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Ruling

Subject: CGT small business concessions - active asset - transfer of land - affiliates

Question:

Are you able to apply the small business capital gains tax (CGT) concessions to any gain made on the transfer of land to your child?

Answer: No.

This ruling applies for the following period:

1 July 2011 to 30 June 2012.

The scheme commences on:

1 July 2011.

Relevant facts and circumstances

You have been farming for a number of years and purchased the relevant property after 20 September 1985. You farmed this property for a few years and have since been leasing it to your child. You remain living on the property.

You are now considering transferring the property to your child.

There are no formal agreements between you and your child, either in relation to business or financial arrangements; however they pays you lease payments.

You commenced a primary production activity on the land when you purchased it and your child carries on the same operation that you started.

During busy work times you have maintained a keen working involvement in the business activities.

You have placed no restrictions on your child as to how they run the business but they continues to run the business in the same manner that you started.

You have no financial control over your child's activities and do not control the business however; you provide support in farming processes.

Your child makes the major decisions about his business but if they want to change any of the processes already in place they always discusses them with you first before implementing them.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 104-10(1)

Income Tax Assessment Act 1997 Subsection 108-5(1)

Income Tax Assessment Act 1997 Subsection 108-5(2)

Income Tax Assessment Act 1997 Paragraph 104-10(3)(a)

Income Tax Assessment Act 1997 Section 100-35

Income Tax Assessment Act 1997 Subsection 116-30(1)

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 Subsection 152-40(1)

Income Tax Assessment Act 1997 Paragraph 152-40(1)(a)

Income Tax Assessment Act 1997 Paragraph 152-40(4)(e)

Income Tax Assessment Act 1997 Section 328-130

Income Tax Assessment Act 1997 Subsection 328-130(2)

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'.

Reachilds for decision

Subsection 104-10(1) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that CGT event A1 will occur when you dispose of a CGT asset. The term CGT asset is defined by subsection 108-5(1) of the ITAA 1997 which is defined as any kind of property. Further, subsection 108-5(2) of the ITAA 1997 lists land as a CGT asset.

Paragraph 104-10(3)(a) of the ITAA 1997 states that the time of the event is when you enter into the contract for the disposal. If there is no contract then the time of the event is when the CGT asset changes hands.

Section 100-35 of the ITAA 1997 explains that you make a capital gain if you receive or are entitled to receive capital amounts from the CGT event which exceed your total costs associated with that event.

The market value substitution rule in subsection 116-30(1) of the ITAA 1997 will apply if you do not receive capital proceeds from a CGT event. In this case the rule states that you are taken to have received the market value of the CGT asset that is the subject of the event. The market value is worked out as at the time of the event.

Under Division 152 of the ITAA 1997, small businesses are able to reduce or disregard a capital gain that they make on the disposal of CGT assets.

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

· a capital gains tax (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.

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

· 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

· 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.

If you satisfy basic condition (d), basic conditions (a), (b) and (c) will need to be satisfied at the time of the CGT event.

Basic condition (d)

The active asset test is outlined in section 152-35 of the ITAA 1997. A CGT asset satisfies the active asset test if:

· 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 or

· 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.

Subsection 152-40(1) of the ITAA 1997 states that a CGT asset is an active asset if, at that time:

· you use it, or hold it ready for use, in the course of carrying on a business, or

· it is used, or held ready for use, in the course of carrying on a business by your affiliate or by another entity that is connected with you.

In accordance with paragraph 152-40(1)(a) of the ITAA 1997 your interest in the property will satisfy the definition of active asset if it is used or held ready for use in the course of carrying on a business by you, your affiliate or an entity connected with you.

As you owned your property for more than 15 years, this test will be satisfied if the property was an active asset of yours for a total of 7 ½ years during your period of ownership.

Paragraph 152-40(4)(e) of the ITAA 1997 provides that an asset whose main use is to derive rent, cannot be an active asset (unless that main use was only temporary).

In your case, you used the property in the course of carrying on a business for a few years. The property was then used by your child in the course of carrying on his business. Therefore, for the property to be an active asset for the period that it was leased to your child, your child will need to be your affiliate or connected with you.

The requirements for an entity to be an affiliate within the meaning of the term in section 328-130 of the ITAA 1997 can be summarised as follows:

· the entity must be an individual or a company

· the entity must carry on a business and

· in relation to the affairs of the business of the individual or the company, the entity must act, or could reasonably be expected to act, in accordance with the directions or wishes, or in concert with, the entity.

We will now consider each of these requirements in relation to your circumstances.

Requirement (a)

Your child is an individual and this requirement is satisfied.

Requirement (b)

We have determined for requirement (a) that your child is an individual. In order to satisfy requirement (b) your child need to be carrying on a business in their capacity as an individual.

They are carrying on a business and this condition is satisfied.

Requirement (c)

Affiliate

An individual or company is an affiliate of a taxpayer if the individual or company acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes, or in concert with the taxpayer in relation to the affairs of the business of the individual or company (section 328-130 of the ITAA 1997). However, subsection 328-130(2) of the ITAA 1997 points out that an individual or company is not your affiliate merely because of the nature of the business relationship.

Taxation Determination TD 2006/79 provides guidance on when an entity is a small business CGT affiliate. TD 2006/79 at paragraph 41 explains that whether a person acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes, or in concert with the taxpayer is a question of fact dependent on all the circumstances of the particular case. The key consideration is the actions of the parties. If the parties act together in pursuit of a common goal or purpose or the taxpayer is able to direct the other person in relation to (not merely where the person is involved in, connected to or participating in) the carrying on of the business, these are factors that may support a conclusion that the parties act in concert or the other person acts in accordance with the taxpayer's directions or wishes.

In accordance with directions and wishes

Relevant factors that may support a finding that a person acts or could reasonably be expected to act in accordance with the taxpayer's directions or wishes include:

1. the existence of a close family relationship between the parties

2. the lack of any formal agreement between the parties prescribing how the parties are to act in relation to each other

3. the likelihood that the way the parties act, or could reasonably be expected to act, in relation to each other would be based on the relationship between the parties rather than on formal agreements

4. the actions of the parties.

No one factor will necessarily be determinative. Example 3 in TD 2006/79 demonstrates that a close family relationship between the owner of the property and the owner of the business does not mean that they are small business CGT affiliates of one another. The key consideration is the actions of the parties. If the person is able to direct the other person in relation to the carrying on of the business, this factor may support a conclusion that the parties act in concert, or the other person acts in accordance with the taxpayer's directions or wishes.

In concert

Whether a person is acting in concert with another is essentially a question of fact.

The term 'act in concert' is not defined in the CGT small business relief provisions in Division 152 of the ITAA 1997 or elsewhere in the ITAA 1997. The term must therefore be interpreted both according to its ordinary meaning and in keeping with the purpose and scope of Subdivision 152-A of the ITAA 1997.

The Macquarie Dictionary, 1991, 2nd edn, Macquarie Library, McMahon's Point, defines the term 'in concert' to mean 'in a coordinated or organised way; together'.

The term 'in concert' has not been considered judicially in an income tax context. However, in IPT Systems v. MTIC Corporate Pty Ltd [2000] WASC 316, Owen J considered the meaning of the term 'acting in concert' for the purposes of paragraph 15(1)(a) of the Corporations Act 1989.

Owen J referred to his earlier consideration of the term in Bank of Western Australia v. Ocean Trawlers Pty Ltd (1995) 13 WAR 407 and the decision in Adsteam Building Industries Pty Ltd v. Queensland Cement & Lime Co Ltd (No 4) [1985] 1 QdR 127 (Adsteam Building Industries Case). His Honour identified the following three principles from those cases:

· the words 'in concert' take their meaning from the context and the scope and the purpose of the legislative framework they appear in;

· the term 'acting in concert' involves at least an understanding between the parties as to a common purpose or object; and

· the common purpose or object can be established by inference as much as by direct evidence.

In the Adsteam Building Industries Case, McPherson J said:

…I cannot see that it is possible for a person to "act in concert" towards an end or object, or even simply to act in concert, unless there is at least an understanding between them as to their common purpose or object. The expression in question evokes the notion of joint actors, or perhaps even joint tortfeasors, as to which it is settled that there must be "concerted action to a common end": see The Koursk (1924) p. 140 at 156.  A mere coincidence of separate acts is insufficient: see Fleming: The Law of Torts, 6th ed., at pp. 227-228.

In Australasian Meat Industry Employees Union v. Allied Trades Federation of Australia (1991) 32 FCR 318 at 329, Gray J said:

The difficulties in the concept of 'in concert' are acute when the acts of one person are confined to advising, requesting, encouraging or inciting the other, who responds by performing the desired act.

At FCR 334, French J said:

The phrase 'in concert' has been construed … as involving knowing conduct, the result of communication between the parties and not simultaneous actions occurring spontaneously. It has been said to involve contemporaneity and a community of purpose which requires a consensual element: …

And, in J-Corp Pty Ltd v. Australian Builders Labourers Federated Union of Workers (WA) (1992) 46 IR 263 at 536; French J said:

Conduct involving direction and response may, according to the circumstances of the case, be conduct in concert on the part of the person directing and the person acting upon that direction.

Consistent with the views drawn from the above cases and the ordinary meaning of the term, a person will be viewed as acting in concert with a taxpayer for the purposes of the 'affiliate' definition where they both act together in pursuit of a common goal or purpose or the taxpayer is able to direct the other person in relation to, and not merely where the taxpayer is involved, connected to or participated in, the carrying on of the business.

Application to your circumstances

In your case, you purchased the land a number of years ago. You commenced farming on the land but then you passed on the farming of the land to your child.

We accept that there is a close family relationship between the parties. You live on the property and help out in times of need.

Your child discusses with you any new ideas or processes but you do not direct him to carry on his business in any particular way nor do you have any financial control.

Whilst you may be involved, connected to or participate in your child's business you do not act together in pursuit of a common goal or purpose and you do not direct him in the carrying on of his business. Overall, your child operates his business as they wishes. The requirements for an entity to be an affiliate within the meaning of the term in section 328-130 of the ITAA 1997 are not met as you do net meet requirement (c) of the definition.

As your child is not your affiliate the property was not an active asset of yours for the years it was leased to your child. The property was only an active asset for the period that you farmed it. As this was less than 7 ½ years, the active asset test is not satisfied. You are therefore unable to qualify for the small business CGT concessions as you do not meet basic condition (d) in subsection 152-10(1) of the ITAA 1997.