Edited version of your written advice

Authorisation Number: 1051378145873

Date of advice: 25 May 2018

Ruling

Subject: Small business concessions

Question 1

Does the company carry on a business?

Answer

Yes.

Question 2

Is the property an active asset?

Answer

Yes.

Question 3

Can the company disregard the gain from the sale of the property under section 152-80 of the ITAA 1997?

Answer

No.

Question 4

Can the company apply the 15 year exemption under section 152-110 of the ITAA 1997?

Answer

No.

Question 5

Can the company apply the small business 50% reduction under section 152-205 of the ITAA 1997?

Answer

Yes.

Question 6

Can the significant individuals of the company utilise the Small Business Retirement Exemption for the remaining capital gain after applying the active asset 50% reduction (up to their lifetime limit of $500,000)?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Company A (The company) was incorporated in 19XX.

The main shareholder and governing Director was Individual A.

The company’s main business investment from incorporation was a 50% share in Company B of which Individual A was also a Director.

In approximately 19XX one of the assets that Company B acquired was a commercially zoned house (the property)

Company B operated its business from the Property with two Directors and several support staff.

Company B undertook some property developments, general investing as well as running the markets.

In approximately 19XX Company B went into liquidation.

The company received several properties from the liquidation, including the property and other assets.

The company’s business activities include a substantial share portfolio and investments in unlisted, syndicate property investments.

No business plan exists.

Individual A attended the office daily and spent significant time on activities and consulted with investment advisors, financial planners and stock brokers.

Individual A was a salary employee of the company.

From 19XX the company had a part time secretary/book keeper. Detailed share ledgers were maintained and annual financial statements and income tax returns were produced.

From 19XX the company rented out one room of the property to a financial planner.

The reception area and majority of the building was utilized by the company.

In 19XX a portion of the building was rented to another party. The tenant occupied an area of 18sqm which equates to less than 1X% of the gross building area.

The arrangement between Suffolk and the Tenant was informal and was not subject to commercial lease tenure agreement. The occupancy was maintained on an informal monthly arrangement.

At all times the company remained the principal occupant of the property occupying the majority balance of the property at 8X% of the gross area.

All the records were contained and retained at the property.

The company continued to conduct its activities at the Property from 19XX until the time of Individual A death in 20XX.

Individual A continuously held X% of the shares in the company until there death.

The annual turnover of the company is below $2 million.

Individual A Will was challenged by one of the beneficiaries. Due this the assets of the estate could not be sold within the 2 year period and is yet to be sold.

Two beneficiaries have each inherited 37.5% of the company from the late Individual A.

The company had a significant individual for a minimum of 15 years.

The individual shareholders of the company are not at least 55 years of age and are not permanently incapacitated.

The individual shareholders of the company are not retiring at the time of the CGT event.

You expect to have a capital gain on the sale of the property.

The company will make a payment to a complying Superannuation Fund or retirement savings account for the individuals if they elect to use the retirement exemption.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104-10

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 Section 152-50

Income Tax Assessment Act 1997 Section 152-55

Income Tax Assessment Act 1997 Section 152-60

Income Tax Assessment Act 1997 Section 152-65

Income Tax Assessment Act 1997 Section 152-70

Income Tax Assessment Act 1997 Section 152-80

Income Tax Assessment Act 1997 Section 152-110

Income Tax Assessment Act 1997 Section 152-205

Income Tax Assessment Act 1997 Section 152-325

Reasons for decision

Question 1

There are no definite rules for determining whether activities amount to carrying on a business. The facts of each case must be examined and a determination made based on the large or general impression gained (Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470; (1953) 10 ATD 226; (1953) 5 AITR 548).

The courts have developed a series of indicators that can be applied to a set of circumstances to help determine whether a business is being carried on. Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production and TR 2017/D7 Income tax: when does a company carry on a business within the meaning of section 23AA of the Income Tax Rates Act 1986? provides the indicators established by the courts that need to be considered when determining whether a business is being carried on.

Relevant indicators of whether a business is being carrying on are:

a. whether your activity has a significant commercial purpose or character;

b. whether you have more than just an intention to engage in business;

c. whether you have a purpose of profit as well as a prospect of profit from the activity;

d. whether there is repetition and regularity of your activity;

e. whether your activity is of the same kind and carried on in a similar manner to businesses in your industry;

f. whether your activity is planned, organised and carried on in a businesslike manner;

g. the size, scale and permanency of your activity; and

h. whether your activity is better described as a hobby, recreation or sporting activity.

Paragraph 15 of TR 97/11 states that no one indicator is decisive (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922). In addition, paragraph 16 of TR 97/11 states that the indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the general impression gained from looking at all the indicators (Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470 at 474; 5 AITR 548 at 551 (Martin’s case), and whether these factors provide the operations with a 'commercial flavour' (Ferguson v. Commissioner of Taxation (1979) 37 FLR 310 at 325; 79 ATC 4261 at 4271; (1979) 9 ATR 873 at 884).

Paragraph 44 of TR 2017/D7 provides that where a company is established and maintained to make a profit for its shareholders, and invests its assets in gainful activities that have both a purpose and prospect of profit, it is likely to be carrying on a business in a general sense (Brookton per Aickin J at (1981) 147 CLR 441, 469; American Leaf per Lord Diplock at [1978] 3 All ER 1185, 1189; Westleigh.)

Application to your situation

In applying factors from TR 97/11 and TR 2017/D7 to determine whether the company was carrying on a business, it is acknowledged that the activities undertaken had the purpose of profit, characterised by regular and repetitive activity, had significant commercial purpose or character and the activities were carried out in a businesslike manner. In conclusion, after looking at all the indicators and factors discussed above, the company is considered to be carrying on a business.

Question 2

Small business concessions - Active asset

Section 152-10 contains the basic conditions you must satisfy to be eligible for the small business CGT concessions. These conditions are:

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

(b) the event would 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

(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, or

(iv) the conditions in subsection 152-10(1A) or (1B) are satisfied in relation to the CGT asset in the income year, and

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

Active asset

A capital gains tax (CGT) asset will satisfy 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 test period, 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 test period.

The test period begins when you acquired the asset, and ends at the earlier of the CGT event and, if the relevant business ceased to be carried on in the 12 months before that time, the cessation of the business.

Subsection 152-40(1) details that a CGT asset is an active asset at a time if it is used, or held ready for use, in the course of carrying on a business that is carried on by you, or your affiliate, or another entity that is connected with you.

The following assets cannot be active assets (subsection 152-40(4)):

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

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

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

● 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

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

● 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.

For a CGT asset of a business to be an active asset for the purposes of Division 152, it must firstly satisfy one of the 'positive tests' in subsection 152-40(1), and then also not be excluded by one of the exceptions in subsection 152-40(4).

Under paragraph 152-40(1)(a) 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.

However, paragraph 152-40(4)(e) provides that an asset whose main use in the course of carrying on the business is to derive interest, annuity, rent, royalties or foreign exchange gains cannot be an active asset (unless that main use was only temporary).

Application to your circumstances

The basic conditions to access the small business concessions are satisfied as; the company carries on a business, has a turnover of less than 2 million and it is expected the CGT event will result in a capital gain. The Commissioner is satisfied the property was activity used in the course of carrying on a business by the company. A portion of the property was used to produce rental income however this amounted to only 1X% of the property. Therefore primary purpose of the property was not to produce rent, but provided a premise to carry out the company’s business activities.

Question 3

When a taxpayer acquires a CGT asset, including acquisition by inheritance, they are potentially liable for tax on any capital gain on that asset when a CGT event subsequently happens to it.

In some instances, a taxpayer can reduce the capital gain made from a CGT event by applying the small business CGT concessions. Section 152-80 potentially extends the availability of the small business CGT concessions to an asset held by a legal personal representative or beneficiary of a deceased estate, to the extent that the deceased would have been entitled to the concessions, if a CGT event happens to the asset within two years of the death or such time allowed by the commissioner under subsection 152-80(3).

Application to your circumstances

The deceased was eligible to apply the 15 exemption to the sale of the property had it been disposed of prior to his death. However in this case as it is the company that holds the property and not the individuals directly, the property did not form part of the estate of the deceased and never passed to a beneficiary or legal personal representative. In order to apply section 152-80 the asset must be held by a legal personal representative or a beneficiary of a deceased estate.

We acknowledge that the individual’s received the shares of the company through the estate however this does not change the fact the owner of the property was the company. In this case the property was not held by a beneficiary or legal personal representative it is owned by the company, accordingly the company is not eligible to apply the 15 year exemption under section 152-80 of the ITAA 1997 to the sale of the property and as such the Commissioner is unable to exercise his discretion to extend the 2 year time period for this exemption to be applied.

Question 4

Subdivision 152-B provides a fifteen year exemption as part of the small business concessions. If you qualify for the small business fifteen year exemption, the capital gain in question is entirely disregarded and it is unnecessary to apply any other concessions.

Section 152-110 addresses the fifteen year exemption as it applies to companies and trusts. Under section 152-110, the entity can disregard any capital gain arising from the disposal of an asset if all of the following conditions are satisfied:

(a) the basic conditions in Subdivision 152-A are satisfied for the gain

(b) the entity continuously owned the CGT asset for the 15-year period ending just before the CGT event

(c) the entity had a significant individual for a total of at least 15 years (even if the 15 years was not continuous and it was not always the same significant individual) during which the entity owned the CGT asset; and

(d) an individual who was a significant individual of the entity just before the CGT event was either:

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

(ii) permanently incapacitated at that time.

Application to your circumstances

None of the shareholders of the company are 55 years or older and are not permanently incapacitated. In addition the CGT event is not in connection with their retirement and therefore they are not eligible to apply the 15 year exemption.

Question 5 and 6

One of the concessions is the small business 50% reduction. Section 152-205 states that a capital gain may be reduced by 50% provided that the basic conditions detailed above are met.

A further concession is the retirement exemption in section 152-305. It is available if the basic conditions are satisfied and, in respect of companies, the entity satisfies the significant individual test in section 152-50 and the company conditions in section 152-325.

The significant individual test is satisfied if the company has an individual who has a small business participation percentage of at least 20%. A small business participation percentage is defined in section 152-65 and 152-70, and can be met by the individual holding the relevant percentage of the voting power in the company, the dividends paid by the company or capital distributions which the company may make.

Section 152-325 requires that the company must make a payment in respect of the event to at least one CGT concession stakeholder which, as defined in section 152-60, includes a significant individual.

If a CGT concession stakeholder is under 55 years old just before a payment is made in relation to them, the company or trust must make the payment to the CGT concession stakeholder by contributing it to a complying super fund or Retirement Savings Account (RSA) on their behalf. The company or trust must notify the trustee of the fund or the RSA at the time of the contribution that the contribution is being made, in accordance with the requirements of the retirement exemption.

Therefore, if you choose the retirement exemption after you have received the capital proceeds (for example, when you lodge your tax return), there is no requirement to make any payment until you have made the choice. Accordingly, you may use the capital proceeds for other purposes before choosing. However, once you choose, you must make the payment by the end of seven days after making the choice.

This is an important requirement. Failure to make a payment by the end of seven days after making the choice to a CGT concession stakeholder or into a complying super fund or RSA (if the stakeholder is under 55 years old), will mean the conditions are not satisfied and the retirement exemption will not be available.

The amount of the capital gain that you choose to disregard (that is, the CGT exempt amount) must not exceed your ‘CGT retirement exemption limit’ or, in the case of a company or trust, the CGT retirement exemption limit of each CGT concession stakeholder receiving a payment.

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.

A company or trust may determine the percentage of the exempt amount attributable to each stakeholder, having regard to each stakeholder’s retirement exemption limit (or remaining limit).

Application to your circumstances

In this case the individuals of the company are significant individuals and the asset that was sold satisfies the active asset test. The company is eligible to apply the 50% active asset reduction and provided that the company makes a payment to a complying superannuation fund or RSA account of the significant individuals within 7 days of making the choice, they will be eligible to apply the retirement exemption to the remaining capital gain up to the limit of $500,000 each.