Edited version of your private ruling

Authorisation Number: 1012441608384

Ruling

Subject: Small business capital gains tax concessions

Question 1

Was the partnership carrying on a business?

Answer

Yes.

Question 2

Will the partner qualify for the 50% discount in Division 115 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 3

Will the partner satisfy the basic conditions for the 50% active asset reduction in Division 152 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2012

The scheme commences on:

1 July 2011

Relevant facts and circumstances

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are: 

· the application for private ruling, and

· the documents provided with the private ruling application.

The partners purchased a property.

The partners' intention was to run a business using the property.

The partnership obtained a Tax File Number, Australian Business Number and registered for GST.

The partnership did not generate profits during the period it operated.

The partnership ceased in the 20ZZ-ZZ financial year due to the partners marriage break up.

The property was sold in the 20YY-YY financial year. The partnership delayed settlement as it was awaiting a ruling from the Australian Taxation Office as to the GST consequences of the sale.

The products were sold off during the 20ZZ-ZZ financial year.

One partner had previous experience in the industry.

Prior to the partners' first purchase, they carried out a great deal of research on the internet and sought the advice from other individuals in the industry.

A formal business plan was not prepared, however the partners agreed to build the business slowly to keep the activities manageable.

The partners did not reside at the property.

The partners anticipated the return to be $X. The return was significantly less than expected.

The partnership sold their product.

The partners spent one day almost every weekend at the property.

The number of product increased yearly during the period the partnership was in operation.

The partnership kept business records, a business bank account and their activities were carried on in a systematic and business like manner.

There were commercial sales of the product. The product was not produced for the partners or their families.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-10,

Income Tax Assessment Act 1997 subsection 152-10(1),

Income Tax Assessment Act 1997 subsection 152-10(1A),

Income Tax Assessment Act 1997 subsection 152-10(1B),

Income Tax Assessment Act 1997 section 152-35,

Income Tax Assessment Act 1997 section 152-35(2),

Income Tax Assessment Act 1997 section 152-49,

Income Tax Assessment Act 1997 subsection 328-110(5), and

Income Tax Assessment Act 1997 section 995-1.

Reasons for decision

Summary

We consider that the partnership's activities were conducted on a sufficient scale to be considered a business. The land used in the business was held for more than 12 months; therefore the land qualifies for the 50% discount. As the basic conditions have been satisfied, the land will also qualify for the 50% active asset reduction.

Detailed reasoning

Question 1

Section 995-1 of the Income Tax Assessment Act 1997 (ITAA 1997) defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'.

The question of whether you are carrying on a business is a question of fact and degree. There are no rigid rules for determining whether the activity amounts to the carrying on of a business. The facts of each case must be examined. In Martin v FC of T (1953) 90 CLR 470 at 474; 5 AITR 548 at 551, Webb J said:

The test is both subjective and objective; it is made by regarding the nature and extent of the activities under review, as well as the purpose of the individual engaging in them, and, as counsel for the taxpayer put it, the determination is eventually based on the large or general impression gained.

However, the courts have developed a series of indicators that can be applied to your circumstances to determine whether you are carrying on a business.

Taxation Ruling TR 97/11: 'Income tax: am I carrying on a business of primary production?' summarises these indicators. In the Commissioner's view, the factors that are considered important in determining the question of business activity are:

· whether the activity has a significant commercial purpose or character

· whether the taxpayer has more than just an intention to engage in business

· whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

· whether there is regularity and repetition of the activity

· whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business

· whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit

· the size, scale and permanency of the activity, and

· whether the activity is better described as a hobby, a form of recreation or sporting activity.

No one indicator is decisive. The indicators must be considered in combination and as a whole.

In AAT Case 11,229 (1996) 33 ATR 1243; Case 54/96 (1996) 96 ATC 521 the Tribunal accepted that the taxpayer was carrying on a business although no business plan was evident. They stated:

…that formal business plans were just not part of the applicant's agenda, for any of his activities (smash repairs, or horse racing and breeding)…and ...the husband was knowledgeable about matters relating to the racing and breeding of horses.

Application to your circumstances

Significant commercial purpose

This indicator is closely linked to the other indicators and is a generalisation drawn from the interaction of the other indicators. It is particularly linked to the size and scale of activity, the repetition and regularity of activity and the profit indicators.

The partnership owned land which was used to run a business. The partnership did not prepare a formal business plan. The partners sought expert advice from experienced individuals and carried out extensive research prior to purchasing the land. The partners also spoke to potential buyers before making purchases.

Intention of the taxpayer

The partnership purchased the property with the intention of operating a business. The land was selected as it was deemed ideal due to its topography and the few temperature extremes experienced in the area.

Prospect of profits

The operations did not generate a profit for the partnership. The income received by the partnership per head was significantly less than the expected return per head. However, information provided suggests that there was a prospect of profit when the property reached stocking capacity.

Repetition and regularity

According to paragraph 55 of TR 97/11 it is often a feature of a business that similar sorts of activities are repeated on a regular basis. The repetition of activities by the same person over a period of time on a regular basis helps to determine whether there is the 'carrying on' of a business.

The partners spent 1 day each weekend working on the property during the period the partnership was operating.

Activities of the same kind and carried on in a similar manner to those of the ordinary trade in that line of business

If a taxpayer carries out their activity in a manner similar to other taxpayers in the industry, it is more likely that their activity amounts to the carrying on of a business. That is, the taxpayer's operations are of the same kind and carried on in the same way as those characteristic of ordinary trading in that particular line of business (IR Commissioners v. Livingston 11 TC 538).

This indicator requires a comparison between the activities of the taxpayer in question and those undertaken by a person in business in the same type of industry. Where the taxpayer's activities are similar in nature to the business, further support is given to the fact that a business exists.

The information provided suggests the operations were conducted in the same or similar manner to other properties in the area. Although the size of the partnership's property was smaller than others, land size varied greatly between individuals. The partnership's production numbers were always comparable with other properties in the area.

Organisation in a business-like manner, the keeping of books, records and the use of a system

The activities conducted by, or on behalf of the taxpayer, should be carried out in a systematic and organised manner. This will usually involve matters such as the keeping of appropriate business records by the taxpayer. If the activities are carried out on the taxpayer's behalf by someone else, there should be regular reports provided to the taxpayer on the results of those activities.

The partnership complied with legal requirements to enable them to sell their product. The partnership kept business records and a separate business bank account.

The size and scale of the activity

The larger the scale of the activity the more likely the rulee will be carrying on a business of primary production, although this may not always be the case.

The number of product increased yearly during the period the partnership was in operation.

Hobby or recreation

The activity does not have the nature of a hobby or recreational pursuit.

Conclusion

In this case, the partnership owned land which was used to run a business. Most aspects of the activity carried on by the partnership are similar to that of others in the industry. We consider that the partnership's activities were conducted on a sufficient scale to be considered a business.

Question 2

Under section 115-10 of the Income Tax Assessment Act 1997 (ITAA 1997), to qualify for the 50% general discount a capital gain must be made by an individual, a complying superannuation entity, a trust or a life insurance company. The capital gain must result from a capital gains tax (CGT) event happening after 11:45am on 21 September 1999 and must not have an indexed cost base. Also, the gain must result from a CGT event happening to an asset that was acquired at least 12 months before the CGT event.

Application to your circumstances

In this case, the partner acquired an interest in the land during the 20XX-XX financial year. This land was then sold in the 20YY-YY financial year. The land was held for more than 12 months; therefore the land qualifies for the 50% discount.

Question 3

To qualify for the small business CGT concessions, you must satisfy several conditions that are common to all concession. These are called the basic conditions. The small business 50% active asset reduction will apply if the basic conditions are satisfied.

Basic conditions

The basic 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 an asset that the taxpayer owns

(b) the event would have, apart from the application of the small business concessions, resulted in a capital gain

(c) one or more of the following applies:

I. the taxpayer satisfies the maximum net asset value test

II. the taxpayer is a "small business entity" for the financial year

III. the asset is an interest in an asset of a partnership which is a small business entity for the financial year, and the taxpayer is a partner in that partnership, or

IV. the special conditions for passively held assets in sub-sections 152-10(1A) or 152-10(1B) are satisfied in relation to the CGT asset in the financial year and

(d) the asset satisfies the active asset test.

Condition (a)

A CGT event occurred when the land was sold in the 20YY-YY financial year.

Condition (b)

The sale of the land will result in a capital gain; therefore condition (b) is satisfied.

Condition (c)

Subsection 152-10(1B) of the ITAA 1997 will be satisfied for a CGT asset a partner in a partnership owns (that is not their interest in a partnership asset) when the following conditions are satisfied in the financial year:

· they were a partner in a partnership in the financial year in which the CGT event happens to the partner's CGT asset

· that partnership uses the asset at a time in the financial year, in carrying on the partnership business and is a small business entity for that financial year

· the only business the partner carries on is as a partner in a partnership.

The partnership was carrying on a business and had a turnover less than $2 million; therefore it was a small business entity while it carried on the business. However, this business ceased in the 20ZZ-ZZ financial year and the land was no longer used.

If an entity is not using the asset in the business in the year the CGT event occurs because the business the entity previously carried on is winding up, section 152-49 of the ITAA 1997 may apply provided the entity used the asset in the business in the year the business ceased.

Section 152-49 of the ITAA 1997 treats the entity as carrying on the business for a moment in time in the financial year the CGT event happens and treats the asset as being used, held ready for use in, or inherently connected with, the business at that same moment in time in the CGT event year.

Additionally, there is a special provision under subsection 328-110(5) of the ITAA 1997 that allows an entity to work out whether it is a small business entity in the CGT event year when the entity is winding up a business it previously carried on. The entity will be taken to be still carrying on the business if:

· it is winding up a business it previously carried on, and

· it was a small business entity in the financial year the entity ceased business.

In this case, the business ceased trading in the 20ZZ-ZZ financial year due to the marriage break down of the partners. It would be reasonable to expect that the winding up of the business could take some time due to the nature of the industry, paired with the marriage breakdown of the partners.

Additionally, the partnership intended to dispose of the land and was awaiting a ruling from the Australian Taxation Office as to the GST consequences of the sale. Taking into consideration the timeframe involved, being that the CGT event occurred in the financial year following the cessation of the business, it would be reasonable to conclude that the business was still being wound up at the time that the CGT event occurred.

Accordingly, subsection 328-110(5) of the ITAA 1997 will apply to treat the partnership as a small business entity in the year the CGT event occurred. Additionally, section 152-49 of the ITAA 1997 will apply to treat the partnership as carrying on the business for a moment in time in the financial year the CGT event happened and treat the asset as being used in the business at the same moment in time in the CGT event year.

The requirements contained in subsection 152-10(1B) of the ITAA 1997 have been met and accordingly, the condition in paragraph 152-10(1)(c) of the ITAA 1997 is satisfied.

Condition (d)

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.

In this case, the partnership used the land in the business from the date of purchase until the business ceased. This period represents more than half of the ownership period. Accordingly, the land satisfies the active asset test.

As all of the basic conditions have been satisfied, the land will qualify for the 50% active asset reduction.