Edited version of private ruling

Authorisation Number: 1011616248866

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Ruling

Subject: Capital gains tax (CGT) - Active Asset

1. Can an asset leased by its owner to another entity be a CGT active asset under section 152-40 of the Income Tax Assessment Act 1997 (ITAA 1997) and pass the active asset test in section 152-35 of the ITAA 1997?

Yes.

2. Will the capital gain meet the basic conditions for the small business concessions in section 152-10 of the ITAA 1997?

It will meet the basic conditions for the small business concessions if the company satisfies the maximum net asset value test.

3. Can the CGT retirement exemption or CGT fifteen year exemption be utilised in respect of an active asset owned by a company where that company has a significant individual for the purposes of section 152-50 of the ITAA 1997?

Yes if the relevant conditions are met.

This ruling applies for the following period

Year ending 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts

The taxpayer acquired an asset. The directors of the taxpayer company operated the asset for a number of years. Eventually, the directors ceased operating the asset themselves and leased it to other parties.

Relevant legislative provisions

Section 108-5 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 152-205 Income Tax Assessment Act 1997

Section 152-305 Income Tax Assessment Act 1997

Section 152-325 Income Tax Assessment Act 1997

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 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

Unless otherwise stated, all references in the following Reasons for Decision are to the Income Tax Assessment Act 1997 (ITAA 1997).

Question 1

Summary

The asset would qualify as an active asset whilst the directors were using it directly in the company's business. That means that the asset has been held for a number of years and was used in a manner which would qualify it as an active asset for approximately half that time. As a consequence, it satisfies the active asset test under paragraph 152-35(1)(b).

Detailed reasoning

Paragraph 108-5(1)(b) defines a CGT asset as including a legal and equitable right that is not property. The asset in question is a statutory right and licence and therefore, by virtue of that paragraph, falls within the definition of CGT asset in section 108-5.

There are several concessions which may reduce or eliminate liability to pay tax on capital gains associated with the disposal of CGT assets. Those concessions are available, where certain qualifications are met, in respect of assets which are classified as active assets of a business.

Section 152-40 of the ITAA 1997 provides the meaning of an active asset. For a CGT asset to be an active asset it must firstly satisfy one of the positive tests in subsection 152-40(1) of the ITAA 1997, and then also not be excluded by one of the exceptions in subsection 152-40(4) of the ITAA 1997. Sub-section (1) states:

(1) 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 it is used, or held ready for use, in the course of carrying on a business that is carried on (whether alone or in partnership) by:

(i) you; or

(ii) your affiliate; or

(iii) another entity that is connected with you; or

(b) if the asset is an intangible asset - you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you.

However, paragraph 152-40(4) (e) states that:

(4) the following CGT assets cannot be active assets:

(e) an asset whose main use by you is to derive …rent, … unless:

(i) the asset is an intangible asset and has been substantially developed, altered or improved…or

(ii) its main use for deriving rent was only temporary.

Therefore, an asset whose main use in a business is to derive rent is specifically excluded from being an active asset. Sub-paragraphs 152-40(4)(e)(i) and 152-40(4)(e)(ii) provide exceptions to the exclusion.

In Federal Commissioner of Taxation v. Murry (1998) 193 CLR 605; 98 ATC 4585; (1998) 39 ATR 129 (Murry's Case ), the High Court considered the nature of the income earnt from a taxi licence. It was held that the lease of a taxi licence does not constitute the carrying on of a taxi business by the lessor. Gaudron, McHugh, Gummow and Hayne JJ, stated that :

Prior to the sale, the taxpayer and her husband exploited the licence in another way. They exploited its economic potential by leasing it. In so far as the licence was relevant to their business, it produced rent.

In recent years, the taxpayer in the present case has been in a similar position. That is, the asset has been used to derive rent. The asset was made available, at a charge, for the use of others to operate a business. The taxpayer's involvement is limited to the fee or rent that it receives for the use of its asset. The asset would therefore not qualify as an active asset during that period because of the exclusion clauses in the definition of an active asset.

However, during the preceding period, the asset was used directly by the directors of the company to earn income. While the period that the asset was actively used by the company represents slightly less than half of the total period of ownership, the majority of the income derived from it would have be generated during the period of its active use. On balance, therefore, it would qualify as an active asset of the company.

The active asset test is presented in section 152-35. Section 152-35 states:

152-35 (1)

A CGT asset satisfies the active asset test 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 specified in subsection (2); 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 7½ years during the period specified in subsection (2).

152-35(2)

The period:

(a) begins when you acquired the asset; and

(b) ends at the earlier of:

(i) the CGT event; and

(ii) if the relevant business ceased to be carried on in the 12 months before that time or any longer period that the Commissioner allows - the cessation of the business.

The asset would qualify as an active asset whilst the directors were actively using it directly in the company's business. That means that the asset has been held for a number of years and was used in a manner which would qualify it as an active asset for approximately half of that period. As a consequence, it satisfies the active asset test under paragraph 152-35(1)(b).

Question 2

Reasoning

As the property passes the active asset test, it will satisfy the basic conditions for the small business CGT concessions set out in section 152-10 and those concessions will be available if the company satisfies the maximum net asset value test in section 152-15.

Question 3

Detailed reasoning

Where an asset qualifies as an active asset and the basic conditions are met, the various small business CGT concessions may then be available in respect of its disposal if any relevant further qualifications are met. The CGT active asset reduction in section 152-205 is available where the asset has been held for more than twelve months, as applies in the present case.

The fifteen year exemption in section 152-110 is available where the taxpayer is a company which has had a significant individual for at least fifteen years during the period which it has had ownership of the relevant asset. The exemption will be available where an individual who was a significant individual of the company just before the CGT event was over fifty-five years of age and the event happened in connection with the individual's retirement.

The meaning of a significant individual is provided in section 152-55. It defines a significant individual of a company as being an individual who holds a participation percentage in the company of at least twenty per cent.

The CGT retirement exemption may be available to a company under sub-section 152-305(2). The retirement exemption is available if the basic conditions are satisfied, the entity satisfies the significant individual test and the conditions in section 152-325 are satisfied.

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