Edited version of your private ruling

Authorisation Number: 1012138176724

This edited version of your ruling will be published in the public register of private binding rulings after 28 days from the issue date of the ruling. The attached private rulings fac sheet has more information.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet.

Ruling

Subject: CGT Small Business Concessions

Question 1

Is X a controller of the Unit Trust by virtue of X being a director and the majority shareholder of Q P/L which is the trustee of the Unit Trust and the fact that X personally directs the actions of both entities?

Answer

As X is entitled to at least 40% of the voting rights in Q P/L X is taken to control the company as provided for in subsection 328-125(2) of the Income Tax Assessment Act 1997 (ITAA 1997). However X cannot be regarded as controlling the Unit Trust in their own right.

Question 2

Is Y an affiliate of X?

Answer

Y is not an affiliate of X. Subsection 328-130(2) of the ITAA 1997 provides that an individual or company is not your affiliate because of the nature of the business relationship you and the individual or company share.

Question 3

Is X a controller of the Unit Trust on the basis that Y is their affiliate or that X is a joint holder with Y of a certain percentage beneficial interest in the income and capital of the Unit Trust?

Answer

As Y is not an affiliate of X, X does not control the Unit Trust as X is not entitled to at least 40% of the distributions of income and / or capital as required by subsection 328-125(1) of the ITAA 1997.

Question 4

Are the Unit Trust and Q P/L connected if X (Y as X's affiliate) is deemed to be the controller of each entity?

Answer

The Unit Trust and Q P/L are not connected through X as X does not control both entities. The Unit Trust and Q P/L are not connected to each other as neither entity controls the other entity as they do not meet the control test in section 328-125 of the ITAA 1997.

Question 5

Is the industrial property an active asset?

Answer

As the land is not used in a business carried on by an affiliate, or an entity connected with, the Unit Trust, it is not an active asset. Accordingly, the capital gain arising from the sale of the asset will not be eligible for the CGT small business concessions.

This ruling applies for the following period:

Year ended 30 June 2011

Relevant facts and circumstances

The Unit Trust acquired an industrial property some years ago.

Q P/L is the trustee of the Unit Trust. X and Y are the directors of Q P/L. X owns AAA ordinary shares in their own name and Y owns BBB ordinary shares in their own name in Q P/L.

The units in the Unit Trust are held as follows:

X and Y: more than 70 % jointly

Q P/L Staff Super Fund: less than 30%

There are no other units on issue now or during the ownership period. The above unit holdings have not changed since the set-up of the unit trust.

The industrial property and has been leased to the related operating company Q P/L since the date of purchase and has been used for factory premises for that whole time. Q P/L has conducted its business from these premises for the entire ownership period.

During the 20XX year the company progressively transferred to larger premises and in a recent year the property was sold by the Unit Trust to an unrelated party.

X and Y were de facto spouses for many years and were de facto spouses for greater than 50% of the ownership period of the property. However they separated several years prior to the sale of the industrial property. They ceased living together several years ago. They are no longer a de facto couple. They continue to work for the company and they retain their separate shareholdings in the company.

Relevant legislative provisions

Income Tax Assessment Act 1997

Subdivision 152-A

Section 152-10

Section 152-15

Section 152-20

Section 152-35

Section 152-40

Section 152-50

Section 152-55

Section 152-50

Section 152-60

Subdivision 152-D

Section 152-305

Section 152-310

Section 152-315

Section 152-320

Section 152-325

Division 328

Subdivision 328-C

Section 328-125

Section 328-130

Section 960-100

Reasons for decision

Question 1

The meaning of 'connected with' an entity

Section 328-125 of the ITAA 1997 sets out how entities are connected with each other by reference to control tests. Subsections 328-125(1) and (2) provide:

An entity is connected with another entity if:

(a) either entity controls the other entity in a way described in this section; or

(b) both entities are controlled in a way described in this section by the same third entity.

Direct control of an entity other than a discretionary trust

An entity (the first entity) controls another entity if the first entity, its *affiliates, or the first entity together with its affiliates:

(a) except if the other entity is a discretionary trust - beneficially own, or have the right to acquire the beneficial ownership of, interests in the other entity that carry between them the right to receive a percentage (the control percentage) that is at least 40% of:

(i) any distribution of income by the other entity; or

(ii) if the other entity is a partnership - the net income of the partnership; or

(iii) any distribution of capital by the other entity; or

(b) if the other entity is a company - beneficially own, or have the right to acquire the beneficial ownership of, *equity interests in the company that carry between them the right to exercise, or control the exercise of, a percentage (the control percentage) that is at least 40% of the voting power in the company.

X owns more than 60% of the shares in Q P/L and therefore has the right to exercise least 40% of the voting power in Q P/L. As such, X controls Q P/L so these two entities are connected with each other.

In relation to the Unit Trust X and Y jointly hold more than 70% of the units in the Unit Trust. However X alone does not own at least 40% of the units in their own right.

Nevertheless X could be taken to control the Unit Trust if X, together with an affiliate, has the rights to at least 40% of the distributions of income or capital from the Unit Trust.

Although X and Y are shareholders in Q P/L and may act together in relation to the business affairs of Q P/L, it does not automatically follow that they are affiliates for the purposes of section 328-130 of the ITAA 1997 - see discussion below.

As X is only entitled to half of any distributions of income and / or capital from the Unit Trust (which is less than 40%) X does not control the Unit Trust.

Question 2

The term 'affiliate" is defined in section 328-130 of the ITAA 1997:

SECTION 328-130 Meaning of affiliate

328-130(1)

An individual or a company is an affiliate of yours if the individual or company acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the *business of the individual or company.

328-130(2)

However, an individual or a company is not your affiliate merely because of the nature of the business relationship you and the individual or company share.

Note:

For small business relief purposes, a spouse or a child under 18 years may also be an affiliate under section 152-47.

Example:

A partner in a partnership would not be an affiliate of another partner merely because the first partner acts, or could reasonably be expected to act, in accordance with the directions or wishes of the second partner, or in concert with the second partner, in relation to the affairs of the partnership.

Directors of the same company and trustees of the same trust, or the company and a director of that company would be in a similar position.

The affiliate rules are designed to ensure that entities that genuinely carry on independent businesses are not aggregated.

An individual or a company is an 'affiliate' of another entity if the individual or company acts, or could reasonably be expected to act, in accordance with the entity's directions or wishes, or in concert with the entity, in relation to the affairs of the business of the individual or company. As an affiliate must be an individual or company, trusts, partnerships or superannuation funds are not capable of being affiliates. Furthermore, an individual or company is not an affiliate merely because of the nature of the business relationship shared by the entity and the individual or company. For example, co-directors, co-trustees or partners are not necessarily affiliates under subsection 328-130(2) of the ITAA 1997.

It should be noted that the definition of affiliate means that an affiliate can only be an individual or a company and that they cannot be an affiliate unless they are carrying on a business.

According to the Explanatory Memorandum to the Tax Laws Amendment (Small Business) Bill 2007 the following factors may have a bearing on whether an individual or company is an affiliate of an entity to the extent that they show that two or more entities are acting in concert:

· Family or close personal relationships

· Financial relationships or dependencies

· Relationships created through links such as common directors, partners or shareholders

· The lack of any formal agreement or formal relationship between the parties dictating how the parties are to act in relation to each other

· The degree to which entities consult with each other on business matters; or

· Whether one of the entities is under a formal or informal obligation to purchase goods or services or conduct aspects of their business with the other entity

However none of these factors is determinative in their own right.

In this case the only relationship between X and Y is that they are both shareholders of Q P/L and beneficiaries of the Unit Trust. They do not have any other financial interdependence other than the pursuit of their common goal to benefit Q P/L's business. Merely performing their normal roles as directors of Q P/L in the normal course of business does not constitute acting in concert as contemplated in the legislation.

Given that the parties have separated after being in a relationship, it would seem unlikely that they would act in accordance with each other's wishes in relation to their individual business interests. Therefore X and are not affiliates for the purposes of the CGT small business concessions.

Question 3

As Y is not an affiliate of X, X does not control the Unit Trust. For X to be taken to control the Unit Trust individually X must have the right to receive at least 40% of the distributions of income and/or capital from the trust. X's joint ownership of units in the Unit Trust only entitles X to less than 40% of those distributions as the distributions are made to X and Y on a 50/50 basis.

As X does not control the Unit Trust, X is not an entity that is connected with the Unit Trust.

Question 4

For the Unit Trust and Q P/L to be connected entities under section 328-125 of the ITAA 1997, one of the entities must control the other or they must both be controlled by the same third entity. It has been established above that X controls Q P/L as X is entitled to receive more than 40% of the distributions of income and / or capital from Q P/L. However X does not control the Unit Trust for the reasons given above under Question 3 as X is only entitled to less than 40% of the distributions from the Unit Trust. As there is no same third entity which controls both the Unit Trust and Q P/L they are not connected entities.

Question 5

The meaning of active asset

Section 152-40 explains what is meant by the term 'active asset':

A *CGT asset is an active asset at a time if, at that time:

The asset in question is land that was owned by the Unit Trust and was leased to Q P/L. The land was used at all times in the course of carrying on Q P/L's business.

In this instance the land will be an active asset if Q P/L is a small business entity and is an affiliate of the Unit Trust or is connected with the Unit Trust.

Are a trust and trustee separate entities?

A 'trust' can be described as:

"An obligation enforceable in equity which rests on a person (the trustee) as owner of some specific property (the trust property) to deal with that property for the benefit of a certain person (the beneficiary) or persons, or for the advancement of certain purposes."

(Ford, HAJ and Lee, WA 1996, Principles of the Law of Trusts, 3^rd edn, LBC Information Services, Sydney p.3)

At law, a trust is not a legal person. It is a collection of rights, duties and powers arising from the property held by the trustee for the benefit of the beneficiaries. Rights and obligations cannot be placed directly on the trust. The trustee is the appropriate party. Consequently a trust entity is identified both by the trust relationship itself (the trust) and by reference to one of the necessary legal persons to that relationship (the trustee).

However under taxation law a trust and a trustee are recognised as separate entities. Subsection 960-100(1) of the ITAA 1997 defines 'entity' to mean, among other things, a trust. Furthermore, subsection 960-100(2) of the ITAA 1997 states:

"The trustee of a trust, of a superannuation fund or of an approved deposit fund is taken to be an entity consisting of the person who is the trustee, or the persons who are the trustee, at any given time."

Is Q P/L connected with or an affiliate of the Unit Trust?

The Unit Trust does not beneficially own, or have the right to acquire the beneficial ownership of, equity interests in the company that carry between them the right to exercise, or control the exercise of, a percentage (the control percentage) that is at least 40% of the voting power in the company. Therefore the Unit Trust is not connected with Q P/L.

Furthermore the two entities cannot be considered to be connected with each other as they are both not controlled by the same third entity (paragraph 328-125(1)(b) of the ITAA 1997). Although X is taken to control Q P/L, X does not control the Unit Trust in their own right.

Q P/L is not an affiliate of the Unit Trust as they have no financial interdependence beyond the trust / trustee relationship (see discussion of 'affiliate' above).

Conclusion

As the land is not used in a business carried on by an affiliate, or an entity connected with, the Unit Trust, it is not an active asset. Accordingly, the capital gain arising from the sale of the asset will not be eligible for the CGT small business concessions.