Edited version of your written advice

Authorisation Number: 1012720715708

Ruling

Subject: Capital gains Tax - Small business capital gains tax concession

Question 1

Are the basic conditions in subsection 152-10(1) of the Income Tax Assessment Act 1997 (ITAA1997) satisfied by the trust upon sale of the real property during the 2014/15 financial year?

Answer

Yes

Question 2

Does the 15 year exemption in subsection 152-110 of the ITAA1997 apply to the capital gain derived by the trust upon the real property being sold in the 2014/15 financial year?

Answer

Yes

This ruling applies for the following period:

1 July 2014 - 30 June 2015

The scheme commences on:

1 July 2014

Relevant facts and circumstances

X Pty Ltd as trustee for Trust 1 owns the real property.

The property comprises approximately X acres, all zoned rural.

The Beneficiaries of Trust 1 are outlined in 'The Schedule' and clause 1.1 of the Trust Deed, but broadly include spouses. Trust 2 includes both spouses and other family members.

No additional land has been purchased since.

Trust 1 has continuously owned the property since acquisition.

Trust 1 is considering selling the land in the 2014/15 financial year.

Trust No. 2

The business of primary production has been conducted continuously since 199X by Trust 2 on the property.

There are two full time employees and at other times of the year part time staff and / or contractors are used on the property.

Trust 2 leases the property from Trust 1 and uses it to carry on its primary production business.

The only entity that has an annual turnover (within the meaning of section 328-120 of the ITAA97) for the purposes of s328-110 of ITAA97 is Trust 2.

Trust 2's aggregated turnover under s328-110 for 2013/14 was $X million. If the land is sold by Trust 1, then Trust 2 will also dispose of its business and consequently X and will retire from their full time work in Trust 2.

Relevant legislative provisions

Income Tax Assessment Act 1997, section 104-10

Income Tax Assessment Act 1997, Division 152

Income Tax Assessment Act 1997, section 152-10

Income Tax Assessment Act 1997, section 152-15

Income Tax Assessment Act 1997, section 152-35

Income Tax Assessment Act 1997, section 152-40

Income Tax Assessment Act 1997, section 152-50

Income Tax Assessment Act 1997, section 152-65

Income Tax Assessment Act 1997, section 152-70

Income Tax Assessment Act 1997, section 328-110

Income Tax Assessment Act 1997, section 328-115

Income Tax Assessment Act 1997, section 328-125

Income Tax Assessment Act 1997, section 328-120

Reasons for decision

Basic conditions for small business CGT relief

To qualify for any of the small business CGT concessions the basic conditions contained in section 152-10 of the ITAA 1997, which are common to all the concessions, must be satisfied.

Subsection 152-10(1) of the ITAA 1997 states that:

A capital gain (except a capital gain from CGT event K7) you make may be reduced or disregarded under this Division if the following basic conditions are satisfied for the gain:

(a) a CGT event happened in relation to a CGT asset of yours in an income year;

(b) the event would (apart from this Division) have resulted in the gain;

(c) at least one of the following applies:

(i) you are a small business entity for the income year;

(ii) you satisfy the maximum net asset value test (see section 152-15);

(iii) you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership;

(iv) the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year;

(d) the CGT asset satisfies the active asset test.

The basic conditions, as they apply to your circumstances, will now be considered.

CGT Event that would have resulted in a gain

According to section 104-10 of the ITAA 1997 CGT event A1 happens when you enter into a contract for the disposal of a CGT asset.

The CGT asset in question is the property, the relevant event will be the disposal of the property, which will cause CGT event A1 under section 104-10 of the ITAA 1997 to happen.

Small business entity

You will be a small business entity (in accordance with section 328-110 of the ITAA 1997) if you are an individual, partnership, company or trust that:

• is carrying on a business, and

• has an aggregated turnover of less than $2 million.

Based on the information you have provided you were not carrying on a business, in your own capacity. As such you are not, in your own capacity, a small business entity.

Maximum net asset value test

You satisfy the maximum net asset value test set out in section 152-15 of the ITAA 1997 if the total net value of CGT assets owned by you, any entities connected with you and any affiliates (and entities connected with your affiliates), is less than $6 million, just before the CGT event you wish to disregard occurred.

You have told us that the total net value of your CGT assets prior to the disposal of the property exceeds $6 million which means you do not satisfy the maximum net asset value test.

Passively-held assets (ss 152-10(1A) of the ITAA 1997)

The conditions in s 152-10(1A) of the ITAA 1997 allows access to small business CGT concessions for a CGT asset you own if:

• you do not carry on a business in the income year other than in partnership,

• you carry on a business in partnership, the CGT asset is not an interest in an asset of the partnership,

• your affiliate, or an entity connected with you, is a small business entity for the income year in which the CGT event happens to your asset,

• your affiliate or entity that is connected with you at a time in the income year is the same small business entity that carries on the business and uses the asset at that time, and

You did not carry on a business in the income year other than in partnership,

Your affiliate, or an entity connected with you is a small business entity for the income year in which the CGT event happens to your asset.

'Connected with' is defined in section 328-125 of the ITAA 1997. In the case of a company, ss 328-125(2) specifies that:

An entity (the first entity) controls another entity if the first entity, its affiliates, or the first entity together with its affiliates:

….

(b) …. beneficially own, or have the right to acquire the beneficial ownership of, equity interests in the company that carry between them the right to exercise, or control the exercise of, a percentage (the control percentage) that is at least 40% of the voting power in the company.

You have told us that Trust 2 has distributed 100% of its trust income to Trust 1 during at least one of the last four years.

Trust 2 will be a small business entity if it is carrying on a business and has an aggregated turnover of less than $2 million. Trust 2 has continually conducted a business on the land since 199X.

Aggregate turnover takes its meaning from section 328-115 of the ITAA 1997 as:

• your annual turnover,

• the annual turnover of any entities connected with you, and

• the annual turnover of your affiliates.

Annual turnover is defined in ss 328-120(1) of the ITAA 1997 as:

… the total ordinary income that the entity derives in the income year in the ordinary course of carrying on a business.

When calculating your aggregate turnover, you do not include income from:

• dealings between you and connected entities or affiliates,

• dealings between any of your connected entities or affiliates, or

• any connected entities or affiliates before (or after) they became a connected entity or affiliate.

The relevant years for determining aggregate turnover are:

• your previous years aggregated turnover (ss 328-110 (1)(b)(i) of the ITAA 1997),

• an estimate of your current year aggregated turnover (ss 328-110 (1)(b)(ii) of the ITAA 1997), or

• Your actual current year aggregate turnover (ss 328-110(4) of the ITAA 1997).

You have told us Trust 1's only income is dividend income. This is considered to be passive income, which is excluded under s328-115(3) of ITAA 1997.

The relevant test entity is Trust 2 as it was carrying on the business. In this regard, where the aggregated turnover is less than $2m for the current or previous income year the $2m threshold test will be passed. You have reviewed and performed an analysis of the aggregated turnover for the Trust 2 for the 2014 income year this analysis shows the aggregated turnover under s328-110 for 2013/14 was $X million.

This means that Trust 2, an entity connected with you, is a small business entity because it is carrying on a business and its aggregate turnover is less than $2 million.

The asset meets the active asset test

The active asset test is contained in section 152-35 of the ITAA 1997. The active asset test will be 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 (see 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.

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).

The meaning of the term 'active asset' is found in section 152-40 of the ITAA 1997. Essentially a tangible 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 or another entity connected with you.

Of relevance, subsection 152-40(4)(e) operates to exclude an asset whose main use by you is to derive rent unless its main use for deriving rent was only temporary.

Based on what you have told us, the property has been continuously owned by Trust 1 for more than 15 years

It is accepted that the property is an active asset.

As the property was purchased in 199X it has been held for more than 15 years. As the property is an active asset and has been used the entire time in the business of a connected entity it is accepted that the property would pass the active asset test.

Summary - Basic Conditions for small business CGT relief

In summary, you satisfy the basic conditions for small business CGT relief because:

• CGT event A1 will occur in relation to a CGT asset of yours in the 2014/15 year,

• this event, apart from Division 152 of the ITAA 1997, would have resulted in a capital gain,

• you satisfy the conditions mentioned in subsection 152-10(1A) of the ITAA 1997, and

• your CGT asset will pass the active asset test.

15-year exemption for companies and trusts

Section 152-110 relates to the 15 year exemption and states:

(1)  An entity that is a company or trust can disregard any * capital gain arising from a * CGT event if all of the following conditions are satisfied:

(a)  the basic conditions in Subdivision 152-A are satisfied for the gain;

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

(c)  the entity 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 the entity owned the CGT asset;

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

(i)  was 55 or over at that time and the event happened in connection with the individual's retirement; or

(ii)  was permanently incapacitated at that time.

Basic Conditions for CGT relief

The previous section titled 'Basic conditions for small business CGT relief' explains that the basic conditions for the small business CGT concessions are satisfied in relation to the property.

Continuously owned the CGT asset for the 15-year period

To satisfy this condition you must have continuously owned the CGT asset for the 15-year period ending just before the CGT event.

The property was acquired in 199X. By the time the property is sold, you will have held the property for a continuous period of over 15 years.

Significant individual

The significant individual test in section 152-50 will be satisfied provided the entity had at least one significant individual just before the CGT event. As per section 152-55, an individual is a significant individual in a company or a trust at a time if, at that time, the individual has a small business participation percentage in the company or trust of at least 20%.

Under section 152-65, an entity's small business participation percentage in another entity is the percentage that is the sum of the entity's direct and indirect small business participation percentage in the other entity.

As per item 2 of the table in section 152-70, an individual's direct small business participation percentage in a trust is the percentage that you have from the holding of the legal and equitable interests in the trust, as determined by:

(a) the percentage of any distribution of income that the trustee may make to which the entity would be beneficially entitled; or

(b) the percentage of any distribution of capital that the trustee may make to which the entity would be beneficially entitled.

(c) the percentage of any distribution of capital.

If these amounts are different, the smallest amount is used.

Under subsection 152-75(1), the holding entity's indirect small business participation percentage is calculated by multiplying:

(a) the holding entity's direct small business participation percentage (if any) in another entity (the intermediate entity) at that time; by

(b) the sum of:

(i) the intermediate entity's direct small business participation percentage (if any) in the test entity at that time; and

(ii) the intermediate entity's indirect small business participation percentage (if any) in the test entity at that time (as worked out under one or more other applications of this section).

From historical analysis that you have provided the trust has had a significant individual for the past X years during which the land has been owned by the Trust 1. Therefore, the trust is entitled to the retirement exemption.

Over 55 and in connection with your retirement

Whether a CGT event happens in connection with an individual's retirement depends on the particular circumstances of each case. There would need to be at least a significant reduction in the number of hours the individual works or a significant change in the nature of their present activities to be regarded as retirement.

The Advanced guide to capital gains tax concessions for small business 2011-12 (NAT 3359-06.2012) provides the following example:

A small business operator and spouse are both pharmacists, are both over 55 years old and carry on business through two pharmacies. They sell one (and make a capital gain) and, accordingly, reduce their working hours from 60 hours a week each to 45 and 35 hours a week respectively. There has been some change to their present activities in terms of hours worked and location. But there has not been a significant reduction in the number of hours or a significant change in the nature of their activities and, therefore, there has been no 'retirement'.

If, on the other hand, one spouse reduced their hours to nil (stopped working), there would be a significant reduction in the number of hours that spouse was engaged in the business activities. The sale would, therefore, be in connection with the retirement of that spouse.

You have told us that X will be X years of age when the land and business are sold and they intend to cease all duties from this date. The funds of the sale will be directed to them personally to invest and provide income for their retirement.

It is accepted, based on your circumstances, outlined above, that the sale of the property is in connection with your retirement.

Conclusion

The small business 15-year exemption is addressed at subdivision 152-B. As you satisfy all the basic conditions in subdivision 152-A and you will have continuously owned the property for at least a 15 year period ending just before its disposal, you satisfy the requirements of paragraphs 152-105 (a) and 152-105(b).

Subparagraph 152-105(d)(i) requires that 'you are 55 or over at the time of the CGT event and that the event happens in connection with your retirement'. You have advised us that X will cease all farming duties at the time the property is sold.

Whether a CGT event happens in connection with an individual's retirement depends on the particular circumstances of each case. There would need to be at least a significant reduction in the number of hours the individual works or a significant change in the nature of their present activities to be regarded as a retirement. However, it is not necessary to be a permanent and everlasting retirement from the workforce.

Taking into account the above facts we are satisfied that the disposal of a property will happen in connection with your retirement and that because you are over 55 years you will meet the requirements of subparagraph 152-105(c).

Therefore, you meet all the necessary conditions and all of the capital gain arising from the disposal of the property will be disregarded.

Does Part IVA or any other anti-avoidance provision apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA of the ITAA 1936 applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936.

If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA of the ITAA 1936 may apply.

For more information on Part IVA of the ITAA 1936, go to our website www.ato.gov.au and enter 'part IVA general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.