Edited version of private advice

Authorisation Number: 1051782272205

Date of advice: 26 November 2020

Ruling

Subject: Small business 15-year exemption

Question 1

Does each of Partner 1's and Partner 2's interest in the Property satisfy the active asset test in section 152-35 of the Income Tax Assessment Act 1997?

Answer

Yes

Question 2

Do Partner 1 and Partner 2 qualify for the small business 15-year exemption under Subdivision 152-B of the Income Tax Assessment Act 1997 in relation to the capital gain from the disposal of their interest in the Property?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 2020

Relevant facts and circumstances

Partner 1 and Partner 2 are partners in the Partnership.

The Partnership purchased the Property, a commercial property, in the 1980s.

The purchase price of the Property was approximately $X. Various capital improvements were made to the Property following its purchase by the Partnership.

A contract for the sale of the Property was entered into during the 2020 income year for the sale price of $Y with settlement occurring during the 2020 income year.

A capital gain was made on the sale of the Property.

The floor area of the Property is Zm².

Throughout the period of ownership, approximately 30% of the Property was used to run a business operated by the Partnership. The remaining 70% was rented to various third party tenants carrying on their own business activities.

The breakdown of income derived by the Partnership since the 2012 income year in connection with the Property has been provided.

Partner 1 and Partner 2 were both over 55 years old when the Property was sold.

Partner 1 and Partner 2 both retired on the date of settlement for the Property.

For the 2020 income year, the Partnership had an aggregated turnover of less than $2 million and was a 'CGT small business entity' within the meaning of that term in subsection 152-10(1AA) of the Income Tax Assessment Act 1997.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 subsection 108-5(1)

Income Tax Assessment Act 1997 paragraph 108-5(2)(c)

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 section 152-10

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

Income Tax Assessment Act 1997 paragraph 152-10(1)(a)

Income Tax Assessment Act 1997 paragraph 152-10(1)(b)

Income Tax Assessment Act 1997 subparagraph 152-10(1)(c)(iii)

Income Tax Assessment Act 1997 paragraph 152-10(1)(d)

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

Income Tax Assessment Act 1997section 152-35

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(4)(e)

Income Tax Assessment Act 1997 Subdivision 152-B

Income Tax Assessment Act 1997 section 152-105

Reasons for decision

Question 1

Summary

Each of Partner 1's and Partner 2's interest in the Property satisfies the active asset test in section 152-35 of the Income Tax Assessment Act 19971.

Detailed reasoning

To qualify for any of the small business capital gains tax (CGT) concessions in relation to a capital gain you make, you must satisfy the 'basic conditions' in section 152-10 that are common to all the concessions.

One of the basic conditions (under paragraph 152-10(1)(d)) requires that the CGT asset in question satisfies the 'active asset test' in section 152-35.

Subsection 152-35(1) requires that where you have owned the CGT asset for more than 15 years, the asset must be an active asset for a total of at least 7½ years during the relevant test period (beginning when the asset was acquired and ending at the time of the CGT event).

Section 152-40 provides the meaning of an active asset. A CGT asset is an active asset if you own it and it is used, or held ready for use, in the course of carrying on a business that is carried on (alone or in partnership) by you, your affiliate or an entity that is connected with you.

However, pursuant to subsection 152-40(4), certain CGT assets are excluded from being active assets for the purposes of the active asset test. Paragraph 152-40(4)(e) specifically excludes assets whose main use is to derive rent (unless its main use for deriving rent was only temporary).

Taxation Determination TD 2006/782 considers circumstances under which an asset's main use is (or isn't) to derive rent. Paragraph 26 of TD 2006/78 states that:

If an asset is used partly for business and partly to derive rent at any given time, it will be a question of fact dependent on all the circumstances as to whether the main use of the asset at that time is to derive rent. No one single factor will necessarily be determinative, and resolving the matter is likely to involve a consideration of a range of factors such as:

•         the comparative areas of use of the premises (between deriving rent and other uses); and

•         the comparative levels of income derived from the different uses of the asset.

Example 5 in TD 2006/78 considers a scenario where a property is partly used for business and partly to derive rent. It reads:

Mick owns land on which there are a number of industrial sheds. He uses one shed (45% of the land by area) to conduct a motor cycle repair business. He leases the other sheds (55% of the land by area) to unrelated third parties. The income derived from the motor cycle repair business is 80% of the total income (business plus rentals) derived from the use of the land and buildings.

In determining if the main use of the land is to derive rent, it is appropriate to consider a range of factors. In this case, a substantial (although nevertheless not a majority) proportion by area of the land is used for business purposes. As well, the business proportion of the land derives the vast majority (80%) of the total income. In all the circumstances, the Tax Office considers the main use of the land in this case is not to derive rent and accordingly the land is not excluded from being an active asset by paragraph 152-40(4)(e) of the ITAA 1997.

Although the floor area of the Property available for rent was larger than the floor area used for the business, the income derived from the business was a significant proportion of total income derived by the Partnership in all years since 2012.

The Commissioner is therefore satisfied that the main use of the Property in the years since 2012 was not to derive rent and the Property is therefore not excluded from being an active asset of the Partnership during any of that period pursuant to paragraph 152-40(4)(e).

As Partner 1's and Partner 2's interest in the Property owned by the Partnership was:

•         an active asset of theirs by virtue of being used in the course of carrying on a business carried on by the Partnership and not subject to any exception under

•         subsection 152-40(4); and

•         an active asset of theirs for at least 7½ years,

their respective interests in the Property satisfy the active asset test for the purposes of paragraph 152-10(1)(d).

Question 2

Summary

Partner 1 and Partner 2 qualify for the small business 15-year exemption under Subdivision 152-B in relation to the capital gain from the disposal of their interest in the Property.

Detailed reasoning

Pursuant to section 152-105, an individual can disregard a capital gain arising from a CGT event happening in relation to a CGT asset other than a share in a company or an interest in a trust if:

1.    the basic conditions in Subdivision 152-A are satisfied for the gain;

2.    the individual continuously owned the CGT asset for the 15-year period ending just before the CGT event; and

3.    the individual is 55 or over at the time of the CGT event and the event happens in connection with their retirement.

The basic conditions in Subdivision 152-A

The basic conditions in Subdivision 152-A that must be satisfied in relation to the disposal of Partner 1's and Partner 2's interest in the Property are set out in subsection 152-10(1):

(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;

(ii) you satisfy the maximum net asset value test (see section 152-15);

(iii) you are a partner in a partnership that is a CGT 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; View history reference

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

An interest in an asset of a partnership is a CGT asset under subsection 108-5(1) (see paragraph 108-5(2)(c)). As such, the interest of Partner 1 and Partner 2 in the Property (being an asset of the Partnership) is a CGT asset. CGT event A1 under section 104-10 happened in relation to that CGT asset in the year the contract for disposal of the Property was entered into (i.e. the 2020 income year), thereby satisfying the condition in paragraph 152-10(1)(a).

Apart from the operation of Division 152, the CGT event A1 would have resulted in a capital gain for each of Partner 1 and Partner 2, satisfying the condition in paragraph 152-10(1)(b).

Partner 1 and Partner 2 are partners in the Partnership. The Partnership was a CGT small business entity for the 2020 income year and (as stated above) the relevant CGT asset is an interest in an asset of the Partnership (i.e. the Property), satisfying the condition in subparagraph 152-10(1)(c)(iii).

As confirmed in response to Question 1 of this ruling, each of Partner 1's and Partner 2's interest in the Property satisfies the active asset test in section 152-35, thereby also satisfying the condition in paragraph 152-10(1)(d).

15-year period of ownership

This requirement is satisfied as each of Partner 1 and Partner 2 have continuously owned their respective interest in the Property for more than 15 years until just before the CGT event.

In connection with retirement

Both Partner 1 and Partner 2 were over 55 at the time their respective interest in the Property was sold, and both partners retired immediately following settlement. The Commissioner is therefore satisfied that the CGT event happened in connection with their retirement.

As each of the requirements in section 152-105 are satisfied, Partner 1 and Partner 2 qualify for the small business 15-year exemption in relation the disposal of their interest in the Property, and the capital gain that arose for each of them for the 2020 income year from that disposal can be disregarded.

1 All legislative references are to the Income Tax Assessment Act 1997.

2 Income tax: capital gains: are there any circumstances in which the premises used in a business of providing accommodation for reward may satisfy the active asset test in section 152-35 of the Income Tax Assessment Act 1997 notwithstanding the exclusion in paragraph 152-40(4)(e) of the Income Tax Assessment Act 1997 for assets whose main use is to derive rent?

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