Edited version of private advice

Authorisation Number: 1051782437753

Date of advice: 17 February 2021

Ruling

Subject: CGT - small business concessions

Question 1

Do you satisfy the basic conditions in Subdivision 152-A of the Income Tax Assessment Act 1997 (ITAA 1997) in relation to the disposal of Property D and Property C?

Answer

No. You do not satisfy the basic conditions in Subdivision 152-A of ITAA 1997 for the commercial properties you are disposing of due to not all properties being considered active assets.

Question 2

If you do meet the basic conditions in Subdivision 152-A of the ITAA 1997, does section 152-110 of the ITAA 1997 apply to wholly disregard the capital gain from the disposal of all of the commercial property assets?

Answer

No, since you do not meet all of the basic conditions in Subdivision 152-A of the ITAA 1997 for all of the commercial properties, section 152-110 of the ITAA 1997 does not apply to wholly disregard the capital gain from the disposal of those properties.

Question 3

Do you meet the basic conditions in Subdivision 152-A of the ITAA 1997 such that Property A is considered to be an active asset and that section 152-110 of the ITAA 1997 apply to wholly disregard the capital gain from its disposal?

Answer

Yes, you do meet the basic conditions in Subdivision 152-A of the ITAA 1997 such that Property A is considered to be an active asset and that section 152-110 of the ITAA 1997 apply to wholly disregard the capital gain from its disposal.

Question 4

Is your interest in the assets of the partnership for Property B considered to be an active asset and that section 152-110 of the ITAA 1997 applies to wholly disregard the capital gain from its disposal?

Answer

Yes, you do meet the basic conditions in Subdivision 152-A of the ITAA 1997. Property B is an active asset and section 152-110 of the ITAA 1997 applies to wholly disregard the capital gain from its disposal.

Question 5

If section 152-110 of the ITAA97 does not apply to your interest in the assets of the partnership for Property B, can section 152-200 of the ITAA 1997 apply to reduce the capital gain by 50%?

Answer

Not relevant as we consider section 152-110 of the ITAA 1197 does apply.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 January 19YY

Relevant facts and circumstances

You are a family owned private company.

You have conducted a property ownership and management business for over 15 years.

Your directors and their associates are your shareholders.

You possessed assets comprising various properties and land, prior to realising them.

To date you have sold a number of properties

Your directors and shareholders wish to wind you up due to a divergence of business interests.

After disposing of your property assets, your remaining assets are to be apportioned to your shareholders in the same proportions as their interests in you.

All shareholders have held their shares in you in excess of 15 years.

All shareholdings in you were acquired after 19 September 1985 (i.e. they are not exempt from capital gains tax).

Your commercial property assets were either sold to third-party purchasers or some of the property assets were sold to your shareholders (and/or their associates) at market value and on arm's length terms.

Your various property assets have been realised within the 20XX financial year.

The sale of the assets to your shareholders (and/or their associates) is to be treated as loans to the shareholders and will be settled out of dividends payable on your winding-up.

After realising all of your assets, you have net assets of approximately $Z million.

Your aggregated turnover for the year ended 30 June 20XX is under $2 million.

Details concerning the commercial properties (Property) that you owned are:

Property A:

•         The property was purchased in 19AA.

•         The condition of the property when it was acquired, required significant improvements and substantial renovation works before it could be utilised for the commercial business purposes of the Taxpayer.

•         You undertook extensive renovations to the property to increase the property's rentability, facilities and attract increased rental yields.

•         These renovations to the property were completed in 19BB.

•         The property was a double story commercial property with ground floor storage.

•         Furthermore, you applied for and obtained planning documents to develop apartments at the property.

•         It was leased to an affiliate company B due to common shareholders (being that two of your directors and shareholders are the directors and shareholders company B).

•         Company B conducted a business from the Property and used over 50% of the property to conduct its business.

•         Company B moved in and leased its part of the Property in 19CC and vacated it in 20DD. The remaining part of the Property was leased to unrelated third parties.

•         Company B ceased operating its business during the 20XX/YY financial year; and

•         The property was sold during the 20AA/BB financial year.

Property B:

•         Was originally purchased (by you in a partnership with two other partners) as vacant land in 20EE.

•         The partnership developed, built and managed the serviced holiday apartments on the land, which was completed in 20FF.

•         You project managed the construction of the development.

•         Since construction was completed, you (in addition to the other partners involved in the partnership), managed the daily management of the apartment complex, and were involved in making key decisions in conjunction with other partners, involving running costs, payment of staff, attending to management decisions, site managers and liaising with the body corporate.

•         You and the other two partners are not affiliated or related to each other and deal with each other as partners to the partnership on arm's length terms.

•         The financial statements of the partnership indicate that it is a small business entity (SBE) as its turnover is less than $2 million.

•         You have a GG% interest in the partnership.

•         The primary source of income from the partnership is derived from the fees in relation to the serviced apartments.

•         The completed serviced apartments are still operated and managed by partnership.

•         The partnership tax returns describe the partnership business as "Investment Operation -Units".

•         The holiday apartments are advertised for 2 days to 2 weeks with many stays less than 3 nights.

•         All linen and towels are provided and changed with the rooms cleaned after 4 days for bookings of a week or more.

•         Food and other supplies such as toiletries are provided.

•         Guests can be removed without refund if they don't follow the house rules; and

•         The onsite managers provide significant front desk services to guests.

Property C:

•         It comprises of a block of four villa units that was purchased in 20XX.

•         The purpose of this acquisition was to redevelop the site into townhouses and hold them for commercial rental income.

•         You obtained development and town planning documentation which included details about the development of two further units on the site.

•         Due to market conditions, in particular the Global Financial Crisis ("GFC"), the redevelopment plans had been postponed.

•         The property was sold in 20HH as part of your winding up process; and

•         During the ownership period, you rented out the villa units in order to generate some economic return.

Property D:

•         Is land which was purchased by a partnership (which you were a 50% partner in).

•         The land consisted of F connected lots.

•         The purpose of this acquisition was to redevelop the site into apartments to be managed by the partnership for the derivation of commercial and holiday rental income.

•         The proposed redevelopment was rendered unviable as a result of various planning restrictions.

•         As a result, the land was held for the purposes of land banking; and

•         The land is currently being sold by the partnership with B lots sold to date.

You own other properties but in your capacity as the trustee of a related Self Managed Superannuation Fund.

Your shareholders have held shares in you for over XX years, are all over 55 years old, are retiring.

All of you directors own more than 20% of shares in you.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 subsection 108-5(1)

Income Tax Assessment Act 1997 subsection 152-10

Income Tax Assessment Act 1997 section 152-15

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 152-55

Income Tax Assessment Act 1997 section 152-110

Income Tax Assessment Act 1997 section 328-110

Income Tax Assessment Act 1997 section 328-125

Income Tax Assessment Act 1997 section 328-130

Reasons for decision

Properties A & B are considered active assets and capital gains made on their disposal can be disregarded under section 152-110 of the ITAA 1997. Properties C & D are not considered active assets therefore you do not meet the basic conditions with regard to those properties and any capital gain made on their disposal will not be eligible to small business CGT concessions.

Detailed reasoning

Section 152-10 of theITAA 1997 contains the basic conditions you must satisfy to be eligible for the small business capital gains tax (CGT) concessions. These conditions are:

(a) a CGT event happens in relation to a CGT asset in an income year.

(b) the event would 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 in section 152-15 of the ITAA 1997

(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 or

(iv) the conditions in subsection 152-10(1A) or (1B) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year.

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

To be eligible to apply the small business CGT concessions you must satisfy all four of the basic conditions above.

A CGT asset is defined in subsection 108-5(1) of the ITAA 1997 as any kind of property or a legal or equitable right that is not property.

Here the properties would satisfy the definition of CGT assets as they are a kind of real property.

Section 104-10 of the ITAA 1997 contains the rules dealing with CGT event A1. CGT event A1 occurs if a taxpayer disposes of a CGT asset.

In this case, CGT event A1 has happened upon the sale of the properties by you which has resulted in capital gains.

Taxation Ruling TR 2019/1 Income Tax: when does a company carry on a business discusses when a company is considered to be carrying on a business for certain income tax provisions including section 328-110 of the ITAA 1997 which defines the term "small business entity", including for the purposes of the CGT provisions.

Applying the principles in TR 2019/1,you are considered to carry on a business. From the facts provided, your activities lead to the conclusion that you were carrying on a business for the following reasons:

•           Your business was one where you undertook property investment and development activities, which include acquiring properties and/or land, holding, preparing, renovating and then developing the property and/or land.

•           The scale and size of your commercial property acquisitions indicate a commercial and business-like approach to your operations and activities.

•           Your objective intention in obtaining development plans and approvals for the further development of the properties to increase their values and commercial rentability. This further indicates a commercial and business-like approach to your operations and activities.

•           Your property ownership and management activities were repetitive and regular in the generation of your business income.

•           You have conducted your business of property ownership and management in a methodical and business-like manner as evidenced from your financial statements and operation methodology. Furthermore, this indicates that you have conducted your business activities for the purposes of profit-making.

•           Although some of the properties appear to have been ultimately held for investment purposes rather than being developed, as per paragraph 55 of TR 2019/1:

...care needs to be taken to distinguish situations where the company has ceased a particular business, from the situation where the company has ceased carrying on any business. For example, a company may cease trading operations permanently but retain some investments. For this reason, it may still be carrying on a business in the general sense.

•           Further at paragraph 58 TR 2019/1 gives examples of when the courts have held a company carried on a business and includes a company that:

-                 holds and rents out single or multiple real properties

-                 invested in real property, intended to be held indefinitely for the purpose of deriving rent, and subsequently sold for profit

•           Example 3 of TR 2019/1 considers a property investment company which the Commissioner considered was carrying on a business and is comparable to you.

As you had an aggregated turnover of less than $2 million in the income year in which the CGT events occurred, you are a CGT small business entity in that income year.

We now have to consider whether each property (or your interest in the assets of the partnership which owned property) were active assets.

Active asset test

Subsection 152-35(1) of the ITAA 1997 states that a CGT asset satisfies 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 period of ownership, or

•           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.

The test period begins when you acquired the asset and ends at the time of the CGT event (subsection 152-35(2) of the ITAA 1997).

Subsection 152-40(1) of the ITAA 1997 provides that a CGT asset is an active asset if you own it and:

•           you use it or hold it ready for use in the course of carrying on a business (whether alone or in partnership)

•           it is an intangible asset (for example, goodwill) inherently connected with a business you carry on (whether alone or in partnership).

A CGT asset is also an active asset if you own it and it is used or held ready for use in the course of carrying on a business or it is an intangible asset inherently connected with a business carried on, (whether alone or in partnership) by any of the following:

•      your affiliate

•      your spouse or child under 18 years

•      an entity connected with you.

Sections 328-125 and 328-130 of the ITAA 1997 are used to determine whether another entity is a connected entity in relation to, or an affiliate of, you. 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. Subsection 328-130(1) provides that an individual or a company is an "affiliate" of another entity if the individual or company acts, or could reasonably be expected to act, in accordance with the entity's directions or wishes, or in concert with the entity, in relation to the affairs of the business of the individual or company.

When an asset is 'held ready for use'?

For an asset to be held ready for use in the course of carrying on a business, it needs to be in a state of preparedness for use in the business and functionally operative. As such, premises still under construction, or land upon which it is intended to construct business premises, could not be said to be 'held ready for use' and would, therefore, not be active assets at that time.

Active Asset exceptions

Subsection 152-40(4) of the ITAA 1997 provides a number of exceptions to the active asset test. Paragraph 152-40(4)(e) provides that an asset whose main use is to derive rent cannot be an active asset. Paragraph 152-40(4A)(b) provides that to determine the main use of an asset, treat any use by your affiliate, or an entity that is connected with you, as your use. Personal use of the asset by you or your affiliate is ignored in determining its main use.

Property A

You owned the property for more than XX years and for approximately XX years an associated entity used approximately 55% of the property to conduct its business. The remaining part of the property was leased to unrelated third parties. The associated entity (Company B) is considered an affiliate of yours as the two director/shareholders of Company B are also shareholders of you and Company B could reasonably be expected to act in accordance with your directions or wishes.

In relation to this property, it is considered that you meet the basic conditions contained in section 152-10 of the ITAA 1997 to access the small business CGT concessions, as you meet the aggregated turnover test and the active asset test.

Property B

You have owned the property for more than XX years in partnership with two other, non-related parties. You have a XX% interest in the partnership. The partnership developed, built and managed the serviced holiday apartments on the land, which was completed in 20AA. You project managed the construction of the development.

Since construction was completed, you (in addition to the other partners involved in the partnership), managed the daily management of the apartment complex, and were involved in making key decisions in conjunction with other partners, involving running costs, payment of staff, attending to management decisions, site managers and liaising with the body corporate.

Significant services are provided to guests, the apartments are serviced regularly, guests stay short term and can be removed without refund if unruly or don't follow house rules. Given the holiday apartment is more akin to a guesthouse than a mere rental arrangement, his property is considered an active asset as it is used in the course of carrying on a business (in partnership).

In relation to this property, it is considered that you meet the basic conditions contained in section 152-10 of the ITAA 1997 to access the small business CGT concessions, as you meet the aggregated turnover test and the active asset test.

Property C

You owned the property for more than XX years which comprised of four villa units. You intended to redevelop the site into townhouses and hold them for commercial rental income. You obtained development and town planning documentation which included details about the development of two further units on the site.

Due to market conditions, in particular the GFC, the redevelopment plans did not proceed. The property was sold in 2019 as part of your winding up process. During the ownership period, you rented out the villa units in order to generate some economic return.

As outlined above, paragraph 152-40(4)(e) of the ITAA 1997 provides that an asset whose main use is to derive rent cannot be an active asset. Despite your intention to develop the property and you taking initial steps to do so, the main use of this property during your period of ownership was to derive rent. Therefore, this property is not considered an active asset.

Therefore you do not meet the basic conditions contained in section 152-10 of the ITAA 1997 in relation to this property and so cannot access the small business CGT concessions in relation to this property.

Property D

You have owned the property for more than 15 years in partnership (you are a 50% partner). The property consisted of F connected lots. The purpose of this acquisition was to redevelop the site into apartments to be managed by the partnership for the derivation of commercial and holiday rental income.

The proposed redevelopment was rendered unviable as a result of various planning restrictions. As a result, the land was held for the purposes of land banking, that is held for future sale or development. The land is currently being sold by the partnership with B lots sold to date.

This property is also not considered an active asset as you did not use it or hold it ready for use in the course of carrying on a business, either by yourself or by an entity affiliated or connected to you. Despite the initial intention to develop the property, it was subsequently held purely as a passive investment.

Summary of active asset status of the various properties

It is considered properties A and B were/are your active assets. Therefore, you meet the basic conditions in relation to those two properties and you will be eligible for the small business CGT concessions in relation to those properties. However, properties C and D are not considered active assets and you therefore do not meet the basic conditions in relation to those properties and so are not eligible for the small business CGT concessions in relation to those properties.

15-year exemption

Section 152-110 of the ITAA 1997 provides a small business 15-year exemption for companies and trusts. Under this section, a company can disregard the capital gain from the disposal of a CGT asset if:

(a) the company satisfies the basic conditions in Subdivision 152-A of the ITAA 1997 for the small business CGT concessions

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

(c) the company 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 time the company owned the CGT asset; and

(d) an individual who was a significant individual of the company just before the CGT event was either:

•      at least 55 years old at that time and the event happened in connection with their retirement or

•      permanently incapacitated at that time.

Section 152-55 of the ITAA 1997 provides that an individual is a significant individual in a company or trust if they have a small business participation percentage in the company or trust of at least 20%; this 20% can be made up of direct and indirect percentages.

All of your directors each own more than 20% of the shares in you and so all are considered significant individuals. All shareholders are over 55 years old and have held their shares in you for over XX years.

The sale of all properties is in connection with the retirement of all shareholders as a result of you being wound up.

Therefore, you can disregard the capital gains made on the sale of properties A and B as for those properties you meet the basic conditions and meet the further requirements of section 152-110 of the ITAA 1997 with regards to the 15 year exemption.

As mentioned previously, since properties C and D are not considered active assets, you are not eligible for small business CGT concessions in relation to those properties.