This information will explain our administrative treatment of the acquisition and disposal of interests (practice interests) in ‘no goodwill’ professional partnerships, trusts and incorporated practices (practices).
Professional practices are traditionally structured in one of two ways, either recognising goodwill or not recognising goodwill in determining whether practitioner entities have to pay to join the practice.
In a 'no goodwill' professional practice the practitioner entities agree that when a new practitioner entity is admitted into the practice they are not required to pay an amount which reflects a value for any goodwill of the practice. Further, when the practitioner exits the practice, they are not entitled to receive a payment which reflects a value for any goodwill of the practice.
These guidelines are concerned with the application of provisions in the tax law which potentially apply where entities carrying on ’no goodwill’ professional practices acquire and dispose of a practice interest for an amount which may differ to the interest’s market value. For example, the guidelines may apply to the acquisition or disposal of a practice interest during either:
- the admission or exit of practitioner entities into and out of the professional practice during the natural course of its business
- a takeover or merger involving more than one practice.
Broadly, the guidelines are concerned with arm’s length dealings between practitioner entities that are unrelated, aside from their involvement in the practice. Accordingly, the guidelines do not apply to the following dealings:
- practitioner entities and entities who are not and will not become a participant in the practice (for example, an ‘Everett assignment’)
- commonly owned or controlled entities (for example, internal restructures or reorganisations).
The provisions in the tax law that potentially apply relate to capital gains tax (CGT), employee share schemes (ESS) and off-market buy-backs (OMB).
This document is intended to highlight the circumstances when the administrative treatment will be available, rather than provide a technical analysis of the issue.
See also paragraphs 22 to 30 of IT 2540 Income tax: capital gains: application to disposals of partnership assets and partnership interests which outlines the ATO view for the tax consequences of a partner in a partnership entering into an Everett assignment
Administrative treatment
The administrative treatment will apply in relation to a tax issue set out in the following table where they adopt the treatment corresponding to that issue and satisfy the guidelines set out below.
|
Tax issue |
Provisions |
Applicable treatment |
|---|---|---|
|
CGT: Calculation of cost bases and reduced cost bases of the practice interest |
Section 112-20, Income Tax Assessment Act 1997 (ITAA 1997) |
The market value of the practice interest at the time of acquisition is treated as being equal to the amount the taxpayer pays (including nil) in respect of the acquisition. |
|
ESS: Calculation of a discount (if any) on the issue of shares in an incorporated practice |
Section 83A-20, ITAA 1997 |
The market value of the practice interest at the time of acquisition is treated as being equal to the amount the taxpayer pays (including nil) in respect of the acquisition. |
|
CGT: Calculation of the capital proceeds in respect of a CGT event happening to a practice interest |
Section 116-30, ITAA 1997 |
The market value of the practice interest at the time of disposal is treated as being equal to the amount the taxpayer receives (including nil) in respect of the disposal. |
|
OMB: Calculation of consideration in respect of an off-market share buy-back of shares in an incorporated practice |
Subsection 159GZZZQ(2), Income Tax Assessment Act 1936 (ITAA 1936) |
The market value of the practice interest at the time of disposal is treated as being equal to the amount the taxpayer receives (including nil) in respect of the disposal. |
Where the administrative treatment is applied, the following conditions must be met:
- The administrative treatment must be applied to all applicable tax issues set out above.
- The CGT treatment of assets which are exchanged for practice interests subject to the guidelines should be determined on a consistent basis.
Where a taxpayer adopts the administrative treatment in relation to an applicable tax issue, we will not undertake compliance action in relation to that issue if they satisfy the requirements in the guidelines set out below.
These guidelines only apply in relation to the tax issue identified above. They do not apply in relation to other tax issues, for example, in determining whether an amount represents a share of the net income of a partnership or trust or a dividend from a company.
Guidelines
For the administrative treatment to apply in relation to the applicable tax issues set out above the taxpayer must satisfy all of the following requirements.
Practitioner entity
The first requirement is that the taxpayer (practitioner entity) must both:
- carry on or participate in the carrying on of a professional practice
- be one of the following
- partner in a partnership carrying on that practice
- shareholder in a company carrying on that practice
- beneficiary of a trust (including a unit holder) carrying on that practice.
For the purposes of these guidelines an entity is also a practitioner entity where they will start to satisfy the above conditions upon acquiring a practice interest or cease to satisfy them upon disposing of such an interest (see further below). The practitioner entity can be an individual, trustee or company.
For the purposes of these guidelines, a practice is a professional practice if both of the following are met:
- Practice income is derived mainly from the provision of services involving the exercise of specialised knowledge and skill of members, excluding services that are commonly considered to be provided by tradespersons (such as plumbers, mechanics, electricians, etc).
- The conduct of its members would normally be regulated by legislation, regulations or other professional standards of conduct and ethical behaviour administered by a professional body or association or regulatory authority.
Applicable circumstances
The second requirement is that the dealings and relationships between the parties satisfy all the following conditions:
- The governing documents of the practice provide that
- in the case of a partnership – consideration payable and receivable by a practitioner entity for the acquisition and disposal of a practice interest in goodwill will be nil or a nominal amount
- in any other case – consideration payable and receivable by a practitioner entity for the acquisition and disposal of a practice interest will be determined on the assumption that the value of goodwill is nil or a nominal amount.
- The governing documents have no further provision relating to consideration for practice interests, or such documents provide that:
- in the case of a partnership – consideration payable and receivable by a practitioner entity for the acquisition and disposal of a practice interest in assets other than goodwill will be nil or a particular amount
- in any other case – consideration payable and receivable by a practitioner entity for the acquisition and disposal of a practice interest will be determined on the assumption that the value of certain assets other than goodwill will be nil or a particular amount.
- An acquisition or disposal occurs in the circumstances covered above.
- The following parties have an arm’s length relationship with one another immediately before the acquisition or disposal
- the acquiring entity (if any)
- each practitioner entity (if any) who disposes of a practice interest which the acquired interest represents or is reasonably attributable to.
- The evidence reasonably supports the conclusion that both of the following represent arm’s length dealings
- the governing documents
- the acquisition and/or disposal transaction.
- The practitioner entity applies the treatment in these guidelines to all acquisitions or disposals covered above.
Governing documents
For the purposes of the guidelines, the term ‘governing documents’ refers to the partnership deed, trust deed, constitution, shareholders’ agreement or other document governing the ongoing relationship between practitioner entities or the operation of the practice.
Practice interest
For the purposes of these guidelines, a practice interest is an interest of a practitioner entity comprising one of the following:
- an interest in a CGT asset of a professional practice structured as a partnership
- a share in a company carrying on a professional practice
- a unit or other interest in a trust carrying on a professional practice.
Arm’s length relationship
For the purposes of condition 4, the term ‘arm’s length relationship’ is intended to have its ordinary meaning. However, a practitioner entity will not be regarded as being in a non-arm’s length relationship with another entity merely because the other entity is either:
- a practitioner entity in the same professional practice
- an individual who is a relative of the practitioner entity (or another practitioner entity) for income tax purposes.
We accept that it is possible for parties dealing at arm’s length to come to an agreement about the future value of an asset; see Granby v. FC of T 95 ATC 4240. However, such an agreement must be reasonably capable of explanation in terms of the commercial or business objectives of a professional practice, and not in terms of an arrangement where the parties have colluded to achieve some ulterior objective.
See also the definition of ‘relative’ in subsection 995-1(1) of the Income Tax Assessment Act 1997.
Arm’s length dealing
For the purposes of the guidelines, the term ‘arm’s length dealing’ has its ordinary meaning.
An arm’s length relationship is to be distinguished from an arm’s length dealing. The former is concerned with the nature of any connection between the parties, whereas the latter is concerned with the nature of a particular transaction between them.
If the parties agree that nil or nominal consideration is payable in respect of interests in practice assets which have been purchased for substantial consideration, it may be inferred that those parties are not dealing at arm’s length.
Particular amount
For the purposes of the guidelines, the term ‘particular amount’ is intended to convey the need for consistency between the treatment of acquisitions and related disposals.
Application
These guidelines replace guidance formerly contained in:
- Taxation Ruling IT 2540 (paragraphs 13 and 14).
- Tax Determination TD 2011/26 (withdrawn).
- Draft Tax Determination TD 2011/D9 (withdrawn).
- Draft Tax Determination TD 2011/D10 (withdrawn).
These guidelines will be applied to all income years, including income years prior to their date of issue.
The guidelines and other compliances issues
The administrative treatment does not apply to other tax compliance issues. In cases where other compliance issues are evident, taxpayers may be subject to compliance action. This would include cases of:
- non-recognition of net capital gains (other than those affected by these guidelines)
- transfer pricing
- misuse of the superannuation system
- promotion of schemes
- repeated failure to lodge returns or a history of late lodgment of returns
- income injection into entities with carry forward losses
- trust reimbursement arrangements
- avoidance of Division 7A
- inappropriate access to low income tax offsets or other benefits
- non-tax advantages that are dependent on taxable income.
Need help?
If you need advice about how the law will apply to you, including the tax consequences of any proposed restructure of your arrangements, you can submit an Early engagement advice request.
Examples
Example 1: Applicable acquisitions and disposals
Chan Partners (CP) is a professional practice conducted by Mr Chan, Ms Brown and Mr Bruni. Under the CP partnership agreement, no amount is payable when a partner joins CP, nor is any amount receivable when a partner exits CP.
New partner
Ms Diamond joins CP as a new partner. At that time, CP’s assets comprise goodwill, work in progress and a trade debtor (trade debtor 1). Ms Diamond does not pay anything to acquire her interest in these assets. The guidelines apply to the acquisition of her interest in CP.
As a result of Ms Diamond joining CP, CGT events happen to the interest of Mr Chan, Ms Brown and Mr Bruni in the assets of the partnership. The guidelines also apply to the disposal of their fractional interests to Ms Diamond when she joins CP.
Internally generated assets
Mr Chan, Ms Brown, Mr Bruni and Ms Diamond perform services. As a result, they create, and acquire an interest in new work in progress and a second trade debtor (trade debtor 2). The partners do not need to apply the guidelines to these acquisitions.
Disposal of internally generated assets
Mr Chan, Ms Brown, Mr Bruni and Ms Diamond then dispose of their interests in trade debtor 1 as a result of CP receiving payment for work performed. The guidelines do not apply to these CGT events.
This is the case, even though the guidelines applied to Ms Diamond when she acquired her interest in trade debtor 1.
Partner retirement
Mr Chan retires from the firm. He should apply the guidelines to the CGT event that happens to his interests in goodwill, work in progress and trade debtors.
As a result of Mr Chan’s retirement, Ms Brown, Mr Bruni and Ms Diamond acquire additional interests in the goodwill, work in progress and trade debtors. The guidelines apply to the partner's acquisition of these interests as a result of Mr Chan retiring from CP.
Sale of practice assets
Chan Partners receive an offer from Boris Partners, a professional practice unrelated to Chan Partners, to purchase the practice of Chan Partners and all of the partnership assets for $1 million, being the market value. Ms Brown, Mr Bruni and Ms Diamond accept the offer. The guidelines do not apply to the CGT events which occur in relation to their interests in these assets.
End of example
Example 2: Admission of an unrelated partner
The ABC partnership (ABC) has 100 partners and carries on a professional practice. The assets of ABC comprise internally generated receivables, work in progress, contractual rights and goodwill.
The partnership agreement for ABC provides that no amount is payable on admission of a partner, nor is any amount receivable when a partner exits the partnership. Mr Chrysler becomes a partner in ABC. He does not pay anything for his interest in the partnership. There is no pre-existing relationship between Mr Chrysler and any of the other partners of ABC.
Mr Chrysler’s entry into the partnership causes CGT events to happen to a part of the interests of the other partners in the assets of ABC. Capital proceeds in respect of those events are taken to equal the market value of those interests when Mr. Chrysler becomes a partner of ABC. The administrative treatment will be available to the other partners of ABC in relation to the CGT treatment of their part-interests in the assets of ABC if they treat the market value of those interests as nil for the purposes of determining:
- the capital proceeds in respect of their disposal
- their cost bases and reduced cost bases – to the extent that they were interests in partnership assets held by ABC at the time of their admission (for example, goodwill).
Example 3: Admission of a related partner
The facts in this example are the same as those in Example 2, except that Mr Chrysler is the son of Mr. Morris, another partner in ABC.
In accordance with the guidelines and in the absence of further facts, the administrative treatment will apply to Mr Morris in relation to the CGT treatment of his part-interest in the assets of ABC. For the purposes of condition 4 of the guidelines, the parties will not be treated as being in a non-arm’s length relationship because of the family relationship between Mr Morris and Mr Chrysler.
Mr Chrysler’s admission to ABC was on the same arm’s length terms and conditions which would apply to the admission of other partners. Further, for the purposes of the administrative treatment, the parties will not be treated as being in a non-arm’s length relationship merely because Mr Chrysler is Mr Morris’ son.
In the absence of any further evidence suggesting the existence of a non-arm’s length relationship between the parties, the administrative treatment can apply.
End of example
Example 4: Retirement of an IPP: arm’s length
Mr Dank, Ms Evans and Mr Frawley are unitholders in the DEF Unit Trust (DEF), which carries on a professional practice. The assets of DEF comprise internally generated receivables, work in progress, contractual rights and goodwill.
The trust deed for DEF provides that a nominal amount is payable or receivable when an individual professional practitioner (IPP) or an entity associated with the IPP, becomes or ceases to be a unitholder. Mr Frawley became a unitholder in DEF on 1 July 2010.
On 30 June 2018, Mr Frawley retires from DEF. His units are acquired by the remaining unit holders, Mr Dank and Ms Evans (in equal proportion), for the nominal amount.
Mr Frawley’s retirement causes a CGT event to happen to him upon disposal of his units in DEF. Capital proceeds in respect of that event are taken to equal the market value of his units at the time of his retirement.
In accordance with the guidelines, the administrative treatment will apply to Mr Frawley in relation to the CGT treatment of his units in DEF if he treats the market value of those units as the nominal amount for the purposes of determining:
- the capital proceeds in respect of his disposal of his units in DEF
- his cost base and reduced cost base – to the extent that they were interests in assets (for example goodwill) held by DEF at the time he acquired his units.
Example 5: Retirement of an IPP: inconsistent treatment on acquisition and subsequent disposal of a practice interest
The facts are the same as in Example 4, except that Mr Frawley determines that the market value of his interest in the goodwill of DEF was $100,000 at the time he acquired his units. Mr Frawley uses that amount as the cost base and reduced cost base of his interest in the goodwill in DEF.
The administrative treatment will not apply to Mr Frawley to determine the capital proceeds in respect of his interest in the goodwill of DEF as he did not apply the guidelines in determining the cost base and reduced cost base of that interest.
It should be noted that the non-availability of the administrative treatment to Mr Frawley will not impact the availability of the administrative treatment to the other unitholders in DEF.
End of example
Example 6: Transfer of an IPP’s interest: not at arm’s length
The facts in this example are the same as those in Example 4, except that instead of Mr Dank and Ms Evans acquiring Mr Frawley’s units in DEF he transfers his units to the trustee of the Frawley family trust (FFT). FFT is a trust which Mr Frawley effectively controls. FFT pays the nominal amount to become a unitholder in DEF.
Mr Frawley asserts that he did not transfer anything of value to FFT and that even if he did, the transfer occurred at arm’s length on the same terms as would apply to a transfer to an unrelated entity.
The administrative treatment will not be available to Mr Frawley as:
- the interest acquired by FFT can reasonably be regarded as corresponding to the interest disposed of by Mr Frawley
- there is a non-arm’s length relationship between Mr Frawley and FFT.
Example 7: Retirement not at arm’s length
On 1 July 2010, Mr Covic, Ms Brand and Mr Pham are partners in the GHI partnership (GHI), which carries on a professional practice. At that time, the assets of GHI comprised internally generated receivables, work in progress, contractual rights and goodwill.
The partnership agreement for GHI provides that no amount is payable or receivable when an individual professional practitioner (IPP) or an entity associated with the IPP, becomes or ceases to be a partner.
On 1 July 2012, the partners each contribute $100,000 in additional equity to GHI to enable GHI to purchase shares in an investment company.
On 30 June 2018, Mr Pham retires from GHI. He does not receive anything for his interest in the partnership.
Without further facts, the administrative treatment may not be available to Mr Pham. It would be necessary to investigate this arrangement further to determine whether the parties are dealing at arm’s length. In particular, it would be necessary to determine why Mr Pham did not receive anything in respect of his shares in the investment company, despite having contributed significant funds to the partnership to enable it to acquire those shares.
End of example
Example 8: Merger of two professional firms: parties at arm’s length
The JKL partnership (JKL) carries on a law firm, which has 40 partners who specialise in corporate, employment and family law matters. The assets of JKL comprise internally generated receivables, work in progress, contractual rights and goodwill. The partnership agreement for JKL provides that no amount is payable or receivable when an individual professional practitioner (IPP) or an entity associated with the IPP becomes or ceases to be a partner.
The MNO partnership (MNO) also carries on a law firm which has 4 partners and specialises in intellectual property matters. The assets of MNO comprise internally generated receivables, work in progress, contractual rights and goodwill. The partnership agreement for MNO also provides that no amount is payable or receivable when an IPP or an entity associated with the IPP becomes or ceases to be a partner.
JKL often refers intellectual property matters to MNO and as a result, the two firms have developed a close working relationship with each other. However, JKL believes it would be more efficient for both firms if their practices merged. MNO agrees and enters into discussions with JKL to discuss the terms of the proposed merger. The parties enter into a merger agreement that provides that no amount is payable or receivable when an IPP or an entity associated with the IPP becomes or ceases to be a partner in the merged firm.
For the purposes of applying the guidelines, the parties to the merger will not be treated as being in a non-arm’s length relationship merely because of their pre-existing work relationship.
The administrative treatment will be available to the partners of MNO in relation to the CGT treatment of their part-interests in the assets of MNO when the MNO partnership merges if they treat the market value of those interests as nil for the purposes of determining:
- the capital proceeds in respect of their disposal
- their cost bases and reduced cost bases – to the extent that they were interests in partnership assets held by MNO when they acquired their initial interest in the partnership (for example, goodwill).
Furthermore, the administrative treatment will be available to the other partners of JKL in relation to the CGT treatment of their part-interests in the assets of MNO if they treat the market value of those interests as nil for the purposes of determining:
- the capital proceeds in respect of their disposal
- their cost bases and reduced cost bases – to the extent that they were interests in partnership assets held by JKL when they acquired their initial interest in the partnership (for example goodwill).
Example 9: Everett assignment: parties not at arm’s length
A professional practice has 60 partners who share equally in the profits of the firm. The firm does not operate a service entity.
On 15 July 2017, the partners decide that it would be acceptable for the partners of the practice to enter into an Everett assignment if they choose to. On that date Mr A, a Partner of the practice, assigns 50% of his interest to the A Family Trust. The A Family Trust is a trust which Mr A effectively controls. The A Family Trust does not pay anything to acquire an interest in the professional practice from Mr A.
The administrative treatment will not apply to Mr A as:
- there is a non-arm’s length relationship between Mr A and the A Family Trust and they are not dealing at arm’s length as there was no consideration paid by the A Family Trust when Mr A assigned his interest
- the making of the assignment is not to a current or future practitioner or the professional practice.
Example 10: Incorporated practice: parties at arm’s length
On 1 July 2010, Ms Cannon became a practitioner-shareholder in X Pty Ltd (X), which carries on a professional practice. Under the X constitution, X shares are traded at a fixed price of $1 per share. Ms Canon purchases 10 shares. Assets of X comprise internally generated receivables, work in progress, contractual rights and goodwill.
Ms Canon decides to retire from the practice. X cancels the shares issued to Ms Canon and pays her $10 for her 10 shares.
The cancellation causes CGT events to happen to the shares held by Ms Canon. Capital proceeds in respect of the event are taken to be the market value of the shares at the time of Ms Canon’s retirement, worked out on the assumption that the cancellation did not and was not proposed to occur.
The administrative treatment will apply to Ms Canon in relation to her CGT treatment of the shares if she treats the market value of the shares as being $1 per share for the purposes of determining:
- the capital proceeds in respect of their disposal
- their cost bases and reduced cost bases.
Example 11: Employee share scheme
Young Pty Ltd (Young) is an incorporated professional practice. Under Young’s constitution, shares in Young are traded at a fixed price of $10 per share.
On 30 June 2018, Mr Young retires and Ms Old, a current employee practitioner within Young, is promoted and acquires an ownership interest in the firm.
The administrative treatment will apply to Ms Old in relation to her application of the ESS provisions to this acquisition. The market value of the shares is treated as being the same as the amount she pays such that no discount is taken to arise.
End of example
Example 12: Off market buy-back
Z Pty Ltd (Z) is an incorporated professional practice. Under Z’s constitution, shares in Z are traded at a fixed price of $10 per share. Mr X acquires shares in Z at a fixed price of $10 per share and becomes a practitioner-shareholder in Z.
Several years later on 30 June 2018, Z has receivables, work-in-progress and goodwill. At this time, Mr X retires from Z and his shares are bought-back for $10 each and cancelled, as part of an off-market share buy-back.
The administrative treatment will apply to Mr X in relation to his tax treatment of the buy-back proceeds if he assumes that the buy-back price of the shares is not less than their market value for the purposes of subsection 159GZZZQ(2) of the ITAA 1936.
End of example