Edited version of private advice

Authorisation Number: 1051669253379

Date of advice: 05 May 2020

Ruling

Subject: CGT small business retirement exemption - basic conditions

Question 1

Are the basic conditions in section 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997) satisfied in relation to the capital gains from the sale of your shares in Company 1 and Company 2 (your shares) and the transfer of your intellectual property (IP)?

Answer

Yes

Question 2

Do you satisfy the requirements of the small business retirement exemption in subdivision 152-D of the ITAA 1997 in relation to the capital gains from the sale of your shares and transfer of your IP?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 2019

The scheme commences on:

September 2018

Relevant facts and circumstances

Company 3 (the Trustee) is the trustee for the Family Discretionary Trust (FDT). FDT was settled in 2008.

The Trustee in its capacity as trustee for FDT acquired shares in:

·   Company 1 in 2013, and

·   Company 2 in 2015.

In 2018, the Trustee in its capacity as trustee for FDT entered into:

·   a Share Sale Agreement (the Share Sale Agreement) to sell its shares in Company 1 and Company 2 (the shares), and

·   a Deed of Assignment of Intellectual Property (the IP Assignment Deed).

The IP Assignment Deed defines the Intellectual Property (IP) as:

'all of the rights and interest of the Assignor in the intellectual property rights set out in the IP Licence Agreements, being all intellectual property in the name and style 'XX' used in the Business.''

Apart from the application of Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997), the sale of the shares and transfer of the IP resulted in a capital gain.

Businesses carried on

During the period covered by this ruling, the Trustee did not carry on business in its own capacity, in its capacity as trustee for FDT, or in any capacity in partnership with any other entity.

Prior to the sale of the business, Company 1 and Company 2 were providing the services.

The IP components listed in the Share Sale Agreement (including business names, domain names, and trademarks) are relevant to those services.

Neither Company 1 nor Company 2 was a CGT small business entity for the period covered by this ruling, as their aggregated annual turnovers were above $2,000,000.

Terms of the Share Sale Agreement

The Share Sale Agreement states:

3.1 Sale of Shares

On the Completion Date, the Seller must sell and the Buyer must buy the Shares:

(a)          for the Purchase Price;

(b)          free of Encumbrances; and

(c)           with all rights attached to them at the Locked Box Date, including the rights to receive all dividends and other distributions declared, paid or made on or after the Locked Box Date.

3.2 Title and risk

Title to and risk in the Shares passes to the Buyer on Completion.

The Share Sale Agreement provides the following definitions and interpretation:

The Share Sale Agreement stipulates that the Share Sale Agreement and the Assignment Deed are interdependent and must take place simultaneously.

Terms of the Assignment Deed

The Assignment Deed states:

Assignment of the Intellectual Property

With effect on and from Completion, the Assignor assigns to the Assignee and the Assignee accepts the Assignor's whole right, title and interest in and to the Intellectual Property, free from all Encumbrances, together with:

(a)    The goodwill associated with the Intellectual Property;

(b)    Full right, sole power and authority to the Assignee to apply for and obtain entry of the Assignee's name in any registers of intellectual property that are appropriate as being the sole proprietor of the Intellectual Property; and

(c)    All rights, if any, that the Assignor has to take action against third parties for infringement of the Intellectual Property, whether or not the infringement took place before the date of this deed.

The definition of 'IP Licence Agreements' provided in the Assignment Deed refers to the same IP licence agreements as listed in the Share Sale Agreement.

Also, the Trustee as trustee for FDT entered into a Licence Agreement with Company 2 (the Licensee) dated DD/MM/2015 to allow the intellectual property/goodwill in the name and style 'XX' to be used in the business of the Licensee.

The Trustee as trustee for FDT terminated the existing IP Licence Agreements to satisfy the condition of the Share Sale Agreement.

Maximum Net Asset Value (MNAV)

The 'net value of the CGT assets' (as defined under section 152-20 of the ITAA 1997) of FDT, its affiliates and the entities connected with it, as of the date of sale, has been provided.

Active Assets Test - the shares in Company 1 and Company 2.

The percentage of the market values of the active assets of Company 1 and Company 2, relative to the market value of their total assets, over the whole period of ownership, has been provided.

You have provided the following comments:

·   all the cash amounts are critical to the businesses working capital,

·   the loan between Company 1 and Company 2 is used to fund the working capital.

CGT Concession Stakeholders

Both Stakeholder 1 and Stakeholder 2 are under 55 years of age.

You distributed the income of FDT for the period covered by this ruling, equally to Stakeholder 1 and Stakeholder 2, 50% each

Neither Stakeholder 1 nor Stakeholder 2 have previously used the CGT small business retirement exemption.

Although Stakeholder 1 continued to be employed by the Buyer after the sale of the shares, their Contract of Employment stipulated the following relevant conditions:

·   the contract is not part of the Share Sale Agreement or the IP Transfer agreement; and

·   the sale is not contingent on Stakeholder 1's employment with the Buyer.

Relevant legislative provisions

Income Tax Assessment Act 1997:

·   subsection 104-10(1)

·   section 152-10

·   subsection 152-10(1)

·   subsection 152-10(2)

·   subsection 152-10(2A)

·   subsection 152-10(1AA);

·   section 152-15

·   section 152-35

·   subsection 152-40(1)

·   subsection 152-40(3)

·   subsection 152-40(3A)

·   section 152-50

·   section 152-55

·   section 152-60

·   section 152-65

·   section 152-70

·   subsection 152-305(2)

·   section 152-325

·   section 328-125

·   subsection 152-75(1)

section 995-1(1)

Reasons for decision

Question 1 - the basic conditions for the small business CGT concession - Subdivision 152-A

Summary

In these reasons for decision, references to you, or your, are references to Company 3 (the Trustee) in its capacity as trustee for Family Discretionary Trust (FDT) as the Rulee.

The basic conditions in subsection 152-10(1) of the Income Tax Assessment Act 1997 (ITAA 1997) are satisfied for the capital gains from:

·   the sale of your shares (the shares) in Company 1 and Company 2, and

·   the transfer of your Intellectual Property (IP).

Further, the additional basic conditions in subsection 152-10(2) of the ITAA 1997 are satisfied in relation to your shares Company 1 and Company 2.

As such, the basic conditions in section 152-10 of the ITAA 1997 are satisfied for the gains.

Detailed reasoning

Under subsection 152-10(1) of the ITAA 1997 a capital gain you make (except a capital gain from CGT event K7) may be reduced or disregarded under Division 152 if the following basic conditions are satisfied for the gain:

(a)  A CGT event happens in relation to a CGT asset of yours in an income year. This condition does not apply in the case of CGT event D1.

(b)  The CGT event would (apart from Division 152) have resulted in the gain.

(c)   At least one of the requirements in subparagraphs 152-10(1)(c)(i) to (iv) are satisfied (discussed further below)

(d)  The CGT asset satisfies the active asset test under section 152-35. This condition does not apply in the case of CGT event D1.

Additional basic conditions for the disposal of CGT assets that are shares in a company are set out in subsection 152-10(2) of the ITAA 1997 and are discussed further below.

Finally, some small business CGT concessions have extra conditions that must be satisfied for the concession to be available. The extra conditions in relation to the small business retirement exemption will be considered in question 2 of this ruling.

Paragraphs 152-10(1)(a) and (b) of the ITAA 1997

Based on the facts provided, the Commissioner accepts that paragraphs 152-10(1)(a) and (b) are satisfied in relation to the capital gains that would, apart from Division 152 of the ITAA 1997, arise from the sale of your shares and from the transfer of your IP rights.

Paragraph 152-10(1)(c) of the ITAA 1997

Paragraph 152-10(1)(c) of the ITAA requires that at least one of the following applies:

(i)     you are a CGT small business entity (CGT SBE) for the income year under subsection 152-10(1AA);

(ii)    you satisfy the maximum net asset value (MNAV) test under section 152-15;

(iii)   you are a partner in a partnership that is a CGT SBE for the income year and the CGT asset is an interest in an asset of the partnership;

(iv)   the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year.

Based on the net value of the CGT asset calculations provided, the Commissioner accepts that you satisfy the MNAV test in subsection 152-15 of the ITAA 1997, and that the requirements in paragraph 152-10(1)(c) are satisfied.

Paragraph 152-10(1)(d) of the ITAA 1997

Section 152-35 of the ITAA 1997 provides 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 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 7 and a half years during the period specified in subsection (2).

Subsection 152-35(2) of the ITAA 1997 sets out that the period begins when you acquired the asset; and 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.

The meaning of active asset is provided in section 152-40 of the ITAA 1997. Subsection 152-40(1) sets out that a CGT asset is an active asset at a time if, at that time:

a)    you 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.

Does your IP satisfy the active asset test?

The facts in relation to the IP transferred under the IP Assignment Deed provide that:

·   the transferred IP was defined in the IP assignment deed as 'all intellectual property in the name and style 'XX' used in the business', with 'the business' referring to the businesses conducted by Company 1 and Company 2.

·   The Share Sale Agreement showed that this included various business names, domain names, and trademarks that were registered by you, and that were related to activities undertaken by Company 1 and/or Company 2 as part of their businesses.

·   The IP was licenced to Company 1 from DD/MM/2013 to DD/MM/2018, which the Commissioner accepts was at least half of the period it was owned by you;

·   Company 1 and Company 2 were connected with you under subsection 328-125 of the ITAA 1997 throughout the period they used the IP.

As such, the IP transferred under the IP Assignment Deed satisfies the definition of active asset in subsection 152-40(1) of the ITAA 1997 and the active asset test in section 152-35 is satisfied in relation to the IP.

Do your shares satisfy the active asset test?

Subsection 152-40(3) of the ITAA 1997 provides that a CGT asset that is a share in an Australian resident company is also an active asset if 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 of the assets of the company (the 80% test).

The 80% test does not need to be applied on a daily basis. If a share in a company was an active asset at an earlier time, and it is reasonable to conclude that it is still an active asset at a later time, then the share is still an active asset at that later time (subsection 152-40(3A) of the ITAA 1997). Further, if a share in a company fails to meet the requirements above at the test time and the failure is temporary in nature, the share remains an active asset (subsection 15240(3B).

Your shares in Company 1 and Company 2 were not used in, held ready for use in, or inherently connected with the businesses carried on by either company. As such, they are not active assets under subsection 152-40(1) of the ITAA 1997

The Commissioner accepts the values of the active assets, financial instruments, cash and non-active assets of Company 1 and Company 2 as at the date of sale, and as at 30 June in each year since the companies were incorporated, and the percentage of active assets to total assets at the relevant times, provided in the facts.

This information shows that your shares in Company 1 and Company 2 satisfied the 80% test throughout the period you owned the shares.

Based on this information, the Commissioner is satisfied that your shares in Company 1 and Company 2 satisfied the active asset test for the gain and the condition in paragraph 152-10(1)(d) is satisfied.

Subsection 152-10(2) of the ITAA 1997

Subsection 152-10(2) of the ITAA 1997 provides additional basic conditions to be satisfied for the disposal of CGT assets that are shares in a company. In your case:

(a)  the shares in Company 1 and Company 2 would still satisfy the active asset test if modified by the assumptions in subsection (2A);

(b)  if you do not satisfy the MNAV test - you are carrying on a business just before the CGT event;

(c)   Company 1 and Company 2 satisfy either:

(i)    a modified CGT SBE test; or

(ii)   a modified MNAV test; and

(d)  just before the sale of the shares, CGT concession stakeholders in each company must have a small business participation percentage (SBPP) in you of at least 90%.

Paragraph 152-10(2)(a) of the ITAA 1997 - the modified active asset test

The assumptions in subsection 152-10(2A) of the ITAA 1997 require modifications to the active asset test as follows:

·   Paragraph (a) excludes financial instruments and cash that are inherently connected with the business if they were acquired for a purpose that included assisting either Company 1 or Company 2 to satisfy the modified active asset test, and

·   Paragraphs (b) - (e) provide various inclusions and exclusions in relation to entities that are owned (directly or indirectly) by Company 1 and Company 2.

Company 1 and Company 2 do not have any direct or indirect shareholdings in companies or interest in any trusts. As such, the additional assumptions in paragraphs 152-10(2A)(b)-(e) do not apply to modify their active asset tests.

In respect of paragraph 152-10(2A)(a) of the ITAA 1997, the Commissioner is satisfied that none of the assets of Company 1 and Company 2 were acquired for a purpose that included assisting either company to satisfy the modified active asset test.

As such, the shares satisfy the modified active asset test and paragraph 152-10(2)(a) of the ITAA 1997 is satisfied.

Paragraph 152-10(2)(b) of the ITAA 1997

As discussed previously, you satisfied the MNAV test so the additional basic condition in paragraph 152-10(2)(b) does not apply.

Paragraph 152-10(2)(c) of the ITAA 1997 - the modified CGT SBE test or MNAV test

Subsection 152-10(2)(c) of the ITAA 1997 modifies the CGT SBE test and the MNAV test by requiring that the following assumptions are made:

·   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;

·   each reference in section 328- 125 to 40% were a reference to 20%;

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

Applying these modifications, only the CGT assets and annual turnovers of Company 1 and Company 2 are relevant, as:

·   they are both affiliates of each other,

·   they do not have any other affiliates,

·   they do not control any other entities, and

·   no determinations have been made under subsection 328-125(6) of the ITAA 1997 for either company.

Based on the information provided, as the MNAVs of Company 1 and Company 2 are under $6,000,000, they satisfy the modified MNAV test. As such, paragraph 152-10(2)(c) of the ITAA 1997 is satisfied for the shares.

Paragraph 152-10(2)(d) of the ITAA 1997 - Ownership percentage of CGT concessions stakeholders

According to section 152-60 of the ITAA 1997, an individual is a CGT concession stakeholder in a company at a time, if the individual is a significant individual in the company at that time.

Section 152-55 of ITAA1997 defines a 'significant individual' in a company at a time is an individual who has a SBPP in the company of at least 20% at that time. An entity's SBPP in another entity at a time is the sum of the entity's direct and indirect SBPP's in the other entity at that time (section 152-65 of the ITAA 1997).

An entity's direct SBPP in a company, from item 1 of the table in subsection 152-70(1) of the ITAA 1997, is:

'the percentage of:

(a)  the voting power in the company;

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

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

that the entity has because of holding the legal and equitable interests in the company's shares.'

If an entity has more than one of the rights in (a) to (c) above, and the relevant percentages are different, the smaller or smallest percentage is the entity's SBPP in relation to the company.

The method for determining an entity's direct SBPP in a trust depends on whether entities have entitlements to all of the income and capital of the trust. From item 3 of the table in subsection 152-70(1) of the ITAA 1997, where entities do not have entitlement to all of the income and capital of the trust, such as FDT:

·   if the trustee makes distributions of income during the income year, an entity's direct SBPP is the percentage of the income distributions to which the entity was beneficially entitled,

·   if the trustee makes distributions of capital during the income year, an entity's SBPP is the percentage of the capital distributions to which the entity was beneficially entitled.

If an entity receives both income and capital distributions, and the relevant percentages are different, the smaller percentage is the entity's SBPP in relation to the trust.

An entity's indirect SBPP in a company is the entity's direct SBPP in an interposed entity multiplied by the interposed entity's total SBPP (both direct and indirect) in the company (subsection 152-75(1) of the ITAA 1997).

Are Stakeholder 1 and/or Stakeholder 2 significant individuals of Company 1 and/or Company 2 (the test entities)?

You hold 100% of shares in the test entities and, because of this, hold all the rights to voting, dividends and capital distributions. As such, just before the CGT event, you had a direct SBPP in each of the test entities of 100% under item 1 of the table in subsection 152-70(1) of the ITAA 1997.

For the year ended 30 June 2019, in which the relevant time (just before the CGT event) occurred, you distributed 50% of FDT's income to 1 and 50% to Stakeholder 2. As such, each of Stakeholder 1 and Stakeholder 2 had direct SBPP of 50% in you just before the CGT event under item 3 of the table in subsection 152-70(1) of the ITAA 1997.

Using the method in subsection 152-75 of the ITAA 1997, just before the CGT event, Stakeholder 1 and Stakeholder 2 each had indirect SBPP's in both Company 1 and Company 2 of 50%.

As these were greater than 20% they were each significant individuals, and CGT concession stakeholders of Company 1 and Company 2.

As both Stakeholder 1 and Stakeholder 2 were CGT concession stakeholders in Company 1 and Company 2 and held SBPPs in you totalling at least 90%, paragraph 152-10(2)(d) of the ITAA 1997 is satisfied.

The additional basic conditions in subsection 152-10(2) of the ITAA 1997 are satisfied in relation to the shares in Company 1 and Company 2.

Question 2 - the small business retirement exemption - Subdivision 152-D

Summary

You satisfy the requirements of the small business retirement exemption in Subdivision 152-D of the ITAA 1997 in relation to the capital gains you made from the sale of your shares and transfer of your IP.

Detailed reasoning

Under the small business retirement exemption (the retirement exemption) in Subdivision 152-D of the ITAA 1997, a trust (except a public entity) 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 trust satisfies the significant individual test in section 152-50; and

(c)   the company or trust conditions in section 152-325 are satisfied (subsection 152-305(2)).

The amount the trust chooses to disregard is the CGT exempt amount, and must be specified in writing. The CGT exempt amount must not exceed the CGT retirement exemption limit of each CGT concessions stakeholder receiving a payment in respect of the retirement exemption (section 152-315 of the ITAA 1997).

An individual's CGT retirement exemption limit is $500,000, reduced by any CGT exempt amounts the individual has previously disregarded under the retirement exemption (section 152-320 of the ITAA 1997).

Subparagraph 152-305(2)(a) - the basic conditions

As discussed in question 1 (above), you satisfied the basic conditions in Subdivision 152-A of the ITAA 1997 for the capital gain from selling your shares and transferring your IP.

Subparagraph 152-305(2)(b) - the significant individual test

Under section 152-50 of the ITAA 1997, a trust can satisfy the 'significant individual' test if it had at least one significant individual just before the CGT event.

Section 152-55 of ITAA1997 defines a 'significant individual' in a trust as an individual with an SBPP of at least 20% - this 20% can be made up of direct and indirect percentages.

As discussed above, each of Stakeholder 1 and Stakeholder 2 were significant individuals of FDT for the year ended 30 June 2019, as each was beneficially entitled to 50% of the income distributions during the income year.

As such, you satisfied the significant individual test.

Subparagraph 152-305(2)(c) - the company or trust conditions

For a trust to choose to disregard all or part of a capital gain under the retirement exemption, the trust must make a payment to at least one of its CGT concession stakeholders (subsection 152-325(1) of the ITAA 1997).

The amount of each payment is worked out by reference to each individual's percentage of the exempt amount. The payment, or sum of the payments, must be equal to the exempt amount or the amount of capital proceeds received, whichever is less (subsections 152-325(3) and (5) of the ITAA 1997).

Where there is more than one CGT concession stakeholder, the trust must keep a written record of the percentage of each CGT asset's CGT exempt amount that is attributable to each of those stakeholders (subsection 152-315(5) of the ITAA 1997).

Where the CGT event that happens to the CGT asset is not CGT event J2, J5 or J6, the payment to the CGT concession stakeholders must be made by the later of

-   7 days after the trust makes the choice to disregard the capital gain, and

-   7 days after the trust receives the capital proceeds from the CGT event.

Finally, if a CGT concession stakeholder is under 55 just before a payment is made in relation to him or her:

(a)  the trust must make the payment to the CGT concession stakeholder by contributing it for the stakeholder to a complying superannuation fund or an RSA in respect of the stakeholder; and

(b)  the company or trust must notify the trustee of the fund or the RSA provider at the time the contribution is made that the contribution is made in accordance with this section.

Based on the facts and assumptions, you will satisfy the requirements in subparagraph 152-305(2)(c) of the ITAA 1997.

As such, you satisfy the requirements for the small business retirement exemption in subdivision 152-D of the ITAA 1997 in relation to the capital gains you make from the sale of your shares and transfer of your IP.