Edited version of private ruling

Authorisation Number: 1011482031095

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Ruling

Subject: Small business retirement exemption

Question 1

Can the trust choose the small business retirement exemption under subsection 152-305(2) of the Income Tax Assessment Act 1997 (ITAA 1997) in relation to any capital gain from the sale of the property A?

Answer

No.

Question 2

If the small business retirement exemption applies, can an amount be distributed tax free to the current beneficiary and then contributed to superannuation under section 292-100 of the ITAA 1997 and not be subject to excess contributions tax?

Answer

As the small business retirement exemption will not apply, it is not necessary to answer this question.

This ruling applies for the following period:

Year ended 30 June 2010

The scheme commences on:

1 July 2009

Relevant facts and circumstances

The trust is a discretionary trust with the main beneficiaries since inception being the current beneficiary and spouse, and their children.

The current beneficiary and spouse moved overseas prior to the inception of the trust.

In view of the spouse's interest in farms, the trust was established with its main activity being farming. The trust has also held a number of passive residential property investments and other investments.

Property A was purchased shortly after and was share farmed with another party known to the current beneficiary and spouse. The share farmer was responsible for the actual farming aspects of the arrangement.

The share farmer signed correspondence agreeing to the terms of the agreement.

The trust subsequently settled on the purchase of property B.

A new share farming agreement was signed with another party in relation to both properties.

The spouse was able to visit the farms regularly to keep an eye on things to ensure that the share farming arrangement was running well.

The current beneficiary then took over the running of the share farming arrangement, however visits to the farms were less frequent.

Eventually property B was sold to a third party.

The share farming arrangement changed to that of a flat rent on the signing of a lease. The applicant states that at that time the business was being wound up and efforts were made to sell property A.

The applicant has also stated that it is uncertain whether the maximum net asset value test is satisfied

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 152-10

Income Tax Assessment Act 1997 Section 152-15

Income Tax Assessment Act 1997 Section 152-35

Income Tax Assessment Act 1997 Section 152-40

Income Tax Assessment Act 1997 Section 328-110

Income Tax Assessment Act 1997 Section 328-130

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA of the ITAA 1936, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Subdivision 152-D of the ITAA 1997 provides a small business retirement exemption as part of the capital gains tax (CGT) small business relief provisions. If the trust qualifies for the small business retirement exemption, the trust can choose to disregard all or part of any capital gain in relation to the sale of property A.

The trust will be able to choose the small business retirement exemption if the basic conditions in Subdivision 152-A of the ITAA 1997, and the specific conditions for the retirement exemption in Subdivision 152-D of the ITAA 1997, are satisfied.

The basic conditions to be satisfied are:

(a) a CGT event happens in relation to a CGT asset of the trust in an income year. This condition does not apply in the case of CGT event D1

(b) the event would (apart from Division 152 of the ITAA 1997) have resulted in the gain

(c) at least one of the following applies:

(i) the trust is a small business entity for the income year

(ii) the trust satisfies the maximum net asset value test in section 152-15 of the ITAA 1997

(iii) the trust is a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership

(iv) the conditions mentioned in subsection 152-10(1A) or (1B) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year.

(d) the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997.

Basic condition (a)

The CGT asset in question is property A. The relevant CGT event will be the disposal of the property, which will cause CGT event A1 under section 104-10 of the ITAA 1997 to happen.

As the CGT event, not being CGT event D1, happened in relation to a CGT asset of the trust in the income year in which the property was sold, this condition is satisfied.

Basic condition (b)

The above CGT event will result in the capital gain, and this condition is satisfied.

Basic condition (c)

The applicant has advised that it is uncertain whether the maximum net asset value test is satisfied. There is also no indication that the trust is either a partner in a partnership that is a small business entity or that the conditions in subsections 152-10(1A) or (1B) of the ITAA 1997 will apply in this case. Therefore, to satisfy this condition, the trust will need to be a small business entity for the income year.

Section 328-110 of the ITAA 1997 provides the meaning of 'small business entity'. The trust will be a small business entity for the income year if:

- the trust carried on a business in the current year and

- one or both of the following applies:

- the trust carried on a business in the income year before the current year and its aggregated turnover for the previous year was less than $2 million or

- the trust's aggregated turnover for the current year is likely to be less than $2 million.

In this case, the arrangement to share income changed to that of a flat rent on the signing of the lease. The applicant states that at that time, the business was being wound up and efforts were being made to sell property A. There is no indication that any business was being carried on by the trust after this time or in particular, the current year as required by condition (a).

Subsection 328-110(5) of the ITAA 1997 provides, however, that the trust will be carrying on a business in the current income year if in that year it was winding up a business it previously carried on, and the trust was a small business entity for the income year in which it stopped carrying on that business.

The question in this case is, however, whether the trust was actually carrying on a business in the current and previous income years. Apart from a number of passive residential property investments and other investments held by the trust, the only other activities carried on by the trust were two share farming arrangements.

Taxation Determination TD 95/62 provides guidelines in relation to share farming arrangements, and in particular whether the share farming arrangement amounts to the carrying on of a business in partnership.

Paragraph 5 of TD 95/62 states that to be carrying on a business, the taxpayer must be involved in the activities that make up that business. This would be evidenced by an element of control over, and/or an ongoing participation in the business. The involvement should be direct or immediate, rather than passive. Paragraph 6 of TD 95/62 states further that in the absence of such an involvement, the receipt by the landowner of a payment from the farmer for the use of the land would be in the nature of income from property.

In this case, there was no ongoing participation in the business. Both the current beneficiary and spouse resided overseas. The spouse was able to visit the farms regularly to keep an eye on things to ensure that the share farming arrangement was running well, and the current beneficiary made less frequent trips. These trips only indicated an element of control over the share farming arrangement. There was no direct or immediate ongoing participation in the business, as both share farmers were responsible for the actual farming aspects of the arrangements.

The trust was therefore not carrying on a business in relation to the share farming arrangements in relation to the properties, nor in any other way since the trust was established. The trust would therefore not be considered to be winding up a business for the purposes of subsection 328-110(5) of the ITAA 1997 and will not be able to satisfy the requirement to be a small business entity.

This condition is therefore not satisfied. This condition can be satisfied, however, if it is determined that the trust satisfies the maximum net asset value test in section 152-15 of the ITAA 1997.

Basic condition (d)

The active asset test in section 152-35 of the ITAA 1997 requires the CGT asset that gave rise to the capital gain to be an active asset for a particular period. As the trust owned property A for less than 15 years, this test will be satisfied if the property was an active asset of the trust for at least half of the relevant period.

Section 152-40 of the ITAA 1997 provides the meaning of 'active asset'. The property will be an active asset at a time if, at that time, the property was used or held ready for use by the trust, an affiliate of the trust, or by another entity that is connected with the trust, in the course of carrying on a business.

Paragraph 152-40(4)(e) of the ITAA 1997 provides that an asset whose main use is to derive rent, cannot be an active asset (unless that main use was only temporary).

In this case, it has been determined above that the trust did not use, or hold the property ready for use, in the course of carrying on a business. There is no indication that the other parties involved in the share farming arrangements were entities connected with the trust. Therefore, unless the property was used by an affiliate of the trust in the course of carrying on a business, the property will not be an active asset and the active asset test will not be satisfied.

Section 328-130 of the ITAA 1997 provides the meaning of 'affiliate'. This provision states that an individual or a company is an affiliate of yours if the individual or company acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the business of the individual or company.

Whether a person acts, or could reasonably be expected to act, in accordance with a taxpayer's directions or wishes, or in concert with the taxpayer is a question of fact dependant on all the circumstances of the particular case. No one factor will necessarily be determinative.

Relevant factors that may support a finding that a person acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes, or in concert with a taxpayer, include:

- the existence of a close family relationship between the parties

- the lack of any formal agreement or formal relationship between the parties dictating how the parties are to act in relation to each other

- the likelihood that the way the parties act, or could reasonably be expected to act, in relation to each other would be based on the relationship between the parties rather than formal agreements or legal or fiduciary obligations, and

- the actions of the parties.

Generally, another business would not be acting in concert with you if they:

- have different employees

- have different business premises

- have separate bank accounts

- do not consult you on business matters, and

- conduct their business affairs independently in all regards.

A person is not your affiliate merely because of the nature of a business relationship you and the person share.

Applying the above guidelines to the circumstances in this case, neither share farmer would be considered to be an affiliate of the trust. There were no close family relationships between the parties and the parties were acting in relation to each other on the basis of formal agreements rather than any relationship between the parties.

Even if it could be argued that the original share farmers were affiliates on the basis of friendship, the time period of this arrangement is not sufficient for the active asset test to be satisfied.

Property A was therefore not an active asset of the trust at any time during the period of ownership of the property, and the active asset test and this condition has not been satisfied.

Conclusion

The trust has not satisfied all of the basic conditions for the small business CGT concessions, and the trust will not be able to choose the small business retirement exemption in subsection 152-305(2) of the ITAA 1997 in relation to any capital gain from the sale of property A.

It is not necessary in this case to consider the other specific conditions for the retirement exemption or Question 2 in relation to the distribution to the current beneficiary.

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