Edited version of your written advice

Authorisation Number: 1013044119758

Date of advice: 15 July 2016

Ruling

Subject: Capital Gains Tax-Small Business Concessions-15 year exemption

Question 1:

Does the trust satisfy the basic conditions for the small business CGT concessions under section 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

Yes

Question 2:

Is the trust entitled to claim a 15 year exemption under section 152-110 of the ITAA 1997 for any capital gain arising from the sale of XX acres?

Answer:

Yes

This ruling applies for the following periods:

Year ending 30 June 2016

Year ending 30 June 2017

Year ending 30 June 2018

Year ending 30 June 2019

Year ending 30 June 2020

The scheme commenced on:

1 July 2015

Relevant facts

A company is the trustee of the trust.

There are two directors and shareholders of the company who are spouses.

The two directors and shareholders of the company are also beneficiaries of the trust.

A review of Australian Taxation Office records of the trust tax returns lodged on the last 15 years shows a consistent distribution with at least one beneficiary receiving 20% or more of the income of the trust.

Distributions of income from the trust have always only been made to these two beneficiaries.

Both beneficiaries of the trust are over 55.

In 19XX the trust purchased farm land (the property).

In 19XX beneficiaries of the trust formed the partnership which was operated a farming business on the property since 19XX.

The partnership has leased the property from the trust since 19XX.

The partnership is a Small Business Entity (SBE) as its business income is less than $2M per year.

Both beneficiaries of the trust have had 100% control over the day to day running of the trust and the partnership since business operations commenced.

Both beneficiaries of the trust have worked over XX hours per week in the farming business since the business was carried on by the partnership.

The trust intends to apply for approval from the local council to subdivide the property into two separate titles of XX acres and YY acres.

The trust intends to sell the XX acres within the next few years.

The XX acres will be used as farm land by the partnership until it is sold.

After the sale of the XX acres both beneficiaries of the trust will continue to work in the primary production business on the remaining YY acres.

Both beneficiaries of the trust intend to substantially reduce their hours of work in relation to the primary production business on the remaining YY acres.

The sale of the XX acres will result in a capital gain made by trust.

The net capital gain made by the trust from the sale of the XX acres will be distributed to both beneficiaries at 50% each.

In future financial years the trust is expected to distribute all of its income to both beneficiaries of the trust.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Paragraph 108-5(1)(a)

Income Tax Assessment Act 1997 Section 152-10

Income Tax Assessment Act 1997 Subsection 152-10(1A)

Income Tax Assessment Act 1997 Paragraph 152-10(1)(b).

Income Tax Assessment Act 1997 Paragraph 152-10(1)(d).

Income Tax Assessment Act 1997 Subsection 152-10(1B)

Income Tax Assessment Act 1997 Section 152-35.

Income Tax Assessment Act 1997 Paragraph 152-35(1)(a).

Income Tax Assessment Act 1997 Paragraph 152-35(1)(b).

Income Tax Assessment Act 1997 Subparagraph 152-40(1)(a)(ii).

Income Tax Assessment Act 1997 Subparagraph 152-40(1)(a)(iii).

Income Tax Assessment Act 1997 Section 152-55.

Income Tax Assessment Act 1997 Section 152-65.

Income Tax Assessment Act 1997 Section 152-70

Income Tax Assessment Act 1997 Section 152-110

Income Tax Assessment Act 1997 Subsection 152-70(1)

Income Tax Assessment Act 1997 Paragraph 152-70(5)(a)

Income Tax Assessment Act 1997 Paragraph 152-70(5)(b)

Income Tax Assessment Act 1997 Subsection 328-125(1)

Income Tax Assessment Act 1997 Subsection 328-125(3)

Income Tax Assessment Act 1997 Subsection 328-125(4)
Income Tax Assessment Act 1997 Section 328-130

Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision

Summary

The trust will be entitled to disregard any capital gain made on the disposal of the property under the small business 15-year exemption concession. This is because:

• the trust meets the basic conditions under section 152-10 of the ITAA 1997

• the trust has owned the property for more than 15 years

• the trust has had a significant individual for at least 15 years during the period of ownership, and

• the two significant individuals are over 55 years of age and will substantially reduce their hours of work after the CGT event.

Detailed reasoning

Small Business Concessions

Section 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997) contains the basic conditions you must satisfy to be eligible for the small business capital gains tax (CGT) concessions. These conditions are:

(a) a CGT event happens in relation to a CGT asset in an income year.

(b) the event would have resulted in a 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 are satisfied in relation to the CGT asset in the income year.

(d) the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997.

Passively held assets - affiliates and entities connected with you

The conditions in subsection 152-10(1A) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year if:

(a) your affiliate, or an entity that is connected with you, is a small business entity for the income year; and

(b) you do not carry on a business in the income year (other than in partnership); and

(c) if you carry on a business in partnership - the CGT asset is not an interest in an asset of the partnership; and

(d) in any case - the small business entity referred to in paragraph (a) is the entity that, at a time in the income year, carries on the business (as referred to in subparagraph 152-40(1)(a)(ii) or (iii) or paragraph 152-40 (1)(b) in relation to the CGT asset.

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 at least 7.5 years during the test period.

The test period is from when the asset is acquired until the CGT event. If the business ceases within the 12 months before the CGT event (or such longer time as the Commissioner allows) the relevant period is from acquisition until the business ceases.

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.

Connected entities

The term 'connected with' is defined in subsection 995-1(1) of the ITAA 1997 as:

'an entity is connected with you in the circumstances described in section 328-125.'

Subsection 328-125(1) of the ITAA 1997 states that an entity is connected with another entity if:

(a) either entity controls the other entity in a way described in this section, or

(b) both entities are controlled in a way described in this section by the same third entity.

Direct control of a discretionary trust may be established via one of two paths: subsection 328-125(3) or subsection 328-125(4) of the ITAA 1997.

Subsection 328-125(3) of the ITAA 1997 provides that an entity controls a discretionary trust if the trustee of that trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the entity, its affiliates, or the entity together with its affiliates.

Subsection 328-125(4) provides, in part, that an entity directly controls a discretionary trust for an income year if, for any of the preceding four income years, the discretionary trust distributed at least 40% of any income or capital paid for that year to either the entity, its affiliates, or to the entity together with any of its affiliates.

Affiliates

An affiliate is, according to section 328-130 of the ITAA 1997, an individual or a company who 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.

The Advanced guide to capital gains tax concessions for small business (NAT 3359) confirms that an individual or a company can be an affiliate of a trust. However, this will only occur providing that the individual or company acts or could reasonably be expected to act in accordance with the directions or wishes of the trust, or in concert with the trust, in relation to the affairs of the individual's or company's business.

Application to the trust's circumstances

The trust intends selling the XX acres of the property giving rise to CGT event A1 and a gain on the sale.

The property was used in the business of the partnership (which is a small business entity) for the entire period it was owned by the trust. Therefore, the conditions in subsection 152-10(1A) will be met if the partnership was either an entity connected with the trust or an affiliate of the trust.

In this case, the two individuals are partners of the partnership and equally controlled the trustee company as both are directors and equal shareholders. In addition they also have 100% control of the day to day running of the trust (subsection 328-125(3) of the ITAA 1997).

From the information provided, we accept that the partnership and trust are connected entities as they are both controlled by the two individuals who are accepted as being affiliates.

The last basic condition that must be met for the small business CGT concessions is the active asset test. As noted above the XX acres were used in the business of the partnership for the entire period it was owned by the trust.

Accordingly, the basic conditions for the small business CGT concessions have been satisfied.

15-year exemption

Section 152-110 of the ITAA 1997 provides that a trust can disregard any capital gain made on the disposal of an asset if all of the following conditions are satisfied:

(a) you satisfy the basic conditions

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

(c) you had a significant individual for a total of at least 15 years of the whole period of ownership (even if the 15 years was not continuous and it was not always the same significant individual), and

(d) the individual who was a significant individual just before the CGT event was:

• at least 55 years old at that time and the event happened in connection with their retirement, or

• permanently incapacitated at that time.

Section 152-55 of the ITAA 1997 explains that an individual is a significant individual in a trust if the individual has a small business participation percentage in the trust of at least 20%. The 20% can be made up of direct and indirect percentages.

A company or trust satisfies the significant individual test if it had at least one significant individual just before the CGT event. The small business 15-year exemption further requires a company or trust to have a significant individual for periods totalling at least 15 of the years of ownership of the CGT asset.

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

(a) the entity's direct small business participation percentage in the other entity at that time; and

(b) the entity's indirect small business participation percentage in the other entity at that time.

Subsection 152-70(1) of the ITAA 1997 explains that an entity's direct small business participation percentage in a trust, where entities do not have entitlements to all the income and capital of the trust, and the trust makes a distribution of income or capital, is the percentage of:

• distributions of income that the entity is beneficially entitled to during the income year, or

• distributions of capital that the entity is beneficially entitled to during the income year.

In the trust's case, the trust will have continuously owned the land for a period of more than 15 years before the CGT event. The trust has had two significant individuals for a total of at least 15 years during the period the trust has owned the property.

Therefore, as the trust;

• satisfies the basic conditions

• has owned the asset for over 15 years

• has had significant individuals for at least 15 years during the period of ownership, and

• the significant individuals will be over 55 at the time of the event and the event will happen in connection with their retirement

the trust meets all the necessary conditions to be eligible to disregard any capital gain made on disposal of the XX acres under section 152-110 of the ITAA 1997.

Additional information

Subdivision and the active asset test

The effect of registering separate new titles under a subdivision is, for the purposes of the CGT provisions, to divide the land parcel into two or more assets (subdivided blocks). The subdivided blocks are then treated as separate assets. They are taken to have been acquired by the owner of the original land parcel when that original land parcel was acquired.

If an original land parcel is split into two or more blocks, and the trust is the beneficial owner of the original land parcel and each of the new blocks then section 112-25 of the ITAA 1997 provides that each element of the cost base and reduced cost base of the original asset (worked out at the time of the separation) is apportioned in a reasonable way and included in the corresponding element of the cost base and reduced cost base of each new asset.

In the trust's case, as each of the properties is taken to have been acquired by the trust when the trust acquired the original property, the properties are all active assets for the purposes of applying the small business CGT concessions. The cost base and reduced cost base of the new assets should be worked out in the way described above.

Distributions of the exempt amount

Section 152-125 of the ITAA 1997 provides that, if a capital gain made by a trust is disregarded under the small business 15-year exemption, any distribution made by the trust of that exempt amount to a CGT concession stakeholder is not included in the assessable income of the CGT concession stakeholder, and not deductible to the trust, if the following conditions are satisfied:

• the trust makes a payment within two years after the CGT event that resulted in the capital gain or, in appropriate circumstances, such further time as allowed by the Commissioner

• the payment is made to an individual who was a CGT concession stakeholder of the trust just before the CGT event, and

• the total payments made to each CGT concession stakeholder does not exceed an amount determined by multiplying the CGT concession stakeholders control percentage by the exempt amount.