Edited version of private advice

Authorisation Number: 1051639557095

Date of advice: 26 February 2020

Ruling

Subject: Small business capital gains concessions

Question 1

Will the trustee for the X Trust (X Trust) satisfy the Maximum Net Asset Value (MNAV) Test just before the sale of its shares in B Ltd by virtue of the net value of the CGT assets of X Trust together with any affiliates and connected entities of X Trust, not exceeding $6,000,000 under section 152-15 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will X Trust satisfy subsection 152-40(3) of the ITAA 1997 by virtue of owning shares in an Australian resident company at a given time and at that time, satisfy the conditions of the Active Asset 80% test outlined in that subsection?

Answer

Yes.

This ruling applies for the following period(s)

Year ending 30 June 20XX.

The scheme commences on

1 July 20XX.

Relevant facts and circumstances

Individual C and Individual D are husband and wife and the only beneficiaries of the X Trust who will receive any distribution of net income or capital for the year ending 30 June 20XX. As part of an internal structuring process, the trustee of the X Trust sold its shares (representing 95% of the total issued shares) in B Ltd to a related company, F Ltd on XX Month 20XX. F Ltd held a small percentage of the shareholding prior to the sale and now own 100% of the shares after the disposal.

X Trust purchased its shares in B Ltd in two transactions, X shares in 20XX and X shares in 20XX.

The intention is for Individual C and Individual D is to apply the CGT method statement whereby any capital losses reduce the capital gain prior to the 50% CGT discount.

On the premise that they meet all the conditions under Division 152, they will apply the CGT small business exemption of 50% and then choose the CGT small business retirement exemption in respect of the residual capital gain. Neither individual has previously made a reduction in their respective lifetime limits of $500,000.

The application is supported by schedules which include calculations for the purposes of the Maximum Net Asset Value Test and the Active Asset Look-Through (80%) Test.

A specialist valuation firm was engaged to prepare an independent valuation report in regard to the shares in B Ltd. Two separate reports have been provided, one a period before the sale and a second, immediately before the sale. The reports include a separate valuation of the business enterprise which is owned and operated by B Ltd.

You provided the following details of the calculation of net assets of connected entities of the test entity, X Trust for the purposes of the Maximum Net Asset Value Test at Appendix 2 of your application.

The following attachments were provided with your application for ruling and reply to request for additional information dated XX Month 20XX and XX Month 20XX. The following information provided form part of the facts of this ruling:

·         Application for private ruling form;

·         Appendix 1 - Details of Business Valuation, cost base of shares and CGT calculations;

·         Appendix 2 Maximum Net Asset Value Test details, included net assets of connected entities;

·         Appendix 3 details of Total Active Assets for B Ltd as at immediately before the sale and for financial years during ownership of the shares in B Ltd;

·         Independent Business Valuations for B Ltd prepared by independent valuer issued

·         XX Month 20XX and XX Month 20XX; and

·         Financial statements of B Ltd for year ended 30 June 20XX.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-15

Income Tax Assessment Act 1997 paragraph 152-15(b)

Income Tax Assessment Act 1997 paragraph 152-15(c)

Income Tax Assessment Act 1997 subsection 152-20(1)

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 subsection 152-40(1)

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

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

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

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

Income Tax Assessment Act 1997 section 328-125

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

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

Income Tax Assessment Act 1997 section 328-130

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

Question 1

Summary

It is considered that the net value of CGT assets of X Trust and its connected entities does not exceed $6,000,000 and therefore the MNAV test in section 152-15 of the ITAA 1997 is met.

Detailed reasoning

Maximum net asset value test

Section 152-15 of the Income Tax Assessment Act 1997 (ITAA 1997) explains that 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 152-20(1) of the ITAA 1997 provides that the 'net value of the CGT assets' of an entity is the amount (whether positive, negative or nil) obtained by subtracting from the sum of the market values of those assets the sum of:

(a)  the liabilities of the entity that are related to the assets; and

(b)  the following provisions made by the entity:

                      i.        provisions for annual leave;

                     ii.        provisions for long service leave;

                    iii.        provisions for unearned income;

                   iv.        provisions for tax liabilities.

The 'net value of CGT assets' means the amount by which the market value (not book value) of each CGT asset exceeds the liabilities that are related to the assets and various specific provisions.

Assets to be included in determining the net value of the CGT assets are not restricted to business assets. They include all CGT assets of the entity, unless they are specifically excluded, such as personal assets.

The current tax law does not define market value in any general provision. It is defined in the 'Definitions' part (section 995-1 of the ITAA 1997), but not in a way that fixes its meaning in all contexts. As a result, 'market value' usually takes the ordinary meanings given below, unless specially defined or qualified in a particular provision.

Business valuers in Australia typically define market value as:

...the price that would be negotiated in an open and unrestricted market between a knowledgeable, willing but not anxious buyer and a knowledgeable, willing but not anxious seller acting at arm's length.

Connected Entity

Paragraph 152-15(b) of the ITAA 1997 requires the inclusion of the net value of the CGT assets of any entities connected with you as part of the maximum net asset value test.

An entity is connected with another entity if the first entity and/or its affiliate controls the other or both entities are controlled by the same third entity in a manner as prescribed in section 328-125 of the ITAA 1997 (subsection 328-125(1) of the ITAA 1997).

An entity controls a company if it, its affiliates or all of them together beneficially own, or have the right to acquire beneficial ownership of equity interests in the company that carry between them at least 40% (the control percentage) of the voting power in the company under paragraph 328-125(2)(b) of the ITAA 1997.

Affiliate

Paragraph 152-15(c) of the ITAA 1997 requires the inclusion of the net value of any affiliates of yours or entities connected with your affiliates (not counting any assets already counted under paragraph (b)).

An affiliate is defined by section 328-130 of the ITAA 1997 as being an individual or company who 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.

The following requirements must be met for an entity to qualify as the entity's affiliate:

(a) the entity must be an individual or company;

(b) the entity must carry on a business; and

(c) in relation to its business affairs, the entity must act, or could reasonably be expected to act according to the directions or wishes of the entity or in concert with the entity.

An individual is not an affiliate merely because of a shared business relationship and the definition of affiliate in section 328-130 of the ITAA 1997 does not automatically include the taxpayer's spouse or child under the age of 18 years.

Whether a person acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes, or in concert with the taxpayer is a question of fact dependent on all the circumstances of the particular case. No one factor will necessarily be determinative.

The Explanatory Memorandum to the Tax Laws Amendment (Small Business) Bill 2007 in Chapter 2 discusses relevant factors that may support a finding that a person acts in such a manner include:

·         the existence of a close family relationship between the parties;

·         the lack of any formal agreement or formal relationship between the parties dictating how the parties are to act in relation to each other;

·         the likelihood that the way the parties act, or could reasonably be expected to act, in relation to each other would be based on the relationship between the parties rather than on formal agreements or legal or fiduciary obligations; and

·         the actions of the parties.

Whether a person is acting in concert with another is essentially a question of fact. The term 'acting in concert' involves at least an understanding between the parties as to a common purpose or object.

Application to the circumstances

Connected Entities of X Trust

Section 152-15(b) of the ITAA 1997 requires the inclusion ofthe net value of the CGT assets of any entities connected with you as part of the maximum net asset value test.

We agree that the connected entities of the test entity, X Trust are as provided in your submission. All these entities are controlled in a way described in section 328-125 of the ITAA 1997 by the same entities, being Individual C and Individual D. Connected entities of X Trust are:

·         B Ltd

·         Individual C;

·         Individual D;

·         G Ltd (Trustee for X Trust);

·         F Ltd; and

·         K Ltd.

Net assets of the connected entities, apart from B Ltd, consist of current assets, such as cash, debtors and inter-entity loans. The net asset values of these connected entities are accepted.

It is noted that B Ltd's Net Assets are as per Valuation Report dated X Month 20XX, immediately before the sale of B Ltd shares. A previous valuation was also provided as at XX Month 20XX. This earlier valuation and methodology used was accepted after referral to the Australian Valuation Office for comment. As the current valuation as immediately before the sale of shares in B Ltd was based upon the same methodology, this is also acceptable.

Based upon the facts presented, X trust has no affiliates as defined in section 328-130 of the ITAA 1997.

Conclusion

Based on the above analysis and Appendix 2 as detailed in the facts, it is considered that the net value of CGT assets of X Trust and its connected entities do not exceed $6,000,000 and therefore the MNAV test in section 152-15 of the ITAA 1997 is met.

Question 2

Summary

It is considered that X Trust satisfies the conditions of the Active Asset 80% test outlined in subsection 152-40(3) of the ITAA 1997 in respect of the relevant test period of its ownership of B Ltd shares.

Detailed reasoning

A capital gain you make on the disposal of a capital gains tax (CGT) asset may be reduced or disregarded under Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997) if certain conditions are satisfied. One of those conditions requires that the CGT asset satisfies the active asset test contained in section 152-35 of the ITAA 1997.

A CGT asset will satisfy 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 test period.

The test period begins when you acquired the asset and ends at the earlier of the CGT event and if the relevant business ceased to be carried on in the 12 months before that time - the cessation of the business.

Subsection 152-40(1) of the ITAA 1997 provides that a CGT asset is an active asset at a time if it is used, or held ready for use, in the course of carrying on a business that is carried on by you, or your affiliate, or another entity that is connected to you.

Subsection 152-40(3) of the ITAA 1997 provides that a share in a company that is an Australian resident can also be an active asset on the basis that:

·         The market values of the active assets of the company; and

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

·         Any cash of the company that is inherently connected with such a business;

is 80% or more of the market value of all the assets of the company.

As the active asset test requires a CGT asset to have been an active asset for at least half of a particular period, as outlined earlier, in order for a share in an Australian resident company to meet this requirement, the company must satisfy the 80% test for that same period.

The 80% test will be taken to be met:

·         where breaches of the threshold are only temporary in nature (subsection 152-40(3B) of the ITAA 1997), and

·         in circumstances where it is reasonable to conclude that the 80% threshold has been passed (subsection 152-40(3A) of the ITAA 1997)' such as where there have been no significant changes to the assets or liabilities of the company.

Application to your circumstances

The CGT assets disposed of are the shares in B Ltd. The shares will be active assets if they meet the 80% market value test. There are two test periods in regards to the shares held by X Trust in B Ltd. They are:

·         X shares acquired on XX Month 20XX and sold X Month 20XX; and

·         X shares acquired on XX Month 20XX and sold X Month 20XX.

The assets of B Ltd are listed in Appendix 3 and include cash assets, accounts receivable, stock and loans. We agree that the assets listed; apart from loans excluded under paragraph 152-40(4(d) of ITAA 1997 are active assets as they are considered to be inherently connected to B Ltd's business.

Appendix 3 has outlined that you have met the 80% test in X of the past X years. It is noted that cash assets in the two years where the active assets were marginally below 80% were considerably lower than in other years. It is considered reasonable in these circumstances to accept that that B Ltd also meets the requirement under subsection 152-40(3) of the ITAA 1997 in those years by the operation of subsection 152-40(3B) of the ITAA 1997.

Regardless of the operation of 152-40(3B) above, it is considered that the requirements of subsection 152-40(3) of the ITAA 1997 were satisfied during the period of ownership of the two parcels of B Ltd shares as the 80% active asset was passed for at least half of the period of ownership as required by section 152-35 of the ITAA 1997.