Edited version of private ruling

Authorisation Number: 1011626312657

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Ruling

Subject: Small business 15-year exemption

Question

Will the small business 15-year exemption in section 152-105 of the Income Tax Assessment Act 1997 (ITAA 1997) apply in relation to the disposal of your business goodwill to another entity?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2011

Year ended 30 June 2012

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You are over 55 years of age.

You have carried on a business in your own name for over 15 years.

The principal asset of the business is its goodwill.

You wish to put in place arrangements which will enable you to sell your business on advantageous terms on your retirement. You wish to do this at a time and in circumstances where you have bargaining power that you may not have at a later time and which will secure a greater likelihood of maximising the value of the business when you retire or if you were to become permanently incapacitated.

You intend to transfer the business goodwill and other assets to a related entity, with the ultimate intention of transferring the business to a third party.

You will make a capital gain from the disposal of the business goodwill in the year of disposal.

You have stated that the basic conditions in Subdivision 152-A of the ITAA 1997 are satisfied for the purposes of this application.

The applicant has advised that there is unlikely to be any reduction in hours worked by you, or any significant change in the nature of your present activities after the disposal of the goodwill to the entity.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 109-10

Income Tax Assessment Act 1997 Section 152-10

Income Tax Assessment Act 1997 Section 152-35

Income Tax Assessment Act 1997 Section 152-105

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

Under the small business 15-year exemption in section 152-105 of the ITAA 1997, you can disregard any capital gain in relation to the disposal of your business goodwill to the entity if all of the following conditions are satisfied:

· the basic conditions in Subdivision 152-A of the ITAA 1997 are satisfied for the gain

· you continuously owned the goodwill for the 15-year period ending just before the CGT event and

· either:

· you are 55 or over at the time of the CGT event and the event happens in connection with your retirement or

· you are permanently incapacitated at the time of the CGT event.

Condition (a)

Section 152-10 of the ITAA 1997 contains the basic conditions to be satisfied. These conditions are:

· a CGT event happens in relation to a CGT asset in an income year. This condition does not apply in the case of CGT event D1

· the event would (apart from Division 152 of the ITAA 1997) have resulted in the gain

· at least one of the following applies:

· you are a small business entity for the income year

· you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997

· you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership or

· the conditions in subsection 152-10(1A) or (1B) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year.

· the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997.

You have stated that the basic conditions in Subdivision 152-A of the ITAA 1997 are satisfied for the purposes of this application.

Condition (b)

You acquired the business goodwill when you started the work that resulted in the creation of the goodwill (subsection 109-10 item 1 of the ITAA 1997), which in your case would be when you commenced your business.

As you still own the goodwill, you will have continuously owned the goodwill for the 15-year period ending just before the CGT event, and this condition will be satisfied.

Condition (c)

On the basis of the facts supplied with your application, condition (c)(i) will be the relevant condition to be satisfied in your case.

You will be over 55 years of age at the time of the CGT event and this part of condition (c)(i) will be satisfied. The CGT event, however, needs to have happened in connection with your requirement for this condition to be satisfied.

The courts consider that the words 'in connection with' have a wide meaning but are to be interpreted in the context of the statute in which they are contained. Davies J stated in Hatfield v. Health Insurance Commission (1987) 15 FCR 487 at 491; 77 ALR 103 at 106-107:

Expressions such as 'relating to', 'in relation to', 'in connection with' and 'in respect of' are commonly found in legislation but invariably raise problems of statutory interpretation. They are terms which fluctuate in operation from statute to statute…

The terms may have a very wide operation but they do not usually carry the widest possible ambit for they are subject to the context in which they are used, to the words with which they are associated and to the object or purpose of the statutory provision in which they appear.

The ITAA 1997 does not provide a definition of when a CGT event happens in connection with the retirement of an individual and as such the interpretation of that phrase takes on its ordinary meaning. The word 'retirement' is defined in the Macquarie Dictionary to mean:

noun

· the act of retiring.

· the state of being retired.

· removal or retiring from service, office or business. …

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

1.5 …the disposal is related to a person retiring…

and

1.69 …an individual small business taxpayer…must be…at least 55 years old and using the capital proceeds for their retirement.

Whether a CGT event happens in connection with an individual's retirement for the purposes of the small business 15-year exemption 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 be 'in connection with your retirement' even if it occurs some time before retirement. Our publication Advanced Guide to Capital Gains Tax Concessions for Small Business 2008-09 provides the following example in this regard:

A small business operator, aged over 55, sells some business assets as part of a wind down in business activity ahead of selling the business. Within six months, she sells the business and ends her present activities. If it can be shown that the earlier CGT event was integral to the business operator's plan to cease her activities and retire, the CGT event may be accepted as happening in connection with retirement.

In your case, there is unlikely to be any reduction in hours worked by you, or any significant change in the nature of your present activities after the disposal of the goodwill to the entity. You state that realisation of the maximum pay-out on retirement is dependent, in part, on you and your staff increasing the profitability of the business in the years between establishing the structure and your retirement. You also state that your retirement may occur as soon as the next couple of years after the transfer of the business to the entity, or it may not occur for a number of years after the structure is put in place.

It can not be said in your case that the disposal of the goodwill is 'in connection with your retirement'. Although you are at an age where retirement could be considered, you have no plan to retire at a specific time and you will not be actually retiring or reducing your hours worked following the disposal of the goodwill. The disposal is not integral to any plan to cease your activities and retire in the short term.

Many people make business and investment decisions to attempt to maximise their assets for their retirement, however this is not sufficient for any CGT events resulting from these decisions to be said to be in connection with their retirement. The CGT event needs to have happened as part of a retirement plan or actual retirement. A general intention to retire at some time in the future would not satisfy this requirement.

We do not consider that this condition will be satisfied.

Conclusion

As you will not satisfy all of the above conditions, the small business 15-year exemption in section 152-105 of the ITAA 1997 will not apply in relation to the disposal of your business goodwill to the entity.

Note

As you will not be eligible for the small business 15-year exemption, you may choose to disregard all or part of the capital gain (up to your CGT retirement exemption limit) under the small business retirement exemption contained in Subdivision 152-D of the ITAA 1997 provided that the relevant conditions are satisfied.

This concession allows you to provide for your retirement, and there is no requirement to terminate any activity or cease business.