Edited version of private advice

Authorisation Number: 1051640781934

Date of advice: 11 March 2020

Ruling

Subject: CGT small business entity

Question

Is Taxpayer a 'CGT small business entity' as defined in subsection 152-10(1AA) of the ITAA 1997?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 2018

The scheme commences on:

1 July 2017

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.

Period to sale of Practice

1. The individual (Taxpayer) operated a medical business (Practice) as a sole trader.
2. Since Taxpayer's purchase of the business his accounting records have recorded income which has consisted of:

·        fees generated by providing patient services

·        service fees charged to the other independent medical practitioners for use of the Practice's administration and business facilities, which facilitated the medical practitioners conducting their own medical practices.

3. Under the contractual arrangement for services provided to the other independent medical practitioners (Agreement), the practitioners were required to pay a service fee to Taxpayer based on their individual arrangement.
4. The services provided under the Agreement included the receipt of payments on behalf of the independent medical practitioners. The independent medical practitioners provided operating services to a hospital and charged the hospital fees in relation to those operating services. The hospital then made payment to the Practice and this payment was recognised as an 'Operating Service Fee' in the Practice's business accounting profit and loss statement. Similarly, the Patient Fees derived by the medical practitioners are also collected by the Practice and recorded in the accounts of the Practice.
5. All of the medical fees generated by the independent medical practitioners, such as the 'Operating Service Fee' and 'Patient Fees' are payable to the Practice's respective medical practitioners and were forwarded on a monthly basis minus the charge which applied to the relevant medical practitioner's Patient Fees billings under the Agreement.
6. Taxpayer did not have an equitable or beneficial interest in the income or capital of the independent medical practitioner's business activities.
7. Each independent medical practitioner was responsible for finding and treating their own patients.
8. Taxation, superannuation and insurance cover were the responsibility of the independent medical practitioner.
9. The Practice had no involvement in managerial decisions or day to day management of the independent medical practitioners.
10. There is no financial interdependency between the Practice and the independent medical practitioners.
11. No other business activity was concurrently conducted by Taxpayer over the period.
12. Taxpayer sold the Practice to an unrelated party during the income year.

Period from sale Practice

13. Taxpayer carried on his medical practice at the Practice as an independent medical practitioner and income from this work is recorded in the account for Taxpayer's accounting purposes.
14. Subsequent to the Practice's sale, Taxpayer did not have an equitable or beneficial interest in the income or capital of the independent medical practitioners' business activities or the Practice.
15. Taxpayer was responsible for finding and treating his own patients.
16. Taxpayer was responsible for his own taxation, superannuation and insurance.
17. No other business activity was concurrently conducted by Taxpayer over this period.
18. Taxpayer had no involvement in managerial decisions and day to day management of the Practice.
19. There are no financial interdependencies between Taxpayer and the independent medical practitioners or the Practice.

The accounts

20. The private ruling applicant provided Taxpayer's business accounting data for the current income year.

Reasons for Decision

Summary

Taxpayer is a 'CGT small business entity' for the 2018 income year as aggregated turnover is less than $2 million in accordance with subsection 152-10(1AA) of the ITAA 1997 and Subdivision 328-C of the ITAA 1997. As a result, the basic condition in subparagraph 152-10(1)(c)(i) of the ITAA 1997, is satisfied. This ruling does not consider the other basic conditions in subsection 152-10(1) of the ITAA 1997.

Detailed reasoning

Section 152-10 of the ITAA 1997 contains the basic conditions an entity must satisfy to be eligible for the small business capital gains tax (CGT) concessions. These conditions are:

(a)      a *CGT event happens in relation to a *CGT asset of yours in an income year;

...

(b)      the event would (apart from this Division) have resulted in the gain;

(c)      at least one of the following applies:

(i)    you are a *CGT small business entity for the income year;

...

(d)      the CGT asset satisfies the active asset test (see section 152-35).

...

Relevantly for subparagraph 152-10(1)(c)(i) of the ITAA 1997, subsection 152-10(1AAA) of the ITAA 1997 defines the term 'CGT small business entity' as:

You are a CGT small business entity for an income year if:

(a)   you are a *small business entity for the income year; and

(b)   you would be a small business entity for the income year if each reference in section 328-110 to $10 million were a reference to $2 million.

The phrase small business entity is defined in subsection 328-110(1) of the ITAA 1997 as:

You are a small business entity for an income year (the current year) if:

(a) you carry on a *business in the current year; and

(b) one or both of the following applies:'

(i) you carried on a business in the income year (the previous year) before the current year and your *aggregated turnover for the previous year was less than $10 million; and

(ii) your aggregated turnover for the current year is likely to be less than $10 million.

Subsection 328-110(4) of the ITAA 1997 also provides another test:

You are also a small business entity for an income year (the current year ) if:

(a) you carry on a *business in the current year; and

(b) your *aggregated turnover for the current year, worked out as at the end of that year, is less than $10 million.

If you are a small business entity only because of subsection (4), you cannot choose any of the following concessions:

Note:

(a) paying PAYG instalments based on GDP-adjusted notional tax: see section 45-130 in Schedule 1 to the Taxation Administration Act 1953;

(b) accounting for GST on a cash basis: see section 29-40 of the GST Act;

(c) making an annual apportionment of input tax credits for acquisitions and importations that are partly creditable: see section 131-5 of the GST Act;

(d) paying GST by quarterly instalments: see section 162-5 of the GST Act;

(e) applying for permission under the Excise Act 1901 to deliver goods for home consumption (without entering them for that purpose) in respect of a calendar month: see section 61C of that Act;

(f) applying for permission under the Customs Act 1901 to deliver like customable goods or excise-equivalent goods for home consumption (without entering them for that purpose) in respect of a calendar month: see section 69 of that Act.

To qualify as a 'small business entity' for an income year, you must carry on a business in that year and satisfy the $10 million aggregated turnover test. However, in accordance with subsection 152-10(1AAA) of the ITAA 1997, to satisfy the definition of 'CGT small business entity' the reference to $10 million is replaced as a reference to $2 million.

Consequently the aggregate turnover must be less than $2 million.

Subsequently, there are several ways you may satisfy the $2 million aggregated turnover test. These are:

-  subparagraph 328-110(1)(b)(i) of the ITAA 1997 - you carried on a business in the previous year and the aggregated turnover for the previous year was less than $2 million;

-  subparagraph 328-110(1)(b)(ii) and subsection 328-110(2) of the ITAA 1997 - your aggregated turnover for the current year, worked out as at the first day of the current year, is likely to be less than $2 million. However, subsection 328-110(3) of the ITAA 1997 provides an exception to this in that you cannot qualify as a small business entity under this provision if you carried on a business in each of the two previous income years and your aggregated turnover in each of those years was $2 million or more;

-  subsection 328-110(4) of the ITAA 1997 - your aggregated turnover for the current year, worked out as at the end of the current year, is less than $2 million.

The term 'Aggregated turnover' is defined by section 328-115 of the ITAA 1997. Your aggregated turnover for an income year is the sum of the relevant annual turnovers (excluding certain amounts as provided for in subsection 328-115(3) of the ITAA 1997).

The relevant annual turnovers as per subsection 328-115(2) of the ITAA 1997 are:

(a) your *annual turnover for the income year; and

(b) the annual turnover for the income year of any entity (a relevant entity) that is *connected with you at any time during the year; and

(c) the annual turnover for the income year of any entity (a relevant entity) that is an affiliate of yours at any time during the income year.

The meaning of the term 'connected with' an entity is set out in subsection 328-125(1) of the ITAA 1997 which provides:

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.

There are different control tests in section 328-125 that apply depending on what type of entity is being tested. Subsection 328-125(2) sets out the criteria to determine when an entity directly controls another entity, other than a discretionary trust.

In this case, as the entities are individuals, the applicable control test is in paragraph 328-125(2)(a) of the ITAA 1997.

Subsection 328-125(2) of the ITAA 1997 states:

An entity (the first entity) controls another entity if the first entity, its affiliates or the first entity together with its affiliates:

a) except if the other entity is a discretionary trust - beneficially own, or have the right to acquire the beneficial ownership of, interests in the other entity that carry between them the right to receive a percentage (the control percentage) that is at least 40% of:

(i) any distribution of income by the other entity; or

(ii) ...

(iii) any distribution of capital by the other entity; or

b) ...

This requires that we determine if the entities are 'affiliates'.

Meaning of affiliates

Section 328-130 states the meaning of affiliate as follows:

(1)        An individual or a 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.

(2)        However, an individual or a company is not your affiliate merely because of the nature of the business relationship you and the individual or company share.

An individual is an affiliate of an entity where that individual acts, or could reasonably be expected to act in accordance with the entity's directions or wishes in relation to the affairs of that individual's business, or in concert with the entity in relation to the affairs of the individual's business. However, an individual is not an affiliate of an entity merely because of the nature of the business relationship the entity and the individual shares.

Taxation Ruling 2002/6 Income tax: Simplified Tax System: eligibility - grouping rules (*STS affiliate, control of non fixed trusts) (TR 2002/6) sets out the Commissioner's views on the meaning of ' STS affiliate' for the purposes of determining whether an entity satisfies the eligibility rules in Subdivision 328-F (the provision has been repealed).

Although the STS no longer operates for the 2007-08 and later income years, the definition of 'STS affiliate' under the former subdivision 328-F is closely aligned with the requirements set out in section 328-125. As such, the Commissioner's guidelines in TR 2002/6 are relevant to the meaning of affiliates for the purposes of section 328-130.

The scope of the affiliate definition is described in TR 2002/6 as follows:

31. The *STS affiliate definition in subsection 328-380(8) does not apply where the potential *STS affiliate acts or could reasonably be expected to act as another directs or wishes, or in concert with it, only in relation to isolated transactions or on an irregular, ad hoc basis. For the definition to apply, the potential *STS affiliate must act in accordance with the entity's directions or wishes or in concert with it, or could reasonably be expected to so act, in relation to all or a substantial part of the affairs of the potential *STS affiliate's business.

Meaning of 'could reasonably be expected'

The Full High Court, in FC of T v. Peabody (1994) 181 CLR 359; 94 ATC 4663; (1994) 28 ATR 344, held that the phrase 'might reasonably be expected' requires more than a possibility.

An entity, the first entity, 'could reasonably be expected' to act in accordance with another entity's, the second entity's, wishes where the second entity has a relationship of control or influence over the first entity. Such a relationship can be evidenced by the entities behaviours and the presence of any influential relationships, such as:

(a) family or other close personal relationships;

(b) financial relationships and dependencies; and

(c) relationships created through links such as common directors, partners or shareholders.

Conversely, the entities' behaviours, obligations to each other and external parties, and their own interests may evidence the lack of such a relationship.

Meaning of in 'concert'

TR 2002/6 explains, at paragraph 59, that entities will only be regarded as acting 'in concert' with each other where:

(a) it is acting together with the other entity in pursuit of a common goal or objective; and

(b)that common goal or objective is the carrying on of a business by the potential *STS affiliate with a substantial degree of connection with or dependence on the business carried on by the other entity.

TR 2002/6 details a number of factors to take into account when determining whether two entities are acting in concert with each other. These include:

-  the nature and extent of commercial dealings between the two entities;

-  common resources, facilities or services;

-  involvement in managerial decisions and day to day management;

-  financial interdependencies;

-  common flow of profits;

-  common ownership/capital;

-  shared purchasing of goods or services;

-  common customers; and

-  similar kind of business

Whether an entity is an affiliate will be a question of fact and degree in relation to which an exercise in judgement is necessary, which involves a process of evaluating and weighing a range of factors for the particular circumstances.

In this case, while there is a business relationship between the individual medical practitioners in that they all use the same business premises and services as provided by the Practice, the relationship is one where the entities act in their own best interest and are only bound by the decisions of the Practice to the extent that it facilitates the efficient operation of the individuals own business. Therefore there is no direct control within the meaning of subsection 328-125(2) of the ITAA 1997 and the individuals are not 'affiliates' of each other.

As the entities are not affiliates, subsection 328-125(2) of the ITAA 1997 provides that Taxpayer will be connected to the other medical practitioners if the relationship is one where the individual beneficially owned, or had the right to acquire the beneficial ownership of, interests in the other medical practitioners that had the right to receive a percentage (the control percentage) that is at least 40% of:

(i) any distribution of income by the other entity; or

(ii) ...

(iii) any distribution of capital by the other entity; or

In this case there is no distribution of income of the other individual business operators. There is no right to distribution of capital. The service charge is an expense of the individuals' business and is for the provision of services.

Broadly, your 'annual turnover' for an income year is the total ordinary income derived by you in the income year in the ordinary course of carrying on a business (subsection 328-120(1) of the ITAA 1997).

Consequently, it is necessary to consider what constitutes ordinary income so that annual turnover for the relevant income year can be established.

The legislation does not provide guidance on the meaning of 'ordinary income' however, guidance as to its meaning can be found in case law. For instance, in Scott v. Commissioner of Taxation (NSW) (1935) 35 SR (NSW) 215, Jordan CJ held that the meaning of 'income' was to be determined according to 'ordinary concept and usages' at 219 as follows:

The word "income" is not a term of art, and what forms of receipts are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income, must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as the statute states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income, or that special rules are to be applied for arriving at the taxable amount of such receipts: A.-G. for British Columbia v. Ostrum ([1904] AC 144 at 147); Lambe v. Inland Revenue Commissioners ([1934] 1 KB 178 at 182-3).

Income according to ordinary concepts, referred to as ordinary income, is included in your assessable income under section 6-5 of the ITAA 1997.

An Australian resident's assessable income includes ordinary income derived directly or indirectly from all sources (subsection 6-5(2) of the ITAA 1997).

In working out whether an amount of ordinary income has been derived by you and (if so) when, subsection 6-5(4) of the ITAA 1997 provides that the amount of ordinary income is taken to have been received as soon as it is applied or dealt with in any way on your behalf or as you direct.

Medical fees generated by the independent medical practitioners

The medical fees generated by the independent medical practitioners are not considered to be income of Taxpayer according to ordinary concepts as:

·        the amounts were received by the Practice at the direction of the individual medical practitioners under the contractual arrangement and consequently were income of the individual medical practitioners. The payments were not amounts derived by Taxpayer pursuant to subsection 6-5(4) of the ITAA 1997;

·        they were amounts which were only received by the Taxpayer (pursuant to the Agreement) on behalf of the independent medical practitioners, such that Taxpayer did not have an equitable or beneficial interest in the amounts at any point in time;

·        they were amounts fully payable to, and therefore applied by Taxpayer on behalf of, the independent medical practitioners pursuant to the Agreement, i.e. they were amounts derived by the independent medical practitioners pursuant to subsection 6-5(4) of the ITAA 1997; and

·        the independent medical practitioners are not employed by the Taxpayer such that the amounts were generated for Taxpayer.

As the medical fees generated by the independent medical practitioners during the 2018 income year were not ordinary income of Taxpayer they are not included in the calculation of Taxpayer's annual turnover for that year, and not included in determining Taxpayer's aggregated turnover under subsection 328-115(1) of the ITAA 1997.

Service fees

The service fees derived by Taxpayer during the year ended 30 June 2018 constitutes ordinary income derived in the ordinary course of carrying on the Practice's business and therefore is included as amounts of annual turnover pursuant to subsection 328-120(1) of the ITAA 1997.

Conclusion

On the basis of the above, Taxpayer's aggregated turnover for the year ended 30 June 2018 should not include the amounts of income derived by the independent medical practitioners, but the amount of fees charged under the Agreement is to be included. The difference between the fee charged by the practice and the earning of the independent medical practitioners is represented by the Professional Fees - Consultants account in Taxpayer's profit and loss. Therefore for the year ended 30 June 2018 Taxpayer's aggregate income for the purposes of section 328-115 is less than $2 million.

It follows that Taxpayer satisfies the requirements of subsection 328-110(4) of the ITAA 1997 with adjustments made for subsection 152-10(1AAA)(d) of the ITAA 1997 and is a 'CGT small business entity' as defined in section 152-115 of the ITAA 1997 for the income year ended 30 June 2018.

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