are not focused around whether or not Sterling’s interest was successfully transferred to Bligh. Rather, the focus was whether the SRD and BND had the effect that Mr Kelly contended (namely declaring trust of his portion of the partnership interest in favour of the BCKPT). Buying-out The general procedure when buying out a partner is that the outgoing partner, in consideration for a sum of money, relinquishes the rights, interest and title in the firm and its entities.15 The two deeds had the legal effect of successfully transferring the partnership interests held by Sterling in both of his capacities to Bligh. This is referred to as a sale of Sterling’s interest in a “practical sense”16 which had the result of re-vesting the interest back to the partnership to subsequently be distributed to the acquiring partners. In contrast, the transaction in 99” failed because the firm never acquired the interest of the retiring partner in the newly formed partnership, before attempting to assign it to the trustees of the BCKPT. Declaration of trust Mr Kelly’s contention was that in entering into the Deeds “for and behalf of the BCKPT”, he was declaring trust over a portion of his interest in the Partnership in favour of the BCKPT. Kelly’s intended declaration of trust over the interest was made based on the collective mistaken belief that the BCKPT held an independent interest following the 99’ transaction.17 The majority asserted that any reference to the BCKPT made in the 2008 deeds were merely passive due to the inexistence of the 20% interest in the BCKPT.18 This argument, raised subsequently as an alternative contention, was in pursuance of a finding by the court that the intention to hold his partnership interest on trust was always established.19 1 3Above n 1 at [32] 1 4Galland v Federal Commissioner of Taxation [1986] HCA 83. 1 5Rushton (Qld) Pty Ltd v Rushton (NSW) Pty Ltd [2003] 1 Qd R 320 at [323-325]. 1 6Above n 1 at [28]. 1 7Above n 1 at [87]. 1 8Ibid. 1 9Above n 5 at [163]. 3

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Although Mr Kelly did not mention this argument in his objections to the FCT, the court entertained the argument with a subsequent rejection based on the lack of evinced intention in the 2008 deeds.20

Summary The legal structure implemented by the firm is for tax benefits and asset protection. Although the partners denied that by assigning interests to the respective trusts they were integrating the trusts into the partnership as partners, the evidence drawn from Kelly No.1 shows the contrary.21 However, the court accepted that by referring to the trusts as partners in various documents, it was merely in a “colloquial” sense22 and did not attract the meaning the FCT alleged. The objective sought by the firm through correspondence with the Queensland Law Society was that a substantial interest in the firm would be assigned to the respective trusts.23 However, assignees do not acquire management rights relating to the firm through the assignment of an interest, as would a partner. 24Due to this principle the partners each retained a 1% interest in the partnership25 to manage on behalf of the trusts as equity partners.26 In conclusion, it seems that the trusts were treated as partners27 by the firm to the extent that they held interest in the firm, earned profits and contributed capital. However, in denying their existence as partners, the trusts retained their inherent tax benefits, asset protection and were not joint or severally liable under partnership law.

2 0Above n 1 at [83-88]. 2 1Above n 5 at [54-70]. 2 2Ibid at [58]. 2 3Above n 1 at [46]. 2 4Above n 3 s34(1). 2 5Above n 5 at [132]. 2 6Above n 5 at [54] (doc. 2). 2 7Morton, Amanda, 'A Matter of Trusts - Partnerships of trusts: Legal and taxation issues' (2010) 44(8) Taxation in Australia 396

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Word Count: 1597

Bibliography 1. Articles/Books Graw, Stephen, An Outline of the Law of Partnership (Thomson Reuters, 4th ed, 2011) Morton, Amanda, 'A Matter of Trusts - Partnerships of trusts: Legal and taxation issues' (2010) 44(8) Taxation in Australia 396

2. Cases Federal Commissioner of Taxation v Everett (1980) 28 ALR 179 Galland v Federal Commissioner of Taxation [1986] HCA 83 Hadlee v Commissioner of Inland Revenue [1989] NZLR 447 Kelly v Federal Commissioner of Taxation [2012] FCA 423 Kelly v Federal Commissioner of Taxation [2013] FCAFC 88 Rushton (Qld) Pty Ltd v Rushton (NSW) Pty Ltd [2003] 1 Qd R 320

3. Legislation Duties Act 2001 (Qld) Partnership Act 1891 (Qld)

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