Edited version of private advice

Authorisation Number: 1051645809919

Date of advice: 16 March 2020

Ruling

Subject: Small business CGT concessions - sale of shares in a related company - extension of time to acquire a replacement asset

Question 1

Did the Trust satisfy the basic conditions under Subdivision 152-A of the Income Tax Assessment Act of 1997 (ITAA 1997) for the capital gain?

Answer 1

Yes

Question 2

Will the Commissioner exercise the discretion in subsection 104-190(2) of the ITAA 1997 to extend the replacement asset period to acquire a replacement asset?

Answer 2

Yes

This ruling applies for the following periods:

Year ended 30 June 20xx

Year ended 30 June 20xx

Year ended 30 June 20xx

Year ended 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

The family discretionary trust owns shares in Australian companies A and B.

The trust beneficiaries are husband and wife.

The trustee and the other shareholder sold all of their shares in company A to a third party under an earnout arrangement.

The trust made a capital gain. The trustee applied the 50% active asset reduction and small business rollover to the capital gain.

Replacement asset

The trustee purchased a commercial property for use in its proposed practice.

The project failed due to restrictive covenants dispute among the shareholders of company B. The other owners argued that the proposed practice will intrude with company B's commercial geographic interests. The parties tried to negotiate for compensation payments should the project continue. The parties did not reach an agreement.

The trustee did not proceed with the project in order to preserve its broader business interest and positive working relationship with the other owners of company B.

Accordingly the trustee is seeking an additional twelve months to acquire an alternative property.

Eligibility conditions

The net asset value for the trust and its connected entities was less than $6 million.

Company A's active assets were more than 80% of its total assets for the trust's entire shareholding period.

Just before the shares were sold, the husband and wife beneficiaries received more than 90% of the trust's distributions, with one of them having more than 20% indirect interest in company A.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 Subdivision 152-C

Income Tax Assessment Act 1997 Subdivision 152-E

Income Tax Assessment Act 1997 section 104-190

Income Tax Assessment Act 1997 section 104-197

Income Tax Assessment Act 1997 section 104-198

Income Tax Assessment Act 1997 subsection 104-197(2)

Reasons for decision

Question 1

Did the Trust satisfy the basic conditions under Subdivision 152-A of the Income Tax Assessment Act of 1997 (ITAA 1997) for the gain?

Summary

The Trust has satisfied the basic conditions in regards to the capital gain from the sale of its shares in Company A.

Detailed reasoning

The rules covering the small business 50% active asset reduction are contained in Subdivision 152-C of the ITAA 1997. If you satisfy the basic conditions, the capital gain that remains after applying any current year capital losses and any unapplied prior year net capital losses, and the CGT discount (if applicable), is reduced by 50%.

On the other hand, the rules covering the small business rollover are contained in Subdivision 152-E of the ITAA 1997. The small business rollover allows you to defer all or part of a capital gain made from a CGT event happening to an active asset. To qualify for the small business rollover, you need to satisfy the basic conditions that apply to all the CGT small business concessions.

Condition 1 ­- Basic conditions in subdivision 152-A of the ITAA 1997

According to subsection 152-10(1) of the ITAA 1997:

A capital gain (except a capital gain from CGT event K7) you make may be reduced or disregarded under this Division if the following basic conditions are satisfied for the gain:

(a) a CGT event happened in relation to a CGT asset of your in an income year;

(b) the event would (apart from this Division) 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;

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;

(d) the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997.

Paragraphs (a) and (b)

The asset in question constitutes the shares in Company A. Shares are CGT assets and the sale of shares is a CGT event A1. Paragraphs (a) and (b) are satisfied as the Trust sold its shareholding in the company and made a capital gain.

Paragraph (c) - maximum net asset value test

Section 152-15 is the maximum net asset value test which a taxpayer will satisfy if the net value of their assets and those of connected entities does not exceed six million dollars. The trust and its connected entities meet this test.

Paragraph (d) - Active asset test

The shares held by the Trust in the Company must satisfy the active asset test in paragraph 152-10(1)(d) of the ITAA 1997.

Shares are not active assets unless they satisfy the 80% test in subsection 152-40(3) of the ITAA 1997.

Under paragraph 152-40(3)(b) of the ITAA 1997 a 'share' is an active asset if:

a) the company is an Australian resident at that time; and

b) the total of:

(i) the market values of the active assets of the company and

(ii) the market value of any financial instruments of the company that are inherently connected with a business that the company carries on and

(iii) any cash of the company that is inherently connected with such a business

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

The active asset test under section 152-35 of the ITAA 1997 requires that a share in a company must satisfy the 80% test for at least 7½ years where shares have been held for more than 15 years, or at least half of the ownership period for shares held for 15 years or less.

Company A is an Australian resident for tax purposes just before the CGT event.

The total market value of Company A's active assets and certain financial instruments were more than 80% of the total market value of all of the assets of the company for more than half of the period of ownership.

In summary, the Trust satisfied the basic conditions for small business relief under subsection 152-10(1) of the ITAA 1997:

CGT event A1 happened on the sale of the shares in Company A

the event resulted in a capital gain

the Trust satisfied the maximum net asset value test

the shares in Company A satisfied the active asset test.

Condition 2 - Additional conditions if the CGT asset is a share or trust interest

There are fewer conditions you have to meet if you made a capital gain relating to shares in a company or an interest in a trust before 8 February 2018.

If the CGT asset is a share in a company or an interest in a trust (the object entity), one of these additional basic conditions must be satisfied just before the CGT event (section 152-10(2) of the ITAA 1997):

a.     you are a *CGT concession stakeholder in the object company or trust; or

b.     CGT concession stakeholders in the object company or trust together have a *small business participation percentage in you of at least 90%.

An individual is a CGT concession stakeholder of a company or trust if the individual is:

a)     a significant individual in the company or trust; or

b)     a spouse of a significant individual in the company or trust, if the spouse has a small business participation percentage in the company or trust at that time that is greater than zero (section 152-60 of the ITAA 1997).

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% (section 152-55 of the ITAA 1997).

'An entity ' s small business participation percentage in another entity at a time is the percentage that is the sum of' the entity's direct small business participation percentage and indirect small business participation percentage in the other entity at that time (section 152-65 of the ITAA 1997).

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

90% test

Where the trust triggers the CGT event, it must satisfy the 90% test, meaning that just before the CGT event, CGT concession stakeholders of the object entity have a small business participation percentage of at least 90% in the trust that made the capital gain.

The trust had shareholding in Company A.

Just before the CGT event, the husband and wife received more than 90% of the trusts' distributions.

Wife's indirect participation percentage in Company A was more than 20% making her a CGT concession stakeholder.

Husband was also a CGT concession stakeholder being the spouse of a significant individual.

The trust satisfied the 90% test.

Question 2

Will the Commissioner exercise the discretion in subsection 104-190(2) of the ITAA 1997 to extend the replacement asset period to acquire a replacement asset?

Summary

Yes, the Commissioner will extend the replacement asset period.

Detailed Reasoning

The small business roll-over allows you to defer the capital gain made from a capital gains tax (CGT) event if you acquire one or more replacement assets within the replacement asset period and you satisfy certain conditions (Subdivision 152-A and section 152-410 of the ITAA 1997).

The replacement asset must be an active asset by the end of the replacement period. An asset will qualify to be an active asset if you own the asset and it is used, or held, ready for use, in the course of carrying on a business by you, your affiliate or another entity that is connected with you (subsection 104-197(2) of the ITAA 1997).

According to subsection 104-190(1A) of the ITAA 1997:

the replacement asset period is the period:

a)     starting one year before the last CGT event in the income year for which you obtain the roll-over; and

b)     ending at the later of:

                                     i.          2 years after that last CGT event; and

                                    ii.          if the first-mentioned CGT event happened because you *disposed of the CGT asset - 6 months after the latest time a possible *financial benefit becomes or could become due under a *look-through earnout right relating to the CGT asset and the disposal.

The Commissioner may extend the replacement asset period (section 104-190(2) of the ITAA 1997).

In determining if the discretion would be exercised the Commissioner has considered the following factors:

there should be evidence of an acceptable explanation for the period of extension requested and that it would be fair and equitable in the circumstances to provide such an extension

·        account must be had of any prejudice to the Commissioner which may result from the additional time being allowed, however the mere absence of prejudice is not enough to justify the granting of an extension

·        account must be had of any unsettling of people, other than the Commissioner, or of established practices

·        there must be a consideration of fairness to people in like positions and the wider public interest

·        whether there is any mischief involved

·        a consideration of the consequences.

You purchased a commercial property within the replacement asset period. You planned to use this space as a practice for one of your connected entities. However, the project was unviable and you require an additional time to acquire an alternative active asset.

Having considered the relevant factors, the Commissioner will exercise his discretion under subsection 104-190(2) of the ITAA 1997 to extend the time period for you to acquire a replacement asset.