Edited version of your written advice

Authorisation Number: 1012912084570

Date of advice: 13 November 2015

Ruling

Subject: Capital gains tax: sale of shares - bare trust - am I in Business

Question 1

Is the disposal of the Company A shares by Company B treated under section 106-50 of the Income Tax Assessment Act 1997 (ITAA 1997) as a disposal by the Trust as the Trustee was absolutely entitled to the Company A shares as against Company B?

Answer

Yes.

Question 2

Was Company C as Trustee of the Trust carrying on a business in relation to promoting and organising a sporting event in the relevant income year?

Answer

Yes.

Question 3

Are the small business capital gains tax (CGT) concessions in Division 152 of the ITAA 1997 available to the Trust to reduce the capital gains derived from the sale of the Company A shares on the basis that the Trust is a small business entity?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Company C is the Trustee of the Trust. For the purposes of this ruling we will refer to the Company C as Trustee for the Trust as 'the Trust'.

The Trust is a discretionary trust established by deed of settlement.

The Trust Deed was amended by deed, and Company C became the Trustee of the Trust. The former trustee of the Trust was Company D (formerly Company E).

Person A and their spouse were the sole directors and shareholders of the trustee company, Company E, just before the CGT event.

Person A is also a director of Company C.

The Primary beneficiaries of the Trust were Person A, their spouse and the children and remoter issue of each of them.

You have stated that the Trust was the beneficial owner of a number of Participating Preferred shares (amongst other shares owned) in Company A. Company A owned 100% of the shares in Company F.

The Company A shares were held by Company B.

A number of years ago a Nominee deed was entered into declaring a bare trust arrangement with the Trust being the beneficial owner of the Company A shares.

You have provided a copy of the Nominee Deed which was entered into with the former Trustee of the Trust being Company E. The deed and the Amendments to that deed executed on various dates form part of the facts of this ruling.

Specifically the second amendment to the Nominee Deed executed on a date states that the following shares in Company A form the 'underlying property' referred to in the original deed:

You have provided a list of shareholding which indicates that the above shares underwent a subdivision subsequently which reflected the following changes:

Company B also held other shares in Company A as a bare trustee for other entities. According to documents that you have provided, the shareholding detailed above comprised over 40% of the shares in Company A just prior to the CGT event happening.

You have also provided calculations showing that Company A's active assets made up at least 80% of the company's assets. A provided document forms part of the facts of this case.

In the relevant income year, Company B sold the Participating Preferred shares in Company A to an unrelated company for consideration of an amount giving rise to a capital gain (the Gain).

Carrying on a business

Subsequently, the Trust commenced organising the Event. This name is in the process of being registered as a trade mark. The first Event was held in 20XX and is intended to be an annual event. The first event attracted a number of competitors. The Event made a loss in its first year of operation.

Person A was the creator and original owner of a successful sporting series. It is intended that the Event will be turned into a multi-million dollar annual event similar to that series.

The Event is currently only a single event. You state that the Trust's intention is to establish the Event as a series with international sponsors, a substantial prize pool, and television coverage.

You advise that a business plan was drawn up with respect to the Event which sets out a five year objective to make more than $1 million dollars in profit from the event. You have provided a copy of the business plan.

A separate bank account was set up for the Event and detailed records have been kept as well as relevant business registrations being obtained.

The Trust engaged an experienced co-ordinator to provide management services and ensure compliance with applicable legal requirements such as obtaining relevant licenses.

The Event also attracted sponsorship in the relevant income year from Company A, and 2 other sponsors.

A website and a Facebook presence have been set up for the event. The Event also ran in 20YY.

2 Million Dollar turnover

You have stated that the Trust's income was derived from a single event. You have noted that the event commenced part way through the year and typically you would be required to make a reasonable estimate of what your turnover would have been if it had been carried on for the full year.

You have submitted that as the income for the year was as a result of a single event, it is reasonable to conclude that the turnover for the full year would be equal to the actual turnover for the part year as all income and expenses generated related to a single event.

You have provided the following table in submission of your statement that the turnover of the Trust and its connected entities is less than $2 million dollars:

According to the financial statements you have provided, the total turnover for Company F was in excess of $2 million for the relevant income year. You have noted in relation to the table above that the turnover amount that you have attributed only includes the sale transactions up to and including the date the contract to sell the shares and that after that date the Trust is no longer connected with Company A. Therefore, you have not included the turnover of Company F from the date of sale to 30 June 20XX.

You have further noted that the total turnover for Company F's financial statements only reflects management fees received from its wholly owned subsidiaries.

We note that we have not scrutinised the above amounts that you have provided.

Relevant legislative provisions

Section 6-5 of the Income Tax Assessment Act 1997

Section 106-5 of the Income Tax Assessment Act 1997

Division 115 of the Income Tax Assessment Act 1997

Division 152 of the Income Tax Assessment Act 1997

Subdivision 328 of the Income Tax Assessment Act 1997

Reasons for decision

All legislative references below relate to the ITAA 1997 unless otherwise specified.

Question 1

Summary

The Trust was absolutely entitled to the Company A shares, therefore, section 106-50 will treat the Company A shares as being the assets of the Trust and any act done in relation to the assets by Company B will be treated as if the act had been done by the Trust.

Detailed reasoning

When considering the disposal of a property, the most important element in the application of the CGT provisions is ownership. It must be determined who is the legal owner of the asset.

Ownership conveys an entitlement to exercise the maximum legally permissible rights over what is owned. In the absence of evidence to the contrary, property is considered to be owned by the person(s) registered on the title.  However, in limited circumstances it is possible for legal ownership to differ from beneficial/equitable ownership for taxation purposes. 

Where beneficial ownership and legal ownership of an asset are not the same, there must be evidence that the legal owner holds the property on trust for the beneficial owner.

When is a beneficiary, absolutely entitled to a CGT asset?

It is considered that a beneficiary is absolutely entitled to a CGT asset of a trust as against the trustee if the beneficiary is:

• absolutely entitled in equity to the asset and thus has a vested, indefeasible and absolute interest in the asset, and

• able to direct how that asset shall be dealt with.

Taxation Ruling TR 2004/D25 sets out the ATO view at paragraph 10:

"The core principle underpinning the concept of absolute entitlement in the CGT provisions is the ability of a beneficiary, who has a vested and indefeasible interest in the entire trust asset, to call for the asset to be transferred to them or to be transferred at their direction. This derives from the rule in Saunders v. Vautier applied in the context of the CGT provisions (see Explanation paragraphs 41 to 50). The relevant test of absolute entitlement is not whether the trust is a bare trust (see Explanation paragraphs 33 to 40). "

Application to your situation

In this situation Company E (the then Trustee of the Trust) entered into an agreement with Company B some years ago. A nominee deed entered into by both parties provided the details of that agreement.

All of the clauses of the nominee deed are consistent with the proposition that the Trust has a vested interest in the relevant shares and was able to direct how those assets should be dealt with. Therefore, the Trust was absolutely entitled to the shares in Company A as against Company B who held the shares as bare trustee.

As Company B held the Company A shares as bare trustee for the Trust who is absolutely entitled to the Company A shares as against Company B, section 106-50 will treat the Company A shares as being the assets of the Trust and any act done in relation to the assets by Company B will be treated as if the act had been done by the Trust.

Accordingly, the Company A shares will be treated as being disposed of by the Trust in the relevant income year and CGT event A1 occurred for the Trust.

As the Trust held the Company A shares (through a bare trustee) for more than 12 months, the Trust is eligible to apply the 50% General discount in Division 115 of the ITAA 1997 to reduce the Gain by 50%.

Question 2

Summary

The Trust carried on a business in relation to promoting and organising an event in the relevant income year.

Detailed reasoning

Section 6-5 provides that a taxpayer's assessable income includes income according to ordinary concepts derived by the taxpayer during an income year. Income according to ordinary concepts includes income derived from a business.

Are you carrying on business?

The question of whether you are carrying on a business is a question of fact and degree. Over the years the courts have developed a series of indicators that assist in establishing if a business exists. These indicators are summarised in Taxation Ruling (TR) 97/11 (Income Tax: am I carrying on a business of primary production?) at paragraph 13.

The relevant indicators of whether you are carrying on a business are:

• whether the activity has a significant commercial purpose or character

• whether the taxpayer has more than just an intention to engage in business

• whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity

• whether there is regularity and repetition of the activity

• whether the activity is of the same kind, and carried on in a similar manner, to that of ordinary trade in that line of business

• whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit

• the size, scale and permanency of the activity, and

• whether the activity is better described as a hobby, a form of recreation or sporting activity.

No one indicator is decisive. The indicators must be considered in combination and as a whole.

Having regard to the indicators contained in TR 97/11 we consider that the Trust carried on a business in relation to promoting and organising an event in the relevant income year. The following factors support this conclusion:

• The activities were carried out in a systematic and organised manner including keeping detailed records, and relevant business registrations being obtained;

• A website, Facebook presence and separate bank account were set up specifically for the Event.

• An expert in event management was engaged to provide management services and to organise the Event.

• The Event attracted sponsorship from a number of parties.

• The Event continued to run in the 20YY year.

• A business plan was drawn up, the trade mark of the Event's name is being registered and a budget/profit projections shows the Event will be profitable in the coming years.

Question 3

Summary

The Trust satisfies the conditions in Division 152 and is able to access the active asset concession.

Detailed reasoning

Was the Trust a small business entity in the relevant income year?

For the Trust to qualify for any of the small business CGT concessions, it must firstly satisfy the basic conditions in section 152-10. One of the basic conditions is whether the Trust was a small business entity for the relevant income year.

Section 328-110 of the ITAA 1997 provides that the Trust is a small business entity if:

• the Trust carried on a business in the relevant income year; and

• either one or both of the following applies:

• the Trust carried on a business in the relevant income year and its aggregated turnover was less than $2 million.

• the Trust's aggregated turnover for the relevant income year is likely to be less than $2 million.

The Trust is also a small business entity for the relevant income year if it's aggregated turnover for that year, worked out at the end of the year, is less than $2 million.

What was the Trust's aggregated turnover for the 2013-14 income year?

Meaning of 'aggregated turnover': section 328-115

When working out its aggregated turnover, the Trust is required to take into account:

• its annual turnover for the income year;

• the annual turnover of any entity that is connected with the Trust at any time during the income year, and

• the annual turnover of any entity that is the Trust's affiliate at any time during the income year.

The aggregated turnover amount does not include:

• amounts derived in the income year from dealings between the Trust, its connected entities or affiliates;

• amounts derived in an income year from dealings between its connected entities and/or affiliates;

• amounts derived by a connected entity or affiliate while the entity is not connected with the Trust and is not its affiliate: paragraph 328-115(3)(c).

Meaning of 'annual turnover': section 328-120

An entity's annual turnover for an income year is the total ordinary income that the entity derives in the income year, in the ordinary course of carrying on a business.

Where a business is not carried on for the full income year, the annual turnover must be worked out using a reasonable estimate of what the annual turnover would be if the business had been carried on for the full income year: subsection 328-120(5).

Summary:

Therefore, the Trust's aggregated turnover for the relevant income year consists of:

• its annual turnover of $X;

• the annual turnover of its connected entities, excluding any amounts derived during the period when the entity was not the Trust's connected entity, and

• the annual turnover of its affiliates, excluding any amounts derived during the period when the entity was not the Trust's affiliate.

Who are the entities connected with the Trust?

Meaning of 'connected with': section 328-125

Subsection 328-125(1) provides that an entity is connected with another entity if:

• either entity is controlled by the other entity (paragraph 328-125(1)(a), or

• both entities are controlled by the same third entity (paragraph 328-125(1)(b).

'Entity; is defined in subsection 960-100(1) to include a trust.

Connected with - Direct control of a company

An entity controls a company if the entity, its affiliates or the entity together with its affiliates:

• own, or have the right to acquire ownership of, interests in the company that give the right to receive at least 40% of any distribution of income or capital by the company (paragraph 328-125(2)(a)), or

• own, or have the right to acquire ownership of equity interests in the company with at least 40% of the voting power in the company (paragraph 328-125(2)(b)).

Where the issued shares of a company include shares of which a discretionary dividend can be paid, or shares that carry preferential rights to dividends, an entity can still be found to control the company under paragraph 328-125(2)(a). For example, an entity would control the company if the entity owns at least 40% of the issue shares of each class. However, depending on the share structure, an entity could control a company with different classes of shares even if the entity does not own shares in each class. This will be the case where each class of shares carry the same rights to any income or capital distribution.

Connected with - Direct control of a discretionary trust

In relation to the control of a discretionary trust, there are two methods to determine whether an entity controls a discretionary trust:

• control of a trustee (subsection 328-125(3)) and;

• beneficiary's control percentage of trust distribution (subsection 328-125(4)).

Control of trustee: subsection 328-125(3)

An entity controls a discretionary trust, if the trustee of the trust acts, or could reasonably be expected to act in accordance with the directions or wishes of that entity, or its affiliates, or the entity together with its affiliates.

Beneficiary's control: subsection 328-125(4)

An entity is taken to control a discretionary trust for an income year if, for any of the previous four years:

• the trustee paid any income or capital of the trust to, or for the benefit of, the entity, its affiliates, or the entity and its affiliates, and;

• the percentage of the income or capital paid or applied to the entity and/or its affiliates, is at least 40% of the total amount of income or capital paid or applied by the trustee for that income year.

Connected with - indirect control of an entity

The control tests for the 'connected with' rules are designed to look through business structures that include interposed entities to determine control. The indirect control rules apply to all entities: Explanatory Memorandum to the Tax Laws Amendment (Small Business) Act 2007.

If an entity (the first entity) directly controls a second entity (the interposed entity) and the interposed entity controls (whether directly or indirectly) a third entity, the first entity is taken to control the third entity (subsection 328-125(7). The exception to this test is where the interposed entity is a public entity (subsection 328-125(8)).

The direct control rules in subsection 328-125(2) to 328-125(6) apply to determine whether the first entity controls the interposed entity. Either the direct or indirect control rules can apply to determine whether the interposed entity controls the third entity.

As per Example 2.8 in the Explanatory Memorandum to the Tax Laws Amendment (Small Business) Act 2007, application of the indirect control rules may result in a number of entities being connected to the first entity.

Application of the law - connected entities

Additional entities

As Person A controls the Trust, any other entity controlled by Person A under section 328-125 will be connected with the Trust. This is because both entities are controlled by the same third entity (Person A) and are therefore connected entities under paragraph 328-125(1)(b).

Person A holds numerous directorships and shareholdings -you have stated that the relevant connected entities are:

• The Trust

• Company A

• Company F

• Company G

• Company H

• Company I

• Company J

• Company K

Who are the affiliates of the Trust?

Meaning of 'affiliate': section 328-130

An individual or a company will be an affiliate if they could reasonably be expected to act in accordance with the Trust's directions or wishes, or in concert with the Trust, in relation to the affairs of the business of the individual or company.

Generally, another business would not be acting in concert with the Trust if they have different employees, different business premises, separate bank accounts and do not consult the Trust on business matters.

Although the trustee Company and Company A have a common director (Person A), there is no direct evidence that Company A or any other entity acts in accordance with or in concert with the Trust.

Summary - small business entity test

You have submitted that the annual turnover of the Trust and its connected entities for the relevant income year is as follows:

As the sum of the above annual turnovers is less than $2 million, the Trust is a small business entity for the relevant income year.

Did the CGT asset satisfy the active asset test?

For the Trust to qualify for any of the small business CGT concessions, the CGT asset (Company A shares) must also satisfy the active asset test in section 152-35.

In this case, the active asset test is satisfied if:

• The Trust owned the Company A shares for 15 years or less and the shares were an active asset for a total of at least half the test period;

• The Trust owned the shares for more than 15 years and the shares were an active asset for at least 7.5 years during the test period.

The test period:

• begins when the Trust acquired the asset;

• 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).

Pursuant to subsection 152-40(3), the Company A shares, being shares in an Australian resident company, will be an active asset if the total of the following is 80% or more of the market value of all of the assets of Company A:

• the market values of the active assets of Company A;

• the market value of any financial instruments of Company A that are inherently connected with a business that Company A carries on; and

• any cash of Company A that is inherently connected with such a business.

You have advised that the Company A shares were continuously owned by the Trust (through Company B) for approximately less than 15 years.

You have also provided calculations showing that Company A's active assets made up at least 80% of the company's assets.

Therefore, the shares satisfy the basic conditions for the active asset test.

As the CGT asset was a share in a company, did the Trust satisfy the additional basic conditions in subsection 152-10(2) just before the CGT event?

Where the capital gain is made in respect of a share in a company, the additional basic conditions include the requirement that either:

• the entity claiming the concession must be a CGT concession stakeholder in the company: paragraph 152-10(2)(a), or

• CGT concession stakeholders in the company together have a small business participation percentage in the interposed entity of at least 90% (the 90% test).

An individual is a CGT concession stakeholder of a company or trust if they are a significant individual or a spouse of a significant individual where the spouse has a small business participation percentage (SBPP) in the company or trust at that time that is greater than zero: section 152-60.

An individual is a significant individual in a company or trust if they have a SBPP in the company or trust of at least 20% section 152-55.

Section 152-65 sets out that an entity's SBPP in another entity at a time, is the percentage that is the sum of the entity's direct and indirect small business participation percentage.

An entity's direct SBPP 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 smaller of the three definitions above.

An entity's direct SBPP in a discretionary trust is determined by the percentage of distributions of income or capital that the entity is beneficially entitled to 'during' the year in which the CGT event happens: item 3 of the table in subsection 152-70(1). It should be noted that this includes distributions made on or after 1 June and on or before 30 June of the income year in which the CGT event happens. Therefore, it is immaterial whether a distribution takes place or after the happening of a CGT event within the relevant income year.

The ATO view is that references to distributions of 'income' in this context means the income of the trust, determined according to the general law of trusts, to which a beneficiary could be entitled: ATO Interpretative Decision (ATO ID) 2012/99 Income Tax: Capital gains tax - direct small business participation percentage in a trust - meaning of 'distributions of income' and capital

Where a beneficiary is entitled to different percentages of income and capital distributions the SBPP will be the smallest percentage: item 3 of the table in subsection 152-70(1). This means that if the income and capital is distributed to different beneficiaries then, unless a beneficiary receives the minimum of 20% of both income and capital, there will not be the requisite direct SBPP.

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 in a company or trust.

Application to your situation

As we have determined, based on the facts you have provided, that the Trust is a small business entity, one of the additional basic conditions in subsection 152-10 must also be satisfied.

According to your submission the Trust held more than 40% of all the shares issued in Company A just before the CGT event. The Trust's direct SBPP in Company A was, therefore, more than 40%.

The Trust cannot be a CGT concession stakeholder in Company A because it is not an individual and, therefore, cannot satisfy paragraph 2(a). However, the Trust can satisfy paragraph 2(b) if CGT concession stakeholders in Company A together have a SBPP in the Trust of at least 90%.

You have advised that paragraph 2(b) is satisfied as follows:

• Person A had a SBPP in the Trust of at least 90% - Person A received X% of distributions from the Trust during the relevant income year;

• Person A was a CGT concession stakeholder in Company A as their SBPP in Company A was greater than 20% - Person A's indirect SBPP in Company A was greater than 20%

Person A's SBPP in the Trust

To determine Person A's direct SBPP in the Trust it needs to be determined the percentage of distributions of income and capital that they were beneficially entitled to during the relevant income year: item 3 of the table in subsection 152-70(1).

The income of the Trust is defined in the trust deed as 'any receipt, profit or gain credited to the Income account for accounting purposes and any other receipt, profit or gain that the Trustee determines to include within the income of the trust.

You have stated that the profits of the sale of Company A shares were treated as accounting profits in the Trust's accounts. You have further provided a Trustee minute which shows that Person A received X% of the net income of the Trust in the relevant income year.

Therefore, as Person A was beneficially entitled to X% of the income of the trust their direct SBPP in the Trust by way of resolution made before 30 June 20XX, and the profit on the sale of the Company A was credited to the income account for accounting purposes, it is reasonable to conclude that they has a SBPP in the Trust of at least 90%.

Person A's SBPP in Company A

In order to satisfy the definition of a CGT concession stakeholder in Company A, Person A must have a SBPP in the company of at least 20%.

Person A's SBPP in Company A is calculated as their direct SBPP in the Trust (X% multiplied by the Trust's SBPP in Company A).

You have stated that the Trust has a greater than 40% SBPP in Company A as noted above. Therefore, the Trust satisfies the additional basic condition in paragraph 152-10(2)(b) to apply the small business CGT concessions.

Therefore Person A's SBPP in Company A is greater than 20%. As the percentage is greater than 20%, Person A satisfies the requirements of being a CGT concession stakeholder in Company A.

ATO view documents

Taxation Ruling TR 97/11

Taxation Ruling TR 2004/D25

ATO ID 2012/99

Other references (non ATO view)

Explanatory Memorandum to the Tax Laws Amendment (Small Business) Act 2007