Edited version of private ruling

Authorisation Number: 1011578180949

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Ruling

Subject: Capital gains tax (CGT) - Asset's eligibility to be an active asset for small business CGT concessions

Do the premises qualify as an active asset under section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997) if it was used partly for income producing and partly for rental for the purposes of the small business CGT concessions?

Yes.

This ruling applies for the following period

Income year ended 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts

Company A was incorporated in the early 1980's.

The shareholders of Company A are a husband and wife since 1969 who were each issued one ordinary share in the company on incorporation. To date, the company has not issued any other shares.

Company A operated a business from 1986 to 1995.

Company A acquired the premises in 1990. The business operated from these premises since the date of acquisition.

In 1996, Company A sold the business to Company B.

Company B was incorporated June 1993 and deregistered September 2009.

Company B has four shareholders (two sets of husband and wife) of which, one set are the shareholders of Company A. These four shareholders were each issued one ordinary share in Company B when the company was incorporated and did not issue any further shares between incorporations and deregistration.

The other set of husband and wife are not related to the shareholders of Company A in any capacity.

Company B carried on the business in the premises from the date of the business acquisition in 1996 until 2008 when the business ceased operations.

Company B was paying rent for the use of the premises from the date of the business acquisition to the date of the business cessation.

One of the Company A shareholder (the spouse) does not operate a business.

Various improvements were made to the premises during the ownership period and one of these is an extension to the premises to facilitate a lease to an unrelated entity, Company C.

Based on floor area, it is estimated that the size of the extension is 14% of the premises.

Company C has been leasing the extension since 1992, in increments of five years, where they operate a liquor outlet business. The lease agreement with Company C will end in 2011.

As Company B ceased business in 2008, the remainder of the premises has been leased to Company D since 2009 who currently operates a supermarket.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Section 152-35

Income Tax Assessment Act 1997 - Paragraph 152-30(2)(b)

Income Tax Assessment Act 1997 - Paragraph 152-40(1)(a)

Income Tax Assessment Act 1997 - Section 152-40(4)

Income Tax Assessment Act 1997 - Paragraph 152-40(4)(e)

Income Tax Assessment Act 1997 - Subsection 328-125(1)

Income Tax Assessment Act 1997 - Subsection 328-130(1)

Reasons for decision

For the small business concessions in Division 152 of the ITAA 1997 to apply to reduce or disregard a capital gain, the basic conditions in Subdivision 152-A of the ITAA 1997 must be satisfied.

The relevant basic condition to your circumstances is that the CGT asset must satisfy the active asset test.

This condition requires that the active asset test in section 152-35 of the ITAA 1997 is satisfied. This test is satisfied if:

a. you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the period detailed below, or

b. you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7 1/2 years during the period detailed below.

The period:

a. begins when you acquired the asset, and

b. ends at the earlier of:

1) the CGT event, and

2) if the relevant business ceased in the 12 months before the CGT event (or such longer time as the Commissioner allows) when the business ceased.

Under paragraph 152-40(1)(a) of the ITAA 1997, a CGT asset is an active asset at a given time if, at that time, you own it and:

· it is used (or held ready for use) in the course of carrying on a business by you, a small business CGT affiliate of yours or an entity connected with you, or

· it is an intangible asset that is inherently connected with a business you carry on (paragraph 152-40(1)(b) of the ITAA 1997).

Certain assets are, however, excluded from being active assets under subsection 152-40(4) of the ITAA 1997.

Paragraph 152-40(4)(e) of the ITAA 1997 excludes, among other things, assets whose main use is to derive rent (unless such use was only temporary). Such assets are excluded even if they are used in the course of carrying on a business. Whether an asset's main use is to derive rent will depend on the particular circumstances of each case.

Taxation Determination TD 2006/78 considers the case where there is part business and part rental use. It states that an asset owned by the taxpayer and used partly for business purposes and partly to derive rent can be an active asset under section 152-40 of the ITAA 1997 where it is considered the main use of the premises is not to derive rent. In deciding if the property was mainly used to earn rent, the Commissioner will consider a range of factors such as:

· the comparative areas of use of the premises (between rent and business)

· the comparative times of use of the premises (between rent and business), and

· the comparative levels of income derived from the different uses of the asset.

Meaning of "connected with" an entity

Section 328-125(1) of the ITAA 1997 provides the meaning of "connected with" an entity. An entity is connected with another entity if:

· either entity controls the other entity, or

· both entities are controlled by the same third entity.

An entity controls another entity, if the first entity, its affiliates or both of them together beneficially own, or have the right to acquire beneficial ownership of, equity interest in the company that give at least 40% (the control percentage) of the voting power in the company under paragraph 152-30(2)(b) of the ITAA 1997.

Affiliates

Subsection 328-130(1) of the ITAA 1997, defines the meaning of "affiliate" to mean an individual or a company that acts or could reasonably be expected to act, in accordance with the directions or wishes of the taxpayer, or in concert with the taxpayer in relation to the affairs of the business of the individual or company. The definition means that an individual or company cannot be an affiliate unless they are carrying on a business.

The definition of "affiliate" in section 328-130 of the ITAA 1997 does not automatically include the taxpayer's spouse or child under 18 years of age. Therefore, the question of whether a spouse or child under 18 years qualifies as an affiliate will depend on applying the test for "affiliate" in section 328-130(1) of the ITAA 1997.

However, for the purpose of a CGT asset owned by the taxpayer that is used in the business carried on by the taxpayer's spouse or child in their own name or through an entity that the spouse or child controls, the spouse or child will be taken to be an affiliate under section 152-47 of the ITAA 1997, which applies to CGT events occurring from 1 July 2007. Section 152-47 replaces former section 152-40(1A) and extends its scope by also including the situation where the taxpayer's asset is used in a business carried on through an entity that the spouse or child controls.

Conclusion

Company A operated a business in the premises from the date of acquisition in 1990 until they sold the business in 1996 to Company B. Company B continued operating the business in the premises from the date of acquisition of the premises until the business cessation in 2008. Company B paid rent for the use of the premises from acquisition to cessation of business.

The shareholders of Company A (husband and wife) each own 50% shares of Company A. The husband is deemed to control Company A as he owns 50% of the shares in the company, which gives him an interest that entitles him to a share of the income, capital and voting rights in the company greater than 40%.

The shareholders of Company A also each own 25% of the shares in Company B. As the wife does not operate a business, she fails to be an affiliate of the husband under 328-130 of the ITAA 1997. However, with the introduction of section 152-47 of the ITAA 1997, in regards to passively held assets, the wife will be deemed to be an affiliate of the husband.

With Company A shareholder's 50% ownership of shares in Company B, the husband will also be deemed to control Company B, giving him an interest that entitles him to a share of the income, capital and voting rights in the company greater than 40%. The husband in Company A therefore satisfies the provisions under section 328-125 to be connected with Company B.

During the ownership period of the premises, various improvements were made to it. One major improvement was the extension of the premises for rental purposes. Since completion of the extension, it has been leased by Company C, who is an unrelated entity to Company A in any way, in increments of five years. The lease agreement with Company C will end in 2011. The proportion by area of the leased premises used for rental purposes is approximately 14% of the premises.

When Company B, the connected entity, ceased business, the remainder of the premises has been leased to another entity not related to company A in any way.

Certainly for the period that the whole premises was rented, the premises could not be considered an active asset as the premises was used to derive rent and would be excluded as an active asset for this period under paragraph 152-40(4)(e) of the ITAA 1997

However, you have owned the asset for more than 15 years and therefore the asset will need to be an active asset for half the ownership period. At the lodgement date of the private ruling request, the premises had been owned for approximately 20 years. Company B, the connected entity, used the premises for a period of approximately 12 years. The period for which the total property had been rented to non-related entities was a year and half, that is, less than half the period.

Having regard to the fact that it is appropriate to consider a range of factors to determine the main use of an asset, the fact that Company B, the connected entity, operated their business in the main part of the premises for 12 years and Company C only rented 14% of the shop, it is considered that the main use of the premises is not to derive rent and accordingly, the premises is not excluded from being an active asset by paragraph 152-40(4)(e) of the ITAA 1997.

The premise is therefore an active asset under section 152-40 of the ITAA 1997.

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