This session continues from last week’s discussion of Harvey v Harvey and turns to the question that necessarily follows: how does section 106-5 of the ITAA 1997 operate where a partnership holds (or appears to hold) a CGT asset, and what does the section actually do under each of the three partnership models considered last week? The provision is poorly drafted, sits in tension with the general law of partnership, and its operation under the Barwick, Walsh/Menzies and Baumgartner models is materially different — a difference the Commissioner’s published views do not engage with.
Section 106-5 predicates a hypothetical interest of each partner in each CGT asset of the partnership. Under the general law no such interest exists — a partner has only a chose in action against the firm and a right to share in the surplus on dissolution (United Builders Pty Ltd v Mutual Acceptance Ltd [1980] HCA 43; FCT v Everett (1980) 143 CLR 440). The section therefore operates on a fiction, and the strain on that fiction differs sharply between the three Harvey models. Where the model is Walsh/Menzies, there may be no partnership CGT asset at all for 106-5 to attach to. Where the model is Baumgartner, the constructive trust crystallises retrospectively and 106-5 is asked to operate on an interest declared as at a past date. Where the model is Barwick, the section has actual partnership assets to bite on, but the proportionate interest it predicates remains hypothetical and is unstable in any partnership where capital and profit ratios are variable.
Discussion Focus
- The hypothetical interest at the heart of 106-5. Subsection 106-5(2) treats each partner as having a separate cost base for an interest in each CGT asset of the partnership. The general law does not recognise a severable interest of that kind. Participants should consider whether the section can be made to work other than by a broad and purposive construction, and what the gulf between the taxation jurisprudence and the general law position means in practice.
- Operation of the section under each Harvey model. Under Barwick, the section has work to do but the proportionate interest is hypothetical. Under Walsh/Menzies, the section may have nothing to attach to because the contributed land is not a partnership asset and the contributing partner retains it. Under Baumgartner, the section is asked to operate on an interest crystallised retrospectively at the date of relationship breakdown or dissolution. We will work through the consequences of each.
- Formation, dealings between partners, and the contract CGT asset. Formation raises the difficulty that 106-5(4) cannot literally apply because the partnership does not exist before the contribution. Dealings between partners raise the question of whether the section’s deeming sits at odds with what the contract between buyer and seller actually does. The contract CGT asset under section 108-5(2)(d) raises a question about the section’s reference to value rather than interest.
- The discretionary partnership overlay. Where profit ratios and capital ratios are reset by partner resolution from time to time, the hypothetical interest predicated by 106-5 is not just hypothetical but also unstable. We will consider whether changes during the life of the firm trigger a CGT event at all, and whether the partners’ rights in the partnership contract remain choses in equity until dissolution.
- Self-generated goodwill. Where partnership goodwill has been built up over time and has no cost base, and a new partner is admitted to the firm, the deeming in 106-5(3) and (4) requires all existing partners to be treated as having yielded up a share of goodwill they cannot identify. The section’s reference to “the extent of an interest in the underlying CGT assets” assumes an actual general-law interest that does not exist. This is where the incoherence of the section is most exposed.
Conclusion
Section 106-5 is the bridge between the general law of partnership and the CGT regime, and it is a bridge that does not quite reach the other side. The Commissioner’s published views assume the section works cleanly. Applied to the three models we considered last week, it does not — and the gap between what the section says and what the general law allows is where the planning and compliance questions in this area arise.
Please see below link to materials which is assumed reading in order to participate in the discussion:
Harvey v Harvey (1970) 120 CLR 529
Discussion led by Joseph Primerano.