Edited version of private advice

Authorisation Number: 1012647937628

Ruling

Subject: Small business concessions

Question 1

When the land is disposed of by the company will subparagraph 152-110(1)(d)(i) of the Income Tax Assessment Act 1997 (ITAA 1997) be satisfied?

Answer

Yes.

Question 2

Is individual A's small business participation percentage X%?

Answer

Yes.

Question 3

When the shares held by individual A are cancelled will section 152-125 of the ITAA 1997 apply such that the amount of the payment made will not be treated as either a dividend or a frankable distribution?

Answer

Yes.

Question 4

Would subparagraph 116-30(2)(b)(ii) of the ITAA 1997 apply to treat the difference between the small business participation percentage and the rights to capital participation as being part of the capital proceeds for the cancellation of the shares?

Answer

No.

Question 5

If the market value substitution rule applies in respect of the cancellation of individual A's shares in the company, would the additional proceeds be treated as a dividend?

Answer

Not applicable.

Question 6

If the market value substitution rule applies in respect of the cancellation of individual A's shares in the company, would the market value proceeds be treated as a capital gain arising under CGT event C2?

Answer

Not applicable.

Question 7

When the company is liquidated (which may not necessarily be within 2 years of the relevant CGT event) will the remaining exempt capital gain in the company be a dividend in accordance with subsection 47(1A) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 8

To the extent that a taxable capital gain arises for each of the remaining shareholders, on the basis that the conditions in Subdivision 152-B of the ITAA 1997 are able to be satisfied will the remaining shareholders be able to rely on the 15 year exemption?

Answer

Invalid - refer to reasons for decision.

This ruling applies for the following periods

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

The company acquired a parcel of land and began carrying on a business.

Due to a change in the shareholding the pre CGT assets of the company (including the land) are considered to be post CGT assets.

Additional shares were issued to several individuals. The shares were issued to reflect the fact that they were all working in the business.

The company carries on a business and has an aggregated turnover for the current year (and prior years) of less than $2 million. There are no entities connected with the company for the purposes of determining the relevant annual turnover under section 328-115 of the ITAA 1997.

In relation to applying the 15 year exemption in Subdivision 152-B of the ITAA 1997, the land is an active asset in accordance with section 152-35 of the ITAA 1997.

Individual A and individual B actively worked in the farming business until individual B's death.

Individual A is over 55 years of age and is a director of the company

Individual A continues to be actively engaged in management and decisions in relation to the company and the business carried on.

One class shares have voting rights, dividend rights and rights to participate in distribution of surplus assets on a wind up.

Another class of shares have voting rights, dividend rights and have the right to participate in distribution of surplus assets on a wind up.

The remaining classes of shares have no rights.

The company has been approached to sell its land with the purchase price payable over a number of years.

When the land is sold by the company, individual A will cease to be involved in the business.

Because of individual A's advanced age, they would like to retire from the business carried on by the company and cease any involvement in the management of the company.

Once the contract for the sale of the land is entered into, the directors of the company will resolve to cancel individual A's shares and in consideration for this cancellation, the company will make a payment in line with their small business participation percentage.

Individual A owns multiple classes of shares with voting rights, dividend rights and the right to participate in distribution of surplus assets on a wind up.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 47

Income Tax Assessment Act 1936 subsection 47(1A)

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 subsection 116-30(2)

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 section 152-55

Income Tax Assessment Act 1997 section 152-110

Income Tax Assessment Act 1997 paragraph 152-105(d)

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

Income Tax Assessment Act 1997 subsection 152-125(2)

Income Tax Assessment Act 1997 subsection 152-125(3)

Reasons for decision

Question 1

15 year exemption

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

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

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

(c) the company 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 owned the CGT asset; and

(d) an individual who was a significant individual of the company 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.

In connection with retirement

The Explanatory Memorandum (EM) to the New Business Tax System (Capital Gains Tax) Bill 1999 makes the following comments about the requirement to be permanently incapacitated or retiring as one of the conditions for the concession:

1.68 One of the requirements of this concession for an individual small business taxpayer is that they must be either permanently incapacitated at the time of the CGT event, or at least 55 years old and using the capital proceeds for their 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. It could be argued that the phrase 'in connection with retirement' means that the capital gain arising from the disposal of active assets is to be used to provide funds for a person's retirement rather than to precipitate retirement at the time of the CGT event. The words used in the EM support this interpretation.

The Advanced guide to capital gains tax concessions for small business 2010-11 (NAT 3359) also supports this view. It makes it clear that it is not necessary for there to be a permanent and everlasting retirement from the workforce. However, 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 paragraphs 152-105(d) or 152-110(1)(d) of the ITAA 1997. The guide also provides that a CGT event may be 'in connection with your retirement' even if it occurs at some time before retirement.

Application to your circumstances

In this case, individual A held the duties and responsibilities of a director. Individual A has continued to be actively engaged in management and decisions in relation to the company and the business carried on. Once the land is sold, individual A will cease all involvement in the business. Accordingly, the CGT event is considered to have happened in connection with individual A's retirement in accordance with paragraph 152-110(1)(d) of the ITAA 1997.

Question 2

Significant individual

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 entities direct small business participation percentage in a company is the percentage of:

• voting power the entity is entitled to exercise

• any dividend payment that the entity is entitled to receive, or

• any capital distribution that the entity is entitled to receive, or

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

Taxation determination TD 2006/77 explains that all classes of shares (other than redeemable shares) issued by a company are taken into account in determining if the company has a significant individual under section 152-55 of the ITAA 1997.

Example 2 states that:

5. A company has two different classes of shares, A and B, which have equal voting and distribution rights. Isaac holds 20% of the shares of each class. The directors can decide to make a distribution of income or capital to either class of shares to the exclusion of the other class of shares.

6. In this situation, the company does have a significant individual. Isaac holds 20% of the voting power and, regardless of how the directors' discretion is exercised, Isaac will always receive 20% of any distribution made by the company.

Application to your circumstances

In this case, individual A holds multiple classes of shares. Individual A is entitled to more than 20% of the voting and capital rights, however if a divided is declared in relation to one class of shares at the exclusion of the other they are only entitled to X% of the dividends. Therefore, individual A's small business participation percentage in the company is X%.

Question 3

Subsection 152-125(3) of the ITAA 1997 states that if a company makes a payment in relation to the 15 year exemption, this Act applies to the payment, to the extent that it is less than or equal to the limit mention in subsection 152-125(2) of the ITAA 1997, as if:

(a) it were not a dividend; and

(b) it were not a frankable distribution.

Application to your circumstances

In this case, the company proposes to make a payment to the significant individual in line with their small business participation percentage. Subsection 152-125(3) of the ITAA 1997 ensures this payment is not treated as a dividend or frankable distribution.

Question 4

Under section 108-5 of the ITAA 1997 an asset for capital gains tax (CGT) purposes is any form of property or a legal or equitable right that is not property. Under section 102-20 of the ITAA 1997 you make a capital gain or capital loss as a result of a CGT event.

Section 104-25 of the ITAA 1997 provides that CGT event C2 happens if the ownership of an intangible CGT asset ends by the asset:

(a) being redeemed or cancelled

(b) being released, discharged or satisfied

(c) expiring; or

(d) being abandoned, surrendered or forfeited

The time of the event is when you enter into the contract that results in the asset ending or if there is no contract, when the asset ends.

Market value substitution rule

Under subsection 116-30(2), the capital proceeds from a CGT event are replaced with the market value of the CGT asset that is the subject of the event if:

a) some or all of those proceeds cannot be valued; or

b) those capital proceeds are more or less than the market value of the asset and:

i. you and the entity that acquired the asset from you did not deal with each other at arm's length in connection with the event; or

ii. the CGT event is CGT event C2 (about cancellation, surrender and similar ending)

If you need to work out the market value of a CGT asset that is the subject of CGT event C2, work it out as if the event had not occurred and was never proposed to occur.

Application to your circumstances

In this case, we accept that the market value of individual A's shares when they are cancelled will be equal to the capital proceeds from the event. Therefore, subparagraph 116-30(2)(b)(ii) of the ITAA 1997 will not apply.

Question 5 & 6

As the answer to question 4 is no, these questions are not relevant.

Question 7

Section 47 of the ITAA 1936 deals with distributions made by liquidators. Distributions to shareholders of a company by a liquidator in the course of winding up the company, to the extent to which they represent income derived by the company (whether before or during liquidation) other than income which has been properly applied to replace a loss of paid-up share capital, are deemed to be dividends paid to the shareholders by the company out of profits derived by it.

Subsection 47(1A) of the ITAA 1936 explains that income derived by a company includes a reference to:

a) an amount (except a net capital gain) included in the company's assessable income for a year of income; or

b) a net capital gain that would be included in the company's assessable income for a year of income if the ITAA 1997 required a net capital gain to be worked out as follows:

Method statement

Step 1.

Work out each capital gain (except a capital gain that is disregarded) that the company made during that year of income.

Step 2.

Total the capital gain or gains worked out under Step 1. The result is the net capital gain for the year of income.

Application to your circumstances

In this case, the capital gain in relation to the sale of the land will be disregarded under the 15 year exemption. Therefore, it will not be considered income derived by the company under subsection 47(1A) of the ITAA 1936.

Question 8

In summary, an application for a private ruling will be valid if:

• the person applying for the ruling (the applicant) is the entity the ruling will apply to, or its agent or legal personal representative. Entity is defined in section 960-100 of the ITAA 1997.

• the application is in respect of a relevant provision as defined in section 357-55 TAA. For information about what is a relevant provision and what can be covered in a private ruling, refer to paragraphs 9 to 18 of TR 2006/11: Private Rulings.

• the application is in writing and in the approved form (section 388-50 of Schedule 1 to the Taxation Administration Act 1953 (TAA). The form details the information that is required by the Commissioner in order to deal with requests for private rulings:

• The application must contain a declaration signed by the taxpayer or their legal personal representative

• The application must identify the questions or issues to be considered.

• The application must identify a scheme (scheme is defined in section 995-1 of the ITAA 1997).

• The application must provide an address to which the ruling can be sent.

The question regarding the remaining shareholder's eligibility for the 15 year exemption is not relevant to the applicants. Therefore, this question is invalid and we have not considered it as a part of this ruling.

For more information, please refer to our website - www.ato.gov.au.