Edited version of your written advice

Authorisation Number: 1012711865819

Ruling

Subject: CGT small business concessions

Question

Is company X a connected entity for the purpose of applying the maximum net asset test?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2014

The scheme commences on:

1 July 2013

Relevant facts and circumstances

Company X has been in the business for several years. The shareholders of Company X and a purchaser entered into a Heads of Agreement contract and a share sale contract on a later date. The sale contract superseded the Heads of Agreement contract. The sale contract stated (in part) that the sellers would provide various warranties and indemnities to the buyer and the shareholding would be restructured to achieve this. This meant that the shareholding was restructured and all the shares transferred to related entities of the two directors who were designated to sign the warranty and indemnities.

The share contract also included clauses which indicated there was an agreement to sell and purchase the company, and that whilst there were conditions attached to the agreement, the non-performance of these conditions may only have resulted in the termination of the contract.

Prior to the share restructure, you owned less than 40% of the shares. After the restructure, you owned 50% or more of the shares. However, this legal ownership percentage was applicable for only a brief period because the shares were then transferred to the buyer as identified in the sale contract. All shares were ordinary voting shares.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 328-125

Income Tax Assessment Act 1997 section 152-15

Income Tax Assessment Act 1997 subsection 104-10(3)

Reasons for decision

Section 102-20 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that you make a capital gain or loss as a result of a CGT event. The most common event is CGT event A1 which happens when an entity disposes of a CGT asset to another entity.

CGT small business concessions
There are a number of concessions that relate to small business and reduce the capital gain on business assets that you must include in your assessable income.

For these concessions to apply, you must first satisfy the basic conditions that apply to all the CGT concessions for small business. Included in these basic conditions is the satisfaction of the maximum net asset value test. You must then satisfy any additional conditions that apply specifically to the individual concessions.

Maximum net asset value test

There is a limit of $6 million on the net value of the CGT assets that you and certain entities can own and still qualify for the small business CGT concessions. This $6 million limit is called the maximum net asset value test. It is not indexed for inflation.

The 'certain entities' include any entities 'connected with' you, any of your affiliates and entities connected with your affiliates. Under section 152-15 of the ITAA 1997, you satisfy the maximum net asset value test if the total net value of CGT assets owned by certain entities does not exceed $6 million just before the CGT event that results in the capital gain for which the concessions are sought.

When an entity is connected with you

Under section 328-125 of the ITAA 1997, an entity is connected with another entity if:

• either entity controls the other entity, or

• both entities are controlled by the same third entity.

In the case of a company, an entity controls another entity when it beneficially owns, or has the right to acquire ownership of, equity interests in the company that give it at least 40% of the voting power in the company. Equity interests include shares.

'Just before' the CGT event

ATO Interpretative Decision 2003/744 Income Tax CGT small business relief: maximum net asset value test - 'just before' the time of the CGT event (ATO ID 2003/744) discusses the term 'just before the CGT event' as used in section 152-15 of the ITAA 1997. It concludes that this time is just before entering into the contract for the sale of the asset.

However, if a contract is subject to conditions, the advice in ATO ID 2003/744 may not apply. If the conditions are precedent to the formation of the contract, the contract does not come into existence until the condition is met. However, if the conditions are precedent to the performance of the contract, the conditions do not prevent the creation of the contract and non-fulfilment of the conditions merely entitles a party to terminate the contract (Perri v. Coolangatta Investments Pty Ltd (1982) 149 CLR 537).

The status of a particular condition depends on the intention of the parties to the contract as expressed in their contract. Where there is a condition subsequent (condition precedent to performance) it would appear to be accepted generally that a contract has been made. Usually the contract will be made upon execution of the contract by both parties. If the condition subsequent is not satisfied, then the aggrieved party may have a number of remedies including specific performance, damages or a rescission of the contract.

Further, in Perri v Coolangatta Investments Pty Ltd (1982) 149 CLR 537 Mason J stated that 'the court will tend to favour that construction which leads to the conclusion that a particular stipulation is a condition precedent to performance as against that which leads to the conclusion that the stipulation is a condition precedent to the formation or existence of a contract.'

Your circumstances

In your case, as a shareholder you entered into a contract to sell your shares in Company X. At this time, you beneficially owned equity interests that gave you less than 40% of voting power in the company.

Due to sale conditions related to warranties and indemnities, the shareholding was restructured and for a brief period, you beneficially owned shares which gave you 50% or more of the voting power in Company X.

Whether these conditions made were conditions precedent to its formation or whether they were condition precedents to performance of the contract depends on the intention of the parties expressed in the contract.

To determine the intention of the parties it is necessary to look at the sale contract. The share contract included clauses which indicated there was an agreement to sell and purchase the company, and that whilst there were conditions attached to the agreement, the non-performance of these conditions may only have resulted in the termination of the contract.

The clauses and conditions in the sale contract did not prevent the formation of the agreement. Accordingly, the terms in the sale contract are conditions subsequent (precedent to performance). This means that the conditions did not prevent the creation of the sale contract, and that the sale contract was formed as at the date of the contract. 'Just before' the CGT event is the time just prior to the signing of the sale contract.

Conclusion

As it is the time just before the sale contract that is most relevant for the purposes of sections 152-15 and 328-125 of the ITAA 1997 and you beneficially owned less than 40% of Company X voting shares at the relevant time, Company X is not a connected entity to you and their assets do not need to be included in the calculation of the maximum net asset value test under section 152-15 of the ITAA 1997.

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