Edited version of private advice

Authorisation Number: 1051849358888

Date of advice: 5 July 20201

Ruling

Subject: Aggregated turnover for CGT small business concessions purposes

Question

Will proceeds from the sale of P&E upon cessation of a farming business be excluded from aggregated turnover when determining whether the entity is a CGT small business entity under section 152-10 of the Income Tax Assessment Act 1997?

Answer

Yes

This ruling applies for the following period:

1 July 2021 to 30 June 2022

The scheme commences on:

1 July 2021

Relevant facts and circumstances

1.    A business entity ('the Entity') conducts a farming business, selling livestock and produce.

2.    The Entity intends to sell all their farmland during the 2022 income year, and cease to carry on a farming business. The Entity also intends to sell the majority of its business P&E either in conjunction with or shortly after the sale of farmland.

3.    The P&E includes high value items such as harvesting equipment, tractors, and feeding bins. The total 'cost' of all P&E is about $2 million.

4.    The Entity holds the P&E for use in the business. Individual P&E items are typically held for a number of years. The Entity is not in the business of buying and selling P&E.

5.    Farming businesses typically replace P&E regularly so that it remains new or in good condition. However, it is not ordinary to have a P&E sale of this magnitude.

Relevant legislative provisions

Section 6-5 of the Income Tax Assessment Act 1997

Section 40-285 of the Income Tax Assessment Act 1997

Section 152-10 of the Income Tax Assessment Act 1997

Section 328-110 of the Income Tax Assessment Act 1997

Section 328-115 of the Income Tax Assessment Act 1997

Section 328-120 of the Income Tax Assessment Act 1997

Section 995-1 of the Income Tax Assessment Act 1997

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997.

Question

Will proceeds from the sale of P&E upon cessation of a farming business be excluded from the Entity's aggregated turnover when determining whether it is a CGT small business entity under section 152-10?

Summary

6.    Yes. Proceeds from the sale of P&E upon the disposal upon cessation of a farming business will be excluded from the Entity's aggregated turnover, because they are not ordinary income derived in the ordinary course of carrying on a business. These proceeds will be excluded from turnover calculations when determining whether it is a CGT small business entity under section 152-10.

Detailed reasoning

Aggregated turnover

7.    Division 152 contains concessions for relief from the tax consequences of capital gains, targeted at small businesses ('the CGT small business concessions'). Section 152-10 contains some eligibility requirements for the CGT small business concessions known as the basic conditions. An entity will satisfy the eligibility requirement in paragraph 152-10(1)(c) if at least one of several alternative criteria is met. One criterion is that the entity is a CGT small business entity for the income year: see subparagraph 152-10(1)(c)(i).

8.    Subsection 152-10(1AA) says:

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.

9.    Section 328-110 gives the meaning of 'small business entity.' An entity will be a small business entity if it meets any of three alternative tests described subsections 328-110(1), 328-110(3) or 328-110(4). Very broadly, a requirement common to all three tests is that the entity must have (or be likely to have, under one test) an aggregated turnover of less than $10 million during a relevant income year.

10.  Section 328-115 gives the meaning of 'aggregated turnover.' Broadly, an entity's aggregated turnover for an income year is the sum of the annual turnovers of itself, its connected entities, and its affiliates, excluding dealings with or between any connected entities or affiliates.

11.  'Annual turnover' is explained in section 328-120. Subsection 328-120(1) says:

An entity's annual turnover for an income year is the total *ordinary income that the entity *derives in the income year in the ordinary course of carrying on a *business.

12.  Subsections 328-120(2), 328-120(3) and 328-120(4) exclude some items from annual turnover (broadly, GST, retail fuel sales, and non arm's length dealings with associates). Subsection 328-120(5) requires that if an entity does not carry on a business for a whole income year, its annual turnover is worked out using a reasonable estimate of what it would be if it carried on a business for the whole income year.

13.  Subject to the exceptions in section 328-115 and 328-120, a receipt will be included in aggregated turnover if it is both:

•         'ordinary income', and

•         derived in the 'ordinary course' of carrying on a business.

Ordinary income - general principles

14.  Section 995-1 says that 'ordinary income' has the meaning given by section 6-5. Subsection 6-5(1) says assessable income includes income according to ordinary concepts, which is called ordinary income.

15.  'Income according to ordinary concepts' is not defined. However, there is a substantial body of case law addressing whether receipts are ordinary income under section 6-5 or similar predecessor provisions.Taxation Ruling TR 2006/3: Income tax: government payments to industry to assist entities (including individuals) to continue, commence or cease business at paragraph 85 summarises some general guidelines, taken from this case law. Very broadly:

•         whether receipts are classified as 'income' for a business taxpayer depend on the circumstances of the receipt and the nature of the taxpayer's business

•         receipts are not income if they are characterised as 'capital' - such as payments for realising capital assets or part of the business' profit earning structure

•         receipts are likely to be income if they are received periodically, regularly, or on a recurring basis, or are consideration for the performance of services

•         receipts from isolated transactions, entered into with the intention to profit, may be income in some circumstances.[1]

16.  The character of receipts will depend on the character of the business. The Entity carries on a farming business, selling livestock and produce. Its P&E (such as harvesting equipment, tractors, feeding bins) is held for use in the business. Buying and selling farming P&E is not part of its business. Farming businesses typically hold and depreciate P&E for some years, for both tax and accounting purposes, replacing them as they begin to age or decline in value.

17.  For a livestock and produce farm like the Entity, its ordinary income would come from livestock and produce sales. Items like harvesting equipment, tractors, and feeding bins are used in the business and form part of its profit earning structure. Proceeds from the sale of these items would not be ordinary income for most livestock or produce farms.

18.  In some very unusual circumstances, it is possible that the character of these receipts could be ordinary income. An example may be where a farming business acquired some of its P&E for resale, rather than use in the business and/or sold its P&E in a manner which indicated an intention to profit.[2].

19.  Here, the Entity uses its P&E in its business, and is not in the business of selling P&E. There is no indication that it intends to profit from the disposal: since the P&E has been used in its business, it would likely have reduced resale value. It is simply disposing of these items as part of a plan to end the business. The disposal would be the mere realisation of capital assets (potentially subject to balancing adjustments under section 40-285), and the proceeds will not be ordinary income to the Entity.

Derived in the ordinary course of carrying on a business

20.  For completeness, we discuss whether the proceeds of disposal of P&E would be in the 'ordinary course of carrying on a business.'

21.  The phrase 'ordinary course of carrying on a business' is not defined, so its meaning must be taken from its ordinary usage and context.[3]

22.  The Macquarie Dictionary[4] says the meanings of:

•         'ordinary' include 'commonly met with, of the usual kind' or 'customary; normal'

•         'course' include 'customary manner of procedure; regular or natural order of events', 'a mode of conduct; behaviour' or 'a particular manner of proceeding'.

23.  Arguably, the periodic sale and replacement of P&E as it deteriorated could be 'customary,' 'normal', 'usual', 'regular' or 'natural' in some situations. This would depend on circumstances of the sale/disposal. If P&E was disposed in a systematic, regular, and organised way, that might suggest the operation was incidental to, and part of the ordinary course of business.[5] This may not be the case where disposals/replacements were conducted in an irregular or ad-hoc basis.

24.  In this case, the Entity is selling all its P&E because it is ceasing to carry on its farming business. Clearly, this is not a customary, regular, normal, or usual event in 'carrying on' the Entity's business. Rather, it is extraordinary, unusual, and has only arisen because the business will no longer be carried on. Therefore, the proceeds of sale will not be in the ordinary course of carrying on the business.

Conclusion

25.  The proceeds from the sale of P&E by the Entity as it ceases its business will not ordinary income derived in the ordinary course of carrying on the business. Therefore, the proceeds will not be included in:

•         annual turnover under section 328-120, or

•         aggregated turnover under 328-115.

26.  It follows that the proceeds from the sale of P&E will not be included in turnover calculations when determining whether the Entity is a CGT small business entity for the purposes of the CGT small business concessions.

[1] Taxation Ruling 92/3: Income tax: whether profits on isolated transactions are income ('TR 92/3') discusses the circumstances in which isolated transactions may be income according to ordinary concepts.

[2] In these cases, the character of the business would most likely have changed, so that it was carrying on a separate or subsidiary business of buying and selling farm equipment, in addition to its farming activities. Therefore, the relevant items would cease to be P&E (or capital assets), but would be instead treated as trading stock.

[3] The same approach was adopted by the Explanatory Memorandum to the Tax Laws Amendment (Small Business) Bill 2007, which introduced section 328-120, and the Full Federal Court in Doutch v Commissioner of Taxation [2016] FCAFC 166 at [8] and [74] per Greenwood, McKerracher and Moshinsky JJ.

[4] Macmillan Publishers Australia, The Macquarie Dictionary online, www.macquariedictionary.com.au, accessed 29 June 2021.

[5] Of course, this conclusion would not necessarily make the proceeds assessable as ordinary income. P&E would be depreciating assets under section 40-30 as they have a limited effective life and can reasonably be expected to decline in value. Any gains or losses from the disposal of depreciating assets would be treated as balancing adjustments under section 40-285, rather than 6-5.