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Ruling

Subject: Capital gains tax: small business roll-over

Question 1

Will any replacement assets acquired by you and leased to a unit trust be active assets at the end of the replacement asset period for the purposes of the small business roll-over in Subdivision 152-E of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will the Commissioner allow you, under subsection 104-190(2) of the ITAA 1997, an extension of the replacement asset period in paragraph 104-185(1)(a) of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

The scheme commences on:

1 July 2011

Relevant facts and circumstances

You carry on a business in a specialized industry.

You made a capital gain and you have chosen the small business roll-over in relation to this gain.

You have actively looked for opportunities to acquire replacement assets and/or investment in businesses.

In view of the various economic uncertainties which have arisen in Europe and the United States in recent months and the foreseeable future, as well as concern over the overheated market in China and India, you are taking extremely prudent approaches to ensure that the capital gain will be reinvested wisely.

You have done a number of feasibility studies relating to the replacement assets and investment opportunities since then. However nothing concrete can be finalized at this stage. In view of your specialty, you state that it is not easy to acquire replacement assets within the two year replacement asset period.

The replacement assets will be held by you. You will then lease the replacement assets to a unit trust, which will pay rent for the replacement assets.

You will hold less than 40% of the units in the unit trust.

The unit trust satisfies the small business entity conditions, and the replacement assets will be used in a business being carried on by the unit trust.

You will receive less than 40% of any distributions of income or capital from the unit trust.

The applicant has stated that the other unit holders of the unit trust are not affiliates of yours.

The deed for the unit trust contains a provision that unit holders must offer their units to other existing unit holders before they can be sold to third parties.

Relevant legislative provisions

Income Tax Assessment Act 1997 Paragraph 104-185(1)(a)

Income Tax Assessment Act 1997 Subsection 104-190(2)

Income Tax Assessment Act 1997 Section 104-197

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 (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

CGT event J5 under section 104-197 of the ITAA 1997 happens if you choose to obtain a small business roll-over under Subdivision 152-E of the ITAA 1997, and by the end of the replacement asset period the replacement asset is not your active asset.

Section 152-40 of the ITAA 1997 provides the meaning of active asset. A CGT asset will be an active asset at a time if, at that time, you own the asset and the asset was used or held ready for use by you, an affiliate of yours, or by another entity that is connected with you, in the course of carrying on a business.

In your case, you will own the replacement assets, however you will not be using these assets in the course of carrying on a business. The replacement assets will be used by the unit trust in the course of carrying on its business and will be paying you rent for the use of these assets. It will therefore need to be determined whether the unit trust is an affiliate of yours, or is an entity connected with you.

Section 328-130 of the ITAA 1997 provides the meaning of affiliate. Under this provision, only an individual or a company can be an affiliate, and the unit trust therefore can not be an affiliate of yours.

Section 328-125 of the ITAA 1997 provides the meaning of connected with an entity. Under this provision, the unit trust will be connected with you if you control the unit trust in a way described. Under subsection 328-125(2), you will control the unit trust if you, your affiliates, or you together with your affiliates, beneficially own, or have the right to acquire the beneficial ownership of, interests in the unit trust that carry between them the right to receive a percentage (the control percentage) that is at least 40% of any distribution of income or capital of the unit trust.

In this case, the other unit holders of the unit trust are not affiliates of yours and you do not have the right to acquire beneficial ownership of interests in the unit trust. The right in the deed of the unit trust where you may be able to acquire the units of an existing unit holder who wishes to sell their units would not be considered to be the right to acquire beneficial ownership of interests in the unit trust as this right is contingent on another unit holder deciding to sell their units. You do not have a right to demand additional units in the unit trust.

Therefore, as you will be receiving less than 40% of any distributions of income or capital from the unit trust, your control percentage is less than 40% and the unit trust will not be an entity connected with you.

Conclusion

Any replacement assets acquired by you will not be active assets at the end of the replacement asset period as these assets will not be used by you, an affiliate of yours, or by another entity that is connected with you, in the course of carrying on a business. CGT event J5 under section 104-197 of the ITAA 1997 will therefore happen in this case.

Question 2

Under paragraph 104-185(1)(a) of the ITAA 1997, the replacement asset period starts one year before, and ends two years after the last CGT event in the income year for which you obtain the small business roll-over. The Commissioner has a discretion to extend the replacement asset period (subsection 104-190(2) of the ITAA 1997).

In your case, you will obtain the small business roll-over in the income year. As you do not expect to acquire a replacement asset within the relevant replacement asset period, the Commissioner may exercise his discretion under subsection 104-190(2) of the ITAA 1997 to extend the time period.

In determining if the discretion to extend the replacement asset period should be exercised, the Commissioner considers the following factors:

· whether there is evidence of an acceptable explanation for the period of extension requested and whether it would be fair and equitable in the circumstances to provide such an extension

· whether there is any prejudice to the Commissioner if the additional time is allowed, however the mere absence of prejudice is not enough to justify the granting of an extension

· whether there is any unsettling of people, other than the Commissioner, or of established practices

· fairness to people in like positions and the wider public interest

· whether there is any mischief involved and

· the consequences of the decision.

In your case, we consider that you have provided an acceptable explanation for not being able to acquire a replacement asset within the replacement asset period. You advise that in view of the current economic conditions overseas, that you are taking extremely prudent approaches to ensure that the capital gain will be reinvested wisely.

You have done a number of feasibility studies relating to the replacement assets and investment opportunities, however nothing concrete can be finalised at this stage. You are in a specialist industry, and it is therefore not easy to acquire replacement assets within the two year replacement asset period.

After considering the above factors against your circumstances, it is considered that you have provided a reasonable and acceptable explanation for the period of extension requested.

Based on the facts and your submissions, it is considered that the Commissioner should exercise his discretion under subsection 104-190(2) of the ITAA 1997 to extend the replacement asset period in paragraph 104-185(1)(a) of the ITAA 1997.