Edited version of private advice

Authorisation Number: 1012643834331

Ruling

Subject: Active asset test

Question 1

Will the shares you held in the company satisfy the active asset test?

Answer

No.

This ruling applies for the following periods:

Year ending 30 June 2014

Year ending 30 June 2015

The scheme commences on:

1 July 2013

Relevant facts and circumstances

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

You acquired three (3) ordinary shares in a company (the company).

Your shareholding in the company represents a one-third interest in the paid up capital.

During the 2010-11 financial year the company began operations.

During the 2013-14 financial year, you disposed of your shares in the company for a capital gain.

Financial statements for the company have been prepared for the years ended 30 June 2011 and 30 June 2012. You have been instructed that the financial statements for the year ended 30 June 2013 are not materially different to the position at 30 June 2012.

The major tangible assets of the company comprise of loans made to related and commonly owned companies in the group. The value of these loans exceeded 20% of the total assets of the company as at 30 June 2011 and 30 June 2012.

The loans arose due to the following reasons:

• Loan 1 - an amount was loaned to a commonly owned entity for it to acquire the assets that the company hires to the general public. Rather than acquire the assets itself the company advanced funds to a related (commonly controlled entity) so that it could acquire the assets. These assets were leased to the company for use in its business.

• Loan 2 - the company does not own its business premises. It leases most of its premises from a related (and commonly controlled) entity. The funds to acquire these premises were funded by external financiers and money advanced by the company. The premises are leased to the company on commercial terms.

Relevant legislative provisions

Income Tax Assessment Act Section 152-35.

Income Tax Assessment Act 1997 Section 152-40.

Reasons for decision

Summary

The loans made to the related or commonly owned entities are not considered to be inherently connected with the business that is carried on. Therefore, the shares that you owned in the company are not active assets.

Detailed reasoning

The active asset test is contained in section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997). 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 at least 7.5 years during the test period.

Under subsection 152-40(1) of the ITAA 1997 a capital gains tax (CGT) asset is an active asset (subject to the exclusions) if it is owned and used, or held ready for use, in the course of carrying on a business by you or your small business CGT affiliate or another entity that is connected with you under paragraph 152-40(1)(c) of the ITAA 1997. An active asset may be a tangible asset or an intangible asset.

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

a) interests in a connected entity (other than those satisfying the 80% test)

b) shares in companies and interests in trusts (other than those satisfying the 80% test)

c) shares in widely held companies unless they are held by a CGT concession stakeholder of the company

d) shares in trusts 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

e) financial instruments, including loans, debentures, bonds, promissory notes, futures contracts, forward contracts, currency swap contracts, rights and options

f) 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.

In this case, you have sold your shares in the company. Shares are not active assets unless they satisfy the 80% test in subsection 152-40(3) of the ITAA 1997.

Under subsection 152-40(3) of the ITAA 1997 a 'share' is an active asset if:

a)   the company is an Australian resident at that time; and

  b)   the total of:

(i) the market values of the active assets of the company and

(ii) the market value of any financial instruments of the company that are inherently connected with a business that the company carries on and

(iii) any cash of the company that is inherently connected with such a business

is 80% or more of the market value of all assets of the company.

The active asset test under section 152-35 of the ITAA 1997 requires that a share in a company must satisfy the 80% test for at least half the period of ownership.

The Advanced guide to capital gains tax concessions for small business 2012-13 (NAT 3359) states that cash and financial instruments are not active assets, but they count towards the satisfaction of the 80% test provided they are inherently connected with the business.

Inherent connection necessarily requires something more than just some form of connection between the financial instrument and the business. A thing might be regarded as inherently connected to a business when it is a permanent or characteristic attribute of the business - for example, goodwill, or trade debtors

The Advanced Guide gives the following example:

Archimedes Pty Ltd carries on a manufacturing business. It lends $300,000 to a related company, Galileo Pty Ltd, to acquire various assets to be used in the businesses of both companies. However, a loan a company makes to a related entity to fund the acquisition of assets is not considered to be a permanent or characteristic attribute of the business the company carries on. As such, loans made between members of a corporate group as part of the overall financing of the group are not considered to be inherently connected with the business the lender carries on. Accordingly, the loan by Archimedes Pty Ltd to Galileo Pty Ltd is not taken into account in determining whether the shares in Archimedes Pty Ltd are active assets.

Your case is similar to the above example. The company that you owned shares in loaned money to two other entities. The other entities used the money to fund assets to be used in the companies' business. However, the loans made between the related or commonly owned entities are not considered to be inherently connected with the business that is carried on (that is, the business of retail car rental).

As the loans to the other entities are not inherently connected to the business, they cannot be included in the calculation of the 80% test. Therefore, the shares that you owned in the company are not active assets.