The Full Federal Court has handed down a split decision on a complex arrangement involving limited partnerships, dividends on a special class of shares, shareholder loans and the penalty regime. It is a surprising decision because of the disagreements between the three judges on some fundamental issues. What is not surprising is that this is yet another example of the ATO’s appetite to challenge complex private structures.
The structure, which appears to have been intended to avoid triggering deemed dividends under Division 7A, involved dividends paid from a company to the general partner of a limited partnership and loans to the same shareholder. It was apparently vital to the success of the structure that (i) the loans be made to an entity which was, or was deemed to be, a company and (ii) the dividends carry franking credits.
Existing provisions, in effect, treat a ‘corporate limited partnership’ as a company for all purposes of tax law, a ‘corporate limited partnership’ being a ‘limited partnership’ which meets certain additional conditions. The taxpayers admitted they were not partners in the usual sense – they were not carrying on business in common – but they argued that the fact of registration under the Queensland Partnership (Limited Liability) Act 1988 was conclusive of their status as a limited partnership. The ATO issued a Tax Determination in 2008 which treats the fact of registration as necessary but not sufficient to establish a limited partnership, and the Full Court agreed, albeit 2 to 1. The majority took the view that, notwithstanding the provisions of the Queensland Act which made a certificate of registration ‘conclusive evidence that the limited partnership was formed …’, only a partnership can become a limited partnership. Logan J took the view that once the certificate was tendered, the court was obliged to accept that the limited partnership existed, relying on overseas authority about the effect of registration and the extent to which it was conclusive.
The difference of opinion within the Court is troubling and hopefully the matter will be resolved quickly one way or the other. In the meantime, there is lesson here is about the need for vigilance in deciding which issues are matters of pure form and which involve a substantive pre-condition because the difference will not always be readily apparent.
The entitlement to franking credits on the dividends turned on whether the underlying shares remained equity interests or had become debt interests. The judges divided over whether:
- the company had received a ‘financial benefit’ when it collected the $10 subscription price for issuing 10 shares. The majority took the view that $10 was something ‘of economic value’; Logan J took the view that a financial benefit had to be more than a nominal amount. This view is an unusual reading of the provision; and
- there was an effectively non-contingent obligation to repay the $10. The company’s constitution provided that after 47 months each share, ‘shall be automatically redeemed at its issue price and cease to exist … whether or not its redemption price has been paid.’ The majority took the view that this clause resulted in the automatic and unconditional redemption of the shares at the issue price after 47 months which made the shares a debt interest and the dividend unfrankable. Logan J took the clause to mean the obligation to pay the redemption price was contingent. This reading is somewhat doubtful: while the redemption price might not be paid, the clause did not mean the company had a choice or discretion whether or not to pay the price. All the clause actually said was that the cancellation would proceed regardless of whether the redemption price had yet been paid, which is a rather different proposition.