On 17 May 2017, the Australian Taxation Office (ATO) released a draft taxation ruling which deals with the question of when a corporate limited partnership (CLP) credits an amount to a partner in the partnership. Until the issue of the Draft Ruling, there has been little guidance as to what `credits' means in the context of the application of the tax rules applicable to CLPs. The uncertainty has historically resulted in additional potential risk for Australian limited partners of CLPs in determining the amount and time at which they should recognise amounts allocated to their accounts as assessable dividends. Whilst clarity provided by the Draft Ruling is welcome, affected investors in CLPs now should consider a number of critical questions and potential actions which are raised by the ATO's preliminary views.
Draft Taxation Ruling TR 2017/D4 intends to clarify the meaning of `credits' for the purposes of section 94M(1) of the Income Tax Assessment Act 1936 (ITAA 1936). This provision operates to ensure that an amount which a CLP pays or credits against the profits or anticipated profits of the partnership, or otherwise in anticipation of the profits of the partnership, to a partner will be a deemed dividend paid out of profits. Submissions can be made on the ATO's draft view until 30 June 2017.
Overview of the current tax treatment of CLPs
For context, it is important to understand the current provisions that govern the taxation of CLPs, which are contained in Division 5A of the ITAA 1936. These provisions broadly state that:
1. A CLP is treated as a company for Australian income tax purpose (other than CLPs that are treated as foreign hybrid limited partnerships under Division 830 of the Income Tax Assessment Act 1997 (ITAA 1997),
2. Subject to limited exceptions, a reference to dividends in the Australian income tax law includes a reference to a distribution made by a CLP to a partner in the CLP, and
3. If a CLP pays or credits an amount to a partner in a partnership against the profits or anticipated profits of the CLP or otherwise in anticipation of the profits of the CLP, the amount paid or credited is taken to be a dividend paid by the CLP to the partner out of profits derived by the CLP.
The Draft Ruling focuses exclusively on the third point, specifically when an amount is `credited' under section 94M(1) of the ITAA 1936.
The Commissioner's view in the Draft Ruling
Under section 94L and 94M(1), a deemed dividend can arise in relation to a CLP where an amount is distributed, paid or credited. Because the provisions specifically refer to three different scenarios, the Draft Ruling contends that the term `credits' in the context of the section means neither paid, nor distributed.
The Commissioner's preliminary view is that a CLP `credits' an amount to a partner for the purposes of section 94M(1) if it applies or appropriates its resources to confer a benefit to that partner which:
- is not subject to a condition precedent and is legally enforceable by the partner, and
- is separate and distinct from the partner's existing interest in the CLP and its assets
The Draft Ruling reasons that this approach is consistent with the purpose of Division 5A to tax the partners of a CLP as if they were shareholders in a company. Furthermore, to suggest that a mere accounting credit entry (in the absence of the above factors being satisfied) gives rise to a crediting under section 94M would align the tax treatment of CLPs with the tax treatment applicable to a normal partnership. This is inconsistent with how shareholders of a company are taxed, and would also mean that a partner of a CLP is taxed on amounts that they have no right to demand from the CLP, which they may never receive.
Where a CLP has `credited' an amount, the Draft Ruling indicates that this `crediting' holds true even if a future event occurs which requires the credited amount to be relinquished or returned to the partnership (although it does not provide examples of circumstances in which this may occur).
In applying the principles in the Draft Ruling, the Commissioner recommends that the following questions are asked:
The application of the above principles is demonstrated by seven examples in the Draft Ruling. The examples consider a wide range of scenarios and principles which are summarised very briefly below:
In our view, the Draft Ruling provides helpful clarity regarding when an amount is `credited' for the purposes of section 94M. However, it also should prompt limited partners to consider the following:
a) whether their method for recognising dividends from a CLP aligns with the methodology outlined in the Draft Ruling (including reviews of existing LPAs to confirm when amounts should be `credited'),
b) whether there are any specific facts and circumstances that are not considered in the Draft Ruling, for which additional clarity should be requested as part of the consultation process, and
c) Follow up discussions with custodians or general partners to check that their process for declaring and recognising dividend income from these investment is in accordance with the Draft Ruling.
Where the taxpayer's approach has differed to the approach outlined in the Draft Ruling, consideration should be given to whether amendments are required to prior period calculations.
For taxpayers that have historically treated `mere credits' as assessable, they should consider whether historic amendment periods have closed, and whether there is any risk of double taxation when amounts are subsequently `credited' in accordance with the Draft Ruling.
The discussion regarding the term `credited' may also be relevant for other parts of the income tax law (for example, the term is also used with reference to dividends, and in the context of withholding taxes). The Draft Ruling is silent on its application to other parts of the income tax law.
Submissions can be made to the ATO in response to the Draft Ruling by 30 June 2017 to highlight different approaches or request clarity on circumstances not contemplated by the Draft Ruling.
As part of this process, taxpayers may also wish to revisit or reconfirm the positions that they have taken in relation to other practical and technical nuances associated with the taxation of CLPs. These include:
- Distinguishing between returns of capital and dividends, including the level of analysis of underlying information that is required to make this assessment.
- Considering the application and overlap with other provisions of the law (including the capital gains tax provisions, section 45B of the ITAA 1936, and section 94M(2)) to ensure that distributions from a CLP are not double taxed at the partner level.