Edited version of your private ruling

Authorisation Number: 1012474901929

Ruling

Subject: CGT Small business concessions

Question 1

Can the Trustee for X Trust (the "X Trust") use the market valuation of the business, as prepared by Y (the "Valuer"), to determine their eligibility for the small business capital gains tax (CGT) concessions using the maximum net asset value test?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 2013.

The scheme commences on:

1 July 2012

Relevant facts and circumstances

Z, on behalf of his/her client, the X Trust, has applied for a private binding ruling (PBR).

The facts describing the scheme are as follows:

1. The X Trust and the W Trust are partners in a partnership called X partnership (the "Partnership"), trading as X (the "Business").

2. The partners entered into an agreement to sell the business to X Pty Limited (the "Purchaser") on X 2012 (see below for details of the sale agreement).

3. The Purchaser paid a premium to the partners.

4. The Partnership is claiming entitlement to concessional CGT treatment under Division 152 of the Income Tax Assessment Act 1997.

5. The Partnership is relying on the maximum net asset value test to be able to receive concessional CGT treatment.

6. In 2012, the Partners commissioned X (the "Valuer"), to prepare a valuation of their Business (see below for details).

The valuation

xx

The sale of the business

An Asset Purchase Agreement (the "Agreement") was made and entered into on X between X, Y and Z.

The purchase price for the business was $ X.

Relevant legislative provisions

Section 152-15 of the Income Tax Assessment Act 1997

Subdivision 152-A of the Income Tax Assessment Act 1997

Section 152-10 of the Income Tax Assessment Act 1997

Section 152-20 of the Income Tax Assessment Act 1997

Section 960-400 of the Income Tax Assessment Act 1997

Subdivision 960-S of the Income Tax Assessment Act 1997

Reasons for decision

All references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated.

Section 152-10 contains the basic conditions that a taxpayer 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 of yours in an income year;

(b) the event would (apart from this Division) 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

(iii) you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an interest in an asset of the partnership;

(iv) the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year;

(d) the CGT asset satisfies the active asset test

You are claiming entitlement to the 50% active asset reduction, on the basis that you satisfy the "maximum net asset value test" in section 152-15.

Maximum net asset value test

The maximum net asset test is stated in section 152-15 and is as follows:

You satisfy the maximum net asset value 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).

Section 152-20 provides the meaning of net value of the CGT assets for the purposes of Section 152-15:

(1)  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.

"Market value"

The current taxation law does not define 'market value' in any general provision. However, section 995-1 ITAA 1997 states that market value has a meaning affected by Subdivision 960-S. The general rule is that the expression 'market value' is used in the income tax laws with its ordinary meaning (section 960-400), but that does not fix its meaning to all contexts. As a result, market value usually takes the ordinary meanings given below, unless specifically defined or qualified by a particular provision.

The most common definition for market value is derived from the High Court case of Spencer v The Commonwealth of Australia (1907) 5 CLR 418 (Spencer v The Commonwealth). In this case, it was held that a valuation of land should be based on the price that a willing purchaser at the date in question would have had to pay to a vendor 'not unwilling, but not anxious to sell'.

In looking to apply the concept of a 'willing buyer and willing seller' to ascertain the market value of land, Griffith CJ commented at 432 in Spencer v The Commonwealth that:

…the test of value of land is to be determined, not by inquiring about 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?

The definition of market value in Spencer v The Commonwealth embraces the following principles:

· The purchaser is willing but not anxious to buy;

· The seller is willing but not anxious to sell; and

· The purchaser is assumed to be independent and dealing at arm's length with the seller.

The expression 'net value of CGT assets', as used in section 152-15, was also examined in Syttadel Holdings Pty Ltd v FC of T 2011 ATC 10-199 (Syttadel Holdings) and Venturi v FC of T 2011 ATC 10-200. In both cases, the Tribunal confirmed that the relevant enquiry was as to "market value" according to its ordinary meaning, as noted in Spencer v The Commonwealth.

A decision impact statement on Syttadel Holdings was released by the Commissioner in February 2012. In that statement, the ATO generally considers the sale price of an asset to be its market value. However, in each particular case, all the relevant facts and circumstances must be taken into account to determine the most appropriate methodology for calculating market value.

In the circumstances of Syttadel Holdings, the most appropriate methodology for calculating market value (according to the term's ordinary meaning) was considered to be by way of an objective business valuation- what a desirous buyer would have paid as a fair price to a vendor willing to sell for a fair price, but not desirous to sell (per Griffith CJ in Spencer at 432).

Guidance on the process to establish a market valuation for various taxation purposes is contained in ATO publication, Market Valuation for tax purposes. The guide outlines accepted principles of valuation, and supplements other advice and guidance provided by the ATO on valuation matters. In the publication, reference is made to the judicial interpretation of the term. The case of Spencer v The Commonwealth is summarised as recognising the following principles:

· 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; and

· both parties being aware of current market conditions.

It is further noted that various valuation methods may be employed, but that valuations undertaken by persons experienced in their field of valuation would be expected to provide more reliable values than those provided by non-experts. Additionally, to ensure the objectivity of the report, the valuer should be independent of the interests of the party commissioning the report.

Part D of Market Valuation for tax purposes provides guidance on the content that is required in a market valuation report. The minimum requirements state that the valuation should:

· be replicable- in effect, this means the valuation should be documented against and explained well enough that another person or valuer can understand how the value was determined; and

· preferably be undertaken by a suitably qualified and experienced person in relation to the asset being valued.

Furthermore, a valuation report should be understandable, and objectively demonstrate the valuation process undertaken in accordance with valuation industry practices.

Application to the facts

In the present case, the Valuer has demonstrated an acceptable level of experience in their field, which is clearly established in the report. There is no evidence to suggest that the Valuer is associated with the Business, and therefore, their interests are independent and objective from that of the partners in the Business.

Conclusion

The valuation of the Business is based on financial statements to 30 June 2012 (and relates to that date), which reflects the value of the business just before the CGT event. The Business was sold on 2 July 2012.

In determining your eligibility for small business CGT concessions under section 152-15, you have asked whether the sale price paid by the purchaser of your business will be included in the net value of the CGT assets held by you, and entities related to you, or whether the price provided by an independent valuer is a reasonable estimation of the market value.

As determined in Syttadel Holdings, the most appropriate methodology for calculating market value was by an objective business valuation, taking into account the specific circumstances of the case. In this instance, you have commissioned an independent valuation of your business, which satisfies the minimum requirements for determining the market value, as outlined in ATO guidance.

Therefore, as all the relevant facts and circumstances must be taken into account when determining the most appropriate methodology for calculating market value, the business valuation will be considered a realistic estimation of the market value, and not the sale price paid by the Purchaser.

In support of the above, the sale price was significantly higher than expected, as the purchasers were an overseas company who were 'very keen' to access the relevant market via an Australian company, indicating that they were 'anxious' to purchase the business. Therefore, in these circumstances, the price was well above that which would be expected of a willing, but not anxious vendor and purchaser. And as such, the business valuation is the best method of determining the market value.

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