Edited version of your written advice

Authorisation Number: 1012720704050

Ruling

Subject: CGT small business concessions

Questions and answers

Are you entitled to reduce any capital gain made on disposal of your property by a discount of 50% by applying step 3 of the method statement in section 102-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Yes.

1. Do you satisfy the basic conditions contained in section 152-10(1) of the ITAA 1997 in respect of any capital gain made on disposal of your property?

Yes.

2. Can you reduce the amount of any capital gain made on disposal of your property (after any applicable discount) by 50% under the small business reduction contained in Subdivision 152-C of the ITAA 1997?

Yes.

3. Can you choose to disregard any capital gain made on disposal of your property (after any applicable discount and/or reduction) by applying the small business retirement exemption contained in Subdivision 152-D of the ITAA 1997

Yes.

This ruling applies for the following periods:

Year ending 30 June 2016

Year ending 30 June 2017

The scheme commences on:

1 July 2015

Relevant facts and circumstances

Person 1 and 2 are married and are both over 55 years of age. They have several children. Their children do not have any involvement in the businesses carried on by the Company or Company 2.

You are another company acting as trustee of a family trust (the Trust). Your sole activity has always been acting as trustee of the Trust. Persons 1 and 2 are your only directors and shareholders. The beneficiaries of the trust include Persons 1 and 2, their children, and the Company.

The Appointor and Guardian of the Trust was Person 1 for a time. After a later time, the role was held by Persons 1 and 2 together. The Appointor has the power to remove and appoint the Trustee, be consulted by the trustee before they exercise any discretion, power or make any determination, and must be consulted by the Trustee before the exercise of 'reserved powers' or 'restricted powers.'

After 19 September 1985, the Trust bought a property (the property). During some previous income years, the company lent the trust funds to refurbish the property. The property was acquired by the trust for use by the Company in the course of carrying on the Company's business. The Company has continued to use the property in the course of carrying on the business. Rent received from the Company has been below market rate. There have been no written lease agreements, no due dates for payment of rent, and the amount of rent has always been determined by Person 1 and the cash flow requirements of you and the Company.

The Company was registered many years ago. Persons 1 and 2 are the directors of the company. The shares in the company are held by Persons 1 and 2, their children, and Company 2 with differing classes of shares. Person 1 holds one A class share. This affords rights to Person 1 such as:

i. Having x times as many votes as the rest of the shareholders

ii. Agreeing to the appointment of any other Director

iii. Being able to pass resolutions by himself as if it had been passed at a meeting of the Directors

Company 2 was incorporated many years ago and its directors were originally Persons 1 and 2, and another person. More recently, Persons 1 and 2 have been the only directors. The current shareholders are Persons 1 and 2, and their children. Company 2 does not carry on business in its own right.

Company 2 beneficially holds the majority of shares in the Company (no other entity holds 40% or more). The majority of shares in Company 2 are held by Persons 1 and 2 (no other entity holds 40% or more).

The trust has held shares in Company 3 since a few years ago. Person 1 and another person are directors of Company 3.

The CGT assets of the trust, those connected with it and/or affiliates just before the CGT event was $XXX. However, after deducting trade creditors, provisions for various taxes, loans, amounts owed to beneficiaries, the net value of the CGT assets is reduced to $YYY.

You intend to sell the property to an unrelated third party. You expect to make a capital gain from this disposal. You expect the CGT exempt amount to be $XXX. In this year, you will distribute 50% of its income (and capital if required) to Person 1 and 50% to Person 2. You will choose an amount in writing for the property which will be the CGT exempt amount, and the amount of the payment required to be made under section 152-325 of the ITAA 1997 will be equal to the lesser of the capital proceeds received and the relevant CGT exempt amount

The payments to Persons 1 and 2 will be made by the later of 7 days after you make the choice and 7 days after you receive an amount of capital proceeds from the disposal of the property.

In the event, that the capital proceeds from the CGT event are received in instalments, you have stated that the trust will comply with the requirements of section 152-325(2) of the ITAA 1997.

Persons 1 and 2's CGT retirement exemption limit will be $500,000 each.

You will not be using the indexation method to calculate your capital gain.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 328-125

Income Tax Assessment Act 1997 section 328-130.

Income Tax Assessment Act 1997 section 152-15.

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 115-5

Income Tax Assessment Act 1997 section 102-5.

Income Tax Assessment Act 1997 section 152-40

Reasons for decision

Section 102-20 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that you make a capital gain or loss as a result of a Capital Gains Tax (CGT) event. The most common event is CGT event A1 which happens when a person disposes of a CGT asset to someone else (such as land and/or buildings).

In your case, you intend to dispose of a property purchased after 19 September 1985 and expect to make a capital gain on disposal.

50% Discount

Generally, you can use the discount method to calculate your capital gain if:

• you are an individual, trust or complying superannuation entity

• a CGT event happens to an asset you own,

• the CGT event happened after 21 September 1999,

• you owned the asset for 12 months or more, and

• you did not choose to use the indexation method.

You will be able to reduce your capital gain by 50% only after you have applied all the capital losses for the year and any unapplied net capital losses from earlier years.

In your case, you as trustee for the Trust have owned the building for more than 12 months. The CGT event has not happened before 22 September 1999 and you are not choosing to apply the indexation method, you can use the discount method to calculate the capital gain on the sale of your building. 

CGT small business concessions

CGT small business concessions reduce the capital gain on business assets that you must include in your assessable income.

You must first satisfy the basic conditions that apply to all the CGT concessions for small business. You must then satisfy any additional conditions that apply specifically to the individual concessions.

You can apply as many concessions to which you are entitled until the capital gain is reduced to nil.

Basic conditions

To qualify for any of the small business concessions there are basic conditions that must be satisfied under section 152-10 of the ITAA 1997.

You must first satisfy at least one of the basic conditions. One of these conditions is the maximum net asset value test. The asset must also pass the active asset test.

Maximum net asset value test

There is a limit of $6 million on the net value of the CGT assets that you and certain entities can own and still qualify for the small business CGT concessions. This $6 million limit is called the maximum net asset value test. It is not indexed for inflation.

The 'certain entities' include any entities 'connected with' you, any of your affiliates and entities connected with your affiliates. Under section 152-15 of the ITAA 1997, you satisfy the maximum net asset value test if the total net value of CGT assets owned by certain entities does not exceed $6 million just before the CGT event that results in the capital gain for which the concessions are sought.

When an entity is connected with you

Under section 328-125 of the ITAA 1997, an entity is connected with another entity if:

• either entity controls the other entity, or

• both entities are controlled by the same third entity.

In the case of a trust, an entity controls another entity when it beneficially owns, or has the right to acquire ownership of, equity interests in the company that give it at least 40% of any distribution of income or capital by the other entity. In the case of a company, an entity controls it when it beneficially owns at least 40% of the voting power in the company.

Who is an affiliate?

An affiliate is an individual or company that, in relation to their business affairs, acts or could reasonably be expected to act:

• in accordance with your directions or wishes, or

• in concert with you.

Trusts, partnerships and superannuation funds cannot be your affiliates. However, a trust, partnership or superannuation fund may have an affiliate who is an individual or company.

However, a person is not your affiliate merely because of the nature of a business relationship you and the person share. Similarly, companies and trusts are not affiliates of their directors and trustees respectively, and vice versa, merely because of the positions held.

Whether a person acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes, or in concert with the taxpayer, is a question of fact dependent on all the circumstances of the particular case. No single factor will necessarily be determinative. Relevant factors that may support a finding that a person acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes, or in concert with the taxpayer, include:

• the existence of a close family relationship between the parties

• the lack of any formal agreement or formal relationship between the parties dictating how the parties are to act in relation to each other

• the likelihood that the way the parties act, or could reasonably be expected to act, in relation to each other would be based on the relationship between the parties rather than on formal agreements or legal or fiduciary obligations

• the actions of the parties.

Generally, another business would not be acting in concert with you if they:

• have different employees

• have different business premises

• have separate bank accounts

• do not consult you on business matters

• conduct their business affairs independently in all regards.

In your case, Company 2 beneficially holds the majority of shares in the Company (no other entity holds 40% or more). The majority of shares in Company 2 are held by Persons 1 and 2 (no other entity holds 40% or more). In addition, Person 1 has x times as many votes as the rest of the shareholders in the Company. The trustee of the Trust cannot exercise a discretion/determination without consulting the wishes of the Guardian (Persons 1 and 2) so the Guardian has control of 100% of the distribution. Accordingly, Persons 1 and 2, Company 2, the Company, and the Trust are all connected.

Person 1 is one of only two directors of Company 3 so it would be reasonably expected that this entity would be acting in accordance with the trust's wishes, or in concert with the trust, so it is an affiliate of the trust.

Your CGT assets, those connected with you and/or affiliates just before the CGT event is expected to be $XXX. However, after deducting trade creditors, provisions for various taxes, loans, amounts owed to beneficiaries, the net value of the CGT assets is reduced to $YYY. As you, those connected with you and/or your affiliates own less than $6 million in CGT assets (net value), you satisfy the maximum net asset value test.

Meaning of active asset
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, or

• an intangible asset, for example goodwill, that is inherently connected with a business carried on (whether alone or in partnership) by you, your affiliate, your spouse or child, or another entity that is connected with you.

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 least 7.5 years during the test period.

Taxation Determination TD 2006/63 Income tax: capital gains: is a CGT asset that is leased by a taxpayer to a connected entity for use in the connected entity's business an active asset under section 152-40 of the Income Tax Assessment Act 1997? states that a CGT asset leased by a taxpayer to a connected entity for use in the connected entity's business is an active asset of the taxpayer in situations where the connected entity is wholly using that asset to conduct their business.

In your case, you have owned the property for several years, and the company (who is connected with you) has been wholly using it in the course of carrying on their business. Accordingly, the property will satisfy the active asset test.

As both the maximum net asset value test and the active asset test have been satisfied, the basic conditions for the small business CGT concessions have been met.

Small business 50% reduction

To apply the small business 50% reduction you only need to satisfy the basic conditions.

If you satisfy the basic conditions, the capital gain that remains after applying any current year capital losses and any unapplied prior year net capital losses, and the CGT discount (if applicable), is reduced by 50%.

This means that if you are an individual or a trust and you have applied the CGT discount and the small business 50% reduction, the capital gain (after being reduced by any capital losses applied against it) is effectively reduced by 75% (that is, 50% then 50% of the remainder).

As it has previously been established that you satisfy all the basic conditions the small business 50% reduction can be applied to the gain made on disposal of your property.

Small Business Retirement exemption

You may choose to disregard all or part of a capital gain under the small business retirement exemption if you satisfy certain conditions.

If you are a company or trust these conditions are:

• You satisfy the basic conditions

• You satisfy the significant individual test

• You keep a written record of the amount you choose to disregard (the exempt amount) and each CGT concession stakeholders' percentage

• You make a payment to at least one of your CGT concession stakeholders worked out by reference to each individual's percentage of the exempt amount

• The payment is equal to the exempt amount or the amount of capital proceeds whichever is less; and

• You must make payments by the later of 7 days after you choose to disregard the capital gain and 7 days after you receive the capital proceeds from the CGT event.

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. For a trust, an entity's direct small business percentage (where the entities do not have entitlements to all the income or capital of the trust and the trust makes a distribution of income or capital) is the percentage of either distributions of income that the entity is beneficially entitled to in the income year or distributions of capital that the entity is beneficially entitled to. A company or trust satisfies the significant individual test if it has at least one significant individual just before the CGT event.

The definition of a CGT concession stakeholder of a trust includes a significant individual as defined above.

The significant individual test is not the same as the control tests used to determine if an entity is 'connected with' another entity for the purposes of the $6 million maximum net asset value test or the $2 million aggregated turnover test.

In this case, the significant individual test is satisfied as the trustee will distribute 50% of the capital gain to Persons 1 and 2 in the income year in which the CGT event happens. They will also be CGT concession stakeholders. The remaining conditions listed above will also be satisfied.

Accordingly, you may choose to apply the small business retirement exemption.

CGT Retirement Exemption Limit

The amount of the capital gain that you choose to disregard (that is, the CGT exempt amount) must not exceed your 'CGT retirement exemption limit' or, in the case of a company or trust, the CGT retirement exemption limit of each CGT concession stakeholder receiving a payment.

An individual's lifetime CGT retirement exemption limit is $500,000, reduced by any previous CGT exempt amounts the individual has disregarded under the retirement exemption. This includes amounts disregarded under former (repealed) retirement exemption provisions.

If you choose this exemption, you can disregard the amount of the capital gain you have chosen as the CGT exempt amount.

In your case, Persons 1 and 2 (the CGT concession stakeholders) retirement exemption limit will be $500,000 each. As the trust will be distributing an amount of less than $500,000 to each of them, the assessable capital gain (after applicable discounts, and reductions) can be disregarded.