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Ruling

Subject: Small business CGT concessions - sale of assets

Question 1:

Are you eligible to apply the small business capital gains tax (CGT) concessions under Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997) on the sale of the rooms to a related party?

Answer: Yes.

Question 2:

Are you eligible to apply the small business CGT concessions under Division 152 of the ITAA 1997 on the sale of the remaining subdivided property?

Answer: No.

This ruling applies for the following periods:

Year ending 30 June 2012.

The scheme commences on:

1 July 2011.

Relevant facts and circumstances

Individual A is a professional and operates in rooms under a company X.

Company X pays salaries to individual A and other professional staff.

Company Y acquired the commercial premises after 20 September 1985. The primary purpose of the acquisition was to provide rooms for company X. Company X has used the premises in its business since the date of acquisition. There are other lots in the property and rent is received directly by company Y for the letting of the other lots. These lots are distinctly separate and are rented to non-related parties

Company Y as owner of the property has applied for and received planning permission to subdivide the premises into four separate lots.

Company Y proposes to sell the rooms to a related party.

The aggregated net assets from all associated entities are estimated at well below $6 million dollars.

There are two ordinary shares issued by company Y. These are held beneficially by individual A and their spouse on behalf of a discretionary trust with the trustees being individual A and their spouse. They are also appointers to the trust.

The discretionary trust has made a family trust election for the year ended 30 June 2011 specifying individual A as the significant individual.

The trustee of the discretionary trust has made a distribution in accordance with the trust deed for the year ended 30 June 2011 to individual A. This distribution represents 100% of the income and capital available to the trust for distribution. No previous income has been received or distributions made.

Individual A holds 66.66% of all ordinary shares issued in company X and their spouse holds the remaining 33.34%.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 subsection 152-10(1)

Income Tax Assessment Act 1997 section 152-15

Income Tax Assessment Act 1997 subsection 152-10(1A)

Income Tax Assessment Act 1997 subsection 152-10(1B)

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 152-15

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 328-125

Income Tax Assessment Act 1997 section 112-25

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

The small business CGT concessions are dealt with in Division 152 of the ITAA 1997.

Subsection 152-10(1) of the ITAA 1997 contains the following basic conditions to be satisfied:

(a) a CGT event happens in relation to a CGT asset of yours in an income year. This condition does not apply in the case of CGT event D1.

(b) the event would (apart from Division 152 of the ITAA 1997) have resulted in the gain

(c) at least one of the following applies:

(i) you are a small business entity for the income year

(ii) you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997

(iii) 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

(iv) the conditions in subsection 152-10(1A) or (1B) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year

(a) the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997.

All of these basic conditions need to be satisfied for you to qualify for the small business CGT concessions. Some concessions also require that other conditions be satisfied.

Basic condition (a)

CGT event A1 under section 104-10 of the ITAA 1997, relating to the disposal of a CGT asset, will happen when you, company Y, disposes of your property, the rooms, which is a CGT asset, to the related party, and this condition is satisfied.

Basic condition (b)

You believe that the above CGT event, the sale of the rooms to the related party, will result in a capital gain, and this condition is satisfied.

Basic condition (c)

The maximum net asset value test in section 152-15 of the ITAA 1997 requires that the total net value of CGT assets owned by you, entities connected with you, and any affiliates of yours or entities connected with those affiliates did not exceed $6 million just before the CGT event that results in the capital gain for which the concessions are sought.

The applicant has advised that you satisfy the maximum net asset value test, and this condition is satisfied.

Basic condition (d)

The active asset test in section 152-35 of the ITAA 1997 requires the CGT asset that gave rise to the capital gain to be an active asset for a particular period. As you owned your property for a number of years the active asset test will be satisfied if the property was an active asset of yours for half the period of ownership.

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

You have provided that company X has used the rooms owned by company Y to carry on a business for the entire period of ownership. It will need to be considered if company X is an entity connected with company Y.

Connected Entities

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.

The meaning of connected entity is defined under section 328-125 of the ITAA 1997 which states as follows

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

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

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

Direct control of entity other than a discretionary trust

328-125(2) An entity (the first entity) controls another entity if the first entity, its *affiliates or the first entity together with its affiliates:

(a) 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:

(i) any distribution of income by the other entity; or

(ii) if the other entity is a partnership - the net income of the partnership; or

(iii) any distribution of capital by the other entity; or

(b) if the other entity is a company - beneficially own, or have the right to acquire the beneficial ownership of, equity interest in the company that carry between them the 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.

328-125(3) An entity (the first entity) controls a discretionary trust if a trustee of the trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the first entity, its *affiliates, or the first entity together with its affiliates.

328-125(4) An entity (the first entity) controls a discretionary trust for an income year if, for any of the 4 income years before that year:

(a) the trustee of the trust paid to, or applied for the benefit of:

(i) the first entity; or

(ii) any of the first entity's *affiliates; or

(iii) the first entity and any of its affiliates;

any of the income or capital of the trust; and

(b) the percentage (the control percentage) of the income or capital paid or applied is at least 40% of the total amount of income or capital paid or applied by the trustee for that year.

Company Y owns the property and company X carries on the business. As company X does not control company Y nor does company Y control company X, the two entities will be connected entities if they are both controlled by a third entity, in this case, individual A.

Company Y has two shares beneficially held by individual A and their spouse for a discretionary trust. Individual A will control the trust if they have received a distribution from the trust of more than 40% in any of the prior four years. In the 2010-11 financial year individual A received 100% of the distribution of the trust and therefore they control the trust. As the trust holds 100% of the shares in company Y, individual A will control company Y.

Company X has three issued shares, two held by individual A and one held by their spouse. Company X is controlled by individual A as they are entitled to more than 40% of any distribution of the company.

As a third entity, individual A, controls both company Y and company X, the companies are connected entities.

Your property, the rooms, will be an active asset for the period of ownership as the property was used by another entity that is connected with you in the course of carrying on a business and this condition is satisfied.

In relation to the rooms, all of the basic conditions have been satisfied and you will qualify for the small business CGT concessions. Some concessions also require that other conditions be satisfied.

Question 2

As above, it is necessary to consider the basic conditions in relation to the other lots.

Basic condition (a)

CGT event A1 under section 104-10 of the ITAA 1997, relating to the disposal of a CGT asset, will happen when you, company Y, dispose of your properties, other lots, which are CGT assets and this condition is satisfied.

Basic condition (b)

You believe that the above CGT events, the other lots, will result in a capital gain, and this condition is satisfied.

Basic condition (c)

The maximum net asset value test in section 152-15 of the ITAA 1997 requires that the total net value of CGT assets owned by you, entities connected with you, and any affiliates of yours or entities connected with those affiliates did not exceed $6 million just before the CGT event that results in the capital gain for which the concessions are sought.

The applicant has advised that you satisfy the maximum net asset value test, and this condition is satisfied.

Basic condition (d)

The active asset test in section 152-35 of the ITAA 1997 requires the CGT asset that gave rise to the capital gain to be an active asset for a particular period. As you owned your property for a number of years the active asset test will be satisfied if the property was an active asset of yours for half the period of ownership.

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

You originally purchased a large property and a business is conducted from part of the property. You have applied for and received permission to subdivide the premises into four lots comprising the rooms, and three other lots.

The subdivision of land or property itself does not constitute a CGT event. Where a property that was acquired as one asset is subdivided, the new assets are treated as though they were always separate assets, section 112-25 of the ITAA 1997. This is evident when land is subdivided from a main residence and the land is sold separately. There is no pro-rata of main residence exemption, the cost base is calculated on the original purchase price of the property and the capital gain is calculated for the total period of ownership.

The subdivided properties will retain the acquisition date of the original property.

The cost base of the original property will be apportioned between the subdivided properties on a reasonable basis.

Taxation Determination TD 97/3 provides that the Commissioner will accept any reasonable method of apportioning the original cost base between the properties (that is, on an area basis or relative market value basis).

The question will then arise, in relation to the small business concessions, if the subdivided lots that are not used in carrying on a business will be active assets.

The other three lots were leased to unrelated parties. Even though they were part of the original building when purchased, they have never been used in carrying on a business by you or an affiliate or an entity connected with you. The other three lots are not active assets and when sold you will not be able to apply the small business CGT concessions to any gain on the sale of these properties.