Edited version of private advice

Authorisation Number: 1051575452695

Date of advice: 3 September 2019

Ruling

Subject: CGT small business concessions

Question 1

Does the property satisfy the active asset test for the purpose of the capital gains tax small business concessions?

Answer

Yes

Question 2

Will you satisfy the significant individual test upon disposal of the property?

Answer

Yes

Question 3

Will you satisfy the conditions under section 152-110 of the Income Tax Assessment Act 1997 (ITAA 1997) to apply the 15 year exemption upon disposal of the property?

Answer

No

Question 4

Will you satisfy the conditions under section 152-305 of the ITAA 1997 to apply the retirement exemption upon disposal of the property?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

B (the company) was incorporated on XX/mth/19XX.

M and O have been Directors of the company since incorporation.

The company acquired a residential property (the property) on after XX/mth/19XX.

The property was occupied by M and O and has been used in M's business since XX/mth/July 20XX.

The company intends to dispose of the property which will result in a capital gain.

The disposal of the property is in connection with M's pending retirement.

You satisfy the maximum net asset value test.

M and O are both over 55 years.

The share structure of the company at incorporation on 13 August 1999 was as follows:

Additional classes of shares were issued to new shareholders, C and N, effective XX March 20XX which resulted in the following share structure:

On XX April 20XX a transfer of shares occurred between C and N to M and O. There was also a transfer of shares between M and O. The result of the various transfers is as follows:

On XX April 20XX Classes B, C, D and E were converted to ordinary shares, resulting in the following holding:

A further issue of ordinary shares were issued on XX April 20XX, which resulted in the current shareholding:

The Directors may determine whether a dividend is payable and fix the amount, the timing and the method of payment (as per clause XX of the Company Constitution).

Distributions of profits and capitalised profits may be made to one or more class of share or classes of shares to the exclusion of the shares of any other class of share or classes of shares (as per clause XX of the Company Constitution).

Ordinary shares possess voting rights and Classes B-E shares have no voting rights (as per clauses XX - XX of the Company Constitution).

On XX March 20XX you lodged an application requesting a private ruling. A private ruling was issued on XX July 20XX. The private ruling issued did not take into account the restructure of the shareholding which occurred in April 20XX.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 152-35(1)

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 subsection 152-40(4)

Income Tax Assessment Act 1997 paragraph 152-40(4A)(b)

Income Tax Assessment Act 1997 subsection 328-125(1)

Income Tax Assessment Act 1997 subsection 328-125(2)

Income Tax Assessment Act 1997 section 152-60

Income Tax Assessment Act 1997 section 152-55

Income Tax Assessment Act 1997 section 152-110

Income Tax Assessment Act 1997 paragraph 152-110(1)(c)

Income Tax Assessment Act 1997 Subdivision 152-D

Income Tax Assessment Act 1997 subsection 152-305(2)

Income Tax Assessment Act 1997 section 152-320

Reasons for decision

Summary

The property satisfies the active asset test and is therefore considered an active asset for the purposes of the small business capital gain concessions.

You will have a significant individual at the time of disposal of the property. However, you do not have a significant individual for at least 15 years, therefore you do not meet the requirements to apply the 15 year exemption.

You will be eligible to apply the small business retirement exemption as long as you meet the remaining requirements under subsection 152-305(2) of the ITAA 1997 relating to the keeping of written records. As both concession stakeholders are over 55 years, there is no requirement to make payment to a complying superannuation fund or retirement savings account on their behalf.

Detailed reasoning

Active asset test

Subsection 152-35(1) of the Income Tax Assessment Act 1997 (ITAA 1997) states that a CGT asset satisfies the active asset test 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 period of ownership, 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 and a half years.

Section 152-40 of the ITAA 1997 provides the meaning of 'active asset'. A CGT asset will be an active asset at a time if, at that time, you own the asset and the asset was used or held ready for use by you, an affiliate of yours, or by another entity that is 'connected with' you, in the course of carrying on a business.

However, subsection 152-40(4) explains that an asset whose main use is to derive rent cannot be an active asset. Paragraph 152-40(4A)(b) of the ITAA 1997 provides that to determine the main use of an asset, treat any use by your affiliate, or an entity that is connected with you, as your use.

Subsection 328-125(1) of the ITAA 1997 explains that an entity is connected with another entity if:

a)    either entity controls the other entity in a way described in this section; or

b)    both entities are controlled in a way described in this section by the same third entity.

Subsection 328-125(2) of the ITAA 1997 provides that an entity (the first entity) controls another entity if the first entity, its affiliates, or the first entity together with its affiliates: if the other entity is a company - beneficially owns, or has the right to acquire beneficial ownership of, equity interests in the company that give at least 40% of the voting power in the company.

In your case, the property was used by a connected entity, M in the course of carrying on their business. M is one of the directors of the company, holding more than 40% of the voting power in the company. The asset was used in the business for the entirety of the ownership period of more than 15 years, satisfying the timing requirements under subdivision 152-35(1) of the ITAA 1997 for an active asset.

The property satisfies the active asset test and is therefore considered an active asset for the purposes of the small business capital gains concessions.

Significant individual

As per section 152-60 of the ITAA 1997 an individual is a CGT concession stakeholder of a company if they are a significant individual or the spouse of a significant individual, where the spouse has a small business participation percentage in the company at that time that is greater than zero.

Under section 152-55 of the ITAA 1997 an individual is a significant individual in a company or trust if they have a small business participation percentage in the company or trust of at least 20%. This 20% can be made up of direct and indirect percentages.

An entity's direct small business participation percentage in a company is the percentage of:

·         voting power that the entity is entitled to exercise

·         any dividend payment that the entity is entitled to receive

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

·         if they are different, the smallest of the three definitions above.

Taxation Determination TD 2006/77 provides that all classes of shares must be taken into account in determining if a company has a significant individual. It follows that a shareholder that holds more than 20% of one class of shares in a company will not be a significant individual if their right to any distribution of income or capital from the company is dependent on a discretion to make distributions to any class of shares to the exclusion of the other classes of shares. A shareholder must be capable of receiving at least 20% of any distribution regardless of how a discretion is exercised.

TD 2006/77 provides the following example:

Bedrock Co has two different classes of shares, A and B, which have equal distribution rights. Only the A class shares have voting rights. Each class of shares is held by different shareholders - the A class shares being held in equal proportions by Fred and Barney and the B class shares being held in equal proportions by their respective wives, Wilma and Betty.

The directors of Bedrock Co can decide to make a distribution of income or capital to either class of shares to the exclusion of the other class of shares. There is the possibility of any of the shareholders receiving 50% of a distribution from the company, depending on the exercise of the directors' discretion.

In this situation, Bedrock Co does not have a significant individual. There is no specific individual who has the right to receive at least 20% of any distribution the company may make. Fred and Barney (who each hold 50% of the voting power) might receive 50% of a distribution or they might not receive anything at all, depending on how the directors exercise their discretion.

From incorporation until XX April 20XX, M held Ordinary Shares and Class B shares; O held Ordinary shares and Class C shares. C and N held Class D and E shares respectively, between XX March 20XX to XX April 2019, at which point these shares were transferred to M and O.

A restructure of the company shares on XX April 20XX, converted share classes B, C, D and E to ordinary shares, resulting in M and O holding XX% of the company's ordinary shares each.

Clause XXX of the Constitution of the company provides that distributions of profits and capitalised profits may be made to any one or more class of share or classes of shares to the exclusion of the shares of any other class or classes of shares.

In accordance with TD 2006/77, the company does not have a significant individual between incorporation up to 15 April 2019 as there is no individual who has the right to receive at least 20% of any distribution the company may make.

M, O, C and N's small business participation percentage in the company is zero as their right to a distribution of income from the company was dependent on how the directors exercised their discretion. The historical distribution of dividends is not taken into account when determining if a company had a significant individual at a point in time.

Accordingly, neither M nor any other shareholder was not a significant individual for the period from incorporation to XX April 20XX.

However from XX April 20XX, after the restructure of the company's shares, M and O each hold XX% of ordinary shares. Both M and O will be considered significant individuals as they each hold more than 20% of voting power and more than a 20% entitlement to any capital distributions or dividend payments made, which results in a small business participation percentage of more than 20%. Therefore the company will have a CGT concession stakeholder immediately before the CGT event.

15 year exemption

Section 152-110 of the ITAA 1997 provides a small business 15-year exemption for companies and trusts. Under this section, a company can disregard the capital gain from the disposal of a CGT asset if:

(a)    the company satisfies the basic conditions in Subdivision 152-A of the ITAA 1997 for the small business CGT concessions,

(b)    the company continuously owned the CGT asset for the 15-year period ending just before the CGT event happened,

(c)    the company had a significant individual for a total of at least 15 years (even if the 15 years was not continuous and it was not always the same significant individual) during which the entity owned the CGT asset, and

(d)    an individual who was a significant individual of the entity just before the CGT event was either:

-        at least 55 years old at that time and the event happened in connection with their retirement or

-        permanently incapacitated at that time.

In your case, you satisfy the basic conditions for the small business CGT concessions, the company has continuously owned the property for more than 15 years and M is a significant individual at the time of the CGT event. M is over 55 years and the disposal of the property is in connection with their retirement.

Although you will have a significant individual at the time of the CGT event, the company has not had a significant individual for at least 15 years, therefore the requirement contained in paragraph 152-110(1)(c) of the ITAA 1997 has not been met. As such you are not eligible to apply the small business 15 year exemption to disregard any capital gain made from the disposal of the property.

Retirement exemption

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

If you are a company or trust, other than a public entity, you can choose to disregard all or part of a capital gain where you meet all the following conditions contained in subsection 152-305(2) of the ITAA 1997:

·         you satisfy the basic conditions

·         you satisfy the significant individual test

·         you keep a written record of the amount you choose to disregard (the exempt amount) and, if there are more than one CGT concession stakeholders, each stakeholder's percentage of the exempt amount (one may be nil, but together they must add up to 100%)

·         you make a payment to at least one of your CGT concession stakeholders worked out by reference to each individual's percentage of the exempt amount

·         the payment is equal to the exempt amount or the amount of capital proceeds, whichever is less, and

·         where you receive the capital proceeds in instalments, you make a payment to a CGT concession stakeholder for each instalment in succession (up to the asset's CGT exempt amount).

If a CGT concession stakeholder is under 55 years old just before receiving a payment, an amount equal to that payment must be paid to a complying superannuation fund or retirement savings account (RSA) on their behalf within 7 days of making the choice. The company or trust must notify the trustee of the fund or the RSA at the time of the contribution that the contribution is being made in accordance with the requirements of the retirement exemption.

There is no requirement to make this contribution if the stakeholder was 55 years old or older.

The amount of the capital gain that you choose to disregard must not exceed your CGT retirement exemption limit or, in the case of a company or trust, the CGT retirement exemption limit of each CGT concession stakeholder receiving a payment.

Under section 152-320 of the ITAA 1997, an individual's lifetime CGT retirement exemption limit is $500,000, reduced by any previous CGT exempt amounts the individual has disregarded under the retirement exemption.

In your case, you satisfy the basic conditions and you satisfy the significant individual test at the time of the CGT event and both M and O will be your CGT concession stakeholders. You will be eligible to apply the small business retirement exemption as long as you meet the remaining requirements under subsection 152-305(2) of the ITAA 1997 relating to the keeping of written records. As both M and O are over 55 years, there is no requirement to make payment to a complying superannuation fund or retirement savings account on their behalf.

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