Edited version of your private ruling

Authorisation Number: 1012441681269

Ruling

Subject: Capital gains tax

Question 1

Are the directors/shareholders of the company considered to be your affiliates for the purposes of the small business entity test?

Answer

No.

Question 2

Are the directors/shareholders of the company considered to be entities that are 'connected with' you for the purposes of the small business entity test?

Answer

No.

Question 3

Is the land considered an active asset?

Answer

Yes.

Question 4

Do you meet the basic conditions necessary to access the capital gains tax (CGT) concessions for small business on the sale of the land?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 2013

The scheme commences on:

1 July 2012

Relevant facts and circumstances

You acquired land in the late 1990's.

The land was acquired to commence primary production activities.

The land has been farmed since its purchase and up until it was sold except for X years in the early 2000s when poor economic and weather conditions suspended activity.

The land contains a property which occupies less than 10% of the total land area. The property is a residential house that has been rented to tenants on an arms length basis and who are unrelated to the company's directors or shareholders. The property first earned rental income from mid 2004-05 to supplement income to support the primary production activities. The property has been rented out continuously since then.

The directors and shareholders of the company (and their shareholdings) at the date of the CGT event are:

· Shareholder 1 - 25% voting power

· Shareholder 2 - 25% voting power

· Shareholder 3 - 25% voting power

· Shareholder 4 - 25% voting power

Shareholder 1 is the only active director involved in the day to day management of the company. Shareholder 1 is the sole initiator of the primary production activity and is the sole decision maker in relation to the company activities. Approximately Z% of all the company's day to day activities are handled by Shareholder 1. The other directors are basically silent directors and have minimal involvement.

The company's annual turnover was less than $2 million in the 20YY-YY financial year.

The shareholders/directors of the company have no other individual business interests.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 328-110(1).

Income Tax Assessment Act 1997 Section 328-115.

Income Tax Assessment Act 1997 Section 328-130.

Income Tax Assessment Act 1997 Subsection 328-130(2).

Income Tax Assessment Act 1997 Subsection 328-125(1).

Income Tax Assessment Act 1997 Section 104-10.

Income Tax Assessment Act 1997 Paragraph 328-125(2)(b).

Income Tax Assessment Act 1997 Section 152-10.

Income Tax Assessment Act 1997 Section 152-15.

Income Tax Assessment Act 1997 Subsection 152-10(1A).

Income Tax Assessment Act 1997 Section 152-35.

Income Tax Assessment Act 1997 Section 152-40.

Reasons for decision

Small business entity

Subsection 328-110(1) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that you are a small business entity for an income year if:

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

b) one or both of the following applies:

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

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

Section 328-115 of the ITAA 1997 explains that your aggregated turnover is your annual turnover plus the annual turnovers of any business entities that are your affiliates or that are 'connected with' you.

Affiliate

An affiliate is defined by section 328-130 of the ITAA 1997 as being an individual or 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 business affairs of that individual or company.

Importantly, subsection 328-130(2) of the ITAA 1997 provides that 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. For 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.

In your case, none of the directors of the company carry on a business in their own right nor do they have an interest in any other business. Therefore, they cannot reasonably be expected to act in accordance with your directions or wishes in relation to their business affairs.

Accordingly, none of the directors are considered your affiliates for the purposes of the small business entity test.

An entity 'connected with' you

Subsection 328-125(1) of the ITAA 1997 provides that an entity is "connected with" another entity if, either entity controls the other entity, or both entities are controlled by the same third entity.

Paragraph 328-125(2)(b) of the ITAA 1997 provides that in the case of a company, an entity will be 'connected with' the company if the first entity, its affiliates, or the first entity together with its affiliates: 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 at least W% of the voting power in the company.

In your case, none of the shareholders of the company individually hold more thanV% of the voting power in the company and none of the directors of the company are considered affiliates of each other. Therefore, none of the shareholders of the company are able to individually (or collectively) control the voting power in the company.

Accordingly, the shareholders are not considered entities that are 'connected with' you for the purposes of the small business entity test.

Small business CGT concession eligibility and the active asset test

Section 152-10 of the ITAA 1997 contains the basic conditions you must satisfy to be eligible for the small business capital gains tax (CGT) concessions. These conditions are:

(a) a CGT event happens in relation to a CGT asset in an income year.

(b) the event would have resulted in the gain

(c) at least one of the following applies:

(i) you are a small business entity for the income year

(ii) you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997

(iii) you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership or

(iv) the conditions in subsection 152-10(1A) or (1B) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year.

(a) the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997.

Section 152-40 of the ITAA 1997 provides the meaning of 'active asset'. A CGT asset will be an active asset at a time if, at that time, you own the asset and the asset was used or held ready for use by you, an affiliate of yours, or by another entity that is 'connected with' you, in the course of carrying on a business.

The active asset test is contained in section 152-35 of the ITAA 1997. The active asset test is satisfied if:

· 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 test period detailed below, or

· 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 7.5 years during the test period.

In your case, based on the information provided, you meet conditions a), b), and c). Therefore it is necessary to now determine whether the land in question is considered an active asset.

You purchased the land in the late 1990's. Accordingly, you have owned the land for more than 15 years. Therefore the land must have been an active asset for at least 7.5 years.

The land includes a property. The property is a residential house whose area is less than 10% of the whole land area. The property has been rented out on an arms length basis to an unrelated third party since mid 20YY-YY. Therefore the company has received both business income and rental income from the land.

Main use to derive rent

Taxation Determination TD 2006/78 considers, amongst other issues, the situation where there is part business and part rental use of an asset. It states that an asset owned by the taxpayer and used partly for business purposes and partly to derive rent can be an active asset under section 152-40 of the ITAA 1997 where it is considered that the main use of the premises is not to derive rent. In deciding if the property was mainly used to earn rent the Commissioner will consider a range of factors such as:

· the comparative areas of use of the premises (between rent and business)

· the comparative times of use of the premises (between rent and business), and

· the comparative levels of income derived from the different uses of the asset.

The property compromises less than 10% of the total area. Therefore the majority of the land is used for the farming activity.

The property has been rented out continuously since mid 20YY-YY. The land has been used or held ready for use for farming since purchased. During a X year period there was no farming activity conducted on the land due to poor economic conditions and limited rainfall. However, to be active, the asset needs to only to be held ready for use. Therefore the land has earned rental income for 8 years and has been used or held ready for use for farming for 15 years.

Having regard to the above circumstances during the ownership of the land, we consider that as the vast majority of area is used to generate business income and the land has been used for farming, or held ready for use for farming, for the entire ownership period. Therefore the main use of the property is to derive business income and not rent. Accordingly, the property satisfies the active asset test under section 152-35 of the ITAA 1997.

Accordingly, you satisfy the basic conditions necessary to be eligible for the capital gains tax concessions for small business.