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Ruling

Subject: CGT - deceased estate

Question 1

Do Lot 1 and Lot 2 satisfy the active asset test under section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Do Lot 4 and Lot 5 satisfy the active asset test under section 152-35 of the ITAA 1997?

Answer

Yes

Question 3

Do Lot 6 and Lot 7 satisfy the active asset test under section 152-35 of the ITAA 1997?

Answer

No

Question 4

Can Taxpayer 1 apply the small business 15 year exemption to any capital gain arising from the disposal of their ownership interest in Lot 4 and Lot 5?

Answer

Yes

Question 5

Can Taxpayer 2 apply the small business 15 year exemption to any capital gain arising from the disposal of their ownership interest in Lot 4 and Lot 5?

Answer

No

Question 6

Can Taxpayer 2 apply the small business 50% active asset reduction and then the small business retirement exemption to the capital gain arising from the disposal of their ownership interest in Lot 4 and Lot 5?

Answer

Yes

This ruling applies for the following periods:

Year ending 30 June 2012

Year ending 30 June 2013

Year ending 30 June 2014

The scheme commences on:

1 July 2011

Relevant facts and circumstances

Theparentof Taxpayer 1 and 2 owned a number of titles of land which were used to carry on a primary production business, with some land offered for agistment. they died after September 1985. they had acquired the land prior to September 1985.

The parent's last will and testament provided that their surviving spouse shall have a life interest in the land, but that the land ultimately be left to their children.

Subsequent to their death, trust tax returns were lodged each year.

A primary production business was conducted on the properties from the date of the parent's death. The business was conducted by the trustees, Taxpayer 1 and Taxpayer 2. During these years, profit was derived both from business as well as agistment.

There was no trading activity or expenses incurred after the death of the spouse, the life tenant. The trust estate was registered for GST until the end of that financial year.

The titles involved have been transferred to Taxpayer 1 and Taxpayer 2 as remainder persons under the will. All remaining assets were sold off at a clearing sale.

All land titles were valued by a licensed valuer at the date of death.

Taxpayer 1 and Taxpayer 2 now wish to sell the properties.

Lot 1 and 2 were used to derive adjistment income. The adjistment arrangement was informal. It was entered into by the taxpayer's parent after the death of their parent. She entered into the agreement with her neighbour that they could run cattle as long as they kept weeds down, maintained fences and provided some labour, this arrangement ran up until in recent years when a new agreement was entered into which was a formal adjistment agreement based on a price per head of cattle.

Lot 4 and 5 were recently sold with subdivision approval, they are cleared and were used principally to run the business. While the plan of subdivision was approved, that was the full extent of any development undertaken in relation to that land. The subdivision plan was passed to the purchaser.

Lot 6 and 7 are fully vegetated.

Taxpayer 1 and Taxpayer 2 both satisfy the maximum net asset value test.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-10

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 subsection 152-40(1)

Income Tax Assessment Act 1997 section 152-105

Income Tax Assessment Act 1997 paragraph 152-105(d)(i)

Income Tax Assessment Act 1997 paragraph 152-105(d)(ii)

Income Tax Assessment Act 1997 section 152-305

Income Tax Assessment Act 1997 subsection 152-315(4)

Income Tax Assessment Act 1997 subsection 152-320(1)

Income Tax Assessment Act 1997 section 995-1

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

Question 1, 2 and 3

Active asset test

The active asset test is set out in section 152-35 of the ITAA 1997:

152 -35(1) A *CGT asset satisfies the active asset test 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 specified in subsection (2); 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 7½ years during the period specified in subsection (2).

152-35(2) 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 to be carried on in the 12 months before that time or any longer period that the Commissioner allows - the cessation of the business.

Subsection 152-40(1) of the ITAA 1997 provides the meaning of an active asset.

152-40(1) A CGT asset is an active asset at a time if, at that time:

(a) you own the asset (whether the asset is tangible or intangible) and;

(i) you use it, or hold it ready for use, in the course of carrying on a business; or

(ii) 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. 

Taxation Determination TD 93/37 provides the Commissioner's view on the date of acquisition of an asset by remainderman where an asset owned by the deceased at the time of death passes to a remainderman on the death of a life tenant. TD 93/37 at paragraph 3 states.

If the deceased dies on or after 20 September 1985, the remainderman is taken to have acquired the asset on the date of death of the deceased.

Carrying on a business

The definition of a primary production business is provided in section 995-1 of the ITAA 1997. According to this section, a primary production business includes maintaining animals for the purpose of selling them or their bodily produce (including natural increase). 

Taxation Ruling TR 97/11 provides the Commissioners view of the law in relation to the carrying on of a business of primary production. This ruling provides a series of indicators at paragraph 13 that are relevant when considering whether a business is being carried on. The following indicators from paragraph 13 are relevant when considering whether a business is being carried on:

(a)     whether the activity has a significant commercial purpose or character,

(b)     whether there is more than just an intention to engage in business,

(c)     whether there is a purpose of profit as well as a prospect of profit,

(d)     whether there is repetition and regularity to the activity,

(e)     whether the activity is of the same kind and carried on in a similar manner to businesses in the industry,

(f)       whether the activity is planned, organised and carried on in a business-like manner,

(g)     the size, scale and permanency of the activity, and

(h)     whether the activity is better described as a hobby or recreation.

The ruling states that no one indicator is decisive and all indicators should be considered in combination and as a whole: Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922). Whether a business is being carried on will depend on the large or general impression gained (Martin v. FC of T (1953) 90 CLR 470 at 474; 5 AITR 548 at 551) from looking at all the indicators, and whether those indicators provide the operations with a commercial flavour (Ferguson v. FC of T (1979) 37 FLR 310 at 325; 79 ATC 4261 at 4271; (1979) 9 ATR 873 at 884). However, the weighting to be given to each indicator may vary from case to case.

In AAT Case 10,331; 95 ATC 404; (1995) 31 ATR 1146 Senior Member Fayle said:

Agisting another's livestock does not ordinarily constitute the carrying on of a business. Agistment fees ordinarily are in the nature of rent. However, where a land owner is charged with the management, maintenance and care of the animals agisted then it is possible that the person is carrying on a business, the reward for which is the agistment fee. This is more likely if the level of the agistment fee depended on the effective management, maintenance and care of the animals. For example, if a land owner agreed with the owner of a herd of cattle to ensure their good health, proper veterinary care and husbandry of the progeny, marketing of their bodily produce and maintenance of the herd, then that land owner may be carrying on a business of primary production.

Taxation Ruling IT 225 provides the Commissioner's view of the law in relation to whether agistment income is earned through a business of primary of production. The general proposition may be stated that where income arises from the use of the assets of a business of primary production and the particular use is a recognised incident of carrying on that sort of business, the income may be regarded as forming part of the proceeds of the business.

That is, income earned from activities that are incidental to the running of a primary production business is considered to be a part of the business.

However, paragraph 4 of IT 225 sets out that this general proposition does not extend to a situation where property or a substantial part of a property is used solely for agistment. The agistment income would be considered separate from the business income earned.

Application to your situation

Lot 1 and Lot 2

According to the information you have provided these lots were used to derive agistment income using an informal agreement.

The first agreement was entered into by your parent after the death of your parent. The basis of the agreement was that her neighbour could run cattle on the lots as long as they maintained the property and structures and provided some labour. This arrangement ran until recent years when a new agreement was negotiated which was a more formal agistment agreement based on a price per head of cattle.

In this case it is considered that the agistment arrangements would not amount to the carrying on of a business.

Neither would the agistment activity be considered to be incidental to the beef cattle grazing business, in accordance with IT 225. The activity is geographically separate, utilises separate assets and there is a significant difference in the carrying out of this activity to the other farming activity. The agistment activity is passive in nature as evidenced by the form of the agreements.

These lots will not satisfy the active asset test as they have not been used in the carrying on of a business.

Lot 4 and Lot 5

According to the information you have provided these lots were used to carry on the beef cattle grazing business commencing in 1992 after the death of your parent and ceasing in the 2010 financial year, thereby meeting the requirements of the active asset test under paragraph 152-35(1)(b) of the ITAA 1997.

Lot 6 and Lot 7

These lots are fully vegetated. As a result they could not be said to be used, or in a condition to be held ready for use in the business. These lots do not satisfy the active asset test.

Question 4 and 5

The small business 15-year exemption in Subdivision 152-B of the ITAA 1997

Under the exemption in section 152-105 of the ITAA 1997, you can disregard any capital gain in relation to the disposal of a CGT asset if all of the following conditions are satisfied:

· the basic conditions in Subdivision 152-A of the ITAA 1997 are satisfied for the gain

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

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

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

Condition (a)

Section 152-10 of the ITAA 1997 contains the basic conditions to be satisfied. These conditions are:

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

· 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 asset of the partnership or

· 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.

Basic condition (a)

It is accepted that CGT event A1 under section 104-10 of the ITAA 1997, relating to the disposal of a CGT asset, would happen on the sale of each of your ownership interests in lot 1 to 7. This basic condition would be satisfied.

Basic condition (b)

It is accepted the CGT event would result in a capital gain and this basic condition would be satisfied.

Basic condition (c)

The facts state that you each satisfy the maximum net asset value test in section 152-15 of the ITAA 1997 and this basic condition is satisfied.

Basic condition (d)

This condition requires that the active asset test in section 152-35 of the ITAA 1997 is satisfied. In the combined answer to question 1,2 and 3 above it was concluded that only Lot 4 and Lot 5 satisfied the active asset test.

The active asset test and this basic condition will be satisfied for these lots only.

Summary for basic conditions

In relation to the CGT assets known as Lot 4 and Lot 5, all of the basic conditions will be satisfied in this case, which means condition (a) for the small business 15-year exemption will be satisfied.

As the other lots do not satisfy the basic conditions you cannot use the small business 15 year exemption for any resulting gain on the disposal of these lots.

Condition (b)

Under TD 93/37 you acquired Lot 4 and Lot 5 on the death of your parent. You each have continuously owned each asset for the 15-year period ending just before the CGT event, and this condition will be satisfied.

Condition (c)

On the basis of the facts supplied with your application:

Paragraph 152-105(d)(i) of the ITAA 1997 will be the relevant condition to be satisfied for Taxpayer 1 (you).

You were over 55 years of age at the time of the CGT event.

Whether there is a retirement for the purposes of the small business 15 year exemption will depend on the circumstances of each particular case. However, it is considered for the term to be satisfied, there must at least be a significant reduction in the number of hours the individual is engaged in present activities, or a significant change in the nature of present activities. It is not necessary for there to be a permanent and everlasting retirement from the workforce.

In your case it is accepted there will be a change in the nature of the present activities. The disposal of your ownership interest in the lots resulted from the decision to stop carrying on the business. You have no plans to continue to carrying on a business and you are almost completely retired from the workforce. This condition will therefore be satisfied.

Paragraph 152-105(d)(ii) of the ITAA 1997) will be the relevant condition to be satisfied for Taxpayer 2 (you).

As you were under 55 years of age at the time of the CGT event and not permanently incapacitated you will not satisfy the conditions.

Conclusion

Taxpayer 1 satisfies all of the above conditions, the small business 15-year exemption in section 152-105 of the ITAA 1997 will apply in relation to the disposal of their ownership interest in Lot 4 and Lot 5.

Taxpayer 2 will not satisfy all of the above conditions and as a result cannot apply the small business 15-year exemption in section 152-105 of the ITAA 1997 to the disposal of their ownership interest in Lot 4 and Lot 5.

Question 6

Small business 50% reduction

To apply the small business 50% active asset reduction, you only need to satisfy the basic conditions in section 152-10 of the ITAA 1997. There are no other requirements.

As discussed in the answer to question 4 above, Taxpayer 2 would satisfy all of the basic conditions except the active asset test, in this case only Lot 4 and 5 satisfy the active asset test. Taxpayer 2 is able to apply the small business 50% active asset reduction to the capital gain arising from the disposal of their ownership interest in Lot 4 and Lot 5.

Small business retirement exemption

The requirements for the small business retirement exemption are contained in Subdivision 152-D of the ITAA 1997. The conditions for a taxpayer to be able to choose the exemption are contained in subsection 152-305 of the ITAA 1997 and are as follows:

· the basic conditions in section 152-10 of the ITAA 1997 are satisfied for the gain

· if the taxpayer is under 55 just before making the choice - an amount equal to the asset's CGT exempt amount is contributed to a complying superannuation fund or an RSA, and

· the contribution is made at the later of when the choice is made and when the proceeds are received.

The taxpayer must specify the amount in writing that they wish to disregard (subsection 152-315(4) of the ITAA 1997), and not have exceeded the CGT retirement exemption limit. Subsection 152-320(1) of the ITAA 1997 states that an individual's CGT retirement exemption limit is $500,000.

In the case of Taxpayer 2, they would satisfy the basic conditions and be under 55 as at the date of the CGT event. They are eligible to apply the small business retirement exemption to the capital gain arising from the disposal of their ownership interest in Lot 4 and Lot 5. Note, they must have regard to the exemption limit and the timing requirements for making the contribution.