Edited version of private advice

Authorisation Number: 1051616681845

Date of advice: 10 December 2019

Ruling

Subject: CGT Concessions for small business

Question 1

In relation to the proposed disposal of the asset owned by the taxpayer, would the taxpayer satisfy the basic condition for capital gain tax (CGT) small business relief under Subdivision 152-A of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

In relation to the proposed disposal of the asset owned by the taxpayer, would the taxpayer be able to choose to disregard a capital gain amount of no more than $X in total by utilising the small business retirement exemption under Subdivision 152-D of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

01 July 20XX to 30 June 20XX

The scheme commences on:

01 July 20XX

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

The taxpayer operates a business under its registered business name.

The taxpayer received an offer from a third party to purchase certain asset owned by the taxpayer.

The taxpayer's aggregated turnover for the relevant income year is stated to be over $2 million.

In calculating the aggregated annual turnover, the taxpayer does not have any connected entity at any time.

Shareholder(s) of the taxpayer do not carry on a business in his/their own right(s).

Shareholder(s) of the taxpayer is/are over the age of 55.

The taxpayer has never utilised any CGT small business relief concessions, nor has made any contributions on behalf of any CGT concession stakeholder(s), including but not limited to its shareholder(s).

The taxpayer's shareholder(s) has/have never utilised any CGT small business relief concession in the past.

Assumptions

For purpose of the maximum net asset value (MNAV) test,

·        the offer price represents the market value of the business just before the time of the CGT event;

·        the provided book value of the taxpayer's assets as at certain date represents their market values just before the time of the CGT event.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 104

Income Tax Assessment Act 1997 Division 152

Reasons for decision

Unless otherwise stated, all legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997).

Question 1

Detailed reasoning

Pursuant to subsection 104-10(1), CGT event A1 happens if a taxpayer disposes of a CGT asset. The disposal of a CGT asset takes place if a change of ownership occurs from the taxpayer to another entity, whether because of some act or event or by operation of law: subsection 104-10(2).

The asset is a CGT asset owned by the taxpayer under section 108-5.

Should the proposed disposal proceed, it constitutes CGT event A1. The taxpayer will make a capital gain from the CGT event.

Division 152 provides CGT small business concessions that can apply to CGT events; these include small business 50% reduction, and the small business retirement exemption.

Pursuant to section 152-205, a capital gain that arises from a CGT event happening to an active asset may be reduced by 50%, if the following basic conditions in Subdivision 152-A are satisfied:

·        a CGT event happens in relation to an asset that the taxpayer owns;

·        the event would otherwise have resulted in a capital gain;

·        one or more of the following applies:

- the taxpayer satisfies the maximum net asset value test,

- the taxpayer is a CGT small business entity for the income year,

- the asset is an interest in an asset of a partnership which is a CGT small business entity for the income year, and the taxpayer is a partner in that partnership, or

- the special conditions for passively held assets in subsections 152-10(1A) or (1B) are satisfied in relation to the CGT asset in the income year;

·        the asset satisfies the active asset test; and

·        if the CGT asset is a share in a company or an interest in a trust, additional basic conditions.

Maximum net asset value test

In accordance with section 152-15, a taxpayer satisfies the maximum net asset value (MNAV) test if, just before the time of the CGT event, the net value of the CGT assets of the taxpayer, its connected entities, its affiliates and the entities connected with those affiliates does not exceed $6 million.

The definition of an entity 'connected with' another entity is contained in subsection 328-125(1), where it provides that, an entity is connected with another entity if:

(a)   either entity controls the other entity in a way described in this section; or

(b)   both entities are controlled in a way described in this section by the same third entity.

Subsequently, subsections 328-125(2) to 328-125(8) describe the meanings of direct control and indirect control of an entity and the circumstance when the Commissioner may determine that an entity does not control another entity.

Affiliate is defined in section 328-130, it states that:

(1)   an individual or a company is an affiliate of yours if the individual or company acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the business of the individual or company.

(2)   however, an individual or a company is not your affiliate merely because of the nature of the business relationship you and the individual or company share.

Paragraph 2.35 of the Explanatory Memorandum (EM) to the Tax Laws Amendment (Small Business) Bill 2007 explains that the affiliate rules are designed to ensure that entities that genuinely carry on independent businesses are not aggregated.

Paragraph 2.36 of the EM to the Tax Laws Amendment (Small Business) Bill 2007 lists down the following factors that may have a bearing on whether an individual or company is an affiliate of an entity:

·        family or close personal relationships;

·        financial relationships or dependencies;

·        relationships created through links such as common directors, partners, or shareholders;

·        the degree to which the entities consult with each other on business matters; or

·        whether one of the entities is under a formal or informal obligation to purchase goods or services or conduct aspects of their business with the other entity.

Existence of an affiliate is a question of fact.

An individual or a company can be an affiliate only if they carry on a business; however a mere shared business relationship between partners, co-directors and co-trustees will not of itself make one party an affiliate of the other without the factual requirement being satisfied.

In the AAT Case Stephens v FCT [2008] AATA 176; 71 ATR 306, it requires that, the individual or company must act in accordance with the directions or wishes of the taxpayer in relation to the business affairs of the individual or company (and not in relation to non-business matters between the parties).

Further, a spouse of the taxpayer is not automatically an affiliate of the taxpayer. Instead, section 152-47 states that a spouse will be an affiliate of a taxpayer only where an asset owned by a taxpayer is used in a business which is not otherwise a "connected entity" or an affiliate of the taxpayer, but that business is carried on by the spouse or through an entity the spouse controls. In that case, the spouse will be considered an affiliate of the taxpayer. In other words, a spouse can be deemed to be an "affiliate" under section 152-47, where an asset of the taxpayer is used in a business that the spouse or child carries on in their own right or through an entity they control.

On the facts, the taxpayer has no connected entity; the taxpayer's shareholder(s) does/do not carry on a business in his/their own right(s), nothing could indicate or establish that any associated individual or entity of the taxpayer acts in accordance with the directions or wishes of the taxpayer in relation to the business affairs of the individuals or entity (if any) or any asset owned by the taxpayer is used in a business that is carried on by any associated individual in their own right through an entity they control. Accordingly, the taxpayer has no affiliate either.

If just before the time of the CGT event, an entity has no connected entities or affiliates, the entity would satisfy MNAV test if net value of the CGT assets of the entity is less than $6 million.

The net value of an entity's asset is measured as the amount equal to the market value of those assets less the sum of liabilities that are related to those assets and provisions for annual leave, long service leave, unearned income and tax liabilities: subsection 152-20(2).

The market value of an asset should be assessed on the basis of its "highest and best use" as recognised in the market.

In the Decision impact statement Syttadel Holdings Pty Ltd and Commissioner of Taxation 2010/1912, it states that, the ATO generally considers the sale price of an asset to be its market value. However, in each particular case all the relevant facts and circumstances must be taken into account to determine the most appropriate methodology for calculating market value.

For purpose of the test, the calculation includes the market value of depreciating assets even though any gains or losses from such assets are disregarded for CGT purposes.

"Liabilities" include legally enforceable debts due for payment and presently existing legal or equitable obligations to pay either a sum certain or ascertainable sums, but does not extend to future obligations, expectancies or liabilities that are uncertain as both a theoretical and a practical matter.

On the facts and the stated assumptions, net value of the CGT assets of the taxpayer is considered less than $6 million. Therefore, the taxpayer satisfies the MNA test under section 152-15.

Active asset test

On the facts, the asset is an active asset of the taxpayer: paragraph 152-40(1)(a) and satisfies the active asset test: section 152-35.

Should the proposed disposal of the taxpayer's asset proceed, the basic conditions for CGT small business relief in Subdivision 152-A are satisfied; accordingly, the amount of capital gain can be reduced by 50% under section 152-205.

Question 2

Detailed reasoning

A taxpayer can choose to disregard a capital gain from a CGT event happening to an asset of its small business if the capital proceeds from the event are used in connection with retirement.

There is a lifetime limit of $500,000 for all choices that can be made in respect of an individual under Subdivision 152-D.

The small business 50% reduction applies before the small business retirement exemption unless you choose not to apply the 50% reduction.

Pursuant to subsection 152-305(2), a company can choose to disregard all or part of a capital gain if:

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

(b)   the company satisfies the significant individual test under section 152-50; and

(c)   the company or trust conditions in section 152-325 are satisfied.

An entity satisfies the significant individual test if the entity had at least one significant individual just before the relevant CGT event: section 152-50.

An individual is a significant individual in a company at a time if, at that time, the individual has a small business participation percentage in the company of at least 20%: section 152-55.

The small business participation percentage is the sum of the entity's direct and indirect small business participation percentage in the company: section 152-65.

Direct small business participation percentage in a company is defined in subsection 152-70(1) as the percentage that the entity has because of holding the legal and equitable interest in shares in the company:

·        the percentage of the voting power in the company; or

·        the percentage of any dividend that the company may pay; or

·        the percentage of any distribution of capital that the company may make;

or, if they are different, the smaller or smallest.

On the facts, the taxpayer satisfies the significant individual test under section 152-50.

The company or trust conditions require the entity to make payments of the CGT exempt amount to at least one of its CGT concession stakeholders upon the time when the entity receiving an amount of capital proceeds from a CGT event A1 for which it chooses to disregard a capital gain under the CGT retirement exemption: subsection 152-325(1).

If the company or trust receives the capital proceeds in instalments (including financial benefits received under a look-through earnout right), payments must be made from each instalment in succession up to the CGT exempt amount.

The shareholder(s) of the taxpayer is/are CGT concession stakeholder(s) of the taxpayer, as they are significant individual(s) in the taxpayer: section 152-60.

In choosing the amount to disregard, section 152-315 requires that:

·        for the taxpayer, the CGT retirement exemption limit for each of the CGT concession stakeholder(s) for whom the choice is made should not be exceeded.

·        the taxpayer must specify the CGT exempt amount in writing in the choice to apply the retirement exemption: subsection 152-315(4). The way in which the income tax return is prepared is not sufficient evidence of the choice.

·        the taxpayer must specify in writing the percentage of each CGT asset's CGT exempt amount that is attributable to each of the CGT concession stakeholder(s), and total of the percentages must add up to 100%: subsection 152-315(5).

In addition, the choice of the taxpayer to apply the retirement exemption must be made by the date of lodgement of its income tax return for the relevant income year in which the CGT event occurs, or such further time as the Commissioner allows: section 103-25.

Payment(s) of the CGT exempt amount must meet the following requirements under the company or trust conditions in section 152-325:

·        where the payment is made to more than one CGT concession stakeholder, the amount of each payment is worked out by reference to the individual's percentage entitlement to the relevant CGT exempt amount: subsection 152-325(3).

·        the percentage entitlement for each CGT concession stakeholder is the amount specified in the written choice to apply the exemption. The percentage can range from nil to 100%, but the total of the percentages must add up to 100%.

·        if the CGT concession stakeholder is an employee of the entity, the payment must not be of a kind mentioned in section 82-135, which specifies certain types of payments that are not employment termination payments, including a payment that is deemed to be a dividend: subsection 152-325(3A).

·        the payment(s) must be made by the later of seven days after:

-       the choice to apply the retirement exemption is made subparagraph 152-325(4)(b)(i), or

-       the entity receives the capital proceeds: subparagraph 152-325(4)(b)(ii).

·        the amount of the payment, or sum of the amounts of the payments, must be equal to the lesser of the capital proceeds received and the relevant CGT exempt amount: subsection 152-325(5).

As the CGT concession stakeholder(s) is/are over the age of 55 before the CGT event takes place, subsection 290-150(4) does not apply in this case.

On the basis that, the CGT concession stakeholder(s) has/have never utilised or accessed any retirement exemption in the past, the respective lifetime limit of $500,000 for each CGT concession stakeholder(s) would not be reduced by any previous amount(s) disregarded: subsection 152-320(1).

In making the choice to apply the retirement exemption, provided the taxpayer satisfies the relevant requirements in section 152-315 and section 103-25, as well as the company or trust conditions in section 152-325, and after application of the small business 50% reduction under section 152-205, the taxpayer can choose to disregard a capital gain amount of up to $X in total from disposal of the business by utilising the small business retirement exemption under Subdivision 152-D.

Consequences of utilising the small business retirement exemption include that:

·        the payments of the CGT exempt amount that taxpayer is to make to the CGT concession stakeholder(s) with the above company or trust conditions cannot be deducted from the taxpayer's assessable income, and they would constitute non-assessable, non-exempt income of the relevant CGT concession stakeholder(s).

·        the lifetime CGT retirement exemption limit of $500,000 for each of the CGT concession stakeholder(s) will be reduced accordingly by the corresponding CGT exempt amount(s) under the written choice within the above company or trust conditions; should the limit of $500,000 for any of the CGT concessional stakeholder(s) have been fully utilised, the relevant CGT concessional stakeholder(s) would not be eligible to utilise or access any retirement exemption in future.