Edited version of your written advice

Authorisation Number: 1051310032415

Date of advice: 23 November 2017

Ruling

Subject: Small business capital gains tax concessions

Question 1

Does the Property satisfy the active asset test as defined in section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

In the alternative, does Parcel Y satisfy the active asset test as defined in section 152-35 of the ITAA 1997?

Answer

Yes.

Question 3

Will the disposal of the Property by the Taxpayer satisfy the requirements of section 152-105(d)(i), specifically the ‘in connection with retirement’ requirement, contained under the Small Business 15-year exemption, subdivision 152-B of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 2018.

The scheme commences on:

July 1997.

Relevant facts and circumstances

You own a number of hectares of rural and across a number of titles (the Property).

The Property was gifted to you, after 20 September 1985, in two separate parcels of equal size:

● Parcel Y – acquired more than 15 years ago, but after Parcel Z

● Parcel Z – acquired more than 15 years ago, but before Parcel Y

The titles of these lots remains separate and they have never been amalgamated.

You also own additional land, adjacent to the Property which you acquired before 20 September 1985 with your spouse. This land is not subject to this ruling.

You have no record of the market value of the properties at the date of the transfer; however you have obtained a retrospective value of the Property.

After you acquired the Property, a professional valuer was engaged and provided you with a market value in relation to your acquisition and its current market value.

You will dispose of the property and your Super Fund will purchase the Property from you and finance the acquisition existing cash reserves and further contributions.

You have provided the following details in relation to the income derived from the Property:

Your main residence is located on nearby farming land, which is not subject to this ruling.

The business

You, in partnership, have conducted various business operations for a number of decades before commencing your current agricultural contracting business some years ago.

From the acquisition of Parcel Z for approximately one year, the Property (together with Parcel Y which you leased at the time) was used to carry on a farming business, in addition to the agricultural contracting business.

Currently, you and your spouse operate an agricultural contracting business. The activities of the business include fencing and related services provided to a range of unrelated clients.

The business also undertakes other work including, agricultural tractor work such as ripping the ground in preparation for tree planting, weed control, and agro plough for the deep ripping of paddocks for soil aeration.

The business has been operating for over 15 years.

Generally, business activities have been conducted from buildings located on Parcel Y of the Property, as well as at client’s locations.

The business requires substantial amounts of heavy machinery and equipment to conduct its operations. This machinery and equipment is stored in the sheds located on Parcel Y.

Your work in the business involves visiting customers’ properties, discussing the required work to be completed (such as fencing/ripping) and subsequently preparing quotes when required.

The business purchases the majority of materials in bulk for the purposes of efficiency and to obtain quantity discounts.

In the case of the fencing activities, you source and purchase materials which you deliver to the Property. At the commencement of a job you select the required number of posts and wire which are then delivered to the customer’s property. Using various machinery (as required), you clear the old line of fence and use a post ramming machine mounted to a tractor to put in large concrete strainer posts and “in line” posts.

You then drive in steel posts, using an air driven driver, pull in fence wires and subsequently mount, restrain and clip the cyclone fencing, to ensure the fences are stock proof. All old fence material is cleared from the site to be stored at your property prior to their disposal.

For ripping and weed control work, you use the tractor and heavy duty ripping implement to rip the ground to a specific depth. This work requires a large degree of concentration to ensure you do not impact existing trees/rocks/telephone line/water pipes etc. This task also requires significant strain on your body due to the need to be constantly looking backwards checking the operation of the ripper.

In addition to storing equipment in the sheds, the Property is also used for the following:

● Storage of fencing materials prior to use.

● Temporary storage of used wire and fencing materials prior to being disposed of through a scrap metal dealer and concrete recycler.

The business’ registered place of business is also your main residence.

Your main residence is where records of the business are kept for administration purposes.

Administration and record keeping in relation to the business is undertaken by your spouse at your main residence.

There are no facilities to undertake business functions such as administration and record keeping on the Property.

The Farm Lease

Additionally, around the time of your acquisition of the Property, the partnership entered into a Farm Lease agreement with an unrelated party.

The Farm Lease agreement comprises both the subject Property and a large number of hectares of adjacent land owned by you and your spouse. The adjacent land was acquired prior to 20 September 1985, and is not subject to this ruling.

The Farm Lease agreement provides the following exclusions:

● “The residential dwelling and associated machinery, sheds and workshop comprising a number of hectares or thereabouts, the Lessor or their nominee shall retain the right ingress and egress to excluded land”;

● “The tree shelter belt containing a number of hectares”; and

● “The shearing shed and sheep and cattle yards”.

Despite these exclusions, the parties have agreed that the lessee may use the shearing shed and sheep and cattle yards.

The current lease agreement has informally been renewed every few years since commencement.

The parties have informally agreed that the Partnership is responsible for general repairs and maintenance of the Property.

Following the disposal of the Property, the Farm Lease agreement will be renewed for at least another 12 months.

Residential Lease

The Property includes an old house located on Parcel Y (the dwelling).

One of your relatives previously resided in the dwelling until some years ago, however you did not charge them rent and commenced leasing out the dwelling after they moved out.

There is no formal residential lease agreement in place.

The dwelling is currently leased to an unrelated party.

The dwelling has always been excluded from the Farm Lease agreement.

No business activities were carried out from the dwelling during your ownership period.

Your retirement

You are currently over the age of 55.

Due to your age and medical conditional, you will withdraw from business operations.

You are reducing the number of hours worked in the business, due to your limited ability to carry out manual labour.

You will further reduce your involvement in the business to the point where you only are engaged in non-labour intensive tasks, with very limited hours.

You have generally worked long hours each week in the business, however, due to medical reasons, have scaled back business operations so that you now work significant less hours per week.

You will retire from the heavy fencing work as the lifting of concrete posts and other materials is impacting on your health.

You will also retire from the more difficult ripping work such as on hills and steep slopes and complex sites with multiple hazards as constantly looking backwards is impacting your neck and shoulders resulting in headaches.

This change in the nature of the services that are able to be provided will result in significantly reduced hours of work. Further, there will be a reduced need for the Property to be utilised in carrying on business activities as the use of equipment and materials will also be significantly reduced.

You expect that business operations will be phased out over the next 12 months, and will enter full retirement.

You are not seeking any new customers and have ceased any local advertising.

You meet the maximum net asset value test in section 152-15 of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Section 152-35

Income Tax Assessment Act 1997 Section 152-40

Income Tax Assessment Act 1997 Section 152-105(d)(i)

Reasons for decision

Questions 1 & 2

Summary

The Property (made of Parcel Y and Parcel Z together) does not satisfy the active asset test, however Parcel Y satisfies the active asset test on its own. Parcel Y and Parcel Z are separate CGT assets.

Detailed reasoning

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.

Paragraph 152-40(4)(e) of the ITAA 1997 states, however, that an asset whose main use in the course of carrying on the business is to derive rent cannot be an active asset unless the main use for deriving rent was only temporary.

Mixed use of a property

Taxation Determination TD 2006/78 Income tax: capital gains: are there any circumstances in which the premises used in a business of providing accommodation for reward may satisfy the active asset test in section 152-35 of the Income Tax Assessment Act 1997 notwithstanding the exclusion in paragraph 152-40(4)(e) of the Income Tax Assessment Act 1997 for assets whose main use is to derive rent? considers the active asset test and the main use to derive rent concept. Paragraph 26 of Taxation Determination TD 2006/78 states that:

If an asset is used partly for business and partly to derive rent at any given time, it will be a question of fact depended on all the circumstances as to whether the main use of the asset at that time is to derive rent. No on single factor will necessarily be determinative, and resolving the matter is likely to involve a consideration of a range of factors such as:

● the comparative areas of use of the premises (between deriving rent and other uses); and

● the comparative levels of income derived from the different uses of the asset.

Example 5 considers mixed use of a property:

Mick owns land on which there are a number of industrial sheds. He uses one she (45% of the land by area) to conduct a motor cycle repair business. He leases the other sheds (55% of the land by area) to unrelated third parties. The income derived from the motor cycle repair business is 80% of the total income (business plus rentals) derives from the use of the land and buildings.

In determining if the main use of the land is to derive rent, it is appropriate to consider a range of factors. In this case, a substantial (although nevertheless not a majority) proportion by area of the land is used for business purposes. As well, the business proportion of the land derives the vast majority (80%) of the total income. In all the circumstances, the Tax Office considers the main use of the land in this case is not to derive rent and accordingly the land is not excluded from being an active asset by paragraph 152-40(4)(e) of the ITAA 1997.

Application to your situation

The Property (Parcel Y and Parcel Z)

In this situation, it accepted that Parcel Z of the Property was an active asset for the period starting from the acquisition to approximately one year later, during which period the Property was used to carry in your farming business. However following, the commencement of the Farm Lease agreement, it would be reasonable conclude that Parcel Z has been used mainly (or solely) to derive rental income. As there have been no business activities carried out at Parcel Z since, it will not be considered to be an active asset.

Therefore, the entire Property (Parcel Y and Parcel Z together) will not be considered to be an active asset. Business activities are generally carried out from Parcel Y, which is a separate CGT asset from Parcel Z.

Parcel Y

It is considered that the use of Parcel Y in the business is necessary in the course of carrying on the business in partnership, and is distinguished from incidental use where a property may be used as convenient place to store materials and would therefore be considered that it is not used or held ready for use in carrying on a business.

The income received from the business activities carried out by the partnership on Parcel Y has been significantly higher than the passive income received from the Farm Lease attributable to Parcel Y and rent from the residential dwelling on Parcel Y. Most recently, income from the business has accounted for more than 80% of income the total income of the Property (almost all of the income attributable to Parcel Y).

Therefore, Parcel Y will satisfy the active asset test as you have owned Parcel Y for more than 15 years, during which it has been used in the course of carrying on your business in partnership. It is not considered that the main use of Parcel Y has been to derive rent.

Question 3

Summary

The disposal is considered to be in connection with your retirement, therefore the requirements in section 152-105(d)(i) of the ITAA 1997 will be met. You will not be eligible to apply to the 15 year exemption to the entire Property as the whole property is not an active asset. As Parcel Y is active asset, you can apply the 15 year exemption, provided you meet all other relevant conditions.

Detailed reasoning

15 year exemption

Section 152-105 of the ITAA 1997 provides that an individual 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) if the CGT asset is a share in a company or an interest in a trust, that company or trust must have had a significant individual for periods totalling at least 15 years during the entire time you owned the share or interest, even if it was not the same significant individual during the whole period; and

(d) you were either:

(i) at least 55 years old at that time and the event happened in connection with your retirement, or

(ii) permanently incapacitated at that time.

In connection with your retirement

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 the very least a significant reduction in the number of hours worked, or a significant change in the nature of their present activities to be regarded as retirement. However, it is not necessary for there to be a permanent and everlasting retirement from the workforce.

Furthermore, a CGT event may be ‘in connection with your retirement’ even if it occurs at some time before retirement. Whether a particular case will satisfy the conditions depends very much on the facts of each case.

Application to your situation

In your case, there is a significant reduction in the number of hours worked, prior to the CGT event and following the CGT event. The significant reduction in hours indicates a desire to undertake a transition into retirement. The nature of the work you carry out will also change and will continue to change so that you no longer conduct labour intensive tasks in the business. Therefore, it is reasonable to conclude that the CGT event will happen ‘in connection with’ your retirement. You can apply the 15 year exemption in relation to Parcel Y, provided all other relevant conditions are met.

Further issues for you to consider

This ruling has not fully considered your eligibility for the small business CGT concessions. You should ensure that you satisfy the relevant conditions for the concessions, including the basic conditions. More information is available in the publication Capital gains tax concessions for small business, which is available on our website www.ato.gov.au.