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Ruling

Subject: Small business CGT roll-over - qualifying as a replacement asset

Question 1:

Can the acquisition of a replacement asset be satisfied by the transfer of farming land from your spouse to you as a result of a matrimonial property settlement?

Answer: Yes.

This ruling applies for the following periods:

1 July 2011 to 30 June 2012.

1 July 2012 to 30 June 2013.

The scheme commences on:

1 July 2011.

Relevant facts and circumstances

You sold an active asset in the 2010-11 financial year and chose to roll-over the resultant capital gain under Subdivision152-E of the Income Tax Assessment Act 1997 (ITAA 1997).

You are separated from your spouse and negotiating a matrimonial settlement with them. It is intended that you will have an asset transferred to you which you will use to conduct a business. The asset was acquired by your spouse after 20 September 1985.

The transfer of the asset will be in accordance with a court order or agreement that is specified in section 126-5 of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 152-E

Income Tax Assessment Act 1997 section 126-5

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 Division 152

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 paragraph 104-198(1)(a)

Income Tax Assessment Act 1997 paragraph 104-198(1)(b)

Income Tax Assessment Act 1997 paragraph 104-198(1)(d)

Income Tax Assessment Act 1997 section 104-198

Income Tax Assessment Act 1997 Subdivision 126-A

Income Tax Assessment Act 1997 subsection 126-5(1)

Income Tax Assessment Act 1997 subsection 126-5(5)

Income Tax Assessment Act 1997 section 126-5

Income Tax Assessment Act 1997 Subdivision 110-A

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 roll-over under Subdivision 152-E of the ITAA 1997 is part of the capital gains tax (CGT) small business relief provisions. This roll-over allows a small business entity to defer the capital gain from a CGT event happening in relation to a small business asset, if it acquires a replacement asset or assets and certain conditions are satisfied. You can choose to obtain the roll-over if:

(1) You satisfy the following basic conditions in section 152-10 of the ITAA 1997 for the gain:

(a) a capital gains tax 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:

· you are a small business entity for the income year

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

· 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

· 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

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

(2) You acquire one or more CGT assets as replacement assets or make a capital improvement to one or more existing assets, or both, within the replacement asset period, paragraph 104-198(1)(a) of the ITAA 1997.

(3) The replacement asset, or the asset to which the capital improvement was made is an active asset at the end of the replacement asset period paragraph, 104-198(1)(b) of the ITAA 1997.

(4) The capital gain that is being rolled over is not more than the sum of the following:

· the first element of the cost base of the replacement asset

· any incidental costs incurred in acquiring that asset (which can include giving property) - that is, the second element of the cost base of the replacement asset, and

· the amount expended on capital improvements to one or more assets that were acquired or already owned - that is, fourth element expenditure, paragraph, 104-198(1)(d) of the ITAA 1997.

Conditions (2), (3) and (4) are the roll-over conditions, and if these conditions are not satisfied within the replacement asset period, the gain will become assessable. CGT event J6 in particular could apply in your circumstances.

CGT event J6

CGT event J6 under section 104-198 of the ITAA 1997 happens if you choose to obtain a small business roll-over, and the first element of the cost base of the replacement asset, incidental costs or capital improvements do not equal or exceed the amount that you have chosen to roll-over.

When CGT event J6 happens, you make a capital gain equal to the amount between the capital gain previously disregarded under the small business roll-over and the sum of the first element of the cost base of the replacement asset, incidental costs and capital improvements.

If a CGT event J6 happens, the time of the event is at the end of the replacement asset period, and any capital gain is included in the income tax return for the income year during which the event happened.

Marriage breakdowns

Subdivision 126-A of the ITAA 1997 deals with CGT events involving spouses.

Subsection 126-5(1) of the ITAA 1997 lists the instances in which this Subdivision applies. It includes a court order under the Family Law Act 1975 or a written agreement that is binding under State or Territory law.

Subsection 126-5(5) of the ITAA 1997 states as follows:

For a disposal case where the transferor acquired the asset on or after 20 September 1985:

· the first element of the asset's cost base (in the hands of the transferee) is the asset's cost base (in the hands of the transferor) at the time the transferee acquired it; and

· the first element of the asset's reduced cost base (in the hands of the transferee) is worked out similarly.

Example:

Your spouse transfers land to you because of a court order under the Family Law Act 1975. Any capital gain or loss your spouse makes is disregarded.

If the land's cost base at the time you acquired it is $10,000, the first element of the land's cost base in your hands becomes $10,000.

Application to you

You state that you have sold an active asset during the 2010-11 financial year and have chosen the roll-over under the small business CGT concessions. You are currently negotiating a matrimonial settlement and are considering accepting an asset that you will use to carry on your business activities.

The transfer will be under an agreement as provided under section 126-5 of the ITAA 1997.

Under subsection 126-5(5) of the ITAA 1997, the first element of the cost base of the asset that will be transferred to you, will be your spouse's cost base on the day that you acquire the asset. You will acquire the asset when you enter into an agreement to become its' owner. Your spouse's cost base will include the amount they paid for it and any other expenses that can be included in the cost base of an asset under Subdivision 110-A of the ITAA 1997.

If the first element of the cost base is equal to or greater than the amount that you have chosen to roll-over then CGT event J6 will not happen.

Even though you have not paid for the land, under the marriage breakdown provisions, there will be an amount that qualifies as 'the first element of the cost base' and therefore the asset transferred to you will be considered a replacement asset.

You will need to meet all of the conditions for roll-over to apply the concessions including acquiring the asset within the replacement asset period and the asset being an active asset at the end of the replacement asset period.