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Ruling

Subject: Small business capital gains tax concessions

Question 1

Is the trust a small business entity under section 328-110 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Is the trust connected with individual A and B under section 328-125 of the ITAA 1997 for the purpose of satisfying section 152-40 of the ITAA 1997?

Answer

Yes.

Question 3

Does the property satisfy the meaning of active asset under section 152-40 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2013

The scheme commences on:

1 July 2012

Relevant facts and circumstances

Individual A and B have owned a property for less than 15 years.

The individuals operated a business at the property for a period.

The individuals then sold the business to the trust.

Individual A maintained some level of control of the business, as a joint appointer of the trust.

The trust now operates a business from the property. The individuals collect rent from the trust.

The trust's annual turnover and the turnover of affiliates and entities connected with the trust was less than $2 million.

The individuals intend to sell the property to the trust on normal commercial terms and conditions.

Individual B will become a joint appointer of the trust.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-35,

Income Tax Assessment Act 1997 section 152-40,

Income Tax Assessment Act 1997 section 152-40(1),

Income Tax Assessment Act 1997 section 152-40 (4),

Income Tax Assessment Act 1997 section 152-47,

Income Tax Assessment Act 1997 section 152-47(1),

Income Tax Assessment Act 1997 section 152-47(2),

Income Tax Assessment Act 1997 section 328-110,

Income Tax Assessment Act 1997 section 328-125, and

Income Tax Assessment Act 1997 section 328-125(3).

Reasons for decision

Question 1

Under section 328-110 of the Income Tax Assessment Act 1997 (ITAA 1997), a taxpayer will be a small business entity if they are an individual, partnership, company or trust that:

· is carrying on a business, and

· has an aggregated turnover of less than $2 million.

Aggregated turnover is an entity's annual turnover plus the annual turnovers of any business entities that are your affiliates or that are connected with you.

In this case, the trust carries on a business. The information provided indicated the turnover of the trust, its affiliates and connected entities is less than $2 million. Therefore the trust will be considered a small business entity.

Question 2

Affiliate

An affiliate is, according to section 328-130 of the ITAA 1997, an individual or a company who 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.

A spouse or a child under the age of 18 years is not automatically an affiliate. Whether a person acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes, or in concert with the taxpayer is a question of fact dependent on all the circumstances of the particular case. No one factor will necessarily be determinative.

However subsection 152-47(1) of the ITAA 1997 applies to deem a spouse or child an affiliate of an entity if:

· one entity (the asset owner) owns a CGT asset (whether the asset is tangible or intangible); and

· either:

o the asset is used, or held ready for use, in the course of carrying on a business in an income year by another entity (the business entity); and

o the asset is inherently connected with a business that is carried on in an income year by another entity (the business entity);and

· the business entity is not (apart from this section) an affiliate of, or connected with, the asset owner.

Under subsection 152-47(2) of the ITAA 1997, in determining whether the business entity is an affiliate of, or is connected with, the asset owner, a spouse or child of the individual is taken to be an affiliate of an individual.

If an entity is an affiliate of another entity as a result of subsection 152-47(2) of the ITAA 1997, then the spouse or child is, in addition, taken to be an affiliate of the individual for the purposes of section 328-125 of the ITAA 1997.

The application of section 152-47 of the ITAA 1997 is not limited to situations where an entity that owns a CGT asset and does not operate a business provides that asset to another entity for use in its business (the standard passively held asset). It also applies to situations where an entity that operates a business owns a CGT asset that it provides to another entity for use in that other entity's business.

Connected entity

Under section 328-125 of the ITAA 1997 an entity controls a 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.

Some factors which might be considered include:

· The way in which the trustee has acted in the past

· The relationship between the trustee and the entity or its affiliates, and the relationship the trustee has with both the entity and its affiliates

· The amount of any property or services transferred to the trust by the entity or its affiliates, or both the entity and its affiliates

· Any arrangement or understanding between the entity and any person who has benefited under the trust in the past.

This entity may control a discretionary trust in addition to any beneficiary with control.

ATO Interpretive Decision ATO ID 2008/139 provides that a person who has the power to remove the trustee of a discretionary trust and appoint a new trustee will control the trust for the purposes of subsection 328-125(3) of the ITAA 1997.

Application to your circumstances

In this case, individual B is an appointer of the trust and therefore controls the family trust. Individual A owned a portion of the property which was used in the business of an entity (the trust) connected with individual B.

Accordingly, section 152-47 of the ITAA 1997 will apply to treat individual A as individual B's affiliate during the period the family trust was carrying on the business at the property. Therefore both individuals are connected with the trust.

Question 3

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.

The following assets cannot be active assets (subsection 152-40(4) of the ITAA 1997):

· interests in a connected entity (other than those satisfying the 80% test)

· shares in companies and interests in trusts (other than those satisfying the 80% test)

· shares in widely held companies unless they are held by a CGT concession stakeholder of the company

· shares in trusts that are similar to widely held companies unless they are held by a CGT concession stakeholder of the trust or other exceptions for trusts with 20 members or less apply

· financial instruments, including loans, debentures, bonds, promissory notes, futures contracts, forward contracts, currency swap contracts, rights and options

· an asset whose main use in the course of carrying on the business is to derive interest, an annuity, rent, royalties or foreign exchange gains. However, such an asset can still be an active asset if it is an intangible asset that has been substantially developed, altered or improved by the taxpayer so that its market value has been substantially enhanced or its main use for deriving rent was only temporary.

Application to your circumstances

In this case, the property has been owned for approximately X years. For just over X years up until the business was sold it was used in the course of carrying on a business by the individuals. During this time, the property would have been an active asset.

The individuals sold the business to the trust. The trust operates the business from the property and the individuals collect rent. For the property to be considered an active asset it must be owned and used, or held ready for use, in the course of carrying on a business by the individuals, their small business CGT affiliate or an entity connected with them. As discussed in question 2, the individuals are connected with the trust. Therefore, the property will be considered an active asset during this period.

For the property to satisfy the active asset test, it must have been active half of the ownership period as it has been owned for less than 15 years. As the property has been active for more than half of the ownership period, it will satisfy the active asset test.