Edited version of private ruling

Authorisation Number: 1011677062011

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Ruling

Subject: Sale of farming land - Division 152 active asset

Question 1

Is land you used for sharefarming an active asset under Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

This ruling applies for the following period

Year ended 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts and circumstances

In the recent year you sold X hectares of farm land.

You acquired this land in the early nineties as a gift from your parent, and for several years the land was used by family members free of charge for farming purposes.

Later, you had a sharefarming arrangement with Farmer A. You provided financial support to Farmer A in the form of a loan, which was repaid after harvest.

A few years later you leased the land to your sibling. During this time the land was farmed by your sibling's spouse.

During this period you contributed money for fertilizer to increase the farming income.

Later, you had a sharefarming arrangement with Farmer B.

The difference between the leasing arrangement with your sibling where Farmer B farmed the land, and the sharefarming arrangement with Farmer B was that during the leased period you received a pre-negotiated, fixed sum in lease payments as opposed to receiving a percentage of the farming proceeds from the sharefarming arrangement.

You then had a sharefarming arrangement with Farmer C until the sale of the land in the recent year.

You signed a formal sharefarming agreement dated <date> with Farmer C, however you had no formal sharefarming agreements with either Farmer A or Farmer B.

The formal sharefarming agreement provided that Farmer C agreed to:

· use the land for the purpose of growing grain and fodder crops,

· undertake cultivation and ploughing activities, planting, harvesting and marketing such crops as you and he mutually agree upon,

· keep and maintain the cultivation area free from noxious weeds and check for soil erosion as far as practicable,

· repair things damaged or destroyed by them, their agents, or their worker's carelessness,

· supply at their own expense all machinery, bulk handling equipment and labour necessary for the performance of their obligations under the agreement,

· provide at their own cost and expense all fuel, oils, greases, repairs, fertilisers, seeds, sprays (insecticides and herbicides), cartage, bales, bulk handling bags and sewing twines for the performance of their obligations under the agreement,

· work the land to obtain the best yield possible and keep the area in a state of cultivation as to be designed to yield at least one crop in every twelve monthly period.

The formal sharefarming agreement provided that you, as land owner, agreed to:

· bear a proportionate share of the cost of cartage, road freight and rail freight and crop insurance,

· provide fencing to prevent the straying of livestock onto the sharefarmed land.

The agreement states:

Nothing herein contained shall be deemed or construed as:-

(a) Granting to the farmer any estate or interest in the said land to be occupied by them as sub-lessee, lessee, or tenant of the owner. The farmer acknowledges that they are the licensee of the owner and only in respect of the said land.

(b) Creating any partnership between the owner and the farmer.

(c) Creating the relationship of employer and employee between the owners and the farmer or either of them and the farmer expressly stipulates that their expectations of revenue by virtue of this agreement and the conditions permitting hereunder are more favourable than would be available to them under any award.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 subsection 152-10(1)

Income Tax Assessment Act 1997 section 152-15

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 subsection 152-35(1)

Income Tax Assessment Act 1997 subsection 152-35(2)

Income Tax Assessment Act 1997 subsection 152-40(1)

Income Tax Assessment Act 1997 Subdivision 328-C

Income Tax Assessment Act 1997 section 328-125

Income Tax Assessment Act 1997 subsection 328-125(1)

Income Tax Assessment Act 1997 subsection 328-125(2)

Income Tax Assessment Act 1997 subsection 328-125(7)

Income Tax Assessment Act 1997 subsection 328-125(8)

Income Tax Assessment Act 1997 section 328-130

Reasons for decision

Summary

As your land was not used or held ready for use in the course of a business being carried on by you, your affiliate or an entity that is connected with you, your land is not an 'active asset' of yours under Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997).

Detailed reasoning

Under subsection 152-10(1) of the ITAA 1997 a capital gain you make may be reduced or disregarded if the following basic conditions are satisfied for the gain:

(a) a CGT event happens in relation to a CGT asset of yours in an income year;

(b) the event would (apart from this Division) have resulted in the gain;

(c) at least one of the following applies:

i. you are a small business entity (as defined under Subdivision 328-C of the ITAA 1997) for the income year;

ii. you satisfy the maximum net asset value test (under section 152-15 of the ITAA 1997);

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

iv. the conditions mentioned in subsection (1A) or (1B) [both relating to passively held assets] are satisfied in relation to the CGT asset in the income year;

(d) the CGT asset satisfies the active asset test (under section 152-35 of the ITAA 1997).

Section 152-35(1) of the ITAA 1997 provides that a CGT asset satisfies the active asset test if 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 period specified in subsection (2).

The period in subsection 152-35(2):

(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.

You acquired the farming land in the early nineties and sold the property on before 30 June in the recent year, an ownership period of more than 15 years. As such, your land must have been an active asset of yours for a total of at least 7 ½ years during the period of your ownership.

The following table summarises the use of your land over your ownership period:

Meaning of active asset

Subsection 152-40(1) explains that a tangible CGT asset, such as your land, is an 'active asset of yours' if:

· you own the asset, and

· it is used or held ready for use,

· in the course of carrying on a business, by:

o you; or

o your affiliate; or

o another entity that is connected with you.

This means that if 'you' are not carrying on a business in which the land is used (or is held ready for use), but you are providing your land to be used in another entity's business (by lease or rental agreement), then that entity must be your affiliate or 'connected with' for your land to meet the definition of an active asset at a particular time.

Carrying on business

Taxation Ruling TR 97/11 is the primary source of the Commissioner's view on whether activities undertaken amount to the 'carrying on of a business' and at paragraph 13 provides a number of relevant indicators as follows:

· whether the activity has a significant commercial purpose or character; this indicator comprises many aspects of the other indicators;

· whether the taxpayer has more than just an intention to engage in business;

· whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity;

· whether there is repetition and regularity of the activity;

· whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business;

· whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit;

· the size, scale and permanency of the activity; and

· whether the activity is better described as a hobby, a form of recreation or a sporting activity.

All the facts and circumstances in each case must be examined. No one indicator is decisive and the indicators often overlap significantly. The indicators must be considered in combination and as a whole. Whether a activities amount to the carrying on of a business will depend on the 'large or general impression gained' and whether the operations overall have a 'commercial flavour' (TR 97/11 paragraphs 15 and 16).

Sharefarming

Taxation Determination TD 95/62 focuses specifically on sharefarming, and whether these activities amount to the carrying on of a business and at paragraph 3 states that in certain circumstances, these arrangements may amount to the carrying on of a business in partnership.

Carrying on business in partnership is more broadly discussed in Taxation Ruling TR 94/8, which explains there are no statutory rules in income tax legislation to guide this decision. Whether a partnership exists is answered by considering the facts and circumstances of the case at hand and is evidenced by the actual conduct of the parties involved.

Paragraph 4 of TR 94/8 provides relevant factors in deciding whether entities are carrying on business as partners:

Intention

· the mutual assent and intention of the parties

Conduct

(a) joint ownership of business assets

(b) registration of business name

(c) joint business account and the power to operate it

(d) extent to which parties are involved in the conduct of the business

(e) extent of capital contributions

(f) entitlements to a share of net profits

(g) business records

(h) trading in joint names and public recognition of the partnership.

In regards to sharefarming arrangements, paragraphs 5 to 7 of TD 95/62 state:

5. To be carrying on a business, the taxpayer must be involved in the activities that make up that business. This would be evidenced by an element of control over, and/or an ongoing participation in, the business. The involvement should be direct or immediate, rather than passive. The payment of expenses relating to the ownership of the land would not, without more, be sufficient.

6. In the absence of such an involvement, the landowner would not be regarded as being engaged in the business of primary production. The receipt by the landowner of a payment from the farmer for the use of the land would be in the nature of income from property rather than from the carrying on of a business of primary production.

7. Similar reasoning would apply if the sharefarming agreement was for the provision of machinery or items of plant.

Was the land being used in the course of a business carried on by you?

During the period when you owned both parcels of land, you entered into sharefarming arrangements with the following individuals (the farmers):

· Farmer A (4 ½ years)

· Farmer B (2½ years), and

· Farmer C (2 years)

You signed a formal sharefarming agreement with Farmer C, but did not have formal agreements in place with Farmer A or Farmer B. However, you advise that the arrangements were that you provided the farm land and farming equipment and were paid 25% of the gross proceeds from sale of crops.

You advise you frequently consulted with the sharefarmers regarding matters relating to the farm, including crop selection, fertilizer application, planting and harvesting, notifications and machinery repairs. However, you did not participate in the conduct of these activities.

In reference to the formal agreement with Farmer C, the document refers to them as your 'licensee', and states you were not acting in partnership with them.

In applying these facts with the indicators of carrying on a business, the relevant factors in determining if a partnership exists, and the Commissioner's more specific view regarding sharefarming arrangements, the following can be concluded:

· It appears the intention of the parties involved was clearly to create a mutually beneficial arrangement, however, there is no suggestion that you intended to be a partner in carrying on a business.

· There was no joint ownership of business assets and your payments were not a share of net profits, equal to a share of business income after business expenses, but a percentage of gross sales, from which you paid your own individual expenses.

· No joint business name was registered, there were no joint business accounts and no joint business records were kept.

· You provided financial assistance to Farmer A, however the money was considered to be a loan and there was an obligation to repay you. As such, this contribution is more accurately described as debt rather than capital contributed to a business partnership.

· You provided money to Farmer B in 2003, however, this was during the period when you leased the land to your sibling, whilst the income you received is characterised as income from leasing the property; not from activities of a business being carried on in which you were a partner.

· Although you conversed with the farmers on matters of the farm such as crop selection, fertiliser application, planting, and harvesting, you were not directly and actively participating in these activities or other business administrative activities.

· You were not in a controlling role as part owner of a business.

As discussed in TD 95/62 paragraphs 6 and 7 above, the income gained from these arrangements required no active involvement by you, but is characterised as income from making your property (both from your land and your equipment), available for use by others in their businesses.

Was the land being used in the course of a business carried on by your affiliate?

Meaning of affiliate - Section 328-130 of the ITAA 1997

An individual or a company is your affiliate if the individual or company acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the individual or company's business. However, an individual or a company is not your affiliate merely because of the nature of the business relationship you and the individual or company share. For example:

A partner in a partnership would not be an affiliate of another partner merely because the first partner acts, or could reasonably be expected to act, in accordance with the directions or wishes of the second partner, or in concert with the second partner, in relation to the affairs of the partnership.

'Acting in concert' means acting as one, singlehandedly, in unison. Factors that may indicate parties are acting in concert may include: family or close personal relationships; financial relationships or dependencies; directors or shareholders; degree of consultation; and whether there is an obligation to conduct business with the other. However, none of these, itself, is decisive.

As the users of the land were not reasonably expected to act, in accordance with your directions or wishes in relation to the affairs of the businesses being carried on they were not your affiliates under the definition provided in section 328-130 of the ITAA 1997.

As such, the land was not being used in the course of a business being carried on by your affiliate at any time during your period of ownership.

Was the land being used in the course of a business being carried on by an entity connected with you?

Meaning of 'connected with' an entity - Section 328-125 of the ITAA 1997

Under subsection 328-125(1) of the ITAA 1997 an entity (Entity A) is connected with another entity (Entity B) if either entity 'controls' the other entity in the way described in section 328-125, or both entities are controlled in that way by the same third entity (Entity C).

So if you are Entity B, Entity A is connected with you if either:

· Entity A controls you; or

· You control Entity A; or if

· Entity A and you are both controlled by Entity C.

Section 328-125 of the ITAA 1997 explains 'control' in terms of direct control and indirect control. As neither you nor any other entity involved in this case are discretionary trusts, subsections 328-125(3), (4) and (5), regarding direct control of a discretionary trust, are not relevant.

Direct control of an entity other than a discretionary trust is described in subsection 328-125(2) and states that an entity (Entity A) controls another entity (Entity B) (except if Entity B is a discretionary trust) if:

· Entity A or its affiliates, or Entity A together with its affiliates,

· beneficially own, or have the right to acquire beneficial ownership of,

· interests in Entity B that carry the right to receive:

o at least 40% of any distribution of income from Entity B; or

o where Entity B is a partnership, at least 40% of the net income of the partnership; or

o at least 40% distribution of capital by Entity B.

Additional rules apply where Entity B is a company, and alternate rules apply where Entity B is a discretionary trust. Some examples may help clarify understanding of direct control:

(1) Entity A is a partner is a partnership (Entity B) and is beneficially entitled to 40% of the net partnership income. Entity A therefore controls the partnership (Entity B).

(2) Entity A beneficially owns interests in a company (Entity B) carrying the right to 30% of distributions of Entity B's capital and income. An affiliate of Entity A has a beneficial interest in Entity B carrying the right to 15%.

Although Entity A's holding alone does not satisfy the 40% test, Entity A will be taken to control Entity B because the combined interests of Entity A and its affiliate are 45%.

Indirect control of an entity is explained in subsections 328-125(7) and (8) and applies to an entity (Entity A) that directly controls another entity (Entity B) as if Entity A also controlled any other entity that is directly, or indirectly by any other application or applications of this section, controlled by Entity B.

As all the entities involved in this case are individuals, and no partnerships exist, you cannot have direct or indirect control over any of the users of the land. The users of the land are not 'connected with' you under the provisions in section 328-125 of the ITAA 1997.

As such, the land was not being used in the course of a business being carried on by an entity connected with you.

Conclusion

As your land was not used or held ready for use in the course of a business being carried on by you, your affiliate or an entity that is connected with you, your land is not an 'active asset' of yours under Division 152 of the ITAA 1997.