Edited version of private advice

Authorisation Number: 1012684246100

Ruling

Subject: Capital gains tax

Question

Will the shares in the company satisfy the active asset test and therefore be considered a replacement asset?

Answer

No.

This ruling applies for the following period

Year ending 30 June 2015

The scheme commences on

1 July 2014

Relevant facts and circumstances

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

• the application for private ruling,

• the documents provided with the application for private ruling, and

• the additional information provided.

The trust is an investment discretionary trust.

The trust held shares in a company which were sold during the relevant financial year.

The trust realised a capital gain on the disposal of these shares and applied the general 50% discount and the 50% active asset reduction.

The small business rollover concession was applied to the remaining capital gain.

The trust intends to purchase shares in a company

The trust already holds an interest in this company.

The trust will acquire a further interest in the company.

The major tangible assets of the company comprise of loans made to a related company in the group. The value of these loans exceeded 20% of the total assets of the company for the year ended 30 June 2014.

The funds have been loaned to the related company to cover exploration costs and the setup of a business operation.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 subsection 104-185(1)

Income Tax Assessment Act 1997 section 152-135

Income Tax Assessment Act 1997 subsection 152-40(1)

Income Tax Assessment Act 1997 paragraph 152-40(1)(c)

Income Tax Assessment Act 1997 subsection 152-40(3)

Income Tax Assessment Act 1997 subsection 152-40(4)

Reasons for decision

Small business rollover

The small business rollover allows you to defer the capital gain made from a capital gains tax (CGT) event if you acquire one or more replacement assets and satisfy certain conditions. The conditions which must be met to obtain relief are set out in Subdivision 152-A of the ITAA 1997.

For you to obtain a rollover, subsection 104-185(1) of the Income Tax Assessment Act 1997 (ITAA 1997) ITAA 1997 requires you to acquire a replacement asset, and that it be an active asset of yours, within a period starting one year before, and ending two years after the date of disposal of the original asset.

If the replacement asset is a share in a company or an interest in a trust, at the end of the replacement asset period:

• you, or an entity connected with you are a CGT concession stakeholder in the company or trust, or

• CGT concession stakeholders in the company or trust have a small business participation percentage in the interposed entity of at least 90%

Active asset test

The active asset test is contained in section 152-35 of the 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 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, the trust sold shares in a company and applied the general 50% discount, the 50% active asset reduction and the small business rollover concession. The trust holds shares in the company and intends to acquire further shares as a replacement asset.

Shares

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 Advanced guide to capital gains tax concessions for small business 2013-14 (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.

This case is similar to the above example. The company that the trust intends to purchase shares in has loaned money to another entity. The other entity used the money to fund exploration costs and the setup of a mining operation. However, the loans made between the related entities are not considered to be inherently connected with the business that is carried on (that is, the business conducted by the company).

As the loans to the other entity are not inherently connected to the business, they cannot be included in the calculation of the 80% test. Therefore, the shares will not be considered active assets and the replacement asset test will not be satisfied.