Edited version of private advice

Authorisation Number: 1051690635347

Date of advice: 03 June 2020

Ruling

Subject: Capital gains tax and small business 15-year exemption

Question 1:

Is your interest in the goodwill related to your original ownership of the Business a pre-CGT asset for the purposes of determining your capital gain under section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997) when it is disposed of under the Sale Agreement?

Answer: Yes

Question 2:

Does the small business 15 year-exemption under Subdivision 152-B of the ITAA 1997 apply to the capital gain made on the disposal of the post-CGT interest in the goodwill of the Business?

Answer: Yes

This ruling applies for the following period:

1 July 2018 - 30 June 2019

The scheme commences on:

1 July 2018

Relevant facts and circumstances

Prior to 20 September 1985 you commenced a business (Business) in partnership with another partner.

In 1986 you purchased the other partner's interest and became the sole owner of the Business.

You continued to operate the Business as a sole trader until the time when you entered into a Sale Agreement to sell the Business to a third party (Purchaser).

The Business provided services to the public and the same business activities were carried out continuously from the commencement of the Business until it was sold.

The purchase consideration was apportioned in accordance with the terms of the Sale Agreement, with the goodwill component being the balance of the consideration after all other assets have been taken into account.

Upon completion of the sale of the Business and pursuant to an Employment Agreement with the Purchaser, you commenced employment for the Business on a part-time basis. The purpose of the employment arrangement is to facilitate a smooth transition to the Purchaser.

Your employment arrangements are for a period of 12 months after the completion of the sale of the Business under the terms of the Employment Agreement, with an option to extend at further reduced weekly hours.

The total weekly hours you are required to work during the 12 months' period are approximately one third of the weekly hours you used to work when you were the owner of the Business.

At the time of the ruling application you intend to extend these employment arrangements to continue to work for the Purchaser after the 12 months' period for a few hours a week limited to performing specialist duties only.

You are willing to continue in this reduced capacity for another few years if required.

Other than your ownership in the Business, the following entities are related to you:

• Family Trust, of which you are the guardian, appointor, beneficiary as well as director and shareholder of the trustee company,
• Super Fund, of which you are a member and director and shareholder of the trustee company,
• Unit Trust, of which you are a director of the trustee company. The Super Fund owns 100% issued units in Unit Trust,
• Investment portfolio jointly with your wife.

Family Trust's only business activity is to provide management and employment services to the Business.

Family Trust is not a shareholder in any company or a unit holder in any trust and has not received any distribution of income or capital from any discretionary trust in any of the 4 previous income years.

You do not have interest in or control of any other entity other than the above.

There is no other entity that acts or could reasonably be expected to act in accordance with your directions or wishes or in concert with you.

Themaximum net asset value (MNAV) for the purpose of the MNAV test under section 152-15 of the ITAA 1997 as at 30 June 2019 was less than $6,000,000.

You were over the age of 55 when the Sale Agreement was entered into.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 paragraph 108-5(2)(b)

Income Tax Assessment Act 1997 subsection 109-5(1)

Income Tax Assessment Act 1997 subsection 152-10

Income Tax Assessment Act 1997 section 152-15

Income Tax Assessment Act 1997 section 152-20

Income Tax Assessment Act 1997 section 152-35

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

Income Tax Assessment Act 1997 section 152-105

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

Income Tax Assessment Act 1997 subsection 328-125(2)

Income Tax Assessment Act 1997 subsection 328-125(3)

Income Tax Assessment Act 1997 subsection 328-125(7)

Income Tax Assessment Act 1997 section 328-130

Reasons for decision

Summary: The pre-CGT interest in the goodwill of the Business is a pre-CGT asset.

Detailed reasoning

Goodwill, or an interest in it, is a CGT asset, pursuant to paragraph 108-5(2)(b) of the Income Tax Assessment Act 1997 (ITAA 1997)[1].

Subsection 104-10(1) provides that CGT event A1 happens on the disposal of a CGT asset.

CGT event A1, therefore, happened to the goodwill of the Business when the Sale Agreement was entered into.

It is accepted that the amount attributed to the goodwill of the Business under the Sale Agreement is the balance of the purchase price after all other assets have been taken into account.

Relevant for the purpose of determining the pre-CGT and post-CGT nature of the goodwill in this case is paragraph 26 of Taxation Ruling TR 1999/16 Income Tax: capital gains: goodwill of a business (TR 1999/16), which states that:

However, an interest in goodwill, unlike goodwill itself, is not a composite asset. For example, a partner who owns a pre-CGT interest in a pre-CGT business might later acquire a post-CGT interest in the business. On acquiring the post-CGT interest in the business (with an associated post-CGT interest in the pre-CGT goodwill of the business), that interest in the business is not subsumed into the partner's pre-CGT interest in the business (and the associated pre-CGT interest in goodwill).

Accordingly, for the purpose of subsection 109-5(1) you acquired 50% interest in the goodwill of the Business when the Business commenced prior to 20 September 1985. The post-CGT interest in the goodwill is the balance 50% acquired in 1986 when you acquired the remaining interest in the Business.

Under subsection 104-10(5) a capital gain or capital loss you make from CGT event A1 is disregarded if you acquired the asset before 20 September 1985. Any capital gains you made in respect of the disposal of the pre-CGT interest in the goodwill of the Business is, therefore, disregarded.

Question 2

Summary: The small business 15 year-exemption under Subdivision 152-B apply to the capital gain you made on the disposal of the post-CGT interest in the goodwill of the Business.

Detailed reasoning

Under subsection 104-10(1) capital gains tax (CGT) event A1 happens when you dispose of a CGT asset. A CGT gain or loss may happen on the disposal of the asset.

Division 152 provides for CGT small business concessions, including the 15-year exemption. To qualify for the small business CGT concessions, you must satisfy several conditions that are common to all the concessions being the basic conditions.

Under section 152-105, you can disregard a capital gain from a CGT event happening to a CGT asset if you:

(a)   satisfy the basic conditions for the small business CGT concessions,

(b)   continuously owned the CGT asset for the 15-year period ending just before the CGT event,

(c)   if the CGT asset is a company share or an interest in a trust - the company or trust had a significant individual for a total of at least 15 years (even if the 15 years was not continuous and it was not always the same significant individual) during which the individual owned the CGT asset, and when the CGT event happened you were permanently incapacitated or you were 55 years old or older, and the event happened in connection with your retirement,

(d)   at the time of the CGT event, you are either: 55 years of age or over and the event happens in connection with retirement, or permanently incapacitated.

You satisfy paragraph (b) as you have operated and owned the Business for more than 15 years continuously. Paragraph (c) is not applicable to your circumstances.

Paragraphs (a) and (d) are considered below.

Paragraph (a) - The basic conditions

Under section 152-10 a capital gain may be reduced or disregarded if the basic conditions are satisfied. Relevant for the purpose of this ruling are the following:

(a) a CGT event happens in relation to a CGT asset of yours in an income year,

(b) the event would have resulted in a gain,

(c) you satisfy the maximum net asset value test,

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

Application to your circumstances

As stated above, your post-CGT interest in the goodwill of the Business is a CGT asset. CGT event A1 happened when the Sale Agreement was entered into on 30 June 2019 and the event would have resulted in a gain.

The asset is an active asset for the purposes of sections 152-35 and 152-40 as you owned it for more than 15 years and it was inherently connected with the business that you carried on.

Maximum net asset value (MNAV) test

Section 152-15 provides that the MNAV test is satisfied if, just before the CGT event, the sum of the net value of the CGT assets owned by you and by any entities connected with you and by any affiliates of yours does not exceed $6 million. The MNAV test treats you and your connected entities and affiliates as one economic unit.

Subsection 328-125(1) 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.

From the information provided:

·        you control Family Trust pursuant to subsection 328-125(3),

·        you control the joint investment portfolio with your wife pursuant to paragraph 328-125(2)(a),

·        you do not control Super Fund under paragraph 328-125(2)(a) and Super Fund is not connected with you under subsection 328-125(1). This is in accordance with Taxation Determination 2006/68 Income tax: capital gains: small business concessions: can trustees or members of a complying superannuation fund 'control' the superannuation fund in the way described in section 328-125 of the Income Tax Assessment Act 1997?,

·        you do not directly or indirectly control Unit Trust under paragraph 328-125(2)(a) or subsection 328-125(7) as Super Fund owns 100% of units in Unit Trust,

·        there is no individual or company that is an affiliate of yours for the purpose of subsection 328-130(1).

For the purpose of the MNAV test, the net value of the CGT assets determined in accordance with section 152-20 is as follows:

·        the net value of your CGT assets,

·        the net value of Family Trust's CGT assets, and

·        the net value of the investment portfolio.

You satisfy the MNAV test in section 152-15 as the sum of the above does not exceed $6,000,000.

Paragraph (d) - In connection with your retirement

Whether a CGT event happens in connection with an individual's retirement depends on the particular circumstances of each case. There would need to be at least a significant reduction in the number of hours the individual works or a significant change in the nature of their present activities to be regarded as a retirement.

In this case the disposal of the Business is considered to be in connection with your retirement.

Conclusion: As you satisfy all the relevant conditions in section 152-105 you are qualified for the small business 15-year exemption in relation to the disposal of the post-CGT interest in the goodwill of the Business.

[1] All legislative references are to the ITAA 1997 unless otherwise stated