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Ruling

Subject: Capital gains tax small business concessions

Question

Do you satisfy the maximum net asset value (MNAV) test under section 152-15 of the Income Tax Assessment Act 1997 (ITAA 1997), thereby making you eligible for the capital gains tax (CGT) concessions for small business?

Answer:

No

This ruling applies for the following period

Year ended 30 June 2012

The scheme commenced on

1 July 2011

Relevant facts and circumstances

You and your spouse, set up a company, Company X.

Company X is made up of a total of XX non voting shares and XX voting shares.

You hold approximately Y% of the voting and non-voting shares in the company. You and your spouse together hold approximately Z% of the voting power in the company.

Your shares in Company X were sold to an international company.

You and your spouse, together with the other two non-related shareholders, received $XX for the sale of your shares in the company.

You and your spouse were beneficiaries of your family trust which owns a tenanted residential property. The family trust also had a share portfolio and cash on hand. There were loans outstanding on the residential property and share portfolio.

The company's turnover for the 12 months over a 4 year period and the period up until the sale of the shares has been in excess of $W million for each period.

You state that you and your spouse are affiliates.

You state that you have no other affiliates or connected entities (apart from the company and family trust).

You state that there are no CGT assets of yours (as an individual) that need to be considered as all of your investments are held by the family trust.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 152-10

Income Tax Assessment Act 1997 Section 152-15

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

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

Income Tax Assessment Act 1997 Section 152-35

Income Tax Assessment Act 1997 Subsection 152-20(1)

Income Tax Assessment Act 1997 Subsection 152-20(2)

Income Tax Assessment Act 1997 Subsection 152-20(3)

Income Tax Assessment Act 1997 Subsection 152-20(4)

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

Income Tax Assessment Act 1997 Subsection 328-125(2)

Income Tax Assessment Act 1997 Subsection 328-125(3)

Income Tax Assessment Act 1997 Subsection 328-125(4)

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

Reasons for decision

Small business CGT concession eligibility

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 (MNAV) 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.

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

You have advised that you are satisfied that the shares that have been disposed of are active assets and only wish to establish that you satisfy the maximum net asset value test in order to take advantage of the CGT small business concessions.

Maximum net asset value test (MNAV)

Section 152-15 of the ITAA 1997 explains that you satisfy the MNAV test if, just before the CGT event, the sum of the following amounts does not exceed $6,000,000:

(a) the net value of the CGT assets of yours;

(b) the net value of the CGT assets of any entities connected with you;

(c) the net value of the CGT assets of any affiliates of yours or entities connected with your affiliates (not counting any assets already counted under paragraph (b)).

Importantly, the Commissioner takes the view, in ATO Interpretative Decision ATO ID 2003/166, that cash or Australian currency is a CGT asset for the purposes of the MNAV test

Subsection 152-20(1) of the ITAA 1997 provides that the net value of the CGT assets of an entity is the amount (whether positive, negative or nil) obtained by subtracting from the sum of the market values of those assets the sum of:

a) the liabilities of the entity that are related to the assets; and

b) the following provisions made by the entity:

i. provisions for annual leave;

ii. provisions for long service leave;

iii. provisions for unearned income;

iv. provisions for tax liabilities.

Subsection 152-20(2) of the ITAA 1997 provides that in working out the net value of the CGT assets of an entity:

a) disregard shares, units or other interests (except debt) in another entity that is connected with the first-mentioned entity or with an affiliate of the first-mentioned entity, but include any liabilities related to any such shares, units or interests; and

b) if the entity is an individual, disregard:

i. assets being used solely for the personal use and enjoyment of the individual, or the individual's affiliate (except a dwelling, or an ownership interest in a dwelling, that is the individual's main residence, including any adjacent land to which the main residence exemption can extend because of section 118-120); and

ii. except for an amount included under subsection (2A), the market value of a dwelling, or an ownership interest in a dwelling, that is the individual's main residence (including any relevant adjacent land); and

iii. a right to, or to any part of, any allowance, annuity or capital amount payable out of a superannuation fund or an approved deposit fund; and

iv. a right to, or to any part of, an asset of a superannuation fund or of an approved deposit fund; and

v. a policy of insurance on the life of an individual.

Subsection 152-20(3) of the ITAA 1997 states that in working out the net value of the CGT assets of:

(a) your affiliate; or

(b) an entity that is connected with your affiliate;

include only those assets that are used, or held ready for use, in the carrying on of a business by you or another entity connected with you (whether the business is carried on alone or jointly with others).

Subsection 152-20(4) of the ITAA 1997 explains that you disregard assets under subsection (3) that are used, or held ready for use, in the carrying on of a business by an entity that is connected with you only because of your affiliate.

This was established in the case, White & Anor v FC of T [2012] FCA 109; ATC 20-301, where the net assets of the company were not included in the MNAV calculation for the taxpayer. This was because the taxpayer was only connected with the entity because of their affiliate and as such subsection 152-20(4) of the ITAA 1997 operated to exclude the value of net CGT assets of the company. Instead, it was only the value of the shares disposed of by the taxpayer in that company which was included in the calculation of the MNAV test.

An entity that is connected with you

Subsection 328-125(1) of the ITAA 1997 explains that an entity is connected with another entity if:

a) either entity controls the other entity in a way described in this section; or

b) both entities are controlled in a way described in this section by the same third entity.

Subsection 328-125(2) of the ITAA 1997 provides that an entity (the first entity) controls another entity if the first entity, its affiliates, or the first entity together with its affiliates: if the other entity is a company - beneficially owns, or has the right to acquire beneficial ownership of, equity interests in the company that give at least 40% of the voting power in the company.

Subsection 328-125(3) of the ITAA 1997 explains that an entity (the first entity) controls a discretionary trust if a trustee of the trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the first entity, its affiliates, or the first entity together with its affiliates.

Subsection 328-125(4) of the ITAA 1997 provides that an entity (the first entity) controls a discretionary trust for an income year if, for any of the 4 income years before that year:

a) the trustee of the trust paid to, or applied for the benefit of:

i. the first entity; or

ii. any of the first entity's affiliates; or

iii. the first entity and any of its affiliates;

any of the income or capital of the trust; and

b) the percentage (the control percentage) of the income or capital paid or applied is at least 40% of the total amount of income or capital paid or applied by the trustee for that year.

You have stated that Company X and your family trust are entities connected with you.

Affiliate

Subsection 328-130(1) of the ITAA 1997 explains 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.

You have stated that your spouse is your affiliate.

Market Value

The current tax law does not define market value in any general provision. It is defined in the 'Definitions' part (section 995-1) at the end of the Income Tax Assessment Act 1997 (ITAA 1997), but not in a way that fixes its meaning in all contexts. As a result, 'market value' usually takes the ordinary meanings given below, unless specially defined or qualified in a particular provision.

Valuers of real property adopt the definition used by the International Valuation Standards Council (IVSC):

... the estimated amount for which an asset should exchange on the date of valuation between a willing buyer and a willing seller in an arm's length transaction, after proper marketing, wherein the parties had each acted knowledgeably, prudently and without compulsion.

Business valuers in Australia typically define market value as:

…the price that would be negotiated in an open and unrestricted market between a knowledgeable, willing but not anxious buyer and a knowledgeable, willing but not anxious seller acting at arm's length.

The High Court cast light on the ordinary meaning of 'market value' in Spencer v The Commonwealth of Australia (1907) 5 CLR 418. In this case, the Commonwealth had compulsorily acquired land for a fort at North Fremantle in Western Australia.

In discussing the concept of market value, Griffith CJ commented (page 432) that:

… the test of value of land is to be determined, not by inquiring what price a man desiring to sell could have obtained for it on a given day, i.e. whether there was, in fact, on that day a willing buyer, but by inquiring: What would a man desiring to buy the land have had to pay for it on that day to a vendor willing to sell it for a fair price but not desirous to sell?

Isaacs J subsequently expanded on the concept (page 441):

… to arrive at the value of the land at that date, we have … to suppose it sold then, not by means of a forced sale, but by voluntary bargaining between the plaintiff and a purchaser willing to trade, but neither of them so anxious to do so that he would overlook any ordinary business consideration. We must further suppose both to be perfectly acquainted with the land and cognisant of all circumstances which might affect its value, either advantageously or prejudicially, including its situation, character, quality, proximity to conveniences or inconveniences, its surrounding features, the then present demand for land, and the likelihood as then appearing to persons best capable of forming an opinion, of a rise or fall for what reasons so ever in the amount which one would otherwise be willing to fix as to the value of the property.

In this case, the High Court recognised the principles of:

· the willing but not anxious vendor and purchaser

· a hypothetical market

· the parties being fully informed of the advantages and disadvantages associated with the asset being valued (in the specific case, land), and

· both parties being aware of current market conditions.

In order to calculate the market value of an asset for the purposes of the maximum net asset value test, the value must be calculated just before the CGT event (section 152-15 of the ITAA 1997).

The words 'just before the CGT event' have been considered in Taxpayer v FC of T [2010] AATA 455. At paragraph 24, Deputy President Hack concludes that the valuation is required just before the contract for disposal is signed. This is consistent with ATO ID 2003/745, where the market value of certain assets may change during the course of a day, affecting the maximum net asset value test at signing time later in that day.

In determining market value, it has been established that a valuer should be informed of any genuine offers for an asset when attempting to value an asset: Phillipou v Housing Commission of Victoria (1969) 18 LGRA 254 at 259-260 per Barber J; Goold v Commonwealth (1993) 114 ALR 135 at 141-144 per Wilcox J.

The offer to buy the shares of the company existed just before the contract for disposal was signed. Therefore, the market value of the shares of the company just before the CGT event is determined by including the offer from the international company as a prospective purchaser. Accordingly, the market value of the shares is the value that was paid for the shares by the international company.

Application to your circumstances

You have stated that your spouse is your affiliate. You have also stated that your family trust and Company X are entities connected with you. Therefore, the assets that will need to be included in the MNAV test calculation will include the assets of you, your spouse and the family trust.

The assets of Company X will not be included in the calculation as you are only connected with the company because of your affiliate. That is, if not for the shareholdings of your affiliate (approximately 25% of the voting shares), together with your Y% of the voting shares, you would not hold enough of the voting power in the company to be considered connected with the company. Therefore, as per the principle established in White & Anor v FC of T [2012] FCA 109; ATC 20-301, the net assets of the company will not be included in the MNAV calculation. Accordingly it is only the value of the shares in the company that will be included in the test.

Based on the information provided the calculation of the maximum net asset value test will include the following;

· Share sale proceeds

· Balance of share sale proceeds

· Excess cash from sale proceeds

· Share sale proceeds (spouse)

· Excess cash from sale proceeds (spouse)

· Family Trust assets

Accordingly, as the net value of the CGT assets of you, your affiliates and entities connected with you exceeds $6 million, you do not satisfy the MNAV test.

As you do not satisfy the MNAV, you are not eligible for the CGT concessions for small business.

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