Edited version of private advice

Authorisation Number: 1052407680053

Date of advice: 12 June 2025

Ruling

Subject: CGT - 15-year exemption

Question 1

Does the property satisfy the active asset test under section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer 1

No.

Question 2

Is the company entitled to apply the small business 15-year exemption in section 152-110 of the ITAA 1997 to disregard the capital gain made on the disposal of the property?

Answer 2

No.

Question 3

Will the distribution of the proceeds of sale be exempt to the shareholders and not deductible to the company under section 152-125 of the ITAA 1997?

Answer 3

Not applicable.

This ruling applies for the following period:

Year Ended 30 June 20XX

The scheme commenced on:

July 20XX

Relevant facts and circumstances

The company shares were originally owned by:

•                     Shareholder A (over 55 years old) - 40%

•                     Shareholder B (over 55 years old) - 40%

•                     Brett Dicker (under 55 years old) - 20%

Shareholder B's shares were then transferred to Shareholder A.

The company purchased the property and operated a business from those premises for a number of years. Shareholder A and Shareholder B retired when the business ceased numerous years ago.

From the cessation of the business until the date of sale of the property, the property was leased to a company owned by Shareholder C which operates a business from the premises (the second company). The 2 companies do not have a relationship with one another by any means other than the company leasing their premises to the second company and Shareholder C holding shares in both companies.

The premises has been sold.

The premises had been continuously used as business premises over the ownership period.

The second company sold its business to the entity that purchased the premises. Shareholder C then worked elsewhere for wages. Shareholder C is now fully retired and is under 55 years of age.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 152-55

Income Tax Assessment Act 1997 section 152-60

Income Tax Assessment Act 1997 section 152-65

Income Tax Assessment Act 1997 section 152-110

Income Tax Assessment Act 1997 section 152-125

Reasons for decision

Question 1

Summary

The property the company disposed of is not an active asset.

The exception at paragraph 152-40(4)(e) of the ITAA 1997 applies to the property. This exception excludes capital gains tax (CGT) assets from being active assets if their main use is to derive rent. The company used the property to derive rent from the second company for a majority of the ownership period and ran its own business on the premises for less than X years. The second company's use of the property in carrying on its business is unable to be treated as the company's use of the property as per paragraph 152-40(4A) of the ITAA 1997, since the second company is not an affiliate of or connected with the company.

Consequently, the main use of the property is to derive rent. As such, the property is not considered to be an active asset.

Detailed reasoning

For an asset to satisfy the active asset test as per section 152-35 of the ITAA 1997:

(a)          the entity must have owned the asset for 15 years or less and the asset was an active asset of the entity for a total of at least half of the test period detailed below; or

(b)          the entity must have owned the asset for more than 15 years and the asset was an active asset of the entity for a total of least 7.5 years during the test period.

The test period:

(a)          begins when the entity acquires 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.

For a CGT asset to be an active asset as per section 152-40 of the ITAA 1997, at the time:

(a)          the entity must hold the asset and the asset must be used or held ready for use in the course of carrying on a business by:

(i)            the entity;

(ii)           its affiliate; or

(iii)         another entity it is connected to; or

(b)          if the asset is an intangible asset, the entity must own it and it must be inherently connected with a business that is carried on by the entity, its affiliate or another entity it connects to.

Period 1

In Period 1, the company operated its own business on the property. The property was therefore, being held ready for use while carrying on a business by the company for less than 7.5 years.

Period 2

Of relevance to this case are the exceptions outlined in subsection 152-40(4) of the ITAA 1997. Paragraph 152-40(4)(e) of the ITAA 1997 specifies a CGT asset is not an active when it is used to derive interest, an annuity, rent, royalties or foreign exchange gains. This is unless:

            (i)                it is an intangible asset and has been significantly developed, altered or improved so its market value has been significantly enhanced; or

           (ii)                its use for deriving rent was only temporary.

However, in determining the main use of an asset, paragraph 152-40(4A)(b) of the ITAA 1997 states to treat any use of a CGT asset by an affiliate or connected entity as the taxpayer's own use. The effect of this provision is that any affiliate or entity connected with the company that used the property as an active asset may allow the company to avoid the exception at paragraph 152-40(4)(e) of the ITAA 1997 and therefore, pass the active asset test.

This view is outlined in Taxation Determination TD 2006/63 Income tax: capital gains: is a CGT asset that is leased by a taxpayer to a connected entity for use in the connected entity's business an active asset under section 152-40 of the Income Tax Assessment Act 1997? (TD 2006/63). TD 2006/63 explains that a CGT asset leased by a taxpayer to a connected entity for use in the connected entity's business is an active asset of the taxpayer under section 152-40 of the ITAA 1997.

The property was being rented to the second company for most of the ownership period. For paragraph 152-40(4A) to apply, it must be established the second company is either an affiliate or connected to the company.

Affiliates

The meaning of affiliate is set out in section 328-130 of the ITAA 1997. Subsection 328-130(1) provides an individual or a company is an affiliate of a taxpayer if the individual or company acts or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes or in concert with the taxpayer, in relation to the affairs of the business of the individual or company. The test is applied in relation to the affairs of the business generally and not merely in relation to the CGT asset.

Therefore, for the second company to be an affiliate of the company, it must be shown the second company acts or could reasonably be expected to act, in accordance with the company's directions or wishes or in concert with the company, in relation to the affairs of the business of the second company.

Apart from renting the property to the second company, the company has no other involvement in the business of the second company. Therefore, there is no conduct in pursuit of an objective or purpose which is common for both companies. Consequently, the second company is not considered to be acting in accordance with the company's directions or wishes or acting in concert with the company in relation to the affairs of the business of the second company.

Moreover, subsection 328-130(2) explains an individual or company is not considered an affiliate merely because of the nature of the business relationship the taxpayer and the individual or company share. Therefore, as Shareholder C is a shareholder of the company and the second company, this does not make them an affiliate of the company or make the companies an affiliate of each other merely due to their business relationship with each company.

Since the second company does not act in accordance with the company's directions or wishes or in concert with the company in the running of its business, the second company is not an affiliate of the company under section 328-130 of the ITAA 1997.

Connected entities

The term connected with is defined in section 328-125 of the ITAA 1997. Subsection 328-125(1) of the ITAA 1997 states an entity connects to another entity if:

a)            either entity controls the other entity in a way as described in this section; or

b)            both entities are controlled in a way described in this section by the same third entity.

Subsection 328-125(2) of the ITAA 1997 sets out what is meant by direct control of an entity other than a discretionary trust. Where the other entity is a company, paragraph 328-125(2)(b) of the ITAA 1997 relevantly states:

An entity (the first entity) controls another entity if the first entity, its affiliates, or the first entity together with its affiliates:

(b)          if the other entity is a company - 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, a percentage (the control percentage) that is at least 40% of the voting power in the company.

Therefore, for the company to be a connected entity with the second company:

•                     the company, together with its affiliates, must own 40% of the equity interests in the second company, or

•                     the company must be controlled by an entity that also controls the second company, whereby control is determined by the entity, together with its affiliates, owning 40% of the equity interests

The company does not hold an equity interest in the second company and has no voting power in the second company. To pass the test at paragraph 328-125(1)(a) of the ITAA 1997, the second company would therefore need to rely on its affiliates having equity interests in the second company of at least 40%.

For the company and the second company to connect to each other in accordance with paragraph 328-125(1)(b) of the ITAA 1997, they would need to be controlled by the same third entity.

Both Shareholder C and their spouse hold more than 40% shares in the second company. Despite this, Shareholder C holds less than 40% shares in the company and their spouse holds no shares in the company. Their spouse therefore does not control the company. As Shareholder C does not have at least 40% of the voting power in the company, they also do not control the company.

Conclusion

The second company is not an affiliate of the company under section 328-130 of the ITAA 1997 and the companies are not connected under section 328-125 of the ITAA 1997. Since the property was being leased to the second company for most of the ownership period and the second company is not affiliated or connected with the company, paragraph 152-40(4A)(b) of the ITAA 1997 has no application. Therefore, the exception at paragraph 152-40(4)(e) of the ITAA 1997 will apply to exclude the property being regarded as an active asset.

The company has owned the property for over X years; however, as the property is only regarded as an active asset for less than X of those years, the asset does not satisfy the active asset test under section 152-35 of the ITAA 1997.

Question 2

Summary

The company does not satisfy all the relevant requirements under section 152-110 of the ITAA 1997 in relation to the sale of the property. Shareholder A, one of the significant individuals of the company, retired numerous years prior to the sale of the property. A requisite connection between Shareholder A's retirement and the sale of the property does not exist. The other significant individual, Shareholder C is under 55 years of age. Furthermore, as the property does not satisfy the active asset test, not all the basic conditions under Subdivision 152-A of the ITAA 1997 are satisfied.

Detailed reasoning

Whether a CGT event happens in connection with an individual's retirement depends on the particular circumstances of each case. We consider that 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 is not necessary for there to be a permanent and everlasting retirement from the workforce.

A CGT event may happen in connection with an individual's retirement irrespective of whether it happens before or after the individual's retirement; however, the individual's retirement must have some proximity to the CGT event. The closer the CGT event is to the retirement, the more likely the CGT event is 'in connection with the individual's retirement'.

In this case, Shareholder A, a significant individual of the company, retired numerous years prior to the sale of the property. While it is acknowledged a retirement can happen sometime before or after the CGT event, there still needs to be a connection between the retirement and the disposal of the property. It is the Commissioner's view that, due to the significant period between Shareholder A's retirement and the disposal of the property, the requisite connection between the 2 events does not exist. The only other significant individual is Shareholder C, who although retired, is under 55 years of age.

Therefore, as the property does not satisfy the active asset test, the sale of the property has not happened in connection with the retirement of a significant individual who was 55 or over, and no evidence has been provided that a significant individual was permanently incapacitated at the time of the CGT event, the company cannot disregard the capital gain made on the disposal of the property under section 152-110 of the ITAA 1997.

Question 3

In accordance with section 152-125 of the ITAA 1997, if a capital gain made by a company is disregarded under the small business 15-year exemption, any distribution made by the company of that exempt amount to a CGT concession stakeholder is (if certain additional conditions are satisfied):

•                     not included in the assessable income of the CGT concession stakeholder

•                     not deductible to the company or trust, and

•                     not considered a dividend or frankable distribution

A 'CGT concession stakeholder' of a company is an individual who is either:

(a)          a significant individual in the company; or

(b)          a spouse of a significant in the company, if the spouse has a small business participation percentage in the company at the that time that is greater than zero.

In this case, as the company does not meet the requirements of the 15-year exemption, section 152-125 of the ITAA 1997 is not applicable.

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