Issue
Is the capital expenditure incurred by the partners of an existing partnership to obtain legal advice in relation to a technical dissolution and reconstitution of the partnership 'expenditure to convert your business structure to a different structure' for the purpose of paragraph 40-880(1)(b) of the Income Tax Assessment Act 1997 (ITAA 1997)?
Decision
Yes. The legal expenses incurred by the partners are expenditure to convert the existing partnership structure to a different partnership structure for the purpose of paragraph 40-880(1)(b) of the ITAA 1997.
Facts
Partnership ABCDE carried on a business for a taxable purpose. The partnership originally had five partners, A, B, C, D and E. In the 2002-03 income year, partners A, B, C and D made a determination under the partnership agreement which resulted in partner E exiting the partnership. Partners A, B, C and D acquired the interest of exiting partner E in the partnership. The exit of partner E from the partnership resulted in a technical dissolution of partnership ABCDE. Partners A, B, C and D continued to carry on the business as reconstituted partnership ABCD.
The partners of partnership ABCDE incurred legal expenses to obtain legal advice on the formation of the reconstituted partnership and the transfer of business assets from partnership ABCDE to reconstituted partnership ABCD.
Reasons for Decision
Subject to the exclusions in subsection 40-880(3) of the ITAA 1997, paragraph 40-880(1)(b) of the ITAA 1997 provides a deduction for capital expenditure incurred by a taxpayer to convert their business structure to a different structure. The term 'business structure' covers the legal entity or the legal relationship that is established as the entity that will carry on the business for a taxable purpose and that will hold the business assets.
The Explanatory Memorandum accompanying Taxation Laws Amendment Bill (No. 5) 2002 distinguishes between an internal reorganisation and a change in business structure and states that the type of structural change intended by paragraph 40-880(1)(b) of the ITAA 1997 is about 'how' something was held and not 'what' was held.
The fractional interests held by the partners in the reconstituted partnership ABCD represent two different interests: one which they originally acquired when they formed partnership ABCDE; and the other which they acquired from exiting partner E upon the technical dissolution of the partnership.
The different fractional interests held by the partners in partnership ABCDE and those held in reconstituted partnership ABCD evidences a change in how the fractional interests in the different partnerships are held. This change falls within the type of structural change intended to be covered by paragraph 40-880(1)(b) of the ITAA 1997.
The technical dissolution of partnership ABCDE and reconstitution of partnership ABCD is, therefore, a conversion from one business structure to a different business structure for the purpose of paragraph 40-880(1)(b) of the ITAA 1997. Accordingly, the legal expenses incurred to obtain legal advice on the formation of the reconstituted partnership and the transfer of business assets from partnership ABCDE to reconstituted partnership ABCD satisfy the requirements of paragraph 40-880(1)(b).
That portion of the legal expenses referrable to the establishment of the reconstituted partnership may also satisfy the requirements of paragraph 40-880(1)(a) of the ITAA 1997 being 'expenditure to establish your business structure'. However, paragraph 40-880(1)(b) of the ITAA 1997 is the more appropriate paragraph to consider in the particular circumstances of this case because it applies to a conversion of structure and paragraph 40-880(1)(a) applies to the establishment of an initial business structure (see section 8-10 of the ITAA 1997).