Edited version of your written advice

Authorisation Number: 1012662742414

Ruling

Subject: Sales of shares - carrying on a business - for purpose of active asset concession

Question:

For the year ended 30 June 20XX, were you a small business entity?

Answer:

No.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 2012

Relevant facts and circumstances

You are a family trust which historically carried on a business of providing specialist services. Unless working in the premises of your clients, you work from your director's home office.

You also held shares in a private company that also historically carried on a business of providing the same kind of services. The private company also had a long term investment asset, which comprised of over 80% of the company's market value.

Prior to 1 July 20XX, you ceased to conduct your historical business activities to devote your time exclusively to the sale of the private company's long term investment asset. During the year ended 30 June 20XX, you did not pay any employees.

During the year ended 30 June 20XX, you sold your shares in the private company for a significant sum, far in excess of your historical business income.

For the year ended 30 June 20XX, you had two sources of income:

• % of your total income from services provided to the private company, to prepare the long term investment asset for sale (prior to the share sale).

• % of your total income from services provided to the purchaser of your shares (after the share sale), to ensure a smooth transition of the asset's ownership. The specialist agreement stipulated your payment on a monthly basis, your working for a specified amount of days and your provision of a wide range of broad and general services related to your intimate knowledge of the long term investment and its various stakeholder relationships.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 87-15  

Income Tax Assessment Act 1997 Section 328-110

Income Tax Assessment Act 1997 Section 995-1

Reasons for decision

Ceasing to carry on a business

Taxation Ruling TR 1999/9 Income tax: the operation of sections 165-13 and 165-210, paragraph 165-35(b), section 165-126 and section 165-132 is about the same business test.

From paragraph 47, TR 1999/9 states that the existence of a period of 'dormancy' often raises an issue as to whether the business is truly still in existence, though greatly reduced in scale, or has actually ceased altogether; that if the taxpayer completely ceases to carry on the business, it necessarily fails the same business test. Any other business it thereafter carries on must be a new business that it has commenced after the cessation of the old business and, therefore, a different business from the business carried on before.

In the High Court of Australia case of Avondale Motors (Parts) Pty Ltd v. FC of T (1971) 124 CLR 97; 45 ALJR 280; 2 ATR 312; 71 ATC 4101 (Avondale Motors), Gibbs J held the taxpayer company did not satisfy the same business test on the basis that prior to the change-over, the business activities of the company, which comprised dealing in motor vehicle spare parts and accessories, had ceased completely. Gibbs J said:

It is further submitted on behalf of the taxpayer that, quite apart from the rather artificial rule to which I have just referred, it should be held that it was still carrying on business after 29 February 1968 notwithstanding its inactivity after that date. It is said that those controlling the taxpayer had no intention of putting it into liquidation and that on the contrary it was obviously their intention that it should again engage in business of a similar kind, after its shares had been sold to a purchaser who wished to benefit by its accrued losses. To say this, however, clearly does not mean that the taxpayer was still carrying on business. There are cases in which it has been held that a company does not cease to carry on business notwithstanding that its activities are reduced to a minimum or indeed are almost entirely suspended. In South Behar Railway Company Limited v. IRC Lord Sumner said: "Business is not confined to being busy; in many businesses long intervals of inactivity occur." In some cases the very nature of the business is such that its conduct may require little activity, e.g. the business ... of acquiring a concession and turning it to financial benefit.

...

In other cases it has been held that a company continues to carry on business notwithstanding a suspension of activity due to causes beyond its control, e.g. where a steamship company had lost its only ship and was in the course of building another ...

In the present case the taxpayer's activity had ceased completely. The cessation of activity was not due to the nature of the business which the taxpayer carried on, or to some temporary adversity which the taxpayer intended to endeavour to overcome; it was due to a decision to discontinue the business previously carried on because it had been unprofitable and there was no intention to resume the conduct of that business.

In your case, we consider you ceased to carry on a business prior to 1 July 2012 in order for your director and principal to work towards the sale of your shares.

Unlike the example of a steamship company given by Gibbs J in Avondale Motors, your period of dormancy was not due to the nature of your former business or to some temporary adversity.

The general impression gained is there was an unrivalled financial incentive for your director/principal to devote their time exclusively to the sale of your shares.

Carrying on a business

Section 328-110 of the Income Tax Assessment Act 1997 (ITAA 1997) provides to be a small business entity for an income year (the current year), you must carry on a business in the current year and your aggregated turnover for the previous year was less than $2 million or your aggregated turnover for the current year is likely to be less than $2 million.

Section 995-1 of the ITAA 1997 defines the term 'business' in the following way:

business includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? explains, at paragraphs 13 and 26, the courts have held that the following indicators are relevant to whether an entity is carrying on a business:

• whether the activity has a significant commercial purpose or character; this indicator comprises many aspects of the other indicators;

• whether the taxpayer has more than just an intention to engage in business;

• whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity;

• whether there is repetition and regularity of the activity… i.e., how often is the activity engaged in? How much time does the taxpayer spend on the activity?

• whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business;

• whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit;

• the size, scale and permanency of the activity; and

• whether the activity is better described as a hobby, a form of recreation or a sporting activity.

The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the 'large or general impression gained' (Martin v. FC of T (1953) 90 CLR 470 at 474; 5 AITR 548 at 551) from looking at all the indicators, and whether these factors provide the operations with a 'commercial flavour' (Ferguson v. FC of T (1979) 37 FLR 310 at 325; 79 ATC 4261 at 4271; (1979) 9 ATR 873 at 884). However, the weighting to be given to each indicator may vary from case to case.

About repetition and a permanent character, continuity the High Court of Australia case of Hope v. Bathurst City Council 80 ATC 4386 at p. 4390; (1980) 144 C.L.R. 1 at p. 9, stated:

Although it has been common ground that "business'' is used in its ordinary meaning in sec. 118(1), the Courts below have refrained from saying what that meaning is. This is perhaps understandable because, as a glance at the Shorter Oxford Dictionary will show, the word has many meanings. Ironically it is the last meaning given by the Shorter Oxford Dictionary, ``19. A commercial enterprise as a going concern.'', that comes closest to the popular meaning which the Courts appear to have acted on in the present case. In truth it is the popular meaning of the word as used in the expression ``carrying on a business'', rather than the popular meaning of the word itself, that is enshrined in the statutory definition. It is the words ``carrying on'' which imply the repetition of acts (Smith v. Anderson (1880) 15 Ch. D. 247, at pp. 277-278) and activities which possess something of a permanent character.

About repetition and regularity, paragraph 55 of TR 97/11 explains:

It is often a feature of a business that similar sorts of activities are repeated on a regular basis. The repetition of activities by the same person over a period of time on a regular basis helps to determine whether there is the 'carrying on' of a business. For example, in Hope the 'transactions were entered into on a continuous and repetitive basis', such that the taxpayer's activities 'manifested the essential characteristics required of a business'

About whether a business is carried on in a manner similar to that in which other participants in the same industry carry on their activities, Lord Clyde in IR Commissioners v. Livingston at TC 542 said that:

... the test, which must be used to determine whether a venture ... is, or is not, "in the nature of trade", is whether the operations involved in it are of the same kind, and carried on in the same way, as those which are characteristic of ordinary trading in the line of business in which the venture was made.'

Paragraph 64 of TR 97/11 states, in considering this indicator, factors that might be compared with the characteristics of others engaged in the same type of business include:

the types of customers the taxpayer sells his/her product to - wholesalers, retailers, the public at large, or friends or relatives - and the manner in which this marketing takes place;

In your case, we consider, for the year ended 30 June 20XX, you were not carrying on a business for reason of the following general impression gained:

• You did not carry on an activity of the same kind and carried on in a similar manner to that of the ordinary trade, namely, to the public in general. You did not have the same type of clients as others engaged in the same type of business or as you historically serviced. Instead, you only provided services to the private company in which you held valuable shares and, then, later, to the purchaser of your shares. As stated in your agreement, you were to provide services to assist in the transfer of your existing information and knowledge about the investment asset and to assist in liaising with the relevant (pre-existing) stakeholders. This demonstrates your services provided were intrinsically related to the disposal of your investment rather than related to services provided to the market in general.

• Your activity of providing personal services did not exhibit the character of 'permanency' and repetition and regularity of activities. Instead, you only provided the amount of services necessarily related to the realisation of your investment. The services provided prior to the share sale were negligible, not demonstrating repetition and regularity of activities. Considering your unrivalled financial opportunity, the impression gained is you only provided services related to the realising your shares investment rather than provided services related to carrying on a business.

• The impression gained is your activity of providing personal services did not have the 'intention' of carrying on a business. Instead, the impression gained is the intention of your provision of personal services was for the purpose of realising a capital gains tax investment.

• The general impression gained is your activities did not have a commercial flavour, in that you did not conduct a business activity that would generate goodwill in relation to your relevant industry in general. Your engagement by your private company and the purchaser of your shares were not related to any commercial process of a client appraising your reputation and goodwill or as a result of a commercial tendering process. Instead, your engagements were solely related to your ownership of and associated intimate knowledge of the investment asset.

In summary, your relationship with the private company was intrinsically for the realisation of your shares investment and your relationship with the purchaser was similar to the seller of a business who continues to work for that business, as a consultant, for a short period, to ensure a smooth transition. Such relationships do not have the nature of carrying on a business.

Personal services income (PSI)

Part 2-42 of the ITAA 1997, which includes Division 87 of the ITAA 1997, is about personal services income and personal services businesses.  

Many consultants and contractors operate their business through a company, partnership or trust. In many cases, the income received for the work they do may be classified as PSI. If the PSI rules apply, it doesn't matter whether you are operating through a company, partnership or trust. PSI is taxed as though earned by you as an individual.

To work out whether income is PSI, you need to consider whether the income relates more to the supply of services rather than the supply of goods. If the majority of the income (more than 50%) is for the skills, knowledge, expertise or efforts of the person who performed the services, the income is PSI.

In your case, the income you earned is PSI because the majority of the income is for the skills, knowledge, expertise or efforts of the person who performed the services

As your income is PSI, it then needs to be worked out if the PSI rules apply to this income. This is done by applying four tests:

• results test

• unrelated clients test

• employment test

• business premises test.

You will pass the results test in the income year if you can answer 'yes' to all three of the following questions for at least 75% of your PSI:

(1) Under your contract or arrangement, will you only receive payment when the work has been completed - that is, after producing the contracted result?

(2) Do you need to provide the equipment or tools necessary to do the work?

(3) Do you have to rectify defects in the work, or are you liable for the cost of rectifying defects?

In your case, you did not pass the results test because:

(1) You did not work for a result because you worked for pay on a monthly basis, regardless of the amount of work you did or the result you achieved. Similar to an employee, you only performed the amount of work the purchase had available rather than completing a specific task. Your specialist agreement merely lists general services to be provided, similar to a duty statement of an employee. The fact that your specialist agreement stipulates you work for a certain number of days per month demonstrates you were not working for a result.

(2) Although you may have provided some equipment or tools necessary to do the work, such as your personal computer, if you had to do major work you would have used the purchaser's office equipment or, in the event of on-site work, used equipment they held or hired.

(3) As explicitly provided for in your specialist agreement, you were not liable for the cost of rectifying defects in your work.

As you did not pass the results test, the next step to work out is whether 80% or more of your PSI came from one client (and their associates) in the relevant income year.

If 80% or more of your PSI came from one client, you will need to apply for a personal services business determination from us to work out whether the PSI rules apply. If you don't apply to us for a determination, the PSI rules will automatically apply.

In your case, for the year ended 30 June 20XX, 80% or more of your PSI came from one client. Further, you did not apply to us for a determination. Therefore, the PSI rules will automatically apply.

We provide a determination advising the PSI rules don't apply when you pass the required conditions for the results test, employment test or business premises test, or unusual circumstances stopped you from passing the results test, employment test or business premises test.

When 80% or more of your PSI comes from one client, we provide a determination advising the PSI rules don't apply when: (i) you pass the required conditions for the unrelated clients test, but unusual circumstances have caused you to have 80% or more of your PSI from one client in the income year; (ii) less than 80% of your PSI comes from each client but unusual circumstances stopped you from passing the unrelated clients test; (iii) unusual circumstances stopped you from passing the unrelated clients test and have caused you to have 80% or more of your PSI from one client in an income year.

In your case, it is unlikely a personal services business determination (from us advising the PSI rules don't apply) would be granted. This is because, for the year ended 30 June 20XX:

• It is unlikely you would pass the unrelated clients test because it is unlikely could answer 'yes' to both of the following questions: (i) did you receive PSI from two or more unrelated clients; and (ii) did you provide your services as a direct result of making offers or invitations (such as by advertising) to the public? This is because you only received income from one unrelated client and because none of your income was from making offers to the public. Your income was intrinsically related to ensuring a smooth transition of the investment asset from you to the new owner, which related to your pre-existing knowledge and to the stakeholder relationships implemented when you were the owner.

• It is unlikely you would pass the employment test because it is unlikely you could answer 'yes' to one of the following questions: (i) did you get employees, partners (in a partnership) or other contractors to perform at least 20% (by market value) of the principal work (principal work doesn't include incidental work such as bookkeeping, issuing invoices or running your home office); and (ii) do you have one or more apprentices for at least half of the income year? This is because your financial statements show you paid no employees for the year.

• It is unlikely you would not pass the business premises test because it is unlikely you could answer 'yes' to all parts of the following question, namely: "At all times in the income year, were your business premises: owned or leased by you; used for personal services work more than 50% of the time; used exclusively by you; physically separate from your residence and your associates' residences; physically separate from the business addresses of clients and their associates?" This is because you worked from your director's private residence (unless working in the premises or on the sites of the purchaser of your shares).

In conclusion, in your case, the PSI rules apply, which results in your PSI is taxed as though earned by you as an individual. It follows your relationship with the purchaser of your shares was similar to an individual employee rather than that of a business. This shows you were not carrying on a business.

In summary, your relationship with the purchaser of your shares was similar to the seller of a business that continues to work for that business, as a consultant, for a short period, to ensure a smooth transition. Such a relationship cannot be deemed to be carrying on a business.

Additional information

Your private ruling application asserts your shares satisfy the active asset test and thus the '80% test' under subsection 152-40(3). Our view is your assertion here is not conclusive.

Under subsection 152-40(1) of the ITAA 1997, to be an active asset of the company, the asset must be used by the company, or held ready for use, in the course of carrying on a business that is carried on by the company.

Your private ruling application states the company operated a specialist business. If the company developed and improved its investment asset over a certain period, it is possible they were not carrying on a business of asset development, where such an asset would be an active asset.

Instead, (as described in Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income) the development activities may have been of an 'isolated' or 'one-off' nature, which do not amount to a business,. In other words, the investment asset may have always been assets held outside of the ordinary course of the business of the company.

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