Edited version of your written advice

Authorisation Number: 1051398383124

Date of advice: 11 July 2018

Ruling

Subject: Income tax - small business concessions – 15 year exemption

Question 1

Did CGT event A1 under section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997) occur when the heads of agreement was signed?

Answer

Yes.

Question 2

Is the Commissioner satisfied that subparagraph 152-110(1)(d)(i) of the ITAA 1997 has been satisfied, namely the CGT event has happened in connection with the retirement of both significant individuals in Company A?

Answer

Yes.

Question 3

Will the Commissioner exercise his discretion under subsection 152-125(4) of the ITAA 1997, to extend the 2 year time limit stipulated in subparagraph 152-125(1)(b)(i) of the ITAA 1997 for the payment of the exempt amount to be made to the significant individuals to XX/XX/20XX?

Answer

Yes.

Question 4

If the Commissioner exercises his discretion favourably in relation to question 3, can the CGT concession stakeholders satisfy subsection 292-100(4) of the ITAA 1997 (regarding contributions to superannuation relating to CGT small business concessions) even though Company A makes the exempt payments to the significant individuals more than two years after the CGT event?

Answer

No.

Question 5

Will subsection 292-100(4) of the ITAA 1997 be satisfied where:

● Company A makes a payment to the CGT concession stakeholders within the two year period in the form of an assignment of part of the receivable owed to it by the property purchaser, and

● the CGT concession stakeholders contribute to the Fund their own personal cash that is no more than the value of the assigned receivable?

Answer

Yes.

This ruling applies for the following period:

Financial year ending 30 June 20xx

Financial year ending 30 June 20xx

Financial year ended 30 June 20xx

Financial year ended 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

Trustee Company Y (the Trustee) is the trustee of the Trust A (the Trust)

The Trust is a small business entity which carries on a business.

The Business has a turnover of under $2 Million in the 20XX financial year and has been operated by the Trust for at least 25 years.

The Trust has operated the Business from the Property in excess of 15 years.

The property is owned by Company A, which was acquired on XX/XX/20XX.

Individual A and Individual B are the directors of the Trustee, and thus the Trustee acts in accordance with their directions or wishes.

The Individuals have at all relevant times been significant individuals in Company A, and have each owned 50% of the shares in Company A for more than 15 years.

The Trust has distributed more than 40% of its income directly or indirectly to the Individuals in many of the last 15 years.

Individual A has always been responsible for the management and decision making of the Business and has worked full time in the Business since commencement.

Individual B worked alongside Individual A in the Business for 25 years, mostly on a part time basis, handling the administration side of the Business. Individual B’s main duties were to manage accounts receivable and payable, and handle all staff payroll payments and manage their entitlements.

Individual B, over 55 years of age, ceased working for the Business in 20XX.

Individual B’s duties have been taken over by Individual C. In the 20XX financial year Individual C took temporary leave from the business and for this time Individual B is working as the business bookkeeper and is completing administrative duties.

Individual B also resigned as a director of the Trustee in 20XX shortly after the property was sold, and makes no further input into the operations of the Business.

Individual A, over 55 years of age, is also transitioning to retirement. His son Individual D, has worked as an employee of the business for a number of years, but more recently has been involved in the management of the Business, under Individual A’s guidance.

Individual A has reduced the number of hours worked in the business from on average 60 hours per week to 25 hours per week. Once Individual D has been trained Individual A will reduce his work hours further.

Individual D has been appointed as a director of the Trustee, as part of the transition to his full management of the Business.

Individual A intends to pass on full responsibility for management of the Business to Individual D after:

a) Settlement of the property takes place,

b) The Business has been established in its new premises going forward.

The sale of the property was subject to legal proceedings.

You provided a draft deed of payment that has been considered as part of this ruling.

The property is in an undeveloped state and permits must be obtained prior to any development commencing. Due to this a long settlement period of X years was required to allow the purchaser adequate time to obtain permits prior to settlement.

You satisfy the basic conditions in Subdivision 152-A of the ITAA 1997 and the property is an active asset.

Individuals A and B will continue to receive distributions from Trust A.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 103-10

Income Tax Assessment Act 1997 paragraph 103-10(2)(b)

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 subsection 104-10(3)

Income Tax Assessment Act 1997 subsection 116-20(1)

Income Tax Assessment Act 1997 subdivision 152-A

Income Tax Assessment Act 1997 section 152-105

Income Tax Assessment Act 1997 section 152-110

Income Tax Assessment Act 1997 subsection 152-125(1)

Income Tax Assessment Act 1997 paragraph 152-125(1)(b)

Income Tax Assessment Act 1997 subsection 152-125(2)

Income Tax Assessment Act 1997 subsection 152-125(4)

Income Tax Assessment Act 1997 section 292-90

Income Tax Assessment Act 1997 subsection 292-100(4)

Part IVA

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter ‘part iva general’ in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise indicated.

Question 1

Summary

The CGT event A1 occurred when the agreement was entered into, therefore the capital gain arising from the sale of your shares is assessable in the year ended XX June 20XX.

Details reasoning

Disposal of an asset

Section 104-10 states that the disposal of a CGT asset causes a CGT event A1 to occur. Subsection 104-10(3) provides that the time of the event is when you enter into the contract for disposal or if there is no contract when the change of ownership occurs.

The CGT provisions take the general law as it stands and this means the date 'you enter' the contract must be the date the contract comes into existence for general law purposes.

A contract generally comes into existence at the time an offer is accepted (provided that there is consideration, certainty, intention to create legal relations etc). However, different rules may apply in some circumstances.

Conditions precedent

Conditions to contracts are generally divided into two categories: conditions precedent and conditions subsequent. Although the distinction between conditions precedent and conditions subsequent have been described as largely a matter of words, conditions precedent can be broken up into two further categories and the distinction between these categories can be critical for CGT purposes.

The categories are conditions precedent to the performance of a contract and conditions precedent to the formation of a contract. A condition precedent to the performance of a contract still sees an operative contract come into existence at the date of the acceptance of an offer (and therefore that date is the date you enter into the contract). On the other hand, a condition precedent to the formation of a contract means that no contract comes into existence until the condition is fulfilled. This makes the time of the contract the time the condition (which is precedent to the formation of the contract) is fulfilled.

This distinction between conditions precedent and conditions subsequent is also elaborated on in Taxation Determination TD 94/89:

The time a contract is made depends upon the terms of the contract and any relevant legislation in each State. If a contract is subject to a condition, it does not affect the time of the making of the contract unless it is a condition precedent to the formation of the contract. Most conditions (e.g. standard 'subject to finance' clauses) operate as conditions subsequent to formation of the contract and do not affect the time of making of the contract. See AAT Deputy President Dr P Gerber's discussion in Case 24/94 94 ATC 239 at 246-248; AAT Case 9451 (1994) 28 ATR 1108 at 1116-1118.

The nature of a condition (that is whether it is a condition precedent to the formation of a contract) depends on the proper construction of the terms of the contract. However, as pointed out by Mason J in Perri & Anor v. Coolangatta Investments Pty Ltd (1982) 149 CLR 537 at p 552, generally speaking a court will tend to favour a construction which leads to the conclusion that a particular stipulation is a condition precedent to performance (as against a construction which leads to the conclusion that the stipulation is a condition precedent to the formation or existence of a contract).

Application to your circumstances

The Commissioner considers that the heads of agreement expresses a clear intent for the parties to contract to arrange for the transfer of the property subject to the terms being finalised in the ‘final’ contract. The heads of agreement provides that it is an agreement to purchase and envisages an exchange of contract as part of the terms. We acknowledge the inclusion of the Special Condition 1, however do not consider this prejudices the view that the heads of agreement amounts to a contract for disposal. Our position has also been supported by the findings of Kennedy J ([2017] VSC 641).

Accordingly the time when the contract was entered into, for the purposes of CGT event A1, is the time when the agreement containing the conditions was entered into. Therefore any capital gain arising from the sale of the property is assessable in the year ended XX June 20XX.

Question 2

Summary

The Commissioner considers that the CGT event was in connection with the retirement of both the individuals.

Detailed reasoning

Section 152-110 provides a small business 15-year exemption for companies and trusts. Under this section, a company can disregard the capital gain from the disposal of a CGT asset if:

(a) the company satisfies the basic conditions in Subdivision 152-A for the small business CGT concessions,

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

(c) the company 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:

● at least 55 years old at that time and the event happened in connection with their retirement or

● permanently incapacitated at that time.

In connection with retirement

Whether a CGT event happens in connection with an individual’s retirement depends on the particular circumstances of each case. A CGT event may be in connection with your retirement even if it occurs at some time before retirement.

The Explanatory Memorandum (EM) to the New Business Tax System (Capital Gains Tax) Bill 1999 makes the following comments about the requirement to be permanently incapacitated or retiring as one of the conditions for the concession:

1.68 One of the requirements of this concession for an individual small business taxpayer is that they must be either permanently incapacitated at the time of the CGT event, or at least 55 years old and using the capital proceeds for their retirement.

The provisions relating to the small business 15-year exemption do not define what is meant by the phrase ‘in connection with a taxpayer’s retirement’, nor does it give any indication of the degree of retirement required in order to take advantage of this concession. It could be argued that the phrase ‘in connection with retirement’ means that the capital gain arising from the disposal of active assets is to be used to provide funds for a person’s retirement rather than to precipitate retirement at the time of the CGT event. The words used in the EM support this interpretation.

The Advanced guide to capital gains tax concessions for small business 2013-14 also supports this view. It makes it clear that it is not necessary for there to be a permanent and everlasting retirement from the workforce. However, there would need to be at least a significant reduction in the number of hours worked or a significant change in the nature of the activities to be regarded as a retirement for the purposes of paragraph 152-110(1)(d)(i).

Application to your circumstances

The Commissioner considers that the CGT event is in connection with both individuals’ retirement. Although Individual A has not completely stopped working, it is considered that there has been a significant decrease in hours worked in the business. Further, once Individual D is trained Individual A will transition fully into retirement. We also considered that there has been a change in the activities performed by Individual A. Individual B’s retirement is considered in connection with the CGT event as it occurred in the following months after the CGT event.

Question 3

Summary

The Commissioner will extend the time limit in paragraph 152-125(1)(b) so that payments made to a capital gains tax (CGT) concession stakeholder can be extended to XX/XX/20XX.

Detailed Reasoning

The distributions made by the company of that exempt amount to a CGT concession stakeholder is not included in the assessable income of the CGT concession stakeholder if the company makes the payment within two years after the CGT event.

In determining the taxable income of the company, the trust, the individual, or any of the interposed entities, subsection 152-125(2) requires you to disregard the total amount of the payment or payments made to the CGT concession stakeholder, up to the following limit:

Stakeholder's participation percentage × Exempt amount

Moreover, the Commissioner may exercise his discretion under subsection 152-125(4) and allow further time to make payments to the concessional stakeholder. The discretion in subsection 152-125(4) simply states that:

(4) The Commissioner may extend the time limit under paragraph (1)(b)

In determining the circumstances in which the Commissioner may be expected to exercise his discretion, the Explanatory Memorandum to Tax Laws Amendment (2006 Measures No. 7) Act 2007 provides the following guidance:

1.62 There is a requirement that the company or trust make the payments relating to the exempt amount within two years of the CGT event. To take into account actual taxpayer circumstances and commercial practices, the Commissioner has a discretion to extend this time limit. This amendment addresses Recommendation 10.4 of the Board of Taxation report. [Schedule 1, item 45, subsection 152-125(4)]

Each request for the exercise of the discretion under subsection 152-125(4) will be considered on a case by case basis after taking into account the individual circumstances and commercial practices of each case. The NAT 3359 Advanced guide to capital gains tax concessions for small business 2013-14 also provides general guidance under the heading 'Extensions of time'.

The range of factors that the Commissioner will consider in allowing an extension of time includes:

a) whether there is evidence of an acceptable explanation for the period of extension requested and whether it would be fair and equitable in the circumstances to provide such an extension;

b) whether there is any prejudice to the Commissioner if the additional time is allowed (however, the mere absence of prejudice is not enough to justify the granting of an extension);

c) whether there is any unsettling of people, other than the Commissioner, or of established practices;

d) the need to ensure fairness to people in like positions and the wider public interest;

e) whether there is any mischief involved; and

f) the consequences of the decision.

Application to your circumstances

Company A is unable to make a payment of the full exempt amount within the 2 year period. Due to the property being in an undeveloped state it was a requirement of the purchasers to include a long settlement in the contract to allow for adequate time for development applications. There was a significant delay to settlement due to the court proceedings that occurred. Having considered the relevant circumstances, the Commissioner will exercise his discretion and extend the two year time limit under subsection 152-125(4).

Question 4

Summary

There is no discretion for the Commissioner within section 292-100 to extend the time limits under subsection 292-100(4).

Detailed Reasoning

Small business owners disposing of commercial property may be eligible for one or more small business CGT concessions. They may then also be able to contribute eligible proceeds of the sale to superannuation and have them counted towards the lifetime CGT cap under section 292-105, rather than the non-concessional or concessional contributions caps.

Section 292-90 provides for certain types of contributions to be excluded from being considered a non-concessional contribution. One such contribution is a contribution covered under section 292-100 relating to certain CGT-related payments, to the extent that it does not exceed your CGT cap amount when it is made.

Subsection 292-100(1) states that a contribution is covered under this section if it is; a) a contribution made by an individual to a fund in respect of the individual; b) the requirement in subsections (2), (4), (7) or (8) is met; and c) the individual chooses to apply this section to an amount that is all or part of the contribution.

Where an individual intends to disregard any capital gain resulting from a CGT event under section 152-110, (15 years exemption for companies and trusts), subsection 292-100(4) is the appropriate subsection to consider. Paragraph 292-100(4)(b) requires the entity to make a payment to the individual before the later of:

● two years after the CGT event; and

● if the CGT event happened because the entity disposed of the relevant CGT asset - 6 months after the latest time possible a financial benefit becomes or could become due under a look- through earnout right relating to that CGT asset and the disposal

Paragraph 292-100(4)(d) then requires the contribution is made to the fund within 30 days after the payment mentioned in paragraph (b).

If the individual does not make the contribution within the designated timeframe then it will not be excluded from being a non-concessional contribution. There is no discretion for the Commissioner within section 292-100 to extend the time limits under subsection 292-100(4).

Question 5

Summary

The Deed of Payment assigned by Company A to the individuals is an entitlement to a receipt of money relating to a CGT event; therefore it will satisfy the purposes of section 103-10. This will in turn form part of the ‘capital proceeds’ as per subsection 116-20(1).

Detailed reasoning

A condition for a CGT small business contribution to be excluded from being a non-concessional contribution under subsection 290-100(4) is that a payment made to a CGT concession stakeholder is contributed to their fund within the relevant timeframe.

Paragraph 292-100(4)(c) states that the contribution to the fund is to be equal to all or part of the stakeholder's participation percentage (within the meaning of subsection 152-125(2)) of the ‘capital proceeds’ from the CGT event (but not exceeding the amount of the payment mentioned in paragraph (b)).

The ‘capital proceeds’ from a CGT event are defined in subsection 116-20(1) as the total of:

An entitlement to the receipt of money or property is defined in section 103-10. Paragraph 103-10(2)(b) states that if a taxpayer will not receive money or other property in relation to a CGT event until a time after the CGT event, including a situation where money is payable by instalments, then the taxpayer is treated as if they are entitled to receive that money or property.

The Deed of Payment assigned by Company A to the individuals is an entitlement to a receipt of money relating to a CGT event; therefore it will satisfy the purposes of section 103-10. This will in turn form part of the ‘capital proceeds’ as per subsection 116-20(1).

If the individuals contribute an amount equal to all or part of their stakeholder participation percentage of the ‘capital proceeds’, then they will satisfy the condition of paragraph 292-100(4)(c). The condition is still satisfied even where they contribute cash from their personal account that is no more than the value of the ‘capital proceeds’. This contribution will need to be made 30 days after receiving the payment to be within the required timeframe.

Further issues for you to consider

This ruling has not fully considered the company’s eligibility for the exemption; it has only addressed the condition under subparagraph 152-110(1)(d)(i). The company should ensure that it satisfies the basic conditions and the other relevant conditions for exemption. More information is available in the publication Advanced guide to capital gains tax concessions for small business, which is available on our website www.ato.gov.au.