Tax Law Week 8 - Tutorial work PDF

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Chapter 25

Question 2 How does Div 5 of Pt III ITAA36 deal with the income and losses of partnerships? What Kind of partnership does Div 5 of Pt III ITAA36 not apply to?

Income derived from a partnership is generally not assessed to the partners under the ordinary income provisions, such as section 6-5 of the ITAA 1997. Rather, Division 5 of Part III of the ITAA 1936 (Division 5) contains the assessing provisions in respect of partnership income. The general structure of Division 5 is that the net income or partnership loss of the partnership is determined under section 90 of the ITAA 1936. Having then determined whether the partnership has a net income or partnership loss for a particular income year, section 92 of the ITAA 1936 then requires that a partner either: -

include in his or her assessable income so much of his or her individual interest in the net income of the partnership (subsection 92(1)); or

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claim as a deduction so much of his or her share of the partnership loss (subsection 92(2)).

Consequently, it is not possible for one partner to have an amount of assessable income under subsection 92(1) and another partner to have a loss under subsection 92(2). The income from a CLP is not taxed to the partners. The scheme of Division 5A of the ITAA 1936 is that the partnership is treated as a company for certain taxation purposes and consequently the taxable income of the CLP is taxed as a company Division 5 of Pt III ITAA36 broadly provides that it is the individual partners who are liable for tax on income from a partnership, not the partnership itself. It requires a partnership to lodge an income tax return but does not require a partnership to pay tax (s 91 ITAA36). Each partner accounts for his or her respective share of the income and losses of the partnership and pays income tax on this income at the appropriate marginal tax rate (s 92 ITAA36).

Division 5 does not apply to ‘corporate limited partnerships’ (other than certain venture capital partnerships), which are generally treated like companies for tax purposes under Div 5A of Pt III ITAA36. An agreement by the partners of a partnership to allow a partner to draw a 'partnership salary' is a contractual agreement among the partners to vary the interests of the partners in the partnership (and thus the partnership net income) between the partners. For such an agreement to be effective for tax purposes in an income year the agreement must be entered into before the end of that income year (FCT v. Galland (1986) 162 CLR 408; (1986) 18 ATR 33; (1986) 86 ATC 4885, AAT Case 5303 (1989) 20 ATR 3905; Case W79 89 ATC 705 (Galland)).

Question 7 How are capital gains and losses relating to partnership assets dealt with?

A partnership does not own assets for capital gains tax (CGT) purposes. A partnership asset is owned by the partners in the proportion to which they have agreed. If a CGT event happens to a partnership during the income year, or the partnership received a share of a capital gain from a trust, each partner must include their share of the capital gain or capital loss on their own tax return. Capital gains or losses made in relation to CGT events in a partnership or one of its CGT assets are assessed in the hands of the individual partners. Therefore, there are no capital gains or losses taken into account in determining net income of a partnership for the purpose of s 90. The amount of an individual partner’s capital gain or loss is determined with reference to their share of the particular asset in accordance with the partnership agreement

Chapter 26 Question 2 Outline the basic legislative scheme for taxing trust estates? The basic legislative scheme for the taxation of trust estates is contained in Div 6 of Pt III ITAA36. The basic scheme is one of flow-through taxation whereby it is not the trust itself that is liable to pay tax; it is the beneficiaries or trustee of the trust that are liable for tax. The manner in which this is achieved is two-fold. Firstly, ‘net income’ of the trust is calculated in accordance with s 95. This is generally calculated in the same way as a resident taxpayer (assessable income less allowable deductions). Secondly, the legislative scheme then determines who is assessed on the net income (or part of the net income) of the trust estate. Generally, this will be ascertained under either s 97, 98, 99, 99A or s 100. In determining who is assessed and on what amounts they are assessed, it must be determined whether a beneficiary is ‘presently entitled’ to a ‘share’ of the ‘income’ of the trust estate and whether the beneficiary is under a ‘legal disability’. The general rules are as follows,  if a beneficiary is presently entitled to a share of the income of a trust estate and is not under a legal disability, they are assessed on their share of the net income of the trust estate under s 97  if a beneficiary is presently entitled to a share of the income of a trust estate but is under a legal disability, the trustee is assessed (on behalf of the beneficiary) on the beneficiary’s share of the net income of the trust estate under s 98, and  if there is a share of the income of a trust estate to which no beneficiaries are presently entitled, the trustee is assessed (in a personal capacity) on any residual net income of the trust estate under s 99A.

Question 8 In what circumstances does s102 ITAA36 apply? Why did it not apply in Truesdale v FC of T 70 ATC 4056? Section 102 ITAA36 applies where a person who has ‘created a trust’ (ie the settlor) has the power to revoke, or alter, the trust so as to acquire a beneficial interest in the income or property of the trust. The provision also applies where income of the trust is payable to, or accumulated or applicable for, the benefit of that person’s children under 18 years of age. Where s 102 ITAA36 applies, the Commissioner has the discretion to assess the trustee to pay tax equal to the amount by which the tax actually payable by the settlor is less than the tax which would have been payable if he or she had also received the relevant income. Section 102 ITAA36 is targeted at discouraging the establishment of family trusts. To avoid the operation of the section, family trusts are usually established by an independent settlor (eg a friend of the family, accountant or lawyer). The deed will provide that the settlor does not have the power to revoke or alter the trust and that neither the settlor nor his or her children are entitled to benefit under the trust. In practice, the independent settlor usually settles only a nominal sum (eg $10) on trust for the benefit of the family. After the trust has been settled, it is common for the family members who are to benefit under the trust to then transfer money and property to the trust for investment by the trustee. Truesdale v FC of T70 ATC 4056 is authority for the principle that a person that transfers property to a trust, which has already been established, is not ‘creating’ a trust for the purposes of s 102 ITAA36. Truesdale concerned three trusts established for the unmarried infant children of Mr King. Each of the trusts had been settled by an accountant (employed by Mr King’s company). Shortly after settlement, Mr King transferred money to the trustee in respect of each trust and this money was used to buy shares which generated dividends. The Commissioner sought to assess the trustee under s 102 ITAA36, and failed because the High Court found that all that Mr King had done was transfer property to a pre-existing trust. Menzies J stated (at 4059), “There is an obvious difference between creating a trust in respect of property, on the one hand, and, on the other hand, transferring property to a trustee to hold upon the terms of an established trust.”...