Edited version of your written advice

Authorisation Number: 1051413007054

Date of advice: 13 August 2018

Ruling

Subject: Small business CGT concessions

Do you satisfy the basic eligibility conditions for the CGT small business concessions under Division 152A of the Income Tax Assessment Act 1997 (ITAA 1997):

(i) Are you a small business entity for the income year?

Answer

No

(ii) Do you satisfy the maximum net asset value test?

Answer

Yes

(iii) Does the CGT asset satisfy the active asset test?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 2019

The scheme commences on:

1 July 2018

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents and further information which form part of and are to be read with this description. The relevant information is:

1. The Company was started by the taxpayer and their sibling (A).

2. There were two directors of the company - the taxpayer and A.

3. The taxpayer owns shares in the company.

4. Valuations were provided by the applicant.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 152-15

Income Tax Assessment Act 1997 Section 152-20

Income Tax Assessment Act 1997 328-130

Reasons for decision

Small Business CGT concessions

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.

A capital gain that you make may be reduced or disregarded under Division 152 if the following basic conditions are satisfied:

(a) a CGT event happens in relation to a CGT asset of yours 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;

(iii) you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an interest in an asset of the partnership;

(iv) the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year; and

(d) the CGT asset satisfies the active asset test.

In addition, where the relevant CGT assets are shares in a company, you must have been a CGT concession stakeholder in the company just before the CGT event (paragraph 152-10(2)(a) of the ITAA 1997) or CGT concessional stakeholders in the company together have a small business participation percentage in you of at least 90%.

CGT Small Business Entity test:

This test requires the aggregated turnover of the entity to be $2 million or less. The Company currently has a turnover above $2 million but under $10 million per annum and fails this test. Therefore, as neither paragraphs 152-10(1)(c)( iii) or (iv) of the ITAA 1997 are relevant the taxpayer must satisfy the $6 million net asset value test.

Section 152-10 of the ITAA 1997 lists the basic conditions for accessing capital gains concessions in Division 152 of the ITAA. Relevantly, one of the conditions is satisfying the maximum net asset value test.

Maximum net asset value test

Section 152-15 of the Income Tax Assessment Act 1997 (ITAA 1997) explains that you satisfy the maximum net asset value 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)).

Subsection 152-20(1) of the ITAA 1997 provides that the ‘net value of the CGT assets’ of an entity is the amount (whether positive, negative or nil) obtained by subtracting from the sum of the market values of those assets the sum of:

(a) the liabilities of the entity that are related to the assets; and

(b) the following provisions made by the entity:

i. provisions for annual leave;

ii. provisions for long service leave;

iii. provisions for unearned income;

iv. provisions for tax liabilities.

The meaning of net value of GCT assets means the amount by which the market value (not book value) of each CGT asset exceeds the liabilities that are related to the assets and various specific provisions.

Assets to be included in determining the net value of the CGT assets are not restricted to business assets. They include all CGT assets of the entity, unless they are specifically excluded such as personal assets.

The current tax law does not define market value in any general provision. It is defined in the 'Definitions' part (section 995-1 of the ITAA 1997), but not in a way that fixes its meaning in all contexts. As a result, 'market value' usually takes the ordinary meanings given below, unless specially defined or qualified in a particular provision.

Valuers of real property adopt the definition used by the International Valuation Standards Council (IVSC):

... the estimated amount for which an asset should exchange on the date of valuation between a willing buyer and a willing seller in an arm's length transaction, after proper marketing, wherein the parties had each acted knowledgeably, prudently and without compulsion.

Business valuers in Australia typically define market value as:

…the price that would be negotiated in an open and unrestricted market between a knowledgeable, willing but not anxious buyer and a knowledgeable, willing but not anxious seller acting at arm's length.

The High Court cast light on the ordinary meaning of 'market value' in Spencer v The Commonwealth of Australia (1907) 5 CLR 418. In this case, the Commonwealth had compulsorily acquired land for a fort at North Fremantle in Western Australia.

In discussing the concept of market value, Griffith CJ commented (page 432) that:

… the test of value of land is to be determined, not by inquiring what price a man desiring to sell could have obtained for it on a given day, i.e. whether there was, in fact, on that day a willing buyer, but by inquiring: What would a man desiring to buy the land have had to pay for it on that day to a vendor willing to sell it for a fair price but not desirous to sell?

Isaacs J subsequently expanded on the concept (page 441):

… to arrive at the value of the land at that date, we have … to suppose it sold then, not by means of a forced sale, but by voluntary bargaining between the plaintiff and a purchaser willing to trade, but neither of them so anxious to do so that he would overlook any ordinary business consideration. We must further suppose both to be perfectly acquainted with the land and cognisant of all circumstances which might affect its value, either advantageously or prejudicially, including its situation, character, quality, proximity to conveniences or inconveniences, its surrounding features, the then present demand for land, and the likelihood as then appearing to persons best capable of forming an opinion, of a rise or fall for what reasons so ever in the amount which one would otherwise be willing to fix as to the value of the property.

In this case, the High Court recognised the principles of:

● the willing but not anxious vendor and purchaser

● a hypothetical market

● the parties being fully informed of the advantages and disadvantages associated with the asset being valued (in the specific case, land), and

● both parties being aware of current market conditions.

Affiliate

Section 152-15 (c) of the ITAA 1997 requires the inclusion of the net value of any affiliates of yours or entities connected with your affiliates (not counting any assets already counted under paragraph (b)).

An affiliate is defined by section 328-130 of the ITAA 1997 as being an individual or company who acts or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the business of the individual or company.

The following requirements must be met for an entity to qualify as the entity's affiliate:

(a) the entity must be an individual or company;

(b) the entity must carry on a business; and

(c) in relation to its business affairs, the entity must act, or could reasonably be expected to act according to the directions or wishes of the entity or in concert with the entity.

An individual is not an affiliate merely because of a shared business relationship and the definition of affiliate in section 328-130 of the ITAA 1997 does not automatically include the taxpayer's spouse or child under the age of 18 years.

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 one factor will necessarily be determinative.

The Explanatory Memorandum to the Tax Laws Amendment (Small Business) Bill 2007 in Chapter 2 discusses relevant factors that may support a finding that a person acts in such a manner 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; and

● the actions of the parties.

Whether a person is acting in concert with another is essentially a question of fact. The term ‘acting in concert’ involves at least an understanding between the parties as to a common purpose or object.

Application to the circumstances

Spouse

To qualify as an affiliate, the individual or company must carry on a business. The taxpayer’s spouse does not carry on a business and therefore cannot be an affiliate of the taxpayer.

Sister/Brother in law

Your sister/brother-in-law is not considered to be an affiliate of yours.

Connected Entity

Section 152-15 (b) of the ITAA 1997 requires the inclusion of the net value of the CGT assets of any entities connected with you as part of the maximum net asset value test.

An entity is connected with another entity if the first entity and/or its affiliate controls the other or both entities are controlled by the same third entity in a manner as prescribed in section 328-125 of the ITAA 1997 (subsection 328-125(1) of the ITAA 1997).

An entity controls a company if it, its affiliates or all of them together beneficially own, or have the right to acquire beneficial ownership of equity interests in the company that carry between them at least 40% (the control percentage) of the voting power in the company under paragraph 328-125(2)(b) of the ITAA 1997.

The Company will not be connected with the taxpayer because the taxpayer’s spouse is not their affiliate and this means that between them they cannot control over 40% of the voting power in the Company.

Conclusion

The maximum net asset value test is satisfied.

Active asset test

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 or an entity connected with you (subsection 152-40(1) of the ITAA 1997).

For a CGT asset to be an active asset for the purposes of Division 152 of the Income Tax Assessment Act 1997 (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.

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 least 7.5 years during the test period.

The test period:

● begins when you acquired the asset, and

● ends at the earlier of

● the capital gains tax event, and

● when the business ceased, if the business in question ceased in the 12 months before the capital gains tax event (or such longer time as the Commissioner allows).

A share in a resident company or an interest in a resident trust is an active asset at a given time if the taxpayer owns it at that time and the total of the following is 80% or more of the market value of the assets of the company or trust:

(i) the market values of the company’s or trusts active assets

(ii) the market value of any financial instruments of the company or trust that are inherently connected with a business that the company or trust carries on and

(iii) any cash of the company or trust that is inherently connected with such a business

This is commonly referred to as the 80% test.

A share in a company or an interest in a trust is therefore an active asset of the entity claiming the small business concession if the company or trust itself has active assets and the 80% test is met. That is, it is necessary to look through the company or trust to establish whether 80% of the company’s or trust assets are active assets.

Application to the facts:

The test is satisfied.

CGT concession stakeholder

For a share interest to qualify as an active asset the CGT concession stakeholder test in 152-10 of the ITAA 1997 must also be satisfied in addition to the 80% active asset test.

An individual is a CGT concession stakeholder of a company at a time if the individual is a significant individual in the company or, a spouse of a significant individual if the spouse has a small business participation percentage (SBPP) in the company at that time that is greater than zero (section 152-60 of the ITAA 1997).

Significant individual

An individual is a significant individual in a company if they have a SBPP in the company of at least 20% at that time. This 20% can be made up of direct and indirect percentages (section 152-55 of the ITAA 1997).

SBPP

Under section 152-65 of the ITAA 1997 an entity’s SBPP in another entity at a time is the percentage that is the sum of:

● the entity’s direct SBPP in the other entity at that time, and

● the entity’s indirect SBPP in the other entity at that time.

Under subsection 152-70(1) of the ITAA 1997 an entity’s direct SBPP in a company is the percentage of:

● voting power that the entity is entitled to exercise, or

● any dividend payment that the entity is entitled to receive, or

● any capital distribution that the entity is entitled to receive, or

● if they are different, the smallest of the three percentages above.

All classes of shares are taken into account.

You are a CGT concession stakeholder of the company based on the information provided.

Conclusion:

The taxpayer meets the basic eligibility conditions for the CGT small business concessions under Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997).

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