Edited version of your written advice

Authorisation Number: 1051369696418

Date of advice: 15 May 2018

Ruling

Subject: Small Business Concessions

Question 1

Will the sale of the shares satisfy the first basic condition for relief in subsection 152-10(1)(a) of the 1997 Act?

Answer

Yes

Question 2

Will the sale of the shares satisfy the second basic condition for relief in subsection 152-10(1)(b) of the 1997 Act?

Answer

Yes

Question 3

Do you satisfy the third basic condition for relief in subsection 152-10(1)(c) of the 1997 Act?

Answer

Yes

Question 4

Are the shares an active asset within the meaning of section 152-40 of the 1997 Act?

Answer

No

Question 5

Will the sale of the shares satisfy the fourth basic condition for relief in subsection 152-10(1)(d) of the 1997 Act?

Answer

No.

Question 6

Do one of the additional basic conditions for shares in a company or interest in a trust in subsection 152-10(2) of the 1997 Act need to be satisfied for a capital gain that you make on the sale of the shares to be reduced or disregarded pursuant to Division 152?

Answer

Yes.

Question 7

Can you disregard any capital gain arising from the sale of the shares pursuant to the 15-year exemption in subdivision 152-B of the 1997 Act?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 201X

The scheme commences on:

1 July 201X

Relevant facts and circumstances

Company Facts

A public company (Company) limited by shares was incorporate to provide accommodation to members of a certain profession.

To provide accommodation, the company purchased a property.

To be a registered holder of ordinary company shares (shares) you must be a member of the particular profession.

The registered holder of X amount of Shares is entitled to occupy a room in a building owned by the Company referred to as a ‘standard size room’. The registered holder of X amount of Shares is entitled to occupy a room owned by the Company, referred to as a ‘half size room’.

The registered holder of Shares is at all times liable for the payment of maintenance contributions levied by the Company in respect of room which are occupied by the registered holder or for which the registered holder is responsible.

You note the following conditions in regards to the shares;

● a sale of Shares is advertised on the Company’s website as the sale of a specified room

● Shares are only transferable to persons qualified to hold the shares

● the transfer of Shares is subject to the approval of the Company’s directors and

● to transfer Shares, the board of the Company requires a letter from the floor secretary approving the new floor member

In addition to providing accommodation, the Company also provides other services and facilities for registered holders of Shares.

Each floor of the property is operated and managed by a different service company.

Taxpayer Facts

You started your profession in 19XX.

In 19XX, you acquired X amount of shares.

As a registered holder of X amount of Shares, you were entitled to occupy a room referred to as a ‘half size room’. From 19XX, you occupied a half size room in the property and carried on your business.

In 19XX, you acquired X amount of shares. As a registered holder of a total of X amount of shares, you were entitled to occupy a room referred to as a ‘full size room’. From 19XX, you occupied a full size room in the property and carried out your business there.

Rental of room to third party

At the request of other members, in 20XX you entered into the Licence Agreement.

The members of the property requested that you enter into the Licence Agreement for the purpose of providing Individual A with a temporary room in property. The arrangement was intended to be temporary and to terminate when a room became available.

Pursuant to the Licence Agreement:

a. you granted a licence to the rights attached to your Shares in relation to the use of the room to Individual A; the monthly licence fee comprised

a. the monthly interest charged by a loan balance in arrears;

b. the monthly maintenance payments payable in respect of the shares; and

c. GST on the above amounts; and

b. the Licence Agreement provided that you could terminate the Licence Agreement at any time, for any reason, with one month’s notice.

You licenced the rights attached to your Shares to Individual A pursuant to the Licence Agreement from the period of 20XX to 20XX, being approximately X months.

For the period from 20XX to December 20XX, you licenced another room in the premises and carried on the Business from those premises.

Additional Information

You have never received and are not entitled to receive dividends from the Shares.

This is the only business that you carry on. .

In each income tax year between the date of acquisition of your Shares and the current income tax year, the ordinary income from carrying on the Business has been less than $2,000,000.

In the tax year ending 30 June 20XX, it is anticipated that your aggregated turnover will be less than $2,000,000.

You propose to dispose of the Shares in the tax year ending 30 June 20XX to an unrelated third party.

Following the sale of the Shares, you intend to retire from your profession and accordingly the Business will cease.

Prior to terminating the Business and retiring from your profession, following the sale of the Shares, you intend to licence a small room in property from which you will finalise and complete any existing activities of the Business.

You anticipate that you will carry on the Business in this reduced capacity until at least 30 June 20XX. During this time, you will not accept any new work. Once all of the existing matters carried on in the Business are finalised, you will terminate the licence of the room and retire from the Business.

Relevant legislative provisions

Income Tax Assessment Act subsection 104-10(1)

Income Tax Assessment Act subsection 104-10(4)

Income Tax Assessment Act section 108-5

Income Tax Assessment Act section 152-10

Income Tax Assessment Act section 152-35

Income Tax Assessment Act subsection 152-40(3)

Income Tax Assessment Act section 328- 110

Reasons for decision

Question 1

Paragraph 152-10(1)(a) of the ITAA 1997 provides the first basic condition that must be satisfied for a capital gain to be reduced or disregarded under Division 152. It provides:

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

The meaning of the term ‘CGT asset’ is defined in section 108-5 of the ITAA 1997. A CGT asset includes any kind of property. The list of examples of CGT assets in Note 1 to section 108-5 of the ITAA 1997 includes shares in a company.

The meaning of the term ‘CGT event’ is defined in section 995-1 of the ITAA 1997. It states:

"CGT event" means any of the CGT events described in Division 104. A CGT event described by number (for example: CGT event A1) refers to the relevant event in that Division.

CGT event A1 is a CGT event described in Division 104 of the ITAA 1997..

Subsection 104-10(1) of the ITAA 1997 provides that:

(1) CGT event A1 happens if you dispose of a CGT asset.

The term ‘dispose’ for the purpose of CGT event A1 is defined in subsection 104-10(2) of the 1997 Act. A taxpayer disposes of a CGT asset if a change of ownership occurs, whether because of some act or event or by operation of law. However, a change of ownership does not occur if a taxpayer stops being the legal owner of the asset but continues to be its beneficial owner.

Application to your situation

As you are the owner of the shares in the company, and those share are considered a CGT asset which you are proposing to sell the basic condition for relief in paragraph 152-10(1)(a) of the ITAA 1997 is satisfied.

Question 2

Paragraph 152-10(1)(b) of the ITAA 1997provides the second basic condition that must be satisfied for a capital gain to be reduced or disregarded under Division 152. It provides:

(b) the event would (apart from this Division) have resulted in the gain;

Subsection 104-10(4) of the ITAA 1997specifies when a taxpayer makes a capital gain on the occurrence of CGT event A1. A taxpayer makes a capital gain if the capital proceeds from the disposal are more than the asset’s cost base.

Application to your situation

You have advised that the proceeds from the sale are more than the cost base of the asset, therefore the event will result in a capital gain. The second basic condition for the relief in paragraph 152-10(1)(b) of the ITAA 1997 is satisfied.

Question 3

The term ‘CGT small business entity’ is defined in subsection 152-10(1AA) of the ITAA 1997. It provides:

You are a CGT small business entity for an income year if:

(a) you are a small business entity for the income year; and

(b) you would be a small business entity for the income year if each reference in section 328-110 to $10 million were a reference to $2 million.

The term ‘small business entity’ is defined in subsection 328-110 of the ITAA 1997. Broadly, an entity will be a small business entity if:

(a) it carries on a business in the current year; and

(b) it satisfies one of the aggregated turnover tests.

Application to your situation

You have advised that your aggregated turnover for the year ending 30 June 20XX will be less than $2,000,000, based on a reasonable estimate of what your turnover would have been if you carried on the business for the whole income year. Therefore you would be considered a small business entity and section 152-10(1AA) of the ITAA 1997 is satisfied.

Question 4 and 5

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.

Under subsection 152-40(1) of the ITAA 1997 a CGT asset is an active asset (subject to the exclusions) if it is owned and used, or held ready for use, in the course of carrying on a business by you or your small business CGT affiliate or another entity that is connected with you under paragraph 152-40(1)(c) of the ITAA 1997. An active asset may be a tangible asset or an intangible asset.

The following assets cannot be active assets (subsection 152-40(4) of the ITAA 1997):

a) interests in a connected entity (other than those satisfying the 80% test)

b) shares in companies and interests in trusts (other than those satisfying the 80% test)

c) shares in widely held companies unless they are held by a CGT concession stakeholder of the company

d) shares in trusts that are similar to widely held companies unless they are held by a CGT concession stakeholder of the trust or other exceptions for trusts with 20 members or less apply

e) financial instruments, including loans, debentures, bonds, promissory notes, futures contracts, forward contracts, currency swap contracts, rights and options

f) an asset whose main use in the course of carrying on the business is to derive interest, an annuity, rent, royalties or foreign exchange gains. However, such an asset can still be an active asset if it is an intangible asset that has been substantially developed, altered or improved by the taxpayer so that its market value has been substantially enhanced or its main use for deriving rent was only temporary.

Shares

Shares are not active assets unless they satisfy the 80% test in subsection 152-40(3) of the ITAA 1997.

Under subsection 152-40(3) of the ITAA 1997 a ‘share’ is an active asset if:

a) the company is an Australian resident at that time; and

b) the total of:

(i) the market values of the active assets of the company and

(ii) the market value of any financial instruments of the company that are inherently connected with a business that the company carries on and

(iii) any cash of the company that is inherently connected with such a business

is 80% or more of the market value of all assets of the company.

Application to your circumstances

The Commissioner acknowledges that the shares you hold provide you a right to occupy a room in a building; however this does not change the character of the asset. In this case the asset that you are disposing of is a share; the additional test for shares must be satisfied in order for the asset to be considered an active asset.

Under subsection 152-40(3) of the ITAA a share in a company will be considered an active asset if 80% or more of the company’s assets are active. You have advised that the 80% would be passed as that 80% or more of the companies are used in the company’s business therefore you have satisfied the requirements of the active asset test to this point, the next thing to consider is whether the exclusion under paragraph 152-40(4)(f) will apply to prevent the asset being an active asset. The requirements of paragraph 152-40(4)(c) will be addressed under question 6 which explains that as you are not considered to be a CGT concession stakeholder in the company then you are not eligible to apply the small business concessions on the sale of your shares.

Main Use to Derive Rent

Paragraph 152-40(4)(e) of the ITAA 1997 excludes, among other things, assets whose main use is to derive rent (unless such use was only temporary). Such assets are excluded even if they are used in the course of carrying on a business. Of course, if the activities carried on do not amount to the carrying on of a business, it is unnecessary to consider whether the main use of the asset is to derive rent.

22. Whether an asset's main use is to derive rent will depend on the particular circumstances of each case. The term 'rent' has been described as follows:

● the amount payable by a tenant to a landlord for the use of the leased premises ( C.H. Bailey Ltd v. Memorial Enterprises Ltd [1974] 1 All ER 1003 at 1010, United Scientific Holdings Ltd v. Burnley Borough Council [1977] 2 All ER 62 at 76, 86, 93, 99);

● a tenant's periodical payment to an owner or landlord for the use of land or premises ( The Australian Oxford Dictionary , 1999, Oxford University Press, Melbourne); and

● recompense paid by the tenant to the landlord for the exclusive possession of corporeal hereditaments. ....... The modern conception of rent is a payment which a tenant is bound by contract to make to his landlord for the use of the property let (Halsbury's Laws of England 4th Edition Reissue, Butterworths, London 1994, Vol 27(1) 'Landlord and Tenant', paragraph 212).

While the share provides a right to occupy a room in the building, the main use to derive rent test does not need to be considered as the asset in question is a share in a company and not real property. However, the Commissioner agrees that the leasing of the property for a short period of time is temporary in nature and if you had held the property directly we would not consider the property’s use as mainly to derive rent.

Question 6

Subsection 152-10(2) of the 1997 Act includes an additional basic condition that must be satisfied for a capital gain made on shares in a company to be eligible for relief pursuant to Division 152. It provides:

If the CGT asset is a share in a company or an interest in a trust (the object company or trust), one of these additional basic conditions must be satisfied just before the CGT event:

(a) you are a CGT concession stakeholder in the object company or trust; or

(b) CGT concession stakeholders in the object company or trust together have a small business participation percentage in you of at least 90%.

Example: A discretionary trust sells shares in an operating company (the object company). Anna receives 90% of the distributions from the trust, and the trust has a 50% interest in the object company.

An individual is a CGT concession stakeholder of a company or trust if they are a significant individual or the spouse of a significant individual where the spouse has a small business participation percentage in the company or trust at that time that is greater than zero.

This participation percentage can be held directly or indirectly through one or more interposed entities.

An individual is a significant individual in a company or trust if they have a small business participation percentage in the company or trust of at least 20% – this 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.

An entity’s direct small business participation percentage in a company is the percentage of:

● voting power that the entity is entitled to exercise (except for jointly owned shares) or

● any dividend payment that the entity is entitled to receive, or

● any capital distribution that the entity is entitled to receive, or

● if they are different, the smallest of the three percentages above.

All classes of shares (other than redeemable shares) are taken into account in determining an entity’s participation percentage in a company.

Application to your circumstances

You have advised that you do not have the right to receive dividends from the shares that you hold; you also own less than 20% of the shares in the company. Therefore your small business participation percentage in the company is 0% and you are not considered to be a significant individual. Accordingly you do not satisfy the additional conditions set out in subsection 152-10(2) of the ITAA 1997 and you are not entitled to apply the small business concessions.

CGT Concession stakeholder and the active asset test

The active asset test also excludes shares in widely held companies as being active assets unless you are a CGT concession stakeholder. You have advised that there are X shareholders of the company. This means that the company will be considered as a widely held company and it is a requirement that you are a CGT concession stakeholder of this company in order for the shares to be considered an active asset. As stated above you are not considered a CGT concession stakeholder and accordingly the shares are not active assets.

Question 7

You can disregard a capital gain from a CGT event happening to a CGT asset if you:

● satisfy the basic conditions for the small business CGT concessions (the active asset test requires the asset to have been an active asset for at least 7.5 years of the whole period of ownership)

● continuously owned the CGT asset for the 15-year period ending just before the CGT event happened.

If you are an individual you must also meet the following conditions:

● when the CGT event happened you were

● permanently incapacitated, or

● at least 55 years old and the event happened in connection with your retirement

● 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.

As you do not meet the basic conditions for the small business concessions you are unable to disregard the capital gain using the 15 year exemption. Due to this we have not considered whether you would meet the additional criteria for this exemption.