Edited version of private ruling

Authorisation Number: 1011745806698

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Question 1

Will the capital gain made from the sale of the Land be eligible for the CGT small business concessions provided for in Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Advice/Answers

Yes. The capital gain will meet the basic conditions in Subdivision 152-A of the ITAA 1997 for the CGT small business concessions.

Question 2

Can you disregard a capital gain made on sale of the Land under the 15-year exemption in section 152-105 of the ITAA 1997?

Advice/Answers

No. As more than 8 years have elapsed since your retirement, there is not a sufficient connection between your retirement and the sale of the Land for you to be eligible for the small business 15 year exemption provided for in Subdivision 152-B of the ITAA 1997.

Question 3

Can you choose to disregard all, or part of, a capital gain made on sale of the Land under the small business retirement exemption as described in Subdivision 152-D of the ITAA 1997?

Advice/Answers

Yes. As you have met the basic conditions for the CGT small business concessions you will be eligible for the small business retirement exemption described in Subdivision 152-D of the ITAA 1997

Question 4

Can you reduce a capital gain made on sale of the Land by applying the discount percentage of 50% under step 3 in subsection 102-5(1) of the ITAA 1997?

Advice/Answers

Yes. You will be eligible to apply the discount percentage, provided that you have not calculated the capital gain using the 'indexation method'.

Question 5

If the answer to question 4 is yes, can you reduce the balance of a capital gain made on sale of the Land by a further 50% under the small business 50% reduction in section 152-205 of the ITAA 1997?

Advice/Answers

Yes. As the basic conditions in Subdivision 152-A of the ITAA 1997 are satisfied, you are eligible to apply the small business 50% reduction to the capital gain.

Facts

Prior to 19 September 1985 you purchased the Land in joint names with your spouse.

A number of years after 1985 your spouse's half of the Land was transferred into your name solely.

From the date of purchase (before 1985) to 199X, the Land was leased to a company which was wholly owned by you and your spouse, each holding a 50% ownership interest and rights to 50% of income and capital distributions.

The company used the Land for dairy farming activities to 199X.

The milk was sold commercially and the activities were conducted in a business like manner.

From 199X for a number of years you and your child used the Land as sharefarmers.

Your intention in entering the sharefarming arrangement was for the business previously operated by the company to continue.

You intended that you and your child continue carry on the farming business together.

Under the sharefarming arrangement you received 50% of the milk income.

Under the sharefarming arrangement you carried out milking activities everyday, and were solely responsible for calf rearing during season, which requires feeding everyday and changing sawdust.

Under the sharefarming arrangement you contributed to decision making and control activities within the business.

There was no written sharefarming agreement between you and your child.

The sharefarming arrangement ceased when your child decided to cease farming in 200X.

The farm was then leased to another relative for a period of 5 years under a written lease agreement.

The lease agreement provided for an option for a further 5 years.

You provide some assistance to your other relative but you have no control over the business.

Your net assets do not exceed $6 million and this position will remain the same up to the time you sell the Land.

Ruling

Subject: Capital gains tax - small business concessions

Summary

The Land is made up of two CGT assets; the first acquired when you originally purchased the Land with your spouse (CGT Asset 1) and the second acquired when your spouse's share of the Land was transferred to you (CGT Asset 2). Each asset is equal to 50% of the Land.

As CGT Asset 1 was acquired prior to the introduction of tax on capital gains, 50% of a gain made from sale of the Land (applicable to this asset) is not subject to CGT and is disregarded.

CGT Asset 2 meets the basic conditions for access to small business capital CGT relief.

Detailed reasoning

Question 1

To be able to disregard or reduce a capital gain under the small business relief provisions, you must satisfy four basic conditions provided in section 152-10 of the ITAA 1997. Additionally, some of the concessions require addition specific conditions are satisfied.

The first basic condition

The first basic condition requires that a CGT event happens in relation to a CGT asset of yours in an income year.

CGT assets

Land and buildings meet the definition of a CGT asset, and where a CGT asset is owned by joint tenants, each individual is treated as if they own a separate CGT asset comprised of equal parts of the asset (sections 108-5 and 108-7 of the ITAA 1997).

When you acquire a second interest in an asset in which you already have an interest (such as when your spouse's half of the Land was transferred to you), the two interests remain separate CGT assets, each with:

· a separate date of acquisition; and

· a separate cost base. (Taxation Determination TD 2000/31 paragraphs 1-3)

This means, under the tax law regarding capital gains and losses, when you and your spouse purchased the Land, you were treated as acquiring a separate CGT asset, being 50% of the Land (CGT Asset 1). Later, when your spouse's half of the Land was transferred to your name you acquired a second separate CGT asset (CGT Asset 2).

CGT events

CGT event A1 happens if you dispose of a CGT asset (section 104-10 of the ITAA 1997). On sale of the Land CGT event A1 will happen to CGT Asset 1. Simultaneously, CGT event A1 will happen to CGT Asset 2.

The second basic condition

The second basic condition requires that the CGT event, in your case the sale of the Land, would have resulted in the capital gain to which the relief is to be applied.

Sale of CGT Asset 1

Under section 104-10 of the ITAA 1997, a capital gain or loss is disregarded if you acquired the asset before 20 September 1985.

As the acquisition date of CGT Asset 1 is the date your name was registered on the title in 19XX (prior to 1985), any gain or loss you make on sale of the Land will be disregarded for this asset (equal to your 50% original interest).

Small business CGT relief under Division 152 is not required as any capital gain from sale effectively does not exist.

Sale of CGT Asset 2

The acquisition date of CGT Asset 2 is the date it was transferred into your name in 199x.

As such, the exemption in subsection 104-10(5) of the ITAA 1997 does not apply and sale of the Land may result in a capital gain. In the event of a gain the second basic condition would be satisfied for CGT Asset 2.

The third basic condition

The third basic condition requires that 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;

· 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;

· the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year;

You have stated that as your net assets do not exceed $6 million, you satisfy the maximum net asset value test and that you will continue to satisfy the test up to the time you sell the Land.

The fourth basic condition

The fourth basic condition requires that the CGT asset satisfies the active asset test provided in section 152-35 of the ITAA 1997.

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 your ownership period. CGT Asset 2 will be an 'active asset of yours' if it was used, or held ready for use, in the course of carrying on a business by:

· you; or

· your affiliate; or

· another entity that is connected with you (section 152-40 of the ITAA 1997).

The term 'connected with' is defined in section 328-125 of the ITAA 1997 which explains that an entity is 'connected with' another entity if:

· either entity controls the other entity, or

· both entities are controlled by the same third entity.

Further, an entity (the first entity) controls another entity (the second entity) if the first entity or its affiliates; or the first entity together with its affiliates; own interests in the second entity that carry the right to receive:

· at least 40% of any distribution of income from the second entity; or

· at least 40% distribution of capital by second entity.

Carrying on a business

CGT Asset 2 has been owned by you for a period of over 15 years. Therefore, it must have been 'an active asset of yours' for a total of at least 7½ years.

From 198X to 199X you leased the Land to the company. You and your spouse wholly owned the Company, each holding 50% of the ownership interests carrying rights to receive 50% of income distributions and capital distributions.

As 50% is greater than the required 40%, you controlled the company and it was 'connected with' you. During the period of the lease, the company used the Land in dairy farming activities. It is the Commissioner's view that the activities carried on during this time amounted to carrying on a business.

In 199X you acquired CGT Asset 2, which was your spouse's share of the property. As such, from 199X to 199Y, CGT Asset 2 was owned by you and was used in the course of carrying on a business by another entity that is connected with you (i.e. the company). It was an 'active asset of yours' during this 2 year period.

Sharefarming - carrying on a business

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'.

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.

From 199X, you and your child entered into a sharefarming arrangement to using CGT Asset 2 in dairy farming activities. In applying the indicators of carrying on a business and the specific ATO view regarding sharefarming arrangements, the following facts are relevant:

Following the death of your spouse, your intention was for the business previously operated in the company name to continue. You intended that you and your child continue carry on the farming business together.

You were actively involved in the farming activities, carrying out milking activities everyday, and rearing calves.

You contributed to decision making and control activities within the business.

Your agreement with your child provided that each entity would receive 50% of the milk income.

As you continued to be actively involved in the management and control of the business, and in the farming activities, your role in the sharefarming arrangement cannot be described as passive receipt of income from another entity's use of your property as described in TD95/62. Your sharefarming arrangement amounts to the carrying on of a business by you and your child.

As CGT Asset 2 was an active asset of yours for a total of more than 9 years during your ownership period it satisfies the active asset test.

As such, the four basic conditions are satisfied in relation to a capital gain made on sale of the Land.

Question 2 - The small business 15-year exemption

The small business 15-year exemption in section 152-105 of the ITAA 1997 provides that you can disregard a capital gain arising from the sale of CGT Asset 2, if all of the following conditions are satisfied:

· the basic conditions are satisfied for the gain;

· you continuously owned CGT Asset 2 for the 15-year period ending just before the CGT event; and

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

There is no definition of 'retirement' in the legislation and so the ordinary meaning of the word must be considered. The word 'retirement' is defined in the Macquarie Dictionary to mean 'the withdrawal from office, business or active life'. The Shorter Oxford English Dictionary gives a number of meanings for 'retirement' including 'retreating or receding from a place or position; the act of withdrawing into seclusion or privacy; withdrawal from something; withdrawal from occupation or business activity.'

The Explanatory Memorandum (EM) 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 the concession:

    '1.5 ... the disposal is related to a person retiring ... '; and

'1.68 ... an individual small business tax payer ... must be ... at least 55 years old and using the capital proceeds for their retirement.'

The Commissioner's view in relation to whether a CGT event happens "in connection with" an individual's retirement is found in the Advanced guide to capital gains tax concessions for small business 2008-09, which states the matter depends on the particular circumstances of each case.

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.

The words 'in connection with' can apply where the CGT event occurs sometime after retirement. Again, this type of case would depend on its own particular facts and cases would need to be considered on a case-by-case basis.

Several reasons may have prompted the sale of the assets. If there is no relevant connection with the small business operator's business, the requirement would not be satisfied. However, if it can be shown that the reason for disposing of the assets is connected to retirement and the later sale is integral to the small business operator's retirement plan, the sale may be accepted as happening in connection with retirement.

In your case, you owned and farmed the Land in business and retired from the business at the beginning of 200X, approximately 8 years ago. At this time the number of hours you worked and the nature of the activities conducted changed significantly. You have no intention of being involved in any further business activity.

As 8 years have elapsed since your retirement and the proposed sale of the Land, we do not accept that the proposed sale is in connection with your retirement.

Question 3 - The small business retirement exemption

The small business retirement exemption in section 152-305 of the ITAA 1997 provides that you can disregard all or part of a capital gain if the basic conditions in section 152-10 are satisfied for the gain, and

· if you are under 55 just before you make the choice to disregard all or part of the capital gain,

· you contribute an amount equal to the asset's CGT exempt amount to a complying superannuation fund or RSA, and

· the contribution is made at the later of when you made the choice to disregard all or part of the capital gain, and when you received the proceeds.

As discussed above the basic conditions in section 152-10 of the ITAA 1997 are satisfied. Therefore, as you are over 55 and the contribution restrictions do not apply in your case, you can disregard all or part of a capital gain made from the sale of the CGT Asset 2.

It should be noted that an individual's CGT retirement exemption limit is $500,000 - refer subsection 152-320(1) of the ITAA 1997.

Question 4 - Discount capital gains - 50% reduction

Under Subdivision 115-A, if:

· an individual makes a capital gain,

· from a CGT event happening after 21 September 1999,

· to a CGT asset that was acquired by the individual at least 12 months before the CGT event,

· the capital gain will be a discount capital gain providing it has been calculated using a cost base that has been calculated without reference to indexation at any time; or cost base that has been recalculated to remove prior reference to indexation.

Therefore, as (a), (b) and (c) above are met in your circumstances, as long as:

· you have not used the indexation method to calculate the cost base of the Land, or

· will recalculate the cost base to remove any prior use of the indexation method,

· a gain made from the sale of CGT Asset 2 is a discount capital gain and can be reduced by the discount percentage of 50%.

Question 5 - The small business 50% active asset reduction

To qualify for the small business 50% active asset reduction on a capital gain, you need to meet the basic conditions only.

This means that, if you meet the basic conditions, you may reduce the capital gain by 50% after applying in the following order, any:

· current year capital losses

· unapplied net capital losses from a previous year.