Edited version of your written advice

Authorisation Number: 1012948002708

Date of advice: 29 January 2016

Ruling

Subject: Capital Gains Tax

Question 1

Can the trust apply the small business active asset reduction in relation to the capital gain made on the shares sold?

Answer

Yes.

Question 2

Can the trust apply the small business retirement exemption in relation to the capital gain made on the shares sold?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 20XX

The scheme commenced on

1 July 20XX

Relevant facts

The trust owned 50% shares in a company.

During the year the trust sold their 50% share to the remaining owner.

The purchase price of the shares was X.

The contract of sale was entered into and the shares were sold for X.

The trust satisfies the maximum net asset value test.

Both A and B are under 55 years of age.

The company only had ordinary class shares half of which were owned by the trust.

A and B will receive 50% each of the capital and income distributions from the trust.

The shares are a share in an Australian Resident company.

For at least half the ownership period the market value of the company's active assets is 100%.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 subsection 152-10(2)

Income Tax Assessment Act 1997 section 152-15

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

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 subsection 152-70(1)

Income Tax Assessment Act 1997 section 152-75

Income Tax Assessment Act 1997 section 152-220

Income Tax Assessment Act 1997 Subdivision 152-D

Income Tax Assessment Act 1997 Section 152-315

Income Tax Assessment Act 1997 Section 152-325

Reasons for decision

To qualify for the small business capital gains tax (CGT) concessions, you must satisfy several conditions that are common to all the concessions. These are called the basic conditions.

A capital gain that you make may be reduced or disregarded under Division 152 of the ITAA 1997 if the following basic conditions are satisfied:

• A CGT event happens in relation to a CGT asset of yours in an income year,

• The event would have resulted in a gain,

• The CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997, and

• At least one of the following applies;

• you are a small business entity for the income year,

• you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997,

• you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an interest in an asset of the partnership, or

• you do not carry on a business, but your CGT asset is used in a business carried on by a small business entity that is your affiliate or an entity connected with you.

In this case a CGT event occurred when the shares were sold and the event resulted in a gain. Additionally, the trust satisfies the maximum net asset value test in section 152-15 of the ITAA 1997.

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.

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.

In this case, for more than half of the 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 subsection 152-40(4) of the ITAA 1997.

Additional basic conditions for shares in a company

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

(a) you are a CGT concession stakeholder in the object company or trust;

or

(b) CGT concession stakeholders in the object company or trust together have a small business participation percentage in you of at least 90%.

A trust cannot satisfy the condition in paragraph (a) because a CGT concession stakeholder in the object company must be an individual.

CGT concession stakeholder

As per section 152-60 of the ITAA 1997 an individual is a CGT concession stakeholder of a company or trust if they are a significant individual or the spouse of a significant individual where the spouse has a small business participation percentage in the company or trust at that time that is greater than zero.

Under section 152-55 of the ITAA 1997 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.

Small business participation percentage

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.

Under subsection 152-70(1) of the ITAA 1997 an entity's direct small business participation percentage in a company is the percentage of:

• voting power that 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 smallest of the three definitions above.

Section 152-75 of the ITAA 1997 details that an entity's indirect small business participation percentage in a company or trust is calculated by multiplying together the 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.

Application to your circumstances

In this case, the trust sold shares held in the company. In order to access the small business concessions not only will the trust have to satisfy the standard basic conditions, but also the additional basic condition or '90% test' set out in subsection 152-10(2) of the ITAA 1997.

To satisfy this test, the CGT concession stakeholders in the company (the object company) together must have a small business participation percentage in the trust of at least 90%.

A and B have a X small business participation percentage in the company. Therefore, both A and B are significant individual and CGT concession stakeholder of the company.

A and B together have a small business participation percentage of 100% in the trust as they are each receiving 50% distribution of the income and capital of the trust.

Accordingly the additional requirements as per subsection 152-10(2) of the ITAA 1997 are satisfied.

Active Asset Reduction

The 50% active asset reduction contained in subdivision 152-C of the ITAA 1997 applies automatically to reduce an eligible capital gain if the basic conditions are met. However, in accordance with section 152-220 of the ITAA 1997, a taxpayer can choose not to apply the 50% active asset reduction.

Application to your circumstances

As the trust has meet the basic conditions and the additional conditions required for sale of shares, the capital gain that remains after applying any current year capital losses and any unapplied prior year net capital losses will be reduced by 50%. However, the trust can choose not to apply the 50% active asset reduction.

Retirement exemption

The rules covering the small business retirement exemption are contained in Subdivision 152-D of the ITAA 1997. An entity may choose to disregard all or part of a capital gain under the retirement exemption if certain conditions are satisfied. If the entity is a trust, they can choose to disregard all or part of a capital gain where all of the following conditions are met:

• the trust satisfies the basic conditions

• the entity satisfies the significant individual test (that is, there was at least one significant individual just before the CGT event)

• a written record of the amount disregarded is kept and if there are more than one CGT concession stakeholders, each stakeholder's percent of the exempt amount (one may be nil, but together they must add up to 100%) (section 152-315 of the ITAA 1997)

• a payment is made to at least one of the CGT concession stakeholders worked out by reference to each individual's percentage of the exempt amount (section 152-325 of the ITAA 1997)

• the payment is equal to the exempt amount or the amount of capital proceeds, whichever is less, and

• where the capital proceeds are received in instalments, a payment is made to a CGT concession stakeholder for each instalment in succession.

The payment to the CGT concession stakeholders must be made by the later of seven days after making the choice or seven days after you receive the capital proceeds from the relevant CGT event.

The amount of the capital gain the trust disregards cannot exceed the CGT retirement exemption limit of each CGT concession stakeholder receiving a payment. An individual's lifetime CGT retirement exemption limit is $500,000, reduced by any previous CGT exempt amounts the individual has disregarded under the retirement exemption.

If a CGT concession stakeholder is under 55 years of age just before a payment is made in relation to them, the trust must make the payment by contributing it to a complying superannuation fund or RSA on their behalf. There is no requirement to make this contribution if the stakeholder is 55 years or older.

Application to your circumstances

As discussed, the trust will satisfy the basic conditions in relation to the disposal of the shares. Both A and B have a direct small business participation percentage in the company of X%. Accordingly, they will both be significant individuals and the significant individual test will be satisfied.

The trust will be eligible to choose the retirement exemption to disregard all or part of the capital gain. However, there are further requirements that must be met after making the choice.

Provided that the trust meets the requirements of section 152-315 of the ITAA 1997 in relation to making the choice and section 152-325 of the ITAA 1997 in relation to making the payments to CGT concession stakeholders, the eligibility requirements for the small business retirement exemption will be met.

Payments to CGT concession stakeholders under the retirement exemption

Where a company or trust makes a choice to disregard all or part of a capital gain under the retirement exemption and the company or trust receives capital proceeds from the relevant CGT event, a payment must be made to one or more of the CGT concession stakeholders in accordance with section 152-325 of the ITAA 1997.

Where a payment is made to a CGT concession stakeholder to comply with section 152-325 of the ITAA 1997, it is not assessable income and not exempt income of the CGT concession stakeholder (subsection 152-310(2) of the ITAA 1997).

Accordingly, if the trust chooses to apply the retirement exemption in accordance with section 152-315 of the ITAA 1997, a non-assessable, non-exempt payment can be made to A and B to comply with section 152-325 of the ITAA 1997 within seven days of making the choice. As A and B will both be under 55 years of age just before a payment is made in relation to them, the trust must make the payment by contributing it to a complying superannuation fund or RSA on their behalf.

The payment must be made by reference to each individual's percentage of the exempt amount.

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