Edited version of private advice

Authorisation Number: 1051849484538

Date of advice: 6 September 2021

Ruling

Subject: CGT - small business concessions

Question

Do the Taxpayers satisfy the basic conditions for small business relief in section 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997) in respect of the disposal of the Land?

Answer

No

This ruling applies for the following period:

Income Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

The Taxpayers

The Taxpayers are siblings who do not conduct a business.

The Land

The Land was originally acquired by the Taxpayers' parent.

Upon the death, the Land was bequeathed to the Taxpayers through their parent's will. The Taxpayers own the Land as tenants in common in equal shares.

The business conducted by the Taxpayers family on the Land

Since the Land was originally acquired by their parent, a farming partnership has been carried on by members of the Taxpayers' family on Land. The members of the farming partnership have changed over time and have at times included the Taxpayers' grandparents, parents, their Sibling and their Sibling's Spouse and the Taxpayers themselves.

The Partnership

Following their parent's death, their Sibling and their Sibling's Spouse (thePartners) have conducted the farming business on the Land in partnership (the Partnership).

The Applicant has advised that the Partners each have a 50% interest in the Partnership. No written partnership agreement has been prepared for the Partnership.

The aggregate turnover of the Partnership for the income years ended 30 June 20XX and 30 June 20XX was below $X million.

Taxpayers' Input into the business

The Applicant has advised that upon inheriting the Land, it was agreed between the Taxpayers and their Sibling that the farm would continue to be farmed by the Partners in consultation with the Taxpayers to assure the Taxpayers that the Land would be well maintained.

It was further agreed that the Taxpayers would provide input into the operations of the farm and would be responsible for certain costs associated with the Land.

No formal arrangements exist for the use of the Land and no leasing fees are charged by the Taxpayers to the Partnership.

The Applicant has advised that the Partners regularly seek advice from the Taxpayers in relation to the farming operations carried out on the Land. This advice is not documented in writing but is conveyed either in person or over the phone.

The Taxpayers have similar input into the operations of the Partnership. Each Taxpayer provides instructions to the Partners to ensure that the Partnership is not run in a manner that would degrade the Land that they own. Each Taxpayer monitors and provides instructions to the Partners in respect of stocking, erosion and weed control in addition to the maintenance of infrastructure to ensure that degradation is not caused to the Taxpayers' land on which the Partnership operates.

The Partners in the Partnership are responsible for implementing the business' yearly farm management plan and, taking into consideration any advice provided by the Taxpayers, make decisions in respect of the business. The Partners in the Partnership bear all the costs of these decisions and the operations of the business.

When the management of the farm has required additional support, the Taxpayers have attended the farm several times per month.

The Taxpayers also inspect the property periodically to check on the operations of the business.

The Taxpayers were not remunerated for the services and advice that they have provided to the Partnership.

The Taxpayers have paid their share of holding costs related to the Land, including council rates.

The Sale of the Land

The Taxpayers entered into a contract (Sale of Land Contract) with the Purchaser for the sale of the Land.

The sale of the Land to thePurchaser was initiated following an unsolicited offer from an unrelated, third party.

No changes were made to the Land in preparation for its sale.

It is understood that the Purchaser intends to develop the Land.

The Partnership intends to continue farming the Land until settlement of the Sale of Land Contract.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 328-125

Income Tax Assessment Act 1997 section 328-130

Reasons for decision

Summary

The Taxpayers do not satisfy the basic conditions for relief pursuant to section 152-10 of the ITAA 1997 in respect of the disposal of the Land.

Detailed reasoning

The basic conditions for relief under the small business CGT concessions are outlined in subsection 152-10(1) of the ITAA 1997. These conditions are:

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

[This condition does not apply in the case of CGT event D1.]

(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 (see 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 (see section 152-35).

Basic condition (a) - A CGT event happens in relation to a CGT asset of yours in an income year

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. Paragraph 108-5(2)(a) of the ITAA 1997 further highlights that part of, or an interest in, an asset referred to in subsection 108-5(1) of the ITAA 1997 is a CGT asset. Note 1 to section 108-5 of the ITAA 1997 lists land and buildings as examples of CGT assets.

The Land is clearly property and therefore, the Taxpayers' interest in the Land is a CGT asset as defined by section 108-5 of the ITAA 1997.

Subsection 104-10(1) of the ITAA 1997 provides that CGT event A1 happens if you dispose of a CGT asset. You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law.

In accordance with the Sale of Land Contract, the Taxpayers will each dispose of their interest in the Land to the Purchaser and therefore, pursuant to subsection 104-10(1) of the ITAA 1997, CGT event A1 will occur for each Taxpayer.

Consequently, the requirements of paragraph 152-10(1)(a) of the ITAA 1997 are satisfied.

Basic condition (b) - The event would have resulted in the gain

Subsection 104-10(4) of the ITAA 1997 provides that you make a capital gain from CGT event A1 if the capital proceeds from the disposal are more than the asset's cost base.

The Applicant has advised that each Taxpayer is expected to make a capital gain from the disposal of their interest in the Land.

Consequently, the requirements of paragraph 152-10(1)(b) of the ITAA 1997 are satisfied.

Basic condition (c) - at least one of the following applies:

(i)            you are a CGT small business entity for the income year

Subsection 152-10(1AA) of the ITAA 1997 provides that you are 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.

Section 328-110 of the ITAA 1997 provides that you are 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.

The Taxpayers did not carry on a business in their own right in the income year ended 30 June 20XX and therefore neither Taxpayer is a CGT small business entity for the income year.

(ii)          you satisfy the maximum net asset value test

Section 152-15 of the ITAA 1997 outlines the requirements to satisfy the maximum net asset value test. It provides that 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)).

In the current circumstances, neither Taxpayer satisfies the maximum net asset value test given that the net value of their CGT assets (which includes a 50% interest in the Land) exceeds $6,000,000.

(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

The Taxpayers are not partners in a partnership and therefore this condition is not satisfied.

(iv)         the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year

Subsection 152-10(1A) of the ITAA 1997

The conditions in subsection 152-10(1A) of the ITAA 1997 are satisfied 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) in any case - the CGT small business entity referred to in paragraph (a) is the entity that, at a time in the income year, carries on the business (as referred to in subparagraph 152-40(1)(a)(ii) or (iii) or paragraph 152-40(1)(b)) in relation to the CGT asset.

Paragraph 152-10(1A)(a) of the ITAA 1997

To satisfy the condition in paragraph 152-10(1A)(a) of the ITAA 1997 it needs to be determined if an affiliate, or an entity that is connected with each of the Taxpayers is a CGT small business entity.

In the current circumstances, this specifically requires us to consider whether the Partnership between their Sibling and their Sibling's Spouse that carries on the business on the Land is connected with the Taxpayers.

With this in mind, it is noted that subsection 328-125(1) of the ITAA 1997 provides that an entity is connected with another entity if:

(a)  either entity controls the other entity in a way described in this section; or

(b)  both entities are controlled in a way described in this section by the same third entity.

The direct 'control' tests which are contained in section 328-125 of the ITAA 1997 differ according to whether the entity is a discretionary trust or not.

The Partnership is not a discretionary trust and therefore the control test in subsection 328-125(2) of the ITAA 1997 applies which states:

An entity (the first entity) controls another entity if the first entity, it's *affiliates or the first entity together with its affiliates:

(a) except if the other entity is a discretionary trust own, or have the right to acquire the ownership of, interests in the other entity that carry between them the right to receive a percentage (the control percentage) that is at least 40% of:

(i) any distribution of income by the other entity; or

(ii) if the other entity is a partnership- the net income of the partnership; or

(iii) any distribution of capital by the other entity; or

(b) if the other entity is a company - own, or have the right to acquire the 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.

There is no written partnership agreement and no information has been provided which indicates that the Taxpayers hold any ownership interest in the Partnership or any right to acquire an ownership interest in the Partnership and therefore the Taxpayers are not connected on this basis.

However, if either of the Taxpayers have an affiliate that has an ownership interest of at least 40% in the Partnership then the control test in subsection 328-125(2) of the ITAA 1997 will be met and the Partnership will be a connected entity.

Is either Partner an affiliate of the Taxpayers?

Subsection 328-130(1) of the ITAA 1997 provides that an individual or a company is an affiliate of yours if the individual or company acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the business of the individual or company.

However, subsection 328-130(2) of the ITAA 1997 provides that an individual or a company is not your affiliate merely because of the nature of the business relationship you and the individual or company share.

The note to subsection 328-130(2) of the ITAA 1997 in part provides the following example in relation to the application of this provision as it states:

A partner in a partnership would not be an affiliate of another partner merely because the first partner acts, or could reasonably be expected to act, in accordance with the directions or wishes of the second partner, or in concert with the second partner, in relation to the affairs of the partnership.

'the affairs of the business of the individual'

In the current circumstances, it is necessary to consider further the reference to 'in relation to the affairs of the business of the individual or company'. In particular, in this case whether this phrase would encompass the individual's business affairs of the partnership.

The term 'partnership' is defined in section 995-1 of the ITAA 1997 to include 'an association of persons carrying on business as partners.'

This aspect of the definition imports the common law meaning of partnership, being the relationship which exists between persons carrying on business in common with a view to profit.

A partnership is not a separate legal identity. Each partner of a partnership is carrying on the partnership business. It follows that, where a partnership is carrying on a business, each partner of that partnership is considered to be carrying on the business.

Therefore, on face value, it would appear reasonable to conclude that when considering the 'affairs of the business of the individual', this would include an individual's business affairs as a partner in a partnership.

Meaning of 'could reasonably be expected'

The Full High Court, in FC of T v. Peabody (1994) 181 CLR 359; 94 ATC 4663; (1994) 28 ATR 344, held that the phrase 'might reasonably be expected' requires more than a possibility.

Whether a person acts, or could reasonably be expected to act, in accordance with a taxpayer's directions or wishes or in concert with a taxpayer is a question of fact dependent on all the circumstances of the particular case. No single factor will necessarily be determinative.

Relevant factors to consider in this assessment include:

• the existence of a close family relationship between the parties;
• the lack of any formal agreement or formal relationship between the parties dictating how the parties are to act in relation to each other;
• the likelihood that the way the parties act, or could reasonably be expected to act, in relation to each other would be based on the relationship between the parties rather than on formal agreements or legal or fiduciary obligations; and
• the actions of the parties.

The ATO website provides the following example of the affiliate test:

Bob and Shirley are married. Bob has an events management business with an annual turnover of $1.7 million, and Shirley owns a consultancy business with an annual turnover of $1.8 million.

Bob acts in accordance with Shirley's wishes because he values her consultancy and business expertise. As a result, Bob is Shirley's affiliate because he acts in accordance with her directions and wishes in relation to his business. Shirley will need to count Bob's turnover in working out her aggregated turnover.

However, Shirley is not Bob's affiliate, because she does not act in accordance with his wishes or in concert with him in relation to her own business.

Taxation Ruling 2002/6 Income tax: Simplified Tax System: eligibility - grouping rules (*STS affiliate, control of non-fixed trusts) sets out the Commissioner's views on the meaning of ' STS affiliate' for the purposes of determining whether an entity satisfies the eligibility rules in Subdivision 328-F (the provision has been repealed).

Although the STS no longer operates for the 2007-08 and later income years, the definition of 'STS affiliate' under the former Subdivision 328-F is closely aligned with the requirements set out in section 328-125 of the ITAA 1997. As such, the Commissioner's guidelines in TR 2002/6 are relevant to the meaning of affiliates for the purposes of section 328-130 of the ITAA 1997.

The scope of the affiliate definition is described in paragraph 31 of TR 2002/6 as follows:

The *STS affiliate definition in subsection 328-380(8) does not apply where the potential *STS affiliate acts or could reasonably be expected to act as another directs or wishes, or in concert with it, only in relation to isolated transactions or on an irregular, ad hoc basis. For the definition to apply, the potential *STS affiliate must act in accordance with the entity's directions or wishes or in concert with it, or could reasonably be expected to so act, in relation to all or a substantial part of the affairs of the potential *STS affiliate's business.

In the current circumstances, taking the above matters into consideration, it is considered that, on balance, the Partners are not affiliates of the Taxpayers because the information provided is not sufficient to demonstrate that they either act or could reasonably be expected to act in accordance with the Taxpayers' directions or wishes in relation to the affairs of the farming business.

Because the Partners are not affiliates of the Taxpayers, the Taxpayers will not control nor be connected with the Partnership on the basis of the Partners' interests in the Partnership. Consequently the conditions in paragraph 152-10(1A)(a) and in turn subsection 152-10(1A) of the ITAA 1997 will not be satisfied.

Subsection 152-10(1B) of the ITAA 1997

Subsection 152-10(1B) of the ITAA 1997 is not applicable in the current circumstances as the Taxpayers are not partners in a partnership.

Conclusion: Paragraph 152-10(1)(c) of the ITAA 1997

Because the Taxpayers do not satisfy any of the requirements in subparagraphs 152-10(1)(c)(i) to 152-10(1)(c)(iv) of the ITAA 1997, they also do not satisfy the requirements of paragraph 152-10(1)(c) of the ITAA 1997.

Conclusion: Subsection 152-10(1) of the ITAA 1997

Similarly, as the Taxpayers do not satisfy the requirements of paragraph 152-10(1)(c) of the ITAA 1997, the basic conditions to be eligible for small business relief in subsection 152-10(1) of the ITAA 1997 are not met.

Although unnecessary in light of the above conclusion, the requirements in paragraph 152-10(1)(d) of the ITAA 1997 will be briefly considered.

Basic condition (d) - the CGT asset satisfies the active asset test

Paragraph 152-10(1)(d) of the ITAA 1997 requires that the CGT asset satisfies the active asset test.

Pursuant to 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 specified in subsection (2); 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 at least 7½ years during the period specified in subsection (2).

Subsection 152-35(2) of the ITAA 1997 provides that the test period is from when the asset is acquired until the CGT event. If the business ceases within the 12 months before the CGT event (or such longer time as the Commissioner allows) the relevant period is from acquisition until the business ceases.

In the current circumstances, the Taxpayers acquired the Land in 19XX upon the death of their father and CGT event A1 happened when the Sale of Land Contract was entered into. Accordingly the Taxpayers have owned the Land for more than 15 years and as such to meet the active asset test, the Land must be an active asset for a total of at least 7 ½ years.

Subsection 152-40(1) of the ITAA 1997 provides that 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 partnership) by you, your affiliate, or an entity connected with you.

As detailed above, it is considered that the Partners are not affiliates of the Taxpayers and therefore the Taxpayers are unable to demonstrate the Land is being used or held ready for use in the course of carrying on a business of an affiliate or a connected entity.

Accordingly, the requirements of paragraph 152-10(1)(d) of the ITAA 1997 are also not satisfied.

Conclusion

In conclusion, as detailed above, it is considered that the Taxpayers do not satisfy the basic conditions for small business relief in section 152-10 of the ITAA 1997 in respect of the disposal of the Land.