Edited version of private advice

Authorisation Number: 1051852557753

Date of advice: 16 June 2021

Ruling

Subject: Small business CGT concessions

Question 1

Is the T Family Trust (TFT) able to disregard the capital gain realised in the income year ended 30 June 20XX on disposal of units in the H Unit Trust (HUT) under the Small Business 15-year exemption in Subdivision 152-B of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Is TFT able to choose to disregard all or a part of the capital gain realised in the income year ended 30 June 2019 on disposal of units in the HUT under the Small Business retirement exemption in Subdivision 152-D of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period periods:

Income year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

BT is a qualified professional, and was of retirement age at 30 June 20XX.

BT significantly reduced his working hours in the income year ended 30 June 20XX as BT had reached retirement age.

AT is BT's spouse. AT is a professional, and was of retirement age at 30 June 20XX.

AT retired from paid employment in 20XX.

AT has not previously chosen to disregard an amount(s) in choices made by AT under Subdivision 152-D, or any former equivalent provisions, and no company and/or trust has made such a choice in relation to AT as a CGT concession stakeholder in that company/trust.

BT and AT have interests in various entities. For the purpose of maximum net asset value test set out in section 152-15, the total net asset value of CGT assets of BT, AT, and entities connect with them or that are affiliates of theirs, is less than $XXX as at 31 May 20XX.

BT and AT are trustees for the T Family Trust (TFT), a discretionary trust which holds various investments.

The investments of TFT included 25% of the issued units in HUT acquired during the income year ended 30 June 19XX.

In each of the five income years up to and including the income year ended 30 June 20XX, AT was beneficially entitled to at least 90% of the income distributed by TFT. No TFT income was distributed to BT in the same period. TFT also did not distribute any capital in that period.

For at least 15 of the income years ended 30 June 19XX to 20XX, inclusive, there was a 'significant individual' in TFT for the purpose of section 152-55 of the ITAA 1936.

On 31 May 20XX, TFT transferred its units in HUT to the T Superannuation Fund for market value consideration. The members of the T Superannuation Fund are AT and BT.

TFT realised a capital gain of $X on the disposal of the units in HUT, and disclosed that capital gain, less a 50% discount under paragraph 115-100(a)(ii) of the ITAA 1936, as an assessable net capital gain in its income tax return for the year ended 30 June 20XX.

J Pty Ltd operates a number of consulting businesses at various locations in the State of ABC.

One of these consulting businesses is operated from a property in State of ABC (the Property), and TM Pty Ltd (TM) provides the use of those premises as part of the provision of management services, and J Pty Ltd pays TM for those services fees.

Apart from the contractual relationship between J Pty Ltd and TM, TM otherwise does not have any connection with J Pty Ltd, TFT, BT, AT, or any of their related entities.

The aggregated annual turnover of J Pty Ltd has always been below $XXX.

H Pty Ltd is the trustee for The H Unit Trust (HUT).

There are no unit holders who hold 40% or more of the issued units in HUT.

HUT was an Australian resident for tax purposes during the income year ended 30 June 20XX.

The Property was acquired by HUT in the income year ended 30 June 19XX.

HUT commenced carrying on a services business, providing services to a number of professionals, in the income year ended 30 June 19XX.

The management services business operated by HUT was located at the Property.

Throughout the period in which HUT carried on a management services business:

(a)          the total market values of the active assets of HUT, and of any financial instruments or cash of HUT that are inherently connected with a business that the trust carries on is 80% or more of the market value of all of the assets of HUT

(b)          the main use of the Property by HUT was as the setting for the carrying on of that business, and not for the purpose of deriving leasing or rental income.

During the income year ended 30 June 20XX, HUT ceased its management services business and leased the Property to TM. TM has continued to lease the Property from HUT to the present day.

Since the income year ended 30 June 19XX, the annual turnover of HUT has been below $X million.

Information provided

The applicant has provided information in a number of documents including:

(a)          the private ruling application

(b)          emails to the Australian Taxation Office

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 103-25

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Subdivision 152-A

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)(ii)

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

Income Tax Assessment Act 1997 Subsection 152-10(2)

Income Tax Assessment Act 1997 Section 152-15

Income Tax Assessment Act 1997 Section 152-20

Income Tax Assessment Act 1997 Subsection 152-35(1)

Income Tax Assessment Act 1997 Paragraph 152-35(1)(b)

Income Tax Assessment Act 1997 Subsection 152-35(2)

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

Income Tax Assessment Act 1997 Subsection 152-40(3)

Income Tax Assessment Act 1997 Paragraph 152-40(3)(b)

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

Income Tax Assessment Act 1997 Section 152-55

Income Tax Assessment Act 1997 Section 152-60

Income Tax Assessment Act 1997 Section 152-65

Income Tax Assessment Act 1997 Subsection 152-70

Income Tax Assessment Act 1997 Section 152-75

Income Tax Assessment Act 1997 Subdivision 152-B

Income Tax Assessment Act 1997 Section 152-105

Income Tax Assessment Act 1997 Paragraph 152-110(a)

Income Tax Assessment Act 1997 Paragraph 152-110(b)

Income Tax Assessment Act 1997 Paragraph 152-110(c)

Income Tax Assessment Act 1997 Paragraph 152-110(d)

Income Tax Assessment Act 1997 Subdivision 152-D

Income Tax Assessment Act 1997 Subsection 152-305(2)

Income Tax Assessment Act 1997 Paragraph 152-305(2)(a)

Income Tax Assessment Act 1997 Paragraph 152-305(2)(b)

Income Tax Assessment Act 1997 Paragraph 152-305(2)(c)

Income Tax Assessment Act 1997 Paragraph 152-305(1)(d)

Income Tax Assessment Act 1997 Subsection 152-310(1)

Income Tax Assessment Act 1997 Subsection 152-310(2)

Income Tax Assessment Act 1997 Subsection 152-315(1)

Income Tax Assessment Act 1997 Subsection 152-315(2)

Income Tax Assessment Act 1997 Subsection 152-315(3)

Income Tax Assessment Act 1997 Subsection 152-315(4)

Income Tax Assessment Act 1997 Subsection 152-320(1)

Income Tax Assessment Act 1997 Paragraph 152-325(1)(b)

Income Tax Assessment Act 1997 Subsection 152-325(3)

Income Tax Assessment Act 1997 Subsection 152-325(4)

Income Tax Assessment Act 1997 Subsection 152-325(5)

Issue 1

Is TFT able to disregard the capital gain realised in the income year ended 30 June 20XX on disposal of units in the H Unit Trust (HUT) under the small business 15-year exemption in Subdivision 152-B of the Income Tax Assessment Act 1997 (ITAA 1997)?

Summary

No. TFT is not able to disregard the capital gain because the CGT event is not connection with the retirement of the significant individual of TFT.

Detailed reasoning

Eligibility for small business concessions

Division 152 provides CGT concessions that allow eligible taxpayers to disregard or defer some or all of a capital gain arising from the disposal of an active asset used in a small business, provided certain conditions (the basic conditions) are met. Subsection 152-10(1) sets out the basic conditions to be satisfied before a taxpayer can access the CGT concessions.

Subsection 152-10(1) 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;

(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;

(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).

TFT disposed of units in HUT in the income year ended 30 June 2019, and those interests in HUT were a CGT asset of TFT. Thus, the condition in paragraph 152-10(1)(a) is satisfied.

The second condition in paragraph 152-10(1)(b) is satisfied, as TFT realised a capital gain on the disposal of units in the HUT.

In relation to the third condition in paragraph 152-10(1)(c), the applicant has stated that the total net value of CGT assets owned by TFT and affiliated and/or connected entities does not exceed the $6 million threshold of the maximum net asset value test in section 152-15. Based on these statements, the third condition in subparagraph 152-10(1)(c)(ii) is satisfied.

The final condition in paragraph 152-10(1)(d) requires the CGT asset to satisfy the active asset test in section 152-35.

Subsection 152-35(1) relevantly states:

A CGT asset satisfies the active asset test if:...

(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) states the period begins when you acquired the asset and ends at the earlier of when the CGT event happens, or the relevant business ceased.

As TFT owned the units in HUT from 1995 until 31 May 20XX, TFT owned the units in HUT for more than 15 years. To satisfy the active asset test, the units must have been an active asset of TFT for at least 7½ years between acquisition in 1995 and when the CGT event happens for the purposes of subsection 152-80(1)(c).

A CGT asset is an active asset if your own the asset and it is used, or held ready for use, in the course of carrying on a business.[1] However, as the relevant CGT assets are units in a trust (HUT), the meaning of an active asset in subsection 152-40(3) is relevant, which states:

A *CGT asset is also an active asset at a given time if, at that time, you own it and:

(a) it is either a *share in a company that is an Australian resident at that time or an interest in a trust that is a *resident trust for CGT purposes for the income year in which that time occurs; and

(b) the total of:

(i) the *market values of the active assets of the company or trust; and

(ii) the market value of any financial instruments of the company or trust that are inherently connected with a business that the company or trust carries on; and

(iii) any cash of the company or trust that is inherently connected with such a business;

is 80% or more of the market value of all of the assets of the company or trust.

The applicant has stated that for the entire period HUT conducted its management services business, the 80% test in paragraph 152-40(3)(b) was met. As HUT is an Australian resident and the units held by TFT are considered active assets for the period 1995 to 2012, or approximately 17 years, the HUT units held by TFT are considered to be active assets under subsection 152-40(3).

TFT held the HUT units for approximately 24 years and during that period those units were active assets for approximately 17 years. Therefore, as TFT held the HUT units for more than 15 years and those units were active assets for at least 7½ years during that period, the units will satisfy the active asset test in paragraph 152-10(1)(d).

TFT will therefore satisfy the basic conditions in subsection 152-10(1).

Small business 15-year exemption

The small business 15-year exemption in Subdivision 152-B, which takes priority over the other small business concessions. If the small business 15-year exemption applies, the entire capital gain is disregarded so there is no need to apply any other small business concessions.

Section 152-110 states:

An entity that is a company or trust can disregard any *capital gain arising from a *CGT event if all of the following conditions are satisfied:

(a) the basic conditions in Subdivision 152-A are satisfied for the gain;

(b) the entity continuously owned the *CGT asset for the 15-year period ending just before the CGT event;

Note: Section 152-115 allows for continuation of the period if there is an involuntary disposal of the asset.

(c) if the entity had a 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 the entity owned the CGT asset;

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

(i) was 55 or over at the time of the CGT event and the event happens in connection with the individual's retirement; or

(ii) was permanently incapacitated at that time.

As discussed above, the basic conditions in subsection 152-10(1) are satisfied, thus the first condition in paragraph 152-110(a) is satisfied.

TFT owned the HUT units for approximately 24 years. Therefore, the second condition in paragraph 152-105(b) is satisfied.

The third condition in paragraph 152-102(c) requires TFT to have a significant individual for a total of at least 15 years whilst TFT owned the HUT units.

Section 152-55 provides that an individual is a significant individual in a trust at a time if, at that time, the individual has a small business participation percentage in the trust of at least 20%.

The small business participation percentage for an individual can be either direct or indirect according to section 152-65. Item 3 of the table in subsection 152-70(1) explains that an individual's direct small business participation percentage in a discretionary trust is the percentage of the income of the trust that the trustee distributes to which the entity is beneficially entitled.

There was a significant individual in TFT in at least 15 of the years in which TFT held the HUT units. Therefore, the third condition in paragraph 152-110(c) is satisfied.

The fourth and final condition in subparagraph 152-110(d)(i) requires the CGT event to happen in connection with the retirement of an individual who was significant individual of the trust just before the CGT event.

BT is not a significant individual in relation to TFT, as he was not entitled to any distributions of income by the TFT in relation to the income year ended 30 June 20XX.

AT is the only significant individual in relation to TFT, as she was beneficially entitled to more than 90% of the income distributed by TFT in the year ended 30 June 20XX.

In order for subparagraph 152-110(d)(i) to be satisfied, the disposal of the HUT units must be 'in connection with' AT's retirement. Expressions such as 'relating to', 'in relation to', 'in connection with' and 'in respect of' are commonly found in legislation but raise issues of statutory interpretation.

The ITAA 1997 does not provide a definition of when a CGT event happens in connection with the retirement of an individual and thus the phrase takes on its ordinary meaning. The word 'retirement' is defined in the Macquarie Dictionary to mean:

noun

1. the act of retiring.

2. the state of being retired.

3. removal or retiring from service, office or business...

The Explanatory Memorandum to the New Business Tax System (Capital Gains Tax) Bill 1999 makes the following comments about the requirement to be retiring as one of the conditions for this concession:

1.5 ...the disposal is related to a person retiring...

and

1.68 ...an individual small business taxpayer...must be...at least 55 years old and using the capital proceeds for their retirement.

We consider that the retirement of the individual must have some proximity to the CGT event for the CGT event to be in connection with retirement, i.e. that the individual is retiring at or near the time of the CGT event. Retirement may mean a significant reduction in working hours, or a significant change in the nature of the activities undertaken. However, it is not necessary for there to be a permanent and everlasting retirement from the workforce.

We are of the view that the disposal of the HUT units by TFT is not in connection with AT's retirement, as she retired in the income year ended 30 June 2014. Instead, the disposal of the HUT units by TFT is in connection with the retirement of BT, who is not a significant individual in relation to TFT.

Therefore, the fourth and final condition in paragraph 152-110(d) is not satisfied.

As the requirements of section 152-110 are not satisfied, TFT will not be entitled to disregard any capital gain realised on the disposal of the HUT units under Subdivision 152-B.

Issue 2

Is TFT able to choose to disregard all or a part of the capital gain realised in the income year ended 30 June 2019 on disposal of units in the HUT under the Small Business retirement exemption in Subdivision 152-D of the ITAA 1997?

Summary

Yes. TFT can choose to disregard all or a part of the capital gain equal to the CGT exempt amount TFT chooses for the HUT units, subject to satisfying all of the conditions.

Detailed reasoning

Small business retirement exemption

If the small business retirement exemption applies, a trust may choose to disregard all or a part of a capital gain (subject to a lifetime limit of $500,000 in relation to the individual for whom the choice is made), provided certain conditions are met.

Subsection 152-305(2) provides that a trust can choose to disregard all or part of a capital gain if:

(a)          The basic conditions in Subdivision 152-A are satisfied for the capital gain; and

(b)          The entity satisfies the significant individual test (see section 152-50); and

(c)           The company or trust conditions in section 152-325 are satisfied.

Note: Section 103-25 tells you when the choice must be made.

As discussed above, the basic conditions in Subdivision 152-A are satisfied, and TFT satisfies the significant individual test.

Paragraph 152-325(1)(b) provides that a trust must make a payment to at least one of its concession stakeholders if the trust receives an amount of capital proceeds from CGT even for which it makes a choice under that Subdivision.

That payment must be made within 7 days after the choice is made, per subsection 152-325(4).

Section 103-25 provides that a choice you can make under Part 3-3 of the ITAA, which includes Subdivision 152-D, must be made 'by the day you lodge your income tax return for the income year in which the CGT event happened', or 'within a further time allowed by the Commissioner'.

Per section 152-60 of the ITAA 1997, a person is a CGT concession stakeholder of a trust if:

(a)          they are a significant individual in the trust, or

(b)          they are the spouse of the significant individual of the trust, and have a small business participation percentage in the trust greater than zero.

As discussed above, AT is a significant individual in TFT, and is therefore a CGT concession stakeholder of TFT. BT is the spouse of a significant individual therefore, but, as he received no distributions from TFT in the year ended 30 June 2019, he has a small business participation percentage in TFT of zero, and thus is not a CGT concession stakeholder in TFT.

If the conditions set out in subsection 152-305(2) are satisfied, a trust can choose to disregard all or part a capital gain to which Subdivision 152-D applies, provided the CGT retirement exemption limit (a maximum of $500,000, per subsection 152-320(1)) of the individual for whom the choice is made is not exceeded, per subsection 152-315(1) and paragraph 152-315(2)(b).

A trust must keep a written record of the CGT exempt amount to be disregarded by the trust, per subsection 152-315(4).

Any payment made by a trust in compliance with subsection 152-325(5) is non-assessable non-exempt income of the individual, and cannot be deducted against the trust's assessable income, per subsection 152-310(2).

Thus, if TFT chooses under Subdivision 152-D to disregard an amount (the CGT exempt amount) that is all or part of the capital gain realised on disposal of the HUT units (noting the gain is less than AT's CGT current $500,000 retirement exemption limit), it must make a payment to AT within the required timeframe that is equal to the lesser of the capital proceeds received on disposal of the HUT units and that CGT exempt amount, and keep a written record of that amount.

Any such payment made by TFT would be non-assessable non-exempt income of AT, and cannot be deducted against the trust's assessable income.

[1] Paragraph 152-40(1)(a).