Edited version of your written advice

Authorisation Number: 1012864780541

Date of advice: 24 August 2015

Ruling

Subject: Capital Gains Tax

Question 1

Is the company eligible for the 15 year exemption in relation to the termination of the contracts?

Answer

Yes.

This ruling applies for the following period

Year ended 30 June 2015

Year ended 30 June 2016

The scheme commences on

1 July 2014

Relevant facts and circumstances

The company carried on a business since the company's registration on XXXX.

The company entered into two agreements with A in XXXX.

These contracts were the company's main source of income.

A wished to terminate the contracts and did so pursuant to the Agreement dated XXXX.

The company made a capital gain as a consequence of the termination of the contracts.

B owns all of the shares in the company and has done so for more than 15 years.

C was a director and secretary of the company and a director of B.

B has two different classes of shares.

C holds X one class of share and X of the other shares.

There have not been any other shareholders in B for the 15 year period.

The aggregate turnover of the company and its associates was less than $2 million.

C is over the age of 55.

C is presently employed full time and proposes to retire.

C retired from their positions as director and secretary of the company.

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 the contracts were terminated. The CGT event resulted in a capital gain as the capital proceeds exceeded the cost base of the asset. Additionally, the company is a small business entity for the income year.

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 an intangible asset that is inherently connected with a business carried on by you, your affiliate, your spouse or child, or another entity that is connected with you.

In this case, the contract was in place for more than 15 years. It has been an active asset for more than 7.5 years as it was an intangible asset that is inherently connected with the company's business. Accordingly, the active asset test contained in section 152-35 of the ITAA 1997 is satisfied. Therefore, the basic conditions in 152-10(1) of the ITAA 1997 have be satisfied.

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.

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.

Small business participation percentage

Under section 152-65 of the ITAA 1997 an entity's small business participation percentage in another entity at a time is the percentage that is the sum of:

• the entity's direct small business participation percentage in the other entity at that time, and

• the entity's indirect small business participation percentage in the other entity at that time.

Under subsection 152-70(1) of the ITAA 1997 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, or

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

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

In this case, C has an indirect participation percentage in the company of X%. Accordingly, C is a significant individual and has been so for 15 years. C retired from the positions as director and secretary of the company and intends to retire from their full time job at the end of the year.

Having regard to the full circumstances, the company satisfies the conditions set out in Section 152-110 of the ITAA 1997 and the capital gain from the cancellation of the contracts can be disregarded.