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Ruling

Subject : Small business CGT 15-year - exemption for excess contributions tax provisions

Question 1

For the purpose of satisfying the excess contributions tax capital gains tax (CGT) cap conditions for contributing a capital gain to superannuation under section 292-100 of the Income Tax Assessment Act 1997 (ITAA 1997), would the small business 15-year exemption in section 152-105 of the ITAA 1997 apply to allow you to disregard any capital gain from the sale of pre CGT goodwill?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2011

Relevant facts and circumstances

You were a partner in a business which operated continuously since pre 20 September 1985.

You exited it in the year ended 30 June 2011. Whilst partner you worked in excess of 50 hours each week.

Upon cessation it was recognised that from a business perspective, and to preserve the existing goodwill, there was a need to gradually transfer your work on hand and your clients to other partners. Further, your retirement gave rise to the need for a mentoring role to be undertaken to assist less experienced workers who were taking on new roles. Whilst transitioning to full time retirement you agreed to undertake these tasks in the capacity of employee on a part time basis.

Initially you entered into a XX month contract until 30 June 20XX. During this period you reduced your attendance to 30 hours per week over five days.

At the completion of this contract you were engaged again for 6 months until 31 December 20XX. Your attendance reduced to 24 hours per week over this period.

You were over XX years of age at the time of your retirement from the partnership.

During the period in which your interest in the partnership business spanned various partners entered and departed the partnership.

You state that your pre CGT interest in the partnership goodwill was an active asset for the whole of the period of its existence.

You state that you satisfy the $Xmillion maximum net asset value test for the relevant year.

You intend to make a personal contribution of some portion of the capital gain to a private superannuation fund.

Relevant legislative provisions

Income Tax Assessment Act 1997, section 102-5

Income Tax Assessment Act 1997, section 104-10

Income Tax Assessment Act 1997, paragraph 104-10(5)(a)

Income Tax Assessment Act 1997, section 152-10

Income Tax Assessment Act 1997, section 152-15

Income Tax Assessment Act 1997, section 152-35

Income Tax Assessment Act 1997, section 152-40

Income Tax Assessment Act 1997, subparagraph 292-90(2)(c)(iii)

Income Tax Assessment Act 1997, section 292-100

Income Tax Assessment Act 1997, subsection 292-100(1)

Income Tax Assessment Act 1997, subsection 292-100(2)

Income Tax Assessment Act 1997, subsection 292-100(5)

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 of the ITAA 1936, 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

Note, all subsequent legislative references are to the ITAA 1997 unless otherwise stated.

Question 1

CGT Calculation
The framework for calculating a net capital gain is contained in section 102-5. Under that framework, only those capital gains that are not otherwise disregarded are taken into account under step 1 of that method statement.

The relevant CGT event that happens when you dispose of an asset will be an A1 event under section 104-10.

If you acquired the asset before 20 September 1985, any capital gain or capital loss made as a result of CGT event A1 is immediately disregarded under paragraph 104-10(5)(a).

It follows that this disregarded capital gain will not be taken into account at step 1 of the method statement in section 102-5, and there will be no requirement to reduce it further under the 15-year exemption provisions or any of the other CGT small business concessions.

Interaction between the excess contributions tax CGT cap and the CGT small business 15-year exemption
In accordance with Division 292 a taxpayer must pay excess contributions tax on the contributions to a complying superannuation fund that exceed the stated CGT cap amount for the financial year in question ($1.155 million for the year ended 30 June 2011).

Subparagraph 292-90(2)(c)(iii) in subdivision 292-C provides that a contribution does not count towards the cap if it is covered under section 292-100.

Subsection 292-100(1) outlines when a contribution is covered under 292-100. It is covered when:

(a) it is made to a complying super fund,

(b) the requirement in subsection (2), (4), (7) or (8) is met, and

(c) you choose under subsection (9) to apply 292-100 to all/part of the contribution.

Subsection 292-100(2) provides that where a contribution to a super fund also qualifies for the 15-year CGT SB concession it will not count towards the excess non-concessional contributions tax cap. This subsection outlines the requirement under section 292-100 as follows:

(a) you must be able to disregard the relevant capital proceeds (which gave rise to the contribution) under the 15-year exemption provisions in section 152-105, and

(b) the contribution is made on or before the later of the day you are required to lodge your tax return for the relevant year, and, 30 days after you received the capital proceeds.

Subsection 292-100(5) confirms that for the purpose of determining if the conditions in 292-100(2) are met a pre CGT asset will be treated as if it is a post CGT asset.

In effect, for the purpose of the excess contributions tax provisions the operation of subsection 292-100(5) allows step 1 of the method statement in section 102-5 to be addressed differently. Instead of being immediately disregarded under paragraph 104-10(5)(a) the capital gain may instead be included and then disregarded under the section 152-105 15-year exemption provisions. This satisfies the requirement under paragraph 292-100(2)(a) and opens up the possibility that, providing other conditions are met, the pre CGT capital gain may be excluded from the excess contributions tax CGT cap calculation.

Therefore, it follows that we must determine your eligibility for the small business 15-year exemption.

Small business CGT 15-year exemption

Under the small business 15-year exemption in section 152-105, your can disregard any capital gain in relation to the sale of a CGT asset if all of the following conditions, as stated in section 152-105, are satisfied:

· the basic conditions in Subdivision 152-A are satisfied for the gain. These appear in section 152-10 (*see below);

· you continuously owned the CGT asset for the 15-year period ending just before the CGT event

· if the CGT asset is a share in a company or an interest in a trust - the company or trust had a significant individual for a total of at least 15 years … during which you owned the CGT asset.

· either:

o you are 55 or over at the time of the CGT event and the event happens in connection with your retirement, or

o you are permanently incapacitated at the time of the CGT event.

*Subsection 152-10 (1) contains the Subdivision 152-A basic conditions to be satisfied. These conditions are:

· a CGT event happens in relation to a CGT asset of yours in an income year

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

· 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 (see section 152-15), or

iii you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership;

iv (iv) the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year

· the CGT asset satisfies the active asset test (see section 152-35).

Goodwill

Taxation Ruling TR 1999/16 discusses the taxation treatment under Part 3-1 in relation to the goodwill of a business. It provides that goodwill, as a whole, is either pre CGT or post CGT.

Paragraph 25 states that the goodwill of a particular business cannot be characterised as partly pre CGT goodwill and partly post CGT goodwill. Goodwill is a composite asset.

However, paragraph 26 clarifies that an interest in goodwill, unlike the goodwill itself, is not a composite asset. This will impact on partnership goodwill if a particular interest is acquired pre CGT and another interest is acquired post CGT. In that instance the post CGT interest is not subsumed into the pre CGT interest in the business.

Application to your circumstances

In determining under what section the capital gain is exempt for the purposes of calculating the amount under the excess contributions tax CGT cap contained within Division 292, the operation of subsection 292-100(5) is such that the pre CGT goodwill will be deemed post CGT goodwill and the appropriate exemption provision will be subdivision 152-B (the small business 15-year exemption).

Provided you qualify for the 15-year exemption your pre CGT goodwill will not contribute towards your excess contributions tax CGT cap.

Small business CGT 15-year exemption

15-year exemption condition (a)

This exemption condition concerns the basic conditions under subdivision 152-A as stated in subsection 152-10(1):

Subdivision 152-A basic condition (a)
This condition requires a CGT event to happen in relation to your CGT asset in an income year. The asset in question is your interest in the partnership goodwill which was disposed of in the year ended 30 June 2011. On this date a CGT event A1 happened. This condition is satisfied.

Subdivision 152-A basic condition (b)
Initially, the CGT A1 event would not have resulted in a gain due to 104-10(5), however the operation of 292-100(5) means that for the purposes of the excess contributions tax provisions the pre CGT gain is now deemed a post CGT gain to which the small business CGT concessions and in particular the 15-year exemption may apply. This condition is satisfied.

Subdivision 152-A basic condition (c)
You have advised that you satisfy the maximum net asset value test. This condition is satisfied.

Subdivision 152-A basic condition (d)
You advise that the goodwill is an active asset within the meaning of section 152-40 and that it qualifies as an active asset under section 152-35. This condition is satisfied.

You satisfy all four of the basic conditions in Subdivision 152-A. Therefore, you also satisfy condition (a) of the small business CGT 15-year exemption provisions.

15-year exemption condition (b)

The pre CGT interest in the partnership goodwill was acquired prior to 20 September 1985 and was disposed of in the year ended 30 June 2011. As this period exceeds the 15-year requirement condition (b) is satisfied.

15-year exemption condition (c)

This condition pertains to interests in companies and trusts only. As you are applying in your individual capacity condition (c) is not applicable to your circumstances.

15-year exemption condition (d)

You are over 55 years old. We accept that upon exiting the partnership your subsequent involvement as an employee of the business was in a reduced capacity, eventually leading to your full time retirement after 18 months. We therefore find that your interest in the partnership goodwill was sold in connection with your retirement and that condition (d) is also satisfied.

Conclusion

In relation to the disposal of your pre CGT goodwill you satisfy all of the conditions for the small business 15-year exemption in section 152-105.

Excess contributions tax

The operation of section 292-100(5) means that for the purposes of the Division 292 excess contributions tax provisions this pre CGT capital gain will be treated as a post CGT capital gain.

It follows that the paragraph 292-100(2)(a) requirement is satisfied and the pre CGT component will not constitute a non-concessional contribution under subparagraph 292-90(2)(C)(iii).

Provided you can satisfy the various other qualifying measures contained within Division 292, this pre CGT component may be excluded from your CGT cap calculation.