Edited version of your written advice

Authorisation Number: 1013099343984

Date of advice: 26 October 2016

Ruling

Subject: Small business concessions

Question 1

Will section 118-192 apply to the dwelling portion of the property?

Answer

Yes.

Question 2

Would the deceased have been entitled to apply the 15-year exemption to any capital gain made on the disposal of the post CGT interests in the property had they disposed of it just prior to their death?

Answer

Yes.

Question 3

Can the trustee for the deceased estate apply the 15-year exemption to any capital gain made on the disposal of the post CGT interests in the property?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 20YY

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The deceased acquired a property prior to the introduction of CGT.

The property adjoins a large commercial farm containing multiple lots of land. The adjoining land and the commercial farm business were owned by the company.

Since the acquisition of the land, the deceased always held more than 50% of the shares in the company.

The property contains a dam which was used to irrigate the surrounding farms held by the company.

In 198X, the deceased constructed a dwelling on the property which was used as their main residence.

In 198X, the deceased transferred 50% of the property to their spouse.

In 199X, the deceased and their spouse divorced. The property was transferred back to the deceased pursuant to a court order under the Family Law Act 1975.

The dwelling remained the main residence of the deceased until 200X.

The dwelling was then used in the farming business.

The company was liquidated in the year ending 30 June 20ZZ.

The assets of the company were distributed to the deceased as per their shareholdings.

The deceased continued to operate the business as a sole trader.

In 201X the deceased became ill. They continued to perform limited physical work on the farm with the expectation of recovering from their illness.

The deceased became significantly more unwell and decided to formalise the arrangement with the neighbouring farmers.

In 201X the deceased passed away, aged over 55.

The deceased was a small business entity at the time of their death.

The deceased's estate sold the property in less than two years from their death.

Reasons for decision

Capital gains tax (CGT) regime applies to CGT events, that happen to CGT asset that were acquired by a taxpayer after 19 September 1985.

Subsection 108-55(2) of the Income Tax Assessment Act 1997 (ITAA 1997) states that a building or structure constructed on land acquired before 20 September 1985 is taken to be a separate CGT asset from the land if:

● you entered into a contract for the construction contract on or after 20 September 1985, or

● if there is no contract, the construction started on or after 20 September 1985.

Therefore, the dwelling constructed by the deceased is considered to be a separate asset from the pre-CGT acquired land.

Marriage breakdown

Section 126-5 of the ITAA 1997 applies where a CGT event occurs between an individual (the transferor) and their spouse or former spouse (the transferee). Its effect is to roll over any capital gain or capital loss where the event has occurred because of any one of a number of binding financial arrangements outlined in that section.

When the spouse's 50% portion of the property transferred back to the deceased, the deceased was taken to have acquired it at the spouse's cost base. After this transfer, he now has four different interests in the property

Main residence exemption

Section 118-110 of the ITAA 1997 states that you can disregard any capital gain or loss realised on the disposal of a dwelling that was your main residence for your entire ownership period.

A capital gain or loss may only be partially disregarded if the dwelling was not your main residence throughout your entire ownership period, or used for the purpose of producing assessable income.

Home first used to produce income

Under section 118-192 of the ITAA 1997, if you start using your main residence to produce income, there is a special rule that affects the way you calculate your capital gain or capital loss. In working out the amount of capital gain or capital loss, the period before the dwelling is first used to produce income is not taken into account.

In the deceased's case, they will be taken to have acquired the dwelling at the time they first started using it for income producing purposes for its market value.

Question 2 and 3

Death and the small business concessions

When a taxpayer acquires a CGT asset, including acquisition by inheritance, they are potentially liable for tax on any capital gain on that asset when a CGT event subsequently happens to it.

Section 152-80 of the ITAA 1997 allows either the legal personal representative of an estate or the beneficiary to apply the small business CGT concessions in respect of the sale of the deceased's asset in certain circumstances.

Specifically, the following conditions must be met:

● the asset devolves to the legal personal representative or passes to a beneficiary, and

● the deceased would have been able to apply the small business concessions themselves immediately prior to their death, and

● a CGT event happens within 2 years of the deceased's death unless the Commissioner extends the time period in accordance with subsection 152-80(3) of the ITAA 1997.

In this case, when the deceased passed away the assets became part of their deceased estate. We must now consider whether the deceased would have been able to apply the small business concessions to the property just prior to their death.

Basic conditions of the small business concessions

To qualify for the small business CGT concessions, you must satisfy several conditions that are common to all the concessions. These are called the basic conditions. Division 152-C applied the small business 50% active asset reduction provided the basic conditions are satisfied.

A capital gain that you make may be reduced or disregarded under Division 152 if the following basic conditions are satisfied:

(a) a CGT event happens in relation to a CGT asset of yours in an income year;

(b) the event would 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;

(iii) you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an interest in an asset of the partnership;

(iv) the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year;

(d) the CGT asset satisfies the active asset test (see section 152-35).

Active asset test

This test requires the CGT asset to be an active asset for:

● seven and a half years, if owned for more than 15 years, or

● half of the ownership period if owned for 15 years or less (section 152-35).

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, you affiliates, your spouse or child or an entity connected with you.

Connected with - control of a company

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 controls another entity that is a company, if it, its affiliates, or it together with its affiliates beneficially owns, or has the right to acquire the ownership of, equity interests in the company that give at least 40% of the voting power in the company.

In this case we accept the basic conditions have been satisfied.

15 year exemption

Subdivision 152-B of the ITAA 1997 provides a small business 15 year exemption as part of the capital gains tax (CGT) small business relief provisions. If you qualify for the small business 15-year exemption, the capital gain is entirely disregarded and it is unnecessary to apply any other concessions.

If you are an individual, you can disregard any capital gain arising from a CGT event 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) if the CGT asset is a share in a company or an interest in a trust, the company or trust had a significant individual for a total of at least 15 years, and

(d) either:

(i) you are 55 or over at the time of the CGT event and the event happens in connection with your retirement, or

(ii) you are permanently incapacitated at the time of the CGT event.

In this case, the deceased was over 55 years of age and would have qualified for the 15-year exemption. As the property was sold within two years of the deceased's passing, the executors can apply the 15 year exemption to the post-CGT interests in the land and the dwelling.