Edited version of your private ruling

Authorisation Number: 1012549077985

Ruling

Subject: Small business concessions

Questions

1. Will the units held in a Property Trust satisfy the active asset test?

Answer

Yes.

2. Will Family Trust B satisfy the additional basic condition in subsection 152-10(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following period(s)

Year ending 30 June 2014

Year ending 30 June 2015

Year ending 30 June 2016

The scheme commences on

1 July 2013

Relevant facts and circumstances

In 19XX, individual A and individual B entered into partnership providing professional services (the Partnership).

At that time, individual B was an income partner. After a few years, individual B became a full equity partner with individual A.

Individual A then assigned, by deed, less than 50% of their interest in the Partnership to spouse A.

From the commencement of the Partnership, a Service Trust provided administrative and secretarial personnel services from premises leased by the Service Trust and licensed to the Partnership.

From the 19YY financial year, all units in the Service Trust were held equally by Family Trust A and Family Trust B. Both family trusts are discretionary trusts.

Individual A and spouse A are both beneficiaries of Family Trust A and are jointly the appointors of that trust (with power to remove and replace the trustee).

In 19YY, a Property Trust was formed for the purpose of acquiring business premises. Company P is the trustee of the Property Trust and individual A and individual B are the shareholders (1 share each) and directors of Company P.

The deed of the Property Trust does not provide any discretion as to the distribution of income or capital to unit holders.

The Property Trust for the purposes of this application was a resident trust for CGT purposes at all relevant times.

The units in the Property Trust have at all times up to the date of this application been held equally by Family Trust A and Family Trust B.

The Property Trust purchased office premises (the Property) and the Property was ready for use by the Practice in early 19ZZ and the Partnership commenced to conduct business from the Property at this time.

Since that time the Property has been leased by the Property Trust to the Service Trust for a commercial rent and provided by the Service Trust under licence to the Partnership as part of the services provided under the service agreement between those entities.

The unit holdings in the Property Trust have remained unchanged since the Property was purchased.

Until late 20XX, individual A and individual B were the sole partners in the Partnership and were equal income and capital partners and all issued units in the Service Trust were held equally by Family Trust A and Family Trust B.

In late 20XX, individual C was admitted as a salaried partner to the Partnership. Under that arrangement individual C was entitled to a fixed salary share of Partnership income. Family Trust C also acquired one third of the units in the Service Trust.

Individual A and individual B remained the sole capital partners (subject to spouse A's entitlement to a share of individual A's Partnership interest) and each continued to hold a 50% equity interest in the Partnership goodwill and tangible assets.

Soon after, individual A, individual B and individual C rolled their respective interests in the Partnership into companies, as approved under the relevant state law - company A, company B and company C were formed. None of those companies acts as the trustee for any trust.

Individual A, individual B and individual C are each the sole shareholders and directors of their respective incorporated companies. Arising out of the Partnership interest assignment in favour of spouse A, individual A holds part of their interest in company A upon constructive trust for spouse A.

In the 20YY financial year, individual C purchased an equal one-third capital and income interest in the partnership.

There has been no change in the ownership of units in the Property Trust and this remains the case to date.

In the year that Family Trust B disposes of its units in the Property Trust, the trustee of Family Trust B proposes to distribute 50% of the income and capital of the trust to individual B and 50% of the income and capital of the trust to spouse B.

Relevant legislative provisions

Income Tax Assessment Act 1997 - Section 152-10

Income Tax Assessment Act 1997 - Section 152-35

Income Tax Assessment Act 1997 - Section 152-40

Income Tax Assessment Act 1997 - Section 152-50

Income Tax Assessment Act 1997 - Section 152-60

Income Tax Assessment Act 1997 - Section 328-125

Income Tax Assessment Act 1997 - Section 328-130

Reasons for decision

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 least 7.5 years during the test period.

The test period:

· begins when you acquired the asset, and

· ends at the earlier of

- the CGT event, and

- when the business ceased, if the business in question ceased in the 12 months before the CGT event (or such longer time as the Commissioner allows).

A CGT asset is also an active asset at a given time if you own it and:

· it is an interest in a trust that is a resident trust for CGT purposes for the income year in which that time occurs, and

· the total of the following is 80% or more of the market value of all of the assets of the trust

- the market values of the active assets of the trust, and

- the market value of any financial instruments of the trust that are inherently connected with a business that the trust carries on, and

- any cash of the trust that is inherently connected with such a business.

This means an interest in a trust is an active asset if the trust itself has active assets with a market value of at least 80% of the market value of all its assets.

In this case, Family Trust B has held 50% of the units in the Property Trust for more than 15 years, and the Property is the only asset of the Property Trust.

In order to satisfy the active asset test, the Property needs to have been an active asset of the Property Trust for a total of at least 7.5 years.

The Property will be an active asset if it is owned by Property Trust and is used or held ready for use in a business carried on (whether alone or in partnership) by the Property Trust, an affiliate of the Property Trust, or an entity connected with the Property Trust.

Affiliate

Under section 328-130 of the ITAA 1997, an affiliate is an individual or company that, in relation to their business affairs, acts or could reasonably be expected to act:

· in accordance with your directions or wishes, or

· in concert with you.

Trusts, partnerships and superannuation funds cannot be your affiliates.

In this case, the Property is leased to the Service Trust and used in its business activity of providing administrative and secretarial personnel and legal administration services to the Partnership. The Service Trust cannot be an affiliate of the Property Trust.

The property is also used by the Partnership as the premises out of which the practice operates. The Partnership also cannot be an affiliate of the Property Trust.

Individual partners and/or the legal practice companies

Relevant factors that may support a finding that 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, include:

· the existence of a close family relationship between the parties

· the lack of any formal agreement or formal relationship between the parties dictating how the parties are to act in relation to each other

· the likelihood that the way the parties act, or could reasonably be expected to act, in relation to each other would be based on the relationship between the parties rather than on formal agreements or legal or fiduciary obligations

· the actions of the parties.

Generally, another business would not be acting in concert with you if they:

· have different employees

· have different business premises

· have separate bank accounts

· do not consult you on business matters

· conduct their business affairs independently in all regards.

In this case, there is no evidence that the Partnership, either the individuals or the corporate entities, conducted their business in concert with the Property Trust. The Property Trust was only set up to acquire and hold the Property, and is essentially the landlord of the property. On the evidence provided, the business affairs of the individual partners and the Property Trust are conducted independently in all regards, and would not be considered to be affiliates for the purposes of section 328-130 of the ITAA 1997.

Entity connected with the Property Trust

Under section 328-125 of the ITAA 1997, an entity is connected with another entity if:

· either entity controls the other entity; or

· both entities are controlled by the same third entity.

An entity controls another entity if it or its affiliate (or all of them together):

· beneficially owns or has the right to acquire beneficial ownership of, interests in the other entity that give the right to receive at least 40% (the control percentage) of

- any distribution of income or capital by the other entity, or

- if the other entity is a partnership, the net income of the partnership, or

· if the other entity is a company, beneficially owns, or has the right to acquire beneficial ownership of, equity interests in the company that give at least 40% of the voting power in the company.

Indirect control

The control tests for the 'connected with' rules are designed to look through business structures that include interposed entities. If an entity (the first entity) directly controls a second entity, and the second entity controls (whether directly or indirectly) a third entity, the first entity is also taken to control the third entity.

Control of the Property Trust

In this case, Family Trust A and Family Trust B each hold 50% of the units in the Property Trust and each has beneficial interest in at least 40% of the income or capital of the Property Trust, or a control percentage. Both Family Trust A and Family Trust B are discretionary trusts.

An entity controls the discretionary trust if the trustee either acts, or might reasonably be expected to act, in accordance with the directions or wishes of the entity or the entity's affiliates, or both the entity and it's affiliates.

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

Individual A and spouse A are joint appointors of Family Trust A (with power to remove and replace the trustee) and are consider to control the trust for the purposes of subsection 328-125(3) of the ITAA 1997.

Under section 152-47 of the ITAA 1997, a spouse may be taken to be your affiliate where an asset is owned by an entity that you own or have an interest in, and that asset is used in a business carried on by your spouse, or an entity that your spouse has an interest in.

In this case, spouse A has an interest in the Property Trust which owns the Property used in a business individual A has an interest in. Therefore, individual A and spouse A are affiliates for the purposes of section 152-47 of the ITAA 1997.

As individual A (together with affiliate, spouse A) controls Family Trust A , which in turn controls the Property Trust, individual A is also taken to control the Property Trust.

Control of the Partnership

From when the Property was ready for use in the Partnership business to when the partners rolled their respective interests in the Partnership into companies, both individual A and individual B had the right to receive more than 40% of the capital of the partnership each.

For the purposes of section 328-125 of the ITAA 1997, both individual A and individual B controlled the Partnership for more than 7.5 years.

Conclusion

The Property Trust was a resident trust for CGT purposes at all relevant times.

As stated above, the units in the Property Trust held by Family Trust B will be active assets where at least 80% of the market value of all the Property Trust's assets are active assets. The Property is the only asset of the Property Trust.

Property will be an active asset of the Property Trust if it is owned by the Property Trust and is used or held ready for use in a business carried on by an entity connected with the Property Trust.

Based on the above discussion, individual A (together with affiliate, spouse A) controlled both the Property Trust and the Partnership either directly or indirectly, therefore, the Partnership is connected with the Property Trust.

The Partnership has used the Property in its business and has been a connected entity of the Property Trust for more than 7.5 years.

As a result, the Property satisfies the active asset test for the purposes of section 152-35 of the ITAA 1997. The Property is the only asset of the Property Trust and its market value is at least 80% of the market value of all the Property Trust' assets.

Therefore, the units in the Property Trust held by Family Trust B are active assets for the purposes of section 152-40 of the ITAA 1997.

Subsection 152-10(2) of the ITAA 1997

Subsection 152-10(2) of the ITAA 1997 contains an additional basic condition that must be met when the CGT asset being disposed of is an interest in a trust. Under this subsection you must be either a CGT concession stakeholder in the object trust or the CGT concession stakeholders of the object trust together have a small business participation in you of at least 90%.

Section 152-60 of the ITAA 1997 defines the meaning of 'CGT concession stakeholder' as an individual who is a 'significant individual' in the trust or the spouse of a significant individual in the trust, if the spouse has a 'small business participation percentage' in the company or trust at that time that is greater than zero.

A significant individual is defined as an individual with a small business participation percentage in the trust of at least 20%. The 20% can be made up of direct and indirect percentages.

Total small business participation percentage

An entity's small business participation percentage in another entity at a time is the percentage that is the sum of:

· the entity's direct small business participation percentage in the other entity at that time, and

· the entity's indirect small business participation percentage in the other entity at that time.

Direct small business participation percentage

An entity's direct small business participation percentage in a trust, where entities have entitlements to all the income and capital of the trust, is the percentage of:

· the percentage of any distribution of income that the trustee may make to which the entity would be beneficially entitled; or

· the percentage of any distribution of capital that the trustee may make to which the entity would be beneficially entitled.

An entity's direct small business participation percentage in a trust, where entities do not have entitlements to all the income and capital of the trust, and the trust makes a distribution of income or capital, is the percentage of:

· distributions of income that the entity is beneficially entitled to during the income year, or

· distributions of capital that the entity is beneficially entitled to during the income year.

Indirect small business participation percentage

An entity's indirect small business participation percentage in a trust is calculated by multiplying together the entity's direct participation percentage in an interposed entity, and the interposed entity's total participation percentage (both direct and indirect) in the company or trust.

Conclusion

In this case, Family Trust A is beneficially entitled to 50% of the income of the Property Trust meaning its direct small business participation percentage in the Property Trust is also 50%. However, Family Trust A cannot be a CGT concession stakeholder in the Property Trust because it is not an individual; therefore, we need to determine if there are any CGT concession stakeholders of the Property Trust who together have a small business participation percentage in Family Trust A of at least 90%.

Family Trust A is a discretionary trust therefore the beneficiaries do not have entitlements to all the income and capital of the trust. In this case, the direct small business participation percentage is based on the percentage of distributions of income or capital that the beneficiaries are beneficially entitled to receive during the income year of the CGT event. In the year Family Trust A disposes of its units in the Property Trust, the trustee of Family Trust A proposes to distribute 50% of the income and capital of the trust to individual A and 50% of the income and capital of the trust to spouse A.

Together they will have a small business participation percentage in Family Trust A of at least 90%.

Individual A and spouse A's indirect small business participation percentage in the Property Trust will be 25%, calculated by multiplying together their 50% direct participation percentage in Family Trust A, and Family Trust A 's 50% participation percentage in the Property Trust. Therefore, as both their interests will be at least 20%, individual A and spouse A will both be a significant individual and a CGT concession stakeholder of the Property Trust, satisfying the additional basic condition in subsection 152-10(2) of the ITAA 1997.