Edited version of private advice

Authorisation Number: 1012633294783

Ruling

Subject: CGT small business concessions

Question 1

Does Trust 1 satisfy the basic conditions for the small business concessions contained in section 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997) in relation to the disposal of the property.

Answer

Yes

Question 2

Can Trust 1 apply the 15 year exemption in relation to any capital gain made from the disposal of the property?

Answer

Yes

Question 3

If the answer to Question 2 is yes, and the exempt amount is distributed to X and Y in accordance with section 152-125 of the ITAA 1997, will the payment be non-assessable income X and Y?

Answer

Yes

Question 4

If the answer to Question 2 is no, does Trust 1 qualify for the general discount contained in Division 115 of the ITAA 1997 in relation to any capital gain made from the disposal of the property?

Answer

Not applicable

Question 5

If the answer to Question 4 is yes, are X and Y required to gross up their share of the capital gain before applying the general discount when calculating their individual net capital gain or loss for the relevant income year in accordance with subsection 115-215(3) of the ITAA 1997?

Answer

Not applicable

This ruling applies for the following period:

Year ending 30 June 2014

The scheme commenced on:

1 July 2013

Relevant facts and circumstances

Trust 1 is a unit trust.

Trust 2, a discretionary trust, holds all of the units in Trust 1.

X and Y are beneficiaries of Trust 2.

Trust 1 purchased the property.

Trust 1 operated a business from the property for a period of more than 7.5 years.

Trust 1 was a small business entity.

The business was sold as a going concern. The property continued to be held by Trust 1 and was leased to the new business owners until it was sold.

During the 2013-14 financial year, Trust 1 entered into a contract for the disposal of the property.

The disposal of the property resulted in a capital gain.

Trust 1 satisfied the maximum net asset value test just prior to the disposal of the property.

The profits from business income and subsequent rental income received by Trust 1 was distributed to Trust 2 as the sole unit holder. Trust 2 then distributed income to X and Y.

During the 15 financial years prior to the disposal of the property, there was always one individual that received at least 20% of the distributions from Trust 2 except where there has been a tax loss.

Trust 2 will make distributions in the 2013-14 financial year to X and Y of at least 20% each.

X and Y have discussed how to best utilise the proceeds from the sale for their retirement with a financial planner. X has ceased all paid work and Y has notified their employer of their resignation.

Both X and Y were over 55 at the time of the CGT event.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 152-10

Income Tax Assessment Act 1997 Section 152-15

Income Tax Assessment Act 1997 Section 152-35

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

Income Tax Assessment Act 1997 Section 152-55

Income Tax Assessment Act 1997 Section 152-60

Income Tax Assessment Act 1997 Subsection 152-70(5)

Income Tax Assessment Act 1997 Section 152-75

Income Tax Assessment Act 1997 Section 152-110

Income Tax Assessment Act 1997 Paragraph 152-110(1)(d)

Income Tax Assessment Act 1997 Section 152-125

Reasons for decision

Basic Conditions

The basic conditions for the small business concessions are contained in section 152-10 of the ITAA 1997. The following conditions must be satisfied:

• a capital gains tax (CGT) event happens in relation to a CGT asset of yours in an income year

• the event results in a capital gain

• the CGT asset satisfies the active asset test, and

• at least one of the following applies;

• you are a small business entity for the income year

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

• 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, or

• you do not carry on a business, but your CGT asset is used in a business carried on by a small business entity that is your affiliate or an entity connected with you.

The active asset test is contained in section 152-35 of the ITAA 1997. Where you have owned the asset for more than 15 years, the active asset test is satisfied if the asset was an active asset of yours for a total of at least 7.5 years of the test period detailed below.

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 an active asset if it is owned by you and is used or held ready for use in a business carried on (whether alone or in partnership) by you, your affiliate, your spouse or child, or an entity connected with you.

However, paragraph 152-40(4)(e) of the ITAA 1997 states that an asset whose main use in the course of carrying on the business is to derive rent cannot be an active asset unless the main use for deriving rent was only temporary. This exclusion generally does not apply to a CGT asset leased to an affiliate or connected entity.

Although Trust 1 derived rental income from the property, it was not for the entire period of ownership. At all other times, and for more than 7.5 years, the property was used solely in the Trust 1's business. Accordingly, the property meets the active asset test and the exclusion contained in paragraph 152-40(4)(e) of the ITAA 1997 does not apply.

In this case, it is accepted that Trust 1 meets the basic conditions due to the following:

• a CGT event occurred when Trust 1 disposed of the property

• the event resulted in a gain

• Trust 1 satisfied the maximum net asset value test, and

• the asset meets the active asset test.

Small business 15 year exemption

Section 152-110 of the ITAA 1997 provides that for a company or trust to be eligible for the small business 15-year exemption you must satisfy the basic conditions and three further conditions:

• you continuously owned the CGT asset for the 15-year period ending just before the CGT event happened.

• you had a significant individual for a total of at least 15 years of the whole period of ownership (even if it was not the same significant individual during the whole period), and

• the individual who was a significant individual just before the CGT event was

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

• was permanently incapacitated at that time.

Significant individual test

Under section 152-55 of the ITAA 1997 an individual is a significant individual in a company or trust if they have a small business participation percentage in the company or trust of at least 20%. This 20% can be made up of direct and indirect percentages.

An entity's direct small business participation percentage in a discretionary trust is the percentage of:

• distributions of income that the entity is beneficially entitled to during the income year

• distributions of capital that the entity is beneficially entitled to during the income year; or

• if they are different, the smallest of the two definitions above.

Section 152-75 of the ITAA 1997 details that an entity's indirect small business participation percentage in a company or 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.

As X and Y hold an indirect interest in Trust 1 their participation percentage in Trust 2 will be multiplied by 100% to determine their participation percentage in Trust 1.

If a discretionary trust did not make a distribution of income or capital during an income year an entity's small business participation percentage in that year (the relevant year) is worked out using the percentage of the distributions that entity was entitled to in the CGT event year or the last income year before the CGT event year that the trustee made a distribution provided that:

• the trust had no net income for the relevant year, or

• the trust had a tax loss for the relevant year (subsection 152-70(5) of the ITAA 1997).

Either X or Y (or both) received at least 20% of the distributions from Trust 2 in all of the last 15 financial years except when Trust 2 had a tax loss. In accordance with subsection 152-70(5) of the ITAA 1997, their participation percentage in the loss year will be deemed to be the same as their participation percentage in the CGT event year. This will be at least 20% for both X and Y.

Accordingly, Trust 1 has had at least one significant individual for at least 15 years during the ownership period of the property.

In connection with retirement

Whether a CGT event happens in connection with an individual's retirement depends on the particular circumstances of each case. A CGT event may be in connection with your retirement even if it occurs at some time before retirement.

The provisions relating to the small business 15-year exemption do not define what is meant by the phrase 'in connection with a taxpayer's retirement', nor does it give any indication of the degree of retirement required in order to take advantage of this concession. However, the Advanced guide to capital gains tax concessions for small business 2012-13 (NAT 3359) provides that there would need to be at least a significant reduction in the number of hours worked or a significant change in the nature of the activities to be regarded as a retirement for the purposes of paragraph 152-110(1)(d) of the ITAA 1997.

Both X and Y were over 55 and are the relevant significant individuals just prior to the CGT event. Since the proceeds were received from the sale of the property, both X and Y have ceased or commenced winding down their employment or work activities.

We consider that the disposal of the property occurred in connection with both X and Y's retirement.

Accordingly, all of the requirements contained in section 152-110 of the ITAA 1997 have been met and Trust 1 can choose to apply the 15 year exemption to disregard the capital gain that resulted from the disposal of the property.

Payments to CGT concession stakeholders

As per section 152-60 of the ITAA 1997 an individual is a CGT concession stakeholder of a company if they are a significant individual or the spouse of a significant individual, where the spouse has a small business participation percentage in the company at that time that is greater than zero.

Section 152-125 of the ITAA 1997 provides that payments made to a trust's CGT concession stakeholders are exempt if:

• a capital gain of the trust is disregarded under the small business 15 year exemption, and

• the company makes one or more payments in relation to the exempt amount within two years after the relevant CGT event to an individual who was a CGT concession stakeholder of the trust just before the event.

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 defined in subsection 152-125(2) of the ITAA 1997.

In this case, Trust 1 is able to disregard the capital gain under the small business 15 year exemption and X and Y were both CGT concession stakeholders at the time of the CGT event. Accordingly, if the company makes a payment to X or Y, within the limits outlined above and within two years of the CGT event, the payment will be not be assessable to the individuals.