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Ruling

Subject: Capital gains tax - active asset test

Question 1

Will your interest in the property owned by the partnership satisfy the active asset test in section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997) if you are the owner of units in the unit trust?

Answer

No.

Question 2

Will your interest in the property owned by partnership satisfy the active asset test in section 152-35 of the ITAA 1997 if the partnership is the owner of the units in the unit trust?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2012

The scheme commences on:

1 July 2011

Relevant facts and circumstances

The entities involved in this application own and operate a business.

The partnership was established for the purpose of holding the property as well as the plant and equipment of the business. The property has been used since its acquisition in the business of the unit trust.

The unit trust operates the business. To facilitate this, the unit trust leases the property and the plant and equipment from the partnership. The lease arrangement is formally documented and is on an arm's length basis.

The unit trust is not a discretionary unit trust.

There are two alternative views in relation to the ownership of the units in the unit trust, that is, firstly that the partners of the partnership own the units in the unit trust, and secondly, that it is the partnership itself that owns the units in the unit trust and is entitled to 100% of the income from the unit trust.

You do not have an entitlement to at least 40% of any distribution of income or capital from either the partnership or the unit trust.

In relation to acquiring beneficial ownership of interests in the partnership or the unit trust, the partners and the unit holders only have a right to buy the interests of the other partners and unit holders respectively. If there was to be a further issue of capital in either entity, then it would be issued equally and there would be no adjustment to the distribution percentages.

The partners of the partnership are considering transferring the property from the partnership into a newly created unit trust. The reasons behind this change in structure include commercial considerations as well as the desire for some of the partners to move their ownership of the property from being in the trusts to other structures.

The individuals behind the trusts who are the partners in the partnership and the unit holders of the unit trust are also involved in another business venture which is structured in a similar way. The business ventures are the only business activities in common between the partners and unit holders.

Relevant legislative provisions

Income Tax Assessment Act 1997 Paragraph 108-5(2)(c)

Income Tax Assessment Act 1997 Section 152-35

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

Active asset test

The active asset test in section 152-35 of the ITAA 1997 is satisfied 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 detailed below 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 7 ½ years during the period detailed below:

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 in the 12 months before the CGT event (or such longer time as the Commissioner allows) when the business ceased.

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.

Question 1

For the purposes of this question, the property is owned by the partnership and is leased to the unit trust which operates the business. You hold units in the unit trust.

It is the individual partners who make a capital gain or capital loss from a CGT event, not the partnership itself. For CGT purposes, each partner owns a proportion of each CGT asset and each partner calculates a capital gain or capital loss on their share of each asset. The relevant CGT asset in this case is therefore your interest in the property, which is a CGT asset under paragraph 108-5(2)(c) of the ITAA 1997.

Your interest in the property was not used by you or the partnership in the course of carrying on a business during the period of ownership. Your interest in the property was used by the unit trust in the course of carrying on its business. It will therefore need to be determined whether the unit trust is your affiliate, 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, you will be connected with the unit trust if you control the unit trust in a way described. Under subsection 328-125(2) of the ITAA 1997 which relates to direct control of an entity other than a discretionary trust, 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 by the unit trust.

In this case, the other unit holders of the unit trust can not be affiliates of yours as all of the other unit holders are trusts and, as discussed above, only an individual or company can be an affiliate.

The right where you may be able to acquire the units of an existing unit holder of the unit trust 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.

Therefore, as you have no relevant affiliates, you receive less than 40% of any distribution of income or capital from the unit trust, and do not have the right to acquire any further beneficial ownership of interests in the unit trust which would increase your percentage of distribution 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 under subsection 328-125(2) of the ITAA 1997.

Conclusion

Your interest in the property would not be an active asset at any time during your period of ownership for the purposes of this question, as the interest is not being used by you, an affiliate of yours, or an entity connected with you in the course of carrying on a business. The active asset test in section 152-35 of the ITAA 1997 will therefore not be satisfied in this case.

Question 2

For the purposes of this question, the property is owned by the partnership and is leased to the unit trust which operates the business. The partnership holds the units in the unit trust.

The relevant CGT asset in this case will also be your interest in the property.

We have already determined above for question 1 that your interest in the property was not used by you or the partnership in the course of carrying on a business during the period of ownership, that the unit trust can not be an affiliate of yours, and that you do not directly control the unit trust under subsection 328-125(2) of the ITAA 1997.

In this case, however, if the partnership holds 100% of the units in the unit trust and is entitled to 100% of the income of the unit trust, then the partnership will have direct control of the unit trust under subsection 328-125(2) of the ITAA 1997. Therefore if you control the partnership under subsection 328-125(2) of the ITAA 1997, you will be also taken to control the unit trust under subsection 328-125(7) of the ITAA 1997 which relates to indirect control of an entity.

We have already determined above for question 1 that the other partners of the partnership (who are also the other unit holders of the unit trust) can not be affiliates of yours. The right where you may be able to acquire the interest of an existing partner of the partnership who wishes to sell their interest would not be considered to be the right to acquire beneficial ownership of interests in the partnership as this right is contingent on another partner deciding to sell their interest.

Therefore, as you have no relevant affiliates, you receive less than 40% of any distributions of income or capital from the partnership, and do not have the right to acquire any further beneficial ownership of interests in the partnership which would increase your percentage of distribution of income or capital from the partnership, your control percentage is less than 40% and the partnership will not be an entity connected with you under subsection 328-125(2) of the ITAA 1997.

The unit trust would therefore not be an entity connected with you in these circumstances as the indirect control provision under subsection 328-125(7) of the ITAA 1997 will not apply.

Conclusion

Your interest in the property would not be an active asset at any time during the period of ownership for the purposes of this question, as the interest is not being used by you, an affiliate of yours, or an entity connected with you in the course of carrying on a business. The active asset test in section 152-35 of the ITAA 1997 will therefore also not be satisfied in this case.