Edited version of private advice

Authorisation Number: 1051699291838

Date of advice: 06 July 2020

Ruling

Subject: Income tax - capital gains tax - small business relief - active asset test

Question

Does the trust satisfy the basic conditions under section 152-10 of the ITAA 1997 to access small business CGT relief?

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 Trust owns land, plant and equipment.

The farm comprises of over 1,000 hectares.

The land is used for both agistment and crop growing.

You intend on selling the land in the near future.

Company Z acts as trustee for the trust.

The sole shareholders of Company Z are Taxpayer A and Taxpayer B.

Taxpayer A also manages a haulage business.

The annual turnover of associated entities is less than $2,000,000.

The asset value of all associated entities is less than $6,000,000.

The farm is run through a Sharefarming Agreement with a farmer.

The Sharefarming Agreement commenced in 20XX. The agreement is for a 1 year rolling term.

The agreement outlines the following arrangements.

The landowner is to receive a percentage of grain grown on the property as payment.

The landowner is to:

1.    Pay property rates.

2.    Contribute cropping and cartage plant to facilitate cropping as is reasonable/available.

3.    Maintain property improvements.

4.    Cart and help spread long acting soil conditions

5.    Supply labour if required to expedite the cropping process.

6.    Cart at their own expense a percentage of the grain.

The farmer is to:

1.    Grow crops per best practice.

2.    Insure the crop.

3.    Harvest the crop.

4.    Purchase long acting soil conditions.

The landowner and farmer mutually decide/agree each year on the following:

1.    Cropping area.

2.    Crop rotation.

3.    Chemical use relevant (crop herbicides/pesticides/fungicides).

4.    Fertilizer application - types and rates.

5.    Any other relevant issues as they arise.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-40

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

Income Tax Assessment Act 1997 section 152-40(4)

Income Tax Assessment Act 1997 section 152-35(1)

Income Tax Assessment Act 1997 section 152-35(2)

Income Tax Assessment Act 1997 section 328-110

Income Tax Assessment Act 1997 section 995-1

Income Tax Assessment Act 1936 section 21A

Reasons for decision

Summary

The Trust does not satisfy the basic conditions under section 152-10 of the ITAA 1997 in relation to CGT relief.

Detailed reasoning

Capital Gains Tax event

You make a capital gain or capital loss if a Capital Gains Tax (CGT) event happens to a CGT asset. Property is considered to be a CGT asset.

CGT event A1 happens if you dispose of your ownership interest in a CGT asset.

As the trust is proposing to dispose of the Farm, CGT event A1 will happen at the time the contract is entered into or when the change of ownership happens.

You make a capital gain if the capital proceeds from the disposal are more than the asset's cost base.

Basic conditions for relief

Division 152 provides CGT concessions that allow eligible taxpayers to disregard or defer some or all of a capital gain arising from the disposal of an active asset used in a small business, provided certain conditions (the basic conditions) are met. Subsection 152-10(1) sets out the basic conditions to be satisfied before a taxpayer can access the CGT concessions.

Subsection 152-10(1) states:

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 happens in relation to a CGT asset of yours 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 CGT 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 CGT small business entity 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;

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

You have advised us that the trust intends on selling the Farm. At the time of sale, CGT event A1 will happen. This will result in the first condition in paragraph 152-10(1)(a) being satisfied.

If a capital gain is made from disposing of the Farm, the second condition in paragraph 152-10(1)(b) will be satisfied.

Only one condition is required to be met in order to satisfy paragraph 152-10(1)(c). This may be met if the total net value of CGT assets owned by you and certain entities does not exceed $6 million or if your business is considered a CGT small business.

In determining the final condition in paragraph 152-10(1)(d), the active asset test in section 152-35 must be passed.

Small business tests

To be eligible for small business entity concessions, you first need to work out if you are a CGT small business entity in an income year.

Section 328-110 of the Income Tax Assessment Act 1997 (ITAA 1997) states that you will be a small business entity for an income year if;

(a)  you carry on a business in the current year; and

(b)  one or both of the following applies:

(i)    you carried on a business in the income year (the previous year) before the current year and your aggregated turnover for the previous year was less than $10 million.

(ii)   your aggregated turnover for the current year is likely to be less than $10 million.

Subsection 152-10(1AA) of the ITAA 1997 adjusts section 328-110 regarding when an entity will be considered a CGT small business entity. Section 152-10(1AA) states:

You are a CGT small business entity for an income year if;

(a)  you are a small business entity for the income year; and

(b)  you would be a small business entity for the income year if each reference in section 328-110 to $10 million were a reference to $2 million.

Business is defined in section 995-1 of the ITAA 1997 to be 'any profession, trade, employment, vocation or calling, but does not include occupation as an employee'.

Taxation Ruling TR 97/11 provides the indicators established by the courts that need to be considered when determining whether a business is being carried on. It should be noted that TR 97/11 specifically deals with carrying on a business of primary production, but the indicators established can be equally applied to most other activities. Paragraph 13 of TR 97/11 states that the following indicators are relevant:

·   Whether your activity has a significant commercial purpose or character.

·   Whether you have more than just an intention to engage in business.

·   Whether you have a purpose of profit as well as a prospect of profit from the activity.

·   Whether there is repetition and regularity of your activity.

·   Whether your activity is of the same kind and carried on in a similar manner to businesses in your industry.

·   Whether your activity is planned, organised and carried on in a businesslike manner.

·   The size, scale and permanency of your activity.

·   Whether your activity is better described as a hobby, recreation or sporting activity.

Paragraph 15 of TR 97/11 states that no one indicator is decisive (Evans v. FC of T 89 ATC 4540; (1989) 20 ATR 922). In addition, paragraph 16 of TR 97/11 states that the indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the general impression gained from looking at all the indicators (Martin v. Federal Commissioner of Taxation (1953) 90 CLR 470 at 474; 5 AITR 548 at 551).

In the Trustee's case, you believe that the Trust is in the business of farming due to the following factors:

·   The farm activity has significant commercial purpose due to the land size.

·   The Trustee has more than a mere intention to engage in business as the Trust is the provider of the land on which the farming operations are performed.

·   The Trust is currently making a taxable profit.

·   The farming activity is seasonal and therefore regular.

·   The Trustee is engaged in the farming activities as per the Sharefarming Agreement.

·   The Trustee is also engaged in running a haulage business that is used to haul a percentage of the crop yield after cropping.

·   The farm generates crop share and agistment income.

·   The crop is sold at standard crop prices as per industry fluctuations.

·   Discussions on management of the land and agistment occur verbally. Crop share management is based on the Sharefarming Agreement.

·   Income from associated entities is less than $2,000,000.

·   Total assets from associated entities is less than $6,000,000.

It is the Commissioner's view that the farm is being run in accordance with other farming activities of a similar nature. The land is being worked by the farmer to produce a profitable harvest. Financial statements confirm the viability of the crop.

The Commissioner does not however believe the Trustee is in the business of carrying out the activity of farming. This view is confirmed in the Sharefarming Agreement which lists the growing, harvesting and insuring of the crop as being the farmer's responsibility.

The Sharefarming Agreement also outlines that the landowner is responsible for maintaining the assets used in farming such as maintenance and improvements. The payment of rates and discussions over crop rotation would be expected of a landowner who is providing his land to a tenant for use. The payment of rent in the form of 20% of the grain harvest is in the nature of a landlord earning passive income, it in no way indicates that the landowner took part in carrying on the small business activity.

Maximum Net Asset Value Test

Under section 152-15 of the ITAA 1997, 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 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.

Paragraph 328-125(2)(a) contains a general direct control test which applies to all entities, except discretionary trusts, and is based on a 'control percentage' of at least 40% of any distribution of income or capital of the entity.

The term entity is defined in section 960-100 of the ITAA 1997 as including a partnership. The term partnership is defined in subsection 995-1(1) of the ITAA 1997 as:

(a) an association of persons (other than a company or limited partnership) carrying on business as partners or in receipt of ordinary income or statutory income jointly.

The first limb of paragraph (a) of the above definition of partnership refers to an association of persons (other than a company or limited partnership) carrying on business as partners and therefore reflects the general law definition of partnership. The second limb of paragraph (a) which includes as a partnership entities which are in receipt of ordinary income or statutory income jointly refers to a tax law partnership.

In this case, the Trustees are the sole shareholders of Company Z, the trustee of the Trust. The trustees also operate a freight transport business. You have advised us that the sum of the assets held by the trustees and their connected entities is less than $6,000,000. Based on this information, you satisfy the maximum net value asset test.

Active asset test

The meaning of an active asset is set out in section 152-40 of the ITAA 1997. It must firstly satisfy one of the 'positive tests' in subsection 152-40(1) of the ITAA 1997 and then also not be excluded by one of the exceptions in subsection 152-40(4) of the ITAA 1997.

Under subsection 152-40(1) of the ITAA 1997, a CGT asset is an active asset if it is owned and used, or held ready for use, in the course of carrying on a business by you or another entity that is connected with you.

Under subsection 152-35(1) of the ITAA 1997 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 detailed below, 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 7.5 years during the period detailed below.

Subsection 152-35(2) of the ITAA 1997 identifies the period that has to be considered in applying the active asset test. It states the period:

(a)  begins when you acquired the asset; and

(b)  ends the earlier of:

·   the CGT event; and

·   if the relevant business ceased in the 12 months before the CGT event (or such longer time as the Commissioner allows) - when the business ceased.

Deriving rent

The meaning of active asset is set out in section 152-40. Of relevance to the Trust are the exceptions in subsection 152-40(4), in particular paragraph 152-40(4)(e), which states:

However, the following CGT assets cannot be active assets:

...

(e)  an asset whose main use by you is to derive interest, an annuity, rent, royalties or foreign exchange gains unless:

(i)    the asset is an intangible asset and has been substantially developed, altered or improved by you so that its market value has been substantially enhanced; or

(ii)   its main use for deriving rent was only temporary.

The Trust has used the Farm for many years to derive rental income through a Sharefarming Agreement. It has not been identified that the Trust has used the land for any other purpose.

Taxation Determination TD 2006/78 examines the circumstances where premises used in a business of providing accommodation for reward satisfy the active asset test. Whether an asset's main use is to derive rent will depend on the particular circumstances of each case. The term 'rent' has been described as follows:

·   the amount payable by a tenant to a landlord for the use of the leased premises,

·   a tenant's periodical payment to an owner or landlord for the use of land or premises, and

·   recompense paid by the tenant to the landlord for the exclusive possession of corporeal hereditaments.

A key factor is to determine whether an occupant of premises is a lessee is whether the occupier has a right of exclusive possession. If, for example, premises are leased to a tenant under a lease agreement granting exclusive possession, the payments involved are likely to be rent and the premises not an active asset. On the other hand, if the arrangement allows the person only to enter and use the premises for certain purposes and does not amount to a lease granting exclusive possession, the payments involved are unlikely to be rent.

In this case, the farm is run by the Farmer with an agreed payment of a percentage of the crop grown on the property. Upon analysis of the Sharefarming Agreement, the farmer performs the activities required to grow, insure and harvest the crop. Management of the land is discussed between the Trustees and the Farmer in relation to the use of the land however the actual farming activities rest solely with the farmer.

Under section 21A of the Income Tax Assessment Act 1936 (ITAA 1936), any non-cash business benefit is to be treated as convertible to cash for the purpose of determining whether the benefit is income of a taxpayer from the carrying on of a business.

Section 21A of the ITAA 1936 does not actually deem any benefit in the form of property or services to be income. Its effect is that in the event that the non-cash benefit is already considered to be income derived in carrying on a business, subsection 21A(2) specifies that the amount to be brought to account is the amount that the taxpayer would have paid the provider for the property or services under an arm's length transaction.

In determining whether the grain is non-cash income the following definitions must be considered:

Income derived by a taxpayer means income derived by a taxpayer in carrying on a business for the purpose of gaining or producing assessable income.

Non-cash business benefit means property or services provided after 31 August 1988:

(a)  wholly or partly in respect of a business relationship; or

(b)  wholly or partly for or in relation directly or indirectly to a business relationship.

The arrangements entered into in this situation indicate that that the farmer has the right to exclusive possession to run the farming activities. The payment of grain is considered non-cash income for the rental of the land.

In the Trust's situation, we consider the Farm's main use is to derive rent. The Trust does not provide any significant services to the Farm that extends past land care and the requirements of a landlord. The arrangement is long term, with non-cash income being received periodically. The Farmer has exclusive use of the Farm and the arrangement is in the nature of a tenant/landlord relationship.

Accordingly, the amounts received by the Trust from the Farm constitute rent.

Conclusion

Upon analysis of the information available, the Farm is not an active asset in the hands of the Trust as the Trustee is not actively utilising the land for any purpose other than deriving rent. The requirement at paragraph 152-10(1)(d) has not been met. The Trust therefore will not satisfy the basic conditions for relief in subsection 152-10(1).