Edited version of your written advice

Authorisation Number: 1012886040835

Date of advice: 29 September 2015

Ruling

Subject: Small business concessions

Question and answer

Can the distribution of the proceeds of the sale of the building to the family trust be treated as a non-assessable capital gain?

No.

This ruling applies for the following period:

Year ended 30 June 2015

The scheme commences on:

1 July 2014

Relevant facts and circumstances

Unit Trust X and Unit Trust Y were established over 15 years ago.

At the time of establishment of the unit trusts:

• each unit trust had a different corporate trustee; however, the directors of each trustee were the same;

• the unitholders in each unit trust comprised of the same family trusts;

• each family trust had the same equal interest in each unit trust.

Each family trust is a discretionary trust.

Unit Trust X was established for the purpose of acquiring business premises for leasing to Unit Trust Y to operate businesses from.

Unit Trust Y was established to acquire an existing business.

Over 15 years ago, Unit Trust X acquired another commercial building and entered into a commercial lease with Unit Trust Y to establish another business outlet.Some years later, it was decided that the second business was no longer a viable operation and it was closed down. Immediately after the closure, Unit Trust X leased the building to an unrelated entity.

Some years later, the building was sold by the Trustee of Unit Trust X for a capital gain and the Trustee distributed the net proceeds of the disposal to the unitholders, the family trusts.

The net CGT assets of Unit Trust X were less than $6,000,000 just before the sale of the building.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Section 152-10

Income Tax Assessment Act 1997 Section 152-35

Income Tax Assessment Act 1997 Section 152-40

Reasons for decision

The small business capital gains tax (CGT) concessions are contained in Division 152 of the ITAA 1997.

Section 152-10 of the ITAA 1997 contains the basic conditions to be satisfied in order to access the small business concessions. These conditions are:

(a) a CGT event happens in relation to a CGT asset in an income year (apart from CGT event D1);

(b) the event would (apart from Division 152 of the ITAA 1997) 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 in section 152-15 of the ITAA 1997;

(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; or

(iv) the conditions in subsection 152-10(1A) or (1B) of the ITAA 1997 (relating to passively held assets) are satisfied in relation to the CGT asset in the income year; and

(d) the CGT asset [that you own] satisfies the active asset test.

For an entity to be able to meet the basic conditions, it must have owned the CGT asset in question.

In this case, Unit Trust X owned the building which was used by Unit Trust Y in the course of carrying on a business. The building was subsequently sold and the sale resulted in a capital gain.

From the above, it is evident that the relevant family trust does not meet the basic conditions contained in section 152-10 of the ITAA 1997 as it did not own the building. Therefore, it must be determined whether Unit Trust X meets the basic conditions.

From the information provided, Unit Trust X satisfies the first three of the four basic conditions as set out in Section 152-10 of the ITAA 1997 as follows:

(a) CGT event A1 occurred in relation to a CGT asset when the building was sold;

(b) the event would (apart from Division 152 of the ITAA 1997) have resulted in a gain;

(c) Unit Trust X satisfies the maximum net asset value test in section 152-15 of the ITAA 1997.

Therefore, it must now be determined whether the building satisfies the active asset test.

Active asset test

Under section 152-35 of the ITAA 1997, a CGT asset satisfies the active asset test if:

(a) 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 period detailed below, or

(b) you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of 7 years during the period detailed below.

The period begins when you acquired the asset and ends the earlier of:

(a) the CGT event; and

(b) if the relevant business ceased in the 12 months before the CGT event (or such longer time as the Commissioner allows) - when the business ceased.

Under paragraph 152-40(1)(a) of the ITAA 1997, a CGT asset is an 'active asset' if you own the asset and it is used, or held ready for use, in the course of carrying on a business that is carried on by:

• you,

• your affiliate, or

• another entity that is connected with you.

Paragraph 152-40(4)(e) of the ITAA 1997 excludes, among other things, assets whose main use is to derive rent, unless such use was only temporary. Such assets are excluded even if they are used in the course of carrying on a business (for example, a business of renting out properties).

In this case, Unit Trust X owned the building; however, the building was not used in the course of carrying on a business that was carried on by Unit Trust X. Instead, the business was carried on by Unit Trust Y.

Therefore, it must now be determined whether Unit Trust Y is an 'affiliate' of Unit Trust X or is 'connected with' Unit Trust X.

Affiliate

Under section 328-130 of the ITAA 1997, an individual or a company is an affiliate of yours if the individual or company acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the business of the individual or company.

It follows from the definition of affiliate that only a company or an individual can be an affiliate of another entity. The reference to 'a company' in the definition is a reference to a company in its capacity as such, and does not extend to a company acting in the capacity of a trustee. Similarly, the reference to an individual would not include an individual acting in the capacity of a trustee. As such, a trustee cannot be an affiliate of another entity. 

Consequently, the Trustee of Unit Trust Y and the Trustee of Unit Trust X and the trusts themselves cannot be affiliates of each other.

Connected with

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.

An entity (the first entity) controls another entity (other than a company or a discretionary trust) if the first entity, its affiliates, or the first entity together with its affiliates own, or have the right to acquire the ownership of, interests in the other entity that carry between them the right to receive a percentage (the control percentage) that is at least 40% of:

• any distribution of income by the other entity; or

• if the other entity is a partnership - the net income of the partnership; or

• any distribution of capital by the other entity.

In this case, neither Unit Trust Y or Unit Trust X owned or had the right to acquire the ownership of, interests in the other trust that carried between them the right to receive a percentage that was at least 40% of any distribution of income or capital of the other trust.

Therefore, the building cannot be considered to be an 'active asset' under paragraph 152-40(1)(a) of the ITAA 1997 as it was not used in the course of carrying on a business that was carried on by:

• Unit Trust X,

• an affiliate of Unit Trust X, or

• another entity that is connected with Unit Trust X.

Consequently, the basic conditions contained in section 152-10 of the ITAA 1997 have not been satisfied in relation to Unit Trust X and the building.

Therefore, the small business concessions are not available in regard to the sale of the building and the distribution of the proceeds of the sale of the building to the family trust cannot be treated as a non-assessable capital gain.