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Edited version of your written advice
Authorisation Number: 1012859890105
Date of advice: 13 August 2015
Ruling
Subject: CGT small business concessions
Question 1
Will the Commissioner's discretion be exercised under subsection 328-125(6) of the Income Tax Assessment Act 1997 (ITAA 1997) to determine that X did not control Y at the time of the sale of the shares?
Answer
Yes
Question 2
If the Commissioner exercises his discretion under subsection 328-125(6) of the ITAA 1997, will X satisfy the basic conditions for the small business concessions contained in section 152-10 of the ITAA 1997 in relation to the sale of the shares?
Answer
Yes
This ruling applies for the following period:
Year ended 30 June 2011
The scheme commenced on:
1 July 2010
Relevant facts and circumstances
Initially, Z was the sole shareholder of Y. Z was the sole director.
From incorporation, Y was involved in active business activities.
Z provided 100% of the capital introduced for Y. Similarly, Z provided all of the funds for bank guarantees, application fees, rent, insurance and legal fees.
There was a verbal agreement between Y and X that once licences had been granted to the company, Y would a minority portion of the equity in Y to X. This subsequently occurred and X became a shareholder of Y.
X never became a director of Y.
You have provided the following information in relation to the running of the business:
• The day-to-day running of the business was handled by Z. They handled all communication with banks, industry bodies, ASIC and negotiations with potential purchasers.
• All strategic business decisions were made by Z. While X may have provided some input, Z's decision was final due to the larger shareholding held and the funds that had been contributed by Z.
• Z had vast experience in the corporate world, having completed a business degree.
• X had no formal tertiary qualifications, however had previously been involved in the relevant industry. X's role in Y was to provide industry advice to Z.
The only assets held by Y were active assets.
Y entered into a Share Purchase Agreement (SPA) on during the 2010-11 financial year for the sale of 100% of the shares in Y for the amount of $X.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 152-10
Income Tax Assessment Act 1997 Section 152-15
Income Tax Assessment Act 1997 Section 328-125
Reasons for decision
Connected entities
The meaning of a connected entity is defined under section 328-125 of the ITAA 1997 which states as follows:
An entity is connected with another entity if:
(a) either entity controls the other entity in the way described in this section; or
(b) both entities are controlled in a way described in this section by the same third entity.
Direct control of a company
Paragraph 328-125(2)(b) of the ITAA 1997 provides that an entity controls a company if the entity, its affiliates, or the entity together with its affiliates beneficially own equity interests in the company that carry between them the right to exercise, or control the exercise of, a percentage (the control percentage) that is at least 40% of the voting power in the company.
In this case, prima facie X controlled Y at the time of the sale of the shares as it held at least 40% of the shares in the company.
Commissioner may determine that an entity does not control another entity
If an entity's control percentage in a company is at least 40% but less than 50%, the Commissioner may determine under subsection 328-125(6) of the ITAA 1997 that the first entity does not control the other entity if the Commissioner thinks that the entity is controlled by a third entity (other than an affiliate of the first entity).
For the Commissioner to be able to consider the exercise of discretion in subsection 328-125(6) of the ITAA 1997 there must be a single, identifiable third entity that has a control percentage of at least 40% of the company. In working out the third entity's control percentage, the interests of any affiliates of the third entity are taken into account. The third entity must control the company in the way described in subsection 328-125(2) of the ITAA 1997. Unless the conditions of subsection 328-125(2) of the ITAA 1997 are met the Commissioner cannot determine that the first entity does not control the company.
If there was a third entity with a control percentage of 40% or more it would then be necessary to consider additional factors such as who is responsible for the day to day and strategic running of the company to determine if the third entity controls it. It is possible that both of the entities having a control percentage of at least 40% may control the company if such responsibilities are shared.
In this case, the Commissioner accepts that Z was responsible for the day to day and strategic running of Y's business. While X brought industry knowledge to the business, we accept that based on the financial risk borne by Z, X did not control the company.
Accordingly, the Commissioner will exercise his discretion under subsection 328-125(6) of the ITAA 1997 to determine that X did not control Y at the time of the sale of the shares.
Small business concessions - basic conditions
In order to be eligible for the small business capital gains tax (CGT) concessions, a number of basic conditions must be satisfied. The basic conditions for the small business CGT concessions are outlined in subsection 152-10(1) of the ITAA 1997:
(a) a CGT event happens in relation to an asset that the taxpayer owns
(b) the event would otherwise have resulted in a capital gain
(c) one or more of the following applies
(i) the taxpayer satisfies the maximum net asset value test
(ii) the taxpayer is a "small business entity" for the income year
(iii) the asset is an interest in an asset of a partnership which is a small business entity for the income year, and the taxpayer is a partner in that partnership, or
(iv) the special conditions for passively held assets in sub-sections 152-10(1A) or 152-10(1B)are satisfied in relation to the CGT asset in the income year and
(d) the asset satisfies the active asset test.
In this case, a CGT event occurred that resulted in a capital gain when the shares were sold and the shares passed the active asset test. The maximum net asset value test will be considered below.
Maximum net asset value test
The maximum net asset value (MNAV) test contained in section 152-15 of the ITAA 1997 requires that the net value of a taxpayer's CGT assets must not exceed $6million just before the relevant CGT event.
You must include the net value of CGT assets owned by:
• you
• any entities connected with you (as per the definition contained in section 328-125 of the ITAA 1997); and
• any of your affiliates (as per the definition contained in 328-130 of the ITAA 1997) and entities connected to your affiliates.
The assets to be included in the calculation of the MNAV test are not restricted to business assets. All CGT assets of the relevant entities need to be included unless they are specifically excluded by the legislation.
In this case, we have determined that X is not connected with Y as a result of the Commissioner exercising his discretion under subsection 328-125(6) of the ITAA 1997. Accordingly, it is only the value of the Y shares owned by X that are required to be included in the MNAV test; not the total value of the assets held by Y. You have advised that other than the shares in Y, there are no other assets that were held by X or entities connected or affiliated with X that would be included in the MNAV test at the time of the CGT event.
We accept that the value of the shares just prior to the CGT event is equal to the sale price, being $X for X% of the shares. Accordingly, X will meet the MNAV test in relation to the sale of the shares.
Conclusion
As a result of the Commissioner exercising his discretion under subsection 328-125(6) of the ITAA 1997, all of the basic conditions for the CGT small business concessions have been met by X in relation to the sale of the shares in Y.
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