Edited version of private advice

Authorisation Number: 1051608326935

Date of advice: 12 December 2019

Ruling

Subject: CGT - small business concessions - basic conditions

Question

Do you satisfy the basic conditions to apply the small business capital gains tax (CGT) concessions?

Answer

No

This ruling applies for the following period:

Year ending 30 June 2018

The scheme commences on:

1 July 2017

Relevant facts and circumstances

You and your spouse jointly acquired the property on XX XX 20XX.

Company 1 Pty Ltd (Company 1) was incorporated on XX XX 20XX with you and your spouse as equal shareholders, holding XX ordinary shares each.

Company 1 ran a business in Location 1 from incorporation until XX XX 20XX, at which time existing stock was transferred to Company 2 Pty Ltd (Company 2). You and your spouse are equal shareholders of Company 2.

The property was used by Company 1 in their business from acquisition until XX XX 20XX, at which time business ceased.

Company 1 was deregistered on XX XX 20XX.

You derived rent from Company 1 for the period in which the property was used in Company 1's business.

After Company 1 ceased trading, the property was leased to a third party until its sale.

The property was sold on XX XX 20XX, with settlement occurring on XX XX 20XX, which resulted in a capital gain.

You and your spouse jointly held X properties holding equal interests in each property.

The Net Market Value of the X properties as at XX XX 20XX, was more than $6 million.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 152-15

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 328-110

Income Tax Assessment Act 1997 section 328-125

Income Tax Assessment Act 1997 section 960-100

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

Summary

You disposed of the property triggering CGT event A1, which resulted in a capital gain. You satisfy the active asset test, however you are not a small business entity in the income year nor do you do not satisfy the maximum net asset value test, therefore you do not meet the conditions to apply the small business CGT concessions.

Detailed reasoning

To qualify for the CGT small business concessions, you must satisfy several conditions that are common to all the concessions.

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)            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.

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

To be eligible to apply the small business CGT concessions you must satisfy all four of the basic conditions above.

A CGT event happens which resulted in a capital gain

CGT event A1 happens if you dispose of a CGT asset. You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. The time of the event is when you enter into the contract for disposal, or if there is no contract when the change of ownership occurs (section 104-10 of the ITAA 1997).

You disposed of the property which resulted in a capital gain, therefore the first two basic conditions will be satisfied.

CGT Small Business Entity

Subsection 152-10(1AA) states:

You are a 'CGT small business entity' for an income year if:

(a)         you are a *small business entity for the income year; and

(b)         you would be a small business entity for the income year if each reference in section 328-110 to $10 million were a reference to $2 million.

Subsection 328-110(1) states:

You are a small business entity for an income year (the current year) if:

(a)         you carry on a *business in the current year; and

(b)         one or both of the following applies:'

(i)           you carried on a business in the income year (the previous year) before the current year and your *aggregated turnover for the previous year was less than $10 million; and

(ii)         your aggregated turnover for the current year is likely to be less than $10 million.

As you and your spouse do not carry on business as individuals, you are not a small business entity. Both you and your spouse are shareholders in Company 2, which does carry on a business; however you do not carry on a business as an individual. To determine whether you pass the third basic condition in paragraph 152-10(1)(c) it has to be determined if you pass the maximum net asset value (MNAV) test.

Maximum Net Asset Value Test

Section 152-15 states:

You satisfy the maximum net asset value test if, just before the *CGT event, the sum of the following amounts does not exceed $6,000,000:

(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)).

Subsection 328-125(1) provides that an entity is connected with another entity if one of the entities controls the other entity, or if the two entities are controlled by the same third entity.

Paragraph 328-125(2)(a) contains a general direct control test which applies to all entities, except discretionary trusts, and is based on a 'control percentage' of at least 40% of any distribution of income or capital of the entity.

The term entity is defined in section 960-100 of the ITAA 1997 as including a partnership. The term partnership is defined in subsection 995-1(1) of the ITAA 1997 as:

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

The first limb of paragraph (a) of the above definition of partnership refers to an association of persons (other than a company or limited partnership) carrying on business as partners and therefore reflects the general law definition of partnership. The second limb of paragraph (a) which includes as a partnership entities which are in receipt of ordinary income or statutory income jointly refers to a tax law partnership.

It is the Commissioner's opinion that co-owners who receive rental income jointly from a rental property they own, would fall within the second limb of paragraph (a) and therefore be a tax law partnership.

In your case, you and your spouse are co-owners in X rental properties (including the property you sold), each holding a 50% interest. You jointly received ordinary income from these properties and therefore fall within the second limb of paragraph (a) and are considered to be a tax law partnership.

As you have a more than 40% control percentage in the tax law partnership, you will be required to include the entire net market value of the jointly held properties in your individual MNAV calculation. As the net market value of these X jointly held properties are more than $6 million dollars, you do not satisfy the MNAV test.

Active asset test

The final basic condition is for the CGT asset to satisfy the active asset test in section 152-35.

Subsection 152-35(1) states:

A *CGT asset satisfies the active asset test if:

(a)         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 specified in subsection (2); or

(b)         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 71/2 years during the period specified in subsection (2).

Subsection 152-35(2) states:

The period:

(a)         begins when you *acquired the asset, and

(b)         ends at the earlier of

(i)           the *CGT event; and

(ii)         if the relevant business ceased to be carried on in the 12 months before that time or any longer period that the Commissioner allows - the cessation of the business.

Subsection 152-40(1) relevantly states:

A *CGT asset is an active asset at a time if, at that time you:

(a)         own the asset (whether the asset is tangible or intangible) and it is used, or held ready for use, in the course of carrying on a *business that is carried on (whether alone or in partnership) by:

(i)           you; or

(ii)         your *affiliate; or

(iii)        another entity that is *connected with you; or

(b)         if the asset is an intangible asset - you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you.

The combined effect of sections 152-35 and 152-40 is that the asset will meet the active asset test if the asset was used, or held ready for use, in the course of carrying on a business for at least half of the time period it was owned, subject to the exclusions in subsection 152-40(4).

You owed the property for less than 15 years and it was used in the business of an entity that was connected with you (Company 1) for more than half the period of your ownership. Therefore the property will satisfy the active asset test.

Conclusion

You disposed of the property triggering CGT event A1, which resulted in a capital gain. You satisfy the active asset test, however you are not a small business entity in the income year nor do you do not satisfy the maximum net asset value test, therefore you do not meet the conditions to apply the small business CGT concessions