Edited version of private advice

Authorisation Number: 1051791308727

Date of advice: 16 December 2020

Subject: CGT small business concessions

Question 1:

Does land used by a lessee satisfy the 'active asset test' for the Capital Gains Tax ('CGT') small business concessions pursuant to section 152-35 of the Income Tax Assessment Act 1997 ('ITAA 1997') if the land is sold?

Answer:

Yes

Question 2:

If the answer to Question 1 is no, can the CGT discount of 50% pursuant to section 115-100 of the Income Tax Assessment Act 1997 be applied if the land is held for longer than one year?

Answer:

Not applicable (as answer to Question 1 is 'Yes')

This ruling applies for the following periods

1 July 2019 to 30 June 2020

RELEVANT FACTS AND CIRCUMSTANCES

Background information

1.      The Applicant was born XX/XX/XXXX and is presently X years of age.

2.      The Applicant ran a primary production business and was the Lessee (tenant) of the land used.

3.      The Applicant paid rent for the use of the land.

The Land

4.      The entirety of the land was predominantly used for the primary production business and the only private asset on the land was the Applicant's residential home.

5.      The land lease included terms and conditions that required the Applicant to product a minimum amount of primary production on the land.

6.      The first land lease was signed XX/XX/XXXX by the Applicant's father.

7.      This land lease was then transferred to the Applicant, via his father's Will dated XX/XX/XXXX, following his death on XX/XX/XXXX.

8.      The second land lease was signed on XX/XX/XXXX by the Applicant.

9.      Both land leases were renewed in XXXX for an additional xy years. The new expiry date for both land leases is now XX/XX/XXXX.

10.   The Applicant sold his land on XX/XX/XXXX for a total amount of $X (including GST). He sold his land in order to retire in Location A.

11.   The majority of the primary production equipment at the property was sold with the leases in XXXX.

The Applicant's retirement

12.   The Applicant sold his land to retire in Location A, where he has continued his activities on a much smaller land. The Applicant sold most of his products in the XXXX financial year, as the new land is too small to accommodate the produce.

13.   The approximate value of the Applicant's total assets less liabilities used for the business is $xyz (including GST for business purposes). This includes vehicles and tractors which were recently purchased and going forward, they will not comprise 100% business use due to changes in the business.

The Applicant's financial details

14.   The Applicant's aggregated turnover for the 20XX financial year was $X (excluding GST + $X fuel tax credits).

15.   The Applicant's aggregated turnover for the 20XX financial year was $X (excluding GST + $X fuel tax credits).

Information provided

16.   You have provided several documents containing detailed information in relation to the Applicant, including:

a.      Private Binding Ruling ('PBR') Application, dated XX/XX/XXXX

b.      Information provided following request for further information by ATO

17.   We have referred to the relevant information within these documents in applying the relevant tests to your circumstances.

Assumption(s)

Not applicable.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 108(5)

Income Tax Assessment Act 1997 Subdivision 115-A

Income Tax Assessment Act 1997 section 115-100

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 section 152-1

Income Tax Assessment Act 1997 section 152-5

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-15

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-205

Income Tax Assessment Act 1997 section 995-1

Further issues for you to consider

Not applicable.

REASONS FOR DECISION

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise stated.

QUESTION 1:

Does land used by a Lessee satisfy the 'active asset test' for the CGT small business concessions pursuant to section 152-35 of the ITAA 1997 if the land is sold?

SUMMARY

The land used by the Applicant satisfies the 'active asset test' for the CGT small business concessions pursuant to section 152-35 of the ITAA 1997 if the land is sold.

QUESTION 2:

If the answer to Question 1 is no, can the CGT discount of 50% pursuant to section 115-100 of the ITAA 1997 be applied if the land is held for longer than one year?

Not applicable.

DETAILED REASONING

18.   As stated in section 152-1 ITAA 1997, subdivision 152-A of the ITAA 1997 sets out the 'basic conditions' which must be satisfied in order for small business entities to qualify for any of the CGT small business concessions to reduce their capital gain by the various concessions in Division 152 of the ITAA 1997.

Basic conditions for small business concessions

19.   Subsection 152-10(1) of the ITAA 1997 sets out the basic conditions which must be satisfied for a capital gain to be reduced or disregarded under this Division, as follows:

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 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 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.

CGT Events and Assets

20.   As defined in section 995-1 of the ITAA 1997, a CGT event means any of the CGT events described in Division 104 of the ITAA 1997. A CGT event described by number (for example, CGT event A1) refers to the relevant event in that Division.

21.   Subsection 108-5(1) of the ITAA 1997, outlines a CGT asset to be:

(a) any kind of property; or

(b) a legal or equitable right that is not property.

22.   To avoid doubt, subsection 108-5(2) lists the following as CGT assets:

(a) part of, or an interest in, an asset referred to in subsection (1);

(b) goodwill or an interest in it;

(c) an interest in an asset of a partnership;

(d) an interest in a partnership that is not covered by paragraph (c).

CGT small business entity

23.   As defined in section 995-1 of the ITAA 1997, a CGT small business entity has the meaning given by subsection 152-10(1AA), as follows:

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.

24.   As defined in section 995-1 of the ITAA 1997, a small business entity has the meaning given by subsection 328-110(1), as follows:

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;

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

25.   As defined in section 995-1 of the ITAA 1997, a business includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

26.   As defined in subsection 328-115 of the ITAA 1997, aggregated turnover is defined as the sum of all relevant annual turnovers. The relevant annual turnovers are outlined in subsection 328-155(2) and exclude any amounts covered by subsection 328-155(3).

27.   Section 328-120 of the ITAA 1997 sets out the meaning of annual turnover as follows:

An entity's annual turnover for an income year is the total ordinary income that the entity derives in the income year in the ordinary course of carrying on a business.

28.   The term ordinary income is defined in section 6-5 of the ITAA 1997 as 'income according to ordinary concepts'. An entity's annual turnover therefore, includes all income according to ordinary concepts derived in the ordinary course of carrying on a business.

29.   The term 'in the ordinary course of carrying on a business' is not defined in the ITAA 1997. The term therefore, takes its ordinary meaning.

30.   In Doutch v FC of T [2016] FCAFC 166, which was an appeal against the decision of the AAT in respect of small business entity concessions, the Full Federal Court confirmed the following reasoning provided by the Tribunal:

70 The phrase "in the ordinary course of carrying on a business", as it appears in

s 328-120(1) of the ITAA 1997, is not defined in the ITAA 1997 and it is necessary to construe those words. In engaging in the exercise of statutory construction, the Court is to consider the text of the statute in context. The High Court in Commissioner of Taxation v Consolidated Media Holdings Ltd (2012) 250 CLR 503 observed as follows at [39]:

"This Court has stated on many occasions that the task of statutory construction must begin with a consideration of the [statutory] text" [Alcan (NT) Alumina Pty Ltd v Commissioner of Territory Revenue [2009] HCA 41; (2009) 239 CLR 27 at 46 [47]]. So must the task of statutory construction end. The statutory text must be considered in its context. That context includes legislative history and extrinsic materials. Understanding context has utility if, and in so far as, it assists in fixing the meaning of the statutory text. Legislative history and extrinsic materials cannot displace the meaning of the statutory text. Nor is their examination an end in itself.

31.   The extrinsic materials to which the High Court referred includes an explanatory memorandum, as follows:

72 The definition of "annual turnover" in s 328-120(1) of the ITAA 1997 was inserted into the ITAA 1997 by Tax Laws Amendment (Small Business) Act 2007 (TLASBA 2007). The "Explanatory Memorandum" to the Tax Laws Amendment (Small Business) Bill 2007 (EM), which Bill was ultimately enacted as the TSLABA 2007, commencing from the 2008 income year, states:

What does 'in the ordinary course of carrying on a business' mean?

2.15 In general, income is derived in the ordinary course of carrying on a business if the income is of a kind that is regularly or customarily derived by the entity in the course of carrying on its business, arising out of no special circumstance or event. Similarly, the income is derived in the ordinary course of carrying on a business if the income although not regularly derived, is a direct result of the normal activities of the business.

32.   Therefore, according to the EM, income is derived in the ordinary course of carrying on a business where:

(a) the income is of a kind that is regularly or customarily derived by an entity in the course of carrying on its business, arising out of no special circumstance or unusual event; and

(b) the income, although not regularly derived, is derived as a direct result of the normal activities of the business.

Maximum net asset value test

33.   The term maximum net asset value test is defined in section 152-15 of the ITAA 1997 as follows:

You satisfy the maximum net asset value test if, just before the CGT event, the sum of the following amounts does not exceed $6,000,000:

(a) the net value of the CGT assets of yours;

(b) the net value of the CGT assets of any entities *connected with you;

(c) the net value of the CGT assets of any *affiliates of yours or entities connected with your affiliates (not counting any assets already counted under paragraph (b)).

34.   Section 152-20 of the ITAA 1997 sets out the meaning of net value of the CGT assets as follows:

The net value of the CGT assets of an entity is the amount (whether positive, negative or nil) obtained by subtracting from the sum of the market values of those assets the sum of:

(a) the liabilities of the entity that are related to the assets; and

(b) the following provisions made by the entity:

(i) provisions for annual leave;

(ii) provisions for long service leave;

(iii) provisions for unearned income;

(iv) provisions for tax liabilities.

Active asset test

35.   Section 152-35 of the ITAA 1997 outlines the active assets test, as follows in subsection 152-35(1):

A CGT asset satisfies the active asset test if:

(a) 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 specified in subsection (2); or

(b) 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 7½ years during the period specified in subsection (2).

36.   Further, subsection 152-35(2) of the ITAA 1997 outlines that the period:

(a) begins when you acquired the asset; and

(b) ends at the earlier of:

(i) the CGT event; and

(ii) if the relevant business ceased to be carried on in the 12 months before that time or any longer period that the Commissioner allows - the cessation of the business.

37.   Section 152-40 of the ITAA 1997 outlines the meaning of active asset at subsection 152-40(1) as follows:

A CGT asset is an active assetat a time if, at that time:

(a) you own the asset (whether the asset is tangible or intangible) and it is used, or held ready for use, in the course of carrying on a business that is carried on (whether alone or in partnership) by:

(i) you; or

(ii) your affiliate; or

(iii) another entity that is connected with you; or

(b) if the asset is an intangible asset - you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you.

APPLICATION TO YOUR CIRCUMSTANCES

38.   For the purpose of this private ruling, a determination is to be made whether the land used by the Applicant satisfies the 'active asset test' for the CGT small business concessions pursuant to section 152.35 of the ITAA 1997 when the land is sold.

39.   In applying the criteria of Subdivision 152-A of the ITAA 1997 as authority, as outlined above in the 'Detailed Reasoning' section, the basic conditions as set out in subsection 152-10(1) of the ITAA 1997 will be assessed regarding the Applicant's circumstances.

40.   There are a number of basic conditions which must be satisfied for a capital gain to be reduced or disregarded under this Division.

41.   Firstly, pursuant to paragraph 152-10(1)(a), a CGT Event must have happened in relation to a CGT asset in the relevant income year. The land held by the Applicant, satisfies the definition of a CGT asset as defined by paragraph 108-5(1)(a) of the ITAA 1997. When the property, including the land, was sold by the Applicant on y YY 20XX, the sale constituted a CGT Event A1 as described in Division 104 of the ITAA 1997. Therefore, the basic condition outlined in paragraph 152-10(1)(a) is satisfied.

42.   Secondly, pursuant to paragraph 152-10(1)(b), the CGT Event must have, apart from this Division, have resulted in the gain. The CGT Event A1, the sale of the property by the Applicant, did result in the financial gain by the taxpayer.

43.   Thirdly, pursuant to paragraph 152-10(1)(c), at least one of the following must apply for the basic conditions to be satisfied:

i.    Pursuant to subparagraph 152-10(1)(c)(i), the entity must be a CGT small business entity for the relevant income year;

ii.      Pursuant to subparagraph 152-10(1)(c)(ii), the entity must satisfy the maximum net asset value test;

iii.     Pursuant to subparagraph 152-10(1)(c)(iii), the entity must be 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; or

iv.     Pursuant to subparagraph 152-10(1)(c)(iv), the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year.

44.   Addressing the criteria set out in subparagraph 152-10(1)(c)(i), the entity must be a CGT small business entity for the relevant income year. The Applicant carried on a business for the 20XX financial year, his aggregated turnover for the 20YY financial year was $yy and his aggregated turnover for the 20XX financial year was $xx. The aggregated turnover amounts are less than the threshold amount of $2million, so the Applicant satisfies this criterion and is a CGT small business entity for the 20XX financial year.

45.   Addressing the criteria set out in subparagraph 152-10(1)(c)(ii), the entity must satisfy the maximum net asset value ('MNAV') test, by having the net value of all business assets not exceed $6million, just before the CGT Event. The Applicant's net value of all his business assets is approximately $xy. This amount falls well within the limit of $6million, so the Applicant satisfies this criterion and satisfies the MNAV test.

46.   As outlined in paragraph 152-10(1)(c) of the ITAA 1997, at least one of the four criteria need to be satisfied for the basic conditions for small business concessions to apply. The Applicant has satisfied two of the criteria as set out at subparagraphs 152-10(1)(c)(i) and 152-10(1)(c)(ii), so satisfies this requirement.

47.   Finally, pursuant to paragraph 152-10(1)(d), the CGT asset must satisfy the active asset test as outlined in section 152-35 of the ITAA 1997. To satisfy the active asset test, the CGT asset must have been owned for 15 years or less and was an active asset for a total of at least half of that period; or, the CGT asset must have been owned for more than 15 years and was an active asset for a total of at least 7.5 years during that period. To satisfy being an active asset, as outlined at section 152-40, the CGT asset must have been used, or held ready for use, in the course of carrying on a business.

48.   The Applicant satisfies these criteria as the land was used in the carrying on of the Applicant's business of running a primary production business and he was the Lessee of the land used for primary production. The land has been owned for more than 15 years and was an active asset for a total of at least 7.5 years during that period, so the land satisfies the active asset test as set out at section 152-35 of the ITAA 1997.

49.   In conclusion, the land used by the Applicant satisfies the 'active asset test' for the CGT small business concessions pursuant to section 152-35 of the ITAA 1997 if the land is sold.

50.   Consequently, the Applicant will qualify for a small business concession to reduce their capital gain by satisfying the 15-year exemption as outlined in section 152-105. Any capital gain may be disregarded as the basic conditions in Subdivision 152-A are satisfied, the CGT asset has been continuously owned for greater than 15 years and the Applicant is aged over xx years and the sale of the assets has occurred in connection with the Applicant's retirement.

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