Contributed by Associate Professor Justin Dabner, Law School, James Cook University; Adjunct research fellow in Business Law and Taxation, Faculty of Business and Economics, Monash University
The Victorian Supreme Court decision in Danvest Pty Ltd & Anor v Commisssioner of State Revenue (Vic) 2017 ATC ¶20-611 once again demonstrates the difficulties in reconciling partnership jurisprudence. In holding that the partners did not have an interest in partnership assets that would attract stamp duty upon a sale of the partnership business, Croft J sought to resolve the apparently conflicting case law. In particular, his Honour took the view that the seminal authority of Canny Gabriel Castle Jackson Advertising Pty Ltd v Volume Sales (Finance) Pty Ltd  HCA 2; (1974) 131 CLR 321 did not hold that partners had an equitable interest in partnership assets.
This decision clearly has implications for stamp duty collections in Victoria and will no doubt lead to a legislative response if the case is not reversed on appeal. However, the other states have differently-worded and, typically, partnership-specific provisions so the stamp duty implications should be restricted to the one state. But what does it mean, if anything, for the application of the income tax legislation?
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A little bit of history: partnerships and the 1986 version of the CGT
Those who have been around for some time will recall the struggle 31 years ago trying to make sense of the original CGT legislation. The numbering, with all the ZZZs, was bad enough but making sense of the provisions was worse still. And we went nine months before we even saw the legislation that applied from 20 September 1985! The younger members of the profession don’t know how good they have it!
The application of the CGT to partnerships was a particular mess. This was a time when Everett assignments were all the rage. I can still recall the consternation when it was realised that all those assignments after 19 September, yet before we had seen and had a chance to interpret the legislation, were likely subject to CGT.
The fundamental problem was that the CGT legislation did not appear to appreciate the (hybrid) nature of a partnership. As it was not a separate legal entity like a company, with its settled principle that shareholders have no interest in company assets, there was a difficulty in restricting a partner’s interest in a similar way. Rather, could it be said that among the rights flowing from a partnership agreement partners had a direct interest in partnership assets? Ultimately, the intellectual resolution was to accept, at least for CGT purposes, that partners had interests at two levels, an amorphous indeterminate right deriving from the partnership agreement, which most advisers speculated was the interest at issue in FCT v Everett 80 ATC 4076, the second being an undivided beneficial interest in the assets. The authority for the later was taken to be Canny Gabriel.
The 1997 amendments
The rewrite of the CGT provisions in the 1990s was premised on plain English and to render the legislation comprehensible for someone with a reading age from around 15. However, it would have been an exceptional 15-year-old indeed who could have made sense of the CGT and partnership provisions in ITAA 1997 Div 106 when read with the definition of CGT asset in s 108-5(1) and (2). The redraft happily did confirm two things. Firstly, that we were not alone in finding it hard to apply the original provisions to partnerships. Secondly, our intellectual accommodation of the nature of a partnership for CGT purposes was sensible as the rewrite more or less seemed to adopt this approach.
Thus, the essence of s 106-5 is to treat partners as having a direct interest in each partnership CGT asset and there is a CGT event in relation to each partner’s interest whenever the members of the partnership change. The one curve ball is the note to s 106-5(3) that countenances the idea that when a partner sells their interest to someone who is not an existing partner the other partners’ interests are unaffected — completely at odds with the provisions but as it makes life easier no one is complaining. A problem with the general approach remains the record-keeping onus for remaining partners, as partners come and go, but with advances in computer power this should have become less of a problem over time.
But how are Everett assignments dealt with in the rewritten legislation? Is it countenanced that each partner holds a second tier asset which they can separately deal with without affecting the other partners? The answer seems to lie in the definition of “CGT asset” in s 106-5. Section 106-5(1) states, rather obliquely, that a CGT asset is any kind of property or a legal or equitable right that is not property. Everett’s case is authority for the proposition that partners have a chose in action that they can assign so this interest seems to be included in the definition no matter how it is charterised. But, just in case, s 106-5(2), commencing with those alarming words “to avoid doubt”, purports to confirm that certain interests are CGT assets including “(c) an interest in an asset of a partnership” (no problems there) and “(d) an interest in a partnership that is not covered by paragraph (c)”. Presumably, paragraph (d) was the draftsman’s peculiar way of confirming that the chose in action at issue in Everett’s case was definitely a CGT asset.
The Danvest litigation
Thirty-one years on from the intellectual rationalisation of partnerships on which the 1997 rewrite was based that rationalisation has now been challenged by the decision in Danvest.
At issue was whether stamp duty applied to the sale of a partnership interest. The legislative provisions at issue charged duty on the acquisition of dutiable property or a change in beneficial ownership of dutiable property. Dutiable property encompassed interests in an estate in fee simple. The partnership was structured such that the main property of the partnership was held by a company on trust for the partnership, with the shares in the trustee company held by the partners. On the sale of the interest, the shares and units issued under the partnership deed were transferred but the properties remained held by the trustee. Nevertheless, the Commissioner of State Revenue issued an assessment in the sum of $1,765,549 on the basis that there was either an acquisition of an interest in partnership property or there had been a change in the beneficial ownership of the underlying assets of the partnership.
The issue was a neat one as to whether the partners had an interest in an estate in fee simple in the partnership property that was capable of being transferred. Following an exhaustive consideration of the authorities, Croft J concluded that the partners had no equitable proprietary interest in the partnership assets and acquired no more than an equitable chose in action — the right to partnership property as a mere expectancy on the dissolution of the partnership and realisation of the assets: para  and . As such, it was a species of personal property: para .
The difficulty in coming to this conclusion was that there were authorities, including the High Court in Canny Gabriel, which made reference to partners having a beneficial interest, or some similar description, in partnership assets. His Honour was able to explain these references away on the limited vocabulary available in equity to describe the range of possible interests. Furthermore, the terminology was sometimes being applied to the relationship between partners which was to be distinguished from where the rights of third parties were at issue.
His Honour placed considerable reliance on the appellants’ arguments based on the more recent High Court decision in Commissioner of State Taxation (SA) v Cyril Henschke Pty Ltd & Ors 2010 ATC ¶20-228 in explaining that Canny Gabriel was not authority for the proposition that partners had an equitable interest in partnership property: para .
Applying these principles, his Honour held that although the corporate trustee held the property “for” the partners it otherwise had full legal ownership. It was not the case that where property is held on trust someone other than the trustee must necessarily be the owner of an equitable estate. It was not until the partnership was dissolved, a distribution declared or their interest was sold that a partner had a present entitlement to any partnership property: para .
So what now for partnerships and CGT?
If the Danvest decision stands then on one view s 106-5 is founded on a fiction. This is not unprecedented but history has demonstrated that “deemed” realities in the tax law based on a fiction inconsistent with the underlying substantive law can lead to unintended outcomes. Whatever the true nature of a partner’s interest in the partnership assets it is likely caught by the extended definition of CGT asset. However, elements of s 106-5 now are unclear. For example, if there is no change in beneficial ownership of partnership assets upon a sale of a partnership business then presumably CGT event A1 does not occur in relation to these assets. Maybe another event occurs (for example, CGT event H2) or a second tier type or lesser interest is treated as changing ownership.
The interpretation of s 106-5(2), (3) and (4) becomes particularly difficult with their reference to “interest” or “share” in a partnership asset. Maybe the answer lies in the inchoate meaning of “interest”, a point alluded to in Danvest. Possibly the provisions can still sensibly operate if we acknowledge partners as having an interest in partnership assets, just something less than a vested equitable interest, although how this fits with the examples may be problematic. Perhaps, the provisions have a deeming effect so that we can continue to apply the CGT provisions as in the past irrespective of the position under partnership law. The difficulty is that this is not clear and, in fact, both s 106-5(1) and (4) expressly defer to the partnership agreement and partnership law.
Possibly, there is an alternative view that the appeal court might adopt which might not only reconcile (most of) his Honour’s interpretation of Canny Gabriel with (most of) the CGT provisions but see a reversal of the decision that gives effect to the Victorian stamp duty regime. Justice Croft concedes that it is not until the partnership is dissolved that the partners obtain an interest in the partnership property. One interpretation could be then that on the instance of dissolution (when the units and shares were transferred on the facts) the existing partners acquired an interest in the partnership property, the beneficial ownership of which then passed immediately back to the corporate trustee to be held “for” the new partners.
The appeal decision is awaited with interest. It is suggested that, while not perfect, if the court adopted the above interpretation this might substantially maintain the integrity of the interaction of the three legal regimes.