Edited version of your written advice

Authorisation Number: 1012757966337

Ruling

Subject: Small business concessions

Question 1

Is the cash in the account of the company inherently connected with the business for the purposes of section 152-40(3) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Are the shares in the company excluded from being an active asset by section 152-40(4) of the ITAA 1997?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2015

The scheme commences on:

1 July 2014

Relevant facts and circumstances

You acquired shares in the company.

From that date to the present time you have been the sole owner of the shares in the company.

The company operates a business.

The company does not undertake any other activities or hold non business related assets.

You intend to transfer the shares in the company to an interposed family trust for asset protection purposes.

In addition to the goodwill reflected in the balance sheet, the goodwill has increased significantly since the date you acquired the shares.

The cash elements of the accounts in the company have been used exclusively for the running of the business since you acquired the shares.

The funds are mainly made up of retained profits. The bank account is used to fund the day to day expenses of the business.

The business has a full equitable interest in the cash and it has been used for, at times, acquisition of plant and equipment, fluctuations in working capital requirements and funding of new contracts.

The funds are also being held with the intention of acquiring land and buildings as the base of operations for the business.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 subsection 152-40(1)

Income Tax Assessment Act 1997 paragraph 152-40(1)(c)

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

Income Tax Assessment Act 1997 subsection 152-40(4)

Reasons for decision

Question 1 & 2

Active asset test

The active asset test is contained in section 152-35 of the ITAA 1997. The active asset test is satisfied if:

• you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the test period detailed below, or

• you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7.5 years during the test period.

Under subsection 152-40(1) of the ITAA 1997 a CGT asset is an active asset (subject to the exclusions) if it is owned and used, or held ready for use, in the course of carrying on a business by you or your small business CGT affiliate or another entity that is connected with you under paragraph 152-40(1)(c) of the ITAA 1997. An active asset may be a tangible asset or an intangible asset.

The following assets cannot be active assets (subsection 152-40(4) of the ITAA 1997):

a) interests in a connected entity (other than those satisfying the 80% test)

b) shares in companies and interests in trusts (other than those satisfying the 80% test)

c) shares in widely held companies unless they are held by a CGT concession stakeholder of the company

d) shares in trusts that are similar to widely held companies unless they are held by a CGT concession stakeholder of the trust or other exceptions for trusts with 20 members or less apply

e) financial instruments, including loans, debentures, bonds, promissory notes, futures contracts, forward contracts, currency swap contracts, rights and options

f) an asset whose main use in the course of carrying on the business is to derive interest, an annuity, rent, royalties or foreign exchange gains. However, such an asset can still be an active asset if it is an intangible asset that has been substantially developed, altered or improved by the taxpayer so that its market value has been substantially enhanced or its main use for deriving rent was only temporary.

Shares

Shares are not active assets unless they satisfy the 80% test in subsection 152-40(3) of the ITAA 1997.

Under subsection 152-40(3) of the ITAA 1997 a 'share' is an active asset if:

a)   the company is an Australian resident at that time; and

  b)   the total of:

(i) the market values of the active assets of the company and

(ii) the market value of any financial instruments of the company that are inherently connected with a business that the company carries on and

(iii) any cash of the company that is inherently connected with such a business

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

The Advanced guide to capital gains tax concessions for small business 2013-14 (NAT 3359) states that 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.

Inherent connection

Inherent connection necessarily requires something more than just some form of connection between the financial instrument and the business. A thing might be regarded as inherently connected to a business when it is a permanent or characteristic attribute of the business - for example goodwill, or trade debtors.

Where a business is holding excess funds arising from a temporary spike in trading activity or the sale of a business asset, the excess funds might also reasonably be regarded as inherently connected with the business. A financial instrument must be inherently connected with a business that the owner of the financial instrument carries on, rather than any business a related entity carries on.

Application to your circumstances

In this case, we accept that the bank account is inherently connected with the business carried on by the company. Therefore even though cash is not an active asset, it will count towards the satisfaction of the 80% test.

You have held shares in the company for less than 15 years. For more than half of your ownership period, at least 80% of the assets held by the company were active assets. Therefore, the shares will not be excluded from being an active asset by section 152-40(4) of the ITAA 1997.

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