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Ruling

Subject: Small business CGT concessions

Question 1

Are your units in the unit trust active assets for the purpose of subsection 152-40(3) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will the Commissioner determine under subsection 328-125(6) of the ITAA 1997 that you will not control the unit trust and are not an entity that is connected with the unit trust for the purposes of the maximum net asset value test in section 152-15 of the ITAA 1997, for the period during which you will have a control percentage in the Trust of at least 40%, but not less than 50%?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2011

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You hold 50% of the units in the unit trust, as does another unrelated third party.

You are contemplating disposing of some of your units in the unit trust to an unrelated third party. After the sale of this first tranche of units, you will own more than 40%, but less than 50% of the issued units in the unit trust.

The unit trust owns or leases several business premises.

For the entire period that the unit trust has owned the business premises, those assets have been exclusively used in the business premise management and leasing operation conducted by the trustee and its agent, a related service entity, without interruption.

There are a large number of tenancies in the business premises.

The management of the business premises requires constant ongoing involvement in the day to day cleaning, security and marketability and control of all premises, attention to the respective retailer's needs and promotion of the business premises through marketing activities. The trustee of the unit trust has also overseen the redesign and rebuilding of some of the business premises.

The unit trust satisfies the GST definition of an enterprise.

The trustee of the unit trust has engaged managers to actively manage the assets. The managers are responsible for various facets of running the business premise businesses, including collecting rent, negotiating leases, implementing measures to limit outgoings, rent review negotiation, contracting third parties to provide services to the centres (for example, cleaners), managing disputes with tenants, insuring the centre and organising finance for the centres (including facilities for day to day operations and long-term capital investment).

The unit trust has control over the shared amenities and services at each business premise.

The unit trust has invested in a specialised management accounting system regarding the collection of rent and other outgoings, and maintains detailed financial accounts.

The relationship between the unit trust and the retailers, all of whom are third parties to the unit trust, are all on arm's length commercial terms.

The unit trust has conducted the management of the business premises for a number of years.

The terms of the business premise tenancies are as follows:

A separate agreement is entered into between the business premise owner, that is, the trustee and/or its agents and each store retailer for the use of part of the relevant business premise.

In certain circumstances, and subject to the relevant retail tenancy legislation, the business premise owner has the right to relocate a retailer to another part of the business premise and enter the retailer's premises without their consent.

The store owners can not assign their rights under the agreement. This is a term of the relevant retail tenancy agreements.

The lease agreements ordinarily run for a number of years and usually include an option to extend.

All of the lease agreements forwarded by you contain a provision in relation to the payment of rent.

The unit trust's financials show that the relative composition of the trust's assets has not materially changed. In particular, the freehold and leasehold interests in the business premises represent at least 80% of the market value of the assets of the unit trust and in the trustee's view, always have.

The trustee of the unit trust is a company.

The unit trust has significant debt.

You have stated that, in conjunction with your connected entities and affiliates, you will satisfy the maximum net asset value test in section 152-15 of the ITAA 1997 when you sell any units in the unit trust.

All the property of the unit trust is situated in Australia.

The central management and control of the unit trust is in Australia.

Australian residents hold all of the beneficial interests in the income and property of the unit trust.

The purchaser of your units (potentially in conjunction with its related entities) will own the remaining units, and will assume control of the trust's day to day operations.

You will cease to be involved in the trust's day to day operations after the sale of the first tranche of units. Your director is elderly, and will continue to have some, albeit relatively little, strategic involvement in the business (namely, operating the business premises) notwithstanding the first sale of his (indirect) interest in the unit trust.

The director will continue to be a director of the trustee company and you, and will also continue to be a shareholder in the trustee company.

You hold 50% of the shares in the trustee company.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 152-15

Income Tax Assessment Act 1997 Section 152-40

Income Tax Assessment Act 1997 Subsection 328-125(6)

Income Tax Assessment Act 1997 Subsection 995-1(1)

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 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

Question 1

Your units in the unit trust will be active assets under subsection 152-40(3) of the ITAA 1997 if the unit trust is a resident trust for CGT purposes for the income year and the total of:

· the market values of the active assets of the unit trust and

· the market value of any financial instruments of the unit trust that are inherently connected with a business that the unit trust carries on and

· any cash of the unit trust that is inherently connected with such a business

· is 80% or more of the market value of all of the assets of the unit trust.

In order to determine whether the above requirements are satisfied, it firstly needs to be determined whether the freehold and leasehold interests in the business premises are active assets. If the interests are active assets, it will then need to be determined if the other requirements as above are satisfied.

Active assets

Section 152-40 of the ITAA 1997 provides the meaning of active asset. The interests in the business premises will be active assets at a time if, at that time, the interests were used or held ready for use by the unit trust, an affiliate of the unit trust, or by another entity that is connected with the unit trust, in the course of carrying on a business.

However, paragraph 152-40(4)(e) of the ITAA 1997 provides that an asset whose main use is to derive rent, cannot be an active asset (unless that main use was only temporary).

Is the unit trust carrying on a business in relation to the interests in the business premises?

The determination of whether an entity is carrying on a business involves a question of fact. The facts of each case must be examined and an answer resolved based upon the large or general impression gained (Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; 5 AITR 548).

Taxation Ruling TR 97/11 has summarised the indicators of the conduct of business that have been developed by the courts. Although TR 97/11 specifically refers to a business of primary production, these indicators can be applied to any venture. These indicators include:

· Whether the activity has a significant commercial purpose or character

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

· Whether the taxpayer has a purpose of profits as well as a prospect of profit

· 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 ordinary trade in that line of business

· Whether the activity is planned, organised and carried on in a businesslike manner

· The size, scale and permanency of the activity and

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

No one indicator is decisive. They must be considered as a whole. Ultimately, it is a question of fact and degree based upon an objective consideration of the circumstances.

Paragraph 5 of Taxation Ruling IT 2423 states:

A conclusion that an individual is carrying on a business of letting property would depend largely upon the scale of operations. An individual who derives income from the rent of one or two residential properties would not normally be thought of as carrying on a business. On the other hand if rent was derived from a number of properties or from a block of apartments, that may indicate the existence of a business.

In this case, the scale of the activity indicates the presence of a business. The unit trust has interests in several business premises and the business premises contain a large number of tenancies. The activity appears to be carried on in a commercial and businesslike manner and applying the above indicators in TR 97/11 to the activity also indicates the presence of a business.

The business premises are therefore being used by the unit trust in the course of carrying on a business.

Is the main use of the business premises to derive rent?

Taxation Determination TD 2006/78 states that whether an asset's main use is to derive rent will depend on the particular circumstances of each case. The term 'rent' has been described as follows:

the amount payable by a tenant to a landlord for the use of the leased premises (C. H. Bailey Ltd v. Memorial Enterprises Ltd [1974] 1 All ER 1003 at 1010; United Scientific Holdings Ltd v. Burnley Borough Council [1977] 2 All ER 62 at 76, 86, 93, 99)

a tenant's periodical payment to an owner or landlord for the use of land or premises (The Australian Oxford Dictionary, 1999, Oxford University Press, Melbourne), and

recompense paid by a tenant to a landlord for the exclusive possession of corporeal hereditaments……..The modern conception of rent is a payment which a tenant is bound by contract to make to his landlord for the use of the property let (Halsbury's Laws of England 4^th Edition Reissue, Butterworths, London 1994, Ch 27(1) 'Landlord and tenant', paragraph 212).

A key factor in determining whether an occupant of premises is a lessee is whether the occupier has a right to exclusive possession (Radaich v. Smith (1959) 101 CLR 209). If, for example, premises are leased to a tenant under a lease agreement granting exclusive possession, the payments involved are likely to be rent and the premises not an active asset. On the other hand, if the arrangement allows the person only to enter and use the premises for certain purposes and does not amount to a lease granting exclusive possession, the payments involved are unlikely to be rent.

Other relevant factors to consider include the degree of control retained by the owner and the extent of any services provided by the owner. Examples provided in TD 2006/78 of services in relation to the provision of accommodation for reward include room cleaning, provision of meals, supply of linen and shared amenities.

Applying the above to your circumstances

In this case, the main assets of the unit trust are the interests in the business premises and the main source of income is the payments received from the tenants of the business premises.

The business premise tenants do not have the right to exclusive possession as all of the agreements provide that in certain circumstances the tenants can be relocated to another space. This is a key factor in determining whether the tenants are lessees. You have also provided a detailed list of the various services which the unit trust provides to the tenants, and the agreements with the tenants contain various restrictions on the use of the retail spaces which indicate that the unit trust retains a degree of control over the use which can be made of the premises.

Having regard to all of the circumstances in this case, we consider that a tenant/landlord relationship does not exist between the unit trust and the tenants. The amounts received by the unit trust from its main assets, being the interests in the business premises, do not constitute rent and the main use of the business premises is not to derive rent.

Accordingly, the interests in the business premises are not excluded by paragraph 152-40(4)(e) of the ITAA 1997 from being active assets.

Conclusion

The unit trust is a resident trust for CGT purposes as all the property of the unit trust is situated in Australia and the central management and control of the unit trust is in Australia (subsection 995-1(1) of the ITAA 1997) and this requirement in subsection 152-40(3) of the ITAA 1997 is satisfied.

As the market values of the interests in the business premises are 80% or more of the market value of all of the assets of the unit trust, these interests will need to be active assets for the other requirements in subsection 152-40(3) of the ITAA 1997 to be satisfied.

The unit trust is carrying on a business in relation to the interests in the business premises, and these interests are being used by the unit trust in the course of carrying on that business. The exclusion in paragraph 152-40(4)(e) of the ITAA 1997 does not apply in this case. The interests in the business premises will therefore be active assets under section 152-40 of the ITAA 1997.

As we have determined that the interests in the business premises are active assets, the requirements in subsection 152-40(3) of the ITAA 1997 are satisfied and your units in the unit trust will also be active assets.

Question 2

One of the basic conditions that must be satisfied to qualify for small business relief in Division 152 of the ITAA 1997 is the maximum net asset value test in section 152-15 of the ITAA 1997.

A taxpayer will satisfy the maximum net asset value test if, just before the CGT event that results in the capital gain, the net value of the CGT assets of the taxpayer and the following entities does not exceed $6 million:

· any entities connected with the taxpayer

· any affiliates of the taxpayer and any entities connected with an affiliate of the taxpayer.

An entity is connected with another entity if either entity controls the other or both entities are controlled by the same third entity.

An entity controls a unit trust if it, its affiliates or all of them together beneficially own, or have the right to acquire beneficial ownership, of units in the unit trust that give at least 40% (the control percentage) of any distribution of income or capital by the unit trust.

If an entity's control percentage in the unit trust is at least 40% but less than 50%, the Commissioner may determine under subsection 328-125(6) of the ITAA 1997 that the first entity does not control the unit trust if the Commissioner is satisfied that the unit trust is controlled by a third entity (other than an affiliate of the first entity).

For the unit trust to be controlled by a third entity, the third entity must also have a control percentage of at least 40% in the unit trust. That is, it must control the unit trust in the way described above.

In other words, for the Commissioner to be able to determine under subsection 328-125(6) of the ITAA 1997 that an entity does not control the unit trust (despite holding at least 40% interest in it), there must be a third entity that has a control percentage (including the interests of any affiliates) of at least 40% in the unit trust.

Alternatively, it is possible that both of the entities with a control percentage of at least 40% may control the unit trust. It would be necessary to consider additional factors to determine if the third entity controls the unit trust. Such additional factors could include who is responsible for the day-to-day and strategic running of the company.

Applying the above to your circumstances

Following the sale of some of your 50% interest in the unit trust, you will have at least 40% but less than 50% of the issued units in the unit trust. The purchaser of your units will, potentially in conjunction with its related entities, own the remaining units in the unit trust. This purchaser will therefore also have a control percentage in the unit trust of at least 40%. Following the sale of the first tranche of units, you will cease to be involved in the trust's day to day business.

You are a 50% shareholder of the trustee company. Your sole director and shareholder is also a director of the trustee company, and will continue to be your director, and a director of the trustee company. This director will also continue to have some, albeit relatively little, strategic involvement in the operation of the business premises following the sale of the first tranche of units.

In this case, in view of your 50% shareholding of the trustee company and having a common director with the trustee company, the Commissioner would not be satisfied that you will not continue to control the trustee company, and therefore the unit trust, following the sale of the first tranche of units. The Commissioner is not satisfied that the Company and therefore the unit trust will be controlled solely by the purchaser of the units following the sale.

The Commissioner will therefore not determine under subsection 328-125(6) of the ITAA 1997 that you will not control the unit trust and are not an entity that is connected with the unit trust for the purposes of the maximum net asset value test in section 152-15 of the ITAA 1997, for the period during which you will have a control percentage in the unit trust of at least 40%, but not less than 50%.