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Ruling

Subject: Small business capital gains tax concessions

Question 1:

Will the small business 15-year exemption in section 152-110 of the Income Tax Assessment Act 1997 (ITAA 1997) apply to allow the trust to disregard any capital gain from the sale of the property?

Answer:

Yes.

Question 2:

Will capital gains tax (CGT) apply to any distribution you make to a beneficiary in relation to the sale of the property?

Answer:

No.

This ruling applies for the following periods:

Year ended 30 June 2012

Year ended 30 June 2013

Year ended 30 June 2014

The scheme commences on:

1 July 2011

Relevant facts and circumstances

The trust is a discretionary trust that owns a property.

An individual is a beneficiary of the trust.

A business was carried on in the property by an individual and their spouse as a partnership.

The new owners of the business have been renting the property. No part of the property was rented out to other parties prior to this. Prior to the sale, the partnership paid the trust sufficient rent to offset expenses.

Prior to the marriage break-up, the individual and his/her spouse were the beneficiaries of the trust.

The individual is now entitled to all distributions from the trust.

The individual is over 60 years of age.

The net value of the capital gains tax assets held by the trust and their related entities is less than $6 million.

Relevant legislative provisions

Income Tax Assessment Act 1997 subdivision 152-A,

Income Tax Assessment Act 1997 subdivision 152-B,

Income Tax Assessment Act 1997 section152-35,

Income Tax Assessment Act 1997 section 152-40,

Income Tax Assessment Act 1997 section 152-60,

Income Tax Assessment Act 1997 section 152-70,

Income Tax Assessment Act 1997 section 152-110, and

Income Tax Assessment Act 1997 section 152-125.

Reasons for decision

Question 1:

Subdivision 152-B of the ITAA 1997 provides a small business 15-year exemption as part of the capital gains tax (CGT) small business relief provisions. If you qualify for the small business 15-year exemption, the capital gain is entirely disregarded and it is unnecessary to apply any other concessions.  

Under section 152-110 of the ITAA 1997, you can disregard any capital gain arising from the disposal of your industrial unit, if all of the following conditions are satisfied: 

(a)   the basic conditions in Subdivision 152-A of the ITAA 1997 are satisfied for the gain 

(b)   you continuously owned the CGT asset for the 15-year period ending just before the CGT event 

(c)   you had a significant individual for a total of at least 15 years (even if it was not the same significant individual during the whole period) of the whole period of ownership of the unit and

  (d)   an individual who was a significant individual of yours just before the CGT event was:

 (i)   at least 55 years old at that time and the event happened in connection with their retirement or

 (ii)   permanently incapacitated at that time.

 Condition (a)

The basic conditions in Subdivision 152-A of the ITAA 1997 (as relevant to this case) are:

· the $6 million limit on the net value of CGT assets

· the active asset test.

Net value of the CGT assets

You will satisfy the maximum net asset value test if, just before the CGT event that results in the capital gain, the net value of the CGT assets of you and the following entities does not exceed $6 million:

· any entities connected with you

· your affiliates and any entities connected to your affiliates (subject to certain exclusions).

An entity is connected with another entity if either entity controls the other or both entities are controlled by the same third entity under subsection 328-125(1) of the ITAA 1997.

Application to your circumstances

The information provided is that the maximum net value of the assets of the Trust, and any entities connected with it would be less than $6 million just before the CGT event. Therefore the trust would satisfy the maximum net asset value test.

Active asset test

A requirement of the active asset test contained in section 152-35 of the ITAA 1997 is that the CGT asset must be an active asset for at least half of the period from when you acquired it until the earlier of the CGT event or when you ceased business, if the relevant business had ceased to be carried on in the 12 months before the CGT event.

The meaning of an active asset is set out in section 152-40 of the ITAA 1997. It must firstly satisfy one of the 'positive tests' in subsection 152-40(1) of the ITAA 1997 and then also not be excluded by one of the exceptions in subsection 152-40(4) of the ITAA 1997.

Under subsection 152-40(1) of the ITAA 1997 a CGT asset is an active asset (subject to the exclusions) if it is owned and used, or held ready for use, in the course of carrying on a business by you or your small business CGT affiliate or another entity that is connected with you under paragraph 152-40(1)(c) of the ITAA 1997.

The combined effect of sections 152-35 and 152-40 of the ITAA 1997 is that the asset will meet the active asset test if the asset was used, or held ready for use, in the course of carrying on a business for at least half of the time period it was owned, subject to the exclusions in subsection 152-40(4) of the ITAA 1997.

Connected entity

An entity is connected with another entity if:

· either entity controls the other entity, or

· both entities are controlled by the same third entity.

An entity controls another entity if it or its affiliate (or all of them together) beneficially own or have the right to acquire beneficial ownership of, interest in the other entity that give the right to receive at least 40% of any distribution of income or capital by the other entity.

An entity controls the discretionary trust if the trustee either acts, or might reasonable be expected to act, in accordance with the directions or wishes of the entity or the entity's affiliates.

Application to your circumstances

If the trust and the partnership are connected entities the industrial unit will satisfy the active asset test.

The individual controlled the partnership as they had the right to 50% of the income and capital distributions. The individual also controlled the discretionary trust as the trustee acts, or could reasonable be expected to act, in accordance with the directions or wishes of the individual.

As both the partnership and the trust are controlled by the individual, they are connected entities. The industrial unit therefore meets all the requirements to be an active asset up to the time the business was sold. The unit was built on 1 January 1992 and the business being carried on occupied the unit for the whole period up to June 2005. The unit was therefore an active asset for the 7 and a half year period required by section 152-35 of the ITAA 1997, and this condition will be satisfied.

Condition (b)

The trust has continuously owned the property for the 15-year period ending just before the CGT event, that is, the sale of the unit, and this condition will be satisfied.

Condition (c)

An individual is a significant individual in a company or trust if they have a small business participation percentage in the company or trust of at least 20%. The 20% can be made up of direct and indirect percentages.

An entity's direct small business participation percentage in a trust, where entities have entitlements to all the income and capital of the trust, is the percentage of either:

· the income of the trust that the entity is beneficially entitled to receive, or

· the capital of the trust that the entity is beneficially entitled to receive.

Section 152-70 of the ITAA 1997 allows another method to work out an entity's small business participation percentage is a discretionary trust, if in the CGT event year, the trustee of the trust:

· did not make a distribution of income or capital during the income year, and

· had no net income or had a tax loss for the income year.

The entity's direct small business participation percentage at the relevant time is worked out using the percentage of the distributions the entity was beneficially entitled to in the last income year before the CGT event year in which the trustee made a distribution.

In this case, the trustee made a distribution in a relevant financial year and more than 20% of the income of the trust was distributed to the individual. The trustee has made no other distributions in any financial years as the trust had no net income. The distribution made can be used to work out the small business participation percentage of the individual for the CGT event year and for the earlier years that the trustee was not able to make any distributions because the trust had no net income.

Therefore, the individual is considered to be a significant individual of the trust.

Condition (d)

The sale of the property will happen in connection with the individual's retirement, as they have retired from the business. The individual is intending to use the proceeds from the sale of the property to clear their debts. The sale of the unit appears to be integral to the individual's retirement plan.

As the individual; will be the trust's significant individual just before the CGT event, be at least 55 years old at that time, and the event will happen in connection with their retirement, this condition will be satisfied.

Conclusion

The trust satisfies all of the conditions for the small business 15-year exemption in Subdivision 152-B of the ITAA 1997, and can disregard any capital gain made from the sale of the property.

Question 2

Section 152-125 of the ITAA 1997 provides that, if a capital gain made by a trust is disregarded under the small business 15 year exemption, any distribution made by the trust of that exempt amount to a CGT concession stakeholder is not included in the assessable income of the CGT concession stakeholder, if the following conditions are satisfied:

· the trust must make a payment within two years after the CGT event that resulted in the capital gain or, in appropriate circumstances, such further time as allowed by the Commissioner

· the payment must be made to an individual who was a CGT concession stakeholder of the trust just before the CGT event and

· the total payments made to each CGT concession stakeholder must not exceed an amount determined by multiplying the CGT concession stakeholders control percentage by the exempt amount.

Condition (a)

Provided that the trust makes the payment of the exempt amount of the capital gain from the sale of the unit to you within two years after the sale, or any further time as allowed by the Commissioner, this condition will be satisfied.

Condition (b)

Section 152-60 of the ITAA 1997 provides the meaning of CGT concession stakeholder. An individual is a CGT concession stakeholder of a trust at a time if the individual is:

· a significant individual in the trust or

· a spouse of a significant individual in the trust, if the spouse has a small business participation percentage in the trust that is greater than zero.

As discussed in question 1, the individual will be a significant individual of the trust just before the CGT event, being the sale of the unit. Therefore, the individual will also be a CGT concession stakeholder of the trust just before the CGT event.

Condition (c)

For a discretionary trust, the CGT concession stakeholders control percentage is worked out using the number of CGT concession stakeholder of the trust just before the CGT event.

The individual is the only CGT concession stakeholder of the trust just before the CGT event. Therefore, the trust is able to pay the whole exempt amount to the individual.