Edited version of private ruling

Authorisation Number: 1011588976286

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Ruling

Subject: Capital gains tax - small business concessions - active asset

1. Is the property owned by the Unit Trust an active asset in accordance with former subparagraph 152-40(1)(a)(i) of the Income Tax Assessment Act 1997 (ITAA 1997)?

No.

2. If question 1 is in the negative, is the individual an affiliate of the Unit Trust in accordance with section 328-130 of the ITAA 1997?

No.

3. If the individual is an affiliate of the Unit Trust, will the property owned by the Unit Trust be an active asset in accordance with former subparagraph 152-40(1)(a)(ii) of the ITAA 1997?

Not applicable.

This ruling applies for the following period

1 July 2007 to 30 June 2008

The scheme commenced on

1 July 2007

Relevant facts

An individual commenced a business prior to 20 September 1985. The individual was the sole principal in the business.

To facilitate the finance of the purchase of a building, the individual established a Unit Trust after 20 September 1985. This Unit Trust was set up to:

· raise the necessary funds for the property to be purchased, and

· provide asset protection for the unit holders.

The Unit Trust purchased a freehold land and building shortly after its establishment.

There are a substantial number of unitholders of the Unit Trust.

The Unit Trust owned the property for many years. The property is a commercial building with its own parking areas. After the purchase of the building the individual established a number of businesses in the property

The Unit Trust's primary activity involved the management of its building and the ongoing maintenance of the building. Income was earned by the Unit Trust through leasing its offices to the individual and other entities.

The individual on behalf of the Unit Trust conducted the ongoing and day to day management of the building. The individual was required to:-

· keep accounts and pay the owner's costs

· attend to the leasing of any vacant offices and office space, including the negotiation of lease terms, dealing with any lease disputes and collection of lease rentals

· deal with the employed staff, and

· undertake all things pertaining to the operations of the property business.

For many years there was no formal lease agreement between the Unit Trust and the individual's businesses. Lease agreements were only rectified prior to the sale of the building and for sale purposes.

Further Information provided stated that:-

· the individual decided when and how much of the premises would be leased

· the individual decided when and how much the Unit Trust would pay the individual for their services

· the Unit Trust never sought recovery of any shortfall or refund of any excess amount of the lease payments.

The property was sold after 20 September 1985.

The Unit Trust now wishes to amend their return to claim the 50% 'active asset discount' available as a small business concession on the sale of an active asset.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 152-10(1)

Income Tax Assessment Act 1997 Section 152-35

Income Tax Assessment Act 1997 Section 152-40

Income Tax Assessment Act 1997 Subsection 152-40(1)

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

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

Income Tax Assessment Act 1997 Section 152-205

Income Tax Assessment Act 1997 Section 328-130

Reasons for decision

Question 1

Is the property owned by the Unit Trust an active asset in accordance with former subparagraph 152-40(1)(a)(i) of the ITAA 1997?

Taxation Determination TD 2006/63 discusses a capital gains tax (CGT) asset that is leased by a taxpayer to a connected entity for use in the connected entity's business and whether the CGT asset is an active asset under section 152-40 of the ITAA 1997. It explains its decision in paragraphs 5 to 10 when it states that:-

5. For the small business concessions in Division 152 of the ITAA 1997 to apply to reduce or disregard a capital gain, the relevant CGT asset must satisfy the active asset test in section 152-35 of the ITAA 1997. The active asset test requires the relevant CGT asset to be an active asset for half a particular period.

6. 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, an affiliate of yours or an entity connected with you; or

it is an intangible asset that is inherently connected with a business you, your affiliate, or another entity that is connected with you, carries on (subsection 152-40(1) of the ITAA 1997).

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

Main use to derive rent

8. 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. Of course, if the activities carried on do not amount to the carrying on of a business, it is unnecessary to consider whether the main use of the asset is to derive rent.

Use by a connected entity

9. If a CGT asset, such as land, is leased by a taxpayer to a connected entity for use in the connected entity's business, the question arises as to whether the main use of the asset is to derive rent. In this situation, the asset is wholly used by the owner to derive rent. However, paragraph 152-40(4)(e) of the ITAA 1997 refers to 'an asset whose main use in the course of carrying on the business mentioned in subsection (1)'.... . If an asset is used in the business of a connected entity, 'the business mentioned in subsection (1)' is the connected entity's business (subparagraph 152-40(1)(a)(ii) of the ITAA 1997). Accordingly, it is the use of the asset in that business that will determine the active asset status of the asset.

10. An asset that is leased to a connected entity for use in its business is therefore an active asset under subparagraph 152-40(1)(c)(ii) of the ITAA 1997, unless the use by the connected entity itself is excluded by paragraph 152-40(1)(a)(ii) of the ITAA 1997 (for example, if the connected entity subleases the asset to an unrelated third party).

In this instance, the property owned by the Unit Trust was leased to a number of different entities including the individual. The applicant has asked whether the activity carried on by the Unit Trust is considered to be carrying on a business in its own right as required by former subparagraph 152-40(1)(a)(i) of the ITAA 1997. This question only becomes relevant if the property is not subject to the exclusion in paragraph 152-40(4)(e) of the ITAA 1997 about its main use being to derive rental income.

The property owned by the Unit Trust was used to earn income from leasing/renting to a number of commercial tenants of various sizes. As the property was used to earn rental income then it is excluded from being an active asset by the exclusion in paragraph 152-40(4)(e) of the ITAA 1997.

Question 2

If question 1 is in the negative, is the individual an affiliate of the Unit Trust in accordance with section 328-130 of the ITAA 1997?

As the property owned by the Unit Trust is not an active asset in its own right as determined by the exclusion in paragraph 152-40(4)(e) of the ITAA 1997 then it is necessary to consider the use of the asset in the business of either the Unit Trust's affiliate or another entity that is connected to the Unit Trust as required by former subparagraph 152-40(1)(a)(ii) of the ITAA 1997 which reads as follows:-

A CGT asset is an active asset at a time if, at that time:

(a) you own the asset (whether the asset is tangible or intangible) and:

(i) it is used, or held ready for use, in the course of carrying on a business by your affiliate, or another entity that is connected with you;

In this instance the applicant has asked the Commissioner to determine if the individual is an affiliate of the Unit Trust as required by section 328-130 of the ITAA 1997.

Section 328-130 of the ITAA 1997 reads as follows:-

328-130(1) 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.

328-130(2) However, an individual or a company is not your affiliate merely because of the nature of the business relationship you and the individual or company share.

Note: For small business relief purposes, a spouse or a child under 18 years may also be an affiliate under section 152-47.

Example:

A partner in a partnership would not be an affiliate of another partner merely because the first partner acts, or could reasonably be expected to act, in accordance with the directions or wishes of the second partner, or in concert with the second partner, in relation to the affairs of the partnership.

Directors of the same company and trustees of the same trust, or the company and a director of that company, would be in a similar position.

The Advanced guide to capital gains tax concessions for small business (NAT 3359) does confirm that an individual can be an affiliate of a trust. However, this will only occur providing that the individual acts or could reasonably be expected to act in accordance with the directions or wishes of the trust, or in concert with the trust, in relation to the affairs of the individual's business.

In this instance, we have been told that the individual undertook the following activities on behalf of the Unit Trust:-

· the individual kept the accounts and paid the owner's costs

· the individual attended to the leasing of the vacant offices and office space, including the negotiation of lease terms, dealing with any lease disputes and collection of lease rentals

· the individual dealt with the employed staff, and

· the individual undertook all things pertaining to the operations of the property business.

In addition we have also been told that:-

· For many years there was no formal lease agreement between the Unit Trust and the individual's businesses. Lease agreements were only rectified prior to the sale of the building and for sale purposes.

· The individual decided when and how much of the premises would be leased.

· The individual decided when and how much the Unit Trust would pay the individual for their services.

· The Unit Trust never sought recovery of any shortfall or refund of any excess amount of the lease payments.

All of the above information supports the submission that the Unit Trust acted in accordance with the directions of the individual in the business of the Unit Trust. However, that is not the question that we need to consider, the question that we need to consider is whether the individual acted or could reasonably be expected to act in accordance with the directions or wishes of the Unit Trust, or in concert with the Unit Trust in relation to the business of the individual.

The only asset that the Unit Trust brought to the business of the individual was the premises which the individual's businesses used.

The term 'act in concert' in not defined in the CGT small business relief provisions in Division 152 or elsewhere in the ITAA 1997 or the Income Tax Assessment Act 1936.

The Macquarie Dictionary (Second Edition) defines the term 'in concert' to mean:

in a coordinated or organised way; together.

The meaning of the term 'acting in concert' for the purposes of paragraph 15(1)(a) of the Corporations Act 1989 was considered in IPT Systems v. MTIC Corporate Pty Ltd (2000) 158 FLR 349; (2000) 36 ACSR 454; (2001) 19 ACLC 386. In his decision Owen J referred to his earlier consideration of the term in Bank of Western Australia v. Ocean Trawlers Pty Ltd (1995) 13 WAR 407; (1995) 16 ACSR 510 (Bank of Western Australia) and the decision in Adsteam Building Industries Pty Ltd v. Queensland Cement & Lime Co Ltd (No 4) [1985] 1 QdR 127; (1984) 14 ACLR 456; (1984) 2 ACLC 829 (Adsteam). His Honour identified the following three principles from those cases:

· the words ' in concert' take their meaning from the context and the scope and the purpose of the legislative framework they appear in

· the term 'acting in concert' involves at least an understanding between the parties as to a common purpose or object, and

· the common purpose or object can be established by inference as much as by direct evidence.

In Adsteam (at ACLC 832), McPherson J said:

I cannot see that it is possible for persons to act in concert towards an end or object, or even simply to act in concert, unless there is at least an understanding between them as to their common purpose or object. The expression in question evokes the notion of joint actors, or perhaps even joint tortfeasors, as to which it is settled that there must be 'concerted action to a common end'. See The Koursk (1924) p. 140 at 156. A mere coincidence of separate acts is insufficient: see Fleming: The Law of Torts, 6^th ed., at pp. 227-228.

In Re Australasian Meat Industries Employees Union v. Meat and Allied Trades Federation of Australia (1991) 32 FCR 318; (1991) 104 ALR 199; ATPR 41-151 at FCR 334, ALR 215 French J said:

The phrase in concert has been construed as involving knowing conduct, the result of communication between the parties and not simultaneous actions occurring spontaneously. It has been said to involve contemporaneity and a community of purpose which requires a consensual element.

And, in J-Corp Pty Ltd v. Australian Builders Labourers Federated Union of Workers (WA) (1992) 111 ALR 502; (1993) ATPR 46-099; (1992) 46 IR 263 at ALR 535-536; French J said:

Conduct involving direction and response may, according to the circumstances of the case, be conduct in concert on the part of the person directing and the person acting upon that direction.

The meaning of the phrase 'to act in concert with' was examined in the context of the Corporations Act and in Bank of Western Australia when his Honour, Owen J said:

The meaning to be ascribed to the words used must be gleaned from the context to which they relate and from the scope and purpose of the instrument in which they appear. The phrase acting in concert connotes knowing conduct the result of communicating between parties and not simultaneous actions occurring contemporaneously…. Acting in concert involves at least an understanding between the parties as to a common purpose or object ….

Finkelstein J in Papua New Guinea Dockyard Ltd v. Adams and Ors (2005) 215 ALR 742; [2005] FCA 413 summarised the cases discussing the meaning of 'acting in concert' as collected by Barrett J in Bateman v. Newhaven Park Stud Ltd [2004] NSWSC 566; (2004) 207 ALR 406; (2004) 22 ACLC 943; (2004) 49 ACSR 597; [2005] ALMD 705; [2005] ALMD 706 when he said, at ALR 746:

These cases show that a person, A, will be acting in concert with another person, B, if A engages in conduct (act or omission) in consequence of an agreement or understanding between A and B and the conduct is in pursuance of an objective or purpose which is common to both. It is not as is sometimes suggested necessary to show that the common objective or purpose has some pejorative element [such as] to circumvent the letter, or perhaps even the spirit, of some other statutory obligation or requirement ….

In Stephens v. Federal Commissioner of Taxation 2008 ATC 10-008; [2008] AATA 176, the Administrative Appeals Tribunal (AAT) held that the CGT small business 50% active asset reduction did not apply to the capital gain realised on the sale of premises used by a law firm but held by the partners' family trusts because it could not be established that the premises were used in the course of carrying on a business by a 'small business CGT affiliate'.

In that case, the taxpayer was a beneficiary of the Stephens Family Trust and, with her husband, was a director and shareholder of the corporate trustee. The taxpayer's husband was also a director of NF Legal which carried on a legal practice. The taxpayer was employed by NF Legal.

A partnership comprising the family trust and six other family trusts purchased a property in 1988. This property was used by NF Legal to carry on the legal practice and also comprised two shops which were rented out to tenants. In the year ended 30 June 2003, the property was sold and the family trust realised a capital gain. It then applied the small business tax concessions to the capital gain and then distributed the whole of the capital gain to the taxpayer. It was contended by the taxpayer that NF Legal acted, or could be reasonably expected to act, in accordance with the directions or wishes of the corporate trustee or in concert with the trustee. The corporate trustee was merely one of six owners of the property and the taxpayer's husband was merely one of seven directors of NF Legal. Of these seven directors, only four had any connection with a co-owner.

In the decision at paragraph 39, Tribunal Member Fice had to consider whether the company acted or could be expected to act in accordance with the family trust or in concert with it when he said that:-

39. It is a question of fact as to whether, at the relevant time, NF Legal, in the conduct of its legal practice, acted or could be reasonably expect to act, in accordance with the directions or wishes of the Stephens Family Trust. It is also important to observe that s 152-25 (1) of the Assessment Act is not limited to the conduct of the small business CGT affiliate in the use of the CGT asset. Rather, it is couched in broad terms and must include the relationship between the parties in the conduct of the affiliate's business generally. The question is whether Mr and Mrs Stephens were in a position to direct the activities of NF Legal in the course of that firm conducting its business at the Armstrong Street premises. That must involve more than merely directing NF Legal's use of the Armstrong Street premises.

Later at paragraph 41 he expanded on his understanding of how the repealed subsection applied in this instance when he said that:-

41. Mr Stephens said in his written statement that when offers were being considered for the rental of the two shops which form part of the Armstrong Street premises, the directors of NF Legal considered the proposed tenants and that the needs of NF Legal were paramount. In fact, one application for a lease of one of the shops was refused because the prospective tenant was another lawyer. This fact, as I understood it, was put as an example of NF Legal acting in accordance with the directions or wishes of Enizer. However, in my view that is, at best, equivocal. It could just as easily be said that the wishes of both parties in this instance merely coincided. There was no evidence of a direction or wish expressed by Enizer which was acted on by NF Legal.

He then said at paragraph 43 that:-

43. Although Mr Young, who appeared for Ms Stephens, submitted there was a high degree of co-operation between Mr Stephens, as the directing mind and will of the trustee Enizer, and the practice of NF Legal, at least as far as the use of the CGT asset is concerned, that seems to fall short of establishing the requirements as set out in s 152-25(1)(b).

It was held that there was insufficient evidence before the Tribunal to determine whether there was in fact an understanding or arrangement between the Stephens Family Trust and NF Legal as to a common purpose or object. There was no direct evidence that NF Legal acted or could be reasonably expected to act in accordance with the directions or wishes or in concert with, the corporate trustee in respect of the conduct of its business. Therefore, the taxpayer failed to discharge the onus of proof, and in particular, failed to prove that NF Legal was a small business CGT affiliate of the Stephens Family Trust.

In Case 2/2010 ATC 1-021, the taxpayer company was the proprietor of a tavern in Queensland. It initially leased the premises but a related entity, Relatedco 1 later acquired the freehold and improvements from which the tavern was operated. A husband and wife and their son were the only members of Relatedco 1 and another company, Relatedco 4. At all material times the husband and son were the directors of the taxpayer and through his company, the son was also a 15% shareholder in the applicant.

There were two distinct parts of the tavern's operations - a hotel that was managed by the son and a motel that was managed by the husband and wife. The son was one of the tavern's duty managers who had primary responsibility for the day to day management of the hotel side of the business while his parents concentrated their endeavours on the motel side.

The hotel business was sold and the taxpayer claimed the small business CGT concessions. The Commissioner considered that the taxpayer's total net assets were above $5 million and it was therefore not entitled to the small business CGT concessions.

One of the issues considered by the Tribunal in determining whether the maximum net asset value test was satisfied was whether the son director was a small business CGT affiliate. The Commissioner contended that the son was a small business CGT affiliate on the basis that:

· the son director had close involvement in the day to day operations of the hotel as its duty manager

· the fact that he was the company's nominee for the purpose of the liquor licensing laws

· the fact that he was the guarantor of the company's liabilities under the Gaming Machine Act 1991 (Qld), and

· the evidence of the male director that the son director generally acted in accordance with the male director's directions, made on behalf of the company in the carrying on of the business of the applicant.

Deputy President Hack disagreed with the Commissioner and stated:

The acts of the son director, that is the first three matters are explicable on the basis of the son director's position as a director or as an employee (or both) of the applicant. That is to say, it was his conduct qua directors of the applicant, not conduct of his in his own right or in his capacity as a director of other entities. Moreover, there is no objective purpose or purpose common to both, the object or purpose that underlies the conduct is that of the applicant, The son director's conduct is directed to that objective or purpose but it is not his objective or purpose. Were the matter to be tested in the way that the Commissioner suggests, every employee would be regarded as a small business CGT affiliate of the employer.

The comments made by Finkelsten J in Papua New Guinea Dockyard Ltd. v. Adams [2005] FCA 413; (2005) 215 ALR 742 at [13], as outlined previously, were also then referred to.

It was concluded that the evidence fell well short of establishing that the son acted, or could reasonably be expected to act, in accordance with the wishes or directions of the taxpayer, or in concert with it.

Although it was held that the entities were not small business CGT affiliates in the above cases, the comments of the above Tribunal Members provide some understanding of how the provision may apply.

Taxation Determination TD 2006/79 outlines the Commissioner's views on small business CGT affiliates and provides guidance on whether parties are operating in concert for the purposes of repealed paragraph 152-25(1)(b) of the ITAA 1997.

Paragraph 41 of TD 2006/79 discusses how a person is considered to act in concert with another person when it states that:-

Whether a person 'acts, or could reasonably be expected to act, in accordance with (the taxpayer's) directions or wishes, or in concert with (the taxpayer)', is a question of fact dependent on all the circumstances of the particular case. The key consideration is the actions of the parties. If the parties act together in pursuit of a common goal or purpose or the taxpayer is able to direct the other person in relation to (not merely where the person is involved in, connected to or participating in) the carrying on of the business, these are factors that may support a conclusion that the parties act in concert or the other person acts in accordance with the taxpayer's directions or wishes.

While paragraph 42 of TD 2006/79 considers the various factors when considering a relationship when it states that:-

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 on formal agreements. Relevant factors may include the existence of a close family relationship or friendship between the parties and any agreement or common understanding between the parties about how the parties are to act in relation to each other.

From the above comments it would appear that in order for the parties to act in concert it is necessary for them to demonstrate that:-

· they act together in the pursuit of a common goal or purpose, or

· one person is able to direct the other person in relation to the carrying on of the business.

While it is accepted that:-

· For many years there was no formal lease agreement between the Unit Trust and the individual's businesses. Lease agreements were only rectified prior to the sale of the building and for sale purposes.

· The individual decided when and how much of the premises would be leased.

· The individual decided when and how much the Unit Trust would pay the individual for their services.

· The Unit Trust never sought recovery of any shortfall or refund of any excess amount of the lease payments.

This indicates that the Unit Trust could have been an affiliate of the individual (if a trust was able to be an affiliate - which is not accepted) then the Unit Trust would have acted or could reasonably be expected to act in accordance with the directions or wishes of the individual or in concert with the individual in relation to the business of the Unit Trust. This however is not the question which we are dealing with, we are asking whether the individual would have acted or could reasonably expected to act in accordance with the directions or wishes of the Unit Trust or in concert with the Unit Trust in relation to the business of the individual.

In this instance there is:-

· no information which supports the contention that the two parties are acting together in the pursuit of a common goal or purpose in relation to the business of the individual, neither

· is there any evidence to support the statement that the Unit Trust is able to direct how the individual can act or can reasonably be expected to act in relation to the business of the individual.

On the information provided the only asset that the Unit Trust brought to the business of the individual was the premises which the individual's businesses use. As stated by Tribunal Member Fice in paragraph 39 in Stephens v. Federal Commissioner of Taxation, repealed paragraph 152-25(1)(b) of the ITAA 1997 requires that it:

must involve more than merely directing NF Legal's use of the Armstrong Street premises.

Therefore its successor, subsection 328-130(1) of the ITAA 1997 in this instance requires:-

that there must involve more than merely directing the individual to use the premises of the Unit Trust.

Therefore, the individual is not considered to be an affiliate of the Unit Trust as required by subsection 328-130(1) of the ITAA 1997 as the individual did not act or could reasonably be expected to act in accordance with the directions or wishes of the Unit Trust or in concert with the Unit Trust in relation to the business of the individual.

Question 3

If the individual is an affiliate of the Unit Trust, will the property owned by the Unit Trust be an active asset in accordance with former subparagraph 152-40(1)(a)(ii) of the ITAA 1997?

As the individual is not an affiliate of the Unit Trust then the property owned by the Unit Trust will not be an active asset in accordance with former subparagraph 152-40(1)(a)(ii) of the ITAA 1997 because it is not used in the course of the carrying on of a business by an affiliate of the Unit Trust's.

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