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This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law.

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Edited version of your private ruling

Authorisation Number: 1012462098813

Ruling

Subject: CGT concessions and Part IVA

Question:

1. Do you qualify for the capital gains tax (CGT) small business 50% active asset reduction?

Answer:

Yes.

2. Do you qualify for the CGT active asset rollover concession?

Answer:

Yes.

3. Will Part IVA apply to the arrangement?

Answer:

No.

This ruling applies for the following period

Year ending 30 June 2014

The scheme commenced on

1 July 2013

Relevant facts

Company A is a private company owned by X and Y in equal shares. X and Y are also directors of company A.

The shares have been held by both parties for more than 12 months.

The company A has been independently valued.

Company A's directors/shareholders wish to plan ahead for asset protection and estate planning by:

All the assets of company A and company B are active assets and the company is a small business entity.

The Family Trusts are discretionary trusts with corporate trustees.

X and Y have always received at least 40% of the distributions made from their respective family trusts.

The restructure will allow the business (company A) to be protected against personal risks such as personal litigation, bankruptcy and etcetera.

It will also allow the imputation credits to be safe from business risk in the company B.

The shares being held in the family trusts will facilitate future specie contributions to self managed super funds of the directors and spouses.

Currently the directors/shareholders are receiving franked dividends and director's fees from company A. After the restructure, the directors/shareholders will still receive franked dividends as distributions from the family trust and will still receive director's fees from company A.

The family trusts have young children as beneficiaries. Some trust distributions may occur to these and other beneficiaries of the family trusts. Any tax advantage as a result of these distributions will be minimal.

Relevant legislative provisions

Income Tax Assessment Act 1997 - section 104-10

Income Tax Assessment Act 1997 - Division 115

Income Tax Assessment Act 1997 - Subdivision 152A

Income Tax Assessment Act 1997 - Subdivision 152C

Income Tax Assessment Act 1997 - Subdivision 152E

Income Tax Assessment Act 1997 - section 152-10

Income Tax Assessment Act 1997 - section 152-35

Income Tax Assessment Act 1997 - section 152-40

Income Tax Assessment Act 1936 - section 177A

Income Tax Assessment Act 1997 - section 177C

Income Tax Assessment Act 1997 - section 177D

Reasons for decision

Discount capital gain

CGT event A1 in section 104-10 of the Income Tax Assessment Act 1997, relating to the disposal of a CGT asset, will happen when you dispose of the property. You will make a capital gain if the capital proceeds from the disposal are more than the cost base. You will make a capital loss of those capital proceeds are less than the reduced cost. 

You will be eligible for the discount capital gains where:

The discount percentage is 50%.

Where a capital gain meets these requirements, that capital gain is a discount capital gain. Generally, the discount percentage is applied to the discount capital gain, to arrive at your net capital gain.

Based on the facts, you will be eligible for the discount capital gains of 50% if your capital gain is calculated without any reference to indexation of the cost base.

Small business CGT concessions

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

If the CGT asset is a share in a company, one of these additional basic conditions must be satisfied just before the CGT event:

In this case, company A's directors/shareholders intend to dispose of their shares in the company, a CGT event, and the sale will result in a gain.

Active asset

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.

A share in an Australian resident company is also CGT active asset at a given time if you own it and the total of the following is 80% or more of the market value of all of the assets of the company:

Cash and financial instruments are not active assets, but they count towards the satisfaction of the 80% test provided they are inherently connected with the business.

The active asset test requires a CGT asset to have been an active asset for at least half of the ownership period. For a share in an Australian resident company to meet this requirement, the company must satisfy the 80% test for that same period.

The 80% test will be taken to have been met:

In this case, company A satisfies the 80% test and the shares pass the active assets test.

Further requirement for shares

If the CGT asset is a share in a company, one of these additional basic conditions must be satisfied just before the CGT event:

An individual is a CGT concession stakeholder of a company if they are a significant individual and they are a significant individual in a company if they have a small business participation percentage in the company of at least 20%.

An individual's direct small business participation percentage in a company is the percentage of:

In this case, each shareholder has a 50% interest in company A and are both significant individuals and CGT concession stakeholders of company A.

50% active asset reduction

Unlike the other small business concessions, the small business 50% active asset reduction applies automatically if the basic conditions are satisfied, unless you choose for it not to apply.

To apply the small business 50% active asset reduction, you need to satisfy only the basic conditions. There are no further requirements.

In this case, you satisfy all the basic conditions and the small business 50% active asset reduction will apply.

Rollover provisions

The conditions surrounding the small business rollover are contained in subdivision 152-E of the ITAA 1997. The small business rollover allows an entity to defer all or part of a capital gain made from a CGT event happening to an active asset.

There are rollover conditions that must be satisfied by the end of the replacement asset period. This period starts one year before and ends two years after the last CGT event that occurs in the income year for which you choose the roll over.

If the rollover conditions are not met within the replacement asset period, the gain will become assessable.

You will satisfy the rollover conditions where you meet all the following conditions:

In this case, you intend to acquire shares in company B as replacement assets within the replacement asset period. Company B will satisfy the 80% test and the shares will pass the active assets test.

The rollover will result in the individual shareholders holding a percentage each of company B while the family trusts will hold the remaining shares.

In order for the individual shareholders to be CGT concession stakeholders in company B, they will need to be 'connected with' at least one of the family trusts.

An entity is connected with another entity if either entity controls the other entity, or both entities are controlled by the same third entity.

A beneficiary is taken to control a discretionary trust only if, for any of the four income years before the year for which relief is sought for a CGT event:

In this case, the individual shareholders have always received at least 40% of the distributions made from the family trusts and are taken to control their respective family trusts. They are considered to be connected with the trusts which will be CGT concession stakeholders of company B.

The capital gain to be rolled over will not exceed the cost base of the replacement asset. Therefore, the rollover conditions will be satisfied.

Please note:

If an entity chooses the rollover concession, all or part of the capital gain will not be included in their assessable income until a change in circumstances happens, for example the replacement asset is sold. Under subsection 104-185(1) of the ITAA 1997 CGT event J2 happens if an entity chooses the rollover concession and a change in circumstances happens. When the change occurs, the deferred capital gain will crystallise.

When an entity disposes of a replacement asset, CGT event A1 happens in addition to CGT event J2. Any capital gain made from the A1 event on the disposal of the replacement asset may qualify for any of the small business CGT concessions if the relevant conditions are satisfied.

Application of Part IVA

Part IVA of the ITAA 1936 is a general anti-avoidance provision that can apply in certain circumstances if a tax benefit is obtained in connection with a scheme, and it can be concluded that the scheme, or any part of it, was entered into for the dominant purpose of enabling a tax benefit to be obtained. Part IVA is a provision of last resort.   

The application of Part IVA depends on the facts of the particular case.  

In order for Part IVA to apply, the following questions must be addressed:

Is there a scheme?

For Part IVA to apply, the identified scheme must fall within the following wide definition of 'scheme'.

The definition applies to any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and any scheme, plan, proposal, action, course of action or course of conduct (subsection 177A(1) of the ITAA 1936).

In the present case, there is a 'scheme' as defined in section 177A of the ITAA 1936, being the following arrangement:

Is there a tax benefit?

The identification of a tax benefit necessarily requires consideration of the income tax consequences, but for the operation of Part IVA, of an 'alternative hypothesis' or a 'counterfactual. This is what would have happened or might reasonably be expected to have happened if the particular scheme had not been entered into or carried out. This alternative arrangement also forms the background against which the objective ascertainment of the dominant purpose of a person occurs in accordance with section 177D of the ITAA 1936.

The counterfactual would involve both X and Y transferring a portion of their interests in company A to their respective family trusts. The transfer would result in a capital gain. As discussed above, the shareholders of company A would be entitled to apply the 50% capital gain discount and the small business active asset reduction and rollover concession under the small business CGT concessions to reduce any capital gain to nil. The counterfactual results in no tax benefit.

Objective purpose test

Section 177D of the ITAA 1936 provides that Part IVA applies to a scheme in connection with which you have obtained a tax benefit if, after having regard to eight specified factors, it would be concluded that a person who entered into or carried out the scheme, or any part of it, did so for the purpose of enabling you to obtain the tax benefit.

As discussed above, any capital gain resulting from the disposal of the shares would be reduced to nil under the small business CGT concessions, result in a nil tax benefit. Therefore, Part IVA will not apply to this arrangement.


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