Edited version of administratively binding advice

Authorisation Number: 1012592590860

Advice

Subject Contribution to superannuation fund as CGT small business exemption

Questions

1. Will capital gains tax (CGT) event A1 occur when ownership of land is transferred from a trust to a superannuation fund?

2. Does the trust satisfy the basic conditions for the small business CGT concessions?

3. Will a payment made, under the small business 15-year exemption, by the trust to a CGT concession stakeholder who is a member of the superannuation fund occur after the relevant CGT event?

4 Will a contribution of the payment received by the CGT concession stakeholder to the superannuation fund in relation to the relevant CGT event satisfy the requirements of subsection 292-100(4) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Advice/Answers

1. No, CGT event E2 will occur.

2. Yes.

3. No.

4. No.

This advice applies for the following period

Income year ending 30 June 2014

The arrangement commences in

Income year ending 30 June 2014

Relevant facts and circumstances

Your advice is based on the facts stated in the description of the scheme that is set out below. If your circumstances are significantly different from these facts, this advice has no effect and you cannot rely on it. The fact sheet has more information about relying on ATO advice.

Company A is the trustee of Family Trust B (the Trust). The Trust is a discretionary trust that holds certain land (the Land) in Australia.

The Land was acquired by the Trust from an individual (Individual A) more than 15 years ago with a specific cost base. It has since been owned by the Trust and is, according to the applicant of this administratively binding advice (the Applicant), 'business real property' within the meaning of subsections 66(5) and (6) of the Superannuation Industry (Supervision) Act 1993 (the SIS Act).

Individual A and another individual (Individual B) are:

(a) the sole appointers of the Trust;

(b) the sole officeholders and shareholders of Company A;

(c) the sole officeholders and shareholders of Company B, which is the corporate trustee of a superannuation fund (the Fund); and

(d) the sole members of the Fund.

The Fund was only recently established. Its Australian business number is not yet available.

Individuals A and B conduct a primary production business on the Land through a partnership (the Partnership). They will retire on or before 1 July 2014. The Partnership will then be wound up, and they will stop working. The adult child of individuals A and B and the adult child's spouse will take over the primary production operations.

Individuals A and B wish to migrate 100% of the interest in the Land from the Trust to the Fund. There is no mortgage or other encumbrance over the Land.

The Trust and the Fund will enter into a formal contract for the sale and purchase of the Land for a specified sum of money. The actual market value of the Land at the time of the proposed migration will, however, be based upon an independent professional valuation.

The proposed migration of interest in the Land will cause a CGT event to happen to the Trust. It will also result in a capital gain which the Trust will, according to the Applicant, be able to disregard using the 'small business 15-year exemption' under Subdivision 152-B of the ITAA 1997. The deemed capital proceeds from the CGT event will be close to the CGT cap amount.

The Fund will not have enough cash to acquire the Land unless contributions are made to it. Individual B, who is under 75 years of age and has not used any of their CGT cap amount is, according to the Applicant, still able to make member contributions to a regulated superannuation fund. The other member, Individual A, is not under 75 years of age and will not be able to make such contributions.

The following sequence of events are proposed to be undertaken:

(a) The Trust will issue a promissory note to Individual B for the specified sum in payment of an 'exempt amount' under section 152-125 of the ITAA 1997.

(b) Individual B will endorse the promissory note to the Fund as a personal contribution to the Fund under subsection 292-100(4).

(c) The Fund will endorse the promissory note to the Trust in payment of the purchase price for the Land.

(d) Settlement of the Land transfer will occur at this point.

The Trust is not a 'small business entity' within the meaning of section 328-110 of the ITAA 1997 and may not satisfy the 'maximum net asset value' test imposed under section 152-15. However, the Applicant of this administratively binding advice (the Applicant) has advised that the requirements of subparagraph 152-10(1)(c)(iv) and subsection 152-10(1A) will be satisfied by reason of the following:

(a) The Partnership, being the entity that conducts a business on the Land, will be 'connected with' the Trust for the 2013-14 income year.

(b) The Partnership will be a 'small business entity' for the 2013-14 income year within the meaning of section 328-110.

(c) The Trust will not carry on a business at any time in the 2013-14 income year.

(d) The Partnership will have carried on the business in relation to the Land in the 2013-14 income year.

With respect to the 'connected with' test under section 328-125 of the ITAA 1997, the Applicant has advised that:

(a) under the Partnership, which conducts a primary production business, Individuals A and B are each entitled to 50% of the net income of the Partnership;

(b) at all times, the conduct of the business by Individuals A and B as partners in the Partnership has been based on their close personal relationship and common goals rather than on any formal arrangement or understanding , i.e., they will be 'affiliates' under section 328-130 at all times during their involvement in the Partnership;

(c) at all times, Company A has been the sole trustee of the Trust while Individuals A and B have been:

(i) the sole appointers of the Trust; and

(ii) the sole officeholders and shareholders of the corporate trustee of the Trust and

(d) it follows that at all relevant times Individuals A and B will 'control' both the Partnership and the Trust, both of which will, therefore, be 'connected-with' entities under paragraph 328-125(1)(b).

The Applicant has confirmed that the 'active asset' test' under section 152-35 of the ITAA 1997 will be satisfied on the basis that the Land has been used in the primary production business of the Partnership for a period of more than 7½ years, during which time the Partnership has been 'connected with' the Trust.

The Applicant has confirmed that the Trust has a 'significant individual' for a total of at least 15 years, during which time the Trust owned the Land. Where the Trust did not make any income or capital distribution for an income year, the Trust either had no taxable income or had a tax loss for that income year. Where the Trust made income or capital distributions to beneficiaries in a particular financial year, it made at least a specified percentage of the total income and capital distributions to a single individual. In Individual A and/or Individual B's case, it was always more than the specified percentage.

The Trust's income for the 2013-14 income year will be distributed such that Individual B will be the only CGT concession stakeholder of the Trust. Individual B will have a stakeholder's participation percentage of 100% for the purposes of subsection 292-100(4) of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 102-25(1).

Income Tax Assessment Act 1997 Section 104-10.

Income Tax Assessment Act 1997 Subsection 104-10(1).

Income Tax Assessment Act 1997 Subsection 104-10(2).

Income Tax Assessment Act 1997 Subsection 104-10(3).

Income Tax Assessment Act 1997 Section 104-60.

Income Tax Assessment Act 1997 Subsection 104-60(1).

Income Tax Assessment Act 1997 Subsection 104-60(2).

Income Tax Assessment Act 1997 Subsection 104-60(3).

Income Tax Assessment Act 1997 Subsection 104-60(4).

Income Tax Assessment Act 1997 Subsection 104-60(5).

Income Tax Assessment Act 1997 Subdivision 152-A.

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 Section 152-15.

Income Tax Assessment Act 1997 Subsection 152-125(b).

Income Tax Assessment Act 1997 Section 152-35.

Income Tax Assessment Act 1997 Subsection 152-35(1).

Income Tax Assessment Act 1997 Section 152-40.

Income Tax Assessment Act 1997 Subparagraph 152-40(1)(a)(i).

Income Tax Assessment Act 1997 Subparagraph 152-40(1)(a)(ii).

Income Tax Assessment Act 1997 Paragraph 152-40(1)(b).

Income Tax Assessment Act 1997 Subsection 152-40(4).

Income Tax Assessment Act 1997 Section 152-55.

Income Tax Assessment Act 1997 Section 152-65.

Income Tax Assessment Act 1997 Section 152-110.

Income Tax Assessment Act 1997 Section 152-120.

Income Tax Assessment Act 1997 Section 152-125.

Income Tax Assessment Act 1997 Section 292-100.

Income Tax Assessment Act 1997 Subsection 292-100(1).

Income Tax Assessment Act 1997 Subsection 292-100(4).

Income Tax Assessment Act 1997 Subsection 292-100(9).

Income Tax Assessment Act 1997 Section 292-105.

Income Tax Assessment Act 1997 Subsection 292-100(9).

Income Tax Assessment Act 1997 Subsection 292-405(1).

Income Tax Assessment Act 1997 Subsection 292-410(2).

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

Income Tax Assessment Act 1997 Subsection 328-125(3).

Superannuation Industry (Supervision) Act 1993 Section 66.

Superannuation Industry (Supervision) Act 1993 Subsection 66(5).

Superannuation Industry (Supervision) Act 1993 Subsection 66(6).

Superannuation Industry (Supervision) Regulations 1994 Regulation 7.04.

Reasons for decision

Summary

CGT event E2 (not A1) happens when interest in the Land is transferred from the Trust to the Fund. While the Trust will satisfy the basic conditions for the CGT small business concession, its proposed payment to Individual B will not satisfy the payment condition as the payment occurs before the CGT event. In turn, Individual B will not satisfy all the conditions for making a contribution to the Fund as a CGT small business concession.

Detailed reasoning

CGT Events

CGT Event A1

Subsection 104-10(1) of the ITAA 1997 states that:

CGT event A1 happens if you dispose of a CGT asset.

According to subsection 104-10(2) of the ITAA 1997, you dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner.

The time of the event, according to subsection 104-10(3) of the ITAA 1997, is:

(a) when you enter into the contract for the disposal; or

(b) if there is no contract - when the change of ownership occurs.

CGT event E2

Subsections 104-60(1) to (5) of the ITAA 1997 state, respectively, that:

(1) CGT event E2 happens if you transfer a *CGT asset to an existing trust.

(2)` The time of the event is when the asset is transferred.

(3) You make a capital gain if the capital proceeds from the transfer are more than the asset's *cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base.

(4) If you are the trustee of the trust and no beneficiary is absolutely entitled to the asset as against you (disregarding any legal disability), the first element of the asset's cost base and reduced cost base in your hands is its market value when the asset is transferred.

(5) CGT event E2 does not happen if you are the sole beneficiary of the trust and:

(a) you are absolutely entitled to the asset as against the trustee (disregarding any legal disability); and

(b) the trust is not a unit trust.

As per subsection 102-25(1) of the ITAA 1997, if more than one CGT event can happen, the event that is the most specific to the situation is to be selected.

In paragraphs 7 and 8 of its 'Reasons for Decision', ATO Interpretive Decision ATO ID 2003/559 titled 'Income Tax-Disposal of a CGT asset to a trust: application of CGT event A1 or CGT event E2' states that:

…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.

Application to your circumstances

In this case, the Trust will sell the asset to the Fund. Individuals A and B are beneficiaries of the Trust and members of the Fund. As such, it cannot be said that the parties are unconnected. Therefore, the most relevant event in this case is CGT event E2. The CGT event will occur when the transfer of interest in the Land from the Trust to the Fund takes place.

Small Business CGT concessions

Basic conditions

To qualify for the small business capital gains tax (CGT) concessions, several conditions that are common to all the concessions must be satisfied. These are the basic conditions under subsection 152-10(1) of the ITAA 1997:

(a) a CGT event happens in relation to a CGT asset of yours in an income year;

(b) the event would (apart from this Division) 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 (see section 152-15);

(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;

(d) the CGT asset satisfies the active asset test (see section 152-35).

Passively held assets

Subsection 152-10(1A) of the ITAA 1997 outlines the conditions that must be satisfied, for a passively held asset, to apply the small business concessions.

(a) your *affiliate, or an entity that is *connected with you, is a *small business entity for the income year; and

(b) you do not carry on a *business in the income year (other than in partnership); and

(c) if you carry on a business in partnership - the CGT asset is not an interest in an asset of the partnership; and

(d) in any case -- the small business entity referred to in paragraph (a) is the entity that, at a time in the income year, carries on the business (as referred to in subparagraph 152-40(1)(a)(ii) or (iii) or paragraph 152-40(1)(b)) in relation to the CGT asset.

Connected entity

It is stated in subsection 328-125(3) of the ITAA 1997 that:

An entity (the first entity) controls a discretionary trust if a trustee of the trust acts, or could reasonable be expected to act, in accordance with the directions or wishes of the first entity, its *affiliates, or the first entity together with its affiliates.

Some factors which might be considered for determining if the entity controls the discretionary trust include:

· the way in which the trustee has acted in the past;

· the relationship between the trustee and the entity or its affiliates, and the relationship the trustee has with both the entity and its affiliates;

· the amount of any property or services transferred to the trust by the entity or its affiliates, or both the entity and its affiliates;

· any arrangement or understanding between the entity and any person who has benefited under the trust in the past.

An entity may control a discretionary trust in addition to any beneficiary with control.

In paragraph 3 of its 'Reasons for Decision', ATO ID 2008/139 provides that a person who has the power to remove the trustee of a discretionary trust and appoint a new trustee will control the trust for the purposes of subsection 328-125(3) of the ITAA 1997.

Active asset test

A CGT asset satisfies the active asset test imposed by section 152-35 of the ITAA 1997 if the CGT asset is an active asset for at least:

· 7½ years, if owned for more than 15 years, or

· half of the ownership period, if owned for 15 years or less.

Assets which cannot be active assets

Pursuant to subsection 152-40(4) of the ITAA 1997 the following assets cannot be active assets:

· Interests in a connected entity (other than those satisfying the 80% test);

· Shares in companies and interests in trusts (other than those satisfying the 80% test);

· Shares in a widely held company unless they are held by a CGT concession stakeholder of the company;

· Interests in a trust that are similar to widely held companies unless they are held by a CGT concession stakeholder of the trust, or other exceptions for trusts with 20 members or less apply;

· Financial instruments, including loans, debentures, bonds, promissory notes, futures contracts, forward contracts, currency swap contracts, rights and options;

· An asset whose main use in the course of carrying on the business is to derive interest, an annuity, rent, royalties or foreign exchange gains. However, such an asset can still be an active asset if it is an intangible asset that has been substantially developed, altered or improved by the taxpayer so that its market value has been substantially enhanced or its main use for deriving rent was only temporary.

Application to your circumstances

In this case, a CGT event will occur when the Land is transferred from the Trust to the Fund. This event will result in a capital gain.

The Trust owns the Land but does not carry on a business. The Partnership, which is a small business entity, carries on a business on the Land. The partners of the Partnership are the appointers of the Trust. The partners are the sole officeholders and shareholders of Company A. Therefore, the Commissioner considers that the Partnership is connected with the Trust.

The Trust has owned the Land for more than 15 years. The Partnership has used this land in the course of carrying on a business for more than 7½ years. The Land will satisfy the active asset test.

Therefore, the Trust will satisfy the basic conditions in section 152-10 of the ITAA 1997.

Small business 15 year exemption

Section 152-110 of the ITAA 1997 provides a small business 15-year exemption for companies and trusts. Under section 152-110, a company or trust can disregard the capital gain from the disposal of a CGT asset if:

(a) the company or trust satisfies the basic conditions in Subdivision 152-A of the ITAA 1997 for the small business CGT concessions; and

(b) the company or trust continuously owned the CGT asset for the 15-year period ending just before the CGT event happened; and

(c) the company or trust had a significant individual for a total of at least 15 years (even if the 15 years was not continuous and it was not always the same significant individual) during which time the company or trust owned the CGT asset; and

(d) an individual who was a significant individual of the company or trust just before the CGT event was either:

· at least 55 years old at that time and the event happened in connection with their retirement; or

· permanently incapacitated at that time.

Significant individual

According to section 152-55 of the ITAA 1997 an individual is a 'significant individual' of a company or trust if they have a 'small business participation percentage' in the company or trust of at least 20%. Section 152-65 permits this 20% to be made up of direct and indirect percentages.

According to item 3 of the table in subsection 152-70(1) of the ITAA 1997, an entity's 'direct small business participation percentage' in a trust, where the entity does not have entitlements to all the income and capital of the trust, and where 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.

An entity's 'indirect small business participation percentage' in a company or trust (the test entity) is, under subsection 152-75 of the ITAA 1997, calculated by multiplying the entity's 'direct small business participation percentage' in an interposed entity by the interposed entity's total small business participation percentage (both direct and indirect) in the test entity.

In the present case, for over 15 years, where the Trust has made income or capital distributions, at least 20% of total income and capital distributions were made to either Individual A or Individual B.

Either Individual A or Individual B has had a small business participation percentage in the Trust of more than the specified percentage for over 15 years. Therefore, either will be a significant individual of the Trust in a given year. Consequently, the Trust has had a significant individual for a period of more than 15 years as is required by paragraph 152-110(1)(c) of the ITAA 1997.

In the relevant financial year, Individual B will receive 100% of the distributions from the Trust. Therefore, Individual B will be a significant individual in the year of the CGT event.

Payment conditions

Any distribution made by a trust under the 'small business 15-year exemption' is not included in the assessable income of the CGT concession stakeholder and is not deductible to the trust if certain conditions are satisfied.

The conditions are:

· the trust must make a payment within two years after the CGT event that resulted in the capital gain;

· the payment must be made to an individual who was a CGT concession stakeholder of the trust just before the CGT event; and

· the total payments made to each CGT concession stakeholder must not exceed an amount determined by multiplying the CGT concession stakeholder's participation percentage by the exempt amount.

The CGT concession stakeholder's participation percentage is:

· for a trust (where entities do not have entitlements to all the income or capital of the trust), the amount (expressed as a percentage) worked out using the formula:

100

(Number of CGT concession stakeholders)

(of the trust before the CGT event)

Application to your circumstances

In this case, the Trust satisfies the basic conditions for the small business concessions. The Trust has also continuously owned the Land for a period of 15 years. As discussed above, the Trust has had a significant individual for a period of at least 15 years. Individual B is over 55 years of age and intends to retire on or before 1 July 20XX.

To satisfy the payment conditions, the Trust must make a payment within two years after the CGT event. In this case, the Trust intends to issue a promissory note to make this payment. This promissory note will be issued to Individual B after a contract for the sale and purchase of the Land is entered into but prior to ownership of the Land being transferred to the Fund.

As discussed earlier, CGT event E2 will occur when the transfer of the Land takes place. In this case, the payment will be made to the significant individual before the CGT event occurs.

Therefore the Trust will not satisfy the payment condition for the purposes of paragraph 152-125(b) of the ITAA 1997.

Excess non-concessional contributions tax

Non-concessional contributions for a financial year are defined under section 292-90 of the ITAA 1997 and include:

· personal contributions for which an income tax deduction is not claimed;

· contributions a person's spouse makes to their superannuation fund account;

· transfers from foreign superannuation funds (excluding amounts included in the fund's assessable income); and

· excess concessional contributions (if any) for the financial year.

Non-concessional contributions made to superannuation funds are subject to an annual cap in accordance with subsection 292-85(2) of the ITAA 1997. For the 2013-14 income year, the non-concessional contributions cap is $150,000.

Under sections 292-80 and 292-85 of the ITAA 1997 a person will be liable to pay excess non-concessional contributions tax (ENCCT) at the rate of 46.5% on any non-concessional contributions in excess of the cap. The person will be given a release authority by the Commissioner in respect of the amount of ENCCT under subsection 292-405(1). Under subsection 292-410(2), the person is required to give that release authority to their superannuation fund for releasing an amount that is equal to their ENCCT liability.

Paragraph 292-90(2)(c) of the ITAA 1997 specifically excludes some contributions from being non-concessional contributions. These include:

· a Government co-contribution;

· a contribution arising from a structured settlement or an order for personal injury;

· a contribution relating to some capital gains tax (CGT) small business concessions to the extent that it does not exceed the CGT cap amount when it is made, as per section 292-100 ( the cap being $1,315,000 for the 2013-14 income year as per section 292-105); and

· a roll-over superannuation benefit.

Relevant to the present case, subsections 292-100(1), (2), (4) and (9) of the ITAA 1997 provide that:

(1) A contribution is covered under this section if:

(a) the contribution is made by you to a complying superannuation plan in respect of you in a financial year; and

(b) the requirement in subsection (2), (4), (7) or (8) is met; and

(c) you choose, in accordance with subsection (9), to apply this section to an amount that is all or part of the contribution.

(2) The requirement in this subsection is met if:

(a) the contribution is equal to all or part of the capital proceeds from a CGT event for which you can disregard any *capital gain under section 152-105 (or would be able to do so, assuming that a capital gain arose from the event); and

(b) the contribution is made on or before the later of the following days:

(i) the day you are required to lodge your income tax return for the income year in which the CGT event happened;

(ii) 30 days after the day you receive the capital proceeds.

…

(4) The requirement in this subsection is met if:

(a) just before a CGT event, you were a CGT concession stakeholder of an entity that could, under section 152-110, disregard any capital gain arising from the CGT event (or would be able to do so, assuming that a capital gain arose from the event); and

(b) the entity makes a payment to you within 2 years after the CGT event; and

(c) the contribution is equal to all or part of your stakeholder's participation percentage (within the meaning of subsection 152-125(2)) of the capital proceeds from the CGT event (but not exceeding the amount of the payment mentioned in paragraph (b)); and

(d) the contribution is made within 30 days after the payment mentioned in paragraph (b).

…

(9) To make a choice for the purposes of paragraph (1)(c), you must:

(a) make the choice in the approved form; and

(b) give it to the superannuation provider in relation to the complying superannuation plan on or before the time when the contribution is made.

The CGT cap under section 292-105 of the ITAA 1997 is a lifetime limit and is reduced by the amount of each contribution that an individual has elected to be covered by the exemption from the non-concessional contributions cap.

In the present case, the question asked is whether a contribution to the Fund of the payment received by Individual B, in relation to the proposed transfer of interest in the Land from the Trust to the Fund, will satisfy the requirements of subsection 292-100(4) of the ITAA 1997.

What the Trust intends to do is to make the payment to Individual B by way of a promissory note to be issued after the contract for the sale and purchase of the Land is entered into, but prior to ownership of the Land being transferred to the Fund. As discussed earlier under CGT Events, CGT event E2 will occur when the transfer of ownership of the Land takes place. As the payment by the Trust to Individual B will be made prior to the happening of CGT event E2, the Trust will not meet the payment requirement of paragraph 152-125(b) of the ITAA 1997.

Echoing the payment requirement of paragraph 152-125(b) of the ITAA 1997, paragraph 292-100(4)(b) likewise requires an entity to make a payment to a CGT concessional stakeholder within two years after the CGT event. As the Trust will not meet the requirement of paragraph 152-125(b), it follows that Individual B will not, for the purpose of making a contribution to the Fund under the small business 15-year exemption, meet the requirement of paragraph 292-100(4)(b) either.