Edited version of private ruling

Authorisation Number: 1011891338703

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Ruling

Subject: CGT - active asset - connected entities - rental exception

Question 1

For the purposes of subsection 152-40(1) of the Income Tax Assessment Act 1997 (ITAA 1997), does your portion of the commercial property satisfy the meaning of active asset via the business conducted by the connected entity?

Answer

Yes.

Question 2

For the purpose of section 152-35 of the ITAA 1997, does your 20% portion of the commercial property sold in the 2010-2011 income year satisfy the active asset test?

Answer

Yes.

Question 3

For the purposes of paragraph 152-40(4)(e) of the ITAA 1997, is the commercial property excluded from being an active asset because it is a CGT asset whose main use is to derive rent?

Answer

No.

Question 4

Are you able to choose to disregard the remaining part of the capital gain using the Small business retirement exemption under section 152-305 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

Both you and another individual owned a business premises. Your percentage of ownership of the business premises was 20 percent.

You operate via a company. You have at least a 50 percent holding in the company. The company operated a business on the premises.

The other owner of the business premises operated a separate business on the premises.

The premises, was let to the business via a partnership structure whereby you received 20 percent of the profits and the other owner received 80 percent.

You and the other owner operated your respective businesses from this address for over 15 years.

The building had not had any other tenants since you and the other individual purchased the property.

The land and buildings were purchased by you and the other individual over 15 years ago. The other individual purchased your 20 percent interest in the premises in the 2010-11 income year.

You made a capital gain from this event.

The businesses operated by yourself and the other individual paid rent to the partnership for a period in excess of 15 years. No personal use of the business premises occurred over this 15 year period.

Your tax agent advised that you meet the Maximum Net Asset Value Test under section 152-15 of the Income Tax Assessment Act 1997 (ITAA 1997) with the total assets of you and your affiliates and connected entities not exceeding $6 million at the time of the sale.

Relevant legislative provisions

Income Tax Assessment Act 1997, section 152-35
Income Tax Assessment Act 1997, subsection 152-35(2)
Income Tax Assessment Act 1997, section 152-40
Income Tax Assessment Act 1997, subparagraph 152-40(1)(a)(i)
Income Tax Assessment Act 1997, subparagraph 152-40(1)(a)(ii)
Income Tax Assessment Act 1997, subparagraph 152-40(1)(a)(iii)
Income Tax Assessment Act 1997, subsection 152-40(4)
Income Tax Assessment Act 1997, subsection 152-40(4)(e)
Income Tax Assessment Act 1997, section 152-47
Income Tax Assessment Act 1997, section 328-125
Income Tax Assessment Act 1997, section 328-125(2)

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 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 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 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 www.ato.gov.au 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

Note that all subsequent legislative references are to the ITAA 1997 unless otherwise stated.

Meaning of active asset
Section 152-40 provides the meaning of active asset. It states, in part, that a capital gains tax (CGT) asset of yours is an active asset if it is used or held ready for use by you, your affiliate, or an entity connected with you, in the course of carrying on a business (whether alone or in partnership).

Active asset test
If you have owned the CGT asset for more than 15 years the active asset test in section 152-35 will be satisfied if the asset was an active asset of yours for a total of at least 71/2 years during the period as outlined in subsection 152-35(2). The period commences when you acquired the asset and ends at the earlier of either (i) the CGT event, or (ii) if the relevant business ceased to be carried on in the 12 months before that time - the date on which the business ceased.

Rental exception
Certain assets are excluded from being active assets under subsection 152-40(4). Paragraph 152-40(4)(e) excludes, among other things, assets whose main use is to derive rent (unless such use was only temporary).

The rental exception is discussed in 'Taxation Determination TD 2006/78' and the 'Advanced guide to CGT concessions for small business'. These ATO view documents provide that if an asset is used partly for business purposes and partly to derive rent then it will be a question of fact dependent upon the circumstances of each case as to whether the assets main use is to derive rent. Factors to be taken into account include comparative areas of use and comparative levels of income.

Small business retirement exemption

Under section 152-300 you can choose to disregard a capital gain from a CGT event happening to a CGT asset of your small business if the capital proceeds from the event are used in connection with your retirement.

There is a lifetime limit of $500,000 for all choices that can be made in respect of an individual under this section.

Application to your circumstances

Your 20% ownership interest in the commercial property will be considered an active asset if you can meet the requirements of section 152-40 for the period stated in section 152-35.

The commercial property was let by the partnership to a company for which you had a controlling interest for business purposes and to the other owner who also used the property for business purposes for over 15 years. Therefore the requirement under section 152-35 that the asset needs to be an active asset of yours for a total of at least 71/2 years during the period as outlined in subsection 152-35(2) is satisfied.

You have at least a 50 percent holding in the company which let 20 percent of the business premises. Under paragraph 328-125(2)(b) this means that you have direct control of the company as you beneficially own equity interests in the company that gives you a 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.

At least a 20 percent proportion of the commercial property was let by the partnership to the company. As the company used the asset in the course of carrying on a business, you meet the requirements of paragraph 152-40(1)(a) and the commercial property is an active asset for CGT purposes.

Therefore paragraph 152-40(4)(e) which advises that an asset whose main use is to derive interest, an annuity, rent royalties or foreign exchange gains cannot be an active asset, does not apply. This is because the asset was used by a connected entity, not withstanding that rent was paid.

Under section 152-305(1) if you are an individual, you can choose to disregard all or part of a capital gain if the basic conditions in Subdivision 152-A are satisfied. As you were over 55 years of age at the time of the capital gain event, there is no requirement for you to contribute the amount to a complying superannuation fund if you specify in writing under subsection 152-315(4) that you wish to disregard all or part of the capital gain.