Edited version of your written advice

Authorisation Number: 1051372134770

Date of advice: 16 May 2018

Ruling

Subject: CGT- SBC – Active asset test - 15 year concession

Question 1

Does your use of Lot X RP XXXXXX (the property) satisfy the Active Asset test in section 152- 40 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will the basic conditions for the small business capital gains tax (CGT) concessions in section 152-10 of the ITAA 1997 be satisfied when the property is sold?

Answer

Yes

Question 3

Will you be eligible to apply the small business 15 year exemption for an individual under section 152-105 of the ITAA 1997 when the option is exercised and the property is sold?

Answer

Yes

This ruling applies for the following periods:

Income years ending:

30 June 20XX

30 June 20XX

30 June 20XX

30 June 20XX

30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You acquired a 50% ownership interest in the property before 20 September 1985.

You acquired the remaining 50% ownership interest in the property in 19XX.

The size of the property is 32.5 hectares, or 80 acres.

You have used the property to produce income since you first acquired an interest in it.

You carry on a small scale beef cattle primary production business on the property as a sole trader.

You run XX Cows, X Bull and XX young stock on the property. This is the greatest amount of cattle that you consider the property can support.

You sell your cattle at market.

You also carry on a horse agistment activity on the property.

You use approximately 22.5% of the property for horse agistment.

The balance of the land is used for cattle farming.

Your main clientele for the horse agistment is trotter race horse owners from surrounding areas.

The number of horses you have on the property can vary, but you estimate that you would host between 4 and 8 horses at any time.

The horses are accommodated separately to the cattle and areas are divided through the use of electric fences.

You charge $XX per day per horse for agistment.

You undertake the following activities in addition to allowing the horse to be accommodated on your property:

● feeding and watering

● moving horses between paddocks

● checking on the welfare of the horses. In relation to veterinary care, you generally ask the owner of the horse to provide the names of two preferred vets. If an emergency occurs, you would call the vet yourself, however if an animal was merely unwell you would consult with the owner as to what, if any, action they wanted you to take.

● corresponding with the owners of the horses

You make verbal agreements with your clients regarding the length of time the horse will be accommodated.

You do not enter into lease agreements with any of your agistment clients.

You do not grant exclusive possession of the property or any part of it to your clients.

Any access to the property is communicated to you.

You return your agistment income as a component of your primary production income.

You spend 40 or more hours per week on both activities.

Your aggregated turnover from both activities was less than $XX million in the current income year and less than $XX million in previous income years.

You keep accounting records for the activities in a cash book.

You intend to carry on both activities until the sale of the property is settled.

You are over 55 years old and you intend to retire upon the sale of the property.

In 20XX you entered into a put and call option agreement to sell part of the property.

In consideration for granting the call option, you received a call option fee of $XXX,XXX (call option fee).

The total purchase price payable under the agreement is $X,XXX,XXX (inclusive of the call option fee).

The call option expires in 20XX.

The property will be reconfigured to create two lots, known as ‘Lot A’ and ‘Lot B’.

You will retain proposed ‘Lot B’. Lot B will be no more than 2ha in size.

The remaining land, ‘Lot A’ will be purchased by the buyer.

The buyer will obtain approval for the subdivision. The buyer will also erect a boundary fence separating Lot B from Lot A, prior to the settlement date.

The sale for the property is conditional on the completion of a similar contract for the sale of property 2 to the buyer. Property 2 is not the subject of this ruling.

The buyer proposes to subdivide and develop the property after the sale is completed.

No development or subdivision activity or works (other than division into lots ‘A’ and ‘B’) will take place on the property prior to the completion of the sale.

Provision is made in the contract for the lease back of the property after the settlement of sale. You negotiated this lease back arrangement to provide time for you to vacate the property after the exercise of the option agreement.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-40

Income Tax Assessment Act 1997 section 115-25

Income Tax Assessment Act 1997 section 116-65

Income Tax Assessment Act 1997 Subdivision 152 A

Income Tax Assessment Act 1997 Subdivision 152 B

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 152-105

Reasons for decision

Question 1

Does your use of the property satisfy the Active Asset test in section 152- 40 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Summary

Your use of the property in your primary production beef cattle business satisfies the meaning of ‘active asset’ in section 152-40 of the ITAA 1997. Your use of the property for agistment activity does not bring the property under the exclusion for assets which main use is to derive rent.

Detailed reasoning

An asset is an ‘active asset’ if it is owned by you and used or held ready for use in the course of carrying on a business by you, or by your affiliate or another entity that is connected with you.

However, an asset whose main use is to derive rent cannot be an active asset, even if the asset was used in the course of carrying on a business (unless that main use was only temporary).

Whether an asset's main use is to derive rent will depend on the particular circumstances of each case. A key factor in determining whether an occupant of premises is a lessee paying rent is whether the occupier has a right to exclusive possession.

Where premises are leased to a tenant under a lease agreement granting exclusive possession, the payments involved are likely to be rent and the premises will not be an active asset. On the other hand, if the arrangement allows the person only to enter and use the premises for certain purposes and does not amount to a lease granting exclusive possession, the payments involved are unlikely to be rent.

Taxation Determination TD 2006/78 (TD 2006/78) discusses circumstances in which premises used in a business of providing accommodation for reward may satisfy the active asset test, notwithstanding the exclusion of properties deriving rental income.

The term 'rent' has been described as follows:

● the amount payable by a tenant to a landlord for the use of the leased premises;

● a tenant's periodical payment to an owner or landlord for the use of land or premises; 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.

Agistment differs from rent in that it is the act of taking in another’s animals to graze, pasture or feed them on land for payment, with an implied agreement that stock will be redelivered to the owner on demand.

Subject to any specific agreement which amounts in substance to the lease of land between the parties, an agistment arrangement is more in the nature of a licence, and what is received are simply fees and thus are commonly referred to as agistment fees.

Ultimately, whether a payment is in the form of rent or an agistment fee is a question of fact depending on all the circumstances involved. Relevant factors to consider in determining this question (in addition to whether the occupier has a right to exclusive possession) include the degree of control retained by the owner over the land and the extent of any services provided by the owner.

Application to your circumstances

In your case, the land has been used by you in the course of carrying on your beef cattle primary production business from when you first acquired an ownership interest in the property, and will be used for this purpose until the sale of the property is completed.

You have also used the property for the agistment of horses under informal verbal arrangements.

You use approximately 20% of the area of the property for the agistment activity with the balance of the land used in your beef cattle business.

You continue to maintain and use the property for your beef cattle activity concurrently with the agistment usage.

You provide day to day care for the horses accommodated on the property, including water and feed. You may organise veterinary car in the case of an emergency or by agreement with the owner.

You do not enter into lease agreements and you do not grant any right of exclusive possession of the property or any part of it to agistment clients. Any access to the property by the client is communicated to you.

Income from the activity is returned as an element of your primary production income, rather than as rent.

Therefore, we do not consider your agistment activity is in the nature of passive landholding involving the derivation of rent.

Accordingly, the exclusion for assets mainly used to derive rent does not apply and the definition of ‘active asset’ contained in s 152-40 of the ITAA 1997 is satisfied in relation to the property.

Question 2

Will the basic conditions for the small business capital gains tax (CGT) concessions in section 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997) be satisfied when the property is sold?

Answer

Yes

Summary

Each of the basic conditions contained in section 152-10 of the ITAA 1997 will be satisfied when the property is sold, provided you still meet the definition of ‘small business entity’ in that year.

Detailed reasoning

A capital gain that you make may be reduced or disregarded under Division 152 of the ITAA 1997 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 (apart from Division 152 of the ITAA 1997) 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 in section 152-15 of the ITAA 1997

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

(d) the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997.

You must also meet any additional conditions which apply to the particular concession you wish to apply to the gain.

Basic condition (a) a CGT event happens in relation to a CGT asset of yours in an income year.

Capital gain resulting from grant of option

CGT event D2 occurs if you grant an option to an entity. The timing of the event is when you enter into the option.

The capital proceeds for CGT event D2 is any amount you receive, or are entitled to receive under the option agreement. In this case, this will include the option fee.

Any capital gain or loss made from CGT event D2 can be disregarded if the option is later exercised.

If the exercising of the option results in the disposal of an asset (CGT event A1), your capital proceeds for the A1 event will include any payment you received for granting the option.

Accordingly, if the option is exercised by the buyer you can disregard any capital gain from CGT event D2, and include these proceeds in the total proceeds for the sale of the property.

If the tax return for the relevant year has already been lodged, you will need to amend your return to exclude the amount relating to the D2 event.

It should be noted that capital gains which arise in relation to CGT event D2 are not eligible for the 50% CGT discount.

CGT event D2 and the active asset test

ATO ID 2011/45 Income Tax: CGT small business concessions: basic conditions - CGT event happening in relation to a CGT asset - granting an option (ATO ID 2011/45) considers whether the small business CGT concessions can apply to a capital gain made from CGT event D2. The ATO ID states:

The first condition in paragraph 152-10(1)(a) of the ITAA 1997 requires that the CGT event happens in relation to a CGT asset of the taxpayer. The fourth condition in paragraph 152-10(1)(d) of the ITAA 1997 requires that the CGT asset satisfies the active asset test.

With respect to the first condition it is considered the words 'in relation to' in paragraph 152-10(1)(a) of the ITAA 1997 are wide enough to allow reference to an underlying asset such as the land in relation to which the option has been granted. They are also wide enough to allow reference to land in relation to which an option to acquire an easement over the land has been granted.

Therefore, if CGT event D2 happens, that event can be said to happen in relation to a CGT asset of the taxpayer, being the land in relation to which the option has been granted, and accordingly paragraph 152-10(1)(a) of the ITAA 1997 can be satisfied.

ATO ID 2011/45 notes that it is the underlying asset, being the land, that must satisfy the active asset test in paragraph 152-10(1)(d) of the ITAA 1997.

Application to your circumstances

In your case, CGT event D2 occurred in when you granted the option to purchase the property.

CGT event A1 will occur if the option is exercised and the contract for the sale of the property is entered into.

Accordingly, basic condition (a) will be satisfied in relation to both events.

Basic condition (b) the event would (apart from Division 152 of the ITAA 1997) have resulted in the gain

Based on the information you have provided, both CGT event D2 and CGT event A1 will result in a capital gain. Therefore, basic condition (b) will be met.

Basic condition (c) (i) you are a CGT a small business entity for the income year

You are a CGT small business entity in an income year if you are a small business entity for the income year, and you would be a small business entity for the income year if each reference in section 328-110 of the ITAA 1997 to $10 million were a reference to $2 million.

Application to your circumstances

In your case, you have carried on a small scale beef production business on the property since you first acquired an ownership interest in it.

You are not involved in any other ‘active’ income producing activities, and you spend approximately 40 hours per week attending to your cattle business and agistment activities. You run the greatest amount of cattle that you consider the land can support on the property, and the greatest area of the property is given over to this activity.

Your aggregated turnover in the 20XX income year was below the $XX million CGT small business entity aggregated turnover threshold.

Accordingly, you were a small business entity in the 20XX income year when CGT event D2 occurred as a result of granting the option.

You will continue to conduct your primary production business and agistment activities in the same manner until the property is sold.

Conclusion

Provided the primary production business continues until the property is sold, and your income is still below the $XX million CGT small business aggregated turnover threshold in that year, you will be considered a small business entity when the option is exercised and CGT event A1 occurs.

Accordingly, the requirements of basic condition (c)(i) will be met in relation to both CGT events.

Basic condition (d) the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997.

Where you have owned an asset for 15 years or longer, the asset must have been an active asset of yours for a total period of at least 7 ½ years in the time from when you acquired it, until the earlier of when the CGT event occurred, or when the business ceased if it ceased to be carried on in the 12 months before the CGT event occurred (or longer period allowed by the Commissioner).

Application to your circumstances

In your case, you acquired your post CGT interest in 19XX. You have therefore owned the post CGT portion of the property for approximately 25 ½ years.

The two relevant CGT events occurred in 2017 (CGT event D2), and CGT event A1 will occur in 2021.

You have used the property in your cattle farming business continuously since you acquired your pre CGT ownership interest in the property, and intend to continue carrying on the business until the sale of the property is settled. The exclusion for assets mainly used to derive rent does not apply to your circumstances.

Conclusion

Because you have owned the property for a period in excess of 15 years and the property was an active asset for the entire period that you owned it, the active asset test in section 152- 35 of the ITAA 1997 will be met in relation to the property when it is sold.

Conclusion

Each of the basic conditions for CGT small business concessions will be satisfied in relation to the sale of the property.

Question 3

Will you be eligible to apply the small business 15 year exemption for an individual under section 152-105 of the ITAA 1997 when the option is exercised and the property is sold?

Answer

Yes

Summary

You may disregard any capital gain which results from the sale of the property under the 15-year exemption provisions because you have owned the property continuously for a period greater than 15 years prior to the CGT event.

Detailed reasoning

If the basic conditions for small business relief are satisfied, capital gains can be reduced by the various concessions in Division 152 of the ITAA 1997. The 4 available small business concessions are:

● the 15-year exemption in Subdivision 152-B;

● the 50% reduction in Subdivision 152-C;

● the retirement concession in Subdivision 152-D;

● the roll-over in Subdivision 152-E.

Some of these concessions have additional, specific conditions which must be satisfied. A capital gain that qualifies for the 15-year exemption is disregarded in its entirety.

The 15-year exemption

An individual may disregard a capital gain under the 15 year exemption if:

● the basic conditions contained in subdivision 152-A of the ITAA 1997 are satisfied,

● you continuously owned the asset for at least 15 years ending just before the CGT event, and

● either:

● you are at least 55 years old at the time of the CGT event and the event happens in connection with your retirement, or

● you were permanently incapacitated at the time of the CGT event.

Application to your circumstances

In your case, the basic conditions in subdivision 152A of the ITAA 1997 will be met when the property is sold.

You inherited 50% of your ownership interest in the property prior to 1985. You inherited the other 50% ownership interest in the property in 19XX.

You will have owned the post CGT interest in the property for longer than the required 15 year period ending just before the CGT event occurs.

You are over 55 years of age, and you intend to retire upon the completion of the sale. While CGT event D2 has occurred prior to your retirement, the event is inherently related to the sale of the property.

When the property is sold, CGT event A1 will occur and you will be entitled to include the proceeds of CGT event D2 with the total proceeds of the sale. As the disposal of the property in its entirety is connected with your retirement, the condition will be satisfied when the property is sold.

Conclusion

The specific conditions relevant to the 15 year exemption will be met when the option is exercised and the property is sold.