Edited version of your written advice

Authorisation Number: 1012839641242

Date of advice: 14 July 2015

Ruling

Subject: Capital Gains Tax

Question 1

Is the coy eligible for the 50% active asset reduction in relation to the disposal of the property?

Answer

Yes.

Question 2

Is the coy eligible for the 15 year exemption in relation to the disposal of the property?

Answer

No.

Question 3

Is the coy eligible for the retirement exemption in relation to the disposal of the property?

Answer

Yes.

This ruling applies for the following period

30 June 2015

The scheme commences on

1 July 2014

Relevant facts and circumstances

The net value of the assets of the coy and its affiliates and connected entities is less than $6million.

The property was purchased on the XXXX and sold in the 2015 financial year.

The property was sold for approximately $X.

The property was used by the coy to operate a business from the XXXX to the XXXX.

A managed the business for the full period.

The business was sold and the property was leased to unrelated entities from the XXXX until the XXXX.

A and B each hold 50% shareholding of the coy.

There has been no change in the shareholdings since inception.

Both Shareholders are over the age of 55.

A retired when the business was sold in XXXX.

B retired approximately 12 months before the business was sold.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 subdivision 152-C

Income Tax Assessment Act 1997 section 152-15

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 subsection 152-10(1)

Income Tax Assessment Act 1997 subparagraph 152-35(2)(b)(ii)

Income Tax Assessment Act 1997 section 152-220

Income Tax Assessment Act 1997 section 152-110

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

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

Income Tax Assessment Act 1997 subdivision 152-D

Income Tax Assessment Act 1997 section 152-315

Income Tax Assessment Act 1997 section 152-325

Income Tax Assessment Act 1997 section 152-60

Income Tax Assessment Act 1997 section 152-55

Reasons for decision

Detailed reasoning

In order to be eligible for the small business CGT concessions, a number of basic conditions must be satisfied. The basic conditions for the small business CGT concessions are outlined in subsection 152-10(1) of the ITAA 1997:

(a) a CGT event happens in relation to an asset that the taxpayer owns

(b) the event would otherwise have resulted in a capital gain

(c) one or more of the following applies

(i) the taxpayer satisfies the maximum net asset value test

(ii) the taxpayer is a "small business entity" for the income year

(iii) the asset is an interest in an asset of a partnership which is a small business entity for the income year, and the taxpayer is a partner in that partnership, or

(iv) the special conditions for passively held assets in sub-sections 152-10(1A) or 152-10(1B)are satisfied in relation to the CGT asset in the income year, and

(d) the asset satisfies the active asset test.

In this case a CGT event occurred when a contract of sale was entered into. The CGT event will result in a capital gain if the capital proceeds exceed the cost base of the asset. Additionally, the coy will satisfy the maximum net asset value test just before the CGT event.

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 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 (under subparagraph 152-35(2)(b)(ii) of the ITAA 1997 the Commissioner can allow a longer period than 12 months).

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.

In this case, the property was owned by the coy for more than 15 years. The property was an active asset for more than 7.5 years as it was used in the business. Accordingly, the active asset test contained in section 152-35 of the ITAA 1997 is satisfied. Therefore, provided the CGT event results in a gain, the basic conditions in 152-10(1) of the ITAA 1997 will be satisfied.

Active Asset Reduction

The 50% active asset reduction contained in subdivision 152-C of the ITAA 1997 applies automatically to reduce an eligible capital gain if the basic conditions are met. However, in accordance with section 152-220 of the ITAA 1997, a taxpayer can choose not to apply the 50% active asset reduction.

Application to your circumstances

As the coy will meet the basic conditions, the capital gain from the sale of the property that remains after applying any current year capital losses and any unapplied prior year net capital losses will be reduced by 50%. However, the coy can choose not to apply the 50% active asset reduction.

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.

In this case, both A and B retired when the business ceased and the property has been passively leased since that time. Therefore, the CGT event has not happened in connection with their retirement and consequently the 15 year exemption will not apply.

Retirement exemption

The rules covering the small business retirement exemption are contained in Subdivision 152-D of the ITAA 1997. An entity may choose to disregard all or part of a capital gain under the retirement exemption if certain conditions are satisfied.

If the entity is a company, they can choose to disregard all or part of a capital gain where all of the following conditions are met:

• the company satisfies the basic conditions

• the company satisfies the significant individual test (that is, there was at least one significant individual just before the CGT event)

• a written record of the amount disregarded is kept and if there are more than one CGT concession stakeholders, each stakeholder's percent of the exempt amount (one may be nil, but together they must add up to 100%) (section 152-315 of the ITAA 1997)

• a payment is made to at least one of the CGT concession stakeholders worked out by reference to each individual's percentage of the exempt amount (section 152-325 of the ITAA 1997)

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

• where the capital proceeds are received in instalments, a payment is made to a CGT concession stakeholder for each instalment in succession.

The payment to the CGT concession stakeholders must be made by the later of seven days after making the choice or seven days after you receive the capital proceeds from the relevant CGT event.

The amount of the capital gain the company disregards cannot exceed 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.

If a CGT concession stakeholder is under 55 years of age just before a payment is made in relation to them, the company must make the payment by contributing it to a complying superannuation fund or RSA on their behalf. There is no requirement to make this contribution if the stakeholder is 55 years or older.

CGT concession stakeholder

As per section 152-60 of the ITAA 1997 an individual is a CGT concession stakeholder of a company if they are a significant individual or the spouse of a significant individual, where the spouse has a small business participation percentage in the company at that time that is greater than zero.

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 company is the percentage of:

• voting power that the entity is entitled to exercise

• any dividend payment that the entity is entitled to receive

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

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

Application to your circumstances

As discussed, the coy will satisfy the basic conditions in relation to the disposal of the property. Both A and B have a direct small business participation percentage in the coy of 50%. Accordingly, they will both be significant individuals and the significant individual test will be satisfied.

The coy will be eligible to choose the retirement exemption to disregard all or part of the capital gain. However, there are further requirements that must be met after making the choice.

Provided that the coy meets the requirements of section 152-315 of the ITAA 1997 in relation to making the choice and section 152-325 of the ITAA 1997 in relation to making the payments to CGT concession stakeholders, the eligibility requirements for the small business retirement exemption will be met.

Payments to CGT concession stakeholders under the retirement exemption

Where a company or trust makes a choice to disregard all or part of a capital gain under the retirement exemption and the company or trust receives capital proceeds from the relevant CGT event, a payment must be made to one or more of the CGT concession stakeholders in accordance with section 152-325 of the ITAA 1997.

Where a payment is made to a CGT concession stakeholder to comply with section 152-325 of the ITAA 1997, it is not assessable income and not exempt income of the CGT concession stakeholder (subsection 152-310(2) of the ITAA 1997).

Accordingly, if the coy chooses to apply the retirement exemption in accordance with section 152-315 of the ITAA 1997, a non-assessable, non-exempt payment can be made to A and B to comply with section 152-325 of the ITAA 1997 within seven days of making the choice. As A and B will both be over the age of 55, there is no requirement that this amount be made by contributing it to a complying superannuation fund or RSA on their behalf.

The payment must be made by reference to each individual's percentage of the exempt amount.

Further issues for you to consider

Section 152-315 of the ITAA 1997 requires that the choice to apply the retirement exemption is made in writing and that the percentage of the exempt amount attributable to each CGT concession stakeholder is identified in writing. Additionally, the choice must be made in such a way to ensure that the CGT retirement exemption limit of $500,000 for each stakeholder is not exceeded.