Edited version of private advice

Authorisation Number: 1051514817056

Date of advice: 5 June 2019

Ruling

Subject: Small Business Concessions - small business rollover

Question

Did a CGT event occur at the end of the replacement asset period?

Answer:

Yes, CGT event J6 has occurred.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

A number of years ago a company was incorporated.

You invested in a share in the company.

The company issued a number of ordinary shares.

You hold one ordinary share valued at $X.

The ordinary share entitles you as a shareholder to the following:

·         a share of the dividends issued by the company

·         a share of any capital distributions

·         voting rights in the company.

No other classes of shares have been issued by the company.

The company purchased a farming property and included in the purchase of the property were a number of assets.

The company's name is on the title deed of the property.

The company has sold some assets and made a profit from the sale.

The company has used the profit to fund the sub-dividing of the property into XX residential blocks with the intention of selling the subdivided blocks.

A contractor was engaged to inspect the land and provide recommendations on how to develop the property and provided advice on how to proceed with a development application.

A development application was prepared and lodged with the local council.

The company has received an approval for the development application.

You provided the following funds to the company under a financial arrangement.

Under the financial arrangement no interest was charged on the funds lent and no loan repayment period was defined. The company is expected to repay the funds after the sub-division has been completed and the company has sufficient funds to repay the amounts lent by you.

You carried on a business.

You sold your business and made a capital gain.

You satisfied the basic conditions undersection 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997) and applied the small business rollover under Subdivision 152-E of the ITAA 1997 and deferred a capital gain of $XXX, XXX.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104-185(1)

Income Tax Assessment Act 1997 Section 104-197(1)

Income Tax Assessment Act 1997 Subsection 104-198(1)

Income Tax Assessment Act 1997 Subsection 104-198(3)

Income Tax Assessment Act 1997 Subdivision 152-E

Income Tax Assessment Act 1997 Section 152-35

Income Tax Assessment Act 1997 Section 152-40

Income Tax Assessment Act 1997 Paragraph 152-40 (4)(d)

Income Tax Assessment Act 1997 Subsection 110-25(5)

Income Tax Assessment Act 1997 Section 152-410

Reasons for decision

Summary

In your case, you made a capital gain on a sale of a business and you applied the small business rollover and deferred a capital gain.

CGT event J6 happened at the end of the asset replacement period as the capital gain you disregarded under the small business rollover exceeded the 'amount incurred' in relation to your replacement asset that is the share in the company.

Detailed reasoning

Where you choose the small business rollover, further CGT events will occur where you don't meet certain conditions by the end of the replacement asset period. This period starts one year before and ends two years after the last CGT event that occurs in the income year for which you choose the rollover, or a longer period that the Commissioner allows.

If the rollover conditions are not met within the replacement asset period the gain will become assessable.

You satisfy the rollover conditions where you meet all the following conditions:

·         you acquire one or more CGT assets as replacement assets or make a capital improvement to one or more existing assets, or both, within the replacement asset period

·         the replacement asset, or the asset to which the capital improvement was made is an active asset at the end of the replacement asset period (a depreciating asset such as plant can be a replacement asset)

·         if the replacement asset is a share in a company or an interest in a trust, at the end of the replacement asset period:

·         you, or an entity connected with you, are a CGT concession stakeholder in the company or trust, or

·         CGT concession stakeholders in the company or trust have a small business participation percentage in the interposed entity of at least 90%

·         the capital gain that is being rolled over is not more than the sum of the following

·         the amount paid to acquire the replacement asset (that is, the first element of the cost base of the replacement asset)

·         any incidental costs incurred in acquiring that asset, which can include giving property (that is, the second element of the cost base of the replacement asset), and

·         the amount expended on capital improvements to one or more assets that were acquired or already owned (that is, fourth element expenditure) (CGT event J6).

Certain assets are excluded from being active assets, including financial instruments (such as loans, debentures, bonds and promissory notes) (paragraph 152-40(4)(d) of the ITAA 1997)

For a share in a company or interest in a trust to be an active asset, the company or trust must satisfy the 80% test, that is, the market value of the active assets and certain financial instruments of the company or trust must be 80% or more of the total of the market value of all the assets of the company or trust.

Application to your circumstances

In your case, you chose the small business rollover in relation to a CGT event. Your replacement asset period commenced on XXXX and ended on XXXX.

CGT event J2

Under subsection 104-185(1) of the ITAA 1997, CGT event J2 happens if an entity chooses the rollover concession and a change in circumstances happens. When the change occurs, the deferred capital gain will crystallise.

When an entity disposes of a replacement asset, CGT event A1 happens in addition to CGT event J2. Any capital gain made from the A1 event on the disposal of the replacement asset may qualify for any of the small business CGT concessions if the relevant conditions are satisfied.

CGT event J5

Section 104-197 of the ITAA 1997 deals with the consequences that arise if a replacement asset is not acquired within the replacement asset period. Subsection 104-197(1) of the ITAA 1997 states that CGT event J5 will occur if 'you' have not acquired a replacement asset within the replacement asset period. In this instance, 'you' refer to the entity that chose the small business rollover. There are no provisions that allow the replacement asset to be acquired by any other entity.

CGT Event J6

Section 104-198(1) of the ITAA 1997 states that CGT event J6 happens when you choose the small business roll-over outlined in subdivision 152-E of the ITAA 1997 and:

a)    By the end of the replacement asset period you have acquired a replacement asset and incurred fourth element expenditure in relation to that replacement asset; and

b)    The replacement asset is your active asset at the end of the replacement asset period; and

c)    the capital gain you disregarded is greater than the sum of the 'amount incurred', which includes:

·         the first element of the cost base of the replacement asset,

·         any incidental costs incurred in acquiring the replacement asset, and

·         the fourth element expenditure incurred in relation to the replacement asset.

Section 104-198(3) of the ITAA 1997 states that the capital gain resulting from a CGT event J6 is the amount by which the capital gain disregarded under subdivision 152-E of the ITAA 1997 exceeds the sum of the 'amount incurred'.

Application of CGT events J2 and J5

In this instance, based on the information provided CGT events J2 and J5 are not relevant a replacement asset has been acquired being the one ordinary share held in the company. Further as there has not been a change in the circumstances of holding the replacement assets, CGT event J2 has no application to your current circumstances.

Please also note that the property that was acquired by a company that you are a CGT concession stakeholder in is not replacement asset of yours as it is owned by the company.

Application of CGT Event J6

You applied the small business rollover of the ITAA 1997 to defer capital gain you made in the 20XX-XX income year. You purchased one ordinary share in the company and contributed funds to the company under a financial arrangement. Based on the information provided the Commissioner accepts the one ordinary share held by you in the company is an active asset under section 152-40 of the ITAA 1997. Further you have incurred first element expenditure of the cost base totalling $X within the replacement asset period in relation to the CGT event.

In respect of the funds lent to the company, you argue the funds lent are an injection of capital into the company as a loan at call and that the debt and equity rules may apply under Division 974 of the ITAA 1997. The debt and equity rules contained in Division 974 of the ITAA 1997 are limited in their application and do not affect the definition of financial instruments contained in section 152-40 of the ITAA 1997. Accordingly, the funds lent to the company as a loan is excluded from the definition of active assets under paragraph 152-40(4)(d) of the ITAA 1997. In addition, the funds lent do not form part of the 4th element of the cost base of an asset (subsection 110-25(5) of the ITAA 1997) as the loan is expected to be repaid at some point in time.

Accordingly, based on the information provided CGT event J6 happened in the 20XX-XX income year as the capital gain you rolled over under section 152-410 of the ITAA 1997 exceeded the 'amount incurred' in relation to your replacement asset that is the share you purchased in the company.

As a result of CGT event J6 happening, you should include in your 20XX-XX income tax return an assessable capital gain.