Edited version of private advice

Authorisation Number: 1051605708771

Date of advice: 7 November 2019

Ruling

Subject: CGT small business concessions

Question 1

Do you meet the basic conditions contained in section 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997) in relation to the transfer of your shares in the Company?

Answer

Yes

Question 2

Can you apply the small business retirement exemption to any capital gain that arises from the transfer of your shares in the Company?

Answer

Yes

Question 3

Will the Commissioner accept the Prospective Purchaser's offer as a basis for valuing the Company?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 2020

The scheme commences on:

1 July 2019

Relevant facts and circumstances

You are under 55 years of age.

You are a director of the Company.

You own more than 20% of the shares issued by the Company.

The total value of your net assets is less than $6million.

An arm's length third party (the Prospective Purchaser) made a formal offer to acquire one of the other shareholder's interests in the Company for $XXX.

The proposed acquisition was due to occur in the 2019 financial year. However, due to an inability of the parties to come to terms on the non-financial terms of the deal this acquisition did not proceed.

It was intended that the Proposed Purchaser would subsequently acquire additional shares in the Company via a new share issue for $XXX. The Company is still in the market for another partner of a similar nature.

Given the Company's intention to potentially merge with a larger group, you intend on transferring your shares in the Company to a discretionary trust (the Trust) for no consideration. The Trust will have a corporate trustee of which you will be the sole director.

There have been no changes to, or increases on value of the assets of the Company since the Prospective Purchaser's offer.

For at least 7.5 years, more than 80% of the Company's assets were active assets.

The Company has ownership interests in two other entities, however these entities hold no or negligible assets.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 152-10

Income Tax Assessment Act 1997 Section 152-15

Income Tax Assessment Act 1997 Subdivision 152-D

Income Tax Assessment Act 1997 Section 328-125

Reasons for decision

Basic Conditions

The basic conditions are contained in subsection 152-10(1) of the Income Tax Assessment Act 1997 (ITAA 1997). You will satisfy the basic conditions in relation to the transfer of the shares as:

·         a CGT event will occur that will result in a capital gain

·         you satisfy the maximum net asset value test as the net value of your relevant assets are less than $ 6 million; and

·         the shares pass the active asset test (more than 80% of the Company's assets have been active for the relevant period.

However, because the asset is shares in a company, there are additional basic conditions to be satisfied. These are considered below.

Additional basic conditions for shares

The additional basic conditions are contained in subsection 152-10(2) of the ITAA 1997. The conditions relevant to your case are:

·         you must satisfy the maximum net asset value test

·         just before the CGT event you must be a CGT concession stakeholder in the Company

·         the Company must satisfy a modified maximum net asset value test; and

·         the shares must satisfy a modified active asset test.

As discussed previously, you satisfy the maximum net asset value test, and as your participation percentage in the Company is more than 20% you will be a CGT concession stakeholder in the Company just before the CGT event.

The modified maximum net asset value test and the modified active asset test will be considered below.

Modified maximum net asset value test

To satisfy the modified maximum net asset value test, the Company or trust must include the assets of its affiliates and entities controlled by it. Under the modified connected entity rule, the company or trust controls another entity if it has a control percentage of at least 20% or more, in that other entity.

In this case, the assets of the Company and the later entities need to be included.

The question of market value was considered in Miley v FC of T 2016 ATC:

That is not to say that it is always necessary to employ the hypothesis of a willing seller and purchaser. That hypothesis is merely a useful and conventional method of arriving at a market value.... Where the asset in question has been the subject of a recent arm's length sale, it is generally unnecessary to hypothesise. If the recent sale transaction can be said to be one between a willing but not anxious seller, and willing but not anxious buyer, the price that the buyer and seller actually agreed on may generally be taken to be the market price, or at least a reliable indicator, if not the best evidence, of the market price.

While the offer from the Prospective Purchaser did not proceed to sale, the offer was from an arm's length purchaser and fell through in relation to the non-financial terms. Accordingly, the Commissioner is willing to accept the offer as a basis for the market value of the Company.

As the assets in the later entities are negligible the modified maximum net asset value test would be satisfied.

Modified active asset test

The modified active asset test is described in the following steps:

Step 1

Work out the total market value of both:

·   the assets of the company or trust

·   the assets of any entity in which the company or trust has a small business participation percentage (a later entity), multiplied by that percentage.

In working out the total market value (Step 1 amount), exclude the market value of shares or interests held, directly or indirectly, by the company or trust.

Step 2

Work out the total market value of both:

·   the active assets of the company or trust

·   the active assets of a later entity, multiplied by that percentage.

Assets of a later entity are only active assets for the purposes of the modified test if both:

·   the later entity, when applying the modified connected entity rule, either

-  is a small business entity

-  meets the maximum net asset value test in relation to a notional capital gain; and

·   you either:

-  have a small business participation percentage of at least 20% in the later entity

-  are a CGT concession stakeholder of the later entity.

Step 3

At least 80% of the Step 1 amount must be made up of:

·   active assets (the Step 2 amount)

·   cash or financial instruments that are inherently connected with a business carried on by the company or trust, or a later entity.

In this case, the 'later' entities would need to be included. These assets hold no or negligible assets. Accordingly, the assets included are those of the Company, more than 80% of which are active for the relevant period. Accordingly, the modified active asset test will be satisfied.

As both the conditions in subsection 152-10(1) of the ITAA 1997 and the additional conditions contained in subsection 152-10(2) of the ITAA 1997 are satisfied, you satisfy the basic conditions.

Retirement exemption

Subsection 152-305(1) of the ITAA 1997 allows an individual to choose to disregard some or all of a capital gain under the small business retirement exemption. An individual can choose to disregard such an amount if:

(a) the basic conditions in Subdivision 152-A are satisfied for the capital gain; and

(b) if you are under 55 just before you make the choice - you contribute an amount equal to the asset's CGT exempt amount to a complying superannuation fund or a retirement savings account.

You satisfy the basic conditions; therefore you can choose to apply the retirement exemption. If you are under 55 years of age at the time you make the choice, you will be required to contribute an amount equal to the exempt amount to a complying superannuation fund or a retirement savings account at the time you make the choice. Any choice is required to be made in writing and cannot exceed your lifetime CGT retirement exemption limit of $500,000.