Edited version of your written advice

Authorisation Number: 1012925307577

Ruling

Subject: small business concessions

Questions and Answers:

1. Will the capital gain made by the trustee of the Trust on the sale of shares in the Company be a discount capital gain under Division 115 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes

2. Will the trustee of the Trust be entitled to apply the small business concessions under Division 152 of the ITAA 1997, excluding the 15 year exemption concession, to reduce the capital gain on the sale of shares in the Company?

Yes

3. Will payments made to the beneficiary by the trustee of the Family Trust of the capital gain on the sale of shares in the Company be able to be tax-free, if paid in order to comply with, and in accordance with section 152-325 of the ITAA 1997?

Yes

This ruling applies for the following period:

Year ended 30 June 2015

The scheme commenced on:

I July 2014

Relevant facts and circumstances

The Trust is one of the shareholders of the Company.

The Company is an Australian private company that has carried on business for over 20 years and is not part of a consolidated group.

The Trust had an interest in the Company of more than 20%.

The Trust held its ordinary shares in the Company for over 20 years.

The Trust sold its shares in the Company and made a capital gain.

The beneficiary and their spouse were entitled to all of the income of the Trust and also to any capital of the Trust distributed during the year of the sale of the shares.

The beneficiary and the Trust both satisfy the maximum net asset value test in section 152-15 of the ITAA 1997.

The beneficiary will not retire as an employee of the Company.

The beneficiary was entitled to more than 20% of the capital distribution if the Trust made a distribution during the year of sale.

Both the beneficiary and their spouse have a remaining balance of $ X of their $500,000 lifetime limit. The distribution from the Trust to the beneficiary will not exceed $500,000.

Neither the Trust nor the beneficiary qualify for the small business 15 year concession in subdivision 152-B of the ITAA 1997.

The following documents of the Company form part of the ruling:

• Profit and loss statements for several years

• Balance sheets for several years.

The Company has various forms of cash assets. The balance of cash assets increased between the time the business commenced and the time of sale of the shares.

An explanation has been provided as to how the cash in its various forms has been used to run the business.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 115-10

Income Tax Assessment Act 1997 Section 115-15

Income Tax Assessment Act 1997 Section 115-20

Income Tax Assessment Act 1997 Section 115-25

Income Tax Assessment Act 1997 Section 152-10

Income Tax Assessment Act 1997 Section 152-15

Income Tax Assessment Act 1997 Section 152-35

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 Subdivision 152-B

Income Tax Assessment Act 1997 Subdivision 152-C

Income Tax Assessment Act 1997 Subdivision 152-D

Income Tax Assessment Act 1997 Subdivision 152-E

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

Income Tax Assessment Act 1997 Section 152-55

Income Tax Assessment Act 1997 Section 152-60

Income Tax Assessment Act 1997 Section 152-65

Income Tax Assessment Act 1997 Section 152-70

Income Tax Assessment Act 1997 Section 152-110

Income Tax Assessment Act 1997 Section 152-305

Income Tax Assessment Act 1997 Section 152-315

Income Tax Assessment Act 1997 Section 152-320

Income Tax Assessment Act 1997 Section 152-325

Reasons for decision

The Trust

A. Discount capital gain

A discount capital gain is one that meets the conditions of sections 115-10, 115-15, 115-20 and 115-25 of the Income Tax Assessment Act 1997 (ITAA 1997). The conditions are as follows:

• the entity making the gain is an individual, trust or complying superannuation fund

• the CGT event happened after 11.45am (by legal time in the ACT) on 21 September 1999

• the entity acquired the asset at least 12 months before the CGT event and

• the entity did not choose to use the indexation method.

The Trust sold its shares in the Company. The Trust held its shares in the Company for over 20 years. The Trust is eligible to claim the 50% discount capital gain under section 115-10 of the ITAA 1997 as CGT event A1 happened on sale of the shares to a trust which held the CGT asset in question (shares) for more than 12 months from the date of acquisition.

B. Small business concessions

There are four CGT concessions available to small businesses which are:

1. The small business 15 year exemption

2. The small business 50% active asset reduction

3. The small business retirement exemption

4. The small business rollover

To qualify for any of the small business CGT concessions, an entity must satisfy several conditions that are common to all the concessions, known as the basic conditions.

Each concession also has further requirements that must be satisfied, except for the small business active asset reduction, which applies if the basic conditions are satisfied. The basic conditions are contained in subdivision 152-A of the ITAA 1997.

Basic conditions in subdivision 152-A of the ITAA 1997

According to subsection 152-10(1) of the ITAA 1997:

A capital gain (except a capital gain from CGT event K7) you make may be reduced or disregarded under this Division if the following basic conditions are satisfied for the gain:

(a) a CGT event happened in relation to a CGT asset of your in an income year;

the event would (apart from this Division) have resulted in the gain;

(b) at least one of the following applies:

I. you are a small business entity for the income year;

II. you satisfy the maximum net asset value test;

III. you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership;

(c) the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997.

Paragraphs (a) and (b)

The asset in question constitutes the shares in the Company. Shares are CGT assets and the sale of shares is a CGT event A1. Paragraphs (a) and (b) are satisfied as the Trust sold its shareholding in the Company and made a capital gain.

Paragraph (c)

Section 152-15 is the maximum net asset value test which a taxpayer will satisfy if the net value of their assets and those of connected entities does not exceed six million dollars. Both the beneficiary and the Trust meet this test.

Paragraph (d) - Active asset test

The shares held by the Trust in the Company must satisfy the active assets test in paragraph 152-10(1)(d) of the ITAA 1997.

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

Under paragraph 152-40(3)(b) 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 active asset test under section 152-35 of the ITAA 1997 requires that a share in a company must satisfy the 80% test for at least 7½ years where a share has been held for more than 15 years. This is known as the 80% rule.

The ATO publication Capital Gains Tax Concessions for Small Business 2015 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 necessarily requires something more than just some form of connection between the financial instrument and the business.

For the purposes of subparagraph 152-40(3)(b)(ii) of the ITAA 1997 a bank account represents a contractual arrangement between the depositor and the bank. A bank account is, at law, a loan to the banker and is considered to be a financial instrument. 

The expression 'inherently connected' is not defined in the legislation. However, the expression is discussed at paragraph 1.38 of the Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No.7) Bill 2006 which introduced subparagraph 152-40(3)(b)(ii) into the ITAA 1997.

This document states that 'inherently connected' is an alternative test for intangible assets because it will be difficult for some intangible assets to meet the requirement to be used, or held ready for use, in carrying on a business. The example considered in the Explanatory Memorandum is goodwill. Goodwill is not 'used' in a business, but is inherently connected with it. From this we can conclude that there is no new meaning to the expression nor is there a criterion to be assessed against.

Generally, a bank account (in credit) used by a taxpayer in the course of carrying on their business could reasonably be seen as being inherently connected with the taxpayer's business. However, in determining whether all of the market value of a particular bank account should be included in the numerator of the 80% test calculation we must consider whether the account contains any cash amounts which, due to their source or use, do not relate specifically to the operations of the business. These amounts may cause the taxpayer to fail the 80% test.

Application to your circumstances

The Company is an Australian private company and thus the first part of the active asset test where a share is the asset is satisfied. We now need to consider if the 80% test is satisfied.

The Company has various forms of cash assets. The balance of cash assets rose a lot between the time the business commenced and the time of sale of the shares.

An explanation has been provided as to how the cash in its various forms has been used to run the business.

The Commissioner is satisfied that the cash accounts were inherently connected with the business such that for at least 7½ years the cash used for the business and the other active assets were 80% or more of the market value of all of the assets of the Company. As the 80% rule is satisfied, the active asset test is met.

Conclusion - basic conditions in subdivision 152-A of the ITAA 1997

The Trust satisfies the basic conditions for small business relief under subsection 152-10(1) of the ITAA 1997 and can be summarised as follows:

• CGT event A1 happened on the sale of the shares in the Company

• The event resulted in a capital gain

• The Trust satisfies the maximum net asset value test

• The shares in the Company satisfy the active asset test.

Accordingly the basic conditions in subdivision 152-A of the ITAA 1997 are met.

Applying the specific small business concessions

The small business concessions need to be applied in a certain order.

The small business 15 year exemption

The small business 15 year exemption concession is in subdivision 152-B of the ITAA 1997 and takes priority over the other small business concessions and the CGT discount. This concession provides a total exemption of a capital gain if the entity has continuously owned the CGT asset for at least 15 years and the relevant individual is 55 years old, or older, and retiring or is permanently incapacitated.

In this case, this concession is not applicable as the beneficiary will not retire as an employee of the Company. In addition they are not aged 55 years or over.

Where the small business 15 year exemption is not applicable as in the case of the Trust, the entity needs to determine if it is eligible for the CGT discount and if so, as in the case of the Trust, reduce the remaining capital gain after offsetting any capital losses. Then the remaining small business concessions can be applied.

Small business 50% reduction

The small business 50% reduction concession is contained in subdivision 152-C of the ITAA 1997.

In accordance with section 152-205 of the ITAA 1997, to be eligible for the small business 50% reduction, an entity only needs to satisfy the basic conditions in subdivision 152-A of the ITAA 1997. As the Trust meets the basic conditions in subdivision 152-A of the ITAA 1997, it is eligible to apply this concession.

Under this concession, 50% of the capital gain is disregarded. An entity can decide not to apply the 50% active asset reduction and go straight to the small business retirement exemption or rollover.

Small business retirement exemption

Subdivision 152-D of the ITAA 1997 provides a small business retirement exemption as part of the CGT small business relief provisions.

Under subsection 152-305(2) of the ITAA 1997 an entity that is a company or trust can choose to disregard any capital gain arising from a CGT event if all of the following conditions are satisfied:

1. The basic conditions in subdivision 152-A of the ITAA 997 are met; and

2. The entity satisfies the significant individual test in section 152-50 of the ITAA 1997; and

3. The company or trust conditions in section 152-325 of the ITAA 1997 are satisfied with regard to CGT concession stakeholders

Condition 1 - Basic conditions in Subdivision 152-A of the ITAA 1997

From the above, condition 1 is satisfied as the Trust meets the basic conditions in subdivision 152-A of the ITAA 1997.

Condition 2 - Entity satisfies the significant individual test

The Trust must satisfy the significant individual test in section 152-50 of the ITAA 1997.

Under section 152-55 of the ITAA 1997 an individual is a significant individual in a company or trust at a time if, at that time, the individual has a small business participation in the company or trust of at least 20%.

Under subsection 152-10(2) of the ITAA 1997 where the CGT asset is a share in a company or an interest in a trust, one of these additional basic conditions must be met just before the CGT event:

• the taxpayer claiming the concession must be a CGT concession stakeholder in the company or trust: or

• CGT concession stakeholders in the company or trust together have a small business participation percentage in the interposed entity of at least 90% (the 90% test)

Under section 152-60 of the ITAA 1997 a CGT concession stakeholder of a company or trust is: 

• a significant individual of the company or trust : or

• a spouse of a significant individual in the company or trust, if the spouse has a small business participation percentage in the company or trust greater than zero.

Under section 152-65 of the ITAA 1997 an entity's small business participation percentage in another entity at a time is the percentage that is the sum of:

• the entity's direct small business participation percentage in the other entity at that time; and

• the entity's indirect small business participation percentage in the other entity at that time.

An entity's direct small business participation percentage in a company is the percentage of:

• voting power that the entity is entitled to exercise, or

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

• any capital distribution that the entity is entitled to receive

An entity's direct small business participation percentage in a trust, where entities have entitlements to all the income and capital of the trust, is the percentage of:

• the income of the trust that the entity is beneficially entitled to receive, or

• the capital of the trust that the entity is beneficially entitled to receive.

An entity's direct small business participation percentage in a trust, where entities do not have entitlements to all the income and capital of the trust, and the trust makes a distribution of income or capital, is the percentage of:

• distributions of income that the entity is beneficially entitled to during the income year, or

• distributions of capital that the entity is beneficially entitled to during the income year.

Applying the calculation for indirect participation, the beneficiary received the majority of the distributions of income and the distributions of capital, if any, from the Trust in the 2015 financial year. Thus the beneficiary is a significant individual of the Company as they have an indirect participation percentage calculated as follows:

participation % in trust x participation % of trust in Company = greater than 20%

Participation percentages are calculated ignoring redeemable shares under subsection 152-70(2) of the ITAA 1997. Thus all ordinary shareholders in the Company are taken to have a direct small business participation percentage of at least 20%.

The Trust must satisfy the basic conditions in paragraph 152-10(2)(b) of the ITAA 1997 requiring that CGT concessional stakeholders of the Company hold participation percentages in the Trust of at least 90%.

The beneficiary will be a significant individual of the Trust in the 2015 financial year when the sale took place. As the beneficiary and their spouse are income beneficiaries of the Trust, they will both be CGT concession stakeholders of:

• the Trust as the beneficiary is entitled to 20% or more of the income, and if capital is distributed, 20% or more of the capital of the Trust and their spouse is entitled to more than 0% of the income of the Trust; and

• the Company as the beneficiary will be entitled to at least x% of the income of the Trust giving the beneficiary the necessary indirect participation percentage in the Company of at least 20%.

In addition, the 90% test is met as the beneficiary and their spouse have a combined interest in the Trust of over 90% as the beneficiary and their spouse received all the income from the Trust in the year of sale.

Condition 3 - Provisions in section 152-325 of the ITAA 1997 satisfied

The company or trust conditions in section 152-325 of the ITAA 1997 must be satisfied with regard to CGT concession stakeholders.

Under Section 152-325 a company or trust must make a payment to at least one of its CGT concession stakeholders if the company or trust receives an amount of capital proceeds from a CGT event for which it makes a choice under this subdivision.

However for a company or trust the choice must be made in a way that ensures the CGT retirement exemption limit of each individual for whom the choice is made is not exceeded.

The following requirements must be satisfied:

• The amount chosen for the asset is its CGT exempt amount and the exempt amount must be specified in writing. If a payment is made to more than one CGT concession stakeholder, the amount of each such payment is to be worked out by reference to each individual's participation percentage. One or more of the percentages may be nil, but all of the percentages must add up to 100%.

• The company or trust must make the choice by the day it lodges its income tax return for the income year in which the relevant CGT event happened.

• If a CGT concession stakeholder is under 55 years of age just before the company or trust makes a payment, the company or trust must make the payment to the CGT concession stakeholder by contributing it on their behalf to a complying superannuation fund.

• The company or trust cannot claim a deduction for the payment. The contribution is treated as a personal contribution of the CGT concession stakeholder. The individual cannot deduct the contribution. It is not assessable income of the complying superannuation fund.

• To satisfy this requirement the company or trust must pay the amount directly into a complying superannuation fund by the later of seven days after it makes the choice for the retirement exemption or seven days after it receives an amount of capital proceeds from the CGT event.

• Failure to do this will mean the conditions are not satisfied and the retirement exemption will not be available.

So long as the Trust satisfies the above requirements, then the conditions in section 152-325 will be satisfied.

Summary - retirement exemption

The Trust satisfies the basic conditions in subdivision 152-A of the ITAA 1997 as well as the significant individual test in section 152-60 of the ITAA 1997. It can disregard the capital gain arising from the sale of the shares in the Company if in summary, the trustee:

• makes a payment to each CGT concession stakeholder, including the beneficiary, worked out by reference to their percentage of the exempt amount

• keeps a written record of the amount that is to be disregarded

• pays the CGT concession stakeholder by seven days after the trustee makes the choice to disregard the capital gain, and

• makes a payment to a complying superannuation fund in respect of the CGT concession stakeholder, if they are under 55 years of age.

CGT retirement exemption limit

An individual's CGT retirement exemption limit is $500,000 reduced by the CGT exempt amounts of CGT assets specified in choices previously made by or for the individual under this subdivision.

Small business roll-over

The small business roll-over concession is contained in subdivision 152-E of the ITAA 1997

To qualify for the concession, the entity only needs to satisfy the basic conditions in subdivision 152-A of the ITAA 1997. As the Trust satisfies this requirement, it is eligible to apply this concession.

C. Implications for the beneficiary

If a trust chooses the retirement exemption and satisfies the requirements for the retirement exemption, the payment received by the beneficiary is not included in their assessable income.

As payments made to the beneficiary by the trustee of the Trust of the capital gain on the sale of shares in the Company will be in accordance with section 152-325 of the ITAA 1997, they will be tax-free for both the beneficiary and the Trust.

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