Edited version of your written advice

Authorisation Number: 1051211283510

Date of advice: 6 April 2017

Ruling

Subject: Capital gains tax

Question 1

Is the taxpayer eligible for a capital gains tax (CGT) discount of 50% in accordance with Division 115 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Does the CGT small business active asset reduction of 50% under Division 152 of the ITAA 1997 apply to 80% of the gains after the CGT discount?

Answer

No, however the small business active asset reduction of 50% will apply to the whole of the capital gain remaining after the CGT discount.

Question 3

Does the CGT small business retirement 'exemption' under Subdivision 152-D of the ITAA 1997, apply to the amount remaining after the CGT small business active asset reduction?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 20ZZ

The scheme commences on:

20YY

Relevant facts and circumstances

The taxpayer and another person formed a partnership (the Partnership), and carried on a business. As partners in the Partnership they purchased a property (the Property).

They used the majority of the property for their business (the Business) and the remaining was rented to another business.

The annual turnover of the Business is more than $2 million.

The Partnership restructured into a company (the Company). Each of the partners owned 50% of the shares of the Company. The Company took over the Business but the Partnership continued to own the property. The Company paid rent to the Partnership for using the property.

The partners had to sell the Property. In 20XX another partnership in which the taxpayer had a 40% interest (the Second Partnership) purchased a new property (the New Property) which is used by the Business.

The Company also increased its share capital in the same year. The taxpayer did not take up the additional shares, the taxpayer's percentage of shareholding decreased to significantly less than 50%.

The partners sold the Property in late 20YY.

At the time of selling the Property the partners still had a mortgage loan.

Other CGT assets of the taxpayer and the Partnership have been provided.

The taxpayer has no other CGT assets apart from the family home and is not involved in the running of any other businesses. The taxpayer is over 55 years of age.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-5,

Income Tax Assessment Act 1997 Division 115,

Income Tax Assessment Act 1997 Division 152,

Income Tax Assessment Act 1997 section 152-10,

Income Tax Assessment Act 1997 section 152-15,

Income Tax Assessment Act 1997 section 152-35,

Income Tax Assessment Act 1997 section 152-40,

Income Tax Assessment Act 1997 Subdivision 152-D,

Income Tax Assessment Act 1997 section 328-125 and

Income Tax Assessment Act 1997 section 328-130.

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Unless otherwise stated, all legislative references are to the Income Tax Assessment Act 1997.

Question 1

Summary

The taxpayer is eligible for a CGT discount of 50% as all of the conditions in Division 115 for the discount are satisfied.

Detailed reasoning

Section 102-5 provides the method of calculating an entity's net capital gain for an income year. The following provides a summary of the steps involved.

Step 1. Reduce the capital gains you made during the income year by the capital losses (if any) you made during the income year.

…

Step 2. Apply any previously unapplied net capital losses from earlier income years to reduce the amounts (if any) remaining after the reduction of capital gains under step 1 (including any capital gains not reduced under that step because the capital losses were less than the total of your capital gains).

…

Step 3. Reduce by the discount percentage each amount of a discount capital gain remaining after step 2 (if any).

…

Step 4. If any of your capital gains (whether or not they are discount capital gains) qualify for any of the small business concessions in Subdivisions 152-C, 152-D and 152-E, apply those concessions to each capital gain as provided for in those Subdivisions.

…

Step 5. Add up the amounts of capital gains (if any) remaining after step 4. The sum is your net capital gain for the income year.

Under Division 115 for a capital gain to be a discount capital gain the following requirements must be satisfied:

● it is made by an individual, a trust or a complying superannuation entity

● a CGT event happens to an asset the entity owns

● the CGT event happened after 11.45am (by legal time in the ACT) on 21 September 1999

● the asset was acquired at least 12 months before the CGT event, and

● the indexation method was not used to calculate the cost base.

For an individual the capital gain is reduced by the discount percentage of 50%. However, the capital gain can only be reduced after all the capital losses for the year and any unapplied net capital losses from earlier years have been applied.

The CGT discount in Division 115 does not require a choice to be made for its application but applies automatically if its conditions are satisfied.

As the taxpayer purchased the Property more than 12 months before the CGT event happened and the other conditions are satisfied for a discount capital gain, the capital gain may be reduced by 50% as outlined in Step 3 of section 102-5.

Question 2

Summary

The CGT small business active asset reduction of 50% applies to the whole of the capital gain remaining after the CGT discount rather than just the 80% of the remaining capital gain.

Detailed reasoning

Section 152-10 contains the basic conditions which the taxpayer must satisfy in order for the small business concessions to apply to the capital gain. They are:

● a CGT event happens in relation to a CGT asset that the taxpayer owns

● the event would otherwise have resulted in a capital gain

● at least one of the following applies:

● the taxpayer satisfies the maximum net asset value test

● the taxpayer is a small business entity for the income year

● the taxpayer is 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, and

● the asset satisfies the active asset test.

The Property was owned by the partners in partnership and the sale of the Property is a CGT event. This event would have resulted in a capital gain apart from the small business relief provisions in Division 152.

As neither the taxpayer nor the Partnership is a small business entity, it is necessary to determine whether the taxpayer passes the maximum net asset value test.

MNAV test

Section 152-15 states that:

You satisfy the maximum net asset value test if, just before the CGT event, the sum of the following amounts does not exceed $6,000,000:

(a) the net value of the CGT assets of yours;

(b) the net value of the CGT assets of any entities connected with you;

(c) the net value of the CGT assets of any affiliates of yours or entities connected with your affiliates (not counting any assets already counted under paragraph (b)).

Under section 328-125 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 if it or its affiliate (or all of them together):

● owns, or has the right to acquire ownership of, interests in the other entity that give the right to receive at least 40% (the control percentage) of any distribution of income or capital by the other entity, or

● if the other entity is a company, owns, or has the right to acquire ownership of, equity interests in the company that give at least 40% of the voting power in the company.

An affiliate is, according to section 328-130, 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 CGT event has happened in relation to a CGT asset of the Partnership and as a partner in a Partnership the maximum net asset value test for the taxpayer would include:

● all the assets of the partnership if the taxpayer is connected with it, and the value of the taxpayer's interest in the partnership is excluded, or

● only the taxpayer's interest in the partnership if the taxpayer is not connected with it, and the assets of the partnership as a whole would not count.

As the Partnership was an entity connected to the taxpayer, the calculation of the MNAV will include all the assets of the Partnership but not the value of the taxpayer's interest in the Partnership. Therefore the value of the Property and other CGT assets of the Partnership are included in the calculation of the MNAV.

Just before the CGT event, the Company was not an entity connected to the taxpayer as the percentage of the taxpayer's shareholding was not sufficient therefore the value of the taxpayer's shares in the Company is included in the calculation of the MNAV.

The taxpayer had no other connected entities and as the taxpayer was not involved in the running of any other businesses had no affiliates.

The value of the taxpayer's CGT assets is below $6,000,000 therefore the taxpayer satisfies the MNAV test.

Active asset test

The active asset test is contained in section 152-35:

152-35(1)

A CGT asset satisfies the active asset test if:

(a) 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 specified in subsection (2); or

(b) 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 7½ years during the period specified in subsection (2).

152-35(2)

The period:

(a) begins when you acquired the asset; and

(b) ends at the earlier of:

(i) the CGT event; and

(ii) if the relevant business ceased to be carried on in the 12 months before the time or any longer period that the Commissioner allows - the cessation of the business.

As is relevant the definition of active asset in section 152-40 provides that:

A CGT asset is an active asset at a time if, at that time:

(a) you own the asset (whether the asset is tangible or intangible) and it is used, or held ready for use, in the course of carrying on a business that is carried on (whether alone or in partnership) by:

(i) you; or

(ii) your affiliate; or

(iii) another entity that is connected with you…

The majority of the Property was used by the Partnership in its business for a number of years and in the same business by the Company for the remaining years.

As the Property was used in a business that carried on by the taxpayer as a partner in the Partnership and then by an entity connected to the taxpayer for more than half of the time it was owned by the taxpayer, it passes the active asset test in section 152-35.

The taxpayer is therefore entitled to further reduce the capital gain on the disposal of the workshop by applying the 50% active asset reduction as outlined in Step 4 of section 102-5.

Question 3

Summary

The CGT small business retirement exemption will apply to the amount remaining after the CGT small business active asset reduction.

Detailed reasoning

The small business retirement exemption may be applied after the CGT discount and the small business 50% active asset reduction have been applied, to the remaining capital gain.

In accordance with Subdivision 152-D an individual can choose to disregard all or part of a capital gain if:

● the small business concessions basic conditions have been satisfied, and

● a written record has been kept of the amount chosen to be disregard (the CGT exempt amount).

The amount of the capital gain that a person chooses to disregard (that is, the CGT exempt amount) must not exceed the individual's CGT retirement exemption limit. An individual's lifetime CGT retirement exemption limit is $500,000, reduced by any previous CGT exempt amounts the individual has disregarded under the retirement exemption. This includes amounts disregarded under former (repealed) retirement exemption provisions.

As discussed above, the taxpayer satisfies the basic conditions and is over 55 years of age. The taxpayer has no previous CGT exempt amounts disregarded under the retirement exemption, therefore will be able to choose to disregard up to $500,000 under the retirement exemption by simply keeping a record of the amount chosen to be disregarded.