Edited version of your written advice

Authorisation Number: 1012929108385

Date of advice: 17 December 2015

Ruling

Subject: Small business concession

Question and Answer:

Is Company A entitled to the small business 15 year exemption under subdivision 152-B of the Income Tax Assessment Act on the sale of its business?

Yes

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

I July 2014

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Company A was established and commenced trading as a business more than 20 years ago.

Company A sold its business during the 20XX income year for a capital gain.

Company A's business consisted of client files and records (with the associated revenue stream), and goodwill.

X was an employee of Company A and was over the age of 55 at the time of sale of the business.

X faced major issues for a few years prior to the sale of the business. X has retired and the business of Company A is in the process of being wound up.

X was a significant individual of Company A just before the sale of the business. X received 100% of the dividend via C Trust.

X held at least 20% of the shares in Company A for at least 15 years.

The entities C Trust, D Trust and E Pty Ltd are connected or affiliates of Company A. The entities do not carry on a business, are not registered for GST and have no employees. The entities earn dividend, interest and rental income.

Company A lost a number of employees and also some major clients. A report has been provided showing the annual turnover would have been less than $2 million had Company A continued to operate for the full 20XX income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 Subdivision 152-B

Income Tax Assessment Act 1997 Section 152-10

Income Tax Assessment Act 1997 Section 152-35

Income Tax Assessment Act 1997 Subsection 152-40

Income Tax Assessment Act 1997 Section 152-55

Income Tax Assessment Act 1997 Section 152-110

Income Tax Assessment Act 1997 Section 328-110

Income Tax Assessment Act 1997 Section 328-115

Income Tax Assessment Act 1997 Section 328-120

Income Tax Assessment Act 1997 Subsection 328-120(5)

Income Tax Assessment Act 1997 Section 328-125

Income Tax Assessment Act 1997 Section 328-130

Reasons for decision

The small business 15 year exemption

The small business 15 year exemption concession in subdivision 152-B of the Income Tax Assessment Act 1997 (ITAA 1997) 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

Under section 152-110 of the ITAA 1997 an entity that is a company or a trust can 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 1997 are satisfied;

2. the entity continuously owned the CGT asset for the 15 year period ending just before the CGT event;

3. the entity had a significant individual for a total of at least 15 years (even if the 15 years was not continuous and it was not always the same significant individual) during which the entity owned the CGT asset;

4. an individual who was a significant individual of the company or trust just before the CGT event either:

• was 55 or over at that time and the event happened in connection with the individual's retirement; or

• was permanently incapacitated at that time

Condition 1 - Basic conditions in subdivision 152-Aof 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;

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

(c) 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;

(d) the CGT asset satisfies the active asset test.

We shall first consider conditions (a), (b) and (d) and then look at condition (c).

Subsection 152-10(1) of the ITAA 1997 - paragraphs (a) and (b)

The client files and records as well as the goodwill of Company A constitute CGT assets under section 108-5 of the ITAA 1997. CGT event A1 under section 104-10 of the ITAA 1997 happened when Company A sold its business for a capital gain. Thus paragraphs (a) and (b) of subsection 152-10(1) of the ITAA 1997 are satisfied.

Subsection 152-10(1)of the ITAA 1997 paragraph (d) - Active asset test

According to subsection 125-40(1) of the ITAA 1997, a CGT asset is an active asset at a time, if at that time you own the asset (whether the asset is tangible or intangible) and you use it, or hold it ready to use, in the course of carrying on a business.

In this case, the active asset test is satisfied as the CGT asset being disposed of by Company A are client files and records (with the associated revenue stream). They have been used in the course of the business conducted by Company A as per paragraph 152-40(1)(a) of the ITAA 1997 and have been held for the required period as per section 152-35 of the ITAA 1997.

Subsection 152-10(1) of the ITAA 1997 - paragraph (c) - Small business entity test

To qualify as a small business, an entity needs to satisfy the conditions of section 328-110 of the ITAA 1997. According to subsection 328-110(1) of the ITAA 1997:

You are a small business entity for an income year (the current year) if:

(a) you carry on a business in the current year; and

(b) one of both of the following applies:

(i) you carried on a business in the income year (the previous year) before the current year and your aggregated turnover for the previous year was less than $2 million;

(ii) your aggregated turnover for the current year is likely to be less than $2 million.

(a) Carrying on a business in the current year

We are satisfied that Company A has been carrying on a business for over 20 years. Thus the first part of the test is satisfied.

(b) Aggregated turnover for current year

Aggregated turnover is explained in section 328-115 of the ITAA 1997 as the sum of the relevant annual turnovers. The relevant annual turnovers are:

1. your annual turnover for the income year, and

2. the annual turnover of any entity that is connected with you at any time during the income year, and

3. the annual turnover of any entity that is an affiliate of yours at any time during the income year.

'Connected with' is defined at section 328-125 of the ITAA 1997 and 'affiliate' is explained in section 328-130 of the ITAA 1997. Annual turnover is described at section 328-120 of the ITAA 1997 as the total ordinary income that the entity derives in the income year in the ordinary course of carrying on a business.

In this case, the entities C Trust, D Trust and E Pty Ltd are connected or affiliates of Company A. The entities do not carry on a business, are not registered for GST and have no employees. The entities earn dividend, interest and rental income. Dividend and interest income is not business income. This is passive income which is excluded under subsection 328-115(3) of the ITAA 1997. Similarly, rental income received does not amount to the carrying on of a business (FC of T v. McDonald 87 ATC 4541; (1987) 18 ATR 957), as it is passive receipt of income from property.

Thus in the calculation of Company A's aggregate turnover for the 20XX income year, only the ordinary income of Company A needs to be taken into account. This amount needs to be less than $2 million.

Under subsection 328-120(5) of the ITAA 1997 if an entity does not carry on a business for the whole of an income year, the entity's annual turnover for the income year must be worked out using a reasonable estimate of what the entity's annual turnover for the income year would be if the entity carried on a business for the whole of the income year.

Paragraph 2.29 of the Explanatory Memorandum to Tax Laws Amendment (Small Business) Bill 2007 states the intention underlying subsection 328-120(5) of the ITAA 1997: 

2.29 The intent of the provision is to ensure that the eligibility test of turnover, as an indicator of the size of a business, is based on income for a full year. Without this rule, entities that carry on a business for part of the income year would have a lower turnover than is truly representative of the size of the business.

In this case, Company A lost a number of employees and also some major clients. A report has been provided showing the annual turnover would have been less than $2 million had Company A continued to operate for the full 20XX income year.

Accordingly the small business entity test in paragraph 152-10(1)(c) of the ITAA 1997 is satisfied.

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

Company A 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 business

• The event resulted in a capital gain

• Company A satisfies the small business entity test

• The client files and records satisfy the active asset test.

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

Condition 2 - Ownership of asset by entity for 15 years continuously ending just before the CGT event

Under this condition, it needs to be shown that Company A continuously owned the asset for the 15 year period leading up to the CGT event. This has been satisfied as Company A commenced business more than 20 years ago and the client files and records (and associated goodwill) have continuously been owned by Company A during this time.

Condition 3 Entity had a significant individual for a total of at least 15 years (even if not continuously for 15 years)

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%.

X held at least 20% of the shares in Company A for at least 15 years. X received 100% of the dividend. X was a significant individual of Company A just before the CGT event and for a period in excess of 15 years. Thus this condition is satisfied as Company A had a significant individual for a total of at least 15 years.

Condition 4 - Significant individual 55 years or over just before the CGT event

X was a significant individual and was aged over 55 years at the time of the CGT event, being the sale of the business by Company A. We are satisfied that the CGT event was related to X's retirement as X faced major health issues for a few years prior to the sale of the business. X has retired and the business of Company A is in the process of being wound up.

Summary - 15 year exemption

As Company A satisfies all the conditions in section 152-110 of the ITAA 1997, it is entitled to disregard the capital gain on the sale of its business under the 15 year exemption small business concession in subdivision 152-B of the ITAA 1997.

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