Edited version of your written advice

Authorisation Number: 1051334571115

Date of advice: 8 February 2018

Ruling

Subject: Capital Gains Tax – Earnout Rights – Small Business Concessions

Question 1

Will the Commissioner accept that the Taxpayer is eligible to receive the protections contained in section 170B of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 2

Will the Commissioner allow the Taxpayer until xx xx xxxx to make a choice under Subdivision 152-D or 152-E of the Income Tax Assessment Act 1997 (ITAA 1997) in relation to the Capital Gain to the extent that is not already covered by a valid choice?

Answer

Yes.

This ruling applies for the following period:

20XX - XX income year

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Taxpayer is a Discretionary Trust with its beneficiaries defined by the Family Trust Election nominating Beneficiary A as the Specified Individual.

Beneficiary A was over age 55. Beneficiary B was under age 55.

The Taxpayer entered into a sale arrangement (the Transaction) whereby 100% of their shares in a private company were sold to a third party. This sale generated the Capital Gain.

The sale document nominated a specific sale price but provided conditions that could increase or decrease this amount based on future events. The sale took place before 24 April 2015.

This Transaction meets the requirements to be a qualifying look through earnout arrangement for the purpose of section 118-565 of the ITAA 1997 had the Transaction taken place after 24 April 2015.

The Taxpayer received the cash proceeds in instalments under the arrangement as the owner of a portion of the shares in the private company. The total received was actually higher than the specific sale price nominated in the sale document.

The arrangement was finalised on receipt of the final proceeds.

The Taxpayer lodged its 2014-15 income year tax return declaring the following at Question 21 about capital gains:

Did you have a CGT event during the year? G Y

Have you applied an exemption or rollover? M Y

Have you applied an exemption or rollover? – code Small business active asset reduction (subdivision 152-C)

Have you applied an exemption or rollover? – code Small business retirement exemption (Subdivision 152-D)

Have you applied an exemption or rollover? – code Small business roll-over (Subdivision 152-E)

Net capital gain P 0

The Taxpayer lodged a CGT schedule for the 2014-15 income year showing the following:

1 Current year capital gains and capital losses

Capital gains – Other shares B xxxxxx

Total current year capital gains J xxxxxx

5 CGT concessions for small business

Small business active asset reduction A xxxxxx

Small business retirement exemption B xxxxxx

Small business roll-over C xxxxxx

Total small business concessions applied D xxxxxx

6 Net capital gain

Net capital gain A 0

7 Earnout arrangement

Are you a party to an earnout arrangement? A No

The gross capital gain was based on the capital proceeds being the specific sale price nominated in the sale document less the cost base of the shares.

The Taxpayer has not made contributions to a superannuation fund on Beneficiary A’s behalf as this beneficiary is older than the age threshold (55) and such contributions are not required.

The Taxpayer’s 2015-16 income year tax return did not include any capital gain on the earnout proceeds received in that year. No capital gain schedule was completed and therefore Item 7 regarding earnout arrangements was also not completed.

The Taxpayer’s 2016-17 income year tax return has not yet been lodged.

Beneficiary A had an earlier capital gain and claimed the CGT small business retirement exemption.

Beneficiary A made another capital gain in an earlier year that was eligible to receive the small business retirement exemption but it was not disclosed on his CGT schedule for that year.

The Taxpayer has now identified some errors in the preparation of the 2014-15 income tax return and CGT schedule. The errors are:

● The amount of the capital gain has been incorrectly calculated as amount of the capital proceeds should be higher, and

● Beneficiary A’s CGT retirement exemption limit for the 2014-15 income year was less than the amount identified in the CGT schedule.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 170B

Tax and Superannuation Laws Amendment (2015 Measures No. 6) Act 2016 Item 39 of Schedule 1

Income Tax Assessment Act 1997 Part 3-1

Income Tax Assessment Act 1997 Part 3-3

Reasons for decision

Question 1

Summary

The Commissioner will not accept that the Taxpayer is eligible to receive the protections contained in section 170B of the ITAA 1936.

Detailed reasoning

On 12 May 2010, the former Government announced that the tax law would be amended to provide look-through CGT treatment for qualifying earnout arrangements entered into as part of the sale of business assets.

On 14 December 2013, the then Assistant Treasurer announced that following consultation on a number of the 92 announced but unenacted measures of the former Government, the Government would proceed with several of the measures including the proposed amendments to provide look-through CGT treatment to qualifying earnout arrangements.

Most of the amendments apply to all earnout arrangements entered into on or after 24 April 2015, the first working day on which draft legislation to give effect to this measure was made public.

Protection for taxpayer anticipation

These amendments do not apply prior to 24 April 2015. However, taxpayers that have reasonably and in good faith anticipated changes to the tax law in this area as a result of the announcement by the former Government will have their current income tax treatment preserved.

This protection measure operates by reference to the protection measure introduced in relation to certain tax measures announced by former Governments that did not proceed in section 170B of the ITAA 1936.

This approach protects taxpayers that have reasonably anticipated changes without requiring complex retrospective changes or requiring taxpayers to make amendments to comply with the specific provisions of the final law the detail of which could not have been anticipated.

As with this earlier measure, the protection will operate by placing a statutory bar on the Commissioner amending an income tax assessment in relation to a particular contained in a statement, to the extent that the particular represents the taxpayer's reasonable anticipation of the announced changes to the law and satisfies the timing conditions.

Amongst other things, the timing conditions for the earlier protection measure applied differently to events before and after 14 December 2013 (see subsection 170B(3) of the ITAA 1936). For the purposes of this measure, the timing conditions will apply differently based on whether events happened before, or on or after 24 April 2015. Broadly, this means that the conditions will be satisfied if either:

● the statement is made between the date of the announcement and 23 April 2015 and if the statement was made in a return, the return was not required to be lodged before 24 April 2015; or

● the statement is made in a return lodged on or after 24 April 2015, the return was not required to be lodged before that date, no prior return had been lodged or assessment made for that income year, and the statement relates to the application of the taxation law to events prior to 24 April 2015 or to which the taxpayer was committed prior to 24 April 2015.

Also consistent with the prior measure, any protection under the measure will be lost if the taxpayer makes a statement for a later year of income that is not consistent with the anticipated amendments reflected in the taxpayer's original statement in a way that is to the taxpayer's benefit. Assessments may be amended at any time to give effect to the loss of protection.

The Taxpayer’s situation

In this case, the original 2014-15 income year tax return was prepared on the basis that the capital proceeds from the sale of the shares was the specific sale price nominated in the sale document and the CGT schedule was completed declaring that the Taxpayer was not a party to an earnout arrangement during the 2014-15 income year.

The draft sale document begins by identifying the sale proceeds as being this specific amount. It is only later in the document that conditions are placed on the total amount that is to be paid (which could be higher or lower).

The best fit to these facts is that the statement in the CGT schedule correctly reflects the understanding of the Taxpayer and Taxpayer’s agent in the preparation of the original 2014-15 income year tax return – being that the sale did not qualify as an earnout arrangement.

The protection is only available where the tax return has been completed on the basis that the sale qualifies as an earnout arrangement.

The Taxpayer is not entitled to the protection provided by section 170B of the ITAA 1936 because the original 2014-15 income year tax return was not prepared in a manner consistent with the announcement made on 11 May 2010.

Question 2

Summary

The Commissioner will allow the Taxpayer until xx xx xxxx to make a choice under Subdivision 152-D or 152-E of the ITAA 1997 in relation to the Capital Gain to the extent that is not already covered by a valid choice.

Detailed reasoning

You may choose to disregard all or part of a capital gain under the small business retirement exemption in Subdivision 152-D of the ITAA 1997 or the small business roll-over exemption in Subdivision 152-E of the ITAA 1997 if you satisfy certain conditions.

The general rule is that a choice available under the capital gains tax provisions once made cannot be changed. Also, such a choice must be made by the time the income tax return is lodged or within such further time as the Commissioner allows (subsection 103-25(1) of the ITAA 1997).

Under subsection 103-25(2) of the ITAA 1997, the way you prepare your income tax return is sufficient evidence of the making of the choice. However, a choice can only be considered to have been made if the choice itself is valid.

In determining if the Commissioner should use his discretion to allow an extension of time the following factors are considered:

• your explanation for not making the choice by the time it should have been made

• whether it would be fair and equitable in the circumstances to allow you more time to make a choice

• if prejudice to the Commissioner of Taxation might result from additional time being allowed to you, however, the absence of prejudice by itself is not enough to justify granting an extension

• whether it would be fair and equitable to people in similar positions and the wider public interest, and

• if any mischief is involved.

After consideration of the above factors and your circumstances, the Commissioner has exercised his discretion and granted you an extension to make the choice to apply either the small business retirement exemption or the small business roll-over exemption (or both).

Consequences of exercising this discretion

The exercise of this discretion allows the Taxpayer more time to choose to apply the either the small business retirement exemption or the small business roll-over exemption (or both) to the portion of the Capital Gain that is not already covered by a valid choice.

Once the Taxpayer’s review of the calculation of the amount of the Capital Gain that occurred due to the Transaction is completed:

• the amount of the Capital Gain will be increased to reflect the correct amount of capital proceeds

• The small business active asset reduction of 50% will apply to the new amount of the Capital Gain (as this choice was validly made)

• The small business retirement exemption will then apply up to the amount of Beneficiary A’s CGT retirement exemption limit for the 2014-15 income year as re-calculated to take into account all of the instances where the small business retirement exemption has been chosen (this is the extent to which this choice was validly made)

• The Taxpayer may then choose to apply the small business retirement exemption in favour of another CGT concession stakeholder up to their CGT retirement exemption limit for the 2014-15 income year (however, this choice must leave at least the original amount available for the small business roll-over)

• The small business roll-over is then made (the amount of this choice must be at least equal to the amount disclosed in the original income tax return)

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