House of Representatives

Tax Laws Amendment (2009 Measures No. 2) Bill 2009

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon Wayne Swan MP)

Chapter 2 Increase access to the small business capital gains tax concessions

Outline of chapter

2.1 Schedule 2 to this Bill amends the law to increase access to the small business capital gains tax (CGT) concessions for taxpayers owning a CGT asset used in a business by an affiliate or entity connected with the taxpayer and for partners owning a CGT asset used in the partnership business. This Schedule also makes a number of other minor amendments to clarify and refine elements of the small business CGT concessions.

Context of amendments

2.2 The small business CGT concessions were introduced to provide small business operators with access to additional funds for retirement or to grow their businesses. The concessions are the:

·
15-year exemption;
·
retirement exemption;
·
active assets 50 per cent reduction; and
·
small business roll-over.

2.3 Tax Laws Amendment (Small Business) Act 2007 (Small Business Act) introduced a single definition of a small business entity, which replaced various threshold eligibility tests for accessing the range of small business concessions, including the CGT concessions. The single definition was introduced to simplify and standardise the various small business concessions.

2.4 In broad terms, a small business entity has to carry on a business and its yearly aggregated turnover has to be less than $2 million. The Small Business Act retained the existing alternative eligibility criteria for accessing the small business CGT concessions for entities that do not meet the new small business entity test but increased the maximum net asset value threshold from $5 million to $6 million.

Entities holding passive assets

2.5 The introduction of the $2 million small business turnover test and the retention of the $6 million net asset value test resulted in a difference between how the two tests treat businesses with passive asset structures (ie, where one entity owns a CGT asset and an affiliate or an entity connected with the asset-owning entity uses the asset in its business).

2.6 Owners of passively held CGT assets used in the business of an affiliate or an entity connected with the asset-owning entity can access the small business CGT concessions via the $6 million maximum net asset value test in some circumstances. However, they do not have access to the small business entity test ($2 million turnover test) because they typically do not meet the requirement of carrying on a business.

Partners in a partnership

2.7 A partner can access the small business CGT concessions via the aggregated turnover test only if the partnership is a small business entity and the relevant CGT asset is an 'asset of the partnership'. An asset of the partnership is an asset that is owned by the partners in accordance with their fractional interest in the partnership or in accordance with their respective interests as specified in the partnership agreement.

2.8 In some circumstances, an individual partner (or partners) owns an asset directly and makes the asset available for general use in the partnership. Under the current rules, this asset is not an asset of the partnership, as the partner (or partners) owns the asset. The partner is not able to access the small business CGT concessions for that asset via the aggregated turnover test but may be able to access the concessions via the maximum net asset value test.

Summary of new law

2.9 The amendments allow a taxpayer owning a CGT asset that is used in a business by the taxpayer's affiliate, or an entity connected with the taxpayer, to access the small business CGT concessions via the $2 million aggregated turnover test (small business entity test).

2.10 The amendments also allow partners who own a CGT asset that is used in a partnership business to access the small business CGT concessions via the $2 million aggregated turnover test where the CGT asset is not an 'asset of the partnership'.

2.11 Schedule 2 also makes a number of other amendments to refine and clarify aspects of the existing small business CGT concessions provisions. These are summarised in the comparison of new and current law in the table below.

Comparison of key features of new law and current law

New law Current law
Taxpayers that do not carry on a business but own a CGT asset that is used in a business by the taxpayer's affiliate or an entity connected with the taxpayer are able to access the small business CGT concessions via the small business entity test. Taxpayers that do not carry on a business but own a CGT asset that is used in a business by the taxpayer's affiliate or an entity connected with the taxpayer are not able to access the small business CGT concessions via the small business entity test.
The spouse or child (under 18 years of age) of an individual is taken to be an affiliate of the individual in a wider range of circumstances and for a wider range of purposes. The spouse or child (under 18 years of age) of an individual is taken to be an affiliate of the individual in a narrow range of circumstances and for a particular purpose.
An individual partner (or partners) in a partnership is able to access the small business CGT concessions via the small business entity test where the asset is owned by the partner, but used in the partnership. An individual partner (or partners) in a partnership can access the small business CGT concessions via the small business entity test only if the relevant CGT asset is an 'asset of the partnership'.
The small business CGT concessions are technically workable for partners in a partnership that are seeking relief via the small business entity test, as the relevant CGT asset is a partner's interest in an 'asset of the partnership'. The small business CGT concessions are technically unworkable for partners in a partnership that are seeking relief via the small business entity test, as a partner's interest in a CGT asset of the partnership is not an 'asset of the partnership'.
Small business owners are allowed to include liabilities in the net asset value test where those liabilities relate to disregarded interests in an entity connected with the taxpayer that are disregarded to avoid double counting. Liabilities are disregarded from the calculation of net asset value where the liabilities are related to interests in an entity connected with the taxpayer that have already been disregarded from the calculation to avoid double counting.
Where an asset is used in an entity that is neither an affiliate of, nor connected with, the taxpayer owning the asset, all the uses of the asset (except for certain personal use and certain uses from which interest, annuity, rent, royalty or foreign exchange gains are derived) are considered in determining what its main use is and, therefore, whether it is an active asset. An asset that has a predominant rental use and a minor business use may qualify as an active asset if the minor business use is undertaken by an affiliate or an entity connected with the taxpayer, but the rental use is by an entity that is neither an affiliate of, nor connected with, the taxpayer owning the asset.
Capital gains made on assets acquired on the death of a joint tenant (or that devolve to the trustee of a trust that is established by the will of an individual), where the deceased would have been able to access the small business CGT concessions and the surviving joint tenant (or trustee) does not continue carrying on the business, are eligible for the small business CGT concessions. Capital gains made on assets acquired on the death of a joint tenant (or that devolve to the trustee of a trust that is established by the will of an individual), where the deceased would have been able to access the small business CGT concessions and the surviving joint tenant (or trustee) does not continue carrying on the business, are not eligible for the small business CGT concessions.
The small business CGT retirement exemption applies appropriately to capital proceeds received by individuals in instalments. There is no provision in the small business CGT retirement exemption to cater for an individual receiving capital proceeds in instalments.
Small business operators do not need to satisfy the basic conditions for the small business CGT retirement exemption if the capital gain arises from CGT event J5 or J6. The small business CGT retirement exemption is not available for CGT events J5 and J6 as taxpayers cannot satisfy the basic conditions for accessing the small business CGT concessions.
The small business CGT retirement exemption caters for CGT exempt payments flowing through small business structures involving interposed entities ultimately to a CGT concession stakeholder without adverse tax consequences. The small business CGT retirement exemption does not cater for CGT exempt payments flowing through small business structures involving interposed entities ultimately to a CGT concession stakeholder.
Division 7A and section 109 of the Income Tax Assessment Act 1936 (ITAA 1936) will not apply to payments made to CGT concession stakeholders to satisfy the retirement exemption conditions. Division 7A and section 109 of the ITAA 1936 could apply to retirement exemption payments made by private companies or trusts to CGT concession stakeholders to treat such payments as dividends.
A partner in a partnership is not a small business entity in their capacity as a partner. This rule applies to the small business concessions generally and not just to the CGT concessions. The CGT provisions treat a partner in a partnership as carrying on a business. This creates uncertainty because a partner could argue that the business, for CGT purposes, is a small business entity where their aggregated turnover is less than $2 million.

Detailed explanation of new law

Partners and partnership assets - subsection 152-10(1) of the ITAA 1997

2.12 Individual partners make capital gains when a CGT event happens in relation to a partnership asset. Therefore individual partners must satisfy the basic conditions in subsection 152-10(1) of the Income Tax Assessment Act 1997 (ITAA 1997) if seeking access to the small business CGT concessions. Although the small business CGT concessions apply to a partner's interest in a CGT asset of the partnership, the provision refers to the asset as 'an asset of the partnership'.

2.13 Therefore, on a strict reading, the current provisions are unworkable for partners in a partnership who are seeking relief via the small business entity test.

2.14 Schedule 2 amends subparagraph 152-10(1)(c)(iii) of the ITAA 1997 to refer to the partner's 'interest in an asset of the partnership', consistent with the references earlier in the subsection. The amendment will clarify this aspect of the law and align it with the intended operation of the provision. [ Schedule 2, item 1, subparagraph 152-10(1 )( c )( iii )]

Treatment of passively held CGT assets

Use of CGT assets by affiliates or entities connected with the asset owner and the small business entity test

2.15 The basic eligibility conditions for the small business CGT concessions are specified in Division 152 of the ITAA 1997. Ignoring partnerships, a taxpayer with an active asset has to be either a small business entity or satisfy the maximum net asset value test to be eligible for the small business CGT concessions (subparagraphs 152-10(1)(c)(i) and (ii) of the ITAA 1997). Section 328-110 of the ITAA 1997 specifies the meaning of small business entity.

2.16 One of the existing conditions for accessing the small business CGT concessions via the small business entity test is that the entity that owns a CGT asset must also be a small business entity, which requires that entity to carry on a business (paragraph 152-10(1)(a), subparagraph 152-10(1)(c)(i) and paragraphs 328-110(1)(a) and (4)(a) of the ITAA 1997).

2.17 This condition means that a taxpayer who owns a CGT asset and who does not carry on a business cannot gain access to the small business CGT concessions via the small business entity test even if the asset is used in the business of an affiliate or an entity connected with the taxpayer that is a small business entity.

2.18 The amendments insert provisions to cover these arrangements so that a taxpayer who owns a CGT asset (and does not carry on a business other than as a partner in partnership) that is used in a business by the taxpayer's affiliate or an entity connected with the taxpayer is able to access the small business CGT concessions via the $2 million aggregated turnover test (small business entity test). [ Schedule 2, item 2, subparagraph 152-10(1 )( c )( iv ); and item 4, subsection 152-10(1A )]

2.19 This access to the small business CGT concessions via the small business entity test for a taxpayer who owns a CGT asset that is used in the business of an affiliate or an entity connected with the taxpayer occurs when the following conditions are satisfied:

·
The taxpayer's affiliate, or an entity that is connected with the taxpayer, is a small business entity for the income year (ie, the income year in which the CGT event happens to the taxpayer's CGT asset).
·
The taxpayer does not carry on a business in the income year other than in partnership.
·
If the taxpayer carries on a business in partnership, the CGT asset is not an interest in an asset of the partnership.
·
The small business entity that is the taxpayer's affiliate, or is connected with the taxpayer, is the entity that carries on the business referred to in subparagraph 152-40(1)(a)(ii) in its proposed new form, or new subparagraph 152-40(1)(a)(iii), or paragraph 152-40(1)(b) in its proposed new form in relation to the CGT asset.

[ Schedule 2, item 4, subsection 152-10(1A )]

2.20 This access to the small business CGT concessions requires a taxpayer's affiliate or entity connected with the taxpayer to be a small business entity in the income year. The access also requires the small business entity to be the entity that carries on the business at a time in the income year referred to in subparagraph 152-40(1)(a)(ii) in its proposed new form, or new subparagraph 152-40(1)(a)(iii), or paragraph 152-40(1)(b) in its proposed new form in relation to the CGT asset. This link is necessary to prevent access to the concessions in a situation where a taxpayer's affiliate or entity connected with the taxpayer is a small business entity but the asset is used by an affiliate or entity connected with the taxpayer that is not a small business entity. [ Schedule 2, item 4, paragraphs 152-10(1A )( a ) and ( d )]

2.21 Where an asset-owning entity is seeking access to the small business CGT concessions via these amendments, the rules contained in section 328-115 of the ITAA 1997 for determining the aggregated turnover of the relevant business are modified by the new special rules for calculating aggregated turnover for passively held assets. [ Schedule 2, item 14, section 152-48 ]

2.22 This access to the small business CGT concessions is only available where the taxpayer that owns the CGT asset, which is used in the business of its affiliate or an entity connected with the taxpayer, is not carrying on a business except as a partner in partnership. Taxpayers owning such CGT assets that also carry on a business other than in partnership would continue to determine their eligibility for the small business CGT concessions via the small business entity test under subparagraph 152-10(1)(c)(i) of the ITAA 1997. [ Schedule 2, item 4, paragraph 152-10(1A )( b )]

Example 2.1 Peter owns land that he leases to a company he wholly owns, Foxxy Farm Pty Ltd, which uses the land in its farming business. Peter does not carry on a business.

Example 2.1

Under the current law, Peter is not able to access the small business CGT concessions via the small business entity test because he does not carry on a business.Under the amendments, Peter would be able to access the small business CGT concessions via the small business entity test depending on the aggregated turnover of Foxxy Farm Pty Ltd. This follows because Foxxy Farm Pty Ltd, which is connected with Peter, uses Peter's land in carrying on its business.

Use of CGT assets by partnerships

2.23 The CGT regime operates on the basis that a partner in a partnership carries on a business. The partner is considered to carry on the business of the partnership but collectively with the other partners. The changes to paragraphs 152-40(1)(a) and (b) of the ITAA 1997 make those paragraphs more explicitly consistent with this understanding of partners carrying on a business. However, a partner cannot be a small business entity (see paragraphs 2.109 to 2.114). [ Schedule 2, item 8, paragraphs 152-40(1 )( a ) and ( b )]

2.24 The amendments insert a new provision specifying rules to access the small business CGT concessions via the small business entity test for CGT assets owned by partners that are used in the business of the partnership but are not interests in assets of the partnership (ie, the partners do not own the CGT assets in accordance with their fractional interest in the partnership or in accordance with their respective interests as specified in the partnership agreement). [ Schedule 2, item 4, subsection 152-10(1B )]

2.25 Under the amendments, an individual partner (or partners) who owns a CGT asset that is not an interest in an asset of the partnership is able to access the small business CGT concessions via the small business entity test provided the asset is made available for use in the partnership. The access is available when the following conditions are satisfied:

·
The taxpayer must be a partner in a partnership in the income year (ie, the income year in which the CGT event happens to the taxpayer's CGT asset).
·
The partnership is a small business entity for the income year.
·
The taxpayer must not carry on a business in an income year other than in partnership.
·
The CGT asset is not an interest in an asset of the partnership.
·
The business that the taxpayer carries on as a partner in the partnership referred to in new paragraph 152-10(1B)(e) is the business the taxpayer carries on referred to in subparagraph 152-40(1)(a)(i) or paragraph 152-40(1)(b) (in their proposed new form) in relation to the CGT asset.

[ Schedule 2, item 4, subsection 152-10(1B )]

2.26 This access to the small business CGT concessions requires the taxpayer who owns the CGT asset to be a partner in a partnership in the income year that the CGT event happens and the partnership to be a small business entity in that year. [ Schedule 2, item 4, paragraphs 152-10(1B )( a ) and ( b )]

2.27 This access also requires the taxpayer not to carry on a business in the income year other than in partnership. If the taxpayer carried on a non-partnership business, they would continue to determine their eligibility for the small business CGT concessions via the small business entity test under subparagraph 152-10(1)(c)(i) of the ITAA 1997. [ Schedule 2, item 4, paragraph 152-10(1B )( c )]

2.28 This access also requires that the taxpayer's asset is not an interest in an asset of the partnership. If the taxpayer's asset were an interest in an asset of the partnership, the taxpayer would continue to determine their eligibility for the small business CGT concessions via the small business entity test under subparagraph 152-10(1)(c)(iii) of the ITAA 1997. [ Schedule 2, item 4, paragraph 152-10(1B )( d )]

2.29 The business the taxpayer carries on in the partnership referred to in new paragraph 152-10(1B)(a) is required to be the business that the taxpayer at a time, in the income year, carries on in subparagraph 152-40(1)(a)(i) or paragraph 152-40(1)(b) (in their proposed new form) in relation to the CGT asset. This link is necessary to prevent access to the concessions in a situation where a taxpayer is a partner in a partnership that is a small business entity but the asset is used by another partnership in which the taxpayer is a partner that is not a small business entity. [ Schedule 2, item 4, paragraph 152-10(1B )( e )]

2.30 The partnership works out its aggregated turnover under the normal rules contained in section 328-115 of the ITAA 1997, but as those rules are modified by the new special rules for calculating aggregated turnover for passively held assets. [ Schedule 2, item 14, section 152-48 ]

Example 2.2 Beau and Irene each own 50 per cent of a supermarket building, which is used in the business of a partnership carried on by Beau, Jack, Casey and Irene. The partnership trades under the name 'Auzzie Supermarket'.

Example 2.2

Operation of current law Under the current law, Beau and Irene would not be able to access the small business CGT concessions via the small business entity test for any capital gain made on the sale of the building as their respective CGT asset is not an interest in an asset of the partnership. For the CGT assets to be interests in an asset of the partnership, Beau, Jack, Casey and Irene would either have to each own 25 per cent of the supermarket building or the partnership agreement would have to specify what interest each partner owned in the building. Operation of new law Under the amendments, Beau and Irene may be able to access the small business CGT concessions in relation to their respective shares of the building via the small business entity test depending on the aggregated turnover of the partnership calculated respectively for Beau and Irene. The aggregated turnover of Auzzie Supermarket must be calculated separately for Beau and Irene taking into account any entities that are affiliates of, or connected with, each of them respectively.

Spouses or children taken to be affiliates

2.31 Subsection 152-40(1A) of the ITAA 1997 currently provides a special active asset rule to treat a CGT asset as active where an individual taxpayer owns the asset and it is used in a business directly carried on by their spouse or child (under 18 years of age). However, this special rule does not treat a CGT asset as active where the taxpayer's spouse owns an entity that uses the CGT asset in its business.

2.32 Where a taxpayer owns a CGT asset and their spouse uses the CGT asset in a business operated by an entity wholly owned by the spouse, the CGT asset may still be an active asset if the entity that carries on the business is an affiliate of the taxpayer. However, it may be difficult in practice to establish that the entity that carries on the business is an affiliate of the taxpayer if there is no visible or direct business relationship between them.

2.33 The amendments repeal subsection 152-40(1A) and insert a rule that treats an individual's spouse or child (under 18 years of age) as an affiliate of the individual for the purposes of determining whether the individual or an entity in which the individual has an interest, or is a beneficiary of, is eligible for the small business CGT concessions where one entity owns a CGT asset and:

·
that asset is used, or held ready for use, in the course of carrying on a business by another entity; or
·
is inherently connected with a business carried on by another entity.

[ Schedule 2, items 11 and 14, subsections 152-47(1 ) and ( 2 )]

2.34 The rule applies only if the 'business' entity is not otherwise an affiliate of, or connected with, the asset-owning entity. This means that if the business entity is an affiliate of the asset-owning entity as a result of applying section 328-130 of the ITAA 1997, an individual's spouse or child (under 18 years of age) would not be treated as an affiliate of the individual. Similarly, if the business entity is already connected with the asset-owning entity via section 328-125 of the ITAA 1997, an individual's spouse or child (under 18 years of age) would not be treated as an affiliate of the individual. [ Schedule 2, item 14, paragraph 152-47(1 )( c )]

2.35 The rule is applied in two stages. The first stage treats an individual's spouse or child (under 18 years of age) as their affiliate, for the purposes of Subdivision 152-A of the ITAA 1997, when determining whether the entity that uses the CGT asset, or holds it ready for use, in its business is an affiliate of, or is connected with, the entity that owns the CGT asset. [ Schedule 2, item 14, subsection 152-47(2 )]

2.36 If the conditions of the first stage are met, the second stage will apply to treat the spouse or child (as the case may be) as an affiliate of the individual for the purposes of Subdivision 152-A of the ITAA 1997 and for the purposes of sections 328-110 to 328-125 of the ITAA 1997 to the extent that these sections relate to Subdivision 152-A. For example, if by the application of the first stage of the rule, the entity is taken to be an affiliate of, or an entity connected with, the entity that owns the asset, the asset is an active asset (subparagraph 152-40(1)(a)(ii) in its proposed new form, or new subparagraph 152-40(1)(a)(iii), or paragraph 152-40(1)(b) in its proposed new form). [ Schedule 2, item 14, subsection 152-47(3 )]

2.37 The new affiliate rule affects access to the small business CGT concessions via the maximum net asset value test in addition to the small business entity test. Compared to the old rule (subsection 152-40(1A) of the ITAA 1997), the new rule increases access to the concessions by treating an individual's spouse or child (under 18 years of age) as their affiliate in a wider range of situations.

2.38 However, for the purposes of the maximum net asset value test, the new rule also reduces access to the concessions by potentially bringing in more affiliates and more entities that are connected with the asset-owning entity than the old rule.

Example 2.3 Philip owns 100 per cent of Horse Farm Pty Ltd. Horse Farm Pty Ltd owns land. Philip's spouse, Crystal, owns Pig Farm Pty Ltd. Pig Farm Pty Ltd uses the land to carry on a business. Philip owns 30 per cent and Crystal 70 per cent of Carrot Pty Ltd. Horse Farm Pty Ltd does not carry on a business.

Example 2.3

Operation of current law Prior to the amendments, Horse Farm Pty Ltd is not able to access the small business CGT concessions via the $2 million turnover test because Horse Farm Pty Ltd is not carrying on a business. The asset is instead being used in Pig Farm Pty Ltd's business.Horse Farm Pty Ltd may be able to access the small business CGT concessions via the $6 million maximum net asset value test. However, this will depend on the fulfilment of two necessary conditions:

·
whether Pig Farm Pty Ltd is an affiliate of Horse Farm Pty Ltd (which would make the land an active asset); and
·
whether Horse Farm Pty Ltd can satisfy the maximum net asset value test.

If Horse Farm Pty Ltd has a maximum net asset value greater than $6 million, it would not be able to access the small business CGT concessions.In these circumstances, Pig Farm Pty Ltd would be an affiliate of Horse Farm Pty Ltd if Pig Farm Pty Ltd acts in concert with Horse Farm Pty Ltd in respect of Pig Farm Pty Ltd's business activities. This requirement may be difficult to demonstrate. Operation of new law If Pig Farm Pty Ltd is already an affiliate of Horse Farm Pty Ltd under section 328-130 of the ITAA 1997, the new affiliate rule would not apply.Proceeding on the basis that Pig Farm Pty Ltd is not already an affiliate of, nor is connected with, Horse Farm Pty Ltd, the amendments treat Crystal as Philip's affiliate in determining whether Pig Farm Pty Ltd (the entity that uses the land in its business) is connected with Horse Farm Pty Ltd (the entity that owns the land). The new affiliate rule applies because one entity (Horse Farm Pty Ltd) owns a CGT asset that is used in the business of another entity (Pig Farm Pty Ltd).Pig Farm Pty Ltd is connected with Horse Farm Pty Ltd because Philip controls Horse Farm Pty Ltd and Philip and his affiliate, Crystal, controls Pig Farm Pty Ltd.This makes the land that Horse Farm Pty Ltd owns an active asset (new subparagraph 152-40(1)(a)(iii)). The land would also have to meet the requirements of the active asset test in section 152-35 of the ITAA 1997.Therefore, Horse Farm Pty Ltd could access the small business CGT concessions if its maximum net asset value is not more than $6 million. Horse Farm Pty Ltd could also access the concessions if Pig Farm Pty Ltd's aggregated turnover is less than $2 million.Because Crystal is treated as Philip's affiliate in determining whether Pig Farm Pty Ltd is an affiliate of, or connected with, Horse Farm Pty Ltd, Crystal is also treated as Philip's affiliate for testing whether Carrot Pty Ltd is connected with Horse Farm Pty Ltd. Carrot Pty Ltd is, therefore, connected with Horse Farm Pty Ltd because Philip controls Horse Farm Pty Ltd and Philip and his affiliate, Crystal, control Carrot Pty Ltd.In seeking access to the small business CGT concessions via the maximum net asset value test, Horse Farm Pty Ltd would need to include the net assets of its affiliates and entities connected with it.In seeking access to the small business CGT concessions via the small business entity test, Pig Farm Pty Ltd's aggregated turnover would include the annual turnovers of its affiliates and entities connected with it.

2.39 The application of the new affiliate rule is not limited to situations where an entity that owns a CGT asset and does not operate a business provides that asset to another entity for use in its business (the standard passively held asset). It also applies to situations where an entity that operates a business owns a CGT asset that it provides to another entity for use in that other entity's business.

2.40 Under the current law, an entity that operates a business and owns a CGT asset that is used in the business of another entity will not be able to access the small business CGT concessions via the small business entity test unless the other entity is an affiliate of, or connected with, the asset-owning entity.

2.41 This could occur where the asset-owning entity is wholly owned by an individual, the entity using the asset in its business is wholly owned by the individual's spouse and the asset-owning entity and business entity are not affiliated and are not connected with each other.

2.42 The new rule applies to these circumstances by treating the individual's spouse as their affiliate. As such, the two entities would be connected and the CGT asset would be an active asset (subsection 152-40(1) of the ITAA 1997). [ Schedule 2, item 14, subsections 152-47(1 ) to ( 3 )]

2.43 The asset-owning entity may now be able to access the small business CGT concessions via the small business entity test if its aggregated turnover is less than $2 million. The asset-owning entity would calculate its aggregated turnover under the relevant provisions in Subdivision 328-C of the ITAA 1997 without any regard to the new special rule for calculating aggregated turnover inserted by these amendments. This is because the asset-owning entity carries on a business other than as a partner in a partnership and may be able to qualify as a small business entity under the normal rules depending on its aggregated turnover.

Example 2.4 Assume the same facts as in Example 2.3, except that Horse Farm Pty Ltd carries on a business other than as a partner in partnership. Operation of current law Horse Farm Pty Ltd may be able to access the small business CGT concessions via the small business entity test if Pig Farm Pty Ltd is an affiliate of Horse Farm Pty Ltd. In these circumstances, Horse Farm Pty Ltd's access would depend on its aggregated turnover. Operation of new law If Pig Farm Pty Ltd is already an affiliate of Horse Farm Pty Ltd under section 328-130 of the ITAA 1997, the new affiliate rule would not apply.Proceeding on the basis that Pig Farm Pty Ltd is not already an affiliate of, nor is connected with, Horse Farm Pty Ltd, the new affiliate rule will apply to make Crystal an affiliate of Phillip. This is because one entity owns a CGT asset that is used in the business of another entity. Therefore, Horse Farm Pty Ltd is connected with Pig Farm Pty Ltd and the land is an active asset. Again, the land would also have to meet the requirements of the active asset test in section 152-35 of the ITAA 1997. Following the same reasoning as in Example 2.3, Carrot Pty Ltd is also connected with Horse Farm Pty Ltd.Depending on Horse Farm Pty Ltd's aggregated turnover, it may be able to access the small business CGT concessions via the small business entity test. However, Horse Farm Pty Ltd will use the relevant provisions only in Subdivision 328-C of the ITAA 1997 to test whether it is a small business entity.In particular, Horse Farm Pty Ltd will use section 328-115 of that Subdivision to calculate its aggregated turnover and will not need to apply the new special rule (new section 152-48) for calculating aggregated turnover that applies where the asset-owning entity is not carrying on a business (other than as a partner in partnership).The application of the net assets test is as outlined in Example 2.3.

CGT assets to which the new affiliate rule applies

2.44 The rule treating an individual's spouse or child (under 18 years of age) as an affiliate of the individual applies in relation to any capital gain from any CGT asset owned by the individual, an affiliate of the individual or an entity connected with the individual. This means in Examples 2.3 and 2.4 that, if Crystal sells a CGT asset, the rule will treat Philip as Crystal's affiliate. [ Schedule 2, item 14, paragraph 152-47(4 )( a )]

2.45 This means that the individual or entity faces the same set of aggregation rules for the purposes of the maximum net asset value test or the aggregated turnover test regardless of which CGT asset the individual is seeking to claim the small business CGT concessions for. However, the rule does not apply for the purposes of determining eligibility for the other small business concessions such as the concessional rules for fringe benefits tax and pay as you go instalments. [ Schedule 2, item 14, paragraph 152-47(4 )( a )]

Example 2.5 Assume the same facts as in Example 2.4 and Horse Farm Pty Ltd owns another parcel of land that it uses in its business. It sells this asset during the year and is testing its eligibility for the small business CGT concessions via the small business entity test. As it owns an asset that is being used in the business of an entity that is connected with it as a result of applying the new affiliate rule, Horse Farm Pty Ltd will bring in the turnovers of Pig Farm Pty Ltd and Carrot Pty Ltd in calculating its aggregated turnover using the relevant provisions in Subdivision 328-C of the ITAA 1997.

2.46 A spouse is only an affiliate of the taxpayer while they are still a spouse. Likewise, a child will only be an affiliate while the child is under 18 years. This caters for situations where an individual's circumstances change during the income year such as the ending of a spousal relationship. [ Schedule 2, item 14, paragraph 152-47(4 )( b )]

Working out the taxpayer's aggregated turnover for the purposes of applying the small business CGT concessions to passively held CGT assets

2.47 The small business entity test includes rules for determining what turnovers to include in calculating the $2 million turnover test. The purpose of this test is to include the turnover of entities that are connected with, or affiliates of, the taxpayer who owns the CGT asset as these entities are, in effect, part of the same business operation.

2.48 The amendments insert special rules for calculating aggregated turnover for passively held assets, which are assets covered by new subsection 152-10(1A) or (1B), that apply in addition to the standard aggregated turnover rules in Subdivision 328-C of the ITAA 1997. [ Schedule 2, item 14, section 152-48 ]

2.49 A special rule treats an entity (the deemed entity) that is an affiliate of, or is connected with, the owner of a passively held CGT asset as an affiliate of, or connected with, the entity that uses the passively held asset in its business (the test entity) if the deemed entity is not already an affiliate of, or connected with, the test entity. [ Schedule 2, item 14, subsection 152-48(2 )]

2.50 This special rule for owners of passively held CGT assets that are used in the business of the asset owner's affiliate or entity connected with the asset owner ensures that the amendments have sufficient integrity and minimises tax planning opportunities by including the turnover of all entities that are, in effect, part of the same business operation.

Example 2.6 Peter owns Pony Farm Pty Ltd. Pony Farm Pty Ltd owns land. Peter's spouse, Diana, owns Worm Farm Pty Ltd. Worm Farm Pty Ltd uses the land in its business. Neither Peter nor Diana carries on a business. Bush Pty Ltd is an affiliate of Pony Farm Pty Ltd. Pony Farm Pty Ltd wholly owns Flowers Pty Ltd so the two entities are connected. Cherry Pty Ltd is an affiliate of Worm Farm Pty Ltd. Worm Farm Pty Ltd wholly owns Earth Pty Ltd so the two entities are connected. Worm Farm Pty Ltd is not an affiliate of Pony Farm Pty Ltd under section 328-130 of the ITAA 1997.

Example 2.6

For the purposes of the small business CGT provisions, Diana and Peter are affiliates because of the new affiliate rule (new section 152-47). Therefore, Diana and Peter are connected with Worm Farm Pty Ltd, Pony Farm Pty Ltd, Flowers Pty Ltd, and Earth Pty Ltd. This makes each of these companies connected with each other. Of particular significance is that Pony Farm Pty Ltd and Flowers Pty Ltd are connected with Worm Farm Pty Ltd.Pony Farm Pty Ltd sells its land and seeks to qualify for the small business CGT concessions via the small business entity test by satisfying the conditions in new subsection 152-10(1A).In these circumstances, the 'test entity' in the special rule is Worm Farm Pty Ltd because it needs to be a small business entity for the purposes of new subsection 152-10(1A).The special rule takes Bush Pty Ltd to be an affiliate of Worm Farm Pty Ltd because Bush Pty Ltd, the deemed entity, is not otherwise an affiliate of, or connected with, Worm Farm Pty Ltd and Bush Pty Ltd is an affiliate of Pony Farm Pty Ltd (the asset owner). Therefore, Worm Farm Pty Ltd would treat Bush Pty Ltd as its affiliate during an income year while it is an affiliate of Pony Farm Pty Ltd during the income year. Worm Farm Pty Ltd would calculate its aggregated turnover in Subdivision 328-C on this basis but this calculation of aggregated turnover only applies for accessing the small business CGT provisions.

Working out aggregated turnover where a taxpayer's asset is used in more than one partnership of which they are a partner

2.51 The amendments insert another special rule to deal with situations where a taxpayer makes their CGT asset available for use in the business of more than one partnership of which they are a partner. The purpose of this rule is to limit tax planning opportunities that may otherwise be available to such taxpayers in these circumstances. These opportunities arise because the partnerships do not have to be connected with the taxpayer to obtain access to the concessions via new subsection 152-10(1B). If the partnerships are not connected with each other and they are not connected with the taxpayer, each partnership would calculate its aggregated turnover without having to include the annual turnover of any of the other partnerships. [ Schedule 2, item 14, subsection 152-48(3 )]

2.52 The new rule for taxpayers in these circumstances treats each partnership that is not already connected with the test entity as being connected with the test entity. [ Schedule 2, item 14, subsection 152-48(3 )]

Example 2.7 Steven owns a CGT asset that he makes equally available for use in the businesses of two partnerships, Partnership One and Partnership Two, that he is a partner in. The partnerships are not connected with each other or Steven.Steven sells the asset. The conditions in new subsection 152-10(1B) are satisfied (apart from the condition that each partnership is a small business entity in the income year the CGT event happens) for the asset (being each of Steven's interests in the asset) that is used separately in the businesses Steven carries on in the two partnerships.Because the partnerships are not otherwise connected with each other, they are taken to be connected with each other under the new subsection 152-48(3). This means that the aggregated turnover of Partnership One will include the annual turnover of Partnership Two; and the aggregated turnover of Partnership Two will include the annual turnover of Partnership One.

Applying the rules where an entity is an affiliate of the test entity and connected with the test entity at different times

2.53 There may occasionally be situations where an entity is, for example, an affiliate of the test entity at one time during an income year, while it neither is an affiliate of, nor connected with, the asset-owning entity; and at another time in the income year the entity is connected with the asset-owning entity, while it neither is an affiliate of, nor connected with, the test entity.

2.54 Applying the special rule in new subsection 152-48(2) to the situation described in the preceding paragraph leads to the entity that is connected with the asset-owning entity being taken to be connected with the test entity for that part of the income year that it is neither an affiliate of, nor connected with, the test entity. This means that the same entity is an affiliate of the test entity and is connected with the test entity at different times during the income year. [ Schedule 2, item 14, subsection 152-48(2 )]

2.55 In calculating the aggregated turnover of the test entity in Subdivision 328-C, the annual turnover of an entity that is both connected with and an affiliate of the test entity at different times in an income year is included only once. This ensures that the entity's annual turnover is not counted twice in calculating the aggregated turnover of the entity being tested.

Businesses that are winding up and passively held assets

2.56 The amendments in new subsections 152-10(1A) and (1B) to increase access to the small business CGT concessions for passively held assets via the small business entity test rely on the CGT event happening in an income year in which the asset is being used in, held ready for use in, or inherently connected with a business carried on by:

·
the taxpayer's affiliate;
·
an entity connected with the taxpayer; or
·
the taxpayer in partnership.

2.57 The existing law provides, for non-passively held assets, a rule in subsection 328-110(5) to permit access to the concessions where the CGT event happens in a later year than that in which the asset owner ceased to carry on a business. This rule provides access to the small business CGT concessions via the small business entity test for the asset owner where the CGT event occurs in a year that the business is being wound up.

2.58 To provide comparable access to the small business CGT concessions for owners of passively held assets, the amendments insert a new rule that permits the CGT event to occur in an income year after the business has ceased operating but while it is being wound up. [ Schedule 2, item 14, section 152-49 ]

2.59 The new rule applies to an entity that previously carried on a business which is being wound up in the CGT event year but only if the asset had been used, held ready for use, or was inherently connected with the business in the income year it ceased to operate. [ Schedule 2, item 14, subsection 152-49(1 )]

2.60 If the conditions in the preceding paragraph apply, the new rule treats the:

·
entity (including a partner) as carrying on the business at a moment in time in the CGT event year; and
·
CGT asset as being used in, held ready for use in, or inherently connected with the business at that same time in the CGT event year.

[ Schedule 2, item 14, subsection 152-49(2 )]

2.61 If the entity that is taken to be carrying on the business in the new paragraph 152-49(2)(a) is the taxpayer (as a partner in a partnership), an affiliate of the taxpayer, or an entity connected with the taxpayer, the CGT asset now:

·
satisfies paragraph 152-40(1)(a) or (b) (in their proposed new form) and the asset is an active asset at the time the business is taken to be carried on in the CGT event year; and
·
can potentially satisfy new paragraph 152-10(1A)(d) or (1B)(e) in the CGT event year depending on whether the business entity is a small business entity (although the partner is taken to carry on the business in partnership, the partnership has to qualify as a small business entity).

[ Schedule 2, item 14, subsection 152-49(2 )]

2.62 The relevant business entity will need to satisfy subsection 328-110(5) to be a small business entity in the CGT event year. Subsection 328-110(5) takes an entity to carry on a business in an income year if:

·
the entity is winding up a business it formerly carried on; and
·
it was a small business entity in the income year that it stopped carrying on the business.

2.63 If the relevant business entity was a small business entity in the year it stopped carrying on a business, that entity would be deemed to carry on a business in the CGT event year. The relevant business entity would need to meet the aggregated turnover test in the CGT event year for it to be a small business entity in that year.

Example 2.8 Assume the same facts as in Example 2.1 but Foxxy Farm Pty Ltd ceases operations in an income year (and was a small business entity in that year) and Peter sold his land in a later income year when Foxxy Farm Pty Ltd is still winding up its business.The new rule applies because:

·
Peter sold his land in an income year that Foxxy Farm Pty Ltd was still winding up; and
·
Foxxy Farm Pty Ltd used the land in its business in the income year it stopped carrying on its business.

As the new rule applies, it will take Foxxy Farm Pty Ltd to:

·
carry on the business in the income year that the land is sold; and
·
take the land as being used in, or held ready for use in, the business Foxxy Farm Ptd Ltd is taken to carry on in that income year.

This means that Peter's land is an active asset at a time in the CGT event year because it is used in the business of an entity (Foxxy Farm Pty Ltd) that is connected with the asset owner (Peter) - that is, it satisfies the new proposed form of paragraph 152-40(1)(a).Subsection 328-110(5) will also take Foxxy Farm Pty Ltd to be carrying on a business in the year the land is sold because it is a wind up year and Foxxy Farm Pty Ltd was a small business entity in the year it ceased to carry on a business. If Foxxy Farm Pty Ltd's aggregated turnover is less than $2 million in the CGT event year (worked out using Subdivision 328-C as modified by the new aggregated turnover rules for passively held assets in new section 152-48), it will be a small business entity in the year the land is sold.Peter's land can now satisfy new paragraph 152-10(1A)(d) because Foxxy Farm Pty Ltd is a small business entity in the year the land is sold (as required by new paragraph 152-10(1A)(a)); and Foxxy Farm Pty Ltd carries on the business referred to in new subparagraph 152-40(1)(a)(iii) at a time in the year the land is sold.As Peter does not carry on any business, he will be able to get access to the small business CGT concessions for any capital gain made on the sale of his land depending on whether:

·
his land satisfies the active asset test over the period that he has owned the land; and
·
Foxxy Farm Pty Ltd's aggregated turnover in the income year the land is sold is less than $2 million.

Example 2.9 Amy is a partner of a partnership named Tasty Eats. Amy has made some land she owns available for use in the partnership and the land is not 'an asset of the partnership' (ie, the partners do not own the CGT asset in accordance with their fractional interest in the partnership or in accordance with their respective interests as specified in the partnership agreement). Amy does not carry on any other business.In the 2010-11 income year when Amy's land is still made available for the partnership, Amy (and the partnership) stops carrying on a business. Tasty Eats is a small business entity in the year it stops carrying on a business. In a later income year, the business Amy carried on in partnership (Tasty Eats) is winding up and Amy sells her land in that year.The new rule applies because:

·
Amy sold her land in an income year that the business she carried on in partnership (Tasty Eats) is winding up; and
·
Amy used the land in carrying on the business in partnership in the income year she stopped carrying on a business.

As the new rule applies, it will take Amy to:

·
carry on a business in partnership in the income year that the land is sold; and
·
take the land as being used in, or held ready for use in, the business Amy is taken to carry on in partnership in that income year.

This means that Amy's land is an active asset at a time in the CGT event year because it is used in the business she caries on in partnership - that is, it satisfies paragraph 152-40(1)(a).Subsection 328-110(5) will also take Tasty Eats to be carrying on a business in the year the land is sold because it is a wind up year and Tasty Eats was a small business entity in the year it ceased to carry on a business. If Tasty Eat's aggregated turnover is less than $2 million in the CGT event year (worked out using Subdivision 328-C as modified by the new aggregated turnover rules for passively held assets in new section 152-48), it will be a small business entity in the year the land is sold.Amy's land can now satisfy new paragraph 152-10(1B)(e) because the business Amy carries on as a partner in partnership in the year the land is sold (as referred to in paragraph 152-10(1B)(a)) is the business Amy carries on in partnership referred to in the new proposed form of subparagraph 152-40(1)(a)(i) at a time in the year the land is sold.As Amy does not carry on any other business, she will be able to get access to the small business CGT concessions for any capital gain made on the sale of her land depending on whether:

·
her land satisfies the active asset test over the period that she has owned the land; and
·
Tasty Eat's aggregated turnover in the income year the land is sold is less than $2 million.

Other amendments

2.64 Schedule 2 also makes a number of minor changes to the small business CGT concession provisions to refine the provisions and to overcome a number of existing problems with those provisions.

Net asset test - liabilities related to interests in affiliates or entities connected with the taxpayer

2.65 In applying the maximum net asset value test, the net value of CGT assets of an entity is determined broadly by subtracting from the market value of the assets the liabilities related to the assets (and certain provisions).

2.66 This calculation of net asset value disregards certain assets, such as personal use assets and main residences, under subsection 152-20(2) of the ITAA 1997. Where an asset is disregarded, any related liability is also disregarded as such liabilities are not related to any asset included in the net asset value calculation.

2.67 Paragraph 152-20(2)(a) of the ITAA 1997 disregards the value of interests in entities connected with the taxpayer or the taxpayer's affiliates to avoid double counting in the net assets calculation, as the assets underlying these interests are already counted.

2.68 However, this excludes the liabilities relating to such disregarded interests so that such liabilities are never taken into account in the net asset value calculation. This disadvantages taxpayers as it excludes liabilities that are indirectly related to assets whose gross value has been included in the net asset calculation.

2.69 The amendment provides that liabilities relating to disregarded interests in entities connected with the taxpayer or the taxpayer's affiliates are taken into account in calculating the net asset value. [ Schedule 2, item 25, paragraph 152-20(2 )( a )]

Example 2.10 Suppose Danny owns all the shares in ATommi Pty Ltd. The net asset value of ATommi Pty Ltd is $1 million. Danny has net assets of $5.2 million (not counting the value of his shareholding in ATommi Pty Ltd).Under the current law, Danny works out his maximum net asset value to be $6.2 million, which includes ATommi Pty Ltd's net asset value of $1 million but excludes the value of Danny's shares in ATommi Pty Ltd.Danny still owes $500,000 that he borrowed to acquire the shares in ATommi Pty Ltd.The current law would exclude from the calculation Danny's $500,000 liability incurred to acquire the shares in ATommi Pty Ltd, resulting in a net asset value of $6.2 million. However, this has excluded a liability that is related (indirectly) to assets whose market value has been included elsewhere in the net asset calculation.The amendment allows Danny to include the $500,000 liability in the calculation, resulting in a maximum net asset value of $5.7 million.

2.70 The amendment applies to CGT events that happen on or after the day on which the amending legislation receives Royal Assent. [ Schedule 2, item 42 ]

Active asset - main use to derive rent

2.71 Schedule 2 amends the active asset test in section 152-40 of the ITAA 1997 to ensure that all the uses of an asset (apart from personal use of an asset by the taxpayer or an individual who is the taxpayer's affiliate) are considered in determining whether it is an active asset for the purpose of the small business CGT concessions. [ Schedule 2, item 26, paragraph 152-40(4 )( e ); and item 27, subsection 152-40(4A )]

2.72 Paragraph 152-40(4)(e) of the ITAA 1997 excludes assets whose main use is to derive rent or certain other forms of passive income from being active assets. However, under the current law it is possible for an asset which has a predominant rental and a minor business use to qualify as an active asset if the minor business use is undertaken by an affiliate or an entity connected with the taxpayer, but the rental use is by an entity that is neither an affiliate of, nor connected with, the taxpayer owning the asset. Example 2.11 illustrates this possibility.

Example 2.11 Kiki owns a property and rents out 90 per cent of the floor area to Lost Dog Pty Ltd that is neither her affiliate nor connected with her. Kiki earns 90 per cent of the revenue derived from owning the property from renting it to Lost Dog Pty Ltd.Beaglehole Pty Ltd, which carries on a dog grooming business, uses the remaining 10 per cent of the floor area of the property as its business premises and pays Kiki rent for using it (this rent forms 10 per cent of the revenue Kiki earns from owning the property). As Kiki owns 60 per cent of Beaglehole Pty Ltd, Beaglehole Pty Ltd is connected with Kiki.Under the current law, the main use of the property in Beaglehole Pty Ltd's business (being the business mentioned in subsection 152-40(1) of the ITAA 1997) is not to derive interest, an annuity or rent. As such, the property is an active asset despite its main use overall (the 90 per cent that is rented to Lost Dog Pty Ltd) being to derive rent.

2.73 The amendments remove the focus on the main use of an asset in the course of carrying on the business mentioned in subsection 152-40(1) of the ITAA 1997 and focus instead on the main use of the asset by the taxpayer. [ Schedule 2, item 26, paragraph 152-40(4 )( e )]

2.74 The amendments adopt an attribution approach in relation to the use of an asset by a taxpayer's affiliate or an entity connected with the taxpayer. This approach treats the use of the asset by the affiliate or the entity connected with the taxpayer as though it were the use of the taxpayer. [ Schedule 2, item 27, paragraph 152-40(4A )( b )]

2.75 This attribution approach, therefore, treats any business use by the taxpayer's affiliate or an entity connected with the taxpayer as business use by the taxpayer irrespective of whether the taxpayer receives rental income from the affiliate or entity connected with the taxpayer. If the affiliate or entity connected with the taxpayer uses the asset to derive interest, rent, royalty, or foreign exchange gains from an entity that is neither an affiliate of nor connected with the taxpayer, that use is treated as the taxpayer's use. [ Schedule 2, item 27, paragraph 152-40(4A )( b )]

2.76 The amendments exclude any personal use of an asset by the taxpayer who owns the asset and any personal use by an individual who is the taxpayer's affiliate from the determination of the main use of the asset. In the affiliate case, this is achieved by treating the affiliate's personal use of the asset as the taxpayer's use. [ Schedule 2, item 27, paragraphs 152-40(4A )( a ) and ( b )]

Example 2.12 Further to Example 2.8:The amendments ensure that the determination of the main use of Kiki's property takes into account the 90 per cent rental use to Lost Dog Pty Ltd, which neither is Kiki's affiliate nor is connected with her.The amendments treat Beaglehole Pty Ltd's use of that part of the property rented to it as Kiki's use because Beaglehole Pty Ltd is connected with Kiki. Because Beaglehole Pty Ltd uses that part of the property as its business premises, Kiki is treated as using that part as business premises. This means that the rent Beaglehole Pty Ltd pays to Kiki is not treated as rent for the purposes of determining Kiki's main use of the property.Kiki's main use of the property is to derive rent, because 90 per cent of the revenue she derives from the property is rent received from Lost Dog Pty Ltd.Therefore, Kiki's property is not an active asset in these circumstances for the purpose of section 152-40 in its proposed new form. Example 2.13 John owns a property that he rents 80 per cent of the floor area of to an affiliate, Peter, and the remaining 20 per cent John uses in his business. John earns 80 per cent of the revenue derived from owning the property from renting it to Peter.Peter uses 60 per cent of the floor area of that part of the property rented to him in his business and rents the remaining 40 per cent to an entity that neither is John's affiliate nor is connected with John.Peter earns 40 per cent of the revenue he derives from the property from his on renting to the third party.The amendments treat Peter's use of that part of the property rented to him as John's use. Therefore, John is treated as renting 40 per cent of that part of the property to an entity that is neither his affiliate nor is connected with him and 60 per cent as being used in a business by John.The main use of the property by John is not to derive interest, an annuity, rent, royalties or foreign exchange gains. This is because 32 per cent (80% × 40%) of John's property is treated as being used to derive rent and the remaining 68 per cent is either actually used in John's business (20 per cent) or is treated as being used in a business by John (48 per cent).Therefore, John's property is an active asset in these circumstances for the purpose of section 152-40 in its proposed new form. John's asset would still have to satisfy the active asset test in section 152-35 of the ITAA 1997 over the period that he has owned the asset. Example 2.14 Neil owns a property that he rents 60 per cent of the floor area to an affiliate, Andrea. Neil uses 15 per cent of the floor area in his business and the remaining 25 per cent is for his own personal use.Because personal use of an asset by the owner or an affiliate of the owner is ignored in determining its main use, the proportions of 60 per cent and 15 per cent have to be adjusted so that they add up to 100 per cent of the use of the asset. This adjustment is made by multiplying the 60 per cent and 15 per cent each by 100/75 as this factor adjusts the two percentages so that they add up to 100 per cent but maintain their current proportionality to each other, which is 4:1.Following the adjustments, Neil rents 80 per cent (60% × 100/75) of the non-personal use floor area of the property to Andrea and uses 20 per cent (15% × 100/75) of the non-personal use floor area in his business.Neal earns 80 per cent of the revenue derived from owning the property from renting it to Andrea.Andrea uses 50 per cent of that part of the property rented to her in her business and rents the remaining 50 per cent to an entity that neither is Neil's affiliate nor is connected with Neil. Andrea earns 50 per cent of the revenue she derives from the property from her on renting to the third party.The amendments treat Andrea's use of that part of the property rented to her as Neil's use. Therefore, Neil is treated as renting 50 per cent of that part of the property to an entity that is neither his affiliate nor is connected with him and 50 per cent as being used in a business by Neil.The main use of the property is not to derive interest, an annuity, rent, royalties or foreign exchange gains. This is because 40 per cent (80% × 50%) of Neil's property is treated as being used to derive rent; and the remaining 60 per cent either is actually used in Neil's business (20 per cent) or is treated as being used in a business by Neil (40 per cent).Therefore, Neil's property is an active asset in these circumstances for the purpose of section 152-40 in its proposed new form. Neil's asset would still have to satisfy the active asset test in section 152-35 of the ITAA 1997 over the period that he has owned the asset.

2.77 The amendments apply to CGT events that happen on or after the day on which the amending legislation receives Royal Assent. [ Schedule 2, item 42 ]

Joint tenants and testamentary trusts - section 152-80 of the ITAA 1997

2.78 Schedule 2 also amends the law to extend access to the small business CGT concessions to capital gains relating to assets acquired on the death of a joint tenant and assets that devolve to the trustee of a trust that is established by the will of an individual where the deceased would have been able to access the concessions. [ Schedule 2, items 30 to 32, section 152-80 ]

2.79 Section 152-80 of the ITAA 1997 applies if a CGT asset forms part of the estate of a deceased individual and devolves to their legal personal representative or passes to a beneficiary.

2.80 This section allows the legal personal representative or the beneficiary to access the small business CGT concessions if the deceased could have accessed the concessions.

2.81 However, if the parties are joint tenants and one dies, the surviving joint tenant(s) is taken to have acquired the deceased's interest in the asset under subsection 128-50(2) of the ITAA 1997. The deceased's interest in the asset does not devolve to the legal personal representative or pass to a beneficiary.

2.82 This denies access to the small business CGT concessions for any capital gains made on this interest acquired by a surviving joint tenant(s) who does not continue with the business they owned as joint tenants with the deceased.

2.83 The amendments will ensure that the concessions are not denied simply because of the death of a joint tenant and the automatic transfer of the asset to the other tenant (rather than going through an estate) where the surviving tenant does not continue with the business. [ Schedule 2, items 30 to 32, subparagraphs 152-80(1 )( a )( ii ) and ( b )( iii ); and paragraph 152-80(2A )( c )]

2.84 Similarly, the amendments will ensure that the concessions are not denied simply because, following the death of an individual, an asset devolves to the trustee of a testamentary trust established by the will of the deceased individual. [ Schedule 2, items 30 to 32, subparagraph 152-80(1 )( b )( i ) and paragraph 152-80(2A )( d )]

2.85 The amendments apply to CGT events that happen in the 2006-07 income year and later income years. [ Schedule 2, item 43 ]

Retirement exemption and proceeds received in instalments

2.86 Schedule 2 inserts a rule to apply the retirement exemption to capital proceeds received in instalments by individuals. [ Schedule 2, item 34, subsection 152-305(1A )]

2.87 Schedule 2 removes the duplicate provision for receipt of capital proceeds in instalments by companies and trusts in subsection 152-310(3) of the ITAA 1997. [ Schedule 2, item 36, subsection 152-310(3 )]

2.88 These changes correct an unintended effect on the operation of the retirement exemption made by Schedule 2 to the Superannuation Legislation Amendment (Simplification) Act 2007 . Those amendments inadvertently removed the rule relating to the receipt of capital proceeds in instalments for individuals and introduced a second rule for capital proceeds received in instalments by companies and trusts.

2.89 The amendment to reinsert the rule for capital proceeds received by individuals in instalments, which favours taxpayers, applies for capital proceeds received in instalments in the 2007-08 and later income years, which ensures that the amendments have the same date of effect as the amendments mentioned in the preceding paragraph. [ Schedule 2, item 44 ]

2.90 The amendment that repeals the duplicate provision for capital proceeds received in instalments by companies and trusts applies to payments made on or after the day on which the amending Bill receives Royal Assent. [ Schedule 2, item 46 ]

Retirement exemption - CGT events J5 and J6

2.91 Tax Laws Amendment (2006 Measures No. 7) Act 2007 altered the operation of the small business CGT roll-over to allow a taxpayer to choose the roll-over before acquiring a replacement asset or making an improvement to an existing asset. It is evident from that legislation and its explanatory memorandum that the retirement exemption was intended to be available for capital gains made from CGT events J5 and J6:

·
CGT event J5 happens if the taxpayer does not acquire a replacement asset or incur relevant improvement expenditure by the end of the two-year replacement asset period.
·
CGT event J6 happens if the cost of the replacement asset or the amount of the improvement expenditure (or both) is less than the amount of the capital gain originally deferred.

2.92 The retirement exemption is currently not available for CGT events J5 or J6 as those capital gains cannot satisfy the basic conditions as required by paragraphs 152-305(1)(a) and (2)(a) of the ITAA 1997.

2.93 The basic conditions include:

·
a CGT event happens in relation to a CGT asset of the taxpayer in an income year (paragraph 152-10(1)(a) of the ITAA 1997); and
·
the CGT asset satisfies the active asset test (paragraph 152-10(1)(d) of the ITAA 1997).

2.94 If no replacement asset has been acquired or no improvement expenditure has been spent, within the two-year period, there is no CGT asset that CGT event J5 happens to for satisfying either paragraph 152-10(1)(a) or (1)(d) of the ITAA 1997.

2.95 CGT event J6 happens because the taxpayer did not acquire a replacement asset of sufficient cost base or incur sufficient improvement expenditure. Thus, the event happens in relation to the non-acquisition of a replacement asset of sufficient cost base rather than in relation to the replacement asset. Therefore, a capital gain from CGT event J6 also cannot satisfy either paragraph 152-10(1)(a) or (1)(d) of the ITAA 1997.

2.96 Schedule 2 inserts a new provision to modify the operation of paragraphs 152-305(1)(a) and (2)(a) of the ITAA 1997 to make satisfying the basic conditions for the small business retirement exemption unnecessary if the gain arises from CGT events J5 or J6. [ Schedule 2, item 35, subsection 152-305(4 )]

2.97 The amendment reduces compliance costs for taxpayers because they do not have to calculate their maximum net asset value or aggregated turnover at the time of the J5 or J6 event.

Example 2.15 Bart sells his entire business with the intention of purchasing a new business. He claims the small business roll-over. At that time he is also eligible to claim the retirement exemption.Bart is unable to find a suitable replacement asset within two years and decides instead to retire from business. Under the current law, CGT event J5 is triggered. As Bart has not acquired a replacement asset or incurred the relevant improvement expenditure, he cannot satisfy the basic conditions for accessing the retirement exemption so the capital gain from CGT event J5 cannot be disregarded.The amendment will permit Bart to access the retirement exemption in these circumstances as he is no longer required to meet the basic conditions for accessing the retirement exemption in relation to his capital gain from the J5 event.

2.98 This amendment favours taxpayers and applies to CGT events that happen in the 2006-07 income year and later income years, which ensures that the amendments have the same date of effect as the 2007 amendments mentioned in paragraph 2.91. [ Schedule 2, item 45 ]

Retirement exemption payments to CGT concession stakeholders through interposed entities

2.99 The 2007 amendments mentioned in paragraph 2.91 enabled indirect ownership to be used to qualify an individual as a CGT concession stakeholder, but the payment requirement for the small business retirement exemption in subsection 152-325(1) of the ITAA 1997 was not updated to allow indirect payments.

2.100 Schedule 2 amends the law to allow a company or trust to make a retirement exemption payment indirectly through one or more interposed entities to a CGT concession stakeholder. [ Schedule 2, item 37, subsection 152-325(1 )]

2.101 The amendments overcome practical difficulties, such as breaching non-tax laws, of complying with the requirement to make a payment directly to a CGT concession stakeholder under the retirement exemption where that CGT concession stakeholder is traced indirectly.

2.102 To ensure that there is no tax impact on the interposed entity, the amendments also provide that the indirect payments are:

·
non-assessable non-exempt income of an interposed entity;
·
not deductible from an interposed entity's assessable income; and
·
neither a dividend nor a frankable distribution.

[ Schedule 2, item 36, subsection 152-310(3 ); and item 38, subsections 152-325(9 ) and ( 10 )]

2.103 The amendments also exclude small business retirement exemption payments made under section 152-325 of the ITAA 1997 from the operation of section 109 and Division 7A of the ITAA 1936 (the 'deemed dividend provisions'). [ Schedule 2, item 38, subsection 152-325(11 )]

2.104 The amendments repeal subsection 152-325(9) of the ITAA 1997. This subsection treated payments made by a company or trust to an employee of an amount exempted under the retirement exemption as being payments made in respect of the termination of employment of the relevant CGT concessions stakeholder. [ Schedule 2, item 38 ]

2.105 The deemed dividend provisions aim to restrict a company from unreasonably reducing its taxable income. Section 109 deems excessive payments to shareholders, directors and associates as a dividend paid by the company and Division 7A prevents private companies from making tax-free distributions of profits to shareholders or their associates in the form of payments, loans or forgiven debts.

2.106 The application of the deemed dividend provisions to the small business retirement exemption is counter to the policy objective of the exemption, which is to allow small business operators to sell their small business assets and provide for their retirement as their business and its assets may be their sole retirement asset (to a $500,000 lifetime limit).

2.107 Excluding the application of section 109 and Division 7A will reduce uncertainty and complexity for taxpayers utilising the small business retirement exemption. It will also remove any potential conflict between the amendments that treat indirect retirement exemption payments between interposed entities as if they were neither a dividend nor a frankable distribution and section 109 or Division 7A. [ Schedule 2, item 38, subsection 152-325(10 )]

2.108 The amendments apply to payments that are made on or after the day on which the amending Bill receives Royal Assent. [ Schedule 2, item 46 ]

Partners and small business entities

2.109 When the small business entity regime was introduced the clear intention was that a partner in a partnership could not in their capacity as a partner be a small business entity. It is only the partnership that could be a small business entity.

2.110 This creates uncertainty because a partner could argue that, as they are considered to carry on a business for CGT purposes (consistent with the general law position), they could be a small business entity where their aggregated turnover is less than $2 million.

2.111 Section 328-110 of the ITAA 1997 specifies the meaning of small business entity for applying the small business concession rules.

2.112 Schedule 2 amends section 328-110 of the ITAA 1997 (meaning of small business entity) to provide that a partner in a partnership cannot be a small business entity in their capacity as a partner. This applies for the small business concessions generally and not just for the small business CGT concessions. [ Schedule 2, item 39, subsection 328-110(6 )]

2.113 The amendment removes current uncertainty about whether a partner in a partnership can be a small business entity.

2.114 The small business entity regime had effect from the 2007-08 income year so the amendment applies to assessments for the 2007-08 income year and later income years. The amendment applies retrospectively as it aligns the legislation with administrative practice. [ Schedule 2, item 47 ]

Application and transitional provisions

Application of the main amendments

2.115 The main amendments apply to CGT events happening in the 2007-08 income year and later income years to align with the date of effect of the small business entity regime amendments. [ Schedule 2, subitem 41(1 )]

2.116 In this regard, the amendments will generally be beneficial to taxpayers. The amendments have been actively sought by industry and will increase access to the small business CGT concessions.

2.117 However, some taxpayers may be disadvantaged under these amendments by the repeal of subsection 152-40(1A) and the introduction of the new affiliate rule that treats an individual's spouse or child (under 18 years of age) as an affiliate of the individual in particular circumstances.

2.118 In particular, some taxpayers may have been able to qualify for the small business CGT concessions under subsection 152-40(1A) of the ITAA 1997 repealed by these amendments and may not qualify under the new rule for treating an individual's spouse or child (under 18 years of age) as their affiliate.

2.119 Taxpayers in these circumstances can still qualify for the small business CGT concessions for CGT events happening up to but not including the day on which the amending Bill is introduced into the Parliament. [ Schedule 2, subitems 41(2 ) and ( 3 )]

Transitional extension of time limit for making choices

2.120 Taxpayers that become eligible to make a choice under Division 152 of the ITAA 1997 due to Schedule 2 to this Bill will have an extended time period, under a transitional rule, to make such a choice in relation to CGT events happening before the day on which this Bill receives Royal Assent. [ Schedule 2, item 48 ]

2.121 The small business CGT concessions require taxpayers to make choices. For example, the small business retirement exemption and small business roll-over are available only if the taxpayer chooses to obtain them.

2.122 Subsection 103-25(1) of the ITAA 1997 limits the date for making a choice to the day the entity lodges its income tax return for the income year in which the relevant CGT event happened or a later date allowed by the Commissioner.

2.123 The transitional rule extends the time limit for a choice an entity becomes eligible to make as a result of this Schedule to the latest of:

·
the day the entity lodges its income tax return for the income year in which the relevant CGT event happened;
·
12 months after the day on which this Bill receives Royal Assent; and
·
a later day allowed by the Commissioner.

[ Schedule 2, subitem 48(2 )]

2.124 The way in which the taxpayer prepares their income tax return is sufficient evidence of the making of this choice.


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