Edited version of private advice

Authorisation Number: 1051852018993

Date of advice: 28 June 2021

Ruling

Subject: CGT - small business concessions

Question

Does the will bank qualify as an active asset for the purposes of the small business capital gains tax concessions?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

Person A is the sole director and shareholder of Company A (You).

Person A was born on X December 19xx and is aged xx.

On xx June 20xx, You agreed to enter into a partnership with Company B (as trustee for the Trust B) (Trust B), Company C (as trustee for Trust C) (Trust C) and Company D (as trustee for the Trust D) (Trust D)

You, Trust B, Trust C and Trust D executed a Partnership Deed (Partnership Deed) on that day.

The partnership was established with effect from 1 July 20xx to conduct a business of providing legal services trading as BOSL.

Person A, Person B, Person C and Person D were the principal lawyers of BOSL.

Under the terms of the Partnership Deed, Company A and Company D each acquired from Trust B and Trust C a 25% interest in a number of assets. Amongst the assets acquired by Company A was a 25% interest in a Will Bank.

The Will Bank comprises a large number of Wills prepared for and kept in safe keeping for clients.

The Will Bank represented a source of future work for the Partnership.

The Will Bank was valued at $x and you paid $x to acquire a 25% interest in the Will Bank.

Person D resigned from the Partnership in December 20xx.

Person A, B and C agreed to continue operating the business of BOSL in Partnership. The Partnership acquired person D's 25% interest in the Will Bank for $x ($xx.xx each) being one third.

In January 20xx, Person A informed Person B and Person C that he wished to retire from the legal practice at the end of 20xx.

In July 20xx, the Partnership entered into an agreement where it agreed to merge the practice with a different legal practice. This was to take effect from x October 20xx and involved a disposal of certain number of assets within the Partnership.

As part of the merger, the Partnership sold the Will Bank for $xxx.

Company A received one third of the proceeds of the sale of the Will Bank.

Company A proposed to pay Person A the one third proceeds.

The Partnership (as BOSL) continued providing legal services between July 20xx and October 20xx.

The turnover of the Partnership for the financial year ended 30 June 20xx was less than $2 million.

The turnover of the Partnership for the financial year ended 30 June 20xx exceeded $2 million.

Trust A, B and C each received less than 40% of the income of the partnership in the income years ended 30 June 20xx and 30 June 20xx.

Person A retired from legal practice in December 20xx.

Person A is a Director of two other companies: Company Y and Company Z

Company Y was established in December 19xx to act as trustee for the Trust K. The Directors and shareholders of Company Y were Person E and Person F

The beneficiaries of the Trust K were Person E, Person F and their two children, Person G and Person H.

Company Z was established in June 19xx. Person E and Person F acted as Directors of Company Z from June 19xx. Both Person E and F owned 10 shares in Company Z.

Company Z received distributions of income from the Trust K and reinvested those amounts. Person E was the person who made the investment decisions.

Person G passed away in October 20xx

When Person E passed away in April 20xx, Person F became the sole shareholder of Company Y.

Person A has been Person F's son-in-law since 19xx. Person A married Person H.

Following the death of Person G, Person H requested that Person A act as a Director of Company Y and Company Z. In July 20xx, Peron A agreed.

Person F relied on Person A to make recommendations and decisions regarding investment strategies for Company Y and Company Z.

Since Person A was appointed as director of Company Y, the income of the Trust K (including all capital gains) has been distributed to Person F and/or Company Z.

Person A, Person H, their two dependants and Company A have never received any distributions of income or capital from Trust K.

The net value of assets owned by Person A and Company A, and connected entities is less than $6 million.

The partnership is a CGT small business entity for the income year in which the CGT event occurred.

Relevant legislative provisions

Subdivision 152-A of the Income Tax Assessment Act 1997 (ITAA 1997)

Subdivision 152-D of the Income Tax Assessment Act 1997 (ITAA 1997)

Section 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997)

Section 152-15 of the Income Tax Assessment Act 1997 (ITAA 1997)

Section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997)

Section 152-40 of the Income Tax Assessment Act 1997 (ITAA 1997)

Section 152-50 of the Income Tax Assessment Act 1997 (ITAA 1997)

Section 152-325 of the Income Tax Assessment Act 1997 (ITAA 1997)

Section 328-110 of the Income Tax Assessment Act 1997 (ITAA 1997)

Section 328-125 of the Income Tax Assessment Act 1997 (ITAA 1997)

Detailed reasoning

You are proposing to make a payment to the Director, Person A, which is an amount equal to the capital proceeds you received from the disposal of the Will Bank. The payment by you to Person A, is not treated as a dividend or a frankable distribution.

CGT Small Business entity

The term 'small business entity' is defined in section 328-110.

Subsection 328-110(1) 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 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 definition of CGT small business entity is contained in subsection 152-10(1AA) of the ITAA 1997 and requires that the entity be a small business entity with aggregated turnover below $2 million for the relevant year and/or the previous year.

Section 328-115 of the ITAA 1997 explains that your aggregated turnover is your annual turnover plus the annual turnovers of any business entities that are your affiliates or that are 'connected with' you. The definition of aggregated turnover is contained in subsection 328-155 of the ITAA 1997 as the sum of the relevant annual turnovers. The relevant annual turnovers are outlined in subsection 328-155(2) and excludes any amounts covered by subsection 328-155(3).

Annual Turnover

The meaning of 'annual turnover' is provided in section 328-120 of the ITAA 1997. Subsection 328-120(1) states:

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.

The term 'ordinary income' is defined in section 6-5 of the ITAA 1997 as income according to ordinary concepts.

An entity's annual turnover therefore includes all income according to ordinary concepts derived in the ordinary course of carrying on a business.

'In the ordinary course of carrying on a business' is not defined in ITAA 1997. The term therefore takes its ordinary meaning.

In Doutch v FC of T [2016] FCAFC 166, which was an appeal against the decision of the AAT in respect of small business entity concessions, the Full Federal Court confirmed the following reasoning provided by the Tribunal:

70 The phrase "in the ordinary course of carrying on a business", as it appears in s 328-120(1) of the ITAA 1997, is not defined in the ITAA 1997 and it is necessary to construe those words. In engaging in the exercise of statutory construction, the Court is to consider the text of the statute in context. The High Court in Commissioner of Taxation v Consolidated Media Holdings Ltd (2012) 250 CLR 503 observed as follows at [39]:

"This Court has stated on many occasions that the task of statutory construction must begin with a consideration of the [statutory] text" [Alcan (NT) Alumina Pty Ltd v Commissioner of Territory Revenue [2009] HCA 41; (2009) 239 CLR 27 at 46 [47]]. So must the task of statutory construction end. The statutory text must be considered in its context. That context includes legislative history and extrinsic materials. Understanding context has utility if, and in so far as, it assists in fixing the meaning of the statutory text. Legislative history and extrinsic materials cannot displace the meaning of the statutory text. Nor is their examination an end in itself.

71 The extrinsic materials to which the High Court referred includes an explanatory memorandum.

72 The definition of "annual turnover" in s 328-120(1) of the ITAA 1997 was inserted into the ITAA 1997 by Tax Laws Amendment (Small Business) Act 2007 (TLASBA 2007). The "Explanatory Memorandum" to the Tax Laws Amendment (Small Business) Bill 2007 (EM), which Bill was ultimately enacted as the TSLABA 2007, commencing from the 2008 income year.

Small Business CGT Concessions

Section 152-10(1) ITAA 1997 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;

Note: 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).

Your 1/3rd interest in the Will Bank is a CGT asset and there is a CGT event in relation to that interest in the financial year ending 30 June 20xx.

The event would have resulted in a capital gain without the application of subparagraph 152-10(1)(c)(iii)

Maximum net asset value test

As per section 152-15 of the ITAA 1997, the maximum net asset value test is satisfied if, just before the CGT event the sum of the following does not exceed $6m:

•         The net market value of your CGT assets

•         The net market value of CGT assets of an entity connected with you; and

•         The net market value of CGT assets of an entity that is a CGT affiliate of yours that are used in carrying on a business with you or another entity connected with you.

In your case, your net assets do not exceed $6m.

Active asset test

The active asset test is contained in section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997) and is satisfied 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 test period detailed below, 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 7.5 years during the test period.

The test period:

•         begins when you acquired the asset;

•         ends at the earlier of:

•         the CGT event, and

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

Section 152-40 of the ITAA 1997 provides that a 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, your spouse or child, or an entity connected with you.

However, 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. Paragraph 152-40(4A)(b) of the ITAA 1997 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.

An active asset must be used or ready for use in a business you, an affiliate or a connected entity carry on. If you are involved in a farming business, the farm will be classed as an active asset.

You acquired the 25% share of the Will Bank in July 20xx. You subsequently acquired another 8.33% (1/3^rd of a 25% share that was disposed of by Trust D) of the Will Bank in December 20xx. This brought your total interest in the Will Bank to be 33.33%

As you have owned the Will Bank for x years, the Will Bank asset would need to have been active for at least half of this time.

The Will Bank was an active asset for more than half of this time that you owned it, therefore will pass the active asset test under section 135-35 of the ITAA 1997.

Connected entity

The meaning of connected with an entity is outlined in Section 328-125 ITAA 1997

Subsection 328-125(1) states:

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.

Direct control of a discretionary trust

Subsection 328-125(3) states:

An entity (the first entity) controls a discretionary trust if a trustee of the trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the first entity, its affiliates, or the first entity together with its affiliates.

Company Y could not be reasonably be expected to act in accordance with the directions or wishes of either you or Person A. Whilst Person A acts as a director of Company Y following the request by Person F to accept the appointment of Director, Person F has the ability as sole shareholder in Company Y to remove Person A at any time. Therefore, Person A is not treated as controlling the Trust K.

You have advised within the ruling request that neither you or Person A have received any distribution of income or capital from the Trust K. As such, you are not treated as controlling the Trust K under subsection 328-125(4) of ITAA 1997.

Neither you or Person A control Company Z. Paragraph 328-125(2)(b) of the ITAA 1997 states:

An entity (the first entity) controls a discretionary trust for an income year if, for any of the 4 income years before that year:

(a) the trustee of the trust paid to, or applied for the benefit of:

(i) the first entity; or

(ii) any of the first entity ' s affiliates; or

(iii) the first entity and any of its affiliates;

any of the income or capital of the trust; and

(b) the percentage (the control percentage) of the income or capital paid or applied is at least 40% of the total amount of income or capital paid or applied by the trustee for that year.

The shares in Company Z are owned by Person F (50%) and Company Y as trustee of the Trust K (50%)

Neither Person A or you own, nor have the right to acquire the ownership of, any equity interests in Company Z.

Company or trust conditions

Section 152-325(1) states:

A company or trust must make a payment (whether directly or indirectly through one or more interposed entities) to at least one of its CGT concession stakeholders if:

(a) the company or trust makes a choice under this Subdivision to disregard a capital gain from CGT event J2, J5 or J6; or

(b) the company or trust receives an amount of capital proceeds from a CGT event for which it makes a choice under this Subdivision.

152-325(2)

If the company or trust receives the capital proceeds from the CGT event in instalments, subsection (1) applies to each instalment in succession (up to the relevant CGT exempt amount).

152-325(2A)

For the purposes of (but without limiting) subsection (2), the company or trust is treated as receiving the capital proceeds in instalments if:

(a) the CGT event happened because the company or trust disposed of the CGT asset; and

(b) the capital proceeds from the disposal are increased by one or more financial benefits that the company or trust receives under a look-through earnout right.

Amount and timing of payments

152-325(3) state:

If a payment is made to more than one CGT concession stakeholder, the amount of each such payment is to be worked out by reference to each individual's percentage (see subsection 152-315(5)) of the relevant CGT exempt amount.

152-325(3A)

If the CGT concession stakeholder to whom the payment is made is an employee of the company or trust, the payment must not be of a kind mentioned in section 82-135 (disregarding paragraph (fa) of that section).

152-325(4)

The payment must be made by:

(a) if paragraph (1)(a) applies - 7 days after the company or trust makes the choice; and

(b) otherwise - the later of:

(i) 7 days after the company or trust makes the choice; and

(ii) 7 days after the company or trust receives an amount of capital proceeds from the CGT event.

152-325(5)

The amount of the payment, or the sum of the amounts of the payments, required to be made under this section must be equal to the lesser of:

(a) either:

i) if paragraph (1)(a) applies - the amount of the capital gain from the CGT event that the company or trust disregarded; or

(ii) otherwise - the amount of capital proceeds received; and

(b) the relevant CGT exempt amount.

Payments may be joint or separate

152-325(6)

If this section requires the company or trust to make 2 or more payments to a single CGT concession stakeholder (whether or not by the same time), the company or trust may meet that requirement by making one payment or by making separate payments.

152-325(7)

If a CGT concession stakeholder is under 55 just before a payment is made under this section in relation to him or her:

(a) the company or trust must make the payment to the CGT concession stakeholder by contributing it for the stakeholder to a complying superannuation fund or an RSA in respect of the stakeholder; and

(b) the company or trust must notify the trustee of the fund or the RSA provider at the time the contribution is made that the contribution is made in accordance with this section.

Note:

For the non-deductibility of the contribution, see subsection 290-150(4).

152-325(8)

For the purposes of Part 3-30, treat a payment mentioned in paragraph (7)(a), made in accordance with this section, as a contribution made by the CGT concession stakeholder.

152-325(9)

Subsection (10) applies if:

(a) a company makes a payment to comply with subsection (1) to:

(i) a CGT concession stakeholder; or

(ii) an interposed entity, in relation to a CGT concession stakeholder; or

(b) both of the following apply:

(i) an interposed entity receives a payment (whether directly or indirectly through one or more interposed entities) that a company or trust makes to comply with subsection (1), in relation to a CGT concession stakeholder;

(ii) the interposed entity passes on the payment to the CGT concession stakeholder or another interposed entity.

152-325(10)

This Act applies to the payment, to the extent that it is less than or equal to the amount mentioned in subsection (3) for the stakeholder, as if:

(a) it were not a dividend; and

(b) it were not a frankable distribution.

152-325(11)

Subsection (10) applies in relation to the payment despite section 109 and Division 7A of Part III of the Income Tax Assessment Act 1936.

Conclusion

The interest in the Will Bank is an active asset for the purposes of 152-35 of ITAA 1997. You have also satisfied other basic conditions of the small business concessions set out in section 152-10 of the ITAA 1997 as the requirements of section 152-10(1A) are met, in that your affiliate, the partnership is a CGT small business entity.

You have also satisfied the conditions set out in section 152-325 of ITAA 1997 and therefore the payment by you to Person A is not treated as a dividend or frankable distribution.