Disclaimer
This edited version has been archived due to the length of time since original publication.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.

You cannot rely on this record in your tax affairs. It is not binding and provides you with no protection (including from any underpaid tax, penalty or interest). In addition, this record is not an authority for the purposes of establishing a reasonably arguable position for you to apply to your own circumstances. For more information on the status of edited versions of private advice and reasons we publish them, see PS LA 2008/4.

Edited version of your private ruling

Authorisation Number: 1012480769257

Ruling

Subject: Small business CGT concessions

Question 1

Will you meet the basic conditions for the small business concessions in relation to the sale of your shares in the company?

Answer

Yes

Question 2

If so, will you qualify for the small business 15 year exemption in relation to the sale of the shares?

Answer

Yes

This ruling applies for the following periods:

Year ending 30 June 2013

Year ending 30 June 2014

Year ending 30 June 2015

Year ending 30 June 2016

The scheme commenced on:

1 July 2012

Relevant facts and circumstances

There are three directors and shareholders in the company, each holding one of the three ordinary shares in the company:

There has been no change to the company ownership structure since incorporation.

Y and Z have a family relationship. You do not have a family relationship with Y and Z.

The company purchased a number of detached shops.

From the date of acquisition, you leased the shop A from the company where you operated your sole trader business. You continued to do for a period of time until you became ill.

The remaining shops have been leased for the entire period of ownership:

A family member re-opened your business to the public as a sole trader at shop A. They continued to operate from shop A for a period of time

The combined period shop A was actively used to operate a business by you and your family member was more than 7.5 years.

Throughout the entire period, no formal lease was in place between the company and either you or your family member and market rent was not paid. You paid council and water rates relating to shop A; building insurance was paid by the company.

Similarly, shop B and C were leased without formal lease agreements and only nominal amounts of rent was paid to the company.

Shop A is currently vacant and requires major renovations.

The company intends to sell Shop A for its current market value. The company will make a capital gain on the sale.

At the same time it is intended that your share in the company will be transferred to the Y and Z for current market value. You will make a capital gain on the disposal of this share. Following this transfer, you will retire as director of the company.

The company will retain ownership of shop B and C.

Due to your conditions, you have not been engaged in any other full time employment for a period of time. However, you have maintained your role as director of the company and were required to carry out duties in this role.

Your assets, for the purposes of the maximum net asset value test, taking into account assets of your affiliates and entities connected to you, have a net value of less than $6 million.

The company's only material assets are the detached shops.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Section 152-10

Income Tax Assessment Act 1997 Subsection 152-10(2)

Income Tax Assessment Act 1997 Section 152-15

Income Tax Assessment Act 1997 Section 152-35

Income Tax Assessment Act 1997 Subsection 152-40(3)

Income Tax Assessment Act 1997 Subsection 152-40(3B)

Income Tax Assessment Act 1997 Paragraph 152-40(4)(e)

Income Tax Assessment Act 1997 Section 152-55

Income Tax Assessment Act 1997 Section 152-60

Income Tax Assessment Act 1997 Section 152-105

Income Tax Assessment Act 1997 Paragraph 152-105(1)(d)

Income Tax Assessment Act 1997 Subsection 328-130(2)

Reasons for decision

Basic conditions

A capital gain that you make may be reduced or disregarded under Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997) if the following basic conditions are satisfied:

· a CGT event happens in relation to a CGT asset of yours in an income year

· the event would have resulted in a gain

· the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997, and

· at least one of the following applies;

- you are a small business entity for the income year

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

- 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, or

- you do not carry on a business, but your CGT asset is used in a business carried on by a small business entity that is your affiliate or an entity connected with you.

In this case, when the share in the company is disposed of, a CGT event will occur in relation to a CGT asset owned by you and it is expected that this event will result in a capital gain. Additionally, you satisfy the maximum net asset value test. The active asset test will be considered below.

Additional basic conditions for shares in a company

Under subsection 152-10(2) of the ITAA 1997, if the CGT asset is a share in a company or an interest in a trust (the object company or trust), one of these additional basic conditions must be satisfied just before the CGT event:

CGT concession stakeholder

As per section 152-60 of the ITAA 1997 an individual is a CGT concession stakeholder of a company or trust if they are a significant individual or the spouse of a significant individual where the spouse has a small business participation percentage in the company or trust at that time that is greater than zero.

Under section 152-55 of the ITAA 1997 an individual is a significant individual in a company or trust if they have a small business participation percentage in the company or trust of at least 20%. This 20% can be made up of direct and indirect percentages.

You hold more than a 20% share in the company. In accordance with section 152-60 of the ITAA 1997 you are a CGT concession stakeholder in the company and satisfy the additional basic condition contained in subsection 152-10(2) of the ITAA 1997.

Active asset test

The active asset test is contained in section 152-35 of the ITAA 1997. Where you have owned the asset for more than 15 years, the active asset test is satisfied if the asset was an active asset of yours for a total of at least 7.5 years of the test period detailed below.

The test period:

· begins when you acquired the asset, and

· ends at the earlier of

A CGT asset is an active asset if it is owned by you and is used or held ready for use in a business carried on (whether alone or in partnership) by you, your affiliate, your spouse or child, or an entity connected with you.

Subsection 152-40(3) of the ITAA 1997 determines that a share in a company that is an Australian resident can also be an active asset. This is provided that the total of:

is 80% or more of the market value of all of the assets of the company or trust.

Subsection 152-40(3B) of the ITAA 1997 provides that the 80% test will taken to have been met where breaches of the threshold are only temporary in nature and in circumstances where it is reasonable to conclude that the 80% threshold has been passed.

In this case, the only material assets owned by the company are the detached shops. Accordingly we need to determine if the shops were active assets for at least 7.5 years.

Paragraph 152-40(4)(e) of the ITAA 1997 states that an asset whose main use in the course of carrying on the business is to derive rent can not be an active asset unless the main use for deriving rent was only temporary. This exclusion may not apply to a CGT asset leased to an affiliate or connected entity. In these cases, it is the use of the asset in the affiliate's or connected entity's business that will determine the active asset status of the asset.

Accordingly, as the shops were used to derive rent, they will only be active if the lessees of the shops use the shops in their businesses and are affiliates or connected with the company.

An affiliate is an individual or a company that, in relation to their business affairs, acts or could be reasonably expected to act in accordance with your directions or in concert with you.

The Advanced guide to capital gains tax concessions for small business 2011-12 (NAT 3359) (Advanced guide), provides a number of relevant factors that may support a finding that a person is an affiliate of a taxpayer:

· the existence of a close family relationship between the parties

· the lack of any formal agreement or formal relationship between the parties dictating how the parties are to act in relation to each other

· the likelihood that the way the parties act, or could reasonably be expected to act, in relation to each other would be based on the relationship between the parties rather than on formal agreements or legal or fiduciary obligations, and

· the actions of the parties.

However, subsection 328-130(2) of the ITAA 1997 points out that an individual or company is not your affiliate merely because of the nature of the business relationship. Companies and trusts are not affiliates of their directors and trustees respectively, and vice versa, merely because of the positions held.

Shop A

In this case, you used shop A in your business. During this time, no formal lease agreement was ever put in place and you paid below the market rate of rent. Additionally, you paid some property expenses such as council and water rates. The fact that no formal agreement was ever put in place supports the notion that the way the parties acted in relation to each other was likely due to their relationship and not a legal or fiduciary obligation.

Taking the above factors into account, we accept that you are an affiliate of the company. We consider that due to your shareholding in the company, it is reasonable to expect that in your capacity as a sole trader, you would act in accordance or in concert with the company.

Similarly, a family member used shop A in their business. Again, no formal lease agreement was ever put in place.

We accept that the family member was also an affiliate of the company due to the lack of formal agreements between the two parties and the close family relationship, being a shareholder of the company.

Shop B

Shop B has been leased to an immediate family member of the Y and Z for the entire period of ownership. Under similar circumstances to shop A. This family member has never entered into a lease agreement with the company and pays below the market rate of rent. The shop is used by the family member to store stock associated with their nearby business.

Taking into account the close family relationship between the lessee of shop B and the controlling minds of the company, Y and Z, we accept that the lessee of shop B is also an affiliate of the company.

Shop C

W Pty Ltd has used shop C in its business for the entire period of ownership. Again, no formal lease agreement was entered into and nominal rent has been paid. Y and Z are directors and shareholders of both companies. Accordingly, we accept W Pty Ltd is an affiliate of the company.

Conclusion

Although the company leased the three shops to various parties, including you, these entities are all considered to be affiliates of the company. Therefore it is the use in the affiliates' businesses that will determine if the property is an active asset. As they did not derive rent from the shops the exclusion contained in paragraph 152-40(4)(e) of the ITAA 1997 does not apply.

All of the company's assets will be active for the period that the shops were actively used in the business of the company's affiliates, and as this period is more than 7.5 years, the 80% test and the active asset test will be satisfied.

Accordingly, you meet all the basic conditions for the small business concessions, including the additional basic condition for shares.

Small business 15 year exemption

Section 152-105 of the ITAA 1997 provides a small business 15-year exemption for individuals. Under this section, you can disregard the capital gain from the disposal of a CGT asset if you:

You meet the basic conditions and have held the shares for more than 15 years, since the incorporation of the company.

Whether a CGT event happens in connection with an individual's retirement depends on the particular circumstances of each case. A CGT event may be in connection with your retirement even if it occurs at some time before retirement.

The Explanatory Memorandum (EM) to the New Business Tax System (Capital Gains Tax) Bill 1999 makes the following comments about the requirement to be permanently incapacitated or retiring as one of the conditions for the concession:

The provisions relating to the small business 15-year exemption do not define what is meant by the phrase 'in connection with a taxpayer's retirement', nor does it give any indication of the degree of retirement required in order to take advantage of this concession. It could be argued that the phrase 'in connection with retirement' means that the capital gain arising from the disposal of active assets is to be used to provide funds for a person's retirement rather than to precipitate retirement at the time of the CGT event. The words used in the EM support this interpretation.

The Advanced guide also supports this view. It makes it clear that it is not necessary for there to be a permanent and everlasting retirement from the workforce. However, there would need to be at least a significant reduction in the number of hours worked or a significant change in the nature of the activities to be regarded as a retirement for the purposes of paragraph 152-105(1)(d) of the ITAA 1997.

In this case, although you have not been undertaking full time work for some time, you have maintained your role and duties as the director of the company. Following the sale of the property, it is intended that you will dispose of your shares in the company and retire as director. Accordingly, there will be a significant change in the nature of your activities in the company.

You are over 55 years of age and it is accepted that the CGT event will be in connection with their retirement.

Accordingly, you meet the additional requirements and are entitled to the small business 15 year exemption.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).