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Authorisation Number: 1051296724763

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Date of advice: 20 October 2017

Ruling

Subject: Small Business Concessions

Question 1

Do the activities of the Company constitute the carrying on of a business?

Answer

Yes

Question 2

If the answer to 1 is yes, is the property an active asset in the business?

Answer

No

Question 3

If the answers to 1 & 2 are yes, do the small business CGT provisions apply, particularly the 15 year exemption should the Property be sold and a capital gain incurred?

Answer

No

Question 4

If the answers to 1, 2 & 3 are yes, will the Commissioner extend the two year period after the death of the significant individual?

Answer

No

This ruling applies for the following periods:

Year ending 30 June 2017

The scheme commences on:

1 July 2016

Relevant facts and circumstances

The Company devolved from another company over that went into liquidation over 15 years ago which was employed fulltime in investment activities.

The Company received a commercial zoned Property from the liquidation settlement.

The Company business activities include a substantial share investment portfolio and investments in unlisted, syndicate property investments.

No business plan exists.

Detailed share investment ledgers were maintained and annual financial statements and income tax returns produced.

Some 15 years ago the Company rented out one room of the Property to an unrelated third party.

The reception area and majority of the building was utilized by the Company. All the records were contained and retained at the Property.

The Company continued to conduct investment activities at the Property until the time of the Directors death.

A significant amount of capital has been employed. The value of the company at the time of death was $x million, of which the share portfolio comprised around $x million.

The annual turnover for the Company was below $x million.

The Directors Will was challenged from a beneficiary which resulted in the two year period being exceeded.

Two beneficiaries have each inherited x% of the Companies investments

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Section 152-15,

Income Tax Assessment Act 1997 Section 152-35,

Income Tax Assessment Act 1997 Section 152-40 and

Income Tax Assessment Act 1997 Section 328-110 .

Reasons for decision

There are no definite rules for determining whether activities amount to carrying on a business. The facts of each case must be examined and a determination made based on the large or general impression gained (Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548).

The courts have developed a series of indicators that can be applied to a set of circumstances to help determine whether a business is being carried on. Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? Provides the indicators established by the courts that need to be considered when determining whether a business is being carried on. Although TR 97/11 refers to primary production, the same principles apply to determining whether other forms of activity amount to carrying on a business. Relevant indicators of whether a business is being carrying on are:

a. whether your activity has a significant commercial purpose or character;

b. whether you have more than just an intention to engage in business;

c. whether you have a purpose of profit as well as a prospect of profit from the activity;

d. whether there is repetition and regularity of your activity;

e. whether your activity is of the same kind and carried on in a similar manner to businesses in your industry;

f. whether your activity is planned, organised and carried on in a businesslike manner;

g. the size, scale and permanency of your activity; and

h. whether your activity is better described as a hobby, recreation or sporting activity.

Paragraph 15 of TR 97/11 states that no one indicator is decisive (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922). In addition, paragraph 16 of TR 97/11 states that the indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the general impression gained from looking at all the indicators (Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470 at 474; 5 AITR 548 at 551 (Martin’s case), and whether these factors provide the operations with a 'commercial flavour' (Ferguson v. Commissioner of Taxation (1979) 37 FLR 310 at 325; 79 ATC 4261 at 4271; (1979) 9 ATR 873 at 884).

Taxation Ruling TR2017/D2 is also relevant in the present discussion. This ruling is not concerned with what amounts to carrying on business. However, generally, where a company is established or maintained to make profit or gain for its shareholders it is likely to carry on business. (Brookton Co-operative Society Ltd v FCT (1981) 147 CLR 441 per Aicken J at 469; American Leaf Blending Co Sdn Bhd v D-G of IR [1978] 3 All ER 1185 Per Lord Diplock at 1189; Inland Revenue Commissioners v Westleigh Estates Company Ltd; South Behar Railway Company Ltd; Eccentric Club Ltd [1924] 1 KB 390). This is so even if the company only holds passive investments, and its activities consist of receiving rents or returns on its investments and distributing them to shareholders.

Application to your situation

In applying factors (a) to (g) from (TR 97/11) to determine whether you were carrying on a business, it is acknowledged that the activities undertaken had the purpose of profit, characterised by regular and repetitive activity, had significant commercial purpose or character and the activities were carried out in a businesslike manner. In conclusion, after looking at all the indicators and factors discussed above, the Company is considered to be carrying on a business.

Question 2 – 4

Small business concessions

Section 328-110 outlines the meaning of small business entity. You are a small business entity for an income year if;

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 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.

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’.

Section 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997) contains the basic conditions you must satisfy to be eligible for the small business CGT concessions. These conditions are:

(a) a CGT event happens in relation to a CGT asset in an income year.

(b) the event would 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 in section 152-15 of the ITAA 1997

(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 or

(iv) the conditions in subsection 152-10(1A) or (1B) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year.

(d) the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997.

Active asset

A capital gains tax (CGT) asset will satisfy the active asset test if:

(a) 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, or

(b) 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 7½ years during the test period.

The test period begins when you acquired the asset and ends at the earlier of the CGT event and if the relevant business ceased to be carried on in the 12 months before that time – the cessation of the business.

Subsection 152-40(1) of the ITAA 1997 details that a CGT asset is an active asset at a time if it is used, or held ready for use, in the course of carrying on a business that is carried on by you, or your affiliate, or another entity that is connected with you.

The following assets cannot be active assets (subsection 152-40(4) of the ITAA 1997):

● interests in a connected entity (other than those satisfying the 80% test)

● shares in companies and interests in trusts (other than those satisfying the 80% test)

● shares in widely held companies unless they are held by a CGT concession stakeholder of the company

● shares in trusts that are similar to widely held companies unless they are held by a CGT concession stakeholder of the trust or other exceptions for trusts with 20 members or less apply

● financial instruments, including loans, debentures, bonds, promissory notes, futures contracts, forward contracts, currency swap contracts, rights and options

● an asset whose main use in the course of carrying on the business is to derive interest, an annuity, rent, royalties or foreign exchange gains. However, such an asset can still be an active asset if it is an intangible asset that has been substantially developed, altered or improved by the taxpayer so that its market value has been substantially enhanced or its main use for deriving rent was only temporary.

For a CGT asset of a business to be an active asset for the purposes of Division 152 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 paragraph 152-40(1)(a) 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.

However, paragraph 152-40(4)(e) of the ITAA 1997 provides that an asset whose main use in the course of carrying on the business is to derive interest, an annuity, rent royalties or foreign exchange gains cannot be an active asset (unless that main use was only temporary).

Application to your circumstances

In your case, you advise that the Property has been used in the business and its main use is to derive income from rent and passive investments (interest, dividends and trust distributions). As the main use of the property has been to derive passive income, it is excluded from being an active asset under paragraph 152-40(4)(e) of the ITAA 1997.

Accordingly, as you do not satisfy the basic conditions for the small business concessions, you are not entitled to apply any of the small business concessions to reduce or disregard the capital gain made on the sale of the Property.

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