Edited version of private advice

Authorisation Number: 1051793555855

Date of advice: 24 December 2020

Ruling

Subject: Capital gains tax - small business 50% reduction

Question 1

Is the Taxpayer eligible to access the small business 50% reduction concession under Subdivision 152-C of the Income Tax Assessment Act 1997 (ITAA 1997) in respect of the sale of the warehouse?

Answer

Yes

Question 2

Can the Taxpayer apply both a CGT discount in accordance with Division 115 of the ITAA 1997 and the small business 50% reduction concession in respect of the same capital gain derived from the sale of the warehouse?

Answer

Yes

This ruling applies for the following period

Year ended 30 June 20XX

Relevant facts and circumstances

The Taxpayer signed a contract to purchase a warehouse (the warehouse) in February 20XX.

Upon settlement of the contract of purchase, the Taxpayer began to lease the warehouse to the Company.

As of June 20XX, the Taxpayer became the sole director of the Company and began to hold 65.5% of the shares issued in the Company. Those shares carry the right to exercise 65.5% of the voting power in the Company.

The Company carries on a business as an online retailer of electronic products and audio equipment. The Company used the warehouse in the course of carrying on this business for the duration of the period the warehouse was owned by the Taxpayer.

The Company had an aggregated turnover of less than $XXX in the 20XX and 20XX income years and qualified as a 'CGT small business entity' pursuant to subsection 152-10(1AA) of the ITAA 1997 in respect of the 20XX income year.

The Taxpayer was a non-resident for tax purposes for the 20XX to 20XX income years.

The Taxpayer became a resident for tax purposes in the 20XX income year.

The Taxpayer executed a contract for sale to sell the warehouse in January 20XX. The warehouse continued to be leased by the Taxpayer to the Company until the contract for sale settled in October 20XX.

The Taxpayer made a capital gain as a result of the sale of the warehouse.

The Taxpayer did not carry on a business in their own capacity during the 20XX income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-5

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 subsection 104-10(4)

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

Income Tax Assessment Act 1997 Division 115

Income Tax Assessment Act 1997 section 115-10

Income Tax Assessment Act 1997 section 115-105

Income Tax Assessment Act 1997 section 115-115

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 subsection 152-10(1)

Income Tax Assessment Act 1997 paragraph 152-10(1)(a)

Income Tax Assessment Act 1997 paragraph 152-10(1)(b)

Income Tax Assessment Act 1997 subparagraph 152-10(1)(c)(iv)

Income Tax Assessment Act 1997 paragraph 152-10(1)(d)

Income Tax Assessment Act 1997 subsection 152-10(1AA)

Income Tax Assessment Act 1997 subsection 152-10(1A)

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 paragraph 152-40(1)(a)

Income Tax Assessment Act 1997 subparagraph 152-40(1)(a)(iii)

Income Tax Assessment Act 1997 paragraph 152-40(1)(b)

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

Income Tax Assessment Act 1997 paragraph 152-40(4)(e)

Income Tax Assessment Act 1997 paragraph 152-40(4A)(b)

Income Tax Assessment Act 1997 Subdivision 152-C

Income Tax Assessment Act 1997 section 152-205

Income Tax Assessment Act 1997 section 328-125

Income Tax Assessment Act 1997 paragraph 328-125(1)(a)

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

Reasons for decision

Question 1

Summary

The Taxpayer has satisfied the basic conditions for relief under Subdivision 152-A of the ITAA 1997 in relation to the capital gain made upon disposal of the warehouse and is therefore eligible to access the small business 50% reduction concession under Subdivision 152-C.

All legislative references are to the ITAA 1997.

Detailed reasoning

The rules covering the small business 50% reduction concession are contained in

Subdivision 152-C. Unlike the other small business capital gains tax (CGT) concessions, the small business 50% reduction may be applied automatically if the basic conditions in Subdivision 152-A are satisfied.

Basic conditions

To qualify for any of the small business CGT concessions the basic conditions contained in section 152-10 which are common to all the concessions must be satisfied.

Subsection 152-10(1) states that a capital gain (except a capital gain from CGT event K7) you make 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 incomeyear;

(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 under section 152-15;

                (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 under section 152-35.

Paragraph 152-10(1)(a) - CGT event happened in relation to a CGT asset

Pursuant to section 104-10, CGT event A1 happens when you enter into a contract for the disposal of a CGT asset.

A CGT asset is defined by subsection 108-5(1) to include any kind or property.

The condition under paragraph 152-10(1)(a) is satisfied as CGT event A1 happened when the Taxpayer entered into a contract to dispose the warehouse (a CGT asset) in January 20XX.

Paragraph 152-10(1)(b) - CGT event resulted in a gain

The condition under paragraph 152-10(1)(b) is satisfied as the Taxpayer made a capital gain at the time he entered into the contract to dispose the warehouse pursuant to subsection 104-10(4).

Subparagraph 152-10(1)(c)(iv) - Subsection 152-10(1A) passively-held assets

The conditions in subsection 152-10(1A) allow access to the small business CGT concessions for a CGT asset you own if:

(a)  your affiliate, or an entity that is connected with you, is a CGT small business entity for the income year; and

(b)  you do not carry on a business in the income year (other than in partnership); and

(c)   if you carry on a business in partnership - the CGT asset is not an interest in an asset of the partnership; and

(d)  your affiliate or the entity that is connected with you at a time in the income year is the small business entity that carries on the business (as referred to in paragraph 152-40(1)(a) or (b)) and uses the asset at that time.

An entity is 'connected with' another entity pursuant to paragraph 328-125(1)(a) if either entity controls the other in a way described by section 328-125.

Subsection 328-125(2) specifies that an entity (the first entity) controls another entity (where that other entity is a company) if the first entity, its affiliates, or the first entity together with its affiliates, own, or have the right to acquire the beneficial ownership of, equity interests in the company that carry between them the right to exercise, or control the exercise of, a percentage (the control percentage) that is at least 40% of the voting power in the company.

As the Taxpayer held 65.5% of the issued shares in the Company during the 20XX income year which between them carry the right to exercise 65.5% of the voting power in the company, the Taxpayer controlled the Company in the way described in subsection 328-125(2) and was therefore 'connected with' the Company for the 2020 income year.

The condition under subparagraph 152-10(1)(c)(iv) is satisfied as the conditions in subsection 152-10(1A) are satisfied in relation to the warehouse. This is because:

•         the Company, being an entity connected with the Taxpayer, is a CGT small business entity for the 20XX income year;

•         the Taxpayer was not carrying on a business in their own capacity in the 20XX income year;

•         the Taxpayer was not carrying on a business in partnership; and

•         the Company is the entity that, at the time of the CGT event, carried on the business (as referred to in subparagraph 152-40(1)(a)(iii)) in relation to the warehouse.

Paragraph 152-10(1)(d) - CGT active asset test

The active test is contained in section 152-35 and will be satisfied 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 test period; or

(b)  you have owned the asset for more than 15 yearsand the asset was an active asset of yours for a total of at least 7.5 years during the test period.

The test period in respect of the warehouse begins when the Taxpayer acquired the asset and ends at the time of the CGT event.

The meaning of the term active asset is found in section 152-40. Essentially a tangible CGT asset is an active asset if it is owned by you and is used or held ready for use in a business carried on (whether alone or in a partnership) by you, your affiliate or another entity that is connected with you.

The Taxpayer owned the warehouse for approximately XX years, throughout which the warehouse was used in a business carried on by the Company, an entity connected with the Taxpayer. The warehouse therefore satisfies the active asset test in section 152-35, subject to the operation of subsection 152-40(4) which excludes certain assets from being active assets.

Paragraph 152-40(4)(e) excludes, among other things, assets whose main use is to derive rent (unless such use was only temporary).

Relevantly, Taxation Determination TD 2006/63 Income tax: capital gains: is a CGT asset that is leased by a taxpayer to a connected entity for use in the connected entity's business an active asset under section 152-40 of the Income Tax Assessment Act 1997? provides that in determining the main use of an asset for the purposes of paragraph 152-40(4)(e), any use of the asset by a connected entity is treated as the taxpayer's use of the asset pursuant to paragraph 152-40(4A)(b). Therefore, an asset leased to a connected entity for use in the connected entity's business will not, by that reason alone, be excluded by paragraph 152-40(4)(e) from being an active asset of the taxpayer.

As such, even though the Taxpayer wholly used the warehouse to derive rent (charged to the Company for its lease), the Company (a connected entity) wholly used the warehouse in the course of carrying on its business. For the purposes of paragraph 152-40(4)(e), the Warehouse is therefore treated as being used by the Taxpayer in the course of carrying on a business and will not be excluded from being an active asset of the Taxpayer.

The condition under paragraph 152-10(1)(d) is consequently satisfied.

As each of the basic conditions in Subdivision 152-A are satisfied in relation to the gain, the Taxpayer is entitled to the small business 50% reduction available under section 152-205.

Question 2

Summary

The Taxpayer can apply both the CGT discount available under Division 115 and the small business 50% reduction available under Subdivision 152-C in respect of the capital gain made from the disposal of the warehouse.

Detailed reasoning

Subdivision 115-A sets out the qualifying conditions for a discount capital gain.

A discount capital gain is a capital gain which is made by an entity listed in section 115-10, including an individual, resulting from a CGT event happening to a CGT asset that was acquired by the entity making the capital gain at least 12 months before the CGT event.

Where:

(a)  you are an individual;

(b)  you acquire a CGT asset;

(c)   you make a discount capital gain from a CGT event happening in relation to the CGT asset;

(d)  the discount testing period (starting on the day you acquired the CGT asset and ending on the day the CGT event happens) ends after 8 May 2012; and

(e)  you were a foreign resident at any time during the discount testing period after 8 May 2012,

section 115-105 applies to adjust the discount percentage so as to deny a discount to the extent that you accrued the capital gain while a foreign resident.

As the Taxpayer was a foreign resident for the income years from 20XX to 20XX (i.e. during some of the discount testing period as is after 8 May 20XX), the taxpayer must make adjustments to the discount percentage using an appropriate formula provided in section 115-115.

The method for working out your net capital gain (if any) for an income year is set out in section 102-5. It provides (at step 3) that a discount capital gain remaining after step 2 (if any) can be reduced by the relevant discount percentage. The amount of any capital gain remaining for the Taxpayer after applying step 3 of the method statement can then be reduced by 50% as a result of the application of the small business 50% reduction under Subdivision 152-C.