Edited version of private advice

Authorisation Number: 1052144948812

Date of advice: 10 August 2023

Ruling

Subject: CGT - small business concession

Question

Has the AA Unit Trust continuously owned the Right to operate the franchise business for a 15 year period within the meaning of paragraph 152-110(1)(b) of Subdivision 152-B of the Income Tax Assessment Act 1997?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 2023

The scheme commenced on:

1 July 2022

Relevant facts and circumstances

1.         BB (Trustee) as trustee for the AA Unit Trust (Taxpayer) was incorporated on DD MM YY to trade as "CC" ('the Business'), at Address, commencing on DD MM YY.

2.          The Taxpayer was established by deed on DD MM YY.

3.          On DD MM YY the Taxpayer entered into a franchise agreement, which granted the Taxpayer the right to develop and promote "DD" trademark and service mark in the geographical area in which it carried on business.

4.          The franchise agreement was then renewed continuously for the period to DD MM YY.

5.          The business known as "EE" traded uninterrupted at all times from the commencement of the business on DD MM YY through to the completion of the deed of surrender on DD MM YY (the Trading period).

6.          For the Trading period, the Business operated as EE and did not use any other marks or intellectual property not related to the trademark and service mark.

7.          The outlet licence is a part of the franchise agreement.

8.          At clause D, for consideration, the franchisee wishes to surrender the agreements (meaning the franchise agreement and the outlet licence) prior to the end of the term.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 paragraph 104-25(1)(d)

Income Tax Assessment Act 1997 subsection 108-5(1)

Income Tax Assessment Act 1997 paragraph 108-5(1)(b)

Income Tax Assessment Act 1997 subsection108-5(2)

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

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

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

Reasons for decision

Relevantly, paragraph 152-110(1)(b) of the ITAA 1997 states:

152-110(1) 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:

...

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

...

Subsection 152-110(1A) of the ITAA 1997 provides that:

152-110(1A) For the purposes of paragraphs (1)(b) and (c), disregard subsection 149-30(1A) (which applies if an asset stops being a pre-CGT asset).

The meaning of the term 'CGT asset' is set out in section 108-5 of the ITAA 1997.

108-5(1) A CGT asset is:

(a) any kind of property; or

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

108-5(2) To avoid doubt, these are CGT assets:

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

(b) goodwill or an interest in it;

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

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

...

CGT event C2 happens if a taxpayer's ownership of an intangible CGT asset ends by the asset being abandoned, surrendered or forfeited (paragraph 104-25(1)(d) of the ITAA 1997).

Application of the law

CGT Asset

As per paragraph 108-5(1)(b) of the ITAA 1997 a CGT asset is a legal or equitable right that is not property.

Accordingly, the right granted to the Trustee to operate the franchise business (the right) pursuant to the various franchise agreements are CGT assets.

The execution of the Deed is the surrender of rights pursuant to the franchise agreement and outlet licence which is a CGT event C2.

15 year exemption

To qualify for the small business 15 year exemption, several conditions must be established. Firstly, the basic conditions as contained in subdivision 152-A of the ITAA 1997 must be satisfied. Relevantly, the Trustee must have continuously owned the business asset for the 15-year period ending just before the franchise agreement was surrendered.

As per Taxation Ruling TR 1999/16 Income tax: capital gains: goodwill of a business a business is not a CGT asset:

Meaning of 'business'

7. For the purposes of this Ruling, the word 'business' in its context in section 118-250 has its ordinary meaning. It is a course of conduct carried on for the purpose of profit and also involves notions of continuity and repetition of actions. It is an undertaking or going concern in which an entity or entities use assets, knowledge, skills, human resources and other things as required in continuing activities or transactions for commercial purposes. A business is not a thing or a series of things. A business is not a CGT asset.

Therefore, it is the individual CGT assets of the Trustee's Business that are being surrendered and it is these separate CGT assets that must be continuously owned by the Trustee for the 15 year period ending just before CGT event C2 happens.

Clause 2.2 of the Deed provides that upon and from the completion date, franchisor accepts the surrender of the franchise agreement and the outlet licence. Also from the completion date, the rights to use the know how, operate the Business and occupy the premises; the use of the words 'CC' or any words resembling or likely to be confused with any of the Marks will cease.

In this situation, we consider that the Deed represents the surrender of the Taxpayer's right to continue to operate the franchise under the terms established in the franchise agreement between the Trustee and franchisor. The consideration for this surrender is the payment of the surrender fee.

The execution of the Deed constitutes a surrender of rights under the franchise agreement which is a CGT event C2. CGT event C2 is defined in section 104-25 of the ITAA 1997 as happening if your ownership of an intangible CGT asset ends in certain ways, including because the asset expires or is redeemed, cancelled, released, discharged, satisfied, abandoned, surrendered or forfeited.

The true nature of the relationship may be identifiable from certain key indicators in this case the series of franchise agreements have been executed on substantially similar terms. The franchise business activities have been carried on continuously for more than the requisite 15 year period.

It is accepted that that the rights, obligations and other terms have remained substantively consistent over the 15 year period and that no new obligations or rights of any substance have been conferred or withdrawn. Consequently, it is the Commissioner's view, based on a holistic view of the facts, that in this particular instance the right to operate the franchise business has been continuous for the 15 year period - relevantly in these circumstances Franchise Agreement A and later franchise agreements are merely extensions of the original:

(a)          The terms of the franchise agreement have remained effectively unchanged since 17 March 1983, which supports the view that both parties intended for the franchise agreement to simply be extended. The Trustee's rights under the franchise were acquired and have been continuously extended since DD MM YY on effectively the same terms and conditions.

(b)          The Franchise Agreements at 'Part O: End of Agreement' provides that when the agreement ends, amongst other things, the franchisee must cease using the know how etc. return materials relating to know how etc. In that case, at the end of each agreement the Trustee should have ceased using and returned know how etc. Other than under the Deed, the Trustee has never acted on or been required to act on this clause of the franchise agreements.

(c)           The nature of the correspondence between the parties suggests that there is an expectation the franchise agreement will remain in place unless the Trustee is informed that the franchiser has decided not to continue with the agreement.

(d)          This intention to extend the original franchise agreement rather than create an entirely new agreement is also reflected in the Trustee's actions and the fact that the Trustee has never reported a CGT event C2 in previous years, which would be expect if the trustee saw the agreement renewal as a new asset at the commencement of the next franchise period.

Accordingly, the Trustee has continuously owned the right to operate the franchise business for the 15 year period required by paragraph 152-110(1)(b) of Subdivision 152-B of the ITAA 1997.

Relevantly, for the basic conditions to apply, the CGT asset also needs to satisfy the active asset test.

Section 152-35 of the ITAA 1997 provides that a CGT asset will satisfy the active asset test if:

•                     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 detailed below,

•                     or you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of least 7.5 years during the test period.

The test period:

•                     begins when you acquired the asset, and ends at the earlier of

-        the CGT event, and

-        when the business ceased, if the business in question ceased in the 12 months before the CGT event.

Section 152-40 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 (whether alone or in partnership) by you, your affiliate or another entity connected with you.

The intangible asset, being the contractual rights and entitlements under and to the franchise agreement, was inherently an asset used by the Trustee in operating the business. It is therefore an active asset.

The Trustee acquired the interest under the original franchise agreement and has operated the business continuously for over 15 years, so this condition is satisfied.

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