Taxation Ruling
IT 2125
Prescribed payments system - credit for deductions of tax from prescribed payments made to a partnership, or the trustee of a trust estate
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FOI status:
May be releasedFOI number: I 1122259PREAMBLE
The question has been raised as to the way in which the prescribed payments system (PPS) credit provisions (sections 221YHF and 221YHG of Division 3A of Part VI of the Income Tax Assessment Act 1936) operate in a situation where the Commissioner receives a deduction form or deduction forms in relation to deductions made in a year of income from prescribed payments to a partnership or to a trustee of a trust estate.
2 In particular, there has been some confusion as to the operation of the law where -
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- a partner in the partnership or a beneficiary of the trust estate is not subject to tax, e.g., the income of the person does not exceed the tax-free threshold represented by the zero rate step in the personal income tax scale or the person is exempt from tax;
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- a "salary" is paid to a partner under the terms of a partnership agreement; or
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- a trust estate has no net income for the year of income or sustains a loss.
3 The purpose of this ruling is to provide general guidelines in relation to the operation of sections 221YHF and 221YHG in allocating and allowing PPS credit.
RULING
Partnerships
4 Sub-section 221YHF(2) sets out the entitlement of partners in a partnership to the credit for PPS deductions made in a year of income from prescribed payments to the partnership. Each partner is entitled to a credit for a part of the tax deducted, determined in the proportion that the partner shares in the net income of the partnership from PPS activities in the year of income or in the net loss from PPS activities. This rule also applies where a partnership deriving PPS income also returns income from another source; the PPS credit is allocated in the same proportion as each partner shares in the net PPS income (or PPS loss) component of the total net income (or loss) of the partnership.
5 The credit allocated to a partner in accordance with sub-section 221YHF(2) is then applied in accordance with the terms of section 221YHG, even though the partner will have no tax liability on his or her distribution, e.g., because the person's taxable income will not exceed the tax-free threshold represented by the zero rate step in the personal income tax scale or because the person is exempt from tax. In this latter regard, however, the special arrangements discussed in paragraphs 18-21 may be applied in some circumstances where a partner/beneficiary (or trustee) has no tax to pay in relation to a particular year of income.
6 In practice, the allocation of PPS credit to a partner in the same proportion that he or she shares in the net income/loss of the partnership will be accepted on the assumption that he or she also shares in the net PPS income/loss in that proportion. In the case where the distribution of the credit is in accordance with the sharing of the net PPS income/loss, but this differs from the basis of sharing in the net income/loss, the partnership return should include an explanation of the basis of distribution of the credit.
7 Consideration has been given to the question of the allocation of PPS credit where partners draw a "salary" and the amount of the drawings is taken into account in determining each partners' share in the net income or net loss of the partnership. Some guidelines are set out below. In applying the principles outlined, it should be borne in mind that the basic rule of the law requires PPS credit to be allocated between partners on the same basis as they share in the net PPS income/loss of the partnership. It is always open to partners to distribute particular income in accordance with the terms of the partnership agreement and, where this has been done and PPS credit distributed accordingly, full details should be disclosed in the return in support of the basis of allocating the credit.
8 Where a partnership profit remains after charging salaries, there is a clear indication of the partners' intentions regarding the manner in which they have agreed to share the net income of the partnership as defined in section 90 of the Assessment Act. Therefore, any PPS credit will be available to partners in the same proportion as they share in the overall net income of the partnership. The following example shows the manner in which the individual credit entitlements of partners will be calculated in these cases (it is assumed that the partners share profits equally after payment of the salary). In fact, the distribution of credit accords with the distribution of income as it should be returned in column (5) of item 1 on the Form P.
| $ | |
|---|---|
| Partnership net income for section 90 purposes | 2000 |
| Salary - Partner A | 1000 |
| Partnership profit after charging salary | 1000 |
| Distribution as between partners - | |
| Partner A - salary $1000 plus $500 (50% of profit of $1000 after salary) = | 1500 |
| Partner B - (50% of profit of $1000 after salary) = | 500 |
$1500 / $2000
3/4 of available credit
$500 / $2000
1/4 of available credit
9 The charging of partners' salaries may result in either the conversion of what would otherwise be the net income of the partnership to a loss, or an increase in the partnership loss. The following examples indicate the manner in which the individual credit entitlements of partners is to be calculated in these cases :
Example A
$ Partnership net income - section 90 400 Salary - Partner A $1600 Partner B NIL 1600 Partnership loss after charging salaries (1200)
If the partners share any profit/loss equally then column (5) of item 1 on the Form P would appear as:
$ Partner A 1000 profit Partner B (600) loss
Partner A is the only partner who could have received the $400 net income and therefore all the PPS credit should be allowed to Partner A.
Example B
$ Partnership net income - section 90 1600 Salary - Partner A $1800 Partner B $1000 2800 Partnership loss after charging salaries (1200)
If the partners share any profit/loss equally then column (5) of item 1 on the Form P would appear as:
$ Partner A 1200 profit Partner B 400 profit
However, the PPS credit will be allocated in accordance with the distribution of the net income in the terms of the partnership agreement so long as each partner's salary exceeds the relevant share of the net income. In this case the credit would be distributed equally.
Example C
Where the level of a partner's salary is such that it is less than what would otherwise be his or her share in the net income, the partner's share in the distribution will be taken to be only the amount of the salary. The balance of that partner's net income will then be assumed to be available for distribution to the other partners in the proportion that they share the balance of the net income.
$ Partnership net income - section 90 1600 Salary - Partner A NIL - Partner B $200 - Partner C $800 2800 - Partner D $1800 Partnership loss after charging salaries (1200)
If the partners are to share the net income/loss equally, column (5) of item 1 on the Form P would appear as:
$ Partner A (300) loss Partner B (100) loss Partner C 500 profit Partner D 1500 profit
Partner A would normally be expected to receive a distribution of $400. As, however, Partner A received no salary he or she will not share in the net income and is not entitled to any PPS credit. Partner B would also be expected to receive a $400 distribution but in fact will share only to the extent of $200. He or she is to be entitled to one-eighth of the credit (200/1600). Partners C and D would share in the net income to the extent they would have otherwise shared the balance after Partners A and B received a share, viz one-half of $1400, namely $700 each. They would each share in the PPS credit to the extent of seven-sixteenths.
Example D
$ Partnership net loss - section 90 (3000) Salary - Partner A $6000 Salary - Partner B $1000 7000 Partnership loss after charging salaries (10000)
If profits/losses are shared equally column (5) of item 1 on the Form P would appear as:
$ Partner A 1000 profit Partner B (4000) loss
However, any PPS credit is to be shared on the basis that the partners are, in the terms of the partnership agreement, to share the net loss calculated in accordance with section 90, i.e. equally in this case.
10 In this Ruling, the reference to "salaries" paid is to those salaries payable under a partnership agreement where the amounts are reasonable in the light of the personal services provided by the partners to the partnership and the salaries have not been paid as a result of agreement entered into after the close of an income year. Any adjustments made as a consequence of the application of the principles adopted by the Board of Review in Case T69, 18 TBRD 353 would be taken into account in applying this Ruling.
Trusts
11 Sub-section 221YHF(3) sets out the entitlement of a trustee, or a beneficiary in a trust estate, as the case requires, to credit for PPS deductions made in a year of income from prescribed payments to the trustee.
12 A beneficiary assessed to a share of the net income of a trust estate under section 97, that is attributable wholly or in part to prescribed payments to the trustee of the estate, is entitled to a credit for PPS deductions made from the prescribed payments determined in the proportion that the beneficiary's share of the net income from PPS activities bears to the net income from those activities. Similarly, the credit available to a trustee assessed under section 98 or under sections 99 or 99A respectively is to be determined on the same basis.
13 Where a trust estate has no net income in a year of income, or sustains a loss, the trustee of the trust estate is, by virtue of paragraph 221YHF(3)(d), entitled to the credit for any PPS deductions made in the year of income from prescribed payments to the trustee.
14 The allocation of credit to a beneficiary or a trustee entitled to a share of the net income of a trust in accordance with the terms of sub-section 221YHF(3) is then applied in the terms of section 221YHG, even though in a particular case there will be no ultimate tax payable.
Application of Credit
15 Section 221YHG sets out the rules for the application of the credit for PPS deductions to which a person is entitled under section 221YHF.
16 Where a partner in a partnership or a beneficiary in a trust estate has on assessment in a year of income a liability to income tax, the amount of PPS credit to which the partner or beneficiary is entitled under section 221YHF in the year of income must be applied first against that income tax liability, with any excess being applied against any outstanding income tax liability of other income years. Any credit then remaining is available for refund.
17 The law operates in a similar manner to apply credit for PPS deductions made from income to which the trustee of a trust estate is liable to be assessed under section 98 or under sections 99 or 99A against the tax liability of the trustee in respect of the relevant assessment. Any excess credit is to be applied in full or part payment of any other tax payable by the trustee under section 98 in respect of a share of the particular beneficiary of the net income of the trust estate of any other year of income, or under section 99 or 99A in respect of the net income or a part of the net income of the trust estate of any other year of income, as the case may be.
18 In some partnership and trust returns which have been lodged, PPS credit has not been allocated in accordance with the provisions of section 221YHF to each person who has shared in the PPS income. Returns lodged on this basis have generally been those where the relevant persons have been entitled to only small distributions of partnership or trust income which, together with other income (if any), will result in them having no tax to pay. It is acknowledged that, in such cases, the allocation of PPS credit only to partners/beneficiaries (or trustee) who have a tax liability results in reduced administrative burdens and is also consistent with the basis on which rates of PPS deductions are calculated for the purpose of issuing a deduction variation certificate.
19 Reflecting these considerations, it has been decided that special arrangements should be implemented to avoid the need to issue refunds for PPS credit allocated in accordance with the terms of section 221YHF to partner/beneficiaries (or trustee) who have no tax to pay. These arrangements will be limited to cases where the relevant share of the net income of the partnership or trust estate is less than the applicable tax-free threshold of the partner/beneficiary (or trustee) concerned, and that person, taking into account other assessable income (if any), will have no tax liability. As a means of implementing this arrangement, any partner/beneficiary (or trustee) in this situation who wishes to have his or her refund of PPS credit applied for the benefit of those partners/beneficiaries (or trustee) who will, in fact, have a tax liability, will be required to advise the Commissioner that he or she will have no tax to pay and authorise the Commissioner to apply that refund of PPS credit otherwise available for the benefit of those other persons.
20 At a practical level, the amount of the refund will be set-off against the tax assessed in the assessment of the partner/beneficiary (or trustee) to whom it is to be applied as if it were PPS credit allocated to that person. In such cases, the Commissioner will also exercise his discretion under sub-section 221YC(1A) of the Assessment Act to ensure that the additional amount so allowed to the taxable partners/beneficiaries (or trustee) is taken into account in calculating any provisional tax of the year of income of the person.
21 For the 1983-84 year of income the lodgement of a partnership or trust return allocating no PPS credit to those partners/beneficiaries (or trustee) whose share of the income is less than the relevant tax-free threshold will be taken to be a statement by those persons that they will have no tax to pay for that year and an authority for the Commissioner to apply the refund otherwise available to the other partners/beneficiaries (or trustee) in the manner indicated in the return. In future years, it will be necessary for each partner/beneficiary (or trustee) concerned to include in the return form a statement in the terms of paragraph 19.
COMMISSIONER OF TAXATION
14 December 1984