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Ruling

Subject: Capital gains tax

Question 1

Is the property owned by the trust considered an active asset?

Answer:

Yes

Question 2

Are you eligible to disregard the capital gain made on disposal of the property under the capital gains tax (CGT) 15-year exemption concession for small business?

Answer:

Yes

Question 3

Will the distribution of the capital gain made by the trust on the disposal of the property be included in the assessable income of the beneficiaries of the trust?

Answer:

No

This ruling applies for the following period

Year ended 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts and circumstances

The Trust is a discretionary trust.

The trust operated a business from the premises.

You advise that the business was under the $2 million turnover threshold for the small business concessions.

The property was purchased post CGT.

The property is comprised of 2 titles totalling Xm².

The property contains a building, unimproved land used as a hardstand area and a car park.

The building area covers Xm² and is utilised as follows:

· Area 1 - Xm² - used by the business.

· Area 2 - Xm²

o prior to a certain year - used in the business

o from then onwards, the area was rented to an external party

The outside area covers Xm², its use is as follows:

· Xm² - used by the business at all relevant times.

· Xm² - used as required by all occupants of the premises.

The remaining area (which includes driveways etc.) does not contain any buildings nor is it used for any particular purposes, or rented to any other party.

You state that prior to the relevant year the whole property was used exclusively in the business.

You state that, in relation to proportion of land area, during a certain period:

· X% of the internal building area was used in carrying on the business.

· X% of the outside hardstand area was used in the business.

You state that, in relation to proportion of income, during the period:

· X% or more of the income generated from the site was income other than rent in a number of years (provided the rental recoveries/outgoings are not treated as rental income)

You state that some fees have been treated as income (and not rent) as while the fees received are nominally for the use of space and facilities, the rights provided to the customers are short of exclusive use of the property as per a rental agreement. You provide that the 'rentals' were only for short periods of time. There were no set fixed terms for length of stay and the area was not a storage area where customers could store items for months. The customers did not have exclusive use of the area and they could be shifted if required.

You state that the rental recoveries (outgoings) are not treated as rental income, but it is income to the business, it includes items such as council and water rates charged to the customers who rent the area.

For the period 1986 to 2007, beneficiary 1 received 100% of any income from the trust. The trust only made distributions to beneficiary 1 during this period in 1989-90 and 1999-00 to 2002-03.

At the time of the CGT event beneficiary 2 was over 55 years of aged and they retired.

In the 2010-11 financial year, the property was sold with the trust reporting a capital gain.

The capital gain was distributed in 2011 between several beneficiaries, with each beneficiary receiving over 20% of the gain.

Relevant legislative provisions

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 Subsection 152-40(4)

Income Tax Assessment Act 1997 Section 152-110

Income Tax Assessment Act 1997 Section 152-55

Income Tax Assessment Act 1997 Section 152-65

Income Tax Assessment Act 1997 Section 152-70

Income Tax Assessment Act 1997 Subsection 152-70(1)

Income Tax Assessment Act 1997 Paragraph 152-70(5)(a)

Income Tax Assessment Act 1997 Paragraph 152-70(5)(b)

Income Tax Assessment Act 1997 Section 152-125

Income Tax Assessment Act 1997 Section 152-60

Reasons for decision

Detailed reasoning

Small business CGT concession eligibility and the active asset test

Section 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997) contains the basic conditions you must satisfy to be eligible for the small business capital gains tax (CGT) concessions. These conditions are:

(a) a CGT event happens in relation to a CGT asset in an income year.

(b) the event would have resulted in the gain

(c) at least one of the following applies:

(i) you are a small business entity for the income year

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

(iii) you are 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 or

(iv) the conditions 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.

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

Section 152-35 of the ITAA 1997 explains that an asset will be an active asset if you have owned the asset for more than 15 years and it was an active asset for a total of at least 7 ½ years from the time when you acquired the asset until the CGT event. The period in which the asset is an active asset does not need to be continuous.

Importantly, subsection 152-40(4) of the ITAA 1997 provides that an asset whose main use is to derive rent cannot be an active asset.

In your case, based on the information provided, you meet conditions a), b), and c). Therefore it is necessary to now determine whether the property in question is considered an active asset.

The outside area (compromising approximately 90% of the outside area) was used both by the business conducted by the trust and by unrelated parties who paid a fee to utilise the area. The fee paid by these parties was for the use of the space and facilities. The length of stay by the parties was only for short periods of time. You provide that there were no set fixed terms for length of stay and the area was not a storage area where customers could store items for months. The customers did not have exclusive use of the area and they could be shifted if required.

Based on the information provided, the users of the space and facilities do not have the right to exclusive possession but rather only the right to have use of the area for particular purposes. As such, we do not consider that a landlord/tenant relationship exists between the parties. Therefore, the amounts received for the use of this area are not considered rent.

Accordingly, during the period between xxxx and xxxx the property was used exclusively in the business conducted by the trust and would be considered an active asset for this period.

Main use to derive rent

Taxation Determination TD 2006/78 considers, amongst other issues, the situation where there is part business and part rental use of an asset. 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 that 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.

Of the utilised portion of the property, the building area covers 26% of the total floor area of the property, the outside hardstand area covers 66% of the total floor area of the property, with remaining 8% utilised as a car park.

For the period between xxxx and xxxx (a period of 6 years and 5 months) the property was used exclusively in the business conducted by the trust and no part of the property was used to derive rental income.

However, we consider that the rental outgoings charged to the user are in fact part of rental income. Rental and other rental-related income is the full amount of rent and associated payments that you receive, or become entitled to, when you rent out your property. Associated payments include all amounts you receive, or become entitled to, as part of the normal, repetitive and recurrent activities through which you intend to generate profit from the use of your rental property.

The rental outgoings would not be charged to the user if the user was not occupying the rental space and therefore they are considered to be related to the earning of rental income from the user. As such, the rental outgoings should be included as part of rental income in each financial year.

The inclusion of the rental outgoings in rental income causes the rental income, as a percentage of total income from the property, to be in excess of 50% of the total income in all relevant financial years. The business income percentages for these years vary.

Having regard to all the circumstances for the financial years xxxx, xxxx, xxxx and xxxx, we consider that as the vast majority of floor space is used to generate business income and just under 50% of income generated from the property is business income, the main use of the property is to derive business income and not rent and therefore the property is an active asset in these financial years.

Based on the information provided, the property is considered an active asset for over 7 ½ years of your ownership period and therefore satisfies the active asset test under section 152-35 of the ITAA 1997.

Accordingly, you satisfy the basic conditions necessary to be eligible for the capital gains tax concessions for small business.

15-year exemption

Section 152-110 of the ITAA 1997 provides that a trust can disregard any capital gain made on the disposal of an asset if all of the following conditions are satisfied:

(a) you satisfy the basic conditions

(b) you continuously owned the CGT asset for the 15-year period ending just before the CGT event

(c) you had a significant individual for a total of at least 15 years of the whole period of ownership (even if the 15 years was not continuous and it was not always the same significant individual), and

(d) the individual who was a significant individual just before the CGT event was:

· at least 55 years old at that time and the event happened in connection with their retirement, or

· permanently incapacitated at that time.

Section 152-55 of the ITAA 1997 explains that an individual is a significant individual in a trust if the individual has a small business participation percentage in the trust of at least 20%. The 20% can be made up of direct and indirect percentages.

A company or trust satisfies the significant individual test if it had at least one significant individual just before the CGT event. The small business 15-year exemption further requires a company or trust to have a significant individual for periods totalling at least 15 of the years of ownership of the CGT asset.

Section 152-65 of the ITAA 1997 provides that an entity's small business participation percentage in another entity at a time is the percentage that is the sum of:

a) the entity's direct small business participation percentage in the other entity at that time; and

b) the entity's indirect small business participation percentage in the other entity at that time.

Subsection 152-70(1) of the ITAA 1997 explains that an entity's direct small business participation percentage in a trust, where entities do not have entitlements to all the income and capital of the trust, and the trust makes a distribution of income or capital, is the percentage of:

· distributions of income that the entity is beneficially entitled to during the income year, or

· distributions of capital that the entity is beneficially entitled to during the income year.

Ordinarily, if the trust did not make a distribution of income or capital during the income year it will not have a significant individual during that income year. However, recent amendments, contained in section 152-70 of the ITAA 1997 allow an entity another method to work out their small business participation percentage in a discretionary trust if, in the CGT event year, the trustee of the trust:

· did not make a distribution of income or capital during the income year, and

· had no net income or had a tax loss for the income year.

Then, the entity's direct small business participation percentage at the relevant time is worked out using the percentage of the distributions the entity was beneficially entitled to in the last income year before the CGT event year in which the trustee made a distribution (paragraph 152-70(5)(b)of the ITAA 1997).

Importantly, a distribution by the trustee during the CGT event year of some or all of the capital gain made from the CGT event is a distribution for the purpose of assigning a small business participation percentage in that income year to the objects of the trust (paragraph 152-70(5)(a) of the ITAA 1997). Trust law would determine whether the distribution is a distribution of income or capital.

In your case, a distribution of the capital gain was made in the CGT event year. Therefore, each individual will be considered a significant individual of the trust for that year as they will all have a small business participation percentage in the trust of more than 20%.

In the 15 years prior to the CGT event year, the trust only made distributions of income from 1999-00 to 2002-03, in which all income was distributed to beneficiary 1. In the remaining years, up until the CGT event year, the trust made losses. As such, beneficiary 1 was the significant individual for the 4 years from 1999-00 to 2002-03, and the four individuals who received the capital gain distribution in the CGT event year would be deemed to be the significant individuals with the same small business participation percentage (as detailed above) for the remaining 11 years.

Therefore, as you;

· satisfy the basic conditions

· have owned the asset for over 15 years

· have had a significant individual for at least 15 years of your ownership period, and

· have a significant individual who was over 55 of the time of the event and has since retired

· you meet all the necessary conditions to be eligible to disregard any capital gain made on disposal of the property under section 152-110 of the ITAA 1997.

Distributions of the exempt amount

Section 152-125 of the ITAA 1997 explains that if a capital gain made by a company or trust is disregarded under the small business 15-year exemption, any distributions made by the company or trust of that exempt amount to a CGT concession stakeholder is:

· not included in the assessable income of the CGT concession stakeholder, and

· not deductible to the company or trust if certain conditions are satisfied.

The conditions are:

· the company or trust must make a payment within two years after the CGT event that resulted in the capital gain or, in appropriate circumstances, such further time as allowed by the Commissioner

· the payment must be made to an individual who was a CGT concession stakeholder of the company or trust just before the CGT event, and

· the total payments made to each CGT concession stakeholder must not exceed an amount determined by multiplying the CGT concession stakeholder's control percentage by the exempt amount.

The CGT concession stakeholder's participation percentage is:

· for a company or a trust (where entities have entitlements to all the income or capital of the trust), the stakeholder's small business participation percentage in the company or trust just before the CGT event, and

· for a trust (where entities do not have entitlements to all the income or capital of the trust), the amount (expressed as a percentage) worked out using the formula:

Section 152-60 of the ITAA 1997 provides that an individual is a CGT concession stakeholder of a company or trust at a time if the individual is a significant individual in the company or trust.

Therefore, as the individuals are significant individuals of the trust, they are also considered to be the CGT concession stakeholders of the trust. Accordingly, the individuals who received a distribution of the trust's disregarded capital gain from the disposal of the property can exclude the amount they received from their assessable income.

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