Edited version of your written advice

Authorisation Number: 1012701133206

Ruling

Subject: Small business concessions

Question 1

Is trust A entitled to the capital gains tax (CGT) small business 15 year exemption concession in relation to property 1?

Answer

Yes.

Question 2

Does property 2 satisfy the active asset test under section 152-35 of the Income Tax Assessment Act 1997?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2014

The scheme commences on:

199X

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.

Company A is the trustee of trust A.

100% of the trust A units are owned by company B as trustee for trust B.

The individuals are both directors of company A.

The individuals are the sole shareholders and directors of company B.

One individual owns 100% of the shares in company C.

Based on the distributions of income and capital that the trustee of trust B has resolved to make for the 2013-14 financial year, both individuals will be CGT concessions stakeholders just before the CGT event.

Trust A satisfied the Maximum Net Asset Test just before the CGT event.

Trust A had a significant year for 21 years.

Company D carried on the business.

Company D ran the business from property 1 from the late 1980's until 200X.

Shareholding in company D changed during the ownership period but the individuals and company C owned the majority of the shares for most of the ownership period.

During mid-200Y the individuals and company C sold all remaining company D shares. The individuals resigned as officeholders of company D.

Trust A purchased property 1 in the late 1980's.

The business operated from property 1.

The workshop and office were located in property 1.

There was no written lease agreement between trust A and company D.

Company D used the property to run the business from purchase until mid-200X.

The contract to sell property 1 was signed at the end of 20XX.

For at least 15 years that trust A owned property 1, trust A has had a significant individual.

Trust A purchased the property 2 in the 2000/200Y financial year.

Property 2 is adjacent to property 1 and used for parking and storage in the business operations.

Property 2 was used by company D for approximately eight years.

A lease was entered into between trust A and a third party over both properties in mid-20YY.

In mid-200Y, the individual ceased being a full-time employee and resigned as director of company D.

The individual was over 55 years of age at the time they ceased being a full-time employee.

The individuals and company C sold all of their shares in company D.

Between mid-200Y and mid-20ZZ, one of the individuals was engaged one or two days a week by company D as a consultant for various administrative roles.

Since mid-20ZZ, the same individual has occasionally worked in the industry. This has been for a maximum of one to two weeks per year.

In 200X, trust A spent $xxx with a number of real estate agencies on marketing campaigns to sell the properties. Due to the GFC it was difficult to find a buyer willing to pay a reasonable price. All of the offers received were below the asking price.

Trust A considered redeveloping the land by building a commercial and residential mixed development in order to make the properties more attractive for sale. $xxx was spent on architects to determine whether it would be feasible to continue with the development. It was decided it wouldn't go ahead.

At the end of 200Z a letter of intent was received from a developer to purchase the properties for the asking price. However this transaction did not proceed.

In mid-20YY a lease was entered into with a third party with an option to buy within three years at the asking price.

At the end of 20XX, a contract was entered into with the third party for the sale of the properties for the asking price.

Reasons for decision

The CGT provisions provide some small business relief in Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997).

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.

Active asset test

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 A derived rental income from the properties, it was only for a period of approximately 3 years out of more than 25 years in the case of property 1 and more than 10 years in the case of property 2. After the business ceased, there was a period of approximately 3 years where the properties were vacant and for sale.

At all other times, and for more than 7.5 years, property 1 was used solely in the business. Property 2 was owned for a period of more than 10 years, the majority of which the property was used in the business.

Accordingly, both properties meet 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 A meets the basic conditions due to the following:

• a CGT event occurred when trust A disposed of the property

• the event resulted in a gain

• the trust satisfied the maximum net asset value test, and

• the assets meet the active asset test.

15 year exemption - conditions for companies and trusts

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

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

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

(c) the trust had a significant individual for a total of at least 15 years during which time the trust owned the CGT asset; and

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

• 55 or over at that time and the event happened in connection with their retirement or

• 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.

Trust A is wholly owned by trust B. As the individuals hold an indirect participation percentage in trust A their participation percentage in trust B will be multiplied by 100% to determine their participation percentage in trust A.

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).

The individuals received at least 20% of the distributions from trust B in more than half of the total ownership period.

Accordingly, trust A has had at least one significant individual for at least 15 years during the ownership period of the properties.

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 2013-14 (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.

An example discussing whether a CGT event occurring after retirement could be considered 'in connection with' your retirement is provided in the Advanced guide to capital gains tax concessions for small business 2013-14 states as follows:

A small business operator 'retires' and his children take over the running of the business. Within six months, they sell some business assets and make a capital gain. Several reasons may have prompted the sale of the assets. If there is no relevant connection with the small business operator's business, the requirement would not be satisfied. However, if it can be shown that the reason for the disposal of the assets is connected to retirement and the later sale is integral to the small business operator's retirement plan, the sale may be accepted as happening in connection with retirement.

In this case, the individual was over 55 and was a significant individual just prior to the CGT event. The business ceased in 200Y and trust A was trying the sell the properties for a couple of years. Significant amounts were spent on advertising the properties for sale and on architects regarding a commercial development. In mid-20YY a lease was entered into with an option to purchase. The properties sold at the end of 20XX. In mid-200Y an individual ceased full time employment. They acted as a consultant for one or two days a week until mid-20ZZ. Since this time they have occasionally worked in the same industry for a maximum of one to two weeks per year.

Based on the information provided, your situation has similarities to the example in the guide (apart from the period of time mentioned). Therefore, while there has been a significant amount of time between when the individual resigned as a director of company D to when the properties were sold, it appears that later disposal of the properties was part of the retirement plan.

As such, we accept that the disposal of the properties is 'in connection with' the individual's retirement. Accordingly, all of the requirements contained in section 152-110 of the ITAA 1997 have been met and trust A can choose to apply the 15 year exemption to disregard the capital gain that resulted from the disposal of property 1.

Property 2 has not been held for 15 years and therefore trust A is not able to apply the 15 year exemption. However, the property is an active asset and trust A would therefore be able to apply the active asset discount.