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Ruling

Subject: Small business CGT concessions

Question 1

Will the Company satisfy the basic conditions to be eligible for the small business concessions under Division 152 of the Income Tax Assessment Act 1997?

Answer

Yes.

Question 2

Will the property held by the principal shareholder and his spouse be included in the net asset value under section 152-20 of the ITAA 1997?

Answer

Yes (50% will be included).

Question 3

Will the one million dollars receivable in twelve months be considered to be part of the sale consideration under subsections 103-10(1) and 103-10(2) and 116-20(1) of the ITAA 1997?

Answer

Yes.

Question 4

For the purposes of section 152-15 of the ITAA 1997, are the employee directors affiliates of the Company in accordance with the meaning provided under section 328-130 of the ITAA1997?

Answer

No.

This ruling applies for the following periods

01/07/2012 to 30/06/2013

The scheme commences on

August 2012

Relevant facts and circumstances

The Company, through their Tax Agent, lodged a request for a private ruling.

The following questions and issues were raised:

Do the small business capital gains tax concessions apply to the company sale of the business that commenced in 1990 and it sold in 2012?
The company has a turnover greater than two million dollars and is relying on the company not exceeding the six million dollar net assets immediately prior to signing of the contract.
Does the 50% active asset reduction apply?
Is the one million dollars receivable in twelve months part of the sale consideration?
Should the unit be included in the net asset value?
Are the employee directors' affiliates of the Company?

The request contains the following information:

· The Company is an IT company supplying hardware, software and computer engineering services.

· The hardware and software are sold by the Company as authorised re-sellers.

· The sale price included Plant & Equipment at WDV.

· The sale did not include Trade Debtors or Trade Creditors.

· The net amount paid on settlement was with $1,000,000 to be paid in 12 months providing, nothing that was warranted under the terms of sale the Company. The Company does not have to do anything or restrain from any action for the amount to be paid.

It was stated that a valuation of the business was completed immediately prior to the sale and was obtained by an independent business valuer. The Company believes the Company's and its associates net assets are less than $6,000,000.

The Tax Agent provided the following background information:

The valuation report shows clearly that the buyer was keen to acquire the clients, staff and business of the Company. Similar to the price paid for Syttadel Holdings Pty Ltd's marina (2011 ATC 10-199).

AAT Case No 2009/5295 answers the question 'are employee directors affiliates of the Company for the very reasons that the son director was not an affiliate.

The property owned by a Director and his wife was rented for 6.5 years then it has since been used solely for private use and has been owned for 15.74. In terms of ID 2011/37 + 38 it is considered that the property is being solely used for private use and should be disregarded from the net asset calculation. The majority of the property use has been for personal use and enjoyment. The Act does not clarify the meaning of 'being used'. The Act does not state 'has been used at all times'. The example in ID 2011/37+38 was rented for all the period of ownership less one month.

The Taxation's Office approach to the ruling in ID2011/37+38 has read into the act additional words which simply are not there. "Being used" is in the present tense and not the past tense.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 103-10;

Income Tax Assessment Act 1997 section 116-20;

Income Tax Assessment Act 1997 section 152-5;

Income Tax Assessment Act 1997 section 152-10;

Income Tax Assessment Act 1997 section 152-15;

Income Tax Assessment Act 1997 section 152-20;

Income Tax Assessment Act 1997 section 152-35;

Income Tax Assessment Act 1997 section 152-40;

Income Tax Assessment Act 1997 section 152-205;

Income Tax Assessment Act 1997 section 328-110;

Income Tax Assessment Act 1997 section 328-125;

Income Tax Assessment Act 1997 section 328-130;

Income Tax Assessment Act 1997 subdivision 152-C.

Reasons for decision

Question 1

Will the Company satisfy the basic conditions to be eligible for the small business concessions under Division 152 of the Income Tax Assessment Act 1997?

Summary

A CGT event occurred as the business has been disposed of. The CGT event resulted in a capital gain and it is confirmed that the Company is entitled to the small business concessions. The Company satisfies the active asset test and the maximum net asset value test.

Detailed reasoning

To qualify for the small business CGT concessions in Sub-Division 152-C of the Income Tax Assessment Act 1997 (ITAA 1997), a taxpayer must satisfy the basic conditions for relief in section 152-10 of the ITAA 1997

The conditions for the small business CGT concessions are outlined in subsection 152-10(1) of the ITAA 1997:

(a) a CGT event happens in relation to a CGT asset of yours in an income year;

(b) the event would have resulted in a capital gain;

(c) 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;

· you are a partner in a partnership that is a small business entity.

(d) the CGT asset satisfies the active asset test.

A CGT A1 event occurred when the Company's business was disposed of which resulted in a capital gain to the Company. The Company is not a partner in a partnership, and is not a small business entity. Section 328-110(1) of the ITAA 1997 provides the meaning of small business entity:

You are a small business entity for the income year if:

· you carry on a business in the current year; and

· one or both of the following applies:

· you carried on a business in the income year (the previous year) before the current year and your aggregated turnover for the previous year was less than $2 million;

· your aggregated turnover for the current year is likely to be less than $2 million.

The Company had an aggregated turnover over $2 million, and does not satisfy the requirements in section 328-110.

As such, the Company will need to satisfy the maximum net asset value test and the active asset test to be able to access the relief.

Maximum net asset value test

As the Company is not a small business entity or partnership they need to satisfy the maximum net asset value test to be able to access the small business CGT concessions. Under this test the net asset value of the CGT assets of the taxpayer and certain related entities must not exceed $6 million just before the time of the CGT event.

Section 152-15 of the ITAA 1997 states:

You satisfy the maximum net asset value test if, just before the CGT event, the sum of the following amounts does not exceed $6,000,000:

· the net value of the CGT asset of yours;

· the net value of the CGT assets of any entities connected with you;

· the net value of the CGT assets of any affiliates of yours or entities connected with your affiliates.

In terms of subsections 152-15(b) and 152-15(c) of the ITAA 1997 respectively, the related entities may consist of any entities connected with you or any affiliate of yours or entities connected with your affiliates.

Under section 328-125 of the ITAA 1997, an entity is connected with another entity if either entity controls the other entity in one of the ways specified in the section (see question 4). In 328-130(1) of the ITAA 1997, an individual or 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.

The taxpayer will satisfy the maximum net asset value test if before the sale contract was entered, the net value of the CGT assets of the taxpayer, its affiliates and connected entities is not more than $6 million.

Based on the valuation of net assets provided by the Company, including the amounts attributable to the principal shareholder, as he is considered 'connected' with the Company (see question 4) and deducting the amounts attributable to the principal shareholder's spouse's assets as she is not considered to be connected with or an affiliate, it is considered that the maximum net asset test is satisfied as the net assets value falls below the $6 million threshold.

Section 152-205 of the ITAA 1997 provides that a capital gain that arises from a CGT event happening to an active asset may be reduced by 50%. To qualify for the reduction the Company must satisfy the active asset test.

Active asset test

Under section 152-35 of the ITAA 1997, 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).

As per subsection 152-35(2) of the ITAA 1997, 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.

As stated in section 152-40 of ITAA 1997 an active asset is an asset you own and use (or hold ready for use) in the course of carrying on a business; or you own but is used in the course of carrying on a business by an affiliate or connected entity. The Company's business commenced in 1990 and was disposed of in 2012. The business is considered an active asset as it was carried on as an IT company from the date it was set up to the date it was disposed of. The test is satisfied as the Company has held the business for a period of more than 15 years, and was an active asset for the whole of the period. .

Therefore, the Company satisfies the conditions of the active asset test.

Small business 50% active asset reduction

The rules covering the small business 50% active asset reduction are contained in subdivision 152-C of the ITAA 1997.

Section 152-205 of the ITAA 1997 provides that the amount of a capital gain remaining is reduced by 50% active asset reduction, if the basic conditions subdivision 152-A of the ITAA 1997 are satisfied for the gain.

The Company has satisfied the basic conditions under subdivision 152 A of the ITAA 1997 and is eligible for the small business capital gains concession of 50% reduction.

Question 2

Will the property held by the principal shareholder and his spouse be included in the net asset value under section 152-20 of the ITAA 1997?

Summary

50% of the value of the unit will be included under subparagraph 152-20(2) (b) (i) of the ITAA 1997 in working out the net value of the Company's CGT assets, as the principal shareholder is considered to be connected with the Company and the asset has been used for income producing and is not considered to have been used solely for personal use.

Detailed reasoning

In coming to our decision, we have taken into consideration ATO Interpretative Decision ATO ID 2011/41 Income tax - CGT small business concessions: maximum net asset value test - disregarded assets - asset being used solely for personal use and enjoyment - income producing use.

ATO ID 2011/41 provides the following information:

A taxpayer satisfies the maximum net asset value test if, just before the CGT event, the net value of their CGT assets and of certain related entities does not exceed a threshold (section 152-15 of the ITAA 1997).

In working out the net value of the CGT assets of an individual, assets being used solely for the personal use and enjoyment of the individual, or the individual's affiliate (except a dwelling, or an ownership interest in a dwelling, that is the individual's main residence, including any relevant adjacent land) are disregarded (subparagraph 152-20(2) (b) (i) of the ITAA 1997).

The question arises as to whether the personal use of the holiday house by others for which rent is paid means that the holiday house is not being used solely for the personal use and enjoyment of the individual.

It is considered that the personal use of the holiday house by others for which rent is paid means that the holiday house is not being used solely for the personal use and enjoyment of the individual. The income producing nature of the arrangement is inconsistent with the concept of personal use and enjoyment. As the test is a sole use test, the holiday unit is not being used solely for the personal use and enjoyment of the individual even if there is only occasional use of the holiday unit by others during the ownership period for which rent is paid.

The Company have stated that principal shareholder and his spouse own a unit which has been rented out for X years and used for private use for Y years. As the principal shareholder is considered to be connected with the Company and his spouse is not considered to be an affiliate or connected with the Company (see question 4), in accordance with ATOID 2011/41, 50% of the value of the unit will be included under subparagraph 152-20(2) (b) (i) of the ITAA 1997 in working out the net value of the Company's CGT assets.

Question 3

Will the $ receivable in twelve months be considered to be part of the sale consideration under subsections 103-10(1) and 103-10(2) and 116-20(1) of the ITAA 1997?

Summary

The $ receivable in twelve months will be considered to be part of capital proceeds for the sale for the business.

Detailed reasoning

Section 116-20(1) of the ITAA 1997 provides the rules regarding capital proceeds.

The capital proceeds from a CGT event are the total of:

(a) the money you have received, or are entitled to receive, in respect of the event happening; and

(b) the market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out at the time of the event).

You are treated as having received money or other property as per subsections 103-10(1) and 103-10(2) of the ITAA 1997:

103-10(1) This part and Part 3-3 apply to you as if you had received money or other property if it has been applied for your benefit (including by discharging all or part of a debt you owe) or as you direct.

103-10(2) Those parts apply to you as if you are entitled to receive money or other property:

(a) if you are entitled to have it so applied; or

(b) if:

(i) you will not receive it until a later time; or

(ii) the money is payable by instalments.

As the amount of $ has been deferred to be paid in twelve months, and the Company is not required to do anything or restrain from any actions to ensure receipt of the payment, the payment will still be considered as part of the capital proceeds and will need to be applied as if it had been received at the time of settlement.

Question 4

For the purposes of section 152-15 of the ITAA 1997, are the employee directors affiliates of the Company in accordance with the meaning provided under section 328-130 of the ITAA1997?

Summary

The employee directors are not considered affiliates or connected with the company.

Detailed reasoning

Section 152-15 of the ITAA 1997 requires that the net value of the CGT assets of a taxpayer, entities 'connected with' the taxpayer, and 'affiliates' of the taxpayer, is aggregated for the purposes of determining if the taxpayer satisfies the $6 million maximum net asset value test.

The term 'connected with' is defined in section 328-125 of the ITAA 1997. Subsection 328-125 (1) states that 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.

Subsection 328-125 (1) states that an entity (the first entity) will control 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.

The term 'affiliate' is defined in section 328-130 of the ITAA 1997. An individual or company is an affiliate of an entity where that individual or company acts, or could be reasonably expected to act:

· In accordance with the entity's directions or wishes in relation to the affairs of that individual or company's business; or

· In concert with the entity in relation to the affairs of the individual or company's business- Section 328-130(1)

Sub-section 328-130(2) provides that an individual or company is not automatically an affiliate merely because of a business relationship. The following example is provided in the sub-section:

A partner in a partnership would not be an affiliate of another partner merely because the first partner acts, or could be reasonably 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.

In line with the above, directors are not automatically affiliates of the company in which they are a director, nor would the company automatically be an affiliate of the directors. Therefore, based on the facts provided, the only reason the employee directors would be acting in concert with each other would be in relation to the affairs of the company. Consequently all the directors are not considered small business CGT affiliates. In line with section 328-125 of the ITAA 1997, the employee directors are not considered to be 'connected with' the Company as their control percentage is less than 40%.

In relation to section 328-125, the principal shareholder holds 70% of the Company shares, he is considered to be 'connected with' the Company. His spouse is not considered an affiliate of the Company as she does not act in concert with respect of the business and does not act in accordance with the directions of the Company. His spouse also is not considered 'connected with' the Company as she does not have any control or voting power.

ATO view documents

ATO Interpretative Decision ATO ID 2011/41 Income tax - CGT small business concessions: maximum net asset value test - disregarded assets - asset being used solely for personal use and enjoyment - income producing use. (ATO view)