Edited version of private advice

Authorisation Number: 1051823541745

Date of advice: 8 April 2021

Ruling

Subject: Small business retirement exemption

Question 1

Is the Trust eligible to choose to apply the small business retirement exemption for the capital gain made from the disposal of the commercial property under subsection 152-305(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Is the Company an 'affiliate' of the Trust within the meaning of that term under section 328-130 of the ITAA 1997?

Answer

Yes.

Question 3

Is Individual A an 'affiliate' of the Trust within the meaning of that term under section 328-130 of the ITAA 1997?

Answer

No.

Question 4

Does the Property qualify as an 'active asset' within the meaning of that term in section 152-40 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

Income year ended 30 June 20YY

Relevant facts and circumstances

Trust

The Trust is a discretionary trust, which purchased a property (the Property) several years ago. The only activity undertaken by the Trust was to lease the Property to the Company. The Company used the Property exclusively for the purposes of running a business (the 'Business').

The Trust leased the Property to the Company from the date of purchase of the Property until the Company sold the Business to an unrelated party sometime in 20XX income year. The Company and the Trust maintained separate bank accounts and rent was physically paid on a regular basis by the Company.

The Property was sold shortly afterwards in the following income year i.e 20YY income year to an unrelated party. The Property remained untenanted from the time the Company sold its business in 20XX income year until the time of the Property's sale.

A capital gain was made by the Trust from the sale of the Property to the unrelated party.

Since the sale of the Property in 20YY income year, the Trust has not undertaken any other activities.

The trustee of the Trust is a company (the Trustee Company). The sole director and shareholder of the Trustee Company is Individual A. Individual A is also the appointor of the Trust.

Individual A is solely responsible for all decision making of the Trust. This includes decisions relating to the making of trust distributions to the Trust's beneficiaries.

The Trust will distribute the capital proceeds from the sale of the Property to two beneficiaries, Individual A and Individual B in equal proportions in the 20YY income year. The Trust will not distribute any income in the 20YY income year. Once the capital proceeds from the sale of the Property are distributed to its beneficiaries in the 20YY income year, the Trust will be wound up.

In the income years preceding the 20YY income year, the Trust made trust distributions of more than 40% each to Individual B and Individual C. Individual C is related to Individual A.

Company

Individual A is the sole shareholder and director of the Company. The shares held by Individual A in the Company carry the rights to receive 100% of any distribution of income and capital from this company and to exercise 100% of the voting power in this company. Individual A is solely responsible for all decision making of the Company.

As mentioned earlier in this document, the Company used the Property exclusively for the purposes of running the Business. The space was not shared with, leased or subleased to any other party.

The Business was sold and its operations wound up during the 20XX income year.

During the 20YY income year, the Company commenced a new business - New Business.

CGT retirement exemption limits

Individual A and Individual B are both over 55 years old. Individual A has used $xxx of the CGT retirement exemption limit in an earlier income year. Individual B has not used any of the of the CGT retirement exemption limit.

Individual A does not carry on a business in their own right. However, they are involved in the business carried on by the Trust (in the capacity as the sole director of the Trustee Company) and the business carried on by the Company (in the capacity as sole director).

Neither Individual C nor Individual B carried on a business in their own right.

Relevant legislative provisions

Subdivision 152-A of the Income Tax Assessment Act 1997

Subdivision 152-D of the Income Tax Assessment Act 1997

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

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

subsection 152-10 of the Income Tax Assessment Act 1997

section 152-20 of the Income Tax Assessment Act 1997

section 152-35 of the Income Tax Assessment Act 1997

section 152-40 of the Income Tax Assessment Act 1997

subsection 152-48(2) of the Income Tax Assessment Act 1997

section 152-50 of the Income Tax Assessment Act 1997

section 152-60 of the Income Tax Assessment Act 1997

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

section 152-325 of the Income Tax Assessment Act 1997

section 328-110 of the Income Tax Assessment Act 1997

subsections 328-115 of the Income Tax Assessment Act 1997

subsection 328-125 of the Income Tax Assessment Act 1997

Reasons for decision

Note: All legislative references in the 'Reasons for Decision' are references to the Income Tax Assessment Act 1997, unless otherwise indicated.

Question 1

Detailed reasoning

Small business retirement exemption conditions

The requirements for the small business retirement exemption are contained in Subdivision 152-D of the ITAA 1997. Under subsection 152-305(2), a trust can choose to disregard a capital gain from a CGT event where all of the following conditions are met:

(a)  the basic conditions in Subdivision 152-A are satisfied for the capital gain;

(b)  the entity satisfies the significant individual test under section 152-50; and

(c)   the company or trust conditions in section 152-325 are satisfied.

Subsection 152-305(3) excludes certain kinds of entities from the small business retirement exemption. These entities are listed in subsection 328-125(8) and include public entities such as public trading unit trust. The Trust, which is a discretionary trust, is not of the entities listed in subsection 328-125(8).

The application of each of the conditions mentioned in paragraphs 152-305(2)(a) to (c), as listed above, are considered below:

Basic conditions in Subdivision 152-A

The first condition in subsection 152-305(2) requires that the basic conditions for CGT relief in Subdivision 152-A must be satisfied for the capital gain. Subsection 152-10(1) which sets out the basic conditions for small business relief, requires that the following four basic conditions be satisfied for the gain:

(a)  A CGT event (other than CGT event K7) happens in relation to a CGT asset of a taxpayer;

(b)  A capital gain would arise (apart from the application of Division 152 - Small business relief);

(c)   The taxpayer satisfies one of the following:

(i)    it is a CGT small business entity for the income year (i.e the CGT Event income year);

(ii)   it satisfies the maximum net asset value test under section 152-15,

(iii)  it is 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 152-10(1A) or subsection 152-10(1B) are satisfied in relation to the CGT asset in the income year;

(d)  The CGT asset satisfies the 'active asset test' under section 152-35.

First and Second Basic conditions

The Trust satisfies the first and second basic conditions specified in paragraphs 152-10(1)(a) and (b) respectively as a CGT event, specifically CGT Event A1 in section 104-10, occurred upon the sale of the Property to an unrelated entity. Broadly, CGT Event A1 applies where a change of ownership of a CGT asset occurs from one entity to another entity such as where there is a sale of real property.

As a result of the CGT Event occurring, a capital gain arose for the Trust from the sale of the Property.

Third Basic condition

The third basic condition in paragraph 152-10(1)(c) relevantly requires that the Trust meet one of three tests. The first test listed in subparagraph 152-10(1)(c)(i) requires that the Trust be a 'CGT small business entity' for the income year. This test is considered below:

CGT small business entity - subparagraph 152-10(1)(c)(i)

Broadly, under subsection 152-10(1AA), an entity is a 'CGT small business entity' for an income year if:

(a)    it is a 'small business entity' for the income year; and

(b)    its aggregated turnover under the aggregated turnover tests for a small business entity in section 328-110 was $2 million instead of $10 million.

Section 328-110 provides that an entity is a 'small business entity' for an income year if it:

(a) is carrying on a *business, and

(b) has less than $2 million aggregated turnover (as modified by paragraph 152-10(1AA)(b)).

The term 'business' used in the expression 'carrying on a business' is defined in section 995-1. It defines 'business' as

'Business: includes any profession, trade, employment, vocation or calling, but not occupation as an employee'.

Normally, the receipt of income from the letting of property to a tenant does not amount to the carrying on of a business (Wertman v. Minister of National Revenue (1964) 64 DTC 5158; Federal Commissioner of Taxation v. McDonald (1987) 15 FCR 172;87 ATC 4541; 18 ATR 957; Cripps v. FC of T 99 ATC 2428; Case X48 90 ATC 384; (1990) 21 ATR 3389).

Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? (TR 97/11) at paragraph 13 outlines the general factors that are considered important in determining the question of whether a business activity is being carried on. These are as follows:

•         whether the activity has a significant commercial purpose or character.

•         whether the taxpayer has more than just an intention to engage in business;

•         whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity;

•         whether there is regularity and repetition of the activity;

•         whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business;

•         whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit

•         the size, scale and permanency of the activity, and

•         whether the activity is better described as a hobby, a form of recreation or sporting activity.

TR 97/11 at paragraph 16 explains that the indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impression gained from looking at all the indicators, and whether these factors provide the operations with a commercial flavour. However, the weighting to be given to each indicator may vary from case to case.

From the information provided, the Trust's sole source of income during was the rental income derived from the Property.

No other business activities were undertaken by the Trust other than renting out the Property to the Company, a related entity. Once the Company sold the Business in 20XX income year, the Property was no longer rented out until it was sold in the 20YY income year.

In light of the above, it is considered that the Trust is not carrying on a business. The Trust's rental activities, which were limited to renting one property, are of a small scale. Further, as the Property was not let to the public but exclusively to a related entity, the rental activities of the Trust are considered not to be of the same kind to that of an entity in the business of letting commercial property.

Therefore, as the Trust is not carrying on a business, it will not qualify as a small business entity under section 328-110. Consequently, it will not be a CGT small business entity and the Trust will not meet the first condition in subparagraph 152(1) (c)(i).

Passively held assets - subparagraph 152(1)(c)(iv)

As the Trust is not a CGT small business entity, in its own right, it will be necessary to consider the application of the third test in subparagraph 152-10(1)(c)(iv). For this test to be met, the Trust will need to satisfy the requirements in subsection 152-10(1A).

Broadly, subsection 152-10(1A) allows an entity which is not carrying on a business to access the small business CGT concessions where the CGT asset is used in the business of a CGT small business entity that is an 'affiliate' of or an 'entity connected' with the taxpayer and the conditions in that provision are satisfied.

For subsection 152-10(1A) to apply, the following conditions must be met in relation to the CGT asset in the income year:

(a)    the taxpayer's affiliate, or an entity that is connected with the taxpayer, is a 'CGT small business entity' for the income year (i.e income year that the CGT event happens);

(b)    the taxpayer does not carry on business in the income year (other than in partnership);

(c)    if the taxpayer carries on 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 that is the taxpayer's affiliate, or is connected with the entity, is the entity that, at a time in the income year, carries on the business referred to in subparagraph 152-40(1)(a)(ii) or subparagraph 52-40(1)(a)(iii) or paragraph 152-40(1)(b) in relation to the CGT asset (the definition of active asset).

As the Trust did not carry on business in the 20YY income year, the condition in paragraph (b), above is met. The condition in paragraph (c) which applies to partnerships is not relevant to the Trust's circumstances.

This leaves the conditions in paragraphs 152-10(1A)(a) and (d) to be considered. Each of these conditions are discussed below:

Condition in paragraph 152-10(1A)(a)

The condition in paragraph (a) requires consideration, amongst others, as to whether the Company which used the Property to carry on the Business is an 'affiliate' or an entity 'connected with' ('connected entity') the Trust within the meaning of those terms under section 328-130 and section 328-125 respectively.

Connected Entity - the Company

In relation to the issue of whether the Company is a connected entity of the Trust, subsection 328-125(1) provides that an entity is connected with another entity if:

(a)  one of the entities 'controls' the other entity;

(b)  2 entities are 'controlled' by the same third entity, in which case all 3 entities will be connected.

Under subsection 328-325(3), an entity can control a discretionary trust in one of two ways. Relevantly, an entity will control a discretionary trust if the trustee acts, or could reasonably be expected to act, in accordance with the directions or wishes of the entity, its affiliates or the first entity together with its affiliates (subsection 328-125(3)).

Factors that can be considered when determining control include: the way the trustee has acted in the past, and the relationship between the trustee and the individual - see ATO website document titled 'Connected entities' [QC 52286].

In the present circumstances, Individual A has been the sole director and shareholder of the Trustee Company for several years. They are also the appointor of the Trust. Moreover, Individual A has sole responsibility for all decisions made by the Trustee Company in respect of the Trust. These decisions included decisions regarding the making of trust distributions to the beneficiaries of the Trust.

It is considered that in these circumstances that Individual A 'controls' the Trust within the terms of subsection 328-125(3) as the Trustee Company has acted and will act in accordance with their directions and wishes with regard to the business affairs of the Trust.

For Individual A to control the Company within the terms of subsection 328-125(2), their ownership interests in the Company must carry the rights to receive at least 40% of any income and capital distribution of this company and to exercise at least 40% of the voting power in this company. Individual A satisfies these requirements as their shares in the Company carry the rights to receive 100% of any distribution of income and capital from this company and to exercise 100% of the voting power in this company.

Consequently, Individual A controls the Company pursuant to subsection 328-125(2). It also follows that Individual A is an 'entity connected with' the Company under subsection 328-125(1).

Therefore, as the Trust and the Company are each 'controlled' by Individual A under section 328-125, the Company is an entity 'connected with' the Trust.

As it is established that the Company is an entity connected with the Trust, it is then necessary to determine whether the Company is a CGT small business entity in the 20YY income year.

[In Question 2 of the 'Reasons for Decision', it is concluded that the Company was also an affiliate of the Trust under section 328-130 as the requirements of this provision were met.]

CGT small business entity - the Company

As mentioned earlier in this document, to qualify as a 'CGT small business entity' an entity must qualify as a small business entity under section 328-110. To qualify as a small business entity for an income year (the current year), it is required that an entity:

(i)    is carrying on a business; and

(ii)   its aggregated turnover is $2 million or less (as modified by paragraph 152-10(1AA)(b)).

The Company is carrying on a business, the New Business in the 20YY income year (the current year). Therefore, the Company meets the first requirement of a small business entity.

In order that the Company meets the second requirement of a small business entity the Company must satisfy one of three tests based on aggregated turnover. One of these tests is in subparagraph 328-110(1)(b)(i) and requires that the Company carry on a business in the income year before the current year (i.e 20XX income year) and its aggregated turnover for the 20XX income year is less than $2 million.

The Company carried on the Business in the 20XX income year.

Under subsections 328-115(1) and (2), the "aggregated turnover" of an entity is the sum of the "annual turnovers" of:

(a)  the entity;

(b)  entities connected with the entity; and

(c)   affiliate(s) of the entity.

In addition, there is a special deeming rule in section 152-48(2) that applies for calculating the aggregated turnover where the asset is passively held.

The special rule in subsection 152-48(2) treats an entity ( 'the deemed entity') that is an affiliate or is connected with the owner of the passively held CGT asset ( i.e the Trust) as an affiliate of, or connected with the entity that uses the passively held asset in its business ('test entity') i.e the Company, if the deemed entity is not already an affiliate, or connected with the test entity.

Therefore, under the standard aggregated turnover rules in subsections 328-115(1) and (2), the aggregated turnover of the Company will include the annual turnovers (if any) of the Company and its connected entities, Individual A and the Trust.

As mentioned in the Detailed Reasoning for Question 2, the Trust cannot be an 'affiliate' of an entity within the terms of section 328-130.

In addition, the special deeming rules in subsection 152-48(2) will treat Individual C and Individual B (the deemed entities) who are, by way of subsections 328-125(1) and (4), 'connected with' the Trust as also being connected with the Company (the test entity) for the purposes of the aggregated turnover test.

Under subsection 328-125(4), an entity could be considered to control a discretionary trust where it received more than 40% of the income and capital of the trust in any of the previous 4 income years. Individual C and Individual B each received more than 40% of the Trust's income in the previous income years. As Individual C and Individual B control the Trust, they are also connected with the Trust under subsection 328-125(1).

Calculation of Annual turnover - the Company

Section 328-120(1) of the ITAA 1997 provides that 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. 'Ordinary income' is defined in subsection 6-5(1) of the ITAA 1997 as income according to ordinary concepts.

The definition of 'annual turnover' looks solely at the entity's business turnover. An entity's turnover does not take into account any other types of ordinary income such as salary and wages or other non-business income e.g dividend or interest income. Nor does the definition include statutory income, such as capital gains and trust distributions (see paragraphs 2.13 to 2.16 in Explanatory Memorandum for Tax Laws Amendment (Small Business) Bill 2007 about the meaning of 'annual turnover').

In the present circumstances, the only amounts to be included in the calculation of the aggregated turnover of the Company for the 20XX income year is the annual turnover for the Company.

In relation to the entities connected with the Company, there are no annual turnover amounts, which are required to be included in the aggregated turnover calculation, from these entities. This is for the reason that these entities did not derive any income from the carrying on a business in the 20XX income year. This is detailed below:

•         the Trust's only source of income for the 20XX income year was rental income. It was previously concluded that the Trusts' activities in relation to the derivation of rental income did not amount to carrying on a business.

•         Individual C and Individual B who are deemed to be connected with the Company were not carrying on a business in the 20XX income year.

•         Individual A, who is the sole shareholder and director of the Company and a connected entity of this company was not carrying on a business in their own right in the 20XX income year.

Based on the facts, the annual turnover of the Company is less than $2 million in the 20XX income year. Therefore, as the aggregated turnover of the Company is less than $2 million in the 20XX income year, the Company will meet the aggregated turnover test

As the Company meets both requirements i.e aggregated turnover test and carrying on the business in 20YY income year, it will be treated as a small business entity under section 328-110. It will also qualify as a CGT small business entity under subsection 152-10(1AA).

Consequently, the first condition in paragraph section 152-10(1A)(a) is met as a connected entity of the Trust i.e the Company is a CGT small business entity for the CGT event year i.e 20YY income year.

Condition in paragraph 152-10(1A)(d)

The final condition in paragraph 152-10(1A)(d) requires that the CGT small business entity that is the connected entity or affiliate of the taxpayer in the CGT event year is the same entity that carries on the business and uses the asset at that time i.e the CGT event year, and the asset also meets the active asset test at that time.

In other words, this provision requires, amongst other things, that the Company carry on the business and uses the asset (i.e the Property) in its business in the CGT event year; i.e 20YY income year.

Although the Company carried on the New Business in the 20YY income year, the Company did not use the Property in the course of carrying on its New Business. The Company's Business, which used the Property had ceased its operations in the 20XX income year. The Property was left untenanted from the time the Company sold the Business up until the time it was sold in the following income year.

Accordingly, the final condition in paragraph 152-10(1A)(d) is not met.

There is a special rule in section 152-49 that permits owners of passively held assets access to the small business CGT concessions where the CGT event happens in a later income year after the business which used the asset has ceased operating. This is on the condition that the business that used the asset is being wound up in the CGT event year.

Subject to these conditions being met, section 152-49(2) will treat the entity as carrying on the business for a moment in time in the income year the CGT event happens and treats the asset as being used by the business at that same moment in time in the CGT event year.

The special rule in section 152-49 has no application in these circumstances as the Company's Business which used the asset was not being wound up in the CGT event year i.e 20YY income. The Company had completed its sale and winding up of the Business during the preceding 20XX income year.

Accordingly, as not all of the conditions in subsection 152-10(1A) are met, the Trust will not satisfy the meet the requirements for on in paragraph 152-10(1)(c)(iv).

Maximum net asset value test

The final test to consider is the maximum net asset value test (MNAV test) in subparagraph 152-10(1)(c)(ii).

For an entity to satisfy the MNAV test in subsection 152-20(1), just before the CGT event, the sum of the net value of the CGT assets of the following entities must be less than $6 million:

(a)       the entity itself;

(b)       any connected entity of the entity,

(c)       an entity's affiliate(s) or connected entities of the affiliates(s) (not counting any assets already counted under paragraph (b) above.

Based on the facts provided, the Trust will satisfy the MNAV with as the sum of the net value of the CGT assets of the relevant entities is less than $6 million.

Consequently, the Trust will also satisfy the third basic condition in paragraph 152-10(1)(c).

Fourth Basic condition - Active asset test

The final basic condition to consider is whether the Trust meets the active asset test in section 152-35. Under this provision, the 'active asset test' is satisfied for a CGT asset if:

(a)       the taxpayer has owned the asset for 15 years or less and the asset was an *active asset of the taxpayer for a total of at least half of the test period specified in subsection 152-35(2); or

(b)       the taxpayer has owned the asset for more than 15 years and the asset was an *active asset of the taxpayer for a total of least 7.5 years during the test period. specified in subsection 152-35(2);

Under subsection 152-35(2), the test period:

(a)  begins when the taxpayer acquired the asset, and

(b)  ends at the earlier of

(i)    the CGT event, and

(ii)   when the business ceased, if the business in question ceased in the 12 months before the CGT event (under subparagraph 152-35(2)(b)(ii) of the ITAA 1997 the Commissioner can allow a longer period than 12 months).

Therefore, for the Property to satisfy the 'active asset test' it will be necessary that it meets the following requirements:

(a)  qualify as an 'active asset' under section 152-40; and

(b)  be used as an 'active asset' for the requisite period of time specified in section 152-35(1);

Each of these requirements are discussed below:

Active Asset

An asset is an 'active asset' under section 152-40(1) if it is owned by the taxpayer and is used or held ready for use in a business carried on (whether alone or in partnership) by the taxpayer, its affiliate, spouse or child, or an entity connected with the taxpayer.

In this case, the Trust owned the Property and it was used by a connected entity, namely the Company, in the course of operating the Business

However, under section 152-40(4) certain CGT assets are excluded from qualifying as active assets.

One of the CGT assets listed is an asset whose main use by the taxpayer is to derive rent, unless amongst other things, its main use for deriving rent was only temporary - paragraph 152-40(4)(e).

In determining the main use of an asset for the purposes of paragraph 152-40(4)(e), any use of the asset by a connected entity is treated as the taxpayer's use of the asset (see paragraph 152-40(4A)(b)).

In the present circumstances, although the Trust used the Property to derive rental income, the Company which is a connected entity of the Trust, used the Property to operate the Business, and this is the primary use for which the Property is applied.

Paragraph 152-40(4A)(b) will apply to attribute back to the Trust, the Company's use of the of the Property of the Business. As a result, the Property will not be excluded from being an active asset under paragraph 152-40(4)(e).

Consequently, the Property qualifies as an 'active asset' under section 152-40.

Test Period

In relation to the second requirement about the time period the asset is used as an active asset, on the facts provided, the Trust has owned the Property for the requisite period of time for subsection 152-35(1)(a) to apply.

Subsection 152-35(1)(a) requires that the Property is an 'active asset' of the Trust for at least half of the test period.

Under subsection 152-35(2), the test period will run from the time the Property was acquired until the sale of the Company's the Business in 20XX income year (see paragraph 152-35(b)).

It was previously concluded that the Property was an active asset. This was on the basis that the Property was owned by the Trust and used by the Company in operating its business. The use of the Property by the Company for the Business occurred during the whole of the test period i.e from the date of purchase of the Property to the sale of the Business by the Company.

Consequently, it is considered that the Property was an active asset of the Trust during the test period.

Therefore, as all of the requirements in subsection 152-35(1) are met, the Property satisfies the 'active asset test'.

In conclusion, the Trust meets the basic conditions in Subdivision 152-A and, therefore the first condition for the small business retirement exemption provision to apply is met.

Significant individual test under section 152-50

The second condition for the small business retirement exemption provision to apply is that the 'significant individual test' in section 152-50 is met.

Under section 152-50, an entity satisfies the significant individual test if the entity had at least one 'significant individual' just before the CGT event.

An individual is a 'significant individual' in a trust if at the relevant time, they have a small business participation percentage in the trust of at least 20% (see section 152-55 of the ITAA 1997).

The small business participation percentage is calculated by considering both the direct and indirect participation percentage (section 152-65).

The method for calculating an entity's direct and indirect small business participation percentage in a trust is outlined in the table in section 152-70.

Under item 3 of the table in section 152-70, an individual has a direct small business participation percentage in a discretionary trust (i.e. a trust where entities do not have entitlements to all the income and capital of the trust) equal to:

(a)       if the trustee makes distributions of income during the income year (the relevant year) in which that time occurs - the percentage of the distributions to which the entity was beneficially entitled; or

(b)       if the trustee makes distributions of capital during the relevant year - the percentage of the distributions to which the entity was beneficially entitled;

or, if 2 different percentages are applicable, the smaller.

The relevant time for the purposes of section 152-50 is just before the CGT event, and therefore, the relevant year for the purposes of determining an individual's direct small business participation percentage is the year in which the CGT event occurs.

In this case, the Trust will be making capital distributions to Individual A and Individual B in the 20YY income year of greater than 20% to each of these individuals.

As these beneficiaries have a small business participation percentage in the Trust of at least 20%, the Trust meets the significant individual test in section 152-50. Consequently, the second condition in section 152-325 is met.

Company or trust conditions - section 152-325

The final condition for the small business retirement exemption provision in section 152-305 to apply is that the 'company or trust conditions' in section 152-325 are satisfied.

Subsection 152-325(1) requires a trust to make a payment to at least one of its 'CGT concession stakeholders' if the trust receives an amount of capital proceeds from a CGT event for which it makes a choice under Subdivision 152-D.

Under paragraph 152-60(a) an individual is a CGT concession stakeholder of a trust if it is a significant individual in the trust.

It was concluded previously in this report that Individual A and Individual B are both significant individuals of the Trust under section 152-55. Consequently, Individual A and Individual B are also CGT concessional stakeholders of the Trust. It is intended that the Trust makes a distribution of the capital proceeds from the CGT event relating to the Property sale to each of these beneficiaries who are also the Trust's CGT concessional stakeholders.

The trustee of the Trust will make a choice under Subdivision 152-D to disregard all or part of the capital gain from the sale of the Property.

The trustee will specify in writing the amount of the capital gain from the sale of the Property that the Trust chooses to disregard ('CGT exempt amount') see subsection 152-315(1) to 152-315(4).

As the Trust has more than one CGT concession stakeholder, it will also choose (and specify in writing) the percentage of the CGT exempt amount that is attributable to each stakeholder, and the total of the percentages must add up to 100%: subsection 152-315(5).

The Trust will ensure that the amount chosen as the CGT exempt amount will not exceed for the CGT retirement exemption limit for each CGT concession stakeholder for whom the choice is made (subsection 152-315(2)).

An individual's CGT retirement exemption limit is $500,000 reduced by any previous CGT exempt amount(s) - see subsection 152-320. In this case, Individual A has used $xxx of their CGT retirement exemption limit. Individual B has not used any amount of their CGT retirement exemption limit.

The Trust will be making a payment of these capital proceeds to Individual A and Individual B who are CGT concession stakeholders of the Trust within 7 days after making the retirement exemption election (subparagraph 152-325(4)(b)(i)).

The amount of the payment or the sum of the amounts of the payments made by the Trust to its CGT concessional stakeholders will be equal to the lesser of (a) the capital proceeds received by the Trust and (b) the CGT exempt amount, as per subsection 152-325(5).

As the Trust satisfies the trust conditions in subsection 152-325 (as is applicable), the third condition in 152-305(2) is met.

Therefore, as the Trust meets all the three conditions in subsection 152-305(2), it can choose to disregard all or part of the capital gain arising from the sale of the Property under section 152-305.

Note: the choice of the trustee of the Trust to apply the retirement exemption must be made by the date of lodgement of its income tax return for the relevant income year in which the CGT event occurs, or such further time as the Commissioner allows: see section 103-25.

Question 2

Detailed Reasoning

Section 328-130 provides that an individual or a company is an affiliate of an entity if the individual or company acts, or could reasonably be expected to act, in accordance with the entity's directions or wishes, or in concert with the entity in relation to the affairs of the business of the individual or company.

However, an individual or a company is not an entity's affiliate merely because of the nature of the business relationship that the entity and the individual or company share with the entity.

Whether a person is acting in concert with another is essentially a question of fact.

In paragraphs 2.35 and 2.36 of the Explanatory Memorandum to the Tax Laws Amendment (Small Business) Bill 2007, it is explained that the affiliate rules are designed to ensure that entities that genuinely carry on independent businesses are not aggregated.

Factors that may indicate that parties are acting in concert may include:

•         family or close personal relationships;

•         financial relationships or dependencies;

•         relationships created through links such as common partners, directors or shareholders;

•         the degree to which the entities consult with each other on business matters; or

•         whether one of the entities is under a formal or informal obligation to purchase goods or services or conduct aspects of their business with the other entity.

However, none of these factors are decisive in itself.

In the present circumstances, there was a financial dependency between the Company and the Trust that existed for a number of years in relation to the leasing arrangement of the Property. For the Trust, the leasing of the Property provided its sole source of income whilst the Company was provided with premises to conduct the Business.

However, this dependency was severed with the sale of the Business in 20XX income year. Since that time, the Company has started the New Business, which is operated independently of the Trust. The Property, which it previously leased, remained untenanted and was sold shortly afterwards in 20YY income year.

Given the financial relationship between the Company and the Trust and the fact that both entities are ultimately controlled by Individual A, it is considered that the Company is an affiliate of the Trust under section 328-130. This is for the reason that that the Company acts, in concert with the Trust in relation to its business affairs.

It is also noted that the opening words of section 328-130(1) requires that an affiliate of an entity must be a company or individual. Therefore, the Trust is not capable of being an 'affiliate' of the Company under section 328-130.

Question 3

Section 328-130 sets out the circumstances where an individual or company will be treated as an affiliate of an entity. For an individual or company to be treated as an affiliate, it is required amongst other things that the individual / company is carrying on a business.

In this case, Individual A is not carrying on a business in their own right and therefore the requirement that Individual A acts, or could reasonably be expected to act, according to the directions or wishes of the Trust in relation to Individual A's business affairs is not met.

As mentioned in Question 2, the opening words of section 328-130(1) requires that an affiliate of an entity must be a company or individual. Therefore, the Trust cannot be an 'affiliate' of Individual A under section 328-130.

Question 4

Detailed reasoning

Refer to the reasoning set out in Question 1 of this Reasons for Decision. In that reasoning, it was concluded that the Property was an 'active asset' of the Trust as it satisfied the requirements found in section 152-40.

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