Edited version of your written advice

Authorisation Number: 1013076141968

Date of advice: 29 August 2016

Ruling

Subject: 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 the 15 year exemption under section 152-110 of the ITAA 1997) for any capital gain arising from the transfer of the property?

Answer:

Yes.

This ruling applies for the following period:

Year ending 30 June 20ZZ

The scheme commenced on:

1 July 20YY

Relevant facts

The trust purchased a property more than 15 years ago.

The trust is a discretionary trust.

A company is trustee of the trust.

Person A is the director of the trustee company and has 100% control over the day to day running of the trust.

Person A and B are married and beneficiaries of the trust.

The property was leased by the trust to person A.

Person A has operated a farming business as sole trader on the property from the date the trust acquired the property.

There is no other business entity that is connected with, or an affiliate of, the trustee company, the trust or the beneficiaries of the trust.

The trust will transfer the property to the adult children of persons A and B.

Both persons A and B are over 55 years of age and will significantly reduce the number of hours they work when they transfer the property to their children.

A review of the trust returns for the 20UU-VV to 20WW-XX financial years shows a consistent distribution with at least one individual beneficiary receiving 20% or more of the income of the trust.

For the 20XX-YY financial year the trust distributed its income to persons A and B on a 50/50 basis. The trust will do the same for the 20YY-ZZ financial year.

The net value of the CGT assets held by the trust, its connected entities, its affiliates and entities connected with its affiliates, for the purposes of the maximum net asset value test is under six million dollars.

Relevant legislative provisions

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 transfer 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 just before the CGT event will be over 55 years of age and will retire by significantly reducing their working hours.

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. 

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 either 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 guide to capital gains tax concessions for small business 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 to transfer the property which will trigger a CGT event and a capital gain on the transfer.

The trust meets the maximum net asset value test.

The property is used in the business of person A who has operated a farming business on the property for the entire period it has been owned by the trust.

Person A controls the trustee company as director of the company and has 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 person A and the trust are connected entities.

As the property has been used in the business of a connected entity for the entire period it has been owned by the trust, the active asset test has been met.

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 (even if it was not the same significant individual during the whole period).

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, upon the transfer of the property a capital gain will be made in the CGT event year. Persons A and B will each receive a distribution of 50% of the trust income in the CGT event year and the prior income year. Therefore, each individual will be considered a significant individual of the trust for those years as they will both have a small business participation percentage in the trust of more than 20%.

The trust made distributions of income for the 20UU-VV to 2014-XX financial years to person B and will make a distribution of income to persons A and B in the 20XX-YY and 20YY-ZZ financial years. The trust had a significant individual for a total of at least 15 years during the period the trust has owned the property.

Further, to be eligible for the 15 year small business exemption as stated above, an individual who was a significant individual just before the CGT event must be either over 55 year of age and retiring or permanently incapacitated at the time of the CGT event. 

The guide to capital gains tax concessions for small business states that whether a CGT event happens in connection with an individual's retirement depends on the particular circumstances of each case. There would need to be at least a significant reduction in the number of hours the individual works or a significant change in the nature of their present activities to be regarded as a retirement. However, it is not necessary for there to be a permanent and everlasting retirement from the workforce. 

In this case, based on the information provided persons A and B will be retiring as they will be significantly reducing the number of hours they work.

Therefore, as the trust;

• satisfies the basic conditions

• has owned the asset for over 15 years

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

• the significant individuals are over 55 at the time of the event and will retire

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