Edited version of your private ruling

Authorisation Number: 1012586564856

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Ruling

Subject: Small business entities and Capital Gains Tax relief

Question 1

Is the company a Small Business Entity pursuant to Subdivision 328-C of the Income Tax Assessment Act 1997?

Answer

Yes

Question 2

Are the basic conditions for Small Business Capital Gains Tax (CGT) relief per Subdivision 152-A of the Income Tax Assessment Act 1997 met?

Answer

Yes, to the extent the entity is entitled to it

This ruling applies for the following period:

· Year ending 30 June 2014

The scheme commences on: 1 July 2013

Relevant facts and circumstances

The entity is a proprietary company limited by shares. The entity was incorporated in 2009.

The share structure consists of three types of shares:

· Class A;

· Class B; and

· Ordinary shares.

The entity has a majority member (Member A) who holds A class shares, B class shares and ordinary shares; 50.02% of the shares.

Member B holds 50,000 A class shares.

Member C holds 80,000 B class shares.

The entity sells products, primarily to end users. The entity operates on retail margins. The entity delivers all products and does not offer facilities to the general public. The entity receives delivery revenue.

The entity carries on a business in the current year (2013/14).

There are no connected entities or affiliates whose annual turnover is to be included in the entity's aggregated turnover.

The aggregated turnover before the current year (2012/13) was less than $2 million.

The aggregated turnover (excluding fuel sales) for the current year (2013/14) is likely to be less than $2 million.

The entity sells products to a store. The product sales account for approximately two per cent of total sales. The transactions take place on identical (retail) terms offered to all other customers.

The entity has recently been approached to consider the sale of its business.

Relevant legislative provisions

Income Tax Assessment Act 1997 6-5

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 109-5

Income Tax Assessment Act 1997 Section 118

Income Tax Assessment Act 1997 Subdivision 152A

Income Tax Assessment Act 1997 Section 152-05

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 Subdivision 328-C

Income Tax Assessment Act 1997 Section 995-1

Fuel Tax Act 2006 (Cwlth)

Bankruptcy Act 1924-1933 (Cwlth) Section 95

Tax Laws Amendment (Small Business) Act 2007 (Cwlth)

Reasons for decision

Issue 1

Are all sales of fuel included in the entity's aggregated turnover and are the basic conditions for CGT relief satisfied?

Question 1

Is the company a Small Business Entity pursuant to Subdivision 328-C of the Income Tax Assessment Act 1997 (ITAA 1997)?

Summary

The entity is considered to be a 'small business entity' as it carries on a business in the current year and it carried on a business in the income year (the previous year) before the current year and its aggregated turnover for the previous year was less than $2 million, and its aggregated turnover for the current year is likely to be less than $2 million.

Detailed reasoning

What is a small business entity?

Subsection 328-110(1) of the ITAA 1997 states:

An entity is a 'small business entity' if it:

a) Carries on a business in the current year, and

b) One or both of the following applies:

i. It carried on a business in the income year (the previous year) before the current year and its aggregated turnover for the previous year was less than $2 million, and

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

The term 'aggregated turnover' is defined in ITAA 1997 section 328-115 as the annual turnover of a business plus the annual turnovers of any businesses it is connected with or affiliated with. An entity's aggregated turnover is the same as its annual turnover if there are no other entities it is connected with or affiliated with.

Meaning of business

The term 'business' is defined in ITAA 1997 subsection 995-1(1) to include any profession, trade employment, vocation or calling, but does not include occupation as an employee. 'Carrying on a business' is not defined in the ITAA 1997 and, therefore, takes its ordinary meaning.

Meaning of annual turnover

ITAA 1997 subsection 328-120(1) defines an entity's annual turnover for an income year as the total ordinary income that the entity derives in the income year in the ordinary course of carrying on a business.

'Ordinary income' is defined in ITAA 1997 section 6-5 as income according to ordinary concepts. An entity's annual turnover therefore includes all income according to ordinary concepts derived in the ordinary course of carrying on a business.

In Taylor v White [1964] ALR 595; (1964) 110 CLR 129; (1964) 37 ALJR 387; (1964) 20 ABC 299; [1964] HCA 11, Dixon CJ observed:

'the time honoured phrase 'in the ordinary course of business' is meant to refer to transactions regularly taking place in a sustained course of activity or some usual process naturally passing without examination.'

How the law applies to your question

Member A is the majority member of the entity, holding A class shares, B class shares and ordinary shares; 50.02% of the shares. The entity has a Director and Secretary. Member A has a Director and Secretary. Member A has a sole member. Member A is not a reporting entity.

Aggregated turnover exclusions

Subsection 328-120(3) of the ITAA 1997 states that in working out an entity's annual turnover for an income year, do not include any amounts of ordinary income the entity derives from sales of retail fuel.

Sales of retail fuel

ITAA 1997 subsection 995-1(1) states that retail fuel means taxable fuel, within the meaning of the Fuel Tax Act 2006, that is sold by retail.

The result is that, for the purposes of calculating its turnover, an entity disregards any income derived from the sale of retail fuel.

The intention behind the exclusion of retail fuels from aggregated turnover is explained in the Tax Laws Amendment (Small Business) Act 2007 Explanatory Memorandum chapter 2, paragraph 17. The memorandum explains:

'…for the purposes of fuel retailers, recognising that entities involved in the sale of retail fuel will often have high levels of turnover with a very low margin, so that the ordinary turnover figure would not be a true indicator of size.'

Meaning of retail

The Macquarie Dictionary (3^rd ed) defines 'retail' to mean:

1. the sale of commodities to household or ultimate consumers, usually in small quantities (opposed to wholesale)

Australian and New Zealand Standard Industrial Classification (ANZSIC) codes, which are used by the Tax Office and Australian Bureau of Statistics to classify and define industry classes, defines 'retail' as being mainly engaged in the resale of new or used goods to final consumers, and includes department stores and mail order houses as retailers.

How the law applies to your question

All products sold by the entity are sold on identical terms, resulting in the same profit. As part of the entity's ordinary business they do not differentiate between customers, all transactions fall into place as part of the undistinguished common flow of business. The intention behind the exclusion of retail fuels from aggregated turnover recognises that entities involved in the sale of retail fuel will often have high levels of turnover with very low margins therefore the ordinary turnover figure would not be a true indicator of size.

As a result, all fuel sold by the entity falls within the meaning of the Fuel Tax Act 2006, is sold on a retail basis and is excluded from their aggregated turnover.

Therefore, the entity is considered to be a 'small business entity' as it carries on a business in the current year and It carried on a business in the income year (the previous year) before the current year and its aggregated turnover for the previous year was less than $2 million, and its aggregated turnover for the current year is likely to be less than $2 million.

Question 2

Are the basic conditions for Small Business Capital Gains Tax per Subdivision 152-A of the Income Tax Assessment Act 1997 met?

Summary

The entity has recently been approached to consider a sale of its business. The business consists of plant and equipment, inventory and goodwill. A sale would precipitate a CGT A1 event - Disposal of a CGT asset.

All the basic conditions for small business relief will have been met.

Detailed reasoning

Small business entities are entitled to certain capital gains tax concessions. To be eligible for these concessions, the taxpayer has to satisfy the basic conditions outlined in section 152-10 of the ITAA 1997 and the specific conditions set out in each various concession provision.

The basic conditions

Subsection 152-10(1) of the ITAA 1997 contains the basic conditions for small business relief in relation to capital gains. The basic conditions to be satisfied for the gain are:

(a) a CGT event happens in relation to a CGT asset of yours in an income year. This condition does not apply in the case of CGT event D1;

(b) the event would (apart from Division 152 of the ITAA 1997) 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;

III. you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an interest in an asset of the partnership;

IV. the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year; and

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

A CGT event occurs

Subsection 152-10(1)(a) requires that a CGT event occurs in relation to a CGT asset of yours in an income year.

The event would have resulted in a gain

Subsection 152-10(1)(b) requires that a gain is made in relation to a CGT event.

Small business entity

Subsection 152-10(1)(c) requires that one of four conditions is met. Subsection 152-10(1)(i) relates to small business entities. You will be a small business entity under section 328-110 of the ITAA 1997 and eligible for the concessions listed in section 328-10 if you:

· are carrying on a business, and

· you have less than $2 million aggregated turnover.  

The CGT asset satisfies the active asset test

This condition requires that the active asset test in subsection 152-35(1) of the ITAA 1997 be satisfied. You will satisfy the active asset test if you:

(a) owned an asset for 15 years or less and the asset was an active asset of yours for at least half the period from when you acquired the asset to when you disposed of the asset; or

(b) you owned the asset for more than 15 years, and the asset was an active asset of 7 of those years.

The time of acquisition of an asset for CGT purposes is determined under Division 109 of the ITAA 1997. Subsection 109-5(1) of the ITAA 1997 states that in general, you acquire a CGT asset when you become its owner.

Section 152-40 of the ITAA 1997 defines what an active asset is. For a CGT asset of a business to be an active asset, 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 if it is owned by a small business entity and it is:

1. used or held ready for use by the small business entity, a small business CGT affiliate, or an entity connected with the small business entity, in the course of carrying on a business, or

2. an intangible asset that is inherently connected with a business carried on by the small business entity, for example, goodwill.

The entity has recently been approached to consider a sale of its business. Taxation Ruling TR 1999/16, Income tax: capital gains: goodwill of a business, states that a business is not a thing or a series of things. A business is not a CGT asset. Each asset of the business is considered separately for the purpose of determining whether a CGT event occurs.

The business consists of plant and equipment, inventory and goodwill.

Plant and equipment: ITAA 1997 section 118-24 states that a capital gain or loss may be disregarded if it arises from a CGT event (that is also a balancing adjustment event) that happens to a depreciating asset. There are exceptions to this rule where the capital gain or loss arises under CGT events J2 and K7.

Inventory: Trading stock is defined in section 70-10 of the ITAA 1997 as including 'anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business.' Inventory would thus be considered trading stock as its purpose is to be sold or exchanged in the ordinary course of a business. The meaning of trading stock is also given in ATO Interpretative Decision ATO ID 2009/97, Income Tax: Definition of trading stock, as 'for purposes of...exchange'.

ITAA 1997 section 118-25 states that a capital gain or loss from trading stock is ignored for CGT purposes. A capital gain or loss is also ignored if the taxpayer starts holding as trading stock a CGT asset it already owns but did not previously hold as trading stock, provided the taxpayer elects for the asset to be treated as having been sold for its cost. If, in such circumstances, the taxpayer elects to treat the asset as being sold for market value, CGT event K4 happens

Goodwill: TR 1999/16 states that goodwill is a CGT asset separate and distinct from other assets of the business such as plant, licences (whether exclusive or non-exclusive licences), statutory permits, quotas, entitlements, valuable contractual rights and items of intellectual property (for example, a trade mark, patent, copyright or registered design).

Goodwill is property, and an asset of a business, because it is the right or privilege of the owner of a business to use the other assets of the business, to make use of all that constitutes the attractive force which brings in custom and to conduct the business in substantially the same manner and by substantially the same means which in the past have attracted custom to the business.

How the law applies to your question

Sale of goodwill is a CGT A1 event (section 104-10 of the ITAA 1997). If a CGT event occurs, it will satisfy the first basic condition for small business relief.

If the entity decides to sell its business and a gain is made the second basic condition for small business relief will be satisfied.

The entity is carrying on a business. A sale of the business will include plant and equipment, inventory and goodwill. The aggregated turnover of the entity is less than $2 million. Therefore, the entity can be considered a small business entity and it will satisfy the third basic condition for small business relief.

The entity was incorporated in 2009 and appears to have continually carried on a business. For the assets of the entity to be considered to be active assets, the entity must be a small business entity and the assets must have been used for at least half the period from asset acquisition to asset disposal in the course of carrying on the business or be an intangible asset that is inherently connected with the business carried on by the small business entity.

It has already been determined that the entity is a small business entity. None of the exceptions contained in section 152-40(4) of the ITAA 1997 are relevant to the circumstances. Goodwill is an intangible asset that is inherently connected with the entity. Therefore, all the assets used in the course of operations, including goodwill, would be considered active assets and it will satisfy the fourth basic condition for small business relief.

All the basic conditions will have been met.