Partnerships, Inter Vivos Trusts and Arrangements Achieving Similar Income-sharing Results

11.25. Under this heading the Committee considers in some detail income-sharing between relatives by means of a partnership, puts forward proposals for denial of tax advantages from income-splitting by this means, and then goes on to apply the principle of those proposals to trusts and other arrangements achieving generally similar income-sharing results. The other arrangements include those under which a business may be in the ownership of one or more persons but the operational skills, work effort and capital are supplied or in part supplied by a relative of the owner or owners in a manner which is not at arm's length; the ownership of income-producing assets is vested in one or more persons and the financing of the purchase has been by interest-free loans by a relative; and substantial property is leased to a relative, at a token rent, to enable the relative to derive the substantial rents from the sub-lessees.

11.26. In considering these income-sharing arrangements, it is necessary to have in mind that the Committee in Chapter 15 recommends a basis of assessment of income of an inter vivos trust to which no beneficiary is presently entitled. Attention here can thus be confined to the taxation treatment of income flowing from such a trust to a beneficiary in circumstances where the beneficiary is assessable on that income. It is also necessary to have in mind the recommendation earlier in this chapter that income of unmarried minors should be assessed at a rate based on parental income, and the recommendation that income arising from assets transferred between married couples, and others, by way of gift should be taxed to the donee in the normal manner.

11.27. As in most taxation systems, the partnership in Australia, though required to make a return, is not taxed as a single entity (section 91). As set out in more detail in

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Chapter 15, the partners themselves are taxed in separate assessments and their assessable incomes include their individual interests in the net income of the partnership (section 92). The only measure directed against income-splitting by the use of a partnership is section 94. That section provides that a partner who does not have the real and effective control and disposal of his share of the partnership income is taxed, unless the Commissioner by reason of special circumstances is of the opinion that it would be unreasonable, at a rate of not less than 50 per cent on that share of income (section 94). For this purpose a direct or indirect share of partnership income of a taxpayer under 16 years of age, as reduced by any amount genuinely attributable to remuneration for services rendered, is uncontrolled partnership income.

11.28. The Ferguson Commission (1932-34) recommended that the administration should not be concerned with the purpose for which a partnership is formed or with the relationship of the partners. The only test to be applied ought to be whether the partnership is bona fide or fictitious, and the partnership should be regarded as bona fide if each partner is the real owner of his share of the capital and profits of the partnership. In many instances, the result in practice of such a test is that the mere production of a partnership agreement meets the test and in almost any occupation provides a partner, frequently a wife or child, regardless of qualifications and despite the performance of services of a very minor nature, with a legal entitlement to a substantial share of the partnership profits. The test propounded by the Ferguson Commission is satisfied and the partners are taxed in accordance with section 92, but the reality of the situation is that the income of the effective owner and operator of the business or profession is split.

11.29. With the greatest respect to the Ferguson Commission, the Committee is unable to agree with its recommendation. The taxation treatment of a family partnership should not depend simply on the existence of a document which, as a matter of form, satisfies the requirements of the law of partnership but which readily presents itself as a vehicle for income-splitting by distributing the profits in arbitrarily determined proportions to relatives whose services (if any) in the partnership activities and/or whose capital or property contributions are not commensurate with the remuneration or share of profits received. The privacy attaching to an inter-familial contract is of itself sufficient to cast an onus upon relatives of displacing the possibility that the transaction they have entered upon is the product of a tax avoidance scheme. This is in keeping with the well-established principle that, where the relevant facts are solely within the keeping of one party, very little is required to change the onus relating to their disclosure. The fact that the partnership comprises family members requires that disclosure. The Commissioner is entitled to be made aware of the whole of the facts surrounding the formation of the partnership.

11.30. The whole of these facts are not necessarily established by the partnership agreement itself. Also relevant are the facts relating to the operation and control of the business, the manner in which its capital and property have been provided, and the relationship between the services performed and the capital and property provided by each of the partners and the remuneration each receives by way of salary and profit-sharing. Neither section 161 (1) of the Act nor Regulations 13 and 14 are sufficient in this regard. The Commissioner should be supplied, in a form accompanying the return of partnership income for the relevant year, with the appropriate information to enable him to be satisfied that the partnership is bona fide and that the individual interests of each partner in the partnership income, when measured in relation to his business or professional activities in the partnership and his provision of

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capital and property, are such as would reasonably be determined upon in all the circumstances by parties acting at arm's length. If the Commissioner was not so satisfied as to the share of any partner or some part thereof, that share or that part of the share should be taxed at a deterrent rate. Where an assessment was objected to, the issue for determination on appeal would not simply be, as it is at present, whether a partnership existed but whether the distribution of its income to each of its members was genuinely commensurate with their contributions of capital and property and their services to the partnership or whether the partnership agreement was merely a cloak for tax avoidance. The bona fide partnership would have no difficulty in resolving this issue in its favour. However, if the reality of the situation were otherwise, it should be apparent that the partners would be faced with the difficulty of proving the truth of the statements accompanying the return of income as to their respective roles and activities and their provision of capital and property in order to discharge the onus that lies upon them to displace the assessment. For this purpose the provision of capital and property to a partnership would not only include funds and assets overtly contributed as partnership capital. It would also extend to property, including loan moneys made available for use in the partnership business without recompense or on favourable terms, and any other benefit given or granted to the partnership by one or more partners but not by all partners according to their shares, such as land, livestock, plant, goodwill, etc. owned by one partner but used by the partnership without realistic recompense.

11.31. The determination of the amount of any share of partnership income to be taxed at a deterrent rate in accordance with what is set out above should also apply as the base figure for determining any liability to gift duty. Paragraphs 24.A54-24.A64 and 24.A67 deal with these questions for gift duty purposes. Thus, where in an equal partnership between a husband and his wife deriving income of $15,000 the Commissioner determines that $5,000 of the $7,500 allocated share of the wife is to be subject to a deterrent rate, that figure of $5,000 would be the base figure for gift duty purposes. As stated in paragraph 24.A105, that amount less the income tax payable on it would be treated as a gift.

11.32. Inter vivos trusts—trusts created by the creator or settlor of the trust during his lifetime—are frequently resorted to by a taxpayer to bring about a sharing of income with those of his relatives who are beneficiaries. In fact it is true to say that an inter vivos trust, where the income of the trust is distributed to the beneficiaries and becomes assessable to tax in their hands, can achieve the same purpose and result as the family partnership considered above. In the view of the Committee, distributions of income from trusts of this kind should be accorded the same tax treatment as distributions from family partnerships. Thus the Commissioner would be required to examine the whole of the facts surrounding the setting up of the trust and its operation and control. This examination would disclose whether the shares of income as allocated to beneficiaries, when measured in relation to their beneficial interest in capital and property of the trust and their business and/or professional contributions to the production of the trust income, are such as would reasonably be determined upon in all the circumstances by parties acting at arm's length. To the extent that the Commissioner could not be so satisfied, income or a part of income distributed would be subject to a deterrent rate of tax.

11.33. In relation to the other arrangements achieving income-sharing mentioned in paragraph 11.25, the Committee recommends the same treatment as for partnerships and inter vivos trusts. Thus, in the case of a business owned by one person and conducted and financed by a relative, including a spouse, the Commissioner would be

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enabled, in effect, to treat the business as a partnership between the relatives involved. Where the incomes derived by each relative could not be supported on the arm's length tests set out previously, the deterrent rate of assessment would apply. The same results would follow where the ownership of assets or property and certain leasing arrangements have been established and operated on bases not in accord with the arm's length test.