Edited version of private advice

Authorisation Number: 1052109828313

Date of advice: 26 April 2023

Ruling

Subject: Small business exemption

Question

Does Coy A satisfy the conditions to be able to choose the small business 15-year exemption in Subdivision 152-B of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

1.            Coy A was incorporated on XX/XX/19XX for the purpose of acquiring Property A.

2.            The current Coy A shareholders are:

(a)          Person A who directly owns 50%

(b)          Person B who directly owns X% and indirectly X% through a trust.

3.            Coy A own 2 properties:

(a)          Property A was purchased on XX/XX/19XX, and

(b)          Property B used solely to derive residential rent.

4.            Property A is a pre-CGT asset.

5.            Coy A has rented the ground floor of Property A to various commercial tenants from 19XX.

6.            Coy A took actions to sell Property A via an auction.

7.            Prior to going to auction, Coy A agreed to sell Property A to a potential purchaser (the Purchaser).

8.            An issue arose which resulted in the contract not going ahead.

9.            Coy A withdrew Property A from auction.

10.          Property A has remained on the market since.

11.          Coy A is considering taking Property A off the market for a period and then re-launching it with a new sales campaign in the next income year.

12.          Coy A has placed Property B on the market.

13.          Person A and the trust both hold more than 40% of the ordinary shares in Coy A. Thus, they are both 'connected entities' with Coy A.

14.          Coy A does not have any affiliates under section 328-130.

15.          There are noother entities that are controlled by either Person A, Person B or the trust.

16.          Neither Person A, Person B or the trust carry on a business.

17.          Person A and Person B are over 55 years of age, and desire to retire. It is intended for Coy A to:

(a)          sell Property A within the next 24 months

(b)          sell Property B within the next 24 months, and

(c)           be wound up, with a liquidator being appointed within the next 24 months.

18.          Coy A's annual turnover for the previous income years have been:

•                     $X for 20XX-20XX, and

•                     $X for 20XX-20XX.

19.          An earlier private binding ruling that issued decided:

•                     Property A satisfies the active asset test,[1] and

•                     Coy A satisfied the conditions to claim the small business 15-year exemption relating to the sale of Property A,

however, the period of this ruling applied to the 20XX-20XX and 20XX-20XX income years.

20.          As the sale of Property A has fallen through, Coy A is now seeking a new private ruling to extend the ruling period to include the 20XX-20XX and 20XX-20XX income years.

Information provided

21.          The information provided was obtained from the private ruling application received on XX/XX/20XX.

Assumptions

22.          The trust is a fixed trust, as the terms of the Will do not provide the trustees with the discretion to distribute income and capital flexibly. The terms of the Will provide Person B with a right to receive 100% of any distribution of income by the trust during their lifetime.

23.          Coy A's annual turnover will be less than $2 million for the 20XX-20XX and 20XX-20XX income years.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 subsection 104-10(1)

Income Tax Assessment Act 1997 subsection 104-10(3)

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Subdivision 152-A

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

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

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

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

Income Tax Assessment Act 1997 subsection 152-35(1)

Income Tax Assessment Act 1997 subsection 152-40(1)

Income Tax Assessment Act 1997 section 152-55

Income Tax Assessment Act 1997 section 152-65

Income Tax Assessment Act 1997 section 152-70

Income Tax Assessment Act 1997 section 152-75

Income Tax Assessment Act 1997 Subdivision 152-B

Income Tax Assessment Act 1997 subsection 152-110(1)

Income Tax Assessment Act 1997 paragraph 152-110(1)(a)

Income Tax Assessment Act 1997 paragraph 152-110(1)(b)

Income Tax Assessment Act 1997 paragraph 152-110(1)(c)

Income Tax Assessment Act 1997 paragraph 152-110(1)(d)

Income Tax Assessment Act 1997 subsection 328-110(1)

Income Tax Assessment Act 1997 subsection 328-115(1)

Income Tax Assessment Act 1997 subsection 328-120(1)

Income Tax Assessment Act 1997 section 328-125

Income Tax Assessment Act 1997 subsection 328-125(1)

Income Tax Assessment Act 1997 subsection 328-125(2)

Income Tax Assessment Act 1997 section 328-130

Reasons for decision

All legislative references are to the ITAA 1997 unless otherwise stated.

Question 1

Does Coy A satisfy the conditions to be able to choose the small business 15-year exemption in Subdivision

152-B?

Summary

Coy A satisfies the conditions to be able to choose to apply the small business 15-year exemption in Subdivision 152-B.

Detailed reasoning

Eligibility for small business relief

1.             An entity may choose to apply the small business relief set out in Division 152 to reduce or disregard a capital gain if the basic conditions set out in Subdivision 152-A are satisfied.

2.             Subsection 152-10(1) provides the basic conditions as follows:

(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;

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

Disposal of property - time of CGT event A1

3.             CGT event A1 happens if you dispose of a CGT asset.[2] The event happens when you enter into the contract for disposal, or if there is no contract when the change of ownership occurs.[3]

4.             Coy A proposes to sell Property A within the next 24 months. A sale contract is intended to be entered into. CGT event A1 will happen when Coy A enters into the sale contract. Coy A will make a capital gain in the income year the sale contract is entered into. Therefore, the first 2 basic conditions in paragraphs 152-10(1)(a) and (b) will be satisfied.

CGT small business entity

5.             The third relevant basic condition in paragraph 152-10(1)(c) requires Coy A to be a CGT small business entity.

6.             You are a 'CGT small business entity' for an income year if:[4]

(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.

7.             You are a 'small business entity' for an income year (the current year) if: [5]

(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

8.             From the information provided, it has been accepted that Coy A is operating business in the current income year.

9.             Your 'aggregated turnover' for an income year is the sum of the relevant annual turnovers.[6] The 'relevant annual turnovers' are your annual turnover for the income year plus the annual turnovers of any connected or affiliated entities of yours during the income year. An entity's aggregated turnover is the same as its annual turnover if there are no other entities connected with or affiliated with it.

10.          Section 328-125 provides 'control' tests which govern when an entity will be deemed to be 'connected with' another entity.

11.          Subsection 328-125(1) states:

An entity is connected with another entity if:

(a)          either entity controls the other 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.

12.          Both Person A and the trust hold more than 40% of the ordinary shares in Coy A. Therefore, both Person A and the trust control Coy A and are connected with Coy A.

13.          In relation to entities other than discretionary trusts (i.e., companies and fixed trusts), the relevant control test is relevantly set out in subsection 328-125(2) as follows:

(a)          an entity (the first entity) 'controls' another entity if the first entity, its affiliates, or the first entity together with its affiliates own or have the right to acquire 40% of the other entity's:

                                                  i.            income distribution

                                                 ii.            capital distribution, or

                                                iii.            if the entity is a company - 40% of its voting rights.

14.          You have stated that the trust is a fixed trust and not a discretionary trust as the terms of the Will does not provide the trustees with the discretion to distribute income and capital flexibly.

15.          Person B has the right to receive 100% of any distribution of income by the trust during her lifetime. Therefore, as Person B is entitled to more than 40% of the income distribution of the trust, Person B controls the trust and is connected to Coy A.

16.          You have stated that Coy A does not have any affiliates under section 328-130 and that there are noother entities that are controlled by either Person A, Person B or the trust.

17.          The relevant annual turnover for Coy A consists of:

(a)          Coy A's annual turnover

(b)          the trust's annual turnover

(c)           Person A's annual turnover, and

(d)          Person B's annual turnover.

18.          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.[7]

19.          'Ordinary income' is defined in section 6-5 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.

20.          You have stated that Person A, Person B and the trust do not carry on a business, therefore their annual turnover would be zero.

21.          Coy A's annual turnover for 20XX-20XX was $X and for 20XX- was $X.

22.          As you are seeking a private ruling for the 20XX-XX and 20XX-20XX income years, you have asked for an assumption be made that Coy A's annual turnover will be less than $2 million for these income years.

23.          Therefore, as Coy A's aggregated turnover will be less than $2 million for these income years, it will satisfy the definition to a CGT small business entity for these income years. Consequently, the third basic condition in subparagraph 152-10(1)(c)(i) will be satisfied.

Active asset test

24.          The final basic condition in paragraph 152-10(1)(d) requires the CGT asset to pass the active asset test.

25.          A CGT asset satisfies the active asset test if:[8]

(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 of ownership 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 for at least 7.5 years during the period specified in subsection (2).

26.          A CGT asset is an active asset at a given time if, at that time:[9]

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

                                                  i.            you; or

                                                 ii.            your *affiliate; or

                                                iii.            another entity *connected with you; or ....

27.          Coy A has owned Property A since 19XX and operated business during the period 19XX to 20XX. As Property A was used in running business it will fall within the definition to be an active asset. With Coy A owning Property A for more than 15 years and it was used as an active asset for at least 7.5 years, Coy A will satisfy the active asset test and therefore the final basic condition in subsection 152-10(1)(d).

Conclusion on satisfying the basic conditions

28.          Based on the facts provided, all the basic conditions for small business relief have been satisfied.

Small business 15-year exemption - Subdivision 152-B

29.          Subdivision 152-B contains the small business 15-year exemption that allows a small business to disregard a capital gain arising from a CGT asset that it has owned for at least 15 years.

30.          Subsection 152-110(1) sets out the following conditions that companies and trusts must satisfy before claiming the small business 15-year exemption:

An entity that is a company or trust can disregard any *capital gain arising from a CGT event if all if all of the following conditions are satisfied:

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

(b) the entity continuously owned the *CGT asset for the 15-year period ending just before the CGT event;

Note: Section 152-115 allows for continuation of the period if there is an involuntary disposal of the asset.

(c) the entity had a *significant individual for a total of at least 15 years (even if the 15 years was not continuous and it was not always the same significant individual) during which you owned the CGT asset;

(d) an individual who was a significant individual of the company or trust just before the CGT event either:

(i) was 55 or over at the time of the CGT event and the event happened in connection with the individual's retirement; or

(ii) was permanently incapacitated at that time.

31.          It has already been established that Coy A will satisfy the basic conditions in Subdivision 152-A for the capital gain that is to be made when Property A is sold. Therefore, the first condition in paragraph 152-110(1)(a) will be satisfied.

32.          Coy A has owned Property A since XX/XX/19XX. Therefore, Coy A has continuously owned Property A for more than 15 years, resulting in the second condition in paragraph 152-110(1)(b) to be satisfied

33.          The third condition in in paragraph 152-110(1)(c) requires Coy A to have a significant individual for a total of at least 15 years during its ownership period.

34.          An individual is a 'significant individual' in a company or a trust at a time if, at that time, the individual has a small business participation percentage in the company or trust of at least 20%.[10]

35.          An entity's 'small business participation percentage' in another entity at a time is the percentage that is the sum of the entity's direct and indirect small business participation percentage in the other entity at that time.[11]

36.          The current Coy A shareholders are:

(a)          Person A who directly owns 50%, and

(b)          Person B who directly owns X% and indirectly X% through the trust.

37.          Coy A has 2 significant individuals in Person A and Person B, as they both have, directly or indirectly, a 50% small business participation percentage in the company. Therefore, the third condition in paragraph 152-110(1)(c) will be satisfied.

38.          At the time the Application was lodged, Person A and Person B are both over 55 when CGT event A1 will happen.

39.          Whether a CGT event happens 'in connection with an individual's retirement' depends on the particular circumstances of each case. There would need to be at least a significant reduction in the number of hours the individual works or a significant change in the nature of their present activities to be regarded as a retirement. However, it isn't necessary for there to be a permanent and everlasting retirement from the workforce.[12]

40.          You have stated that once Property A has been sold, Coy A will no longer be conducting any active business operations, as Property B is a residential rental property and is currently being sold. Therefore, after Property A is sold, the time that Person A and Person B would spend as directors will dramatically decrease.

41.          As Coy A will have 2 significant individuals who will be over 55 at the time CGT event A1 happens and this event will happen in connection with their retirement, the final condition in paragraph 152-110(1)(d) will be satisfied.

42.          Based on the information provided, Coy A should satisfy all the conditions in subsection 152-110(1) and be entitled to claim the small business 15-year exemption to disregard the capital gain that will arise from the sale of Property A.

[1] Section 152-35.

[2] Subsection 104-10(1).

[3] Subsection 104-10(3).

[4] Subsection 152-10(1AA).

[5] Subsection 328-110(1).

[6] Subsection 328-115(1).

[7] Subsection 328-120(1).

[8] Subsection 152-35(1).

[9] Subsection 152-40(1).

[10] Section 152-55.

[11] Sections 152-65, 152-70 and 152-75.

[12] Refer to the Guide to Capital Gains Tax 2021.

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