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Edited version of private advice
Authorisation Number: 1051583261271
Date of advice: 30 September 2019
Ruling
Subject: Small business concessions - 15 year exemption
Question
Are you eligible for the capital gains tax small business 15-year exemption under Subdivision 152-B of the Income Tax Assessment Act 1997 when capital gains tax event K4 occurs in relation to the Property?
Answer
Yes.
This ruling applies for the following period:
Income year ending 30 June 20XX
The scheme commences on:
1 July 20XX
Relevant facts and circumstances
You, being Persons A and B, established a partnership (the Partnership) to carry on primary production activities.
The Partnership carried on its primary production business on the Property which had been held by Person A's family for multiple generations.
The primary production business undertaken by the Partnership involves the running cattle for the purpose of selling them, their offspring, or their bodily produce.
The Partnership was registered for Goods and Services Tax (GST) from 20XX to 20XX when it was deregistered due to low annual turnover.
The Property has a land area of XX hectares and has farming equipment and facilities ordinarily used in primary production activities located on it.
Person X, the owner of the Property, passed away in 20XX with probate being granted after a number of months.
You inherited the Property with the legal title being transferred into your names as joint tenants in 20XX.
After a number of years the Partnership commenced scaling down its primary production activities and you started to consider your retirement and how best to realise the Property. At that time rates for the Property had increased significantly due to the rezoning of the area and you were advised that land tax would be substantial if the use of the Property for primary production activities ceased.
The gross income derived by the Partnership from carrying on the primary production activities for the 2014-15 to 2016-17 income years was less than $XX,XXX.
It is projected that the gross income of the Partnership from carrying on the primary production activities will be below $XX,XXX for any 12 month period going forward.
You have been approached by a number of professional property developers over the years who have offered to develop the Property once the Precinct Structure Plan (PSP) was gazetted. However, you did not accept these offers because the Partnership was still operating its primary production activities on the Property.
The Property is currently within a gazetted PSP incorporated into the local council's planning scheme enabling it to be redeveloped for residential use.
You were approached by Company A in relation to the development of the Property by them. You engaged in a number of discussions with Company A around the terms of the development.
During the following year Company A introduced you to another developer, Company Z, who was Company A's capital partner, and who had offered to develop, subdivide and sell the Property in conjunction with Company A.
Following these discussions, you decided that the best way to realise the value of the Property given your desire to retire was to grant rights for Company Z to develop, subdivide and sell the Property rather than selling the Property in its current form to Company Z, or another developer.
You entered into a Development Agreement (DA) with Company Y (the Developer), an entity associated with and controlled by Company Z, to grant the Developer the rights to develop, subdivide and sell the subdivided vacant lots of land (the Project) which includes the following information:
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The Developer: · intends to develop the Property in stages in accordance with the Initial Development Plan, subsequent Development Plans, the budget and all approvals obtained in relation to the Project; · agrees that you, being the Landowner, will continue to farm those parts of the Property not required for the Project until those parts are required for the Project · will lodge a mortgage over the Property in consideration for the Developer providing property development services to you · execute relevant documents, notices and ancillary forms relating to matters such as approvals, planning agreements, development contributions, plans of subdivision and sale contracts in relation to the Project · is responsible for applying for and pursuing all approvals from Government Agencies as required for the Project · will take out and maintain all insurance required to undertake the Project · will obtain finance to fund the Project · will engage the services of all consultants · will obtain a market valuation of the Property from two of the nominated valuation companies, with the Agreed Value being the greater of $XX.X million or the market valuations · is responsible for the cost of all subdivisions and consolidations including the preparation of necessary documents, obtaining approvals, certification and registrations as required · will be solely responsible for the financing and payment of all development costs · will provide you with written reports on the progress of the Project within the specified period after the date of the DA, and then provide Quarterly Reports · must advance by way of an interest free loan to you (the Advance), various amounts commencing on the Commencement date, then after a specified number of months, and then annually for a number of years · pay the Landowner the sum of $XX,XXX per annum, a Development cost, with respect to its cost of participation in the Project Control Group, commencing on a specified date · will appoint a solicitor who will deal with the gross sale proceeds and GST amounts in the following order: - pay any GST payable on the sale of the Property, or any part of the Property - pay any sales commissions owing in respect to the sale of the Property or any part of the Property subject to the consent of the Development Finance Provider - pay the Development Finance Provider to repay the development finance including interest, but excluding any amount owing to your original mortgage - pay the fees payable under the Development and Project Marketing Agreement - pay you the Landowner's Entitlement for each sold lot that the settlement has occurred as calculated under the terms outlined in the DA - pay the Developer their Development Costs plus GST (but not of input credits claimed by the Developer in respect of those costs) incurred by the Developer with the exception of sums that have been included in the payment of the mortgage - pay XX% of the balance, plus GST, to the Developer and the remaining XX% of the balance to you until the Developer's IRR equals XX%, when it will be retained by you until you and the Developer have received an equal sum; - the balance remaining after you and the Developer have received an equal sum as outlined above, XX% plus GST to be paid to the Developer and XX% to be paid to you · will establish a Project Control Group, which includes your representative to meet formally within specified periods during the Development Period for the purpose of making key decisions in relation to the DA. Each member of the Group will have one vote. |
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You: · will execute and deliver the power of attorney to the Developer to allow them to undertake the Project in accordance with the DA · agree that the Developer subdivides the Property, develops, markets and sells the subdivided lots · will appoint the Developer as your agent solely for the purpose of signing all documents required by the Developer to obtain approvals in relation to the Project · will appoint the Developer as the exclusive agent in relation to the advertising, marketing and sale of the subdivided lots · will remain the owner of the Property until the settlement of sale contracts, transfers to local and other authorities, compulsory acquisition or any other disposal of the land in accordance with the DA · agree to pay the Developer a Development Fee to the Developer in consideration for them undertaking the Project · you will receive the Agreed Value amount of $XX,XXX,XXX, or the amount as determined by a nominated valuer · you will authorise all distributions of gross sales proceeds prior to payment by the Developer. However, the Developer may distribute a maximum of $XX,XXX at specified periods from the Sales Proceeds Account set up by the Developer to pay outstanding development costs without obtaining your authorisation provided that the development costs are incurred in accordance with an approved budget · may appoint a firm of solicitors to receive on your behalf the Gross Sale Proceeds and any amounts on account of Goods and Services Tax (GST) on the disposal of each lot · must pay your mortgage from the gross sale amounts distributed from the Developer's solicitor until the mortgage is discharged · will grant the Developer non-exclusive licences to enter and occupy the Property for purposes relating to the Project. You must maintain insurance · you must repay the Advance to the Developer on the earlier of no later than a specified period after the date of termination if either party terminates the DA for any reason, or by deduction from the Gross Sale Proceeds by making proportionate repayments from all sums received by you until the Advance is repaid in full. |
The construction in relation to the various stages is estimated to commence in 20XX and continue for a number of years, with the construction estimated to be finished a number of years after each stage had commenced. The Project expected to end in 20XX.
Neither you, nor the Partnership have any property development experience and have never undertaken a property development project previously. They have also never undertaken any planning or development activities in respect of the Property and were not actively involved in the PSP process.
Neither you nor the Partnership are associates or related parties of the Developer and you have dealt with the Developer on arm's length terms at all times in negotiating the DA.
The Property is currently encumbered with a mortgage in favour of a financial institution securing a facility up to $XXX,XXX in your name.
In early 20XX, the cattle on the Property being used for primary production were XX female cattle and X male cattle.
You and the Developer agreed to the Valuation Amount of $XX.X million, an amount higher than in the amount provided in the DA.
The Developer has lodged the Planning Permit Application with the local council in relation to the Project which is anticipated to be approved by late 2019.
You have held the Property on capital account and the Property is an active asset.
You are both over 55 years of age.
You will make the election under paragraph 70-30(1)(a) of the ITAA 1997 to be treated as having sold the Property for its market value.
Person A has spent an average of XX hours per week in relation to the primary production activities from prior to 20XX until the 2018-19 income year, with Person B undertaking on average XX hours during that period.
Your hours spent on the primary activities have not changed at this point as the planning permit has not been issued at this point and the development activities have not physically commenced.
It is anticipated that the Partnership will continue to use the Property for their primary production activities on those parts of the Property not immediately being physically required in relation to the Project, with areas of the Property being progressively fenced off as the Project progresses. This will result in the gradual reduction of your activities during the course of the Project.
It is not anticipated that any revenue will be received from the sale of the subdivided lots as a result of the Project prior to 20XX.
Property B
The Developer also plans to undertake the development of Property B which is also situated in the PSP.
Property B is held by a partnership by two entities who are associates of Company Z and the Trustee of a Trust.
You control the Trust which has a equal ownership in Property B.
Property B is being developed by the Developer under a separate DA from the Project. However, the Project DA provides connection between the two projects as outlined below:
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Adjustment - Overall Project The Landowner and Developer agree that the Development Costs incurred by the Developer include costs associated with the Overall Project and the overall return for the Company Z Parties and the parties related to you shall be determined on the basis of the Gross Sale Proceeds received from the Project and the gross sales proceeds received from the development of Property B. At specified dates during each year the Developer and the Landowner will reconcile the amounts received respectively by them in relation to the Project and the amounts received in relation to the Property B development to ensure that distributions made progressively through the Development period, after the reimbursement to the Developer of Development Costs for the Overall Project incurred by the Developer are distributed as follows: · pay XX% of the balance to the Company Z Parties and XX% of the balance to the parties related to you until the Company Z Parties' IRR for the Overall Project is equal to XX% and then retained by the parties related to you until the Company Z Parties and the parties related to you have received an equal sum; and · the balance remaining, after the parties related to you and the Company Z Parties have received an equal sum as outlined in the above clause as follows: - XX% paid to the Company Z Parties (excluding GST); and - XX% retained by the parties related to you (Adjustment). |
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 6-5
Income Tax Assessment Act 1997 Section 104-10
Income Tax Assessment Act 1997 Section 104-220
Income Tax Assessment Act 1997 Section 70-30
Income Tax Assessment Act 1997 Subdivision 152-A
Income Tax Assessment Act 1997 Subdivision 152-B
Income Tax Assessment Act 1997 section 152-35
Income Tax Assessment Act 1997 paragraph 152-40(4)(e)
Reasons for decision
Summary
As you meet the conditions contained in Subdivision 152-A and 152-B of the ITAA 1997, you will be eligible to disregard any capital gain made when you start holding the Property as trading stock. However, the small business CGT exemptions will not apply in relation to proceeds received the sale of the proposed subdivided lots.
Detailed reasoning
Small business concessions basic conditions
To qualify for the small business capital gains tax (CGT) concessions, you must satisfy several conditions that are common to all the concessions being the basic conditions.
A capital gain that you make may be reduced or disregarded under section 152-10 of the ITAA 1997 if the following basic conditions are satisfied:
(a) a CGT event happens in relation to a CGT asset of yours in an income year;
(b) the event would have resulted in a gain;
(c) at least one of the following applies;
- you are a small business entity for the income year;
- you satisfy the maximum net asset value test;
- you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an interest in an asset of the partnership;
- you do not carry on a business, but your CGT asset is used in a business carried on by a small business entity that is your affiliate or an entity connected with you (passively held assets as outlined in subsections 152-10(1A) and 152-10(1B) of the ITAA 1997); and
(d) the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997.
Passively held asset - partnerships
A partner who owns a CGT asset (that is not an interest in an asset of the partnership) and who does not carry on a business (other than as a partner in a partnership) may access the small business CGT concessions where the CGT asset is used in the business of the partnership if all of the conditions the following conditions are satisfied:
· the taxpayer is a partner in a partnership in the income year in which the CGT event happens
· the partnership is a CGT small business entity for the income year
· the taxpayer does not carry on business in the income year (other than in partnership)
· the CGT asset is not an interest in an asset of the partnership
· the partnership is the entity that, at a time in the income year, carries on the business in relation to the CGT asset.
You will be a small business entity if you are an individual, partnership, company or trust that is carrying on a business and has an aggregated turnover of less than $2 million.
Active asset test
The active asset test is contained in section 152-35 of the ITAA 1997. The active asset test is satisfied 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 test period detailed below, 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 7.5 years during the test period.
The test period is from when the asset is acquired until the CGT event. If the business ceases within the 12 months before the CGT event (or such longer time as the Commissioner allows) the relevant period is from acquisition until the business ceases.
A CGT asset is an active asset if it is owned by you and is used or held ready for use in a business carried on (whether alone or in partnership) by you, your affiliate, your spouse or child, or an entity connected with you.
15 year exemption
You can disregard a capital gain from a CGT event happening to a CGT asset you have owned for at least 15 years if you:
· satisfy the basic conditions for the small business CGT concessions and
· continuously owned the CGT asset for the 15-year period ending just before the CGT event happened.
If you are an individual:
· when the CGT event happened
- you were permanently incapacitated, or
- you were 55 years old or older, and the event happened in connection with your retirement.
Whether a CGT event happens in connection with an individual's retirement depends on the particular circumstances of each case. There would need to be at least a significant reduction in the number of hours the individual works or a significant change in the nature of their present activities to be regarded as a retirement.
Application to your circumstances
The basic conditions for the small business capital gains tax (CGT) concessions in Subdivision 152-A of the ITAA 1997 (as relevant to this case) are that:
· a CGT event will occur to your asset;
· you will make a capital gain;
· your asset is a passively held asset used by a partnership that is a CGT small business entity; and
· the Property satisfies active asset test.
Based on the information provided the basic conditions contained in Subdivision 152 A of the ITAA 1997 will be satisfied because:
· a CGT event will occur when you commence treating the Property as trading stock;
· the CGT event will result in a capital gain;
· the Property was used by you in relation to the Partnership's primary production business prior to when you acquired your ownership interests in the Property to the present time; and
· the Partnership is a CGT small business entity.
In addition:
· you will have continuously owned the Property for a period of more than 15 years; and
· you were both over 55 years of age before the CGT event occurred and the event will happen in connection with your retirement.
Therefore, you qualify for the small business 15-year exemption in section 152-105 of the ITAA 1997 in relation to the Property. Consequently, you can disregard the capital gain you make as a result of making the election under paragraph 70-30(1)(a) of the ITAA 1997 to treat the Property as having been sold.
Further information
Trading stock
Under subsection 70-30(1) of the ITAA 1997, if you start holding as trading stock an item you already own, but do not hold as trading stock, you are treated as if:
(a) just before it became trading stock, you had sold the item to someone else (at arm's
- its cost (as worked out under subsection (3) or (4));
- its market value just before it became trading stock; and
(b) you had immediately bought it back for the same amount.
We note that the amount offered for outright purchase of the property would be relevant in establishing the property's market value just before it became trading stock.
When you must make the election
Under Subsection 70-30(2) of the ITAA 1997 you must make the election by the time you lodge your income tax return for the income year in which you start holding the item as trading stock.
CGT event K4
Subsection 104-220(1) of the ITAA 1997 provides that CGT event K4 occurs if:
(a) you start holding as trading stock a CGT asset you already own but do not hold as trading stock; and
(b) you elect under paragraph 70-30(1)(a) of the ITAA 1997 to be treated as having sold the asset for its market value.
Subsection 104-220(2) of the ITAA 1997 provides that the time of the event is when you start holding the asset.
CGT event K4 occurs when the property is bought in as trading stock.
Based on the information provided it is viewed that the small business 15 year exemption will apply up to the point when the Property ceased being a capital asset and commenced being trading stock due to you making the election under paragraph 70-30(1)(a) of the ITAA 1997 to be treated as having sold the Property for its market value.
The proceeds you receive in relation to the sale of the proposed subdivided lots will be assessable under section 6-5 of the ITAA 1997 on revenue account. Therefore, you will not be eligible to apply the CGT small business concessions on their sale.