Edited version of private advice

Authorisation Number: 1051621238834

Date of advice: 18 December 2019

Ruling

Subject: Income tax - capital gains tax - small business concessions - sale of shares

Question 1

Do you satisfy the basic conditions to apply the small business capital gains tax (CGT) concessions in relation to the disposal of shares in the company on XX July 20XX?

Answer

Yes

Question 2

Do you satisfy the basic conditions to apply the small business CGT concessions in relation to the disposal of shares in the company on XX December 20XX?

Answer

No

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Individual A is the Trustee of AB Trust (the trust), which is a discretionary trust.

Individual A is a beneficiary of the trust.

The trust acquired XXX shares in CD Pty Ltd (the company) in January 20XX, which equated to at least a 20% holding in the company.

The company is an Australian resident for tax purposes and operates a business.

On XX July 20XX the trust disposed of half its shares in the company to an unrelated party which resulted in a capital gain, reducing the holding in the company to less than 20%.

On XX December 20XX the trust disposed of XX shares in the company to another unrelated party which related in a capital gain.

Individual A was a director of the company until XX January 20XX when he resigned the position.

The trust resolved to distribute 100% of the income of the trust to Individual A in the year ended 30 June 20XX.

Assets of the trust as at 30 June 20XX are as follows:

·   Cash at bank $X

·   Market value of XXX Shares in the Company $XXX,XXX

The net assets of the company as at 30 June 20XX were $X,XXX,XXX

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-15

Income Tax Assessment Act 1997 subsection 328-125(1)

Income Tax Assessment Act 1997 paragraph 328-125(2)(a)

Income Tax Assessment Act 1997 subsection 152-35(1)

Income Tax Assessment Act 1997 subsection 152-35(2)

Income Tax Assessment Act 1997 subsection 152-40(3)

Income Tax Assessment Act 1997 subsection 152-10(2)

Income Tax Assessment Act 1997 subparagraph 152-10(2)(d)(i)

Income Tax Assessment Act 1997 subparagraph 152-10(2)(d)(ii)

Income Tax Assessment Act 1997 section 152-50

Income Tax Assessment Act 1997 section 152-55

Income Tax Assessment Act 1997 section 152-65

Income Tax Assessment Act 1997 section 152-70

Income Tax Assessment Act 1997 subsection 152-70(1)

Income Tax Assessment Act 1997 subsection 152-75(1)

Reasons for decision

Summary

In relation to the disposal of the shares on XX July 20XX, you have satisfied the basic conditions, the modified active asset test and the additional basic conditions for shares in a company or units in a trust; therefore you are entitled to apply the CGT small business concessions to any capital gain made from the disposal of the shares on 1 July 20XX.

In relation to the disposal of shares on XX December 20XX, you have not satisfied the additional basic conditions under subsection 152-10(2) of the ITAA 1997 and therefore you are not entitled to apply the CGT small business concessions to any capital gain made from the disposal of the shares on XX December 20XX.

Detailed reasoning

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 capital gains tax (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)         the conditions in subsection 152-10(1A) or (1B) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year.

(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.

Maximum Net Asset Value Test

Section 152-15 of the ITAA 1997 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) of the ITAA 1997 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) of the ITAA 1997 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.

Active asset test

Subsection 152-35(1) 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)

In your case, a CGT event occurred in relation to each disposal of your shares in the company, which resulted in a capital gain. You had two separate CGT events, one on XX July 20XX and the other XX December 20XX.

Your net assets are less than $6 million therefore you satisfy the maximum net asset value test. As more than 80% of the assets of the company are active assets or cash and financial instruments inherently connected with the business of the company, your shares are considered active assets and have been active assets over half of the period you have held them, therefore satisfying the active asset test.

Additional basic condition for shares in a company or interests in a trust

For CGT events happening on or after 8 February 2018, subsection 152-10(2) of the ITAA 1997 states:

The following additional basic conditions must be satisfied if the *CGT asset is a *share in a company, or an interest in a trust, (the object entity):

(a) the CGT asset would still satisfy the active asset test (see section 152-35) if the assumptions in subsection (2A) were made;

(b) if you do not satisfy the maximum net asset value test (see section 152-15) - you are carrying on a *business just before the *CGT event;

(c) either:

(i) the object entity would be a *CGT small business entity for the income year; or

(ii) the object entity would satisfy the maximum net asset value test (see section 152-15);

if the following assumptions were made:

(iii) the only CGT assets or *annual turnovers considered were those of the object entity, each affiliate of the object entity, and each entity controlled by the object entity in a way described in section 328-125;

(iv) each reference in section 328-125 to 40% were a reference to 20%;

(v) no determination under subsection 328-125(6) were in force;

(d) just before the CGT event, either:

(i) you are a *CGT concession stakeholder in the object entity; or

(ii) CGT concession stakeholders in the object entity together have a *small business participation percentage in you of at least 90%.

In your case, you satisfy the modified active asset test. Applying the modified connected entity rule, you would still satisfy the maximum net asset value test when including the net assets of the company in the calculation.

You are a trust that holds shares and not an individual therefore subparagraph 152-10(2)(d)(i) of the ITAA 1997 does not apply. To determine whether you pass the additional basic condition in subparagraph 152-10(2)(d)(ii) of the ITAA 1997 it has to be determined if you have a CGT concession stakeholder that has a small business participation percentage of at least 90%.

Section 152-50 of the ITAA 1997 states:

An entity satisfies the significant individual test if the entity had at least one significant individual just before the CGT event.

Section 152-55 of the ITAA 1997 states:

An individual is a significant individual in a company or a trust at a time if, at that time, the individual has a *small business participation percentage in the company or trust of at least 20%.

An individual's small business participation percentage is worked out in accordance with section 152-65 of the ITAA 1997 and is the sum of the individual's direct and indirect small business participation percentage.

An individual's direct small business participation percentage in a company is the least of the following percentages:

(a)  the percentage of voting power in the company; or

(b)       the percentage of any dividend that the company may pay; or

(c)       the percentage of any distribution of capital that the company may make.

Section 152-70 of the ITAA 1997 describes the direct small business participation percentage. On XX July 20XX you owned 20% of shares in the company and were entitled to any dividends that they may pay, you had a small business percentage of 20% in the company.

Individual A received 100% of the distribution of the income of the trust in the 20XX income year.

Under subsection 152-70(1) of the ITAA 1997, table item (3) Individual A has a direct small business participation percentage in the trust of 100% in the 20XX income year..

However, to determine if you have a significant individual in the company, the indirect small business participation percentage needs to be determined.

Subsection 152-75(1) of the ITAA 1997 states that to work out the indirect small business participation percentage that an entity (the holding entity) holds at a particular time in another entity (the test entity) by multiplying:

(a)       the holding entity's *direct small business participation percentage (if any) in another entity (the intermediate entity) at that time; by

(b)       the sum of:

(i)         the intermediate entity's direct small business participation percentage (if any) in the test entity at that time; and

(ii)        the intermediate entity's indirect small business participation percentage (if any) in the test entity at that time (as worked out under one or more other applications of this section).

Individual A has a small business participation percentage of 100% in the trust. The trust has a small business participation percentage in the company of 20% as at XX July 20XX. To determine Individual A's indirect small business participation percentage these two amounts are multiplied. Anthony has an indirect small business participation percentage of 20% at XX July 20XX.

Individual A is a significant individual of the company at XX July 20XX.

In relation to the disposal of the shares on XX July 20XX, you have satisfied the basic conditions, the modified active asset test and the additional basic conditions for shares in a company or units in a trust; therefore you are entitled to apply the CGT small business concessions to any capital gain made from the disposal of the shares on XX July 20XX.

In relation to the disposal of shares on XX December 20XX, Individual A has a small business participation percentage of 100% in the trust. The trust has a small business participation percentage in the company of less than 20% as at XX December 20XX. Individual A therefore has an indirect small business participation percentage of less than 20% at XX December 20XX and is not considered a significant individual of the company at XX December 20XX.

As such you have not satisfied the additional basic conditions under subsection 152-10(2) of the ITAA 1997 and you are therefore not entitled to apply the CGT small business concessions to any capital gain made from the disposal of the shares on XX December 20XX.