Edited version of private advice

Authorisation Number: 1051750578065

Date of advice: 23 September 2020

Ruling

Subject: Small business capital gains tax concessions

Question 1

Whether Folios 83 and 85 acquired by the client was an active asset for the purposes of section 152-40 of the Income Tax assessment Act 1997 (1997 Act), such that the active asset test in section 152-35 of the 1997 Act was satisfied at the time the land was sold?.

Answer

Yes

Question 2

Whether Folio 84 acquired by the client was an active asset for the purposes of section 152-40 of the Income Tax assessment Act 1997 (1997 Act), such that the active asset test in section 152-35 of the 1997 Act was satisfied at the time the land was sold?.

Answer

No

This ruling applies for the following period

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Relevant facts and circumstances

You advised that:

Person A and Person B are, and always have been, shareholders of the below companies, each owning 50% shareholding in the respective company:

a. Company A (The Client) and

b. Company B (The Affiliate).

Company A is an incorporated company in Australia under the Corporations Act 2001 in year 19XX.

Both Person A and Person B have been the only directors from 19XX to date.

Company B is a company incorporated in Australia under the Corporations Act 2001 in the year 20XX.

Person A and Person B have been the only directors of Company B from 20XX to date.

Company A and Company B have only ever had one class of shares on issue, being ordinary class shares.

Purchase of the property

The property, was originally registered under three separate title Folio numbers A, B and C. Folio A covers a defined area of the property, of approximate XXX square meters (Folio A), and Folio B and Folio C cover a defined area of approximately XXX square meters each (Folio B and Folio C). The defined areas under these Folios are adjacent to each other.

On or around the X of X 19XX, you acquired a an interest as tenant in common in The Property for $XXX,XXX (the first acquisition). The first acquisition was made for the purpose of allowing you to carry on its smash repair business from that property.

Around the time of the first acquisition and because the first acquisition did not entitle you to exclusive possession of any particular area of the property, a deed of co-ownership and lease was entered into by all owners of The Property which governed the use of The Property(the co-ownership deed). The effect of the co ownership deed was that:

a.    The Client had exclusive rights to the use and occupy that part of the property known as Folio A; and

b.    The other owners had exclusive rights to that part of the property known as Folios B and C.

It is also the case that on or about XX X 20XX, a lease agreement was put in place between, on one hand, you and the owner of the balance of the property at the time as lessors, and the you as lessee. You were required to pay nominal rent and the effect of the lease was to continue to provide you with exclusive possession over that of the property known as Folio A, so that it was able to conduct its business uninterrupted.

On or around X X 20XX, you purchased the remaining two thirds interest in The property from two unrelated parties (second acquisition).

Folio A, Folio B and Folio C were later consolidated into a single certificate of title in 20XX, at which time the taxpayer owned 100% of the property.

Uses of the Property

Folio A was used for a smash repair business by Company A and later by Company B from the time Company A made the first acquisition in 19XX until the business was sold.

Company B sold the business on XX X 20XX.

Since you owned 100% of the Property from X X 20XX until the business was sold:

The client rented Folio A to Company B from X July 20XX (when Company B commenced operating the business) until X XX 20XX when Company B sold the business;

You rented Folio B to unrelated third-parties for this entire period (ie from X X 20XX until the property was sold.);

You rented Folio C to an unrelated third party for approximately X months from X X 20XX, and then rented Folio C to Company B from X 20XX for the use in the business until the business was sold.

After the business was sold, Company A rented 100% of the Property to unrelated third parties.

On X X 20XX Company A entered into a contract to sell the Property to a third party. Contract has now been completed.

Both the client and affiliated entity would be defined as a small business based on a turnover of less than $X million and total combined assets of less than $X million.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 subsection 152-10(1)

Income Tax Assessment Act 1997 subsection 152-10(1A)

Income Tax Assessment Act 1997 subsection 152-10(1AA)

Income Tax Assessment Act 1997 section 328-125

Reasons for decision

Question 1 and 2

Basic conditions for small business concessions

To qualify for any of the capital gains tax (CGT) small business concessions, an entity must satisfy several conditions that are common to all the concessions, known as the basic conditions. The basic conditions are contained in subdivision 152-A of the Income Tax Assessment Act 1997(ITAA 1997).

According to subsection 152-10(1) of the ITAA 1997:

A capital gain (except a capital gain from CGT event K7) you make may be reduced or disregarded under this Division if the following basic conditions are satisfied for the gain:

(a) a CGT event happened in relation to a CGT asset of your 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 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 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;

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

Basic condition 152-10(1)(c)(iv) of the ITAA 1997

Paragraph 152-10(1)(c) of the ITAA 1997, states that at least one of the requirements listed at subparagraphs (i) to (iv) must apply. For the purposes of this ruling we are considering subparagraph (iv):

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

For section 152-10(1)(c)(iv) of the ITAA 1997 to apply the conditions mentioned in subsection 152-10(1A) or (1B) must be satisfied in relation to the CGT asset in the income year. Subsection 152-10(1B) of the ITAA 1997 is not relevant in this case. Subsection 152-10(1A) is discussed below.

The conditions in subsection 152-10(1A) of the ITAA97 are satisfied if:

(a) your *affiliate, or an entity that is *connected with you, is a *CGT 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 CGT 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.

This ruling focuses on the condition in subsection 152-10(1A)(a) of the ITAA97.

Paragraph 152-10(1A)(a)

To satisfy the condition in subsection 152-10(1A)(a) of the ITAA97 it needs to be determined if an affiliate, or an entity that is connected with you is a CGT small business entity. This is considered below:

Affiliate, or an entity that is connected

Paragraph 152-10(1A)(a) of the ITAA97 requires us to determine whether the taxpayer is connected with the company. The rules for determining whether an entity is 'connected with' another entity are contained in section 328-125.

The entity that operates the business on Folio A and C is a company and the entity that owns the land is also a company. Both entities are owned by the same joint directors, who own 50% of each of the companies. In this instance, it would be reasonable to assume that the directors would control the both the companies, if the directors either act, or may reasonably be expected to act, in accordance with the directions or wishes of the entity and/ or the entity's affiliates.

You have also stated in your application that the directors are connected to the operating company for the purposes of section 328-125 of the ITAA97.

For the purposes of this ruling we are considering if the operating company, a connected entity, is a CGT small business entity as per paragraph 152-10(1A)(a) of the ITAA97.

CGT small business entity

The term 'small business entity' is defined in section 328-110 of the ITAA97. It requires the entity to carry on a business and have aggregated turnover below $10 million. The definition of CGT small business entity is contained in subsection 152-10(1AA) of the ITAA97 and requires that the entity be a small business entity with aggregated turnover below $2 million. The definition of aggregate turnover is contained in subsection 328-155 of the ITAA97 as the sum of the relevant annual turnovers.

Carrying on a Business

It is accepted that the operating company operating a smash repairs business, is carrying on a business for the purposes of section 328-110 of the ITAA97.

Aggregate Turnover

The aggregated turnover of the Operating Company and relevant entities must be below $2 million as per subsection 152-10(1AA) of the ITAA97 to satisfy the definition of a CGT small business entity.

For the year ended X X 20XX, you have confirmed that the aggregated turnover of the Operating Company and relevant entities are less than $X million and meets subsection 152-10(1AA) of the ITAA97.

Connected entity test

Paragraph 152-10(1A)(a) of the ITAA97 requires us to determine whether Company A is connected with the Company B. The rules for determining whether an entity is 'connected with' another entity are contained in section 328-125 of the ITAA97.

To demonstrate that entities are connected, you must be able to show that

a) Either entity controls the other entity in a way described in 328 -125(1) of the ITAA 1997; or

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

For the purposes of this ruling we are considering if the company is, a connected entity, is a CGT small business entity as per paragraph 152-10(1A)(a) of the ITAA97.

Application to your circumstances

Originally you purchased one third interest in a property in X 19XX which was covered by three Folios A, B and C. Agreements were made between the tenants in common of the property, to allocate the area covered by Folio A, for your exclusive use. It was used for a smash repair business by Company A and later by Company B (the affiliate) from on or around the time Company made the first acquisition in 19XX until the business was sold.

On or around X X 20XX, you purchased the remaining two thirds interest in the Property from two unrelated parties (second acquisition). You rented Folio B to unrelated third-parties for this entire period (ie from X XX 20XX until the property was sold.) You rented Folio C to an unrelated third party for approximately X months from X X 20XX, and then rented Folio C to Company B from X 20XX for the use in the Business until the business sale.

Active Asset Test

A CGT asset is an active asset if you own it and:

•you use it or hold it ready for use in the course of carrying on a business (whether alone or in partnership)

•it is an intangible asset (for example, goodwill) inherently connected with a business you carry on (whether alone or in partnership).

The active asset test is satisfied if the asset was an active asset of yours:

•or a total of at least 7½ years during the test period, if you've owned it for more than 15 years, or

•for at least half of the test period, if you've owned it for 15 years or less.

Question 1

Folio A

Through your one third interest in the property and agreements, Folio A was owned and operated by you and your affiliate for more than 15 years. During this period, you and your related affiliate ran a smash repairs business form the property for almost the entire period. This was more than 71/2 years so therefore it would be considered an active asset for the purposes the Small Business capital gains tax (CGT) concessions of 50%.

Folio C

The area covered by Folio C was owned from X X 20XX and a smash repair business was ran by your related affiliate from this part of the property from X 20XX. Period of use from X 20XX until X 20XX represents more than half the period of ownership. As this is for at least half of the test period, as you've owned it for less than 15 years would eligible for the 50% Small Business CGT discount for use as an active asset.

Question 2

Folio B

However, with regards to Folio B as you have leased the premises to an unrelated third party for the vast majority of the period of ownership, therefore it cannot be an active asset for your Small Business CGT concessions.

Commissioner of Taxation v Eichmann [2019] FCA 2155 states:

·         The expression which requires interpretation is "asset... used, or held ready for use, in the course of carrying on a business".

Despite Folio A, Folio B and Folio C later being consolidated into a single certificate of title in 20XX, each Folio was utilised differently. These were utilised as either part of the business or rented/leased out to an unrelated third party. Furthermore, the area covered by Folio B was not used or was held ready for use, in the course of carrying on a business by yourself or your affiliate.

Therefore, only the areas covered by Folio A and C would be eligible for the Small Business CGT active asset 50% discount because they were used either directly by the client or their connected affiliate during the period/s of ownership.

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