Edited version of your written advice

Authorisation Number: 1013051138945

Date of advice: 13 July 2016

Ruling

Subject: Capital Gains Tax

Question 1

Does section 328-110 (5) of the Income Tax Assessment Act 1997 apply to treat the Trust as a small business entity if the trustees for the Trust sell a property in Mid 20FF pursuant to an option granted in 20KK?

Answer

Yes

Question 2

Will the sale of the property qualify as a disposal of an active asset within the meaning of section 152-40 of the ITAA 1997?

Answer

Yes

Question 3

If the Trust realises a capital gain on the disposal of the property, can the Trust disregard the capital gain under section 152-110 of the ITAA 1997?

Answer

Yes

Question 4

If the trustees for the trust pay 50% of any capital gain realised on the disposal of the property to one of the trustees within two years of the date of the relevant contract of sale, does section 152-125 of the ITAA 1997 apply so that the trustee may disregard this amount in determining their taxable income?

Answer

Yes

Question 5

If the trustees for the trust pay 50% of any capital gain realised on the disposal of the property to one of the trustees within two years of the date of the relevant contract of sale, does section 152-125 of the ITAA 1997 apply so that the trustee may disregard this amount in determining their taxable income?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 20KK

Year ended 30 June 20HH

Year ended 30 June 20II

Year ended 30 June 20JJ

Year ended 30 June 20GG

Year ended 30 June 20FF

The scheme commences on:

1 July 20EE

Relevant facts and circumstances

Trustee A and Trustee B act as trustees for a Trust, being a unit trust established by a deed.

Trustee A owns X ordinary units and Trustee B owns X ordinary units in the Trust. The Y ordinary units are all the issued units in the Trust.

Trustee A is aged more than 65. Trustee B is aged 60.

In November 20AA, the trustees of the Trust entered in to a contract to purchase a property. The property is approximately 38.5 hectares.

Trustee A and Trustee B purchased the property as trustees of the Trust with the intention that Trustee A and Trustee B would establish a partnership to operate a business on the property.

In March 20BB the trustees of the Trust settled the purchase of the property.

The partnership commenced business from the date that the trustees took possession of the property. The trustees were engaged in working in the business on a full time basis. Trustee A undertook much of the physical labour of the business and Trustee B was involved in the management.

In January 20CC, Trustee A was a victim of crime and suffered an injury. As a result, Trustee A suffered a stroke and required surgery, rehabilitation and ongoing physiotherapy. They were unable to work in the business during this time.

From the time of the attack, Trustee B assumed responsibility for Trustee A's full time care and was unable to work in the business.

Trustee B enlisted family and friends to keep the business operating during this period.

By 20DD, Trustee A's condition had not improved and was still unable to work in the business. The family and friends were unable to support the business any longer.

They hoped that Trustee A would be able to resume working in the business in the future, but their health meant that they were unable to keep the property in continuous production themselves.

The trustees decided to allow a neighbour to lease approximately 2/3 of the property for a number of years (until a future date) on the basis that the neighbour would continue to grow crops on that part of the property in order to keep it productive.

Under the terms of this arrangement, the neighbour agreed that they would allow the trustees to retake possession of the property if Trustee A's condition improved sufficiently.

The trustees retained possession of the remaining 1/3 of the property and continued to use the part of the property to operate a separate business of raising livestock for sale. The trustees have derived a small amount of income from that activity.

In early 20EE, the trustees came to the conclusion that Trustee A would never be able to resume working in the business on the property. The trustees decided to sell the property and in early 20EE they instructed a land broker to take steps to sell the property and instructed local solicitors to prepare the documents to effect the sale of the property.

The trustees have identified a purchaser who is prepared to purchase the property.

The proposed purchaser is a land developer who wishes to develop the property into residential land.

However, the proposed purchaser does not wish to complete the purchase of the property until 20FF - when it is anticipated that the property is deemed viable for development.

The proposed purchaser has indicated that that it is prepared to pay an amount for the property payable as follows:

(a) A preliminary holding deposit paid to the land broker;

(b) An amount payable on signing a formal contract;

(c) An instalment payable 1 year from the date of the contract;

(d) An instalment payable 2 years from the date of the contract;

(e) An instalment payable 3 years from the date of the contract;

(f) An instalment payable 4 years from the date of the contract; and

(g) A final payment payable 5 years from the date of the contract.

The trustees are proposing to enter into an arrangement by which they will grant an option to purchase the property for a sum exercisable in mid 20FF. The prospective purchaser will pay a fee for the grant of the option. Although the option will be structured so that it is not exercisable until mid 20FF, the option will lapse in a future date unless the prospective purchaser elects to extend the option as follows:

(a) A right to extend the option for a period of 1 year (to mid 20II) on payment of an extension fee payable by Mid 20HH;

(b) A right to extend the option for a period of 1 year (to Mid 20JJ) on payment of an extension fee payable by Mid 20II;

(c) A right to extend the option for a period of 1 year (to Mid 20GG) on payment of an extension fee payable by Mid 20JJ;

(d) A right to extend the option for a period of 1 year (to Mid 20FF) on payment of an extension fee payable by Mid 20GG

The option fee and the various extension fees will be applied to the purchase price of the property.

If the prospective purchaser pays the original option fee and pays all of the amounts to extend the option, the trustees of the Trust will have received a total of the payments for the options, so there will be a final payment payable on or before Mid 20FF.

If the prospective purchaser fails to exercise its right to extend the option at any time, the option will lapse and the trustees will be entitled to sell the property to another person.

The trustee's turnover from the business and the business of raising livestock never exceeded $2 million in any financial year.

In the 20LL income year, the trustees of the Trust derived assessable income from the lease of part of the property to their neighbour. Trustee A and Trustee B each derived taxable income in the 20LL income year.

In the 20EE income year, the trustees of the trust derived assessable from the lease of part of their property to their neighbour. Trustee A and Trustee B each derived taxable income in the 20EE year.

In the 20KK income year, the trustees of the trust have continued to derive assessable income from the lease part of the property to their neighbour. The amounts they have derived from those activities are comparable in scale to the amounts derived in the 20LL and 20EE years.

Relevant legislative provisions

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 152-105

Income Tax Assessment Act 1997 section 152-110

Income Tax Assessment Act 1997 section 152-125

Income Tax Assessment Act 1997 section 328-110(1)

Income Tax Assessment Act 1997 section 328-110(5)

Reasons for decision

Question 1

Basic conditions

To qualify for the small business 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.

Small Business Entities

Section 328-110(1) provides you are a small business entity if you meet the following for the current year:

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

(b)      one or 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

Section 328-110(5) applies to treat you as if you carried on a business in an income year where:

(a) in that year you were winding up a business you previously carried on; and

(b) you were a small business entity for the income year in which you stoped carrying on that business.

Applying the above to your factual circumstance you have carried on operating a business since you acquired the property. You have stated that your aggregated yearly turnover has always been and will continue to be below $2 million.

Even though your business has ceased operating on the property, the effect of section 328-110(5) of ITAA 1997 will be to treat you as still being a small business entity when you sell the property, as you are disposing of the asset in the course of winding up your business. Your actions in entering into an option for sale are still in essence you disposing of the assets of your business, merely in an enterprising way so as to secure the best price.

Question 2

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.

The test period:

• begins when you acquired the asset, and

• ends at the earlier of

• the CGT event, and

• when the business ceased, if the business in question ceased in the 12 months before the CGT event (or such longer time as the Commissioner allows).

The asset does not need to be an active asset just 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 your case, you have held the asset since 20BB. Your business ceased in 20DD. You intend to sell the property in Mid 20FF. Because you have held it for over 15 years and the asset was an active asset of yours for over 7.5 years during the test period, it satisfies the active asset test.

Question 3

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

Section 152-105 of the ITAA 1997 provides a small business 15-year exemption for individuals. Under this section, you can disregard the capital gain from the disposal of your property, being CGT event A1 happening to the asset, if you:

(a) satisfy the basic conditions in subdivision 152-A of the ITAA 1997 for the small business CGT concessions.

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

(c) you are:

(i) at least 55 years old at that time and the event happened in connection with your retirement or

(ii) permanently incapacitated at the time.

In your case, you are deemed to be a small business entity for the income year and you have satisfied the active asset test, therefore condition (a) is satisfied. Condition (b) is satisfied as you will have owned the asset for more than 15 years at the time of the disposal of the property. Condition (c) is satisfied as Trustee A is permanently incapacitated and Trustee B will be aged over 55 when the option is exercised and the sale of the property occurs.

Questions 4 and 5

Section 152-125 of the ITAA 1997 states that this section applies to exempt payments to trust's CGT concession stakeholders if:

• under section 152-110 of the ITAA 1997 a capital gain of a trust is disregarded, and

• the trust make one or more payments in relation to the exempt amount within two years after the relevant CGT event to an individual who was a CGT concession stakeholder of the trust just before the event.

In this case, the trust is able to disregard any capital gain under section 152-110 of the ITAA 1997. If the company makes payments to Trustee A and Trustee B, who are both CGT concession stakeholders of the trust, within two years of the CGT event, the payments are exempt payments under section 152-125 of the ITAA 1997 and are not included in their assessable income.

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