Edited version of private advice

Authorisation Number: 1051564954719

Date of advice: 13 August 2019

Ruling

Subject: Capital gains tax concessions for small business

Question 1

Can you utilise the 50% active asset reduction on the sale of your property for the purposes of the capital gains tax (CGT) concessions for small business?

Answer:

No.

Question 2

Can you utilise the retirement concession for the purposes of the CGT concessions for small business?

Answer:

No.

This ruling applies for the following period

Year ending 30 June 2020

The scheme commences on

1 July 2019

Relevant facts and circumstances

X is over 45 years of age and runs a business at 'the property' as a sole trader.

X has continuously run the business from the property since 20XX.

In 20XY, X and Y established a unit trust (the trust), with a corporate trustee.

X and Y hold half of the units each in the trust.

The trust purchased and owns the property, which is its only asset.

The trust is not undertaking any business activity and the corporate trustee's only role is as trustee of the trust.

The property is 87sqm in total and consists of four separate areas:

·        Residential Flat 1 - X sqm, rent $X.00 per week

·        Residential Flat 2 - X sqm, rent $X.00 per week

·        Residential Flat 3 - X sqm, rent $X.00 per week

·        Commercial Shop - X sqm, rent $X.00 per week

X rents the commercial shop from the trust and runs the business from there.

The trust rents the three apartments through to unrelated tenants.

The trust intends to sell the property as it has been offered a very reasonable price.

The contract is expected to be signed in mid 20YZ and settled in mid 20YZ.

X will be presently entitled to income of the trust in the 20ZZ income year.

The trust will be dissolved as the property is the only asset.

The business will continue to trade.

Aggregated turnover for the 20ZY-YZ financial year for both X and the trust is under $2 million.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 152-10

Income Tax Assessment Act 1997 Section 152-40

Income Tax Assessment Act 1997 Section 152-35

Reasons for decision

Summary

The property is not an active asset for the purposes of the capital gains tax (CGT) concessions for small business. This is because the main use of the property is to derive rent.

As the property is not an active asset, the basic conditions necessary to be eligible for the CGT small business concessions cannot be met. Therefore, X cannot utilise the 50% active asset reduction, nor the retirement concession on the sale of the property.

Small business CGT concession eligibility

Section 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997) 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 of the ITAA 1997

(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) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year.

(d)      the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997.

In your case, the trust intends to dispose of the property, triggering CGT event A1. The event will potentially result in a capital gain.

Active asset test

Section 152-40 of the ITAA 1997 provides the meaning of 'active asset'. A CGT asset will be an active asset at a time if, at that time, you own the asset and the asset was used or held ready for use by you, an affiliate of yours, or by another entity that is 'connected with' you, in the course of carrying on a business.

Subsection 152-35(1) of the ITAA 1997 states that a CGT asset satisfies the active asset test if:

·        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 period of ownership, or

·        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 7 and a half years.

However, paragraph 152-40(4)(e) of the ITAA 1997 provides that an asset whose main use is to derive rent cannot be an active asset. Paragraph 152-40(4A)(b) of the ITAA 1997 provides that to determine the main use of an asset, treat any use by your affiliate, or an entity that is connected with you, as your use. Notably, personal use of the asset by you or your affiliate is ignored in determining its main use.

Taxation Determination TD 2006/78 considers, amongst other issues, the situation where there is part business and part rental use of an asset. It states that an asset owned by the taxpayer and used partly for business purposes and partly to derive rent can be an active asset under section 152-40 of the ITAA 1997 where it is considered that the main use of the premises is not to derive rent. In deciding if the property was mainly used to earn rent the Commissioner will consider a range of factors such as:

·        the comparative areas of use of the premises (between rent and business), and

·        the comparative levels of income derived from the different uses of the asset.

Application to the facts

The trust owns and rents out approximately 61% of the total floor area of the property (i.e. the residential flats) to unrelated parties. The trust earns approximately 68% of the revenue derived from owning the property from these parties.

X carries on their business from the shop, which consists of the remaining 39% of the floor area. A pays the trust rent for the shop and this rent forms 31% of the revenue the trust earns from owning the property.

Even if we treat X's business use as the trust's use (i.e. the trust is treated as using the shop as a business premises) and do not treat the rent X pays the trust as rent for the purposes of determining the trust's main use of the property, the main use of the property is still to derive rent. This is because 61% of the floor area is used to derive rent and 68% of the revenue the trust derives from the property is rent received from the unrelated parties.

Therefore, the main use of the property is to derive rent. Accordingly, it cannot be an active asset.

As the property is not an active asset, the basic conditions necessary to be eligible for the CGT small business concessions cannot be met. Therefore, X cannot utilise the 50% active asset reduction, nor the retirement concession on the sale of the property.