Edited version of your written advice

Authorisation Number: 1051351473307

Date of advice: 23 March 2018

Ruling

Subject: CGT – small business concessions

Question

Do you satisfy the basic conditions for the capital gains tax (CGT) small business concessions under subdivision 152-A in relation to the sale of the property?

Answer

Yes.

This ruling applies for the following period:

Income year ended 30 June 2017.

The scheme commences on:

DD MMM YYYY

Relevant facts and circumstances

Person A and Person B are spouses and trustees (you) of a discretionary trust (the Trust).

Person A has operated a number of businesses a sole trader for a number of years.

Person A was small business entity and had an aggregated turnover of less than $2 million.

The Trust does not carry on a business.

The Trust satisfies the maximum net asset value test.

Acquisition of property

Some years ago, the Trust acquired a floor in commercial building (the property).

By acquiring the property, it would enable the Trust to provide office space for Person A’s businesses.

The Trust borrowed funds to acquire the property.

Units in the property

The property was originally divided into three suites. One of these suites was later portioned so that the property was divided into four suites.

Various parts of the property were used by Person A in carrying on their businesses as follows:

● One suite was used as an office for the businesses from acquisition until a later date when work was done elsewhere

● Another suite was later used for meetings by the businesses for a period of time

From acquisition, Person A used one the suites for their businesses until changes meant the office was not required.

During some years, work was carried out elsewhere and Person A would supervise an employee working from another location.

Following subsequent changes some year later, it was decided the businesses would commence using another suite at the property which was vacated by a previous tenant.

This suite had office furniture and was used to hold meetings, while Person A also worked from this office from time to time.

A further suite was also vacant for a period during this time but did not have office furniture.

Preceding sale, there was a period where the property was not used or held ready for use by Person A.

Income details

You have provided details of gross rental income derived by the Trust and business income derived by Person A.

The following rent was paid by Person A.

Rent was paid at market rate for the first period Person A used one of the suites.

No rent was paid by Person A during the second period.

Sale of the property

Person A retired from one of their businesses and it ceased operation in a specific income year.

Another business continued to operate but did not require office space at the property.

You considered selling the property however this presented difficulties due to the following factors:

● Depressed market conditions for the sale or lease of commercial offices

● A number of the suites in the property were vacant

● A number of strata lots on other levels in the same building had been on the market for sale or lease for sometime

As over 50% of the property was vacant, it was decided to first find a tenant to occupy one of the vacant suites, before placing the property on the market.

Approximately one year after Person A retired, one of the suites was leased out and you engaged an agent to sell the property.

The property was subsequently sold some months later.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 Section 152-35

Income Tax Assessment Act 1997 Section 152-40

Reasons for decision

Summary

You satisfy the basic conditions under subdivision 152-A in relation to the sale of the property. For more than half of your ownership period, the property has been used or held ready for use by a connected entity. The property is considered to be an active asset and its main use was not to derive rent.

Detailed reasoning

To qualify for the small business concessions, you must satisfy several conditions that are common to all the concessions. These are called the basic conditions.

The basic conditions in Subdivision 152-A of the ITAA 1997 which are relevant to you are:

● the passively held assets – affiliates and entities connected with you; and

● the active asset test.

Passively held assets - affiliates and entities connected with you

The conditions in subsection 152-10(1A) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year if:

(a) your affiliate, or an entity that is connected with you, is a small business entity for the income year; and

(b) you do not carry on a business in the income year (other than in partnership); and

(c) if you carry on a business in partnership - the CGT asset is not an interest in an asset of the partnership; and

(d) in any case - the small business entity referred to in paragraph (a) is the entity that, at a time in the income year, carries on the business (as referred to in subparagraph 152-40(1)(a)(ii) or (iii) or paragraph 152-40 (1)(b) in relation to the CGT asset.

A connected entity is defined under section 328-125 of the ITAA 1997 as being:

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.

An entity controls a discretionary trust if a trustee of the trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the first entity, its affiliates, or the first entity together with its affiliates (subsection 328-125(3) of the ITAA 1997).

Application to your situation

It is accepted that Person A (along with their affiliate spouse) controls the Trust as trustee. It could reasonably be expected that the actions of the trustee would be in accordance with Person A’s directions and wishes. Therefore a connection has been established and the Trust and Person A are connected entities.

The Trust did not carry on a business. Person A had an aggregated turnover of less than $2 million from their business activities as sole trader and is a small business entity for the purposes of the small business concessions.

Active asset test

The active asset test is contained in section 152-35 of the ITAA 1997. 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;

● 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).

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, your affiliate, your spouse or child, or an entity connected with you.

Paragraph 152-40(4)(e) of the ITAA 1997 states, however, that an asset whose main use in the course of carrying on the business is to derive rent cannot be an active asset unless the main use for deriving rent was only temporary.

Mixed use of a property

Taxation Determination TD 2006/78 Income tax: capital gains: are there any circumstances in which the premises used in a business of providing accommodation for reward may satisfy the active asset test in section 152-35 of the Income Tax Assessment Act 1997 notwithstanding the exclusion in paragraph 152-40(4)(e) of the Income Tax Assessment Act 1997 for assets whose main use is to derive rent? considers the active asset test and the main use to derive rent concept. Paragraph 26 of Taxation Determination TD 2006/78 states that:

If an asset is used partly for business and partly to derive rent at any given time, it will be a question of fact depended on all the circumstances as to whether the main use of the asset at that time is to derive rent. No on single factor will necessarily be determinative, and resolving the matter is likely to involve a consideration of a range of factors such as:

● the comparative areas of use of the premises (between deriving rent and other uses); and

● the comparative levels of income derived from the different uses of the asset.

Example 5 considers mixed use of a property:

Mick owns land on which there are a number of industrial sheds. He uses one she (45% of the land by area) to conduct a motor cycle repair business. He leases the other sheds (55% of the land by area) to unrelated third parties. The income derived from the motor cycle repair business is 80% of the total income (business plus rentals) derives from the use of the land and buildings.

In determining if the main use of the land is to derive rent, it is appropriate to consider a range of factors. In this case, a substantial (although nevertheless not a majority) proportion by area of the land is used for business purposes. As well, the business proportion of the land derives the vast majority (80%) of the total income. In all the circumstances, the Tax Office considers the main use of the land in this case is not to derive rent and accordingly the land is not excluded from being an active asset by paragraph 152-40(4)(e) of the ITAA 1997.

Application to your situation

The property was used or held ready for use in course of carrying on a number of businesses by Person A as sole trader. A portion of the property was used or held ready for use by Person A (a connected entity) for more than half of the ownership period.

Furthermore, the property’s main use is not considered to have been to derive rent. Although the area used by Person A was relatively smaller than the area used to derive rent, the business income generated by Person A equated to well over 80% of total income derived from the property for the relevant periods it was used or held ready for use by Person A.

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