Edited version of your written advice

Authorisation Number: 1051215125046

Date of advice: 5 May 2017

Ruling

Subject: Capital gains tax - small business concessions

Question 1

Did the capital gains tax (CGT) event being the disposal of the units in the Unit Trust occur in the year ended 30 June 2016?

Answer:

Yes.

Question 2:

Can the Commissioner exercise the discretion provided in subsection 328-125(6) of the Income Tax Assessment Act 1997 (ITAA 1997) or his general powers of administration in this case?

Answer:

No.

Question 3:

Will the Commissioner exercise the statutory remedial power in section 370-5 of Schedule 1 to the Taxation Administration Act 1953 (TAA) to negate or amend the operation of subsection 328-125(2) of the ITAA 1997 in the current circumstances?

Answer:

Invalid private ruling question.

Question 4:

Does Z satisfy the maximum net asset value (MNAV) test in section 152-15 of the ITAA 1997?

Answer:

No.

This ruling applies for the following period:

Year ended 30 June 2016

The scheme commenced on:

1 July 2015

Relevant facts and circumstances

Z and Y each owned 50% of the units in the Unit Trust and consequently were each entitled to a 50% distribution of the income and capital of the Unit Trust.

Z and Y entered into an option agreement (the Option Deed) where the parties agreed that Y may elect to acquire the units held by Z.

The Option Deed provided the following:

● Y may in its absolute discretion and at any time prior to the Sunset Date, elect to acquire all of the units held by Z on the terms and conditions set out in the Option Deed.

● Notification of the election will be made by Y by serving an Election Notice giving 60 days notice ('Notice Period') on Z.

● If Y serves an Election Notice on Z and does not serve a Revocation Notice on Z prior to the expiry of the Notice Period, an agreement is constituted on the date of expiry of the Notice Period under which Z is required to transfer the units in accordance with the terms and conditions set out in the Option Deed.

● How the purchase price was to be determined.

● The Completion Date is 21 days after expiry of the notice given under the Election Notice or at any other time of date agreed in writing by the parties.

During the year ended 30 June 2016, Y gave formal notification in a letter of an intention to exercise its option to acquire Z's units. The letter stated:

The notice period runs for 60 days after which a contract for the sale will automatically form on XX/XX/2016. Settlement of the sale will be 21 days thereafter on XX/XX/XXXX effective prior to the start of the business.

The notice period of 60 days finished during the year ended 30 June 2016.

Settlement and transfer of Z's units occurred during the year ending 30 June 2017 for consideration exceeding $X million.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 104-10(1)

Income Tax Assessment Act 1997 Subsection 104-10(3)

Income Tax Assessment Act 1997 Section 152-15

Income Tax Assessment Act 1997 Section 152-20

Income Tax Assessment Act 1997 Section 328-125

Income Tax Assessment Act 1997 Subsection 328-125(1)

Income Tax Assessment Act 1997 Subsection 328-125(2)

Income Tax Assessment Act 1997 Subsection 328-125(6)

Taxation Administration Act 1953 Subsection 359-5(1) of Schedule 1

Reasons for decision

All subsequent legislative references are to the Income Tax Assessment Act 1997 unless noted otherwise.

Summary

Taking into account the terms of the Option Deed and the notice of the exercise of the option, it is considered that a contract for the disposal of the units in the Unit Trust came into existence during the year ended 30 June 2016 and consequently the CGT event happened in that year.

As Z has a control percentage under subsection 328-125(2) of exactly 50%, which is not 'less than 50%' as required for the discretion under subsection 328-125(6) to be available, the Commissioner is unable to exercise that discretion in this case. Also, it is not considered that the Commissioner is able to exercise his general powers of administration in this case.

Your question with respect to the Commissioner's remedial power is invalid as private rulings relate to a particular taxpayer and their particular circumstances and the remedial power cannot be exercised in favour of a particular entity to make a determination only in respect of their particular circumstances.

We acknowledge the arguments you have put forward on why you consider the market value of the units just before the CGT event was less than the sale price. However, it remains the view of the Commissioner that the sale price is the best evidence of market value. Consequently, the net value of the CGT assets owned by Z and its connected entities exceeds $6,000,000 and as a result Z fails to meet the MNAV test.

Detailed reasoning

Date of disposal

If an option is exercised then the CGT asset being the subject of the option will be disposed of by the grantor so that CGT event A1 will happen (subsection 104-10(1)). Any capital gain or loss made from the granting of the option is disregarded (subsection 104-40(5) but any capital proceeds from the granting of the option is included in the capital proceeds from the disposal of the CGT asset that was the subject of the option (section 116-65).

The time of CGT event A1 is when the taxpayer enters into the contract for the disposal or if there is no contract, when change of ownership occurs (subsection 104-10(3)).

The date of disposal of an asset sold on the exercise of an option is the date of the transaction entered into as a result of the exercise of the option (Taxation Determination TD 16). When the option is exercised a legally binding contract to buy and sell the property will be created and the date of disposal of the CGT asset will be the date that the option is exercised.

In this case, your contention is that no disposal contract was entered into and consequently the time of the CGT event is when the change of ownership of the units occurred during the year ending 30 June 2017.

However, it is noted that the Option Deed states that if Y serves an Election Notice on Z and does not serve a Revocation Notice on Z prior to the expiry of the Notice Period, an agreement is constituted on the date of expiry of the Notice Period under which Z is required to transfer its units to Y.

Also, the formal notice of the exercise of the option stated that a contract for the sale will automatically form at the end of the notice period which occurred during the year ended 30 June 2016.

Having regard to the terms of the Option Deed and the content of the notice of the exercise of the option, it is considered that there was a contract for the disposal of the units and it came into existence during the year ended 30 June 2016.

Connected entity

Section 328-125 states the following:

(1) An entity is connected with another entity if:

(a) either entity controls the other entity in the way described in this section; or

(b) both entities are controlled in a way described in this section by the same third entity.

(2) An entity (the first entity) controls another entity if the first entity, its affiliates or the first entity together with its affiliates:

(a) except if the other entity is a discretionary trust - beneficially own, or have the right to acquire the beneficial ownership of, interests in the other entity that carry between them the right to receive a percentage (the control percentage) that is at least 40% of:

(i) any distribution of income by the other entity; or

(ii) if the other entity is a partnership - the net income of the partnership; or

(iii) any distribution of capital by the other entity; or

(b) if the other entity is a company - beneficially own, or have the right to acquire the beneficial ownership of, equity interest in the company that carry between them the right to exercise, or control the exercise of, a percentage (the control percentage) that is at least 40% of the voting power in the company.

In this case, Z holds 50% of the units held in the Unit Trust and consequently has a right to 50% of the income and capital distributions. Therefore, Z is deemed to be 'connected with' the Unit Trust under section 328-125.

Commissioner may determine that an entity does not control another entity

Subsection 328-125(6) states:

If the control percentage referred to in subsection (2) or (4) is at least 40%, but less than 50%, the Commissioner may determine that the first entity does not control the other entity if the Commissioner thinks that the other entity is controlled by an entity other than, or by entities that do not include, the first entity or any of its affiliates.

In the present case, you contend that the Unit Trust is effectively controlled by Y rather than Z and provided reasons why, such as the trustee of the Unit Trust being controlled exclusively by Y.

However, the discretion under subsection 328-125(6) is only available to the Commissioner if the taxpayer's control percentage is 'at least 40%, but less than 50%' (emphasis added).

Z does not have a control percentage under subsection 328-125(2) of less than 50%, rather it is exactly 50%. Therefore, Z is deemed under subsection 328-125(2) to control the Unit Trust and the Commissioner is unable to make a determination under subsection 328-125(6).

The Commissioner's general powers of administration

You have asked that the Commissioner exercise his general powers of administration (GPA) to make a determination having the same effect as a determination under subsection 328-125(6).

Law Administration Practice Statement PS LA 2009/4 explains when, and how, the Commissioner's GPA can be exercised. It states:

In the rare circumstance where the operation of the law is unclear or leads to unforseen or unexpected consequences, it may be appropriate to consider whether the issue can be resolved using the Commissioner's GPA.

In this case we think the law operates as it was intended, as illustrated in the following examples from our website (https://www.ato.gov.au/general/capital-gains-tax/in-detail/small-business-concessions/capital-gains-tax-concessions-for-small-business-2016/?page=21):

Olivia and Jill conduct a professional practice in partnership. As they each have a 50% interest in the partnership, they each control the partnership. Therefore, the partnership is connected with each partner, and Olivia and Jill are each connected with the partnership.

Joseph is a sole trader. He also owns shares in a company that carry 50% of the voting power in the company. The net value of his CGT assets (apart from the shares in the company) is $3 million. In determining whether he satisfies the maximum net asset value test, Joseph must take into account the net value of his CGT assets ($3 million) and the net value of the company's CGT assets because the company is connected with him. He does not include the market value of his shares in the company in the net value of his CGT assets because this amount is already reflected in the net value of the company's CGT assets.

PS LA 2009/4 also states:

The GPA are narrow in scope and governed by the operation of administrative law principles. A proper exercise of the powers is confined to dealing with management and administrative decisions, such as the allocation of compliance resources more broadly recognised as practical compliance approaches.

In addition the Commissioner's GPA cannot be used to remedy defects or omissions in the law.

Having regard to all of the above, it is considered that Commissioner cannot exercise his GPA in this case.

Remedial power

Division 359 of Schedule 1 to the TAA sets out the rules that are specific to private rulings.

A private ruling is the Commissioner's written expression of how a relevant provision applies, or would apply, to a particular taxpayer in relation to a specified scheme (subsection 359-5(1) of Schedule 1 to the TAA).

The Commissioner's remedial power (CRP) is contained in Division 370 of Schedule 1 to the TAA. The Commissioner cannot provide a private ruling on the exercise of the CRP as:

● Private rulings relate to a particular taxpayer and their particular circumstances.

● The legislative framework governing the CRP makes it clear that any modification (by disallowable legislative instrument tabled in Parliament) applies generally, to all taxpayers or a specified subset of taxpayers.

The CRP simply cannot be exercised in favour of a particular entity to make a determination only in respect of their particular circumstances. The Tax and Superannuation Laws Amendment (2016) Measures No. 2 Bill 2016 explanatory memorandum explains this as follows:

1.54 The Remedial Power cannot be used to modify the operation of a taxation law for a particular entity. This includes exercising the power in relation to a class that is so narrowly defined that it could practically only consist of a particular entity. This can be distinguished from a class that may be capable of consisting of many entities but actually only applies at any given time to one particular entity.

1.55 Having the Remedial Power apply broadly to entities and circumstances ensures that the power properly relates to taxation and helps prevent it from being exercised in an arbitrary way. This ensures that its use is consistent with the requirements of the Constitution.

Further, as explained in our response with respect to the Commissioner's GPA, we think the law in this case operates as it was intended.

Maximum net asset value test (MNAV test)

Section 152-15 explains that you satisfy the MNAV test if, just before the CGT event, the sum of the following amounts does not exceed $6,000,000:

(a) the net value of the CGT assets of yours;

(b) the net value of the CGT assets of any entities connected with you;

(c) the net value of the CGT assets of any affiliates of yours or entities connected with your affiliates (not counting any assets already counted under paragraph (b)).

Section 152-20 provides that the net value of the CGT assets is the 'market value' of those assets.

The expression 'market value' is used in the income tax laws with its ordinary meaning (section 960-400). The most common definition for market value is derived from Spencer v. Commonwealth (1907) 5 CLR 418. In that case it was held that a valuation of land should be based on the price that a willing purchaser at the date in question would have had to pay to a vendor not unwilling, but not anxious to sell.

In Syttadel Holdings Pty Ltd v. FC of T 2011 ATC 10-199 (Syttadel's Case), the AAT confirmed, in the context of 'net value of CGT assets', that the relevant inquiry was to the market value according to its ordinary meaning, as noted in Spencer. In Syttadel's Case, the most appropriate methodology for calculating market value was considered to be by way of an objective business valuation.

The ATO Decision Impact Statement on Syttadel in February 2012 stated that the ATO generally considers the sale price of an asset to be its market value.

In Excellar Pty Ltd v. FC of T [2015] AATA 282, the AAT held that the selling price of a particular parcel of land was the best evidence of its market value at the relevant date.

We acknowledge your views in respect of the methodology used to determine the purchase price of the units as agreed under the Option Deed. However, it is the view of the Commissioner that the sale price of the units is still the best evidence of their market value. Therefore, the Commissioner considers that the net value of the CGT assets owned by Z and its connected entities exceeds $6,000,000 and consequently Z fails to meet the MNAV test.

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