Edited version of your written advice

Authorisation Number: 1012761376512

Ruling

Subject: Capital gains tax

Question 1

Will the 15 year exemption apply to disregard the capital gain on the proposed sale of the two properties owned by the company?

Answer

Yes.

Question 2

If the answer to question 1 is yes, will the payment of the exempt capital gain amount be exempt in the hands of the shareholders?

Answer

Yes.

Question 3

Will the set off of loan accounts owed by two of the shareholders and the loan of funds by the third shareholder to the company be a payment for the purposes of subparagraph of section 152-125(1)(b) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2015

Year ended 30 June 2016

Year ended 30 June 2017

The scheme commences on

1 July 2014

Relevant facts and circumstances

The company was incorporated prior to 1985.

Upon incorporation the shares were held by several individuals.

The company owns several properties.

The properties have been used by one of the shareholders to operate a business. The business had a turnover of less than $2 million.

The properties have also been used by a partnership conducted by several of the shareholders. The partnership has a turnover of less than $2 million.

The partnership will continue to run the business from the properties until they are sold.

One shareholder is over 55 years of age. They intend to retire once the properties are sold

As part of the retirement plan, it is intended that the other shareholders will each purchase one of the properties for their market value.

The shareholders will pay what they can in cash towards the purchase of the properties and the remainder will be financed by way of a loan owed by each of them to the company.

As the only significant assets owned by the company are the properties and the remainder will be financed by way of a loan owned by each of them to the company.

As the only significant assets owned by the company are the properties and it does not conduct a business in its own right, after repayment of the loans, the company will be wound up.

The company is proposing to make payments to the shareholders by way of agreed set off of the amounts owed by them to the company that arose as a result of their previous purchase of the properties.

The company is proposing to make a payment to the other shareholder by way of the funds being credited to their loan account and loaned to the company pursuant to a formal loan agreement.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 subsection 152-10(1A)

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40(1)(a)

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

Income Tax Assessment Act 1997 Subdivision 152-B

Income Tax Assessment Act 1997 section 152-110

Income Tax Assessment Act 1997 section 152-125

Income Tax Assessment Act 1997 subparagraph 152-125(1)(b)

Reasons for decision

Question 1

Subdivision 152-B of the ITAA 1997 provides a small business 15-year exemption as part of the CGT small business relief provisions. If the conditions for the small business 15-year exemption are satisfied the capital gain is entirely disregarded and it is unnecessary to apply any other concessions.

Under section 152-110 of the ITAA 1997, a company can disregard any capital gain arising from the disposal of the properties, if all of the following conditions are satisfied:

(a) the basic conditions in Subdivision 152-A of the ITAA 1997 are satisfied for the gain

(b) the entity continuously owned the CGT asset for the 15-year period ending just before the CGT event

(c) the entity had a significant individual for a total of at least 15 years (even if it was not the same significant individual during the whole period) of the whole period of ownership of the unit and

(d) an individual who was a significant individual of the entity just before the CGT event was:

i. at least 55 years old at that time and the event happened in connection with their retirement or 

ii. permanently incapacitated at that time.

Condition (a)

The basic conditions in Subdivision 152-A of the ITAA 1997 (as relevant to this case) are:

• the passively held assets test, and

• the active asset test.

Passively held assets

The conditions in subsection 152-10(1A) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year if:

(a) your affiliate, or an entity that is connected with you, is a small business entity for the income year; and

(b) you do not carry on a business in the income year (other than in partnership); and

(c) if you carry on a business in partnership - the CGT asset is not an interest in an asset of the partnership; and

(d) in any case - the small business entity referred to in paragraph (a) is the entity that, at a time in the income year, carries on the business (as referred to in subparagraph 152-40(1)(a)(ii) or (iii) or paragraph 152-40(1)(b)) in relation to the CGT asset.

Connected entity

An entity is connected with another entity if:

• either entity controls the other entity, or

• both entities are controlled by the same third entity.

An entity controls another entity if it or its affiliate (or all of them together) beneficially own or have the right to acquire beneficial ownership of, interest in the other entity that give the right to receive at least 40% of any distribution of income or capital by the other entity.

Active asset test

A requirement of the active asset test contained in section 152-35 of the ITAA 1997 is that the CGT asset must be an active asset for at least half of the period from when you acquired it until the earlier of the CGT event or when you ceased business, if the relevant business had ceased to be carried on in the 12 months before the CGT event.

The meaning of an active asset is set out in section 152-40 of the ITAA 1997. It must firstly satisfy one of the 'positive tests' in subsection 152-40(1) of the ITAA 1997 and then also not be excluded by one of the exceptions in subsection 152-40(4) of the ITAA 1997.

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.

The combined effect of sections 152-35 and 152-40 of the ITAA 1997 is that the asset will meet the active asset test if the asset was used, or held ready for use, in the course of carrying on a business for at least half of the time period it was owned, subject to the exclusions in subsection 152-40(4) of the ITAA 1997.

In this case, we consider that the conditions in subsection 152-10(1A) of the ITAA 1997 have been satisfied.

Condition (b)

The company will have owned the properties for the 15 year period ending just before the CGT event.

Condition (c)

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.

An entities direct small business participation percentage in a company is the percentage of:

• voting power the entity is entitled to exercise

• any dividend payment that the entity is entitled to receive, or

• any capital distribution that the entity is entitled to receive, or

• if they are different, the small of the three definitions above.

An entities indirect small business participation percentage in a company (or trust) is calculated by multiplying together an entity's direct participation percentage in an interposed entity and the interposed entity's total participation percentage (both direct and indirect) in the company or trust.

In this case, each of the shareholders are significant individuals as they have an interest of more than 20%.

Condition (d)

One shareholder is currently 55 years of age and the sale of the properties will occur in connection with their retirement.

As the shareholder is a significant individual of the company just before the CGT event, is over 55 years old, and the event will happen in connection with their retirement, this condition will be satisfied.

The company satisfies all of the conditions for the small business 15-year exemption in Subdivision 152-B of the ITAA 1997, and can disregard any capital gain made from the sale of the properties.

Question 2

Section 152-125 of the ITAA 1997 provides that, if a capital gain made by a company is disregarded under the small business 15 year exemption, any distribution made by the company of that exempt amount to a CGT concession stakeholder is not included in the assessable income of the CGT concession stakeholder, if the following conditions are satisfied:

• the company must make one or more payments within two years after the CGT event that resulted in the capital gain or, in appropriate circumstances, such further time as allowed by the Commissioner

• the payments must be made to an individual who was a CGT concession stakeholder of the company just before the CGT event and

• the total payments made to each CGT concession stakeholder must not exceed an amount determined by multiplying the CGT concession stakeholders control percentage by the exempt amount.

Subsection 152-125(3) of the ITAA 1997 states that is a company makes such a payment, to the extent that it is less than or equal to the exempt amount, it will not be treated as a dividend or frankable distribution.

CGT concession stakeholder

Section 152-60 of the ITAA 1997 provides the meaning of CGT concession stakeholder. An individual is a CGT concession stakeholder of a company at a time if the individual is:

(a) a significant individual in the trust or

(b) a spouse of a significant individual in the trust, if the spouse has a small business participation percentage in the trust that is greater than zero.

As discussed in question 1, the shareholders are significant individuals. Therefore, they will also be CGT concession stakeholders of the company just before the CGT event.

Provided the amount each individual receives does not exceed their CGT concession stakeholder participate percentage, the payments will be excluded from their assessable income.

Question 3

As discussed above, to satisfy the requirements of the 15 year exemption a company is required to make a payment to the CGT concession stakeholders within two years after the CGT event that resulted in the capital gain or, in appropriate circumstances, such further time as allowed by the Commissioner.

ATO ID 2006/132 discusses the concept of what it means to make a payment. Essentially, it details that a journal entry is not sufficient unless it is a set off of mutual liabilities.

In Brookton Co-operative Society Limited v Federal Commissioner of Taxation [1981] HCA 28 the concept of the payment of a dividend was discussed. It was said that:

Payment of a dividend may occur in a variety of ways not involving payment in case or by bill of exchange, as, for example, by agreed set-off, account stated or an agreement which acknowledged that the amount of the dividend is to be lent by the shareholder to the company and is to be repaid to the shareholder in accordance with the terms of that agreement. It is, however, well settled that the making of a mere entry in the books of a company without the assent of the shareholder does not establish a payment to the shareholder.

We accept that the set-off of loan accounts and loan of funds to the company under a written agreement will satisfy the requirement in subparagraph 152-125(1)(b) of the ITAA 1997.

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).