Edited version of your private ruling

Authorisation Number: 1011963990391

This edited version of your ruling will be published in the public register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fact sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.

Ruling

Subject: Active asset and affiliates

Question 1

Are the siblings all affiliates as defined under section 328-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

If the siblings are then affiliates of each other, then do they, or does one of them together with their affiliates, then control both the Unit Trust and the taxpayer in the manner as set out in paragraph 328-125(1)(b) of the ITAA 1997?

Answer

The siblings are not affiliates of one another.

Question 3

If they are affiliates, then does for instance, X, together with his affiliates, control both the Unit trust and the taxpayer, in accordance with subsection 328-125(2) of the ITAA 1997, by virtue of the operation of subsection 328-125(7)?

Answer

The siblings are not affiliates of one another.

Question 4

Are the siblings controllers of the Family Discretionary Trust for the years ended 30 June 2009 and/or 30 June 2008 if the trustee nominates each of the siblings to be controllers in accordance with subsection 152-78(4) of the ITAA 1997?

Answer

Yes, if the nominations comply with subsection 152-78(4).

Question 5

Is the post 1985 land held by the taxpayer an active asset under paragraph 152-40(1)(a)(ii) or 152-40(1)(a)(iii) of the ITAA 1997, as it is used in the course of carrying on a business, by a connected entity of the taxpayer being the Unit Trust?

Answer

No.

This ruling applies for the following period

Year ending 30 June 2011

Year ending 30 June 2012

The scheme commenced on

1 July 2010

Relevant facts

The taxpayer is a company and all its ordinary shares are held by three siblings equally.

The taxpayer holds several parcels of land, some of which are post CGT. The post CGT land is used in carrying on a business by a Unit Trust.

The Unit Trust has been carrying on a business on the land owned by the taxpayer since acquisition by the taxpayer.

Whilst rent has been imposed and paid by the Unit Trust for the use of the property, there is not a formal lease agreement between the Unit Trust and the taxpayer for the use of the land in the business carried on by the Unit Trust. The rent is subject to agreement between the taxpayer and the trustee of the Unit trust.

100% of the Unit Trust's units are owned by a Family Discretionary Trust.

The shares in the trustee company of the Unit Trust are held one third each by each of the three siblings.

The shares in this trustee company of the Family Discretionary Trust are also held one third each by each of the three siblings.

The beneficiaries of the Family Discretionary Trust are the three siblings and their immediate families. For the years ended 30 June 2007, 2008, and 2009, there has been no distribution of income or capital from this trust. The income for the year ended 30 June 2010 and 2011 was distributed equally between the three siblings.

Two of the siblings are actively involved in the day to day running of the business operations.

All three siblings are actively involved in the day to day operations and decisions of the taxpayer.

The siblings all have a close family relationship.

The taxpayer is guarantor, in respect of a loan to the Unit Trust, with the security being a mortgage over the properties owned by the taxpayer plus improvements to these properties.

The taxpayer is considering disposing of the post CGT land, and needs to be certain that the land would qualify as an active asset.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 152-40

Income Tax Assessment Act 1997 Section 328-125

Income Tax Assessment Act 1997 Section 328-130

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

Legislative references referred to herein are from the ITAA 1997, unless otherwise stated.

Summary

The asset would not meet the definition of an active asset in subsection 152-40(1) as you are not connected with (section 328-125) the entity that operates the business from your property. Nor is the entity that operates the business your affiliate (section 328-130). Consequently, the basic conditions to qualify for the small business concessions in section 152-10 are not satisfied.

Detailed reasoning

For the small business capital gains tax (CGT) concessions in Division 152 to apply to reduce or disregard a capital gain, the relevant CGT asset must satisfy all the basic conditions for relief as outlined in section 152-10.

One of these conditions is the active asset test under section 152-35.

The active asset test is presented in section 152-35. Section 152-35 states:

152-35 (1)

A *CGT asset satisfies the active asset test if:

(a) you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the period specified in subsection (2); or

(b) 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).

152-35(2)

The period:

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 have advised that the Unit Trust used the premises for their business for the entire period of the taxpayer's ownership.

Active Asset

Section 152-40 discusses the meaning of the term 'active asset', and at subsection 152-40(1) states, in part, that a CGT asset is an active asset at a time if, at that time, you own the asset and it is used, or held ready for use, in the course of carrying on a business that is carried on by you or your affiliate, or another entity that is connected with you.

In order for the property to be an active asset it must be used in the business of an entity connected to you or your affiliate.

Connected with an entity

An entity is connected with another entity if (subsection 328-125(1)):

either entity controls the other entity in a way described in this section; or

both entities are controlled in a way described in this section by the same third entity.

Direct control of an entity other than a discretionary trust

Subsection 328-125(2) in part states, an entity (the first entity) controls another entity if the first entity, its affiliates, or the first entity together with its affiliates:

except if the other entity is a discretionary trust - beneficially own, or have the right to acquire the beneficial ownership of, interests in the other entity that carry between them the right to receive a percentage (the control percentage) that is at least 40% of any distribution of income by the other entity; or if the other entity is a partnership - the net income of the partnership; or any distribution of capital by the other entity;

This means that an entity is connected to another entity if either entity controls the other entity or both entities are controlled by the same third entity. It also means that an entity is connected to another entity, if the entity, its affiliates or both of them beneficially own, or have the right to acquire the beneficial ownership of interests in, the other entity that give them the right to receive at least 40% of the distribution of income or capital by the other entity.

In your case, pursuant to paragraph 328-125(2)(a) an entity (the taxpayer) is connected with another entity (the Unit Trust) if:

The taxpayer, their affiliates or the taxpayer together with their affiliates beneficially own, or have the right to acquire the beneficial ownership of, interest in the unit trust that carry between you the right to receive a percentage that is at least 40% of any distribution of income or capital by the unit trust.

You have advised that the Family Discretionary Trust owns 100% of the units in the Unit Trust. The taxpayer does not beneficially own, or have the right to acquire the beneficial ownership of interests in the Unit Trust that carry the right to receive a percentage that is at least 40% of income or capital.

Are the Unit Trust and/or the siblings your affiliates?

The meaning of affiliate is under section 328-130, which reads as follows:

328-130(1) An individual or a company is an affiliate of yours 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 business of the individual or company.

328-130(2) 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.

The following requirements must be met for an entity to qualify as the entity's affiliate:

· the entity must be an individual or company;

· the entity must carry on a business, and

· in relation to its business affairs, the entity must act, or could reasonably be expected to act according to the direction or wishes of the entity or in concert with the entity.

It follows that an individual or a company can only be an affiliate of another entity if the individual or company is carrying on a business. Accordingly, if an individual or a company is not carrying on a business, the individual or company could not be an affiliate of another entity.

The Unit trust cannot be the taxpayer's affiliate because it is not an individual or company. The siblings are individuals but fail to be affiliates of each other or the taxpayer, because they are not carrying on a business. The entity that is carrying on the business in this case is the Unit Trust.

Controlled by the same third entity

All the taxpayer's ordinary shares are held by the siblings equally.

Paragraph 328-125(2)(b) describes the control of a company as an entity having a control percentage that is at least 40%. As discussed above the brothers are not affiliates of each other and individually they hold less than 40% interest in the taxpayer.

Controllers of discretionary trust

Subsection 152-78(2) states the trustee of a discretionary trust may nominate not more than four beneficiaries as being controllers of the trust for an income year for which the trustee did not make a distribution of income or capital if the trust had a tax loss, or no net income for that year. A nomination must comply with the provisions of subsection 152-78(4).

You have stated that the trustee nominated the siblings as controllers of the trust for the 2008 and 2009 financial years.

As stated above, the siblings, individually, do not hold the control percentage of the company, therefore the Unit Trust and the taxpayer company are not controlled by the same third party.

Indirect control of an entity

Subsection 328-125(7) applies to an entity (the first entity) that directly controls another entity (the second entity) as if the first entity also controlled any other entity that is directly, or indirectly by any other application or applications of this section, controlled by the second entity.

Subsection 328-125(4) states that an entity controls a discretionary trust for an income year if, for any of the four income years before that year the trustee of the trust paid to, or applied for the benefit of the first entity; or any of the first entity's affiliates; or the first entity and any of its affiliates any of the income or capital of the trust and the percentage of income or capital paid is at least 40% (control percentage).

You have advised that the Unit Trust carries on the business and the Family Discretionary Trust owns 100% of the units. The discretionary trust in the 2010 and 2011 years distributed income equally between the siblings.

The siblings individually received less than 40% distribution of income from the trust (being the control percentage required by subsection 328-125(4)) and as stated previously they are not affiliates, therefore, they do not control the discretionary trust. As a result, they do not have indirect control of the Unit Trust.

Conclusion

The provisions in subsection 328-125(1) have not been satisfied in this case, therefore the post CGT land would not meet the definition of an active asset in subsection 152-40(1) as you are not connected with the Unit Trust that operates the business from your property. Nor is the entity that operates the business your affiliate (section 328-130). Consequently, the basic conditions to qualify for the small business concessions in section 152-10 are not satisfied.