Edited version of private advice

Authorisation Number: 1051629363778

Date of advice: 21 February 2020

Ruling

Subject: Small business concessions

Question 1

Do you meet the basic conditions necessary to access the capital gains tax (CGT) concessions for small business on the sale of the property as per Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Is the land considered an active asset for the purposes of section 152-35 of the ITAA 1997?

Answer

No

Question 3

Are the current partners eligible to access the small business 50% reduction under section 152-205 of the ITAA 1997?

Answer

No

Question 4

Are the current partners eligible to access the retirement concession in subdivision 152-D of the ITAA 1997?

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

The property has an area of approximately X hectares.

B was the sole owner of the property until their death after 20 September 1985.

After B's death, the property passed from B to the spouse, C and their children, D, E and F (current partners) in equal shares under B's will.

On X February 19XX a partnership was formed comprising C, D, E and F.

On or about X February 19XX, the property (and any income generated from the land) was considered property of the partnership, albeit there was general agreement for C to be the primary recipient of the income generated from the property in the early years.

In October 20XX, C died and thier interest in the property passed under their will to the current partners equally. From that date the property has been held by the current partners in equal shares as tenants in common.

You disposed of the property on XX October 20XX to an unrelated third party.

Current information

The current partners all meet the maximum net asset value test individually.

The current partners are all over the age of 55.

None of the current partners have chosen to exempt capital gains under subdivision 152-305 of the ITAA 1997 and the full CGT retirement exemption limit is available

Land usage

The property was used by the partnership to carry on business activities from February 19XX to 20XX. From the 20XX-XX income year to present, business activity has ceased on the property.

In addition to the use of the property for the partnership business activity, other activities have also been occurring on the property, with the partnership deriving rent and royalties in relation to these activities.

Since 19XX the partnership leased part of the land to various unrelated third parties to derive rent and allowed those third parties to undertake activities, from which the partnership derived royalty income.

Since XX April 20XX, a contract lease has been in place with an unrelated third party allowing them to conduct activities on part of the land.

Between 19XX and 20XX, approximately XX% of the property was used to derive royalties and rent. Between 20XX and 20XX the amount of the property used to derive royalties and rent increased to approximately XX%.

In 19XX, when the partnership commenced, the income from farming activities and from rent and royalty payments were almost equal.

Between 19XX and 20XX, while the farming activities were still being undertaken, the income derived from rent and royalty payments averaged XX% of the total partnership income.

The annual partnership income from farming activities between 19XX and 20XX ranged from $XXXX to $XXXXX; whilst the income from the rent and royalty payments ranged from $XXXXX to $XXXXXX per annum.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-15

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 152-205

Income Tax Assessment Act 1997 section 152-210

Income Tax Assessment Act 1997 Subdivision 152-D

Reasons for decision

Summary

A CGT event will happen upon the disposal of the property, which will result in a capital gain. Each partner satisfies the maximum net asset value test, however as the land is excluded from being an active asset, you do not satisfy the active asset test. As such, you have not satisfied all four of the basic conditions to be eligible to apply the CGT small business concessions

Detailed reasoning

Basic Conditions

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 Income Tax Assessment Act 1997 (ITAA 1997) states that 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).

Paragraph 152-40(4)(e) provides that a CGT asset cannot be an active asset where an assets main use is to derive interest, an annuity, rent, royalties or foreign exchange gains.

For the purposes of paragraph 152-40(4)(e) of the ITAA 1997, in determining the main use of an asset any personal use or enjoyment of the asset by the taxpayer is disregarded and any use by the taxpayer's affiliate, or an entity connected with the taxpayer, is treated as the taxpayer's use (subsection 152-40(4A) of the ITAA 1997)

Taxation Determination TD 2006/78 considers, amongst other issues, the situation where there is part business and part rental use of an asset. It states that an asset owned by the taxpayer and used partly for business purposes and partly to derive rent can be an active asset under section 152-40 of the ITAA 1997 where it is considered that the main use of the premises is not to derive rent.

In deciding if the property was mainly used to earn rent the Commissioner will consider a range of factors such as:

·         the comparative areas of use of the premises (between rent and business)

·         the comparative times of use of the premises (between rent and business), and

·         the comparative levels of income derived from the different uses of the asset.

Application to your circumstances

Active asset test

The property has been used both for business purposes and to derive royalties. In determining whether the main use of the land is to derive royalties, it is appropriate to consider a range of factors.

Comparative areas of use of the property

Between 19XX to 20XX, approximately X% of the land area of the property was used to derive rent and royalties increasing to just over X% of the land area from 20XX to disposal. The remaining land area was used for farming activities between 19XX to 20XX, when farming activities ceased.

Comparative levels of income derived from different uses of the asset

In 19XX, when the partnership commenced, the income from farming activities and from rent and royalty payments were almost equal.

However, between 19XX and 20XX, while the farming activities were still being undertaken, the income derived from rent and royalty payments ranged from averaged X% of the total partnership income being derived from rent and royalties.

The annual partnership income from farming activities between 19XX and 20XX ranged from $XXXX to $XXXXX; whilst the income from the rent and royalty payments ranged from $XXXXX to $XXXXXX per annum.

In this case, a substantial (although not a majority) proportion by area of the land is used for the derivation of rent and royalties. Additionally, the rent and royalty portion of the land derives a vast majority (XX% on average) of the total income of the partnership. In these circumstances, we consider the main use of the land is to derive rent and royalties and accordingly the land is excluded from being an active asset under paragraph 152-40(4)(e) of the ITAA 1997.

In your case, a CGT event will happen upon the disposal of the property, which will result in a capital gain. Each partner satisfies the maximum net asset value test, however as the land is excluded from being an active asset, you do not satisfy the active asset test. As such, you have not satisfied all four of the basic conditions to be eligible to apply the CGT small business concessions.

Small business 50% reduction and retirement exemption

Section 152-205 provides that you get the small business 50% reduction if the basic conditions in subdivision 152-A of the ITAA 1997 at satisfied for the gain.

Subdivision 152-D of the ITAA 1997 contains the small business retirement exemption. You may choose to disregard all or part of a capital gain under the small business retirement exemption if you satisfy certain conditions.

As an individual you can choose to disregard all or part of a capital gain if:

·         you satisfy the basic conditions

·         you keep a written record of the amount you chose to disregard (the CGT exempt amount), and

·         if you are under 55 years old just before you choose to use the retirement exemption, you make a person contribution equal to the exempt amount to a complying superannuation fund or retirement savings account.

There is no requirement to make this contribution if the individual was 55 years old or older.

In your case, you have not satisfied the basic conditions in subdivision 152-A of the ITAA 1997 and therefore you do not satisfy the conditions to apply either the small business 50% reduction or the retirement exemption.