Edited version of private advice

Authorisation Number: 1052118885373

Date of advice: 25 May 2023

Ruling

Subject: CGT concession - retirement

Issues

Question 1

Did Individual A acquire the Initial Shares upon Individual Y's death pre-CGT for a consideration equal to the asset's market value for the purposes of former subsection 160ZX(3) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes

Question 2

Does Division 128 of the Income Tax Assessment Act 1997 (ITAA 1997) apply to Individual A's pre-CGT Initial Shares that passed to the legal personal representative (LPR) of their estate upon their death post-CGT?

Answer

Yes

Question 3

Is the Company considered to be carrying on a business for the purposes of paragraph 328-110(1)(a) of the ITAA 1997 in the income years when the Company disposes of parts of the Land and is still leasing parts of the Land, such that it is a CGT small business entity and as such meets one of the basic conditions requirements in section 152-10(1)(c)(i) of the ITAA 1997 for the purposes of the small business CGT concessions in Division 152 of the ITAA 1997?

Answer

Yes

Question 4

Given that the Land may have to be sold progressively in parts over a number of income years, would the Company be deemed under section 328-110(5) of the ITAA 1997 to be carrying on a business in the income years when it has stopped leasing the Land up to the time when the last parcel of the Land is sold consistent with its aim of disposing of all of the Land in winding down of its leasing business, and as a consequence, meets one of the basic conditions requirements in section 152-10(1)(c)(i) of the ITAA 1997 for the purposes of the small business CGT concessions in Division 152 of the ITAA 1997?

Answer

Yes

Question 5

Given that the Land may have to be sold progressively in parts over a number of income years and it is not possible for Individual F to retire immediately from their business, would the occurrence of CGT event A1 under section 104-10 of the ITAA 1997 for the Company on each progressive sale be considered to be in connection with Individual F's retirement for the purposes of section 152-110(1)(d)(i) of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

1 July XXXX to 30 June XXXX

Relevant facts and circumstances

Individual X held land described as the X Land. They passed away pre-CGT.

Under the first direction in Individual X's Will, a life interest testamentary trust (Life Interest Trust) was created under which Individual X's executors held the X Land on trust:

a)    to pay the annual income derived from the X Land to Individual Y; and

b)    on Individual Y's death, to hold the X Land for their children in equal shares.

Individual Y had three children, Individual A, Individual B and Individual C. Individual C assigned their remainder interest in the Life Interest Trust to Individual A and Individual B in equal shares pre-CGT.

The trustees of the Life Interest Trust had a power of sale and pre-CGT the trustees of the Life Interest Trust restructured the ownership of X Land to transfer ownership to the Company) under the following transactions:

Company A was incorporated pre-CGT with the trustees of the Life Interest Trust owning 100% of the shares. (The trustees of the Life Interest Trust held all but 1 share each as nominee for the Life Interest Trust.)

The Company was incorporated pre-CGT with the trustees of the Life Interest Trust owning 100% of the X shares in the Company. One share was transferred to Company and the remaining one share was transferred to the nominee for Company A. (The share was later transferred to Individual D post-CGT who currently holds it as nominee for Company A.)

The Company was then funded to acquire X Land for around $X via the trustees of the Life Interest:

(i)            subscribing for X shares of $X each in Company A, and Company A in turn subscribing for X shares in the Company at $X each; and

(ii)           lending $X to Company A at interest and Company A loaning the amount of $X to the Company at interest.

The end result of the transactions outlined above was that:

(a) the trustees of the Life Interest Trust owned X shares in Company A; and

(b) Company A owned X shares in the Company (legally and beneficially) and an individual owned a share in the Company as nominee for Company A.

Individual Y passed away pre-CGT.

Post-CGT, the trustee of the Life Interest Trust transferred the legal title to X Company A shares to Individual A (Initial Shares) and the legal title to X Company A shares to Individual B as they were the remaindermen under the Life Interest Trust.

Post-CGT, Individual B transferred X Company A shares to Individual A for $X which was the shares' market value at the time. As a result, Individual A held X shares and Individual B held X shares in Company A.

Individual A died post-CGT.

Individual D and Individual E were the executors of Individual A's Will.

Under Individual A's Will, a discretionary testamentary trust (Testamentary Trust) was established to deal with Individual A's Company A shares. Relevantly:

(a) Individual D and Individual E are the trustees; and

(b) the beneficiaries are:

(i) Individual F (surviving spouse);

(ii) surviving children Individual G, Individual H and Individual I; and

(iii) the grandchildren of Individual A.

The trustees of the Testamentary Trust propose to obtain an independent valuation of the shares.

Individual B died post-CGT and currently their X shares in Company A is held by the executor of their estate.

Individual A left a non-binding memorandum of wishes (which outlined, amongst other things, how they wished the Testamentary Trust to be managed. Significantly, Individual A indicated that:

•         Individual A be permitted to use the Land in their business up until the time they turned X years of age;

•         the Company and Company A be liquidated on the earlier of the following occurring:

o   Individual F ceasing to operate their business;

o   Individual F attaining the age of X years;

o   Individual F requesting the trustees to do so; or

o   Individual F moving off the Land permanently;

•         the benefit of certain land parcels comprising the Land be allocated to each of Individuals F, G, H and I; and

•         the remaining net cash of the Company on its liquidation be gifted to Individual F.

Individual F turned X years of age on XXXX and they wish to retire from their business.

In light of this, the trustees of the Testamentary Trust wish to implement Individual A's wishes by disposing of the Land. Currently, it is contemplated that some of the Land which fall within Individual G's share of the Land as allocated to them under the non-binding memorandum of wishes, will be transferred to Individual G and the balance will be sold to third parties.

The Company owns land comprising X separate land titles with a total area size of approximately X hectares (collectively the Land). All of the Land apart from a small land parcel is Y Land. The small parcel of land was acquired from Individual A post-CGT.

Broadly, since the time it was incorporated to date, the Company has leased the Land to various related entities and partnerships in order to carry businesses on the Land on commercial terms. There was also a time in the past (broadly covering 7.5 years) when the Company carried on a business in partnership with a related entity.

The Company has been leasing the Land to Individual F to use in their sole trader business since XXXX to date.

Company investment income from its investment portfolio each year.

Currently it is estimated that the Land has an aggregate market value of around $X.

It is likely that the Land will have to be sold progressively in parts.

It may be that there will be a future period of time where Individual F has ceased carrying on a business on the Land, and the Company is still trying to sell the remaining parts of the Land. Where this arises, to manage holding costs the Company may seek to lease the Land to ensure that its potential (and hence marketability) remains the best it can. During this time the Company will remain focused on trying to dispose of the Land to fulfil Individual A's wishes.

The disposal of all parts of the Land is expected to be completed by XXXX.

The Company intends to claim the 15 year exemption in relation to any capital gain it makes on the disposal of the Land. Individual F will use the proceeds they receive from the disposal of the Land to fund their retirement.

Apart from section 152-10(1)(c)(i) of the ITAA 1997 (in respect of which this ruling application has been made), the Company otherwise satisfies all the basic conditions in section 152-10 of the ITAA 1997 in relation to the Land and in particular the Company's Land satisfies the active asset test in section 152-40 of the ITAA 1997.

Apart from section 152-110(1)(d)(i) of the ITAA 1997 (in respect of which this ruling application has been made), the Company otherwise satisfies all the conditions as outlined in section 152-110 of the ITAA 1997 for the 15 year exemption to apply to the capital gains it makes on the disposal of the Land. Individual A was a significant individual of the Company for at least 15 years.

The aggregated turnover of the Company in each income year when it disposes of part of the Land will not exceed $2 million.

Individual F will continue to use the Land in their business during the time when the Company is progressively selling parts of the Land up until the time Individual F ceases their business.

In line with their trust obligations to consider the best interests of beneficiaries and their desire to fulfil Individual A's wishes, the trustees of the Testamentary Trust propose that in the income years in which the contracts to sell parts of the Land are entered into:

•         The Company would pay dividend income to Company A;

•         Company A would pay dividend income to the Testamentary Trust; and

•         the trustees of the Testamentary Trust make distributions as follows to make Individuals F, G, H and I significant individuals:

o   if the trustees make distributions of income during the income year, at least 21% of the distributions will be made to each of Individuals F, G, H and I; and

o   if the trustees make distributions of capital during the income year, at least 21% of the distributions will be made to Individuals F, G, H and I.

Company A holds X% of the shares in the Company and the trustee of the Testamentary Trust holds X% of the shares in Company A, a beneficiary who is distributed 21% of distributions from the Testamentary Trust.

The trustees of the Testamentary trust will ensure that the lowest percentage of income and capital distributions that a beneficiary, who is intended to be a significant individual of the Company, is at least 21%. Individual F will be a significant individual in relation to each disposal of the Land with respect to which the Company seeks to claim the 15 year exemption in relation to any capital gain it makes on the disposal of the Land (i.e. each CGT event) as it relates to Individual F's retirement.

Since Individual A's Memorandum of Wishes allocates the benefit of different land parcels to Individuals F, G, H and I, it may be that in an income year when a land parcel sales contract has been exchanged that the trustees of the Testamentary Trust only make some of these beneficiaries significant individuals taking into account the allocation of different land parcels.

In an income year there may be four CGT concession stakeholders of the Company just before the contracts to sell the Land are exchanged and as such the amount that would be paid out by the Company to these concession stakeholders would be up to the exemption limit as outlined in subsection 152-125(2) of the ITAA 1997.

The hours that Individual F works fluctuates with demand.

Over the years, Individual F has worked an average of X to X hours per week spread over a 7 day week. Individual F will reduce their duties and hours worked.

The current directors of the Company are Individuals D, E and F. The directors of Company A are Individuals D, E and F.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 152-D

Income Tax Assessment Act 1997 Section 328-110

Reasons for decision

Questions 1 and 2

Summary

Individual A would have been taken to have acquired the Initial Shares for their market value on the death of Individual Y's death.

The executors of Individual A's estate will be taken to have acquired the Initial Shares for market value at the date of Individual A's death.

Detailed reasoning

In Taxation Determination TD 93/35 Income tax: capital gains: what are the CGT consequences where an asset, which was acquired by a legal personal representative (LPR) after the death of the deceased, passes to a remainderman on the death of a life tenant? (Withdrawn) the Commissioner explains the application of former subsection 160ZX(3) of the ITAA 1936.

Where an asset was not owned by the deceased at the time of death, former section 160X of the ITAA 1936 does not apply to deem it to have been acquired at the time of the deceased's death. Nor does former section 160V of the ITAA 1936 apply to deem the asset to have been acquired by the remainderman. When the asset was acquired by the LPR, the remainderman was not absolutely entitled to the asset because the life tenant continued to have an interest in that asset.

On the death of the life tenant, the LPR (as trustee of a testamentary trust) is deemed to have disposed of the asset to the remainderman.

The trustee/LPR is taken to have disposed of the asset for a consideration equal to the market value of the asset at the time of disposal (that is, when the remainderman became absolutely entitled to the asset) - former subsection 160ZX(3) of the ITAA 1936: the remainderman is taken to have acquired the asset for a consideration equal to the asset's market value at the time he/she became absolutely entitled to it - former subsection 160ZX(3) of the ITAA 1936.

Individual X did not own shares in Company A (or the Company) at the time of their death. The Initial Shares did not form part of their estate.

As such, Individual A, as remaindermen, was not absolutely entitled to the Initial Shares at time of Individual X's death.

However, on the death of the life tenant, Individual Y, the legal personal representative (as trustee of a testamentary trust) is deemed to have disposed of the asset to the remainderman, Individual A. Consequently, Individual A would have been taken to have acquired the Initial Shares for their market value at that time.

CGT event A1 under section 104-10 of the ITAA 1997 happens when there is a change of ownership of an asset. As the death of a person causes a change in the ownership of all the assets owned by that person, death would cause the disposal of the assets of the deceased and in the absence of a relieving provision, potentially trigger a liability for CGT.

Division 128 of the ITAA 1997 contains rules that apply when an asset owned by a person just before they die, passes to their LPR or passes to a beneficiary in a deceased estate. Under section 128-10 of the ITAA 1997, when a person dies, any capital gain or loss from a CGT event that results from a CGT asset the person owned just before dying is disregarded.

Relevantly, LPR is defined in subsection 995-1(1) of the ITAA 1997 to mean an executor or administrator of an estate of an individual who has died.

Where the deceased's CGT assets are acquired by their LPR or passes to a beneficiary in the deceased's estate, the LPR or beneficiary is taken to have acquired the asset on the day the person died under subsection 128-15(2) of the ITAA 1997. Further, subsection 128-15(3) of the ITAA 1997 provides that any capital gain or capital loss the LPR makes if the asset 'passes' to a beneficiary in the deceased's estate is disregarded.

The table in subsection 128-15(4) of the ITAA 1997 sets out the modifications to the cost base and reduced cost base of the CGT asset in the hands of the LPR or beneficiary. Relevantly, pursuant to Item 3A of the cost base of the asset is its market value on the date the deceased passed away.

Under section 128-20 of the ITAA 1997, an asset passes to a beneficiary in a deceased estate if the beneficiary becomes the owner of the asset:

a)    under your will, or that will as varied by a court order; or

b)    by operation of an intestacy law, or such a law as varied by a court order; or

c)    because it is appropriated to the beneficiary by your legal personal representative in satisfaction of a pecuniary legacy or some other interest or share in your estate; or

d)    under a deed of arrangement if:

(i)    the beneficiary entered into the deed to settle a claim to participate in the distribution of your estate; and;

(ii)   any consideration given by the beneficiary for the asset consisted only of the variation or waiver of a claim to one or more other CGT assets that formed part of your estate.

It does not matter whether the asset is transmitted directly to the beneficiary or is transferred to the beneficiary by your legal personal representative.

The trustee of a testamentary trust (being a trust created under a will or by the operation of statute, such as intestacy laws) is treated in the same manner as the LPR for the purposes of applying Division 128 of the ITAA 1997: ATO Practice Statement Law Administration PS LA 2003/12 Capital gains tax treatment of the trustee of a testamentary trust. As stated in the PSLA:

Broadly stated, the ATO's practice is not to recognise any taxing point in relation to assets owned by a deceased person until they cease to be owned by the beneficiaries named in the will (unless there is an earlier disposal by the LPR or testamentary trustee to a third party of CGT event K3 applies).

Individual A passed away on XXXX, at which time the Initial Shares owned by Individual A were transferred to the executors of their estate. For CGT purposes, the executors are taken to have acquired the Initial Shares on the date of Individual A's death for the purposes of subsection 128-15(2) of the ITAA 1997.

Questions 3 and 4

Summary

The Company is a small business entity for the purposes of section 328-110 of the ITAA 1997. The Company remains a small business entity where it disposes of land in the course of winding up a business it formerly carried on and it is a CGT small business entity in the income year that it stopped carrying on the business.

Detailed reasoning

Taxation Ruling TR 2019/1 Income tax: when does a company carry on a business? sets out the principles to determine whether a company is carrying on a business.

Relevantly, it explains that:

Companies are typically formed for the purpose of carrying on a business.

Where a company aims to make and has a prospect of profit, it is presumed that it intends to, and does in fact, carry on a business.

The profit-making activities of a company, and those activities it carries on with a profit-making purpose, normally have a commercial character unlike those of an individual or trust. These differences have led the courts to observe that profit-making activities, such as receiving rent from property, do not give rise to a presumption that an individual is carrying on a business, whereas it would if those same activities are undertaken by a company.

The degree of repetition or regularity of the company's activities is relevant to determining whether it carries on a business

Companies have been held to carry on a business where its ongoing activities are relatively limited and its key activities consist of letting the company's premises for rent on an ongoing basis.

The activities of a company that holds assets which generate ongoing returns may be limited to its ongoing management, ensuring it meets ASIC regulatory requirements, decisions (whether express or implicit) to continue holding a relatively static investment portfolio, the receipt and distribution (or retention) of income and other matters of an administrative nature. While relatively limited, this level of activity is sufficient to amount to the carrying on of a business.

Taxation Determination TD 2021/2 Income tax: can a company that carries on a business in a general sense as described in Taxation Ruling TR 2019/1 Income tax: when does a company carry on a business? but whose only activity is renting out an investment property claim the capital gains tax small business concessions in relation to that investment property? confirms that such companies would be carrying on a business in the general sense.

In this case, the Commissioner would accept that the Company has been carrying on a business in the general sense as described in TR 2019/1 - relevantly:

• There is an intention to carry on a business.
• The nature of the activities reflects a profit-making purpose, in particular:

o   the activities are repeated and regular (the Company has been leasing out land since 1972);

o   the size and scale of a Company's activities (X parcels of land comprising XXX hectares); and

o   the activities are conducted in a business-like manner, including the keeping of books, records and the use of a system.

TR 2019/1 explains when a change in activities and purpose of the company may amount to the cessation of business:

Need for an ongoing assessment - changes in activities and purpose

53. Whether a company carries on a business must be assessed based on its activity and status at that time.

...

55. Whether a company ceases to carry on any business requires careful consideration of all the facts. A company that becomes dormant and where there is no further activity or no intention to resume its former or any other business, may cease to carry on a business. This is not likely to be the case where its activities are simply limited in nature (see paragraph 39 of this Ruling). It is also not likely if activities are paused, even for a lengthy period, where there is an intention to resume them. As with starting a business, care needs to be taken to distinguish situations where the company has ceased a particular business, from the situation where the company has ceased carrying on any business. For example, a company may cease trading operations permanently but retain some investments. For this reason, it may still be carrying on a business in the general sense.

56. Where a company has entered liquidation, the courts consider whether there has been a change in the company's activities, their purpose and nature. If the liquidator is no longer carrying on any of the company's profit-making activities and whose only aim is to realise the company's assets in the most advantageous manner for the purpose of liquidating the company and distributing assets to its creditors and members, it may no longer carry on a business. In contrast, if it continues to trade in the process of winding a business down, it likely still carries on that business. If a company sells the entirety of its former business it ceases to carry on that business from the date it is sold.

...

However, pursuant to subsection 328-110(5) of the ITAA 1997 an entity is a small business entity if:

a)    the entity is winding up a business it formerly carried on; and

b)    it was a CGT small business entity in the income year that it stopped carrying on the business.

As such the Company would be considered a small business entity, including at the time it commences winding up its leasing business to the time when the last parcel of the Land is sold consistent with its aim of disposing of all of the Land in winding down of its leasing business on the basis that a business previously carried on was being wound up and when that business stopped the Company is a small business entity.

Summary

Individual F is least XX years old and will be using the capital proceeds with respect to the disposal of the Land for their retirement.

Detailed reasoning

Subdivision 152-B of the ITAA 1997 allows a CGT small business entity to disregard a capital gain arising from a CGT asset that it has owned for at least 15 years if certain conditions are met.

Relevantly, for a company, subsection 152-110(1) of the ITAA 1997 provides:

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

...

(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 that time and the event happened in connection with the individual's retirement; or

(ii) was permanently incapacitated at that time.

In connection with retirement

This phrase 'in connection with their retirement'has no statutory definition.

The provisions relating to the small business 15-year exemption do not define what is meant by the phrase 'in connection with their retirement', nor does it give any indication of the degree of retirement for the purposes of this concession.

Whether a CGT event happens in connection with an individual's retirement depends on the particular circumstances of each case.

The Explanatory Memorandum (EM) to the New Business Tax System (Capital Gains Tax) Bill 1999 makes the following comments about the requirement to be permanently incapacitated or retiring as one of the conditions for the concession:

Requirement to be permanently incapacitated or retiring

1.68 One of the requirements of this concession for an individual small business taxpayer is that they must be either permanently incapacitated at the time of the CGT event, or at least 55 years old and using the capital proceeds for their retirement.

The legislation does not provide a specific definition of the word 'retirement' for the purpose of subparagraph 152-110(1)(d)(i) of the ITAA 1997. Consequently, it takes its ordinary meaning.

The Macquarie Dictionary (online version, downloaded 7 August 2019) defines 'retirement' to mean 'removal or retiring from service, office, or business, especially in reaching the end of one's working life'.

The phrase 'in connection with' has been judicially considered in numerous cases.

In Collector of Customs v Pozzolanic Enterprises Pty Ltd (1993) 43 FCR 280 (Pozzolanic), it was stated by the Full Court of the Federal Court that:

The words 'connected with' are capable of describing a spectrum of relationships ranging from the direct and immediate to the tenuous and remote. As Sheppard and Burchett JJ observed in Australian National Railways Commission v Collector of Customs (SA) [(1985) 69 ALR 367 at 377-378; 8 FCR 264, at 265] the meaning of the word 'connection' is wide and imprecise, one of its common meanings being 'relation between things one of which is bound up with, or involved in, another': Shorter Oxford English Dictionary. (at 288)

Given the potential width of the words 'in connection with', the question remains in a particular case what kind of relationship will suffice to establish the connection contemplated by the statute. This in turn will require a value judgment about the range of the statute: see Pozzolanic at 289 and Taciak v Commissioner of Australian Federal Police (1995) 59 FCR 285 at 295.

Wilcox J of the Federal Court considered the meaning of the phrase 'in connection with the retirement' in Claremont Petroleum NL v Cummings (1992) 110 ALR 239 (Claremont). The case concerned the application of provisions within the Queensland Companies Code and in particular, whether payments made were in connection with the retirement of certain individuals. Wilcox J made the following observations on the phrase 'in connection with:

The phrase "in connection with" is one of wide import, as I had occasion to observe in a different context in Our Town FM Pty Ltd v Australian Broadcasting Tribunal (1987) 16 FCR 465 at p479-80; 77 ALR 577 at pages 591-2:

The words 'in connexion with'...do not necessarily require a causal relationship between the two things: see Commissioner for Superannuation v Miller (1985)8 FCR 153 at 154, 160, 163; 63 ALR 237at 238, 244, 247. They may be used to describe a relationship with a contemplated future event: see Koppen v Commissioner for Community Relations (1986) 11 FCR 360 at 364, Johnson v Johnson [1952] P 47 at 50-1. In the latter case the United Kingdom Court of Appeal applied a decision of the British Columbia Court of Appeal, Re Nanaimo Community Hotel Ltd [1945] 3 DLR 225, in which the question was whether a particular court, which was given 'jurisdiction to hear and determine all questions that may arise in connection with any assessment made under this Act', had jurisdiction to deal with a matter which preceded the issue of an assessment. The trial judge held that it did, that the phrase 'in connection with' covered matters leading up to, or which might lead up to an assessment. He said...: 'One of the very generally accepted meanings of "connection" is "relation between things one of which is bound up with or involved in another"; or, again "having to do with". The words include matters occurring prior to as well as subsequent to or consequent upon so long as they are related to the principal thing. The phrase "having to do with" perhaps gives as good a suggestion of the meaning as could be had.'

Having regard to the context of subparagraph 152-110(1)(d)(i) of the ITAA 1997, the Commissioner considers that it would be reasonable to adopt the meaning given to the phrase 'in connection with' in Claremont such that it is not necessary for there to be a permanent and everlasting retirement from the workforce; however, there would need to be at least a significant reduction in the number of hours worked or a significant change in the nature of the activities to be regarded as a retirement for the purposes of paragraph 152-110(1)(d)(i) of the ITAA 1997.

Similarly, the words 'in connection with' can apply where the CGT event occurs sometime after retirement. Again, this would depend on the particular facts, and would need to be considered on a case-by-case basis.

Relevantly, in this case:

• The basic conditions for relief in Subdivision 152-A of the ITAA 1997 are satisfied.
• The Company continuously owned the CGT asset (i.e. the Land) for the 15-year period ending just before the CGT event.
• The entity had a significant individual (i.e. Individual A) for a total of at least 15 years
• Individual F is a 'significant individual' just before the transfer of the relevant CGT assets (i.e. each CGT event) through their indirect interests for the purposes of section 152-75 of the ITAA 1997.

Individual F has been working on average for X to X hours per week for business performing duties in relation to business operations and will retire from this work. They will reduce their duties and hours worked.

As such, the Commissioner is satisfied that in these circumstances the sale of the CGT assets by the Company is in connection with Individual F's retirement for the purpose of subparagraph 152-110(1)(d)(i) of the ITAA 1997.

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