Edited version of your written advice

Authorisation Number: 1051376724623

Date of advice: 23 May 2018

Ruling

Subject: Accessing capital gains tax (CGT) small business relief

Question 1

Can the discretionary trust (the X trust) apply the general 50% CGT discount and the small business 50% reduction to its capital gain?

Answer

Yes.

Question 2

Can the X trust apply the small business retirement exemption to its capital gain for both beneficiaries of the trust?

Answer

Yes.

Question 3

What date should the payments to the beneficiaries under the small business retirement exemption be made by?

Answer

The later of:

● seven days from the date of lodgment of the X trust’s income tax return for the income year in which the relevant CGT event happens

● seven days after the X trust receives the next instalment of capital proceeds from the sale of the property.

Question 4

Can the X trust apply the small business rollover to its remaining capital gain?

Answer

Yes.

Question 5

What is the replacement asset period for the X trust to obtain a replacement asset under the small business rollover?

Answer

The replacement asset period will end two years after the last CGT event.

Question 6

When is the X trust’s capital gain required to be reported?

Answer

The capital gain must be reported within a reasonable period after settlement occurs. The X trust, and any relevant beneficiaries, will be required to amend their assessments for the income year in which the contract for the disposal of the property was signed.

Question 7

Will a shortfall interest charge or penalties be imposed on the X trust, and any relevant beneficiaries, should they amend their income tax returns to take account of the capital gain?

Answer

No, provided that the assessments are amended within a reasonable period after settlement; usually one month.

This ruling applies for the following period:

1 July 20XX to 30 June 20XX.

Relevant facts and circumstances

The X trust, a discretionary trust, was established in 20XX. The trustee is a corporate entity, controlled by the primary beneficiaries of the trust. Both beneficiaries are under 55 years of age. The beneficiaries are spouses.

In 20XX, the following entities purchased a property as tenants in common in the respective proportions:

● The X trust – 30%

● The Y trust – 60%

● The Z trust – 10%.

The property was used in the course of a farming business. Originally, the farming business was carried on by each of the landholders in partnership however, from 20XX, only the X trust and the Y trust continued to carry on the farming business in partnership.

The farming business carried on by the X and Y trust partnership had turnover of less than $2 million per annum.

In 20XX, the landholders sold the property for $XX,XXX,XXX. The proceeds are to be paid as follows:

● $ XX,XXX,XXX paid on signing of the contract

● $ XX,XXX,XXX to be paid a year after signing the contract

● $ XX,XXX,XXX to be paid two years after signing the contract

● $ XX,XXX,XXX to be paid two and a half years after signing the contract.

Settlement is to occur two and a half years after signing the contract. The landholders will receive the proceeds of sale in the same proportion as they held the property.

The farming business was carried on the property from the date the property was purchased to the date the contract of sale was entered into.

Both the Y trust and the Z trust independently operate unrelated businesses. The landholders of the property act independently of one another and no landholder is able to influence another in relation to their independent business affairs and dealings. At no time have any of the landholders of the property made distributions of trust income to each other, even though they may come within the class of general beneficiaries of each other given their existing relationship. The X trust does not carry on any other business other than the farming business conducted on the property.

It is anticipated that the beneficiaries of the X trust will each be made presently entitled to more than 20% of the income, and specifically entitled to more than 20% of the capital, of the X trust for the year ended 30 June 20XX.

The beneficiaries have never previously accessed small business CGT relief.

Assumptions

It is assumed that no other entities are connected with, or are affiliates of, both the:

● X trust

● X trust and Y trust partnership.

It is assumed that the beneficiaries will each be made presently entitled to more than 20% of the income, and specifically entitled to more than 20% of the capital, of the X trust for the year ended 30 June 20XX.

Relevant legislative provisions

Income Tax Assessment Act 1997

Reasons for decision

Question 1

Summary

The X trust meets the basic conditions for small business CGT relief. As it meets those conditions, it can apply both the general 50% CGT discount and the small business 50% reduction to its capital gain.

Detailed reasoning

Basic conditions for small business CGT relief

In order to access small business CGT relief, an entity must meet the basic conditions contained in section 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997)¹. All of the basic conditions below must be satisfied:

● A CGT event happens in relation to a CGT asset of yours in an income year.

● The event would, apart from the small business relief, have resulted in a gain.

● At least one of the following applies

● You are a CGT small business entity for the income year

● You satisfy the maximum net asset value test

● You are a partner in a partnership that is a CGT small business entity for the income year and the CGT asset is an asset of the partnership

● Conditions relating to passively held assets are satisfied in relation to the CGT asset in the income year.

● The CGT asset satisfies the active asset test.

The basic conditions will now be considered in relation to the X trust and the sale of the property.

A CGT event happens in relation to a CGT asset of yours in an income year

The sale of the property constitutes CGT event A1, which happens on the disposal of a CGT asset. Subsection 104-10(3) provides that the time of the CGT event is when the contract for the disposal is entered into. Thus, CGT event A1 happened in 20XX.

The event would, apart from the small business relief, have resulted in a gain

The property was sold for $XX,XXX,XXX. The X trust is entitled to 30% of this amount and results in a gain to the X trust.

You are a partner in a partnership that is a CGT small business entity for the income year and the CGT asset is an asset of the partnership

An asset is a partnership asset if the partners own the asset in line with their respective interests in the partnership. The X trust is a partner in a partnership with the Y trust, but the Z trust is also a landholder in the property. So the property is not an asset of the X and Y trust partnership.

However, the X trust is eligible for the small business CGT relief under subsection 152-10(1B) if all the below conditions are met:

● the partnership is a CGT small business entity

● the X trust does not carry on a business in the income year, other than in partnership

● the asset meets the active asset test.

Is the partnership a CGT small business entity?

Subsection 152-10(1AA) provides that a CGT small business entity is one that carries on a business in an income year and has an aggregated turnover of less than $2 million. Section 152-48 provides that the aggregated turnover of a partnership in this case includes the turnover of any entities connected with the X trust, or that are an affiliate of the X trust, at any time during the income year.

Section 328-125 provides that an entity is connected with another entity if:

● either entity controls the other entity

● both entities are controlled by the same third entity.

Section 328-130 provides that an affiliate is an individual or company that, in relation to their business affairs, acts or could reasonably be expected to act:

● in accordance with your directions or wishes

● in concert with you.

Both the Y trust and the Z trust independently operate unrelated businesses. The landholders of the property act independently of one another and no landholder is able to influence another in relation to their independent business affairs and dealings. At no time have any of the landholders of the property made distributions of trust income to each other. It is assumed that no other entities are connected with, or are affiliates of, the X trust or the X trust and Y trust partnership.

The X trust does not carry on any other business other than in partnership with the Y trust. The X trust and the Y trust had turnover of less than $2 million per annum.

Hence, the X trust and the Y trust partnership is a CGT small business entity.

The CGT asset satisfies the active asset test.

Section 152-35 provides that an asset satisfies the active asset test if an entity has owned the asset for 15 years or less and the asset was an active asset for at least half of the period between the acquisition of the asset and the CGT event. Section 152-40 provides that an active asset is an asset used, or held ready for use, in the course of carrying on a business whether alone or in partnership. As the property was used in the farming business conducted by the partnership for the whole duration of its ownership, the property is an active asset.

Conclusion

Considering all of the above factors, the X trust meets the basic conditions for small business CGT relief.

Application of the general 50% CGT discount and the small business 50% reduction

Division 115 provides that the X trust can apply the general 50% CGT discount as it has held the asset for at least 12 months before the CGT event.

Section 152-205 provides that the amount of the capital gain is reduced by 50% if the basic conditions for small business CGT relief are met. As the X trust meets those basic conditions, it can also apply the small business 50% reduction in addition to the discount under Division 115.

Section 152-210 provides that the capital gain, as reduced by the general CGT discount and the small business 50% reduction, may also qualify for both the small business retirement exemption and the small business rollover and you may choose which order to apply them in.

Question 2

Summary

The X trust can choose to apply the small business retirement exemption to payments it makes to the beneficiaries. The CGT exempt amount for each of them is $500,000 and the payments must be made to a complying superannuation fund or a RSA.

The X trust must make the payments on receipt of each instalment up to the $500,000 total limit for each beneficiary respectively.

Detailed reasoning

Subsection 152-305(2) provides that a trust can choose to disregard part of a capital gain if the basic conditions for small business CGT relief are met, the entity satisfies the significant individual test, and that further conditions in section 152-325 are met.

As it has already been determined that the trust satisfies the basic conditions for small business CGT relief, it must now be determined whether the X trust satisfies the significant individual test.

Significant individual test

The X trust will satisfy the test if it had at least one significant individual just before the CGT event. Section 152-55 provides that an individual is a significant individual in a trust at a time if, at that time, the individual has a small business participation percentage in the trust of at least 20%. Section 152-65 provides that an individual’s small business participation percentage in a trust at a time is the sum of its direct and indirect small business participation percentages in the trust at that time.

Item 3 in the table in subsection 152-70(1) provides that an individual’s direct small business participation percentage in a trust at a relevant time, where the beneficiaries do not have entitlements to all of the income and capital of the trust, is the percentage of the distributions to which the individual is beneficially entitled, if the trustee makes distributions of income or capital during the relevant year.

The beneficiaries of the X trust do not have entitlements to all of the income and capital of the trust as it is a discretionary trust, where the trustee, in its absolute discretion and in accordance with the trust deed, may pay, apply, or set aside all or any part of the trust income for the benefit of the beneficiaries or accumulate all or any part of it.

Subsections 152-70(4) and 152-70(5) provide that, for the purpose of working out the direct small business participation percentage in an entity in connection with a CGT event that happened in an income year, and the trustee for the trust has not made a distribution of income or capital, the relevant year is the CGT event year, if the trustee makes a distribution of income or capital during that year.

In the present case, it is anticipated that the beneficiaries will each be made presently entitled to more than 20% of the income, and specifically entitled to more than 20% of the capital, of the X trust for the year ended 30 June 20XX, which is the CGT event year. Thus, provided that the trustee for the X trust makes such resolutions as anticipated, both the beneficiaries each hold a direct small business participation percentage of at least 20% in the trust at the relevant time. They are both significant individuals for the CGT event year.

Therefore, the X trust satisfies the significant individual test.

It must now be determined whether the further conditions relating to trust payments in section 152-325 are satisfied.

Further conditions relating to trust payments

Subsection 152-325(1) provides that a trust must make a payment to at least one of its CGT concession stakeholders if it receives an amount of capital proceeds from a CGT event and it makes a choice to apply the small business retirement exemption.

Section 152-60 provides that an individual is a CGT concession stakeholder in a trust if he or she is a significant individual in the trust.

As it has been determined that both beneficiaries are significant individuals of the X trust, provided that the trust makes the anticipated resolutions, they are also CGT concession stakeholders.

Amount of the payment

Subsection 152-325(3) provides that if a payment is made to more than one CGT concession stakeholder, the amount of each payment is to be worked out by reference to each individual's percentage of the relevant CGT exempt amount.

Subsection 152-325(5) provides that the amount of the payment, or the sum of the amounts of the payments, made to the CGT concession stakeholder must be equal to the lesser of the:

● amount of capital proceeds received

● relevant CGT exempt amount.

Section 152-315 provides that a trust must ensure that the total amounts of the payments made to the CGT concession stakeholders will not exceed the CGT retirement exemption limit, otherwise known as the CGT exempt amount, of each individual for whom payments are made under the small business retirement exemption. The CGT exempt amount must be specified in writing. Subsection 152-320(1) provides that an individual's CGT retirement exemption limit at a time is $500,000 reduced by the CGT exempt amounts of CGT assets specified in choices previously made by or for the individual.

Subsection 152-315(5) provides that if a trust is making the choice and it has more than one CGT concession stakeholder, it must specify in writing the percentage of each CGT asset's CGT exempt amount that is attributable to each of those stakeholders. One or more of the percentages may be nil, but all of the percentages must add up to 100%.

Capital proceeds received in instalments

Subsection 152-325(2) provides that if the trust receives the capital proceeds in instalments, the payments must be made to the CGT concession stakeholder in succession up to the relevant CGT exempt amount.

The requirement to make a payment must be satisfied to the greatest extent possible out of the initial instalments, rather than in some other way, such as apportionment across all the instalments received.

Timing of the payment

Subsection 152-325(4) provides that the payment must be made by the later of:

● seven days after the trust makes the choice

● seven days after the trust receives an amount of capital proceeds from the CGT event.

Subsection 152-325(6) provides that if the trust is required to make two or more payments to a single CGT concession stakeholder, whether or not at the same time, the trust may meet this requirement by making one payment or separate payments.

Timing of the choice to apply the small business retirement exemption

In accordance with section 103-25, a trust must make the choice to apply the small business retirement exemption by the day it lodges its income tax return for the income year in which the relevant CGT event happened, or within a further time allowed by the Commissioner.

Subsection 103-25(2) provides that the way the trust prepares its income tax returns is sufficient evidence of making the choice. This does not apply to the choice of the CGT exempt amount or the trust’s beneficiaries’ percentages of the CGT exempt amount, which both must be specified in writing.

Making the payment to the CGT concession stakeholder

Subsection 152-325(7) provides that if a CGT concession stakeholder is under 55 just before a payment is made, the trust must:

● make the payment to the CGT concession stakeholder by contributing it for the stakeholder to a complying superannuation fund or a retirement savings account (RSA) in respect of the stakeholder

● notify the trustee of the fund or the RSA provider at the time the contribution is made that the contribution is made in accordance with section 152-325.

Consequences of choice

If a trust makes the choice to apply the small business retirement exemption for any part of the capital gain from the CGT asset, that part of the capital gain equal to its CGT exempt amount is disregarded under section 152-310.

Subsection 152-310(2) provides that any payment or part of one the trust makes:

● is not assessable income, and is not exempt income, of the CGT concession stakeholder to whom it is made

● cannot be deducted from the company's or trust's assessable income.

Application of the small business retirement exemption

In this case, the X trust can choose to apply the small business retirement exemption to payments it makes to the beneficiaries. Neither of the beneficiaries has used the exemption before, thus the CGT exempt amount for each of them is $500,000. They are both under 55 years of age, so the payments must be made to a complying superannuation fund or a RSA.

As the capital proceeds from the sale of the property exceed $500,000, both the beneficiaries may receive this total CGT exempt amount from the X trust.

The capital proceeds from the sale of the property will be received in instalments over a number of years. In accordance with subsection 152-325(2), the X trust must make the payments on receipt of each instalment up to the $500,000 total limit for each beneficiary respectively.

These payments must be made by the later of:

● seven days after the X trust makes the choice to apply the small business retirement exemption

● seven days after the X trust receives an instalment of the capital proceeds from the sale of the property.

The X trust must:

● make the payments to the beneficiaries by contributing it for them to a complying superannuation fund or an RSA

● notify the trustee of the fund or the RSA provider at the time the contribution is made that the contribution is made in accordance with section 152-325

● keep a written record of the CGT exempt amount for each beneficiary and each beneficiary’s percentage of the exempt amount (one may be nil, but together they must add up to 100%).

Question 3

Summary

The relevant CGT event occurred in the 20XX–XX income year, so the payment made under the small business retirement exemption must be made within seven days from the date of lodgment of the X trust’s income tax return for that income year, or seven days after the X trust receives the next instalment of capital proceeds from the sale of the property.

Detailed reasoning

As discussed above, subsection 152-325(4) provides that the payment must be made by the later of:

● seven days after the trust makes the choice

● seven days after the trust receives an amount of capital proceeds from the CGT event.

Also, in accordance with section 103-25, the X trust must make the choice by the time it lodges its income tax return for the year in which the CGT event happened. As the contract of sale for the property was signed in 20XX, the relevant CGT event occurred in the 20XX–XX income year, so the payment must be made within seven days from the date of lodgment of the X trust’s income tax return for that same income year, or seven days after the X trust receives the next instalment of capital proceeds from the sale of the property.

Question 4

Summary

The X trust meets the basic conditions for small business CGT relief, so it can choose to apply the small business rollover to its remaining capital gain.

Detailed reasoning

The X trust may choose to apply the small business rollover to as much of the capital gain as it decides. It may also choose to apply both the small business retirement exemption and the rollover for different parts of the remaining capital gain, after applying the available CGT discounts.

Section 152-410 provides that a trust can obtain the small business rollover for a capital gain if the basic conditions for small business CGT relief are met. It can choose to obtain a rollover even if it hasn’t yet acquired a replacement asset or incurred expenditure on a capital improvement to an existing asset. As the X trust meets the basic conditions for small business CGT relief, it can choose to apply the small business rollover to its remaining capital gain.

Question 5

Summary

The X trust has until two years after the contract for the sale of the property was signed to purchase a replacement asset. Therefore, the replacement asset period for the X trust will be until 20XX.

Detailed reasoning

As the X trust can apply the small business rollover, the period in which the trust must obtain a replacement asset must now be determined. Subsection 104-190(1) provides that the replacement asset period starts one year before the last CGT event in the income year for which you obtain the rollover and ending the later of:

● two years after that last CGT event

● six months after the latest possible time a possible financial benefit becomes due under a look-through earnout right relating to the disposal of a CGT asset.

Although the X trust receives the capital proceeds from the sale of the property in instalments, this is not a look-through earnout right as defined in subsection 118-565(1).

Therefore, the X trust has until two years after the contract for the sale of the property was signed to purchase a replacement asset. The replacement asset period for the X trust will be until 20XX.

Subsection 104-190(2) provides that the Commissioner may extend the replacement asset period. Each request for extension is decided on its merits and the Commissioner considers the following factors relevant:

● The taxpayer has an acceptable explanation for not making the choice to apply the rollover by the time it should have been made.

● It would be fair and equitable in the circumstances to allow the taxpayer more time to make apply the rollover.

● Prejudice to the ATO might result from additional time being allowed to the taxpayer (the absence of prejudice by itself is not enough to justify granting an extension).

● It would be fair and equitable to people in similar positions and the wider public interest.

● Whether any mischief is involved.

If the X trust is not able to obtain a replacement asset within the replacement asset period, it may consider applying for an extension before the period ends.

Question 6

Summary

The X trust, and any relevant beneficiaries, is not required to report the capital gain on the sale of the property until settlement occurs. They will be required to amend assessments for the 20XX–XX income year within a reasonable period after settlement.

Detailed reasoning

As has been determined, CGT event A1 happened when the property was sold. The timing of the CGT event was when the contract for the sale of property was made. Settlement occurs in a subsequent income year.

Taxation Determination TD 94/89 Income tax: capital gains: in what year of income is a taxpayer required for tax purposes to include a capital gain or loss in relation to land disposed of under a contract which is made in one year of income, but which is settled in a later year of income? (TD 94/89) explains that a taxpayer is not required to include any capital gain in the appropriate year until an actual change of ownership occurs. Thus, when settlement occurs, the taxpayer is then required to include any capital gain in the year of income in which the contract was made. If an assessment has already been made for that year of income, the taxpayer may need to have that assessment amended.

In the present case, the X trust and any relevant beneficiaries are not required to report the capital gain on the sale of the property until settlement occurs. They will be required to amend assessments for the 20XX–XX income year within a reasonable period after settlement.

Question 7

Summary

No shortfall interest charge or penalties will be imposed on the X trust, and any relevant beneficiaries, if they lodge amendments to their 20XX–XX income year assessments within one month of settlement.

Detailed reasoning

As an amendment, which will include a net capital gain, will be lodged for a prior-year assessment, a liability for shortfall interest charge may arise. The remission of interest will be dealt with in each case on its own merits.

However, in accordance with TD 94/89, it is expected that the Commissioner will ordinarily remit the shortfall interest charge in full where requests for amendment are lodged within a reasonable time after the date of settlement. In most cases, the Commissioner considers a period of one month after settlement to be a reasonable period.

As such, no shortfall interest charge or penalties will be imposed on the X trust, and any relevant beneficiaries, if they lodge amendments to their 20XX–XX income year assessments within one month of settlement.