Edited version of private advice

Authorisation Number: 1051565978368

Date of advice: 21 August 2019

Ruling

Subject: The capital gains tax (CGT) small business concessions

Question

Is the Unit Trust entitled to utilise the small business CGT concessions in Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997) in relation to the capital gain made on the sale of its properties?

Answer

No.

This ruling applies for the following period:

30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Unit Trust was established by deed. Unit Trust Pty Ltd is the corporate trustee. Under the deed, the unit holders' entitlements to capital and income are fixed.

There are three unit holders, which each hold one third (or 33.33%) of the units. These unit holders are discretionary trusts.

The unit holdings have not changed since establishment.

The Unit Trust acquired the ownership interests in properties at various times.

Each of the properties was leased to another discretionary trust (X Trust) which used them in carrying on its business.

The business of X Trust was sold to an unrelated third party which continued to operate the business on the Unit Trust's properties. The Unit Trust maintained ownership of the properties and continued to manage the sites as landlord. No independent property agents or managers were appointed.

In the 20XX income year all the properties were sold to an unrelated third party.

The Unit Trust did not receive distributions from X Trust.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 328-125

Income Tax Assessment Act 1997 section 328-130

Reasons for decision

The small business CGT concessions are contained within Division 152 of the ITAA 1997. In order to access the concessions, the CGT assets that have resulted in a capital gain to you need to pass the active asset test.

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

However, a CGT asset will not be an active asset while its main use was to derive rent (see paragraph 152-40(4)(e) of the ITAA 1997).

Subsection 152-40(4A) of the ITAA 1997 states that for the purposes of paragraph 152-40(4)(e) of the ITAA 1997, in determining the main use of an asset you treat any use of the asset by an affiliate or an entity connected with you as your use. That is, if you rent your asset to an affiliate or an entity connected with you, and they use the asset in their business and do not sub-let it themselves in order to earn rent, then the rental exclusion provided by paragraph 152-40(4)(e) of the ITAA 1997 would not apply to prevent your asset from being an active asset.

An individual or company is an affiliate of yours if the individual or company 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. However an individual or company is not your affiliate merely because of the nature of the business relationship you and the individual or company share (see section 328-130 of the ITAA 1997).

An entity is connected with another entity if:

(a)  Either entity controls the other entity as described below; or

(b)  Both entities are controlled in a way described below by the same third entity (see subsection 328-125(1) of the ITAA 1997).

Control of a unit trust that is not a discretionary trust is determined by the distributions of income or capital. An entity (together with its affiliates) controls a non-discretionary trust if it owns or has the right to acquire interests in the unit trust that carry between them the right to receive at least 40% of any distribution of income or any distribution of capital (see subsection 328-125(2) of the ITAA 1997).

A CGT asset satisfies the active asset test if:

(a)  You have owned the asset for 15 years or less and it was active asset of yours for a period of at least half your ownership period; or

(b)  You have owned the asset for greater than 15 years and the asset was an active asset of yours for a period of at least seven and a half years of your ownership period (see section 152-35 of the ITAA 1997).

Application to your circumstances

The properties were variously acquired over the years by the Unit Trust, with some interests being owned for more than 15 years and some less. For the total ownership period that each of the properties was owned, the Unit Trust's properties were either rented to X Trust for use in X Trust's business or to an unrelated third party for use in its business.

It is not possible for a trust to be an affiliate of another entity. This is made clear in the words of section 328-130 of the ITAA 1997 which limits individuals and companies to being affiliates. The unit holders of the Unit Trust are three discretionary trusts. As a result, the three discretionary trusts cannot be affiliated with one another. Further X Trust (which operated the business) is also a discretionary trust. It is not possible for X Trust and the Unit Trust to be affiliated as per the test.

Each of the discretionary trusts that are unit holders in the Unit Trust hold a one third share and so are entitled to a one third share in the income and capital of the Unit Trust. This means that none of the discretionary trusts has a right to income or capital of the Unit Trust that satisfies the control test in subsection 328-125(2) of the ITAA 1997. Also, as the unit holders in the Unit Trust are trusts, they cannot be affiliates of each other and therefore their entitlements to distributions from the Unit Trust cannot be combined when determining whether the control test is met. Further, as none of the unit holders holds 40% or more of the units in the Unit Trust, it is not possible for the Unit Trust and X Trust to be controlled by the same third entity. The control test in section 328-125 of the ITAA 1997 cannot be satisfied in regards to the Unit Trust.

Whilst the properties were used in the course of the Unit Trust's activity, their main use was to derive rent. As it is not possible for the Unit Trust to have X Trust as an affiliate, and X Trust was not connected to the Unit Trust, the exception to the rental exclusion in subsection 152-40(4A) of the ITAA 1997 does not apply.

Therefore, the CGT assets that the Unit Trust disposed of in the 20XX income year were at no time active assets.

Additional information

As the active asset test is not met, the Unit Trust is not entitled to utilise the small business CGT concessions, and it was not necessary to consider whether the Unit Trust met the other basic conditions required in order to access the concessions. That is, we have not considered whether the Unit Trust was a CGT small business entity in the 20XX income year or alternatively, met the maximum net asset value test.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).