Edited version of private advice

Authorisation Number: 1051609910268

Date of advice: 20 November 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 upon the sale of the units in the holding trust?

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

The Family Trust (family trust) is a discretionary family trust.

The family trust acquired XX% of units on XX November 20XX and an additional XX% of units on XX April 20XX in a fixed trust, The Holding Trust (holding trust).

The holding trust holds all the units in another fixed trust, The Trading Trust (trading trust).

The trading trust operates a retail business.

The assets of the holding trust as per the Balance Sheet (as at 30 June 20XX) consist of:

Units in the trading trust $ X,XXX

Loan to the trading trust $X,XXX,XXX

Intangible assets - formation costs $ XXX

Total Assets $X,XXX,XXX

The approximate market value of the units in the trading trust is $XXX,XXX.

Assets of the trading trust (from the Balance Sheet as at 30 June 20XX) consist of cash; stock on hand, trade debtors, plant and equipment and goodwill, with assets totalling $X,XXX,XXX.

The approximate market value of the trading trust's assets is $X,XXX,XXX.

The family trust sold its units in the holding trust in April 20XX which produced a capital gain.

The family trust satisfies the maximum net asset value test.

The family trust, the holding trust and the trading trust are all resident trusts for CGT purposes.

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 subsection 152-40(3)

Income Tax Assessment Act 1997 paragraph 152-40(4)(d)

Reasons for decision

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.

Active asset

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.

The test period begins when you acquired the asset and ends at the time of the CGT event (subsection 152-35(2) of the ITAA 1997).

A CGT asset is also an active asset at a given time if you own it and:

·        it is either a share in a company that is an Australian resident at that time or an interest in a trust that is a resident trust for CGT purposes for the income year in which that time occurs, and

·        the total of the following is 80% or more of the market value of all the assets of the company or trust.

-      The market values of the active assets of the company or trust; and

-      The market value of any financial instruments of the company or trust that are inherently connected with a business that the company or trust carries on; and

-      Any cash of the company or trust that is inherently connected with such a business. (subsection 152-40(3) of the ITAA 1997)

Certain assets are excluded from being active assets, including financial instruments (such as loans, debentures, bonds and promissory notes) (paragraph 152-40(4)(d) of the ITAA 1997). However, if a financial instrument is inherently connected with the business the company or trust carries on, it can count towards the satisfaction of the 80% test.

Inherent connection requires more than just some form of connection between the cash or financial instrument and the business. A financial instrument may be inherently connected to a business when the financial instrument is inherently connected with a business that the owner of that financial instrument carries on, rather than any business that a related entity carries on. Also, when an asset is a permanent or characteristic attribute of the business, such as goodwill or trade debtors it is considered to have an inherent connection.

An interest in an entity that itself holds interests in another entity that operates a business may be an active asset, depending on the successive application of the 80% test at each level.

Application to this case

A CGT event occurred upon the disposal of the units in the holding trust by the family trust, which resulted in a capital gain. The family trust also satisfies the maximum net asset test.

As the CGT asset are units in the holding trust, and the holding trust in turn holds units in the trading trust, we will need to apply the 80% test at each level to determine if the units in the holding trust are considered an active asset and whether the active asset test is satisfied.

Trading Trust

We consider that the assets and financial instruments of the trading trust (such as the cash, stock, plant and equipment, trade debtors and goodwill) are used within the retail business of the trading trust and are inherently connected with that retail business. As more than 80% of the assets held by the trading trust are active assets, the units in the trading trust are also considered active assets for the holding trust.

Holding Trust

The holding trust holds all the units in the trading trust, which are considered an active asset. The holding trust also has a loan to the trading trust which is a financial instrument and specifically excluded from being an active asset under paragraph 152-40(4)(d) of the ITAA 1997.

The loan is not considered to be inherently connected with a business that the holding trust carries on and therefore it will not count toward the satisfaction of the 80% test.

As less than 80% of the assets of the holding trust are not active assets, the holding trust does not meet the 80% test and therefore the units in the holding trust are not considered to be an active asset for the family trust.

Family Trust

To be eligible to apply the small business CGT concessions you must satisfy all four of the basic conditions. As the units in the holding trust are not considered active assets, the active asset test has not been satisfied and the family trust will not be eligible to apply the small business CGT concessions to the gain made from the disposal of the units.