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Edited version of your written advice
Authorisation Number: 1013133934061
Date of advice: 30 November 2016
Ruling
Subject: Small business CGT concessions
Question 1
Is the land considered to be an active asset under section 152-40 of the Income Tax Assessment Act 1997 (ITAA 1997) for the period it was held to generate rental income?
Answer
No.
Question 2
Are your lessees considered to be your affiliates under subsection 328-130(1) of the ITAA 1997?
Answer
No.
This ruling applies for the following period:
Year ending 30 June 2016
The scheme commences on:
1 July 2015
Relevant facts and circumstances
You purchased a business and land in 199X.
You operated the business yourself for a few years.
During this time you renovated the property and increased turnover.
You sought to employ managers to operate the business, however you were unsuccessful in finding suitable applicants.
You sold the operating business and you retained ownership of the land.
The land was leased to third parties, with formal lease contracts in place.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 152-10,
Income Tax Assessment Act 1997 Section 152-35,
Income Tax Assessment Act 1997 Section 152-40,
Income Tax Assessment Act 1997 Section 328-130 and
Income Tax Assessment Act 1997 Subsection 328-125(1).
Reasons for decision
To access the small business capital gains tax (CGT) concessions, an entity must first satisfy the basic conditions in section 152-10 of the ITAA 1997.
One of the basic conditions requires the relevant CGT asset to satisfy the active asset test in section 152-35 of the ITAA 1997.
This test requires the CGT asset to be an active asset for:
● seven and a half years, if owned for more than 15 years, or
● half of the ownership period if owned for 15 years or less (section 152-35).
A CGT asset is an active asset if it is owned by you and is used or held ready for use in a business carried on (whether alone or in partnership) by you, you affiliates, your spouse or child or an entity connected with you.
The meaning of an active asset is provided in subsection 152-40(1) of the ITAA 1997, which states:
(1) A CGT asset is an active asset at a time if, at that time:
(a) you own the asset (whether the asset is tangible or intangible) and it is used, or held ready for use, in the course of carrying on a business that is carried on (whether alone or in partnership) by:
(i) you; or
(ii) your affiliate; or
(iii) another entity that is connected with you; or
(b) if the asset is an intangible asset - you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you.
Certain assets are, however, excluded from being active assets under subsection 152-40(4) of the ITAA 1997. An asset whose main use is to derive rent (unless such use was only temporary) is excluded from being an active asset. Such assets are excluded even if they are used in the course of carrying on a business.
Affiliates
Subsection 328-130(1) of the ITAA 1997 defines the meaning of an affiliate as an individual or company that, in relation to their business affairs, acts or could reasonably be expected to act in accordance with your directions or wishes, or in concert with you.
However a person is not your affiliate merely because of the nature of a business relationship you and the person share (subsection 328-130(2) of the ITAA 1997).
Whether a person acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes, or in concert with the taxpayer is a question of fact dependent on all the circumstances of the particular case. No single factor will necessarily be determinative.
Relevant factors that may support a finding that a person acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes, or in concert with the taxpayer, include:
● The existence of a close family relationship between the parties,
● The lack of any formal agreement or formal relationship between the parties dictating how the parties are to act in relation to each other
● The likelihood that the way the parties act, or could reasonably be expected to act , in relation to each other would be based on the relationship between the parties rather than on formal agreements or legal or fiduciary obligations
● The actions of the parties.
Generally, another business would not be acting in concert with you if they:
● have different employees,
● have different business premises,
● have separate bank accounts,
● do not consult you on business matters, or
● conduct their business affairs independently in all regards.
The affiliate relationship does not include the relationship between the controller of an entity and the entity itself. The relationship in these situations is considered to be dictated more by obligations imposed by law, formal agreements and fiduciary obligations.
The guide Capital gains tax concessions for small business states franchisees are not necessarily affiliates of the franchisor simply because of the franchise arrangement. Whether the franchisee acts in concert with the franchisor in respect of their franchise business depends on, among other things, the nature of the franchise agreement between them.
Connected with
Subsection 328-125(1) of the ITAA 1997 states that an entity is connected with another entity if either entity controls the other entity, or both entities are controlled by the same third entity.
Generally speaking an entity controls another entity if it owns interests in the other entity that give the right to receive at least 40% of any distribution of income, the control percentage.
Application to your circumstances
In your case, there are two periods of your ownership in the land that needs to be considered for the purposes of the active asset test. Prior to the business sale, when the land was used in your business, and after the sale, when the land was leased to third parties.
Prior to the business sale, as the land was used in your business, it satisfies as an active asset.
After the sale, as the land was rented, we must consider whether your lessees are considered your affiliates or connected with you for it to be considered an active asset for this period.
Your lessees did not act in accordance with your directions or wishes, or in concert with you, it was the nature of the lease agreement you had with your lessees that saw them act in certain ways. Your lessees are not your affiliates.
Your property was leased to third parties in arm's length transactions. You did not have any ownership interest in the lessees. Therefore you were not connected with the lessees.
Subsequently, as the land was not used by an affiliate or an entity connected with you, it does not satisfy as an active asset.
As you have owned the land for more than 15 years, and the land was an active asset for less than the required 7 and a half years, you do not meet the active asset test. Therefore you do not qualify to apply the small business CGT concessions on the sale of the land.
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