Edited version of your written advice

Authorisation Number: 1013101292225

Date of advice: 18 October 2016

Ruling

Subject: CGT consequences upon the sale of the property

You had different ownership interests in the property which have been divided into item numbers for clarity. The ownership interests covered by the item numbers can be found in the facts.

Issue 1: Main residence exemption

Question 1

Are you entitled to a partial main residence exemption in relation to the lot on which the dwelling was located?

Answer

Yes.

Issue 2: Portion of the property not eligible for the main residence exemption

References in the questions below to items 1 to 4 are in relation to the portion of those items that not eligible for the main residence exemption.

Question 1

Will the capital gain on the disposal of the property in relation to item 1 be disregarded on the basis of it being acquired prior to 19XX?

Answer

Yes.

Question 2

Can you choose to disregard a capital gain made from the disposal of the property in relation to item 2 under the Small Business 15 year Exemption provided in Subdivision 152-B of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 3

Are you entitled to a discount capital gain under Division 115 of the ITAA 1997 in relation to item 3 upon the sale of the property?

Answer

No.

Question 4

Are you entitled to a discount capital gain under Division 115 of the ITAA 1997 in relation to item 4 upon the sale of the property?

Answer

Yes.

Question 5

Are you entitled to the Small Business 15 year Exemption under Subdivision 152-B of the ITAA 1997 in relation to items 3 and 4 upon the sale of the property?

Answer

No.

Question 6

Are you entitled to the Small Business 50% Reduction under Subdivision 152-C of the ITAA 1997 in relation to items 3 and 4 upon the sale of the property?

Answer

Yes.

Question 7

Are you entitled to the Small Business Retirement Exemption under Subdivision 152-D of the ITAA 1997 in relation to items 3 and 4 upon the sale of the property?

Answer

Yes.

Question 8

Is the first element of the cost base for items 3 and 4, the market value of the item on the day party 2 passed away?

Answer

Yes, for item 3; No for item 4. The first element of your cost base for item 4 is its cost base for party 2 when they passed away. The first element of party 2's cost base for item 4 would be the market value of item 4 on the day party 1 passed away.

This ruling applies for the following period

Year ended 30 June 20ZZ

The scheme commenced on

1 July 20YY

Relevant facts and circumstances

Prior to 19XX a property consisting of multiple lots with a house on one lot (property) was purchased by you and two others as tenants in common. The property was used as a farm.

The other two owners never lived on the property but you commenced living there when the property was purchased and you operated a farming business on the property as a sole trader during the entire ownership period.

You lived on the property during the period from 19XX until the property was sold.

One of the two co-owners passed away (19XX) and their share of the property passed equally to the second party and you.

Half of the property was sold several years ago.

The second party passed away recently. Their ownership in the property passed to you.

The remaining property was sold in 20ZZ for $XX.

With the proceeds from the sale of the property you purchased another farm for substantially less than what you sold the previous property for. You will significantly cut down your working hours and in time retire.

You carried on a business in the 20YY-ZZ income year and your aggregated turnover for the 20WW-YY income year was less than $2m.

Neither of the other two parties had any input into how the farm was operated.

You are over 55 years of age.

Ownership

Originally you, party 1 & party 2 each owned a third of the total property.

When party 1 died, you and party 2 received half each of the third share owned by party 1. You and party 2 then owned half of the property each.

When party 2 passed away you received the half of the property which was owned by them, giving you full ownership of the property.

Item 1 - your original 1/3 ownership (1/3)

Item 2 - the ½ of party 1's 1/3 ownership which passed to you when they died (1/6)

Item 3 - party 2's 1/3 original ownership which passed to you upon their death (1/3)

Item 4 - the ½ of party 1's 1/3 ownership which passed to party 2 when party 1 died and subsequently passed to you upon party 2's death (1/6))

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Subdivision 115-A

Income Tax Assessment Act 1997 Section 128-10

Income Tax Assessment Act 1997 Subsection 128-15(4)

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 Subdivision 152-B

Income Tax Assessment Act 1997 Subdivision 152-C

Income Tax Assessment Act 1997 Subdivision 152-D

Income Tax Assessment Act 1997 Section 328-110

Reasons for decision

All legislative references are in relation to the Income Tax Assessment Act 1997.

Summary

The capital gains tax outcomes for items 1 to 4 are summarised below:

Item 1 - The capital gain on this portion can be disregarded as it is a pre-CGT asset.

Item 2 - The capital gain on this portion can be disregarded due to the application of a partial main residence exemption and the Small Business 15 year Exemption for the remaining part of item 2 that does not qualify for the main residence exemption.

Item 3 - The first element of your cost base for item 3 is its market value when party 2 passed away. You are entitled to a partial main residence exemption. Any remaining capital gain in relation to item 3 can be reduced by the Small Business 50% Reduction and the Retirement Exemption.

Item 4 - The first element of your cost base for item 4 is its market value when party 1 passed away plus any other amounts that were included in its cost base when it was owned by party 2 (if any). You are entitled to the general 50% discount and the Small Business 50% Reduction in relation to item 4 which means the capital gain can be reduced by 75% (that is, 50% then 50% of the remainder). Any remaining capital gain in relation to item 4 can be reduced by the Small Business Retirement Exemption. It should be noted that there is a $500,000 lifetime limit on the capital gains that can be disregarded under the Small Business Retirement Exemption.

Detailed reasoning

Issue 1: Main residence exemption

A CGT exemption may apply to a main residence including a maximum area of 2 hectares of land, under and adjacent to, the dwelling.

As each of the lots is greater than 2 hectares, it is apparent that an exemption for the dwelling could not apply to the entire lot on which it is situated.

It is also noted that you have separate ownership interests (items 1 to 4) in relation to the lots.

Consequently, the dwelling and the hectares associated with the dwelling would have to be apportioned across items 1 to 4 in relation to the lot on which the dwelling is located. The main residence exemption would apply to your separate ownership interests in that lot as follows:

Item 1 - Any capital gain or loss is already disregarded as you acquired this ownership interest before 19XX. Therefore the portion of the main residence exemption that applies to this ownership interest is of no additional benefit to you.

Item 2 - Under section 118-195 you would be entitled to a partial exemption in relation to the dwelling as the deceased from whom you acquired the ownership interest (party 1) had acquired it themselves before 19XX and you lived in the dwelling from when you acquired the ownership interest (when party 1 passed away) until you disposed of it. You are entitled to the Small Business 15 year Exemption (see the explanation further below) to disregard the remaining capital gain in relation to item 2 that is not exempt under the partial main residence exemption.

Item 3 - Under section 118-195 you would be entitled to a partial exemption in relation to the dwelling as the deceased from whom you acquired the ownership interest (party 2) had acquired it themselves before 19XX and you lived in the dwelling from when you acquired the ownership interest (when party 2 passed away) until you disposed of it.

Item 4 - You are not entitled to an exemption under the general main residence provision section 118-110 as the exclusion under paragraph 118-110(1)(c) for ownership interests that pass to beneficiaries applies. You are also not entitled to an exemption under section 118-195 as unlike with item 3 discussed above, this ownership interest that passed to you from party 2 was not acquired by them before 19XX. Therefore there is no partial main residence exemption that applies in relation to item 4.

Issue 2: Portion of the property not eligible for the main residence exemption

References below to items 1 to 4 are in relation to the portion of those items that not eligible for the main residence exemption.

Question 1

Item 1 - Your share which was purchased pre-19XX

Under section 104-10 CGT event A1 happens if you dispose of a CGT asset. A capital gain or capital loss you make is disregarded if you acquired the asset before 19XX.

In your case you held item 1 since before 19XX. CGT event A1 occurred on the sale of the property but the capital gain on item 1 is disregarded because this ownership interest was acquired by you before 19XX.

Question 2

Item 2 - Your share which was passed to you from party 1 upon their death

CGT Small Business Concessions - Basic conditions

A capital gain you make may be reduced or disregarded if the following basic conditions are satisfied for the gain:

(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) you are a Small Business Entity (SBE)

(d) the CGT asset satisfies the active asset test.

Section 328-110 in part states you are a Small Business Entity (SBE) in the current income year if you carry on a business in the current income year and your aggregated turnover for the previous year was less than $2 million.

A CGT asset satisfies the active asset test if you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of 7.5 years during the period which began when you acquired the asset and ends when the CGT event happened or if you owned the asset for less than 15 years and it was an active asset of yours for a total of at least half of the period from when you acquired the asset to the CGT event.

A CGT asset is an active asset at a time if at that time 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 to you.

In your case a CGT event happened, which resulted in a gain, when you sold the remaining lots. You met the conditions to be a SBE in that you carried on a business in the 20YY-ZZ financial year and your turnover was less than $2 million from the business you conducted in the 20WW-YY income year. You used the property in your primary production business from the time it was originally purchased by you and the two other parties to the day it was sold in 20ZZ. Therefore all your ownership interests in the property (that is, items 1 to 4) were active assets for the whole time they were owned by you and you pass the active asset test. You have therefore met all the basic conditions for relief.

Small Business 15 year Exemption

The main conditions for relief to disregard the capital gain under the Small Business 15 year Exemption are:

1. the basic conditions are met

2. you continuously owned the asset for the 15 year period leading up to the CGT event

3. if the entity is an individual, the individual is permanently incapacitated or the CGT event happens in connection with their retirement.

As previously stated the basic conditions have been met and you continuously owned the half of party 1's share of the property (1/6 total) since their death which is longer than 15 years and the sale of the property is part of your retirement plan. Therefore you are entitled to the Small Business 15 year Exemption for item 2.

Questions 3 and 4

Discount capital gain (Items 3 and 4)

A discount capital gain is a capital gain that meets the requirements under Subdivision 115-A. In part it states that in order to be entitled to the discount capital gain:

• the capital gain must be made by an individual

• the discount capital gain must be made after 21 September 1999

• the discount capital gain must not have indexed cost base; and

• the discount capital gain must be on an asset acquired at least 12 months before.

The rate of the discount percentage is 50% for an Australian resident.

You acquired item 3 upon party 2's death which is within 12 months of the sale date. Therefore, you are not entitled to a discount capital gain in relation to item 3.

You also acquired item 4 upon party 2's death which is within 12 months of the sale date. However, section 115-30 states that for the purposes of working out eligibility for the discount capital gain, a CGT asset that passed to the acquirer as the beneficiary of a deceased estate except one that was a pre-CGT asset of the deceased, is taken to have been acquired when the deceased acquired it. Therefore, as item 4 is a CGT asset that was acquired by you from party 2's estate and they acquired it post 19XX (when party 1 passed away), section 115-30 will apply to deem that for the purposes of the discount capital gain, you acquired it when party 1 passed away. Consequently you are considered to have held item 4 for more than 12 months for the purposes of the discount capital gain.

The special acquisition rule in section 115-30 does not apply to item 3 as the deceased acquired it pre-CGT.

Question 5

Small Business Concessions (Items 3 and 4)

A capital gain you make may be reduced or disregarded if the following basic conditions are satisfied for the gain:

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. you are a Small Business Entity (SBE)

d. the CGT asset satisfies the active asset test.

Under section 152-35 it states in part that a CGT asset satisfies the active asset test 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 period from when you acquired the asset and the CGT event.

In this case a CGT event happened in relation to items 3 and 4 and the CGT event resulted in a capital gain. You are also a SBE. You pass the active asset test as items 3 and 4 were active assets of yours for more than half the period from when you acquired the items to the date of the CGT event. Therefore, you have met all the basic conditions in relation to items 3 and 4.

In order to be entitled to the Small Business 15 year Exemption you must have continuously owned the CGT asset for the 15-year period ending just before the CGT event, be 55 or over at the time of the CGT event and the event happened in connection with your retirement.

In your case you have not owned items 3 and 4 for a 15 year period. Therefore, you are not entitled to Small Business 15 year Exemption for these items.

Question 6

To apply the CGT Small Business 50% Reduction, you only need to satisfy the basic conditions for the CGT Small Business Concessions.

As discussed above at Question 5, you meet the basic conditions with respect to items 3 and 4 so consequently you are entitled to apply the Small Business 50% Reduction to those items.

For item 4, you are also entitled to the general CGT discount of 50%, so for item 4 you can effectively reduce the capital gain by 75% (that is, 50% then 50% of the remainder).

Question 7

An individual can choose to disregard all or part of a capital gain under the Small Business Retirement Exemption if he/she:

• satisfies the basic conditions for the Small Business Concessions;

• keeps a written record of the amount he/she chooses to disregard (the CGT exempt amount); and

• if he/she is under 55 years old just before they choose to use the retirement exemption, he/she makes a personal contribution equal to the exempt amount to a complying superannuation fund or retirement savings account.

There is a lifetime limit of $500,000 for all choices that can be made in respect of an individual under this exemption. You may choose not to apply the concessions under the Small Business Retirement Exemption.

In your case you are an individual, the basic conditions have been met, and you are over 55 years old and therefore not required to make a superannuation contribution in order to be able to choose to disregard all or part of a capital gain under the Small Business Retirement Exemption up to the lifetime limit of $500,000.

Question 8

Paragraph 128-15(4) sets out modifications to the normal cost base rules for assets that pass to you as a beneficiary in an estate. How the rules apply depend in part on whether the deceased from whom the asset passed acquired the asset before 19XX.

For item 3 the first element of its cost base is the market value of item 3 on the day party 2 passed away. This is because they acquired item 3 before 19XX.

For item 4 the first element of its cost base is taken to be party 2's cost base for item 4 when they passed away, that is, you have 'inherited' party 2's cost base for item 4 rather than having it deemed to be the market value when they passed away as with item 3. This is because unlike item 3 they acquired item 4 after 19XX. The first element of party 2's cost base for item 4 would be the market value of item 4 on the day party 1 passed away. Therefore, unless there are other elements that would be included in party 2's cost base for item 4, the first element of your cost base for item 4 is the market value of item 4 when party 1 passed away.