Edited version of your private ruling

Authorisation Number: 1012451964584

Ruling

Subject: CGT - sale of real property to trustee and active asset test

Question 1

Is the most appropriate CGT event in connection with your disposal of real property to an entity that is a trustee of a trust, CGT event E2?

Answer

No

Question 2

Is the real property asset you disposed of an active asset for CGT purposes?

Answer

Yes

This ruling applies for the following periods

Year ended 30 June 2012

Year ended 30 June 2013

The scheme commenced on

1 July 2011

Relevant facts and circumstances

You are a unit trust.

The unitholders of the unit trust are discretionary trusts. The discretionary trusts are all controlled by individuals or their associates.

You purchased a commercial property in xx year (the property), and immediately rented the property to an associated entity to be used as a business premises.

The associated entity that the property was rented to is a partnership. During the period of ownership of the property, one partner passed away. There was no change to the unitholders of the unit trust at this time, but the deceased partner's interest in the partnership was acquired by the surviving partners in equal shares.

In year ended 30 June 20XX, the associated entity vacated the property and you leased it to an unrelated party.

A contract for sale was entered into in year ended 30 June 20XX to sell the property to an unrelated party that was a company acting in its capacity as trustee of a trust.

Settlement of the property occurred in year ended 30 June 20YY.

You contend that at all relevant times the partnership controlled the unit trust and the entities worked completely in concert with each other.

All of the related entities have less than $2m in turnover, and you contend that collectively and separately all related entities would be small business entities.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 104-60

Income Tax Assessment Act 1997 subsection 102-25(1)

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

Income Tax Assessment Act 1997 subsection 328-125(2)

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 subsection 152-35(2)

Income Tax Assessment Act 1997 subsection 152-40(1)

Income Tax Assessment Act 1997 paragraph 152-40(1)(c)

Income Tax Assessment Act 1997 paragraph 152-40(4)(e)

Reasons for decision

Question 1

Detailed reasoning

CGT event A1 happens if the ownership of a CGT asset changes (section 104-10 of the ITAA 1997). CGT event E2 happens if a CGT asset is transferred to an existing trust (section 104-60 of the ITAA 1997).

If more than one CGT event happens in respect of a transaction, the most specific event is to be used (subsection 102-25(1) of the ITAA 1997).

There may be different tax outcomes for a taxpayer depending on which CGT event happens. For example, CGT event A1 happens on the contract date whereas CGT event E2 happens when the ownership change occurs. This may affect the income year in which a capital gain or capital loss is taken to be made.

On its face, CGT event E2 happens whenever an asset is transferred to a trust and is therefore an applicable event in this case. However, it is considered that CGT event A1 (rather than CGT event E2) is the most specific event where, as in this case, an asset is transferred to another party and the transferor is indifferent as to the identity of that party. That is, CGT event A1 is the most specific event where the parties are completely unconnected and are dealing with each other at arm's length.

In this case, the purchaser was acting in a trustee capacity. CGT event A1 is considered the most specific event whenever the parties are unconnected. It would be inappropriate for a different CGT event to apply depending on whether the vendor knew the capacity in which the purchaser was acquiring the asset. On the other hand, CGT event E2 will be the most specific event if, for example, an asset is transferred to a trust of which the transferor or an associate is a beneficiary or object.

In accordance with ATO ID 2003/559 - Disposal of a CGT asset to a trust: application of CGT event A1 or CGT event E2, CGT event A1 is the most specific event in your circumstances as the property was sold to the trustee of a trust that has no connection with you or your associates.

Question 2

Detailed reasoning

In order to be eligible for the small business capital gains tax (CGT) concessions, a number of basic conditions must be satisfied. One of these conditions is that the asset must satisfy the active asset test.

Special conditions for passively held assets

The special condition under subsection 152-10(1A) of the Income Tax Assessment Act 1997 (ITAA 1997) is satisfied if you do not carry on business (other than as a partner) but your asset is used in a business carried on by a small business entity that is your affiliate, or an entity connected with you.

Entity connected with you

The basic rule is that an entity is connected with another entity if either entity 'controls' the other, or both entities are controlled by a common third entity.

Where the other entity is not a discretionary trust, subsection 328-125(2) of the ITAA 1997 states you have direct control over that other entity if you and your affiliates have the right to receive a percentage (the control percentage) that is at least 40% of any distribution of either the income or the capital by the other entity.

You are considered to control the partnership, and the partnership is an entity that is connected with you for the purposes of subsection 152-10(1A) of the ITAA 1997.

You have indicated that the partnership was a small business entity. Accordingly, you satisfy the special conditions under sub-section 152-10(1A) of the ITAA 1997.

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.

The term 'active asset' is defined in subsection 152-40(1) of the ITAA 1997 as an asset you own and use (or hold ready for use) in the course of carrying on a business; or in the course of carrying on a business by a connected entity under paragraph 152-40(1)(c) of the ITAA 1997.

Paragraph 152-40(4)(e) of the ITAA 1997 states, however, that an asset whose main use in the course of carrying on the business is to derive rent can not be an active asset unless the main use for deriving rent was only temporary.

The exclusion in paragraph 152-40(4)(e) of the ITAA 1997 will not apply in this case as it is considered that the main use of the property was for an entity connected with you to carry on a business and not to derive rent (Taxation Determination TD 2006/63).

In your case, you acquired the property in XX year. The property will be considered an active asset because it has been used in the course of carrying on a business by a small business entity that is connected with you. As you have held the property for a period greater than 15 years, it must have been an active asset for a least 7 ½ years from the time you acquired the asset, to the earlier of either the disposal, or cessation of the related entity's business, to satisfy the active asset test. The active asset test will be satisfied as the property was used in the course of carrying on the partnership's business from the date it was acquired until it was disposed of.