Edited version of private advice

Authorisation Number: 1051560722004

Date of advice: 6 August 2019

Ruling

Subject: Small business concessions - maximum net asset value test

Question 1

Is your sibling an affiliate under section 328-130 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Are you and your sibling a 'partnership' as defined in section 995-1 of the ITAA 1997 in relation to the joint ownership of the properties?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You jointly own various land with your sibling.

You and your family live on part of one of the properties.

The Partnership

The Partnership operates a business on the Properties

The Partnership was established over XX years ago and was originally constituted by you, your sibling and your parents as partners.

Your parents retired as partners and the Trust, of which you and your sibling are the trustees, was added as a new partner. The reconstituted Partnership has continued to operate pursuant to the terms of the previous partnership agreement.

Operation of the Partnership's business

In operating the Partnership's business, you and your sibling separately make decisions about the two distinct aspects of the business.

In making these decisions in relation to the separate parts of the Partnership's business, you and your sibling:

a)    Act independently of each other

b)    Do not act at the direction of each other; and

c)    Give effect to your own individual wishes based on their independent assessments of what is best for the business.

The only decisions that you and your sibling make jointly are in relation to the financing of the business. Neither you nor your sibling exerts more control than the other, or is able to direct the other, in relation to these decisions.

Other than maximising profit, you and your sibling share no common goal or family purpose in relation to the Partnership's business. You have each always focused on the distinct aspect of the business' operations for which they have individual responsibility.

Moreover, you and your sibling's objectives and views in relation to the operation of the business have now diverged to such an extent that you are considering restructuring the Partnership's business so that you can operate your own businesses completely independent of each other.

In particular, you and your sibling cannot agree upon:

a)    Your respective budgets for equipment and inputs - as each of you believe your particular part of the business is more worthwhile

b)    The future direction of the business

The Partnership's use of the Properties

The Partnership has never paid, nor been required to pay, rent to you and your sibling for its use of the Properties

You and your sibling have no intention to charge the Partnership or any other entity rent for its use of the Properties in the future.

You and your sibling do not carry on any business together in a two-way partnership.

You and your sibling previously operated a business together as partners until recently when the partnership ceased trading.

After that point, you and your sibling ceased lodging tax returns as partners. You both also cancelled the Old Partnership's registration for GST.

You and your sibling do not have any individual business affairs outside of the business of the Partnership.

You and your sibling:

a)    Are not registered for GST as a partnership

b)    Do not lodge joint income tax returns; and

c)    Account for interest and borrowing costs related to their ownership of the Properties separately

You and your sibling keep their personal finances completely separate and have separate bank accounts.

Neither you nor your sibling is a director of any company.

Proposed transaction

You and your sibling are considering separating your joint ownership of the Properties.

The Partnership will be restructured in that you and your sibling will separate the operations so you both can go your separate ways

The purpose of the proposed transaction is to facilitate the separation of the business so that you and your sibling can operate your own businesses completely independently of each other.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-15

Income Tax Assessment Act 1997 subsection 152-15(b)

Income Tax Assessment Act 1997 section 328-130

Income Tax Assessment Act 1997 subsection 328-130(1)

Income Tax Assessment Act 1997 subsection 328-130(2)

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Summary

You and your sibling will not be considered to be affiliates or considered to be in partnership in relation to the co-ownership of your properties.

Detailed reasoning

As part of satisfying the basic conditions to access the Capital Gains Tax (CGT) small business concessions, a taxpayer has to either need to be a CGT small business entity or the net value of assets that the taxpayer and related entities own must not exceed $6 million.

In your situation, you state that the maximum net asset value test is relevant to your situation.

Maximum Net Asset Value Test

This test is contained in section 152-15 of the Income Tax Assessment Act 1997 (ITAA 1997). It is as follows:

You satisfy the maximum net asset value test if, just before the CGT event, the sum of the following amounts does not exceed $6 million:

a)    The net value of the CGT assets of yours;

b)    The net value of the CGT assets of any entities connected with you;

c)    The net value of the CGT assets of any affiliates of yours or entities connected with your affiliates (not counting any assets already counted under paragraph (b)

Under section 328-125 ITAA 1997, an entity is connected with another entity if the first entity, its affiliates, or the first entity together with its affiliates own, or have the right to acquire the ownership of, interests in the other entity that carry between them the right to receive a percentage that is at least 40% of:

i)              Any distribution of income by the other entity, or

ii)             If the other entity is a partnership - the net income of the partnership, or

iii)            Any distribution of capital by the other entity

In your situation, if you and your sibling are considered affiliates then the CGT assets of your sibling will be included in the test. This will include their interests in the properties you jointly own. Alternatively, if a partnership for tax purposes is established between you and your sibling, then their assets will be included in the test. This is because each sibling would be taken to control the partnership due to the greater than 40% in the net income of the partnership. Therefore each sibling would be connected with the partnership.

This means there are two issues that need to be answered, whether you and your sibling are affiliates, or alternatively whether you are in partnership for tax law purposes together.

Issue 1: Whether you and your sibling are affiliates

The definition of affiliate is contained in section 328-130 of the ITAA 1997. It is set out below:

Meaning of affiliate

(1)  An individual or a company is an affiliate of yours if the individual or company acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the business of the individual or company.

(2)  However, an individual or a company is not your affiliate merely because of the nature of the business relationship you and the individual or company share.

Note: For small business relief purposes, a spouse or a child under 18 years may also be an affiliate under section 152-47.

Example: A partner in a partnership would not be an affiliate of another partner merely because the first partner acts, or could reasonably be expected to act, in accordance with the directions or wishes of the second partner, or in concert with the second partner, in relation to the affairs of the partnership.

The Explanatory Memorandum (EM) to the Tax Laws Amendment (Small Business) Bill 2007 at paragraph 2.36 lists the following factors that are relevant to the issue of whether an individual or company is an affiliate of an entity:

a)    Family or close personal relationships

b)    Financial relationship or dependencies

c)    Relationships created through links such as common directors, partners or shareholders

d)    The lack of any formal agreement or formal relationship between the parties dictating how the parties are to act in relation to each other

e)    The degree to which entities consult with each other on business matters

f)     Whether one of the entities is under a formal or informal obligation to purchase goods or services or conduct aspects of their business with the other entity

The EM notes that none of these factors are determinative in their own right.

Application to your circumstances

While you and your sibling are partners in the business, the legislation makes it clear that this in itself is not enough to establish that your sibling was your affiliate. You have to look at the entire factual situation to determine this question.

In your circumstances, you and your sibling have distinct areas of the business in which you have control. You do not discuss the operations of your specific area of expertise of the business with the other. The only collaboration and agreement you have with each other is in relation to financing of the business. You are now trying to actively split the properties and business to have clear separate between you and your sibling. The example in the legislation makes it clear that even when one partner acts, or could reasonably be expected to act, in accordance with the directions or wishes of the second partner or in concert with the second partner, in relation to the affairs of the partnership, the partners would not necessarily be affiliates. This language makes it clear that it must be particularly close relationship where the required actions are in relation to the business itself, not merely the affairs of the partnership.

In your situation there is enough separation between you and your sibling in relation to the affairs of the business that you will not be considered affiliates.

Issue 2: Whether you and your sibling are in a Partnership for tax law purposes

Partnership is defined in section 995-1 of the ITAA 1997:

a)    An association of persons (other than a company or a limited partnership) carrying on a business as partners or in receipt of ordinary income or statutory income jointly

Goods and Services Tax Ruling GSTR 2004/6 Goods and services tax: tax law partnerships and co-owners of property states the Commissioner's view of what the phrase 'in receipt of ordinary income jointly' means.

It states at paragraph 27:

The expression 'in receipt of ordinary income...jointly' suggests that two or more persons have commenced an activity which gives rise to, or will give rise to, a right or entitlement to receive jointly an amount of payment of a revenue nature

Application to your circumstances

Carrying on a business

In relation to the co-ownership of the property, you and your sibling are not carrying on a business together. This co-ownership of the properties is separate to your interests in the Partnership.

You bought these properties jointly outside of any business relationship. Therefore you fail the first limb of the definition of partnership.

Tax law partnership

To be a partnership in relation to the co-ownership of the properties, you and your sibling need to be in receipt of ordinary income or statutory income jointly.

In your situation, there is no expectation of receiving income jointly. You do not charge the Partnership rent and will not charge rent in the future. This includes either the Partnership or any other entity. There is no entitlement to receive income from the co-ownership of the properties.

Therefore you do not satisfy the second limb of the definition of partnership. Accordingly you will not be considered to be a partnership for tax law purposes.