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This draft Ruling sets out the Commissioner's preliminary, but considered view on when a Corporate Limited Partnership (CLP) 'credits' an amount to one of its partners within the meaning of section 94M of the Income Tax Assessment Act 1936. [1]

This draft Ruling does not deal with: • whether an amount credited to a partner in a CLP is against the profits or anticipated profits of the CLP, or • how the anti-overlap provisions apply to avoid double taxation where an amount credited is subsequently paid or distributed.

A CLP 'credits' an amount to one of its partners within the meaning of section 94M if, in substance, it applies or appropriates its resources to confer a benefit on the partner that: (a) is not subject to a condition precedent and is legally enforceable by the partner, and (b) is separate and distinct from the partner's existing interest in the CLP and its assets.

A mere credit entry in a CLP's accounts is not a crediting within the meaning of section 94M unless it records an underlying act or transaction that meets the requirements in paragraph 3 of this draft Ruling.

A CLP does not need to make a distribution or pay an amount to a partner in order for it to credit an amount to that partner.

If the requirements in paragraph 3 of this draft Ruling are satisfied a partner of the CLP is 'credited' with that amount, even if a future event may occur which requires the benefit to be relinquished or returned to the partnership.

CLPs and their partners are taxed according to the rules set out in Division 5A of Part III (Division 5A). [2] The object of Division 5A is to tax partners in CLPs as if they were shareholders in a company [3] , rather than as partners in a partnership (who are taxed under Division 5 of Part III).

Sections 94L and 94M deem certain distributions, payments and credits made by a CLP to a partner to be dividends. These deemed dividends are included in the partner's assessable income by subsection 44(1).

'Credits' is not defined for the purposes of section 94M. Nor is there any case law that has considered its meaning in that context.

The Oxford and Macquarie Dictionaries relevantly define 'credits' as credit entries in books of accounts that represent a right to obtain funds, record a payment made or a sum due. [4]

'Credits' is one of three events used in sections 94L and 94M to define when a dividend is deemed to be paid to a partner in a CLP. Those events are when an amount is distributed, paid or credited to a partner by the partnership. It follows that credits means neither paid nor distributed. [5]

This is consistent with the case law on the meaning of 'credits'. [6] The context [7] and case law, do however suggest that a crediting involves something akin to a payment or distribution. [8]

For an amount to be credited within the meaning of section 94M, there must be more than a mere credit entry in the CLP's accounts.

If the position were otherwise, it would create a tax treatment in respect of the profits of a CLP that is substantively identical to that created under Division 5. It would effectively mean the partners in CLPs are taxed on their individual interest in the net income of a CLP as if it were a normal partnership. [9] This is inconsistent with the object of Division 5A to tax partners in a CLP as if they were shareholders in a company. [10]

Such an approach would also mean that a partner in a CLP may be taxed on amounts they have not received in fact or substance, may never receive, and may have no right to demand payment of from the CLP. This is inconsistent with how shareholders in a company are taxed under section 44.

The case law shows that the first element required for there to be a crediting is that there must be an in substance appropriation or application of the resources of the CLP to confer a benefit on a partner. [11]

This distinction can be seen by contrasting McNeil's case, where the conferral of a proprietary right on a shareholder was found not to be a crediting, with cases in which the conferral of benefits was found to be a crediting. [12] In contrast to those cases, the benefit conferred on the shareholder in McNeil's case did not require, or involve, as a matter of substance, any application or appropriation of the company's resources.

The 'benefit' conferred on the partner which results from a crediting may be any type of legally enforceable right. For example, it may be a debt, [13] new property right [14] , a right to receive a distribution or payment, [15] or a release from a liability. [16]

The benefit conferred on the partner must be legally enforceable for there to be a crediting. [17]

If the benefit is subject to a condition precedent that prevents the partner from enforcing it, it will not be credited until the condition is satisfied and it becomes legally enforceable. [18] For example, where the 'benefit' is revocable by unilateral action of the CLP prior to it becoming enforceable by the partner, this will not be a legally enforceable benefit sufficient to amount to a crediting until it is no longer revocable. [19]

Section 94M deems payments out of anticipated profits to partners to be dividends when they are paid to the partner. This is so, whether or not the amount of the profits or anticipated profits is ascertainable or the amount may be required to be repaid if a future event occurs. For example a partnership agreement of a CLP may provide that payments of interim distributions of profits are to be repaid in some circumstances. For example, if the final annual profits are less than a specified level. [21]

Section 94L similarly deems a dividend to have been paid at the time that property is distributed by the partnership.

There is no reason why this treatment should not apply in relation to amounts credited under section 94M. This means that once a benefit is actually conferred on or received by the partner that meets the requirements in paragraph 3 of this draft Ruling there is a crediting to the partner within the meaning of section 94M. This is so even if the benefit is subject to a condition subsequent that may require it to be to be relinquished or returned to the CLP on the occurrence of a future event.

When determining whether a legally enforceable benefit has been conferred on a partner by the CLP it is necessary to consider: (a) the partnership agreement [22] (b) the laws governing: i. the partnership [23] , and ii. the benefit in question. [24]

These laws and agreements may contain restrictions that mean no legally enforceable benefit has been conferred on a partner. For example, where a partner's right to receive a distribution of profits from the CLP is said to be offset against the partner's unpaid obligation to contribute to the partnership liabilities. Such transactions may not satisfy the rules governing how limited partners may discharge their liability to make contributions towards the liabilities of the CLP and consequently confer no legally enforceable benefit on the partner. [25] This may be as a result of the transaction not being recorded in the CLP's statutory record. [26]

In considering whether a CLP has in substance applied or appropriated its resources to confer a legally enforceable benefit on a partner, relevant considerations include: (a) the legal result of the act or transaction [27] (b) how the act or transaction was recorded in the CLP's accounts, or what would have been recorded if the substance of the act or transaction was properly recorded [28] , and (c) either: i. acts or transactions that, while not actually occurring, would necessarily have to have occurred as a matter of fact and law in order for the legal result to be achieved [29] , or ii. alternative acts or transactions by which the benefit in question could have been conferred on the partner. [30]

The following involve an in substance application by a CLP of its resources to confer a legally enforceable benefit on one or more of its partners: (a) an act or transaction that creates an irrevocable and legally enforceable debt owing from the CLP to the partner [31] (b) a legally enforceable forgiveness by the CLP of a debt owed to it by one of its partners [32] , and (c) where permitted by the relevant partnership law, a limited partner giving up a right to receive a distribution of profits from the CLP: i. in return for a legally enforceable discharge of their unpaid obligation to contribute to the CLP's partnership liabilities [33] , or ii. as a means of making an additional contribution of capital to and increasing their interest in the CLP's capital and profits. [34]

The benefit that is conferred on a partner must be separate and distinct from their existing interest in the partnership. [35] For example, a new interest in the partnership and its profits [36] or the extinguishment of a debt owing. [37]

In order to identify whether a benefit received by a partner is separate and distinct from their existing interest in a CLP, it is necessary to identify what the partner's interest in the CLP and the partnership property was, immediately before the act or transaction.

When the final Ruling is issued, it is proposed to apply both before and after its date of issue. However, the Ruling will not apply to taxpayers to the extent that it conflicts with the terms of settlement of a dispute agreed to before the date of issue of the Ruling (see paragraphs 75 to 76 of Taxation Ruling TR 2006/10).

You are invited to comment on this draft Ruling, including the proposed date of effect. Please forward your comments to the contact officer by the due date.

A compendium of comments is prepared for the consideration of the relevant Rulings Panel or relevant tax officers. An edited version (names and identifying information removed) of the compendium of comments will also be prepared to: • provide responses to persons providing comments, and • be published on the ATO website at www.ato.gov.au. Please advise if you do not want your comments included in the edited version of the compendium. Due date: 30 June 2017 Contact officer details have been removed following publication of the final ruling.