AUSTRALIA TAXATION

Module 7
TAXATION OF SBES AND PARTNERSHIPS
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Contents
Preview 303
Introduction
Objectives
Teaching materials
Small business entity concessions core concepts 305
Refresher on the definitions of small business entity
Company tax rates for small business entities
Refresher on trading stock rules for small business entities
Refresher on capital allowance rules for small business entities
Refresher on capital gains tax concessions for small business entities
Calculating the small business income tax offset 310
What is the small business income tax offset?
Calculating net small business income for the small business income tax offset
Eligible income and deductions
Small business restructure rollover 313
What is the small business restructure rollover?
Who can access the rollover?
Eligible assets
When is the rollover available?
Taxation implications of the rollover
Partnership taxation core concepts 316
What is a partnership?
Tax status of a partnership
Partnership income tax return
Overview of partnership losses
Determining the net partnership income/loss 318
Determining net partnership income or loss
Tax administration
Calculating a partner’s share of tax payable 319
Non-commercial loss rules
Partnership elections
Impact of salaries paid to a partnership
Impact of interest paid to partners
Alteration of partner’s interest 327
Real and effective control of partnership income
Alteration of partner’s entitlement to profit
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General work in progress rule

General capital gains tax rule
Dissolution or reconstitution of a partnership

Summary and review 334

Suggested answers 335

References 339
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Module 7:
Taxation of SBEs
and partnerships
Study guide

Preview
Introduction
Module 7 looks at the taxation consequences of two entities—small business entities (SBEs)
and partnerships. What constitutes an SBE has already been defined in this course, and is
presented again in this module. SBEs have concessional taxation treatment across a range of
areas, including special trading stock rules, simplified depreciation rules, small business capital

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gains tax (CGT) concessions, a start-up expenditure deduction, a CGT small business rollover
exemption and a small business tax offset.

Partnerships are required to lodge a partnership tax return, and the partnership derives ‘net
income’ to the extent that the difference between the partnership’s assessable income exceeds
its allowable deductions. The most important element about determining partnership income
is that each individual partner is liable for individual taxation on their share of partnership
income. Each partner is taxed in their individual capacity on their share of the net income
of the partnership, whether it is distributed to the partner or not.

The module content is summarised in Figure 7.1.

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Figure 7.1: Module summary—taxation of small business entities and partnerships

Taxation of SBEs

SBE tests

27.5% tax rate

Trading stock rules

Simplified depreciation

Start-up expenditure

CGT small business

concessions

Small business income

tax offset

Small business restructures

Taxation of partnerships

Determining partnership Determining partner’s Alteration of

Core concepts
income or loss share of tax partner’s interest

Partnership income Non-commercial

Tax status Salary Interest payable
tax return loss

Source: CPA Australia 2019.

Objectives
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After completing this module, you should be able to:

• evaluate the tax implications for eligible small business entities (SBEs) based on the
available tax concessions;
• determine the net partnership income or partnership loss;
• calculate a partner’s share of the net partnership income or partnership loss; and
• evaluate the tax implications from an alteration of a partner’s interest in a partnership.

Teaching materials
• Legislation:
–– Income Tax Assessment Act 1936 (Cwlth) (ITAA36)
–– Income Tax Assessment Act 1997 (Cwlth) (ITAA97)

• Glossary:
–– Following is a link to a glossary of common tax and superannuation terms. You may want
to consult the glossary when you come across an unfamiliar term: https://www.ato.gov.au/
Definitions/
–– For languages other than English: https://www.ato.gov.au/general/other-languages/
in-detail/information-in-other-languages/glossary-of-common-tax-and-superannuation-
terms/
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Small business entity concessions core concepts

Refresher on the definitions of small business entity
In the first section of Module 4, we defined a small business entity (SBE) for taxation purposes.
This section identified the various eligibility measures and the various thresholds available to
determine the different types of SBE entities for different types of taxation laws.

Table 7.1 summarises the different types of SBEs, the different threshold amounts, and the type
of taxation law that applies to each amount.

Table 7.1: Refresher on small business entity definitions

Carrying on Aggregated Taxation area and

Title a business turnover test study guide reference

Small business entity The entity must be $10 million aggregated Depreciation (capital
‘carrying on a business’ turnover test. allowances regime)—
(ITAA97, s. 328-110(1)). The threshold is Module 4.
An entity will also be $2 million for tax years
taken to be carrying on a before 1 July 2016. Fringe benefits tax
business if it winds up a Aggregated turnover (FBT)—Module 9.
business that it formerly is the sum of the annual
carried on, and it was turnover of the income Goods and services
an SBE for the income year, the annual turnover tax (GST) simplified
year in which it stopped of any entity connected registration and
carrying on the business with the main entity reporting—Module 10.
(ITAA97, s. 328-110(5)). during the income year,
and the annual turnover Company tax rate of
of an affiliate (ITAA97, 27.5% for base rate
s. 328‑115). entities.

Small business entity Must carry on a business $5 million aggregated Eligibility for small
(for the purposes of the turnover test. business income tax
small business income offset—see the section
tax offset) ‘Calculating net small

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business income for
the offset’.

CGT small business Must carry on a business $2 million aggregated Capital gains tax (CGT)
entity turnover test. concessional treatment
as outlined in ITAA97,
Division 152—Module 5.

Source: CPA Australia 2019.

Definitions
Section 995-1 of ITAA97 defines a business as including ‘any profession, trade, vocation or
calling’. In the majority of cases, it’s very clear whether or not a business is being carried out.
It’s not always certain though, especially when the activity is carried out as ancillary or as a
side activity to the individual’s main income.

The criteria for meeting the business entity test are presented in Module 4, in the section
‘Carrying on a business’.
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Aggregated turnover is the sum of the annual turnover of the income year, the annual turnover
of any entity connected with the main entity during the income year, and the annual turnover of
an affiliate (ITAA97, s. 328-115).

Company tax rates for small business entities

Companies that are base rate entities apply a 27.5 per cent company tax rate. A base rate entity
is a company that both:
• has an aggregated turnover less than $50 million for the 2018–19 income year, and
• has no more than 80 per cent base rate entity passive income. This income includes dividend
income and franking credits on such dividends, interest income, royalties and rental income,
net capital gains and distributions from partnerships and trusts, to the extent it is referable to
an amount that is otherwise passive income (Treasury Laws Amendment (Enterprise Tax Plan
Base Rate Entities) Act 2018 (Cwlth), s. 23AA).

SBEs would generally qualify as base rate entities, and so would apply the reduced 27.5 per cent
tax rate.

All other companies—that do not meet the rules for a base rate entity—are taxed at the
30 per cent company tax rate.

Refresher on trading stock rules for small business entities

Table 7.2 presents an overview of the trading stock rules as applied to SBEs. Refer back to the
section ‘Trading stock concessions for small business entities’ in Module 2 for more information.

Table 7.2: Small business entity trading stock rules

Rule Description Application

Trading stock Where the difference Under these rules the taxpayer does not have to:
concession between the value of • conduct a stocktake at the end of the
opening stock and the income year
estimated value of closing • account for any changes in the value of the
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stock is $5000 or less. trading stock. In other words, the value of the
opening stock may be kept as the value of
the closing stock

The taxpayer is required to record how they

estimated the value of the closing stock,
but does not have to notify the Australian Taxation
Office (ATO) of how they have chosen to apply
the estimate.

Source: CPA Australia 2019.

Refresher on capital allowance rules for small business entities

Table 7.3 presents an overview of the simplified depreciation rules that can be used by SBEs.
Refer back to the section ‘Capital allowance rules for small business entities’ in Module 4.
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Table 7.3: Small business entity capital allowance rules

Rule Description Application

Access Annual aggregated turnover Must use these rules to calculate the deductions
of less than $10 million for all depreciating assets.
for tax years 1 July 2016
onwards, or less than Entire set of rules (presented in the next section)
$2 million for previous must be applied, not just individual elements.
tax years.
Claim a deduction for the portion of the asset that
is used for business or other taxable purposes.

Instant asset Instant write-off for the The deduction is claimed in the year that the asset
write‑off business portion of most is purchased and used, or installed ready for use.
assets that cost less
than $20 000.

In place until 30 June 2019.

Small business Assets costing $20 000 or If the SBE stops using the small business
asset pool more are allocated to a depreciation rules, the general depreciation rules
small business asset pool. will apply. In that case, any assets that are currently
Then apply: in the small business pool will continue to be
• 15% diminishing value depreciated in that pool.
deduction in the first
year (regardless of when If the balance of the pool, prior to calculating the
the asset was purchased pool deduction for the year, falls below $20 000,
or acquired during that amount may be claimed as a deduction in
the year) that year.
• 30% diminishing value
deduction each year There are no simplified provisions for project pool
after the first year. expenditure for SBEs.

Deduction for start- Deduction for capital Applicable expenditure:

up expenditure expenditure for a proposed • obtaining of professional advice or services
business. about the structure or operation of the
proposed business
• tax, charge or fee paid to an Australian

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government agency.

Source: CPA Australia 2019.

Refresher on capital gains tax concessions for small business

entities
As discussed in Module 5, there are four CGT small business concessions for certain SBEs.
These are separate to the small business restructure rollover discussed in detail in the section
‘Small business restructures’ later in this module.

There are four specific concessions available that allow qualifying SBEs to disregard or defer
part or all of a capital gain from an active asset used in a small business. The first requirement
is that the asset must be an active asset to meet the concessions.
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A CGT asset is an active asset if the taxpayer owns it, and:

• the taxpayer, their affiliate or an entity connected to them uses it, or holds it ready for use,
in the course of carrying on a business (whether alone or in partnership)
• it is an intangible asset (e.g. goodwill) inherently connected with a business they carry on
(whether alone or in partnership).

Shares in a resident company and interests in a resident trust may be active assets in certain
circumstances. Note that where the capital gain has arisen from a sale (or other CGT event) of
shares in a company or units in a trust, there are additional conditions that need to be fulfilled
for CGT small business concession eligibility.

Certain CGT assets cannot be active assets, even if they are used or held ready for use in
the course of carrying on a business—for example, assets whose main use is to derive rent.
Please see Module 5 under ‘CGT small business concessions’.

A CGT asset must also satisfy the active asset test under ITAA97, s. 152-35(1). The active asset
test is met if:
(a) you have owned the asset for 15 years or less and the asset was an active asset of yours for
a total of at least half of the period specified in subsection (2); or
(b) you have owned the asset for more than 15 years and the asset was an active asset of yours for
a total of at least 7½ years during the period specified in subsection (2) (ITAA97, s. 152-35(1)).

The entity must be a CGT small business entity for the income year with an aggregated turnover
of less than $2 million, or it must meet the maximum net asset value test under s. 152-15 of
ITAA97. Under this test, the entity (including related entities or affiliates) must have net assets
of no more than $6 million (excluding personal use assets such as a home, to the extent that it
hasn’t been used to produce income).

The small business concessions are summarised in Table 7.4. Additional examples showing the
application of the CGT concessions are provided after this table.

Table 7.4: CGT small business entity concessions

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Rule Description
15-year exemption If the business has continuously owned an active asset for 15 years
and the taxpayer is aged 55 or over, and is retiring or permanently
incapacitated, then there will not be an assessable capital gain upon
sale of the asset.

50% active asset reduction Reduction of the capital gain on an active asset by 50%. This is in
addition to the 50% CGT discount if applicable.

Retirement exemption Capital gains from the sale of active assets are exempt up to a lifetime
limit of $500 000. If the taxpayer is under 55, the exempt amount
must be paid into a complying superannuation fund or a retirement
savings account.

Rollover exemption All or part of the capital gain can be subject to a rollover where the
taxpayer makes an election to do so. However, if such an election is
made, then by the end of two years after the CGT event, the amount
subject to the rollover must have been used for the acquisition of a
replacement active asset, and/or for incurring expenditure on making
capital improvements to an existing active asset. If this is not the case
then, in effect, the rollover will be reversed and the taxpayer will be
subject to a CGT liability.

Source: CPA Australia 2019.

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Example 7.1: Fifteen-year exemption

Megan and Mary are partners in a partnership that conducts a coffee wholesale business on commercial
land they purchased in 1990 and have owned continuously since that time. The net value of their CGT
assets for the purpose of the maximum net asset value test is less than $6 million.

Megan and Mary are both over 60 years old and wish to retire. As they have no children, they decide
to sell the major asset of the wholesale commercial business, the land. They sell the land for a total
capital gain of $870 000.

Both Megan and Mary qualify for the small business 15-year exemption in relation to the capital gain.
Consequently, the capital gain is not included in their assessable income.

Example 7.2: Fifty per cent active asset reduction

Tony Ryan operated a car-washing business for 10 years as a sole trader. On 2 May 2019 Tony sold
the business for $950 000 and made a capital gain of $300 000. Tony had prior-year capital losses
totalling $40 000.

Assuming all the conditions for the concession are met, Tony’s capital gain for the 2018–19 tax year
is calculated as follows:
$
Capital gain 300 000
Less: Prior years losses 40 000
260 000
Less: 50% general CGT discount 130 000
130 000
Less: 50% small business reduction 65 000
Assessable capital gain 65 000

This capital gain may be further reduced by the small business retirement exemption or small business
rollover, or a combination of both (if applicable).

Example 7.3: Retirement exemption

Suppose, using Example 7.2, that Tony Ryan was aged 60 when he sold the car-washing business and

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Tony used those proceeds to fund his retirement. Tony had not previously used any of his lifetime
CGT retirement limit.

In this situation, Tony would also be eligible for small business retirement relief if he so elects in writing,
as the resulting net capital gain of $65 000 (after applying the 50% CGT discount and the 50% small
business CGT reduction) is less than the CGT retirement limit of $500 000.

As Tony is aged 60, he can disregard the $65 000 gain and is not required to contribute that amount
to a complying superannuation fund or retirement savings account. Thereafter, Tony’s CGT lifetime
retirement limit will be reduced to $435 000 ($500 000 – $65 000).

Example 7.4: Rollover exemption

Anne McDonough sold the premises from which she had operated her small business—a bookshop—
since 2001 for a capital gain of $450 000. As Anne satisfies the basic conditions for the CGT small
business concessions, and has elected to use the rollover exemption, this capital gain is reduced by
the 50 per cent general CGT discount to $225 000 and then by the 50 per cent small business reduction
to $112 500, which is then subject to the rollover. If Anne acquires a replacement asset within the
replacement asset period, she can disregard the $112 500 capital gain. If at the end of the two-year
replacement period, Anne has only spent $72 500 on a replacement active asset, CGT event J6 will
occur and Anne will incur a capital gain of $40 000 (the difference between the original capital gain
rolled over and the amount of expenditure incurred on the replacement asset).
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Calculating the small business income tax offset

What is the small business income tax offset?
The small business income tax offset reduces the tax paid by an eligible sole trader and a SBE
by up to a maximum of $1000 each year. This offset is also known as the unincorporated small
business tax discount. It is not available to incorporated entities, namely companies. It is found in
Subdivision 328-F of ITAA97.

The offset, which is worked out on the proportion of tax payable on business income, is 8 per cent
for the 2018–19 income year.

The offset will increase to:

• 13 per cent in 2020–21
• 16 per cent in 2021–22.

To be eligible for the offset, the taxpayer must be carrying on a small business as a sole trader,
or have a share of net small business income from a partnership or trust. The small business must
have an aggregated turnover of less $5 million for the 2018–19 income year (ATO 2018c).

The formula for calculating the small business tax offset is contained in s. 328-360(1) of ITAA97
and is reproduced below:

 Your total net small business income 

8% ×  × Your basic income tax liability for the year 
 Your taxable income for the income year 

Calculating net small business income for the small business

income tax offset
Net small business income for the purposes of the small business income tax offset is all of the
assessable income from eligible business activities minus deductions. It is not calculated on
gross income.
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The offset is applied to the net small business income earned as a small trader, or the individual’s
share of net small business income from a partnership or trust. If the net small business income
is a loss, it is treated as zero for the purposes of the application of the small business income
tax offset. In that case, there is no offset available.

If the taxpayer generated eligible business income from more than one sole trader or
partnerships during the income year, then they must combine all of the assessable business
income from all their sole trader businesses, minus the deductions from that income,
to determine eligibility.

If carrying on more than one business, and any of these made a loss, the non-commercial
losses rules must first be applied. Net small business income is only reduced by losses deductible
in the current year. To work out net small business income, start with the net business income
or loss. Increase this amount by any deferred non-commercial losses not deductible in the
current year.

The non-commercial loss rules are discussed generally in the ‘Non-commercial loss rules’ section
in Module 3.
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Eligible income and deductions

The following can be included in net small business income for the purposes of the offset:
• any farm management deposits claimed as a deduction
• any repayments of farm management deposits included as income
• any net foreign business income that relates to sole trading business
• other income or deductions such as interest or dividends derived in the course of conducting
your business (ATO 2018a).

The following types of income cannot be included in net small business income for the purposes
of the offset:
• net capital gains made from carrying on your business
• personal services income (unless you were a personal services business)
• salary and wages received
• allowances and director’s fees
• government allowances and pensions
• interest and dividends unless it’s related to a business activity
• interest earned on a farm management deposit (ATO 2018a).

Furthermore, the following deductions cannot be included in net small business income for
the purposes of the offset:
• tax-related expenses such as accounting fees
• gifts, donations or contributions
• personal superannuation contributions
• current year business losses which are not deductible this year under the non-commercial
loss rules
• tax losses from prior years (unless they are deferred non-commercial losses [as discussed
in Module 3]) (ATO 2018a).

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Example 7.5: Calculating the small business tax offset
For the year ended 30 June 2019, Lucy derived $65 000 in assessable income from eligible business
activities in her work as a freelance public relations consultant. She operates as a sole trader and does
not have any other sources of income. She has $18 000 deductions (all allowable for calculating net
small business income).

Lucy’s eligible income for calculating the tax offset is $47 000 ($65 000 – $18 000). Tax payable on
$47 000 for the 2018–19 tax year is $6822 (excluding the 2% Medicare levy). The Medicare levy is not
included in computing the offset.

The rate of the small business tax offset for the 2018–19 tax year is 8 per cent. The amount of Lucy’s
small business tax offset is calculated as follows:

 $47 000 
8% ×  × $6822  =
$546
 $47 000 

Note that Lucy would also be eligible for the low- and middle-income tax offset (LMITO; discussed in
Module 6). However, this does not impact the calculation of the small business tax offset, which is
based on the tax liability before offsets.
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➤➤Question 7.1
Lucian runs a small accounting practice as a sole trader, Ballarat Accounting, and has operated in
the same premises for eight years. He has generated assessable business income of $250 000 this
year and employs a part-time bookkeeper who is paid a salary of $25 000. His eligible allowable
deductions (excluding the above-mentioned salary) totalled $130 000.
Lucian has no partner or children, and holds private hospital insurance. He is not liable for
Medicare Levy Surcharge.
During the 2018–19 income year, Lucian received unfranked dividends of $20 000 from ASX
publicly listed companies in respect of investments that he owns in his own name.
Ballarat Accounting’s annual aggregated turnover in the last financial year was $220 000.
(a) Determine if Lucian is eligible to be an SBE and a CGT small business entity.

(b) Calculate the amount of small business income tax offset Lucian will receive.

Lucian and his bookkeeper, Charlie, have a promising business opportunity to provide remote
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bookkeeping services to farmers utilising Cloud accounting software. Charlie and Lucian decide
to set up a partnership to pursue this idea. They have signed a partnership agreement and
commenced business as the Bookkeeping on the Move Partnership on 1 October 2018.
Charlie has a 60 per cent share of the partnership, while Lucian has a 40 per cent share.
The partnership agreement splits profits and losses in accordance with the above percentages.
The Bookkeeping on the Move Partnership generated $30 000 gross income over the 2018–19
income tax year. The partnership agreement states the following:
– Charlie will receive a partnership salary of $14 000 per annum.
– The partnership has $8000 in allowable deductions.
– The management of the business shall be the sole responsibility of Charlie.
– After payment of salaries, all profits and losses are to be shared between Charlie and
Lucian in the ratio of Charlie 60 per cent and Lucian 40 per cent.
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(c) Calculate the net partnership income of the Bookkeeping on the Move Partnership.

(d) Determine how the net partnership income of the Bookkeeping on the Move Partnership
should be distributed to the partners.

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Check your work against the suggested answer at the end of the module.

Small business restructure rollover

What is the small business restructure rollover?
The small business restructure rollover allows small businesses to transfer active assets from one
entity (the transferor) to one or more other entities (transferees) without incurring an income tax
(including, but not limited to, CGT) liability.

The small business restructure rollover applies to transfers on or after 1 July 2016. The operation
of the rollover is contained in ITAA97, Subdivision 328-G. The following is a summary of
the small business restructure rollover. It is discussed in more detail in Module 5 under the
‘Rollover provisions and other reliefs’ section.
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Who can access the rollover?

The rollover will apply if each entity that is party to the transfer event is (in the income year
where the transfer occurs):
• a small business entity [meeting all the SBE requirements]
• an entity that has an affiliate that is a small business entity
• an entity that is connected with a small business entity
• a partner in a partnership that is a small business entity.
This means that an entity not carrying on a business, but holding assets for a small business entity,
may be able to apply the rollover. For example, where one entity owns a property in which another
connected entity is carrying on a business (ATO 2017).

Eligible assets
This rollover applies to active assets that are CGT assets, depreciating assets, trading stock or revenue
assets transferred between entities as part of a genuine restructure of an ongoing business.
Active assets are assets used, or held ready for use, in the course of carrying on a business.
The rollover is not available for any other business assets. Assets such as loans to shareholders
of a company are not active assets of the business carried on by the creditor, and as such are not
eligible (ATO 2017).

When is the rollover available?

The rollover is available when the following conditions are met:
• the entity is an applicable SBE or related entity
• the rollover is part of a genuine restructure (not an artificial or tax-driven scheme)
• the rollover must not result in a change to the ultimate economic ownership of the
transferred assets.

Determining a genuine restructure

Determining whether a restructure is ‘genuine’ is a matter of fact—that is, it depends on all
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the facts surrounding the individual restructure.

The legislation includes a safe harbour rule to provide an alternative way of satisfying the
requirement that a restructure is genuine, which provides greater protection for small business
that a genuine restructure will be considered as such.

No change to ultimate economic ownership

The restructure must not result in a change to the ultimate economic ownership of the
transferred assets.
The ultimate economic owners of an asset are the individuals who, directly or indirectly, own an
asset. Where there is more than one individual with ultimate economic ownership … each
individual’s share of ultimate economic ownership must be maintained (ATO 2017).
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Note that:
Non-fixed (discretionary) trusts may be able to meet the requirements for ultimate economic
ownership—for example, where there is no practical change in which individuals economically
benefit from the assets before and after the transfer.
Family trusts may meet an alternative ultimate economic ownership test where:
• the trustee has made a family trust election [see Module 8], and
• every individual who had ultimate economic ownership of the transferred asset before the
transfer, and every individual who has ultimate economic ownership after the transfer, must be
members of the family group relating to the family trust (ATO 2017).

Trusts are discussed in more detail in Module 8.

Taxation implications of the rollover

There are several taxation implications from applying the small business restructure rollover.
First, the ‘assets transferred under the rollover will not result in an income tax liability arising for
either party at the time of the transfer’ (ATO 2017). Second, if the transferor is established:
to have received an amount for the transferred asset equal to the transferor’s cost of the asset for
income tax purposes … the transferee will be taken to have acquired the asset at the time of the
transfer for an amount that equals the transferor’s cost just before transfer (ATO 2017).

Specific taxation implications are presented in Table 7.5.

Table 7.5: Taxation implications of the same asset rollover

Tax Description
CGT Pre-CGT assets will retain their pre-CGT status after the transfer.
To be eligible to claim the CGT discount for any subsequent sale of the
asset, the taxpayer will need to wait at least 12 months before a CGT event
happens to that asset.
For the purposes of determining eligibility for the 15 year CGT exemption,

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the transferee is taken as having acquired the asset when the transferor
acquired it (ATO 2017).

Trading stock The rollover cost of an asset that is trading stock is either the:
• cost of the item for the transferor at the time of the transfer, or
• value of the item for the transferor at the start of the income year, if the
transferor held the item as trading stock at that time (ATO 2017).

Depreciating assets The rollover prevents the transferor from having to make a balancing
adjustment when assets are transferred. This allows the transferee to deduct
the decline in value of the depreciating asset using the same method and
effective life as the transferor was using (ATO 2017).

Revenue assets If the asset is a revenue asset, the rollover cost is the amount that
would result in the transferor not making a profit or loss on the transfer.
The transferee will inherit the same cost attributes as the transferor just
before transfer (ATO 2017).
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Tax Description

Shares or interests in This rollover does not require that market value consideration, or any
a company/trust consideration, be given in exchange for the transferred assets.
Where membership interests are issued as consideration for the transfer,
the cost base or reduced cost base of those new membership interests
should be worked out based on the following formula:
(Sum of rollover costs and adjustable values of the rollover assets minus
liabilities the transferee assumes for the assets) divided by number of
new membership interests
An integrity rule is included to ensure that a capital loss on any direct or
indirect membership interest in the transferor or transferee that is made
subsequent to the rollover will be disregarded (ATO 2017).

Stamp duty/GST Must be considered before restructuring.

Anti-avoidance rule Even though a restructure may satisfy the rollover requirements, this does
not prevent the general anti-avoidance rule from applying to a scheme
involving the application of the rollover (ATO 2017).

Module 11 examines the general anti-avoidance rules.

Source: Based on ATO 2017, ‘Small business restructure rollover’, accessed December 2018,
https://www.ato.gov.au/general/capital-gains-tax/small-business-cgt-concessions/small-business-
restructure-rollover/.

Partnership taxation core concepts

What is a partnership?
There will be a partnership for tax purposes where it falls under either (or both) limbs of the
definition of ‘partnership’ in the tax legislation (ITAA97, s. 995-1).

The first limb covers a situation where there is a partnership in general law. A partnership in
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general law exists where there is a relationship that subsists between persons carrying on a
business in common with a view of profit (Partnership Act 1892 (NSW), s. (1)1). All states and
territories in Australia have a Partnership Act that contains a virtually identical definition to
the one contained in the NSW Partnership Act.

A partnership begins when the partners agree to conduct their business activity together.
This can be before the business actually begins to trade, such as when premises are leased
and a bank account opened. There must be at least two partners.

In most cases, there is no doubt about the existence of a partnership. The partners declare their
intention by such steps as signing a written partnership agreement and adopting a business
name. These outward and visible signs of the existence of a partnership are not essential,
however—a partnership can exist without them. No formal agreement is required to set up a
partnership, and the fact that two people carry on business together may be enough to show
that a partnership does exist—there may be a partnership in law even if the parties do not legally
recognise themselves as partners.

The second limb of the tax definition of partnership applies where persons receive income jointly.
For instance, where two people own a rental property together, this would be unlikely to fall
under the first limb of the definition of a partnership because they are not carrying on a business,
but would fall under the second, because they are earning income (rental income) jointly.
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A partnership is not a separate legal entity. Hence, it does not have a taxable income and it
cannot pay income tax in its own right. However, a partnership is considered a taxpayer for the
purposes of the tax legislation because it derives income.

The partnership itself must register an Australian Business Number (ABN) and for GST with the
ATO if the turnover of the partnership is at least $75 000 per annum (see Module 10). It is also
required to lodge a partnership tax return with the ATO. However, a partnership does not pay
income tax in its own right—any tax from income from the partnership is paid by the individual
partners in their own returns.

Tax status of a partnership

A partnership is a common form of tax structure. Partnerships allow for legitimate income
splitting under the taxation acts, and also allow individuals to pool capital, know-how and skill.

However, as stated in the previous section, the partnership itself is not taxed on the net income
of the partnership.

A partnership is instead merely a flow-through vehicle where each partner shares in the net
income of the partnership in proportion to the interest that the partner holds in the partnership.
The partner then includes their share of the net income from the partnership in the calculation of
their individual assessable income. The individual partners are therefore liable to pay tax on their
share of income derived from the partnership structure, and declare their share in their individual
tax returns.

Partnership income tax return

As previously mentioned, a partnership is required to lodge a partnership income tax return.

In the partnership tax return, the partnership includes its assessable income and deducts
its allowable deductions. The partnership will derive net income to the extent that the
partnership’s assessable income exceeds its allowable deductions. The term ‘net income’ of the
partnership is used instead of ‘taxable income’ as a partnership is not a separate legal entity
and does not pay tax. Hence, it does not have a taxable income.

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Once the net income of the partnership has been ascertained, this tax profit is distributed to
each partner (in the case of a partnership at general law) in accordance with their profit sharing
ratio as per the partnership agreement. This is the case, regardless of whether there has been
a cash distribution of the profit or not (see Rowe v. FC of T 71 ATC 4157).

Each partner consequently includes their share of the partnership distribution in their respective
income tax returns and pays tax on this partnership distribution at their respective marginal tax
rates (ITAA36, s. 92(1)).

Overview of partnership losses

If the partnership derives a loss, unlike a trust or company, the loss is distributed in that tax year
to each of the partners in accordance with their respective interests in the partnership. In other
words, unlike a company or trust, partnership losses are not quarantined within the partnership.

A partner is entitled to a share of any partnership loss according to that partner’s proportional
interest in the partnership. Each partner will be entitled to offset their share of partnership loss
against any other assessable income derived in the partner’s individual tax return.
 318 | TAXATION OF SBES AND PARTNERSHIPS

Determining the net partnership income/loss

Determining net partnership income or loss
Two key terms in this section, ‘net income’ and ‘partnership loss’, are defined as follows.

Net income is defined as assessable income of the partnership less all allowable deductions,
except:
1. tax losses of earlier years under Division 36 of ITAA97, which should have been claimed
in the tax returns of the individual partners in the year that the net partnership loss was
incurred, and
2. deductions for partners’ personal superannuation contributions under s. 290-150 of ITAA97,
which are generally deductible to the individual partners if they meet certain criteria
(s. 90 of ITAA36).

A partnership loss occurs where allowable deductions except 1 and 2 in the definition of net
income exceed the assessable income of the partnership (s. 90 of ITAA36).

The net income or loss of the partnership is calculated as if the partnership was a resident
taxpayer. Both Australian and foreign source income and deductions are assessed when
calculating the net partnership income.

Partner is a resident
Where a partner is a resident, the partner includes their share of net partnership income as
assessable income in their tax return. The partner derives their share of any exempt partnership
income and any non-assessable, non-exempt partnership (NANE) income. The partner is entitled
to their share of any partnership loss.

Where net partnership income includes franked dividends or foreign source income on which
foreign tax has been paid, the resulting franking credit (see Module 8) and foreign income
tax offsets (see Module 6) flow to the resident partners based on their share of these classes
of income.
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Partner is a non-resident for whole year

Special rules apply to non-resident partners. If a partner is a non-resident for the whole year,
that partner is only assessed on their share of the net partnership income attributable
to Australian sources, and is entitled to a deduction for their share of partnership losses
attributable to Australian sources.

Partner is a non-resident for part-year

If a partner is a non-resident for only part of the year, that partner will be assessed on their
share of partnership net income attributable to Australian sources, plus net income attributable
to foreign sources during the period of Australian residency. The same rules apply to a partner’s
share of losses, exempt income and NANE income.
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Example 7.6: Share of partnership income

Michael, Mica and Morris are partners in a small partnership operating a contract catering service.
Each of the three partners receives an equal share of any distributions. During the 2018–19 tax year,
the partnership received a franked dividend of $1200. The dividend statement showed $400 franking
credits attached.

The partnership met all the conditions to be eligible to claim the franking credit. As a result of receiving
the dividend, the partnership includes $1600 in the net partnership income that is shared by the
partners (i.e. $1200 + $400).

Each partner is assessed on their $533 share of the partnership income (being $1600 × 1/3), and is entitled
to a tax offset of $133 representing their proportionate share of the franking credit (being $400 × 1/3).

Tax administration
We now know that a partnership does not pay tax itself, but it is still required to calculate a net
income or loss as if it were a taxpayer in its own right.

The partnership is not required to make Pay-As-You-Go (PAYG) income instalments for the
partnership, as the payment of taxation is the responsibility of each individual partner based on
their share of partnership income. As such, it is the individual partners that pay PAYG instalments
based on the profit distribution and their other sources of income.

In order for the individual partners to be in a position to be able to pay PAYG on their own
individual quarterly activity statements, the partnership will need to calculate its income or loss
position at the end of each reporting period, and report this to the partners accordingly.

It is the individual partner’s obligation to pay tax on their share of the partnership income.

Calculating a partner’s share of tax payable

Non-commercial loss rules

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The non-commercial loss rules in Division 35 of ITAA97 apply to partnerships in a modified form.
These rules are discussed in further detail in the ‘Non-commercial loss rules’ section in Module 3,
which you should refer back to.

How do the non-commercial loss rules apply to partnerships?

These rules determine whether a partner is eligible to offset a loss from a business activity
in the partnership against other assessable income. When calculating whether the business
activity passes any of the four tests in Division 35, assets that are owned by partners who are not
individuals need to be excluded. Similarly, any assessable business activity income that goes
to partners who are not individuals must be excluded. Note that a person may be involved in a
business activity both as an individual and as a member of a partnership. In determining whether
the person is eligible to offset a loss, both partnership and individual income and assets need
to be taken into consideration.
 320 | TAXATION OF SBES AND PARTNERSHIPS

Rules concerning partnership losses where adjusted taxable income is less

than $250 000
As provided for in s. 35-10(2E), if the partnership’s adjusted taxable income is less than $250 000,
the taxpayer should also check if they pass any of the following four tests. If yes, then the
business losses derived by the partnership can be offset against individual taxation income.
If the taxpayer’s adjusted taxable income is more than $250 000, then they must defer the loss
to a future income year, or apply for the Commissioner of Taxation’s (Commissioner’s) discretion
in limited circumstances.

These tests are summarised in Table 7.6.

Table 7.6: Non-commercial loss rules

Tax Description

Assessable income Business has assessable income of at least $20 000 per annum.

Profits Business had a profit for tax purposes in three out of the past five years
(including the current year).

Real property Value of real property or of an interest in real property used in the business
on a continuing basis was at least $500 000.

Other assets Value of assets (excluding real property, cars, motorcycles and similar vehicles)
used on a continuing basis in carrying on the business was at least $100 000.

Source: Based on ATO 2018, ‘Four tests’, accessed December 2018,

https://www.ato.gov.au/business/non-commercial-losses/four-tests/.

Example 7.7: The assessable income test

Jarli is in business in partnership with Ross and a company. The partnership earned $22 000 assessable
income last year from the business activity.

Of that income, $4000 went to the company and $9000 to each individual in the partnership. Therefore
the partnership income would not be sufficient to allow Jarli to pass the income test ($22 000 − $4000
MODULE 7

= $18 000).

However, Jarli has an interest in the business activity outside the partnership. He received $3500 in
assessable income from this non-partnership interest, so that the total assessable income he can
count for the purposes of this test is $21 500 ($3500 + $9000 + $9000). Jarli’s adjusted taxable income
is below the $250 000 threshold; therefore, he is able to deduct the loss.

Ross cannot take into account the non-partnership assessable income earned by Jarli for the purpose
of this test. Ross does not satisfy the assessable income test.

Source: Adapted from ATO 2018, ‘Partnerships’, accessed December 2018,

https://www.ato.gov.au/business/non-commercial-losses/partnerships/.
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Example 7.8: The profits test

Neha and Raj operate a business activity as a partnership. This year, Neha and Raj both have adjusted
taxable income of less than $250 000. They each receive $5000 in income from the partnership and
have received the same amount for the past four years.

Raj does not have any tax deductions for his part in the business, so he has made a profit every year—
therefore, he has no loss to offset.

Neha took out a loan to finance her investment in the partnership and is paying $8000 a year in interest.
Therefore, she has made a net loss of $3000 every year for the past four years, but as she does not
pass the profits test she cannot offset her losses.

Source: Adapted from ATO 2018, ‘Partnerships’, accessed December 2018,

https://www.ato.gov.au/business/non-commercial-losses/partnerships/.

Example 7.9: Real property test

John, Bill and George are equal partners in a real estate business. The business has five offices.

The partnership owns four of the offices, which have a property value of $450 000. Bill and George
have no property interests in the business except as partners, so neither Bill nor George pass the real
property test as the property value is less than $500 000.

However, John has adjusted taxable income of less than $250 000 and owns the fifth office in his own
right. It is valued at $70 000. Adding the value of his property to the value of the property assets held in
partnership allows him to pass the real property test and claim a loss ($450 000 + $70 000 = $520 000).

Source: Adapted from ATO 2018, ‘Partnerships’, accessed December 2018,

https://www.ato.gov.au/business/non-commercial-losses/partnerships/.

Example 7.10: The other assets test

Marika and Bill both have adjusted taxable income of less than $250 000. They are in partnership with
Steelco Pty Ltd. They are equal partners in a manufacturing enterprise that has plant, equipment and
trading stock valued at $210 000.

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Steelco owns $70 000 of these assets and as Steelco is a company, this amount must be ignored for
the purposes of the other assets test.

However, as the balance is still above $100 000 ($210 000 − $70 000 = $140 000) both Marika and Bill
are entitled to deduct losses.

Source: Adapted from ATO 2018, ‘Partnerships’, accessed December 2018,

https://www.ato.gov.au/business/non-commercial-losses/partnerships/.
 322 | TAXATION OF SBES AND PARTNERSHIPS

➤➤Question 7.2
Garry and Joanne are partners in a business. The partnership commenced operations in March
2015 and has made profits in each of the past four income years.
The partnership carries on business in both Australia and Sweden. The net income of the
partnership for the year ended 30 June 2019 has been calculated as $80 000. The Australian-
sourced net income of the partnership came to $60 000. The Swedish-sourced income was $20 000.
According to the partnership agreement, Garry is entitled to 60 per cent of the partnership
profits and Joanne 40 per cent.
(a) Assuming that Garry and Joanne are both residents for Australian tax purposes, what is each
partner’s share of the net income of the partnership for the year ended 30 June 2019?

(b) Assume the same facts as above. However, this time assume that Garry is a resident and
Joanne is a non-resident for Australian tax purposes. What is each partner’s share of the net
income of the partnership for the year ended 30 June 2019?

$
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(c) Do the non-commercial loss provisions have any application to the partnership?

Check your work against the suggested answer at the end of the module.
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Partnership elections
Elections affecting the calculation of partnership income, such as valuation of trading stock
and method of depreciation, are required to be made by the partnership and not by the
partners individually.

The most important point is that an election made by the partnership applies to all partners.

Impact of salaries paid to a partnership

As previously mentioned, a partnership is not a separate legal entity. Partners cannot enter into
a contract of employment with the partnership.

The tax consequence of this status is that a partner’s salary is not deductible under the general
income provisions of s. 8-1, but rather the salary is distributed out of the net partnership income.
Broadly, the partnership salary does not change the size of the net income of the partnership.

However, a partner taking a salary does change how this net income is distributed between the
partners. It changes how much of the profit goes into each of the partner’s assessable income.

The salary is distributed to the relevant partner(s) and any residual amount of net income is
then split among the partners. The split of the residual distribution between partners is made
according to the profit-sharing ratio stated in the partnership agreement.

For example, if the partnership agreement says income will be distributed equally between three
partners, then that is how the income split will be made.

Partnership salary agreement

An agreement by the partners to pay a partnership salary to a partner is a contractual
agreement. This agreement is between the partners to vary the interests of the partners in
the partnership (and thus the partnership net income) between the partners.

For the agreement to be effective for tax purposes in a tax year, the agreement must be entered
into before the end of the applicable tax year.

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As the partnership salary is not a deduction, the payment of salary to a partner cannot result
in or contribute to a partnership loss for tax purposes. Furthermore, where the current year’s
partnership profits are not sufficient to cover a partner’s salary (taken as drawings in advance of
profits), the excess salary over the partner’s share of net partnership income is not assessable
income to the partner in that tax year.

The excess is assessable to the partner in a future tax year when sufficient profits are available
and the partner’s interest is also deducted (see the section ‘Alteration of partner’s interest’
for more on the impact of interest).

The following three examples show the application of a partner salary. They are taken
from Taxation Ruling (TR) 2005/7. The latest version of this taxation ruling was issued on
5 November 2014.
 324 | TAXATION OF SBES AND PARTNERSHIPS

Example 7.11: Implications of partnership salary agreements 1

Anna and Robert formed a partnership under which it was agreed that they would share the profits
and losses of the partnership equally. The partnership agreement allowed the partners to draw a salary
if the partners so agreed. It was agreed at the beginning of the income year that Anna would draw
a salary of $20 000, for managing the business, and that the balance of profits and losses would be
shared equally. The net profit after paying Anna’s salary was $35 000.

Determination of the net income is as follows:

$
Partnership profit (after deducting salary) 35 000
Plus:
Anna’s salary 20 000
Net income 55 000

The net income is then distributed, in accordance with the partnership agreement, being 50 per cent
each, as follows:

Anna: $
Salary 20 000
Plus interest in balance of net income:
50% of (55 000 – 20 000) 17 500
Distribution 37 500

Robert: $
Interest in balance of net income:
50% of (55 000 – 20 000) 17 500
Distribution 17 500
Total distribution 55 000

Source: Adapted from Taxation Ruling TR 2005/7, ATO Legal Database, accessed December 2018,
http://law.ato.gov.au/atolaw/view.htm?docid=TXR/TR20057/NAT/ATO/00001.

Example 7.12: Implications of partnership salary agreements 2

Christine and Julia formed a partnership under which it was agreed that they would share the profits
and losses of the partnership equally. The partnership agreement provided that in addition to this,
MODULE 7

Christine would be entitled to draw $20 000 a year for managing the business. The tax year’s net
(accounting) loss, after paying Christine’s salary, was $10 000.

Determination of the net income is as follows:

$
Partnership net loss (after deducting salaries) (10 000)
Plus:
Christine’s salary 20 000
Net income 10 000

The net income is then distributed, in accordance with the partnership agreement, being 50 per cent
each, as follows:

Christine: $
Salary: 10 000
Interest in partnership net income:
50% of ($10 000 – 10 000) 0
Distribution 10 000

Julia: $
Interest in partnership net income:
50% of ($10 000 – 10 000) 0
Distribution 0
Total distribution 10 000
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The $20 000 was taken by Christine as drawings in advance of profits. Christine’s drawings do not
affect her liability to tax, other than to determine her individual interest in the net income and loss of
the partnership under s. 92 of ITAA36.

The $10 000 drawn in excess of available profits will be met from profits in future years and be assessable
to Christine under subsection 92(1) of ITAA36 in that future year when sufficient profits are available.
If the partnership is wound up before this time, the $10 000 excess is repayable by her and thus not
assessable under subsection 92(1) of ITAA36 or s. 6-5 of ITAA97.

Source: Adapted from Taxation Ruling TR 2005/7, ATO Legal Database, accessed December 2018,
http://law.ato.gov.au/atolaw/view.htm?docid=TXR/TR20057/NAT/ATO/00001.

Example 7.13: Implications of partnership salary agreements 3

Christine and Julia formed a partnership under which it was agreed that they would share the profits
and losses of the partnership equally. The partnership agreement provided, however, that Christine
would be entitled to draw $20 000 a year for managing the business. The agreement regarding the
sharing of profits or loss is to be construed as an agreement to share equally in profits remaining after
the salary is taken into account, if any, and equally in losses. The 2018–19 year’s net (accounting) loss,
after paying Christine’s salary, was $30 000.

Determination of the net loss, for the purpose of completing the Statement of Distribution on the
Partnership return, is as follows:
$
Partnership net loss (after deducting salaries) (30 000)
Plus:
Christine’s salary 20 000
Net loss (10 000)

The net loss is then distributed, in accordance with the partnership agreement, being 50 per cent
each, as follows:

Christine: $
Interest in partnership net loss 50% of $(10 000) (5 000)
Distribution (5 000)

Julia: $

MODULE 7
Interest in partnership net loss 50% of $(10 000) (5 000)
Distribution (5 000)
Total distribution (10 000)

The $20 000 ‘partnership salary’ cannot create or increase a partnership loss. The salary was taken
by Christine as drawings in advance of profits. Christine’s drawings do not affect her liability to tax,
other than to determine her individual interest in the net income or loss of the partnership under
s. 92 of ITAA36.

The $20 000 drawn in excess of available profits will be met from profits in future years and be assessable
to Christine under subsection 92(1) of ITAA36 in that future year when sufficient profits are available.
If the partnership is wound up before this time, the $20 000 excess is repayable by her and thus not
assessable under subsection 92(1) of ITAA36 or s. 6-5 of ITAA97.

Source: Adapted from Taxation Ruling TR 2005/7, ATO Legal Database, accessed December 2018,
https://www.ato.gov.au/law/view/document?docid=TXR/TR20057/NAT/ATO/00001.
 326 | TAXATION OF SBES AND PARTNERSHIPS

Impact of interest paid to partners

Interest paid on monies advanced (lent) to the business by a partner is tax deductible to the
partnership if the partnership uses the funds for the purpose of producing income. The reason is
that the partner lends that money to the partnership not in their capacity as a partner, but in the
capacity of a lender.

However, the interest on a partner’s capital account or on a credit balance in a partner’s current
account (in other words, interest paid on a partner’s equity) is not deductible to the partnership.
The interest is merely an agreed means of distributing a partnership profit or loss, similar to
a partner’s salary. Interest debited to a partner’s current account is not regarded as income of
the partnership.

Where a partnership borrows money from a bank to repay in part, loans to the partnership
from partners (i.e. partner’s funds in their capital account), the interest paid will be deductible
to the partnership under s. 8-1 of ITAA97 provided the borrowed monies are used for working
capital purposes, which will subsequently allow the partnership to produce assessable income
(see FC of T v. Roberts; FC of T v. Smith [1992] 92 ATC 4380).

The Full Federal Court said that a deduction for interest on such financing would be limited to
the capital of the partnership. This includes:
• capital contributed by the partners
• retained profits.

Partners drawings are not taken into account in determining the net income of the partnership.
They are neither assessable to the individual partners nor deductible to the partnership for
taxation purposes.

The taxation consequences of interest, partner salaries and drawings on both the partnership
structure and individual partner are summarised in Table 7.7.

Table 7.7: Summary of taxation consequences of partner interest,

salaries and drawings
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Tax consequences

Transaction Partnership Partner

Interest on partner’s capital Non-deductible—merely Allocation of profits (s. 92)

account or credit balance on allocation of profits
current account

Interest on loan provided to Deductible Assessable interest

partnership by partner for income
producing purposes

Interest on loan provided to Deductible for a general law N/A

the partnership by bank to partnership (FC of T v. Roberts;
repay partners’ funds previously FC of T v. Smith [1992] ATC 4380)
used to generate partnership
assessable income

Salary paid to partners Non-deductible—merely Allocation of profits (s. 92)

allocation of profits

Drawings Ignored for tax purposes Ignored for tax purposes

Note: Partners are not entitled to a deduction under s. 8-1 for interest on borrowings to pay personal
income tax. This is a personal expense and is not incurred in deriving assessable income.

Source: CPA Australia 2019.

 Study guide | 327

➤➤Question 7.3
Susan and Jack formed a partnership in which it was agreed to share profits and losses equally.
As Susan would be more active in attending to the partnership business, it was agreed that she
be paid an annual salary of $30 000.
The accountant has just finalised the partnership results for the 2018–19 tax year and has advised
the partners that the partnership derived a net loss of $20 000 after paying Susan’s salary.
(a) For the purposes of completing the partnership tax return, what is the partnership net income
or loss?

(b) How is the partnership net income or loss as calculated in Part (a) to be distributed to each
partner for tax purposes based on the partnership agreement?

Check your work against the suggested answer at the end of the module. MODULE 7

Alteration of partner’s interest

Real and effective control of partnership income
Family partnerships could enter into income splitting arrangements through the inclusion of
children or adults as partners when they do not have the real and effective control and disposal
of their share of the partnership income.

To minimise this opportunity for loss of revenue, s. 94 of ITAA36 imposes special rates of tax
on certain partners who receive a share of uncontrolled partnership income.
 328 | TAXATION OF SBES AND PARTNERSHIPS

Where a person under the age of 18 years is allegedly a partner in a partnership, the minor’s
interest in the partnership income will be potentially subject to the provisions of Division 6AA,
as s. 94 is inapplicable to minors. Division 6AA was discussed in Module 6 (‘Tax treatment
of minors’).

Division 6AA basically allows the Commissioner to determine what is a reasonable return for the
time and effort put into the partnership by the minor together with a reasonable return on any
capital invested by the minor. Those amounts considered to be reasonable (‘excepted assessable
income’) will be taxed at normal rates, whereas any excess amounts referred to as ‘eligible
taxable income’ will be assessed at special rates (generally 45% plus 2% Medicare levy).

Alteration of partner’s entitlement to profit

Assignment of a partner’s interest in a partnership
A partner may assign their share, or part of their share, in a partnership with the consequence
that the net income of the partnership attributed to the assigned share is derived beneficially
by the assignee. These arrangements are referred to as an Everett assignment.

This principle was established by a full High Court decision in FC of T v. Everett 80 ATC 4076
(Everett’s case).

In Everett’s case, the taxpayer, a partner in a firm of solicitors, assigned by deed and for valuable
consideration six-thirteenths of his share in the partnership to his wife. Under the terms of
the assignment, Everett’s wife was not entitled to become a member of the partnership or to
interfere in the business. The High Court held that a partner’s interest in a partnership is a chose
in action (essentially a bundle of personal rights over property) that may be assigned in whole or
part. The assigning partner stands in the relationship of a trustee to the assignee who receives
the income as net income of a trust estate.

As a beneficiary, Everett’s wife was assessable on the trust income and Everett was not liable for
any tax on that income.

Taxation treatment of an Everett assignment: Capital gains tax provisions

MODULE 7

Where a partner has entered into an Everett assignment, the ATO will treat the assignment as a
disposal of a CGT asset (the partner’s interest, or part interest, in the partnership).

CGT provisions will apply to any disposal of a partner’s share of partnership assets acquired after
19 September 1985. The cost base of the partnership interest will be the amount of consideration
given by the partner to acquire the partnership interest (s. 110-25(2)), and as the assignment is
usually not an arm’s-length transaction, the consideration received on disposal of the assigned
partnership interest by the assignor would be deemed to be the market value of the interest
(s. 116-30). The market value of the interest is to be determined by discounting the expected
net cash flow accruing to the assigned interest by an appropriate rate.

Note: The ATO has suspended the application of the Everett assignment guidelines and web
material as of 14 December 2017. This means that those looking to enter into new Everett
assignment arrangements from 14 December 2017 can no longer rely on the ATO guidelines
and must contact the ATO individually. Those who have entered into assignments before
14 December 2017, which comply with the guidelines and do not demonstrate any high-risk
factors, can continue. Those arrangements demonstrating high-risk factors may be subject
to review. High-risk factors include the use of related party financing and self-managed
superannuation funds (SMSFs).
 Study guide | 329

During 2018, the ATO began consulting with stakeholders with a view to publishing draft
guidance on this issue. However, as at the date of writing, no such guidance has been issued
on this matter.

Treatment of expenses on assignment of a share in a partnership

Where a partner assigns their share of an interest in a partnership, any expenses incurred by the
assignor partner in connection with the partnership may have to be apportioned in accordance
with the interest assigned.

For example, if a partner assigns half their interest in a partnership, a deduction is only allowable
to the assignor partner for the share of the partnership interest not assigned.

Expenditure incurred by the assignor partner that is unrelated to the partner’s proportionate
interest in the partnership, such as subscriptions, travel expenses and depreciation of
professional library, remains fully deductible to the assignor partner.

Treatment of partnership loss

Where there is a partnership loss, the share of a partnership loss attributable to the assigned
interest is deductible to the assignor in the capacity of trustee for the trust estate of the
assigned interest.

This means that the loss will be carried forward in the trust estate and applied against trust
income in future years, and no deduction is allowed to the assignee in the year in which the
partnership loss is incurred (see Income Taxation Ruling (IT) 2608).

Alteration of profit/loss entitlements

Attempts by partners towards the end of the tax year to adjust the ratios in which they share
profits or losses for the year are ineffectual (established in Board of Review Case P73, 82 ATC 346
and Case Q53, 83 ATC 285). Two other case examples are described in Example 7.14.

Example 7.14: Alteration of profit/loss entitlements

MODULE 7
In the Board of Review Case W79 89 ATC 705, the Tribunal held that a decision to pay a salary to
one of the partners after the end of the tax year was an attempt to redistribute partnership income.
To make a decision to pay a salary after the close of the tax year was too late to alter what had derived.

In FC of T v. Nandan 96 ATC 4095 the Federal Court held that a dissolution agreement entered into
on the last day of the tax year to give one partner a fixed sum of $15 000 out of the final annual profit,
with the other partner receiving the remainder, displaced the original partnership agreement, which had
provided for both partners to receive 50 per cent of the profits.

General work in progress rule

Where a partnership returns income on an accruals basis, the value of work in progress is not
included in the net income of the partnership unless it creates a recoverable debt for which
the partnership is entitled to payment.

However, where, on the retirement or death of a partner, a payment for unbilled work in progress
is made to the retiring partner or to the trustee of the deceased’s estate as a reflection of the
partner’s future expected profit, that payment is assessable income to the retiring partner or to
the trustee of the deceased partner’s estate.
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General capital gains tax rule

It is the individual partners who make a capital gain or capital loss from a CGT event, not the
partnership itself. For CGT purposes, each partner owns a proportion of each CGT asset.
Each partner calculates a capital gain or capital loss on their share of each asset (ATO 2018b).

Each partner claims their share of a credit for foreign resident capital gains withholding amounts.

Dissolution or reconstitution of a partnership

At common law, the dissolution or reconstitution of a partnership occurs when there is a
change in the membership of the partnership.

This change may occur because of the death or retirement of a partner or the admission
of a new member, notwithstanding any clause in the partnership agreement.

A partnership is dissolved through:

• agreement of the partners
• the death or bankruptcy of a partner
• a court on application of a partner.

It should be noted that old partnerships, although dissolved, may continue to subsist for
purposes such as the collection of book debts.

A partnership is reconstituted where:

• a partner dies and the remaining partners agree to continue the partnership
• a partner retires and the remaining partners continue the partnership, or
• a new partner is admitted to the partnership.

If there is a change in the composition of a partnership (a partner retires, dies, or a new partner
is admitted) then the old partnership is dissolved and a new partnership is formed.

This means that, when a partnership is dissolved and then reconstituted, the partnership is
required to lodge a partnership tax return for both the old and new partnerships. This will show
the net partnership income or partnership loss to the date of dissolution (the old partnership)
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and from the date of reconstitution to the end of the tax year (the new partnership). The new
partnership may also need to apply for a tax file number (TFN).

Reconstituted continuing entity

A partnership can allow for multiple and successive partnership changes to be made via
the partnership agreement, thereby ensuring they do not need to meet the administrative
requirements mentioned previously. Where the partnership is a reconstituted continuing entity,
it only needs to lodge one income tax return covering the whole year using its existing TFN.
It does not need to have a new TFN or ABN.
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The ATO:
will treat a changed partnership as a reconstituted continuing entity if the original partnership
agreement incorporated a provision for a change in membership or shares and the following
factors apply:
• the partnership is a general law partnership
• at least one of the partners is common to the partnership before and after reconstitution
• there is no period where there is only one ‘partner’ …
• the partnership agreement includes an express or implied continuity clause or, in the absence
of a written partnership agreement, the conduct of the partners is consistent with continuity
• there is no break in the continuity of the enterprise or firm (ATO 2019).

Taxation consequences: Calculation

The taxation consequences of a partnership dissolution or reconstitution affect four main areas:
• trading stock
• depreciation (capital allowances)
• CGT
• GST.

The taxation consequences of the dissolution/reconstitution of a partnership are summarised

in Table 7.8.

Table 7.8: Tax consequences of dissolution/reconstitution

Trading stock Disposal taken into account at the partnership level in determining partnership
(s. 70-100 of ITAA97) profit and loss—partners receive their proportionate share.

Note: Election to treat trading stock at its tax value is possible if at least
25 per cent of the partner’s interest in the old partnership continues into the
new partnership.

Depreciation Balancing adjustments are considered at the partnership level to determine the
(s. 40-340 and 40-345 net income of the partnership.

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of ITAA97)
Note: Balancing adjustment will not be required if both the transferor(s) and
transferee(s) make a written joint election for rollover relief.

Capital gains Partnership entity is ignored and a fractional interest approach is taken.
(ss. 108-5(2)(c) and Each partner has a fractional interest in each and every partnership asset.
106‑5 of ITAA97)
Capital gains/losses are excluded from partnership calculations—these are
taken into account at individual partner level.

GST (GST Ruling Dissolution

(GSTR) 2003/13) • Part of carrying on the partnership’s enterprise.
• In-kind distribution deemed to be a supply in the course of an enterprise.

Reconstitution
• Reconstituted partnership retains its GST registration despite a change in
its membership.
• Change in membership does not give rise to any supplies or acquisitions
from one partnership to another partnership.

Source: CPA Australia 2019.

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Example 7.15: Admission of new partner to the partnership

Lucas and Eddie are equal partners in a business. The partnership acquired business premises to
run its business on 16 March 2012 for $240 000. The current market value of the property is $360 000.

Lucas and Eddie are considering admitting a third and equal partner, Melanie, into the partnership.
Melanie will contribute $120 000 for admission into the partnership.

What are the CGT consequences to Lucas and Eddie of admitting Melanie into the partnership?

The CGT consequences for Lucas and Eddie, respectively, on disposing of their one-third individual
interest are as follows.

Capital proceeds received for giving up one-third $

interest in CGT asset of partnership
(in this case capital proceeds equals half of the $120 000
contributed by Melanie for the one-third interests
disposed of by Lucas and Eddie) 60 000 each

Less: Individual cost base

Lucas and Eddie are deemed to have disposed
of one-third of their interest in the
partnership business premises (1/3 × $240 000 / 2) 40 000 each

Capital gain ($60 000 − $40 000) 20 000 each

CGT 50% discount (as held for more than 12 months) (10 000) each

Net capital gain 10 000 each

➤➤Question 7.4
On 1 July 2018 Pablo Alonso commenced business as an electrician in partnership with his wife,
Kate, and son Noah, aged 17. Noah still attends high school and works with his father on weekends
and the school holidays. The partnership agreement provides the following:
• Noah shall work in the business on weekends and on school holidays and be paid a salary
that is considered reasonable for the hours that he works.
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• Pablo will receive a salary of $25 000 per annum.

• The management of the business shall be the sole responsibility of Pablo.
• After payment of salaries, all profits and losses are to be shared equally between the three
partners.
For the year ended 30 June 2019, the partnership had net income of $45 000 after paying Pablo
a salary of $25 000 and Noah a salary of $6000 (which was considered reasonable).
 Study guide | 333

Calculate the net income of the partnership.

$ $

Check your work against the suggested answer at the end of the module.

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 334 | TAXATION OF SBES AND PARTNERSHIPS

Summary and review

This module has covered the core concepts of an SBE, including revisiting the definition
of an SBE and the core income tax concessions that apply to SBEs. These include the capital
allowances provisions, trading stock and CGT small business concessions.

An SBE must carry on business and meet the aggregated turnover test. The aggregated turnover
test is different for different areas of taxation—mainly the test is $10 million aggregated turnover
to meet the definition of an SBE. For the purposes of SBEs using the small business CGT
concessions, the aggregated turnover is $2 million.

The company tax rate of 27.5 per cent applies to base rate entities. For the year ended 30 June
2019, this tax rate applies to those entities with an aggregated turnover of less than $50 million
that have no more than 80 per cent base rate entity passive income (BREPI).

The small business income tax offset was also discussed, which reduces the tax paid by
an eligible sole trader and an eligible SBE. The small business tax offset is calculated on a
proportional rate up to a maximum of $1000 at 8 per cent for the 2018–19 income year. Net small
business income for the purposes of the income is all of the assessable income from eligible
business activities minus deductions.

The module then turned its attention to the taxation of partnerships. A partnership is not a
separate legal entity. Hence, it does not have a taxable income and does not pay income tax
in its own right. Instead, a partnership is required to include in its tax return all of its assessable
income less allowable deductions. The resultant figure is referred to as the ‘net income of the
partnership’. This amount is distributed to the partners in accordance with the profit sharing
arrangements in the partnership agreement.

This partnership distribution is included in each partner’s respective income tax return and tax
is paid by each partner based on their marginal tax rate. Where a partnership derives a loss,
unlike a trust and company, this loss is distributed to the partners and claimed as a deduction
to offset against their other income. In other words, a partnership loss is not carried forward
in the partnership.
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A partner’s salary is not deductible to the partnership but, instead, is regarded as part of the
profit distribution. However, interest paid by the partnership on an advance (or loan) made by
a partner to the partnership is considered an allowable deduction provided the funds were
used to produce assessable income.

A minor’s interest in the partnership income will be potentially subject to the provisions of
Division 6AA of ITAA36.

The module concluded with a brief discussion of Everett assignments and the CGT, trading stock,
depreciation and GST consequences regarding the dissolution or reconstitution of a partnership.
 Suggested answers | 335

Suggested answers
Suggested answers

Question 7.1
(a) To be treated as a SBE, Ballarat Accounting is required to carry on business and have an
aggregated turnover of less than $10 million in the 2018–19 income tax year. To access the
CGT concessions, its aggregated turnover must be less than $2 million (or the net asset
value test must be satisfied). Ballarat Accounting has an annual turnover of $250 000 for
the 2018–19 income year, so this is well below the $10 million threshold.

(b) Lucian’s eligible income for the purposes of calculating the small business tax offset is
$95 000 (i.e. $250 000 – $25 000 – $130 000).

The unfranked dividends received of $20 000 do not come into the calculation of net small
business income, but do form part of Lucian’s overall taxable income for the year ended
30 June 2019 of $115 000 (being the denominator in the small business tax offset formula

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shown below).

Tax payable on Lucian’s taxable income of $115 000 for the 2018–19 tax year is $30 047
(excluding the 2% Medicare levy). The Medicare levy is not included in computing the offset.

The rate of the small business tax offset for the 2018–19 tax year is 8 per cent. The amount
of Lucian’s small business tax offset is calculated as follows:

 $95 000 
8% ×  × $30 047  =
$1986 (rounded)
 $115 000 

The amount of Lucian’s small business tax offset is $1986. However, the maximum small
business tax offset that is able to be claimed is $1000. Hence, Lucian will receive $1000
(s. 328-360).
 336 | TAXATION OF SBES AND PARTNERSHIPS

(c) See the following calculation of net income:

$
Gross income 30 000
Minus partnership salary (14 000)
Minus allowable deductions (8 000)
Net income 8 000
Add back non-deductible salaries:
Salary—Charlie 14 000
Section 90 of ITAA36 Net partnership income 22 000

(d) See calculation of how the net partnership income is assessable and distributed as follows.

The net partnership income would be assessable as follows:

Charlie $
Salary (as agreed) 14 000
Partners share of residual ($22 000 – $14 000) × 0.6 4 800
Sub-total (Charlie) 18 800

Lucian
Share of residual ($22 000 – $14 000) × 0.4 3 200

Net partnership income 22 000

Charlie will declare $18 800 (which is his share of the partnership income) in his personal
income tax return and add it to his other income.

Lucian’s share of the income of the partnership is $3200. Lucian will declare this amount in
his personal income return and add it to his other income.

Return to Question 7.1 to continue reading.

Question 7.2
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(a) Assuming that Garry and Joanne are both residents for Australian tax purposes, their share
of the net income of the partnership for the year ended 30 June 2019 in accordance with
s. 92(1)(a) of ITAA36 is as follows:
$
Garry—resident ($80 000 × 60%) 48 000
Joanne—resident ($80 000 × 40%) 32 000
Net income of the partnership 80 000

Hence, Garry will include an amount of $48 000 in his 2019 income tax return, while Joanne
will include an amount of $32 000.
 Suggested answers | 337

(b) The share of the net income of the partnership for the year ended 30 June 2019 in
accordance with ss. 92(1)(a) and 92(1)(b) is as follows:
$
Garry—resident ($80 000 × 60%) 48 000
Joanne—resident ($60 000 Australian-sourced income × 40%) 24 000
Net income of the partnership 72 000

Garry will include an amount of $48 000 in his 2019 income tax return, while Joanne will
only include an amount of $24 000. This is her share of the Australian-sourced income
(i.e. $60 000).

(c) Despite the fact that the net income of the partnership is less than $250 000, the non-
commercial loss provisions do not apply due to the fact that partnership has derived a net
income. The non-commercial loss provisions contained in Division 35 of ITAA97 only apply
where the partnership has derived a loss for taxation purposes.

Return to Question 7.2 to continue reading.

Question 7.3
(a) Partnership net income
$
Partnership net loss after deducting Susan’s salary (20 000)
Add salary paid to Susan 30 000
Net income of partnership 10 000

(b) Net income of $10 000 as calculated in Part (a) is distributed as follows:

Susan $
Salary 20 000
Interest in partnership net income
50% of ($10 000 less $10 000) Nil
10 000

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Jack
Salary Nil
Interest in partnership net income
50% of ($10 000 less $10 000) Nil
Nil
Total distribution of partnership 10 000

The $30 000 salary taken by Susan represents a distribution of partnership profits in advance.

As the partnership’s net income was only $10 000, which has all been allocated to Susan due
to her salary entitlement, the excess of $10 000 over available profits will be assessable to
her in a future year when sufficient profits are available. The $30 000 salary does not affect
her liability to tax other than to determine her individual interest in the net income and loss
of the partnership.

Return to Question 7.3 to continue reading.

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Question 7.4
The net partnership of Pablo, Kate and Noah Alonso is as follows:

$ $
Net income after paying salaries 45 000

Add back non-deductible salaries:

Salary—Pablo 25 000
Salary—Noah 6 000 31 000
Net partnership income 76 000

The net partnership income would be assessable as follows:

Noah†
Salary 6 000
Share of residual ($76 000 – $31 000) / 3 15 000 21 000

Kate
Share of residual ($76 000 – $31 000) / 3 15 000

Pablo
Salary 25 000
Share of residual ($76 000 – $31 000) / 3 15 000 40 000
Net partnership income 76 000

†
As Noah is a prescribed person (i.e. a minor), his partnership distribution and salary will be subject to
the principles contained in Division 6AA of ITAA36. The salary (provided it is considered reasonable)
will be regarded as excepted assessable income and be subject to the normal rates of income tax
applicable to resident Australian taxpayers.

On the other hand, Noah’s share of the distribution of partnership income is likely to be regarded as
eligible taxable income and taxed at the special rates of tax contained in Division 6AA.

Return to Question 7.4 to continue reading.

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 References | 339

References
References

ATO 2017, ‘Small business restructure rollover’, accessed March 2019, https://www.ato.gov.au/
General/Capital-gains-tax/Small-business-CGT-concessions/Small-business-restructure-rollover/.

ATO 2018a, ‘Claiming the offset’, accessed December 2018, https://www.ato.gov.au/

business/income-and-deductions-for-business/in-detail/small-business-income-tax-
offset/?anchor=Claimingtheoffset.

ATO 2018b, ‘Guide to capital gains tax’, accessed December 2018, https://www.ato.gov.au/
forms/guide-to-capital-gains-tax-2018/.

ATO 2018c, ‘Small business income tax offset’, accessed December 2018, https://www.ato.gov.
au/business/income-and-deductions-for-business/in-detail/small-business-income-tax-offset/.

ATO 2019, ‘Partnership tax return instructions 2015’, accessed April 2019, https://www.ato.gov.au/

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forms/partnership-tax-return-instructions-2015/?page=13.
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