Edited version of private advice

Authorisation Number: 1052135218907

Date of advice: 30 June 2023

Ruling

Subject: 15-year retirement concession

Issues

Question 1

Does the Company satisfy the basic conditions set out in section 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997) for the purposes of Subdivision 152-B of the ITAA 1997 with respect to the disposal of the Property?

Answer

Yes

Question 2

Does the Company satisfy the requirements in subsection 152-110(1) of the ITAA 1997 to apply the 15-year exemption in respect of the sale of the Property?

This ruling applies for the following periods:

1 July XXXX to 30 June XXXX

Relevant facts and circumstances

On XXXX, the Property was acquired by the following entities as tenants in common in equal shares:

•                     The Company - 50%; and

•                     Individual A (in their personal capacity) - 50%.

The Property was purchased for approximately $X by Individual A and the Company, with each paying 50% of the purchase price.

On XXXX, Individual A and the Company entered into a contract of sale of real estate with the Purchasers) for the sale of the Property.

Settlement of the sale of the Property occurred on XXXX.

The disposal of the property resulted in a capital gain for the purposes of CGT Event A1.

No changes in the ownership of the Property occurred between the time the Property was purchased by Individual A and the Company and when it was sold by them.

The Company

The Company was incorporated after 20 September 1985.

At all times the ordinary shares in the Company were owned:

•                     50% by Individual B; and

•                     50% by Individual C.

From the time of its incorporation, the Company operated a business.

The Company relocated the business to the Property sometime in XXXX.

The business continued from the Property until around XXXX when the Company decided to dispose business assets. Accordingly, the business wound down until around XXXX.

Finally in XXXX, the Company's use of the premises ceased entirely.

The Company's gross turnover from its activities has never exceeded $2 million.

The Company made a profit in each income year from 2005 to 2022.

For the years ended 30 June XXXX and XXXX, the Company did not have any:

•                     'connected entities' within the meaning of section 328-125 of the ITAA97; or

•                     'affiliates' within the meaning of section 328-130 of the ITAA 1997.

Use of the Property

The Property has been used for various business activities since it was purchased in XXXX. Specifically, the Property has been used by:

a)    Company B in its business. Company B operated its business from XXXX through to XXXX when settlement of the Property was completed;

b)    The Company and Company B, for their respective businesses.; and

c)    Individual A, in the operation of their own business.

Company B

Company B was incorporated before 20 September 1985 and was originally owned by a third party to operate a business.

At some time during the XXXX, Individual B purchased the shares in Company B and continued the business.

Company B also conducted its operations from the Property around XXXX

Between XXXX and XXXX, the shares in Company B were owned:

•                     51% by Individual B; and

•                     49% by Individual A.

On XXXX, Individual B's shares in Company B were bought back by the company. From that point, Individual A was the sole shareholder of Company B.

Individual B and Individual C

Individual B and Individual C solely operated the business via Company B between the XXXX until Individual A joined the business (at which point they jointly ran the business). In addition, Individual B and Individual C operated the Company's business until it ended in XXXX.

Around early XXXX, Individual A suffered an injury. Due to their health/medical conditions, Individual B was unable to work.

Subsequently Individual B suffered further injury in XXXX and as result has very limited capacity.

As at the date of sale of the Property Individual B and Individual C are at least 55 years old.

Individual C is still in good health and currently:

•                     acts as Individual B's primary carer; and

•                     manages the investments and general affairs of the Company.

As the Property was a significant asset of the Company's, the sale of the Property will now enable Individual C to take a more passive role (reducing their activities as it relates to the management of the investments and compliance obligations of the company) and even wind up the Company (thus ceasing their role as a director of the company).

The Company's share of the proceeds from the sale of the Property will be used to fund Individual B and Individual C's retirement.

Both Individual B and Individual C, being of advanced years, do not plan to engage in any future employment or business ventures.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 104-10

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-55

Income Tax Assessment Act 1997 section 152-65

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

Income Tax Assessment Act 1997 section 328-110

Income Tax Assessment Act 1997 section 328-125

Reasons for decision

Questions 1 and 2

Summary

The sale of the Property by the Company is in connection with Individual B and Individual C's retirement.

Individual B is at least 55 years old, and also permanently incapacitated, and will be using the capital proceeds with respect to the disposal of the Property for their retirement.

Individual C is at least 55 years old and will be using the capital proceeds with respect to the disposal of the Property 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:

(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;

...

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

(ii) was permanently incapacitated at that time.

Basic conditions in Subdivision 152-A of the ITAA 1997

Subsection 152-10(1) of the ITAA 1997 sets out the basic conditions.

Relevantly, the requirements include the following:

(a)          A CGT event happens in relation to a CGT asset in an income year.

(b)          The event would (apart from Division 152 of the ITAA 1997) have resulted in a gain.

(c)           You are a small business entity for the income year

(d)          The CGT asset satisfies the active asset test in section 152-35 of the ITA 1997.

CGT event giving rise to a capital gain

Section 102-20 of the ITAA 1997 provides that a capital gain or capital loss is made if a CGT event happens to a CGT asset.

The Property is a CGT asset (section 108-5 of the ITAA 1997).

Relevantly, under subsection 104-10(1) of the ITAA 1997, CGT event A1 happens if you dispose of a CGT asset.

Under subsection 104-10(2) of the ITAA 1997, you dispose of a CGT asset when a change of ownership occurs from you to another entity.

The effect of CGT Event A1 happening is that you make a capital gain if the capital proceeds from the disposal are more than the asset's costs base or a capital loss if those capital proceeds are less than the asset's reduced cost base (subsection 104-10(5) of the ITAA 1997).

The time of the event is when you enter into the contract for the disposal, or, if there is no contract, when the change occurs (subsection 104-10(3) of the ITAA 1997).

Small business entity

Pursuant to subsection 152-10(1AA) of the ITAA 1997:

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.

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

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 an inactive company with retained profits is considered to e carrying on a business where it continues to make a profit:

Example 1 - inactive company with retained profits

62. InactiveCo is a company incorporated in Australia. InactiveCo carried on a trading business that was wound up in the 2015-16 income year. InactiveCo has $400,000 of retained earnings which it holds in a bank account.

63. In the 2016-17 and later income years, the company's income has consisted solely of interest of $12,000 a year. InactiveCo has no intention of resuming its trading business. InactiveCo pays an annual company review fee of $254 to ASIC. The company's income is consistently greater than its expenses. As a result, the company has made a profit in each income year from 2016-17.

64. InactiveCo's activities have both a purpose and prospect of profit. InactiveCo is carrying on a business.

Active asset test

Under subsection 152-35(1) of the ITAA 1997, a CGT asset will satisfy 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 test period, 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 test period.

Under subsection 152-35(2) of the of the ITAA 1997 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.

Subsection 152-40(1) of the ITAA 1997 provides that a CGT asset is an active asset at a time if, at that time you own the asset and it is used, or held ready for use, in the course of carrying on a business that is carried on by you, or your affiliate, or another entity that is connected with you.

Under subsection 328-125(1) of the ITAA 1997, an entity is connected with another entity if:

(a)          either entity controls the other entity; or

(b)          both entities are controlled by the same third entity.

Relevantly, paragraph 328-125(2)(b) of the ITAA 1997 provides that a company is controlled by you if you, or you together with your affiliates, own, or have the right to acquire the ownership of, equity interests in the company that carry between them the right to exercise, or control the exercise of, at least 40% of the voting power in the company.

Continuously owned

The Commissioner explains in Taxation Determination TD 94/89 Income tax: capital gains: in what year of income is a taxpayer required for tax purposes to include a capital gain or loss in relation to land disposed of under a contract which is made in one year of income, but which is settled in a later year of income? that, generally for CGT purposes, ownership in relation to the disposal of property is determined with reference to settlement:

3. However, a taxpayer is not required to include any capital gain or loss in the appropriate year until an actual change of ownership occurs. Settlement effects a change of ownership and a disposal (subsection 160M(1)) which then triggers the operation of subsection 160U(3). When settlement occurs, the taxpayer is then required to include any capital gain or loss in the year of income in which the contract was made (subsection 160U(3)). If an assessment has already been made for that year of income, the taxpayer may need to have that assessment amended.

However, whether an entity has continuously owned the CGT asset for the 15-year period set out in paragraph 152-110(1)(b) of the ITAA 1997 is determined with reference to when the CGT asset commences to be owned by the entity to just before the CGT event (in the case of CGT event A1, the date of the contract for the sale of the CGT asset).

Significant individual

Relevantly, an entity will be a significant individual under section 152-55 of the ITAA 1997 if they hold a small business participation percentage in the company of at least 20%.

Small business participation percentage in section 152-65 of the ITAA 1997 is defined as:

'An entity's small business participation percentage in another entity at a time is the percentage that is the sum of:

a)            the entity's direct small business participation percentage in the other entity at that time, and

b)            the entity's indirect small business participation percentage in the other entity at that time."

Broadly, a direct small business participation percentage is the percentage that the entity has from holding shares in the company.

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 e.g. 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.

Application in these circumstances

Relevantly, in this case:

•                     The basic conditions for relief in Subdivision 152-A of the ITAA 1997 are satisfied:

-        the sale of the Property will result in a capital gain for the purpose of CGT event A1

-        notwithstanding that it is inactive, the Company is carrying on a business as it has made a profit in each of the income years from the cessation of its activities to the disposal of the Property and its aggregated turnover is less than $2 million for the purposes of section 328-110 of the ITAA 1997; and

-        the Property is an active asset as was owned by the Company (and Individual A) for more than 15 years and it was used by the Company and Company B for a total of at least 7½ for the period it was owned in carrying on the Company and Company B's business activities, with the Company conducting its business from the Property, broadly, from XXXX to XXXX and Company B from XXXX to XXXX. The Company and Company B are connected through Individual B's shareholdings of more than 40% in the Company and Company B.

•                     The Company (and Individual A) have continuously owned the CGT asset (i.e. the Property) for the 15-year period ending just before the CGT event - i.e for, the acquisition of the Property to the contract for the sale of Property.

•                     The Company has had a significant individual for a total of at least 15 years: as Individual B and Individual C have continuously held 50% of the shares in the Company, they both hold a small business participation percentage of 50% and are both considered significant individuals.

•                     Individual B has retired and/or is permanently incapacitated. Individual C has reduced their activities/involvement in the Company due to the circumstances of providing primary care for Individual B and the sale of the Property.

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

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