Edited version of private advice

Authorisation Number: 1051879189926

Date of advice: 16 August 2021

Ruling

Subject: 15-year retirement exemption

Question

Is Company X Pty Ltd (Company X) eligible to apply the 15-year exemption in Subdivision 152-B of the Income Tax Assessment Act 1997 (ITAA 1997) to disregard any capital gain upon the sale of the business?

Answer

No.

This ruling applies for the following period:

Income year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Background

The Family Trust has held 100% of the shares in Company X since 20XX. Individuals Y and Z have each held 50% of the shares in the corporate trustee since it was established. The Family Trust is a discretionary trust and individuals Y and Z are the beneficiaries of the trust.

The Family Trust has not had any net income or tax losses since it was established. Consequently, the trustee has never made a distribution of income.

The Family Trust also holds 100% of the shares in a number of other company's (the Group) that carry on the business.

Company X carried on the business with other company's in the Group up until a contract was entered into to sell the business.

Individual Y commenced some preliminary activities to establish the business more than 15 years ago.

As the business grew, additional sites were developed and operated by company's in the Group that were established.

At the time of the business sale, the business was operated at a number of different sites.

The purchaser is an unrelated third party, but is a competitor in the same industry and will continue to operate the business after the sale.

The business assets sold were either used, held ready for use in carrying on the business, or inherently connected with the business.

It has been established in a previous private ruling issued by the ATO that Company X satisfied the maximum net asset value test in section 152-15 of the ITAA 1997 just before the sale of the business assets.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 104-10(1)

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

Income Tax Assessment Act 1997 Subdivision 152-B

Income Tax Assessment Act 1997 Section 152-10

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 Paragraph 152-10(1)(c)

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 Section 152-15

Income Tax Assessment Act 1997 Section 152-20

Income Tax Assessment Act 1997 Section 152-35

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

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

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

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

Income Tax Assessment Act 1997 Section 152-55

Income Tax Assessment Act 1997 Section 152-65

Income Tax Assessment Act 1997 Subsection 152-70(1)

Income Tax Assessment Act 1997 Subsections 152-70(4)

Income Tax Assessment Act 1997 Subsections 152-70(5)

Income Tax Assessment Act 1997 Subsections 152-70(6)

Income Tax Assessment Act 1997 Section 152-75

Income Tax Assessment Act 1997 Subsection 152-110

Income Tax Assessment Act 1997 Subsection 152-110(1)

Income Tax Assessment Act 1997 Paragraph 152-110(1)(a)

Income Tax Assessment Act 1997 Paragraph 152-110(1)(b)

Income Tax Assessment Act 1997 Paragraph 152-110(1)(c)

Income Tax Assessment Act 1997 Paragraph 152-110(1)(d)

Reasons for decision

Summary

Company X is not eligible for the 15-year retirement exemption in Subdivision 152-B of the ITAA 1997 because, the requirements in paragraphs 152-110(1)(b), (c) and (d) of the ITAA 1997 are not satisfied.

Detailed reasoning

The 15-year exemption in Subdivision 152-B of the ITAA 1997 allows an entity to disregard a capital gain arising from a CGT asset that it has owned for at least 15 years if certain conditions are met.

Subsection 152-110(1) of the ITAA 1997 provides that a company 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)   the entity 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 that time and the event happened in connection with the individual ' s retirement; or

(ii) was permanently incapacitated at that time.

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

The basic conditions for relief under the small business CGT concessions are outlined in section 152-10 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).

Each of these requirements will now be considered separately.

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.

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.

As a business is not a CGT asset, each asset that has been sold as part of the business must be considered separately.

Various CGT assets have been disposed under the business sale contract and therefore CGT event A1 happened under subsection 104-10(1) of the ITAA 1997 upon the disposal of each of these CGT assets.

Consequently, the requirement in paragraph 152-10(1)(a) of the ITAA 1997 is 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 capital proceeds from the business sale are more than the cost base of the CGT assets. It is therefore expected that Company X will make a capital gain upon the disposal of some of the CGT assets included in business sale. Consequently, the requirement of paragraph 152-10(1)(b) of the ITAA 1997 is satisfied in respect of any capital gain arising from the disposal of these CGT assets.

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

(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)).

It has been established in a previous private ruling that Company X satisfied the maximum net asset value test in section 152-15 of the ITAA 1997 just before the sale of the business assets.

Accordingly, the requirements of subparagraph 152-10(1)(c)(ii) of the ITAA 1997 are satisfied and it is not necessary to consider the other alternative tests in paragraph 152-10(1)(c) of the ITAA 1997.

Basic condition (d) - 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.

Paragraph 152-40(1)(a) of the ITAA 1997 provides that a tangible or intangible 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.

Paragraph 152-40(1)(b) provides that an intangible asset is also an active asset if you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you.

It has been stated in the facts that all of the CGT assets sold under the sale contract have either been used in carrying on the business or are inherently connected to the business. Accordingly it is considered that they were used in the business for at least half the time that Company X has owned them and therefore are active assets such that the active asset test in section 152-35 of the ITAA 1997 is satisfied.

Accordingly, all of the basic conditions for the gain in paragraph 152-110(1)(a) of the ITAA 1997 are satisfied.

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

As Company X entered into a contract to sell its business, CGT event A1 will happen in accordance with section 104-10 of the ITAA 1997 at this time, to the CGT assets disposed of under the sale contract. Therefore, it must be established whether Company X has continuously owned the relevant CGT assets for the 15-year period ending just before this time.

No specific evidence has been provided which shows that Company X owned any of the CGT assets disposed of under the sale contract more than 15 years prior to when the contract was entered into.

In these circumstances, it is however also necessary to consider when the business commenced, as any goodwill disposed of, in accordance with item 1 of section 109-10 of the ITAA 1997, is taken to have been acquired when a taxpayer commences business and starts to create the goodwill.

The actual date of commencement of a business activity is a question of fact (Goodman Fielder Wattie Ltd v. FC of T 91 ATC 4438; (1991) 22 ATR 26)).

Guidance on the commencement date of a business is provided in Taxation Ruling TR 2001/14 Income Tax: Division 35 non-commercial losses. Paragraph 69A of TR 2001/14 states that for a business activity to have commenced a person must have:

•         made a decision to commence the business activity;

•         acquired the minimum level of business assets to allow that business activity to be carried on; and

•         actually commenced business operations.

Individual Y commenced preliminary activities to establish the business more than 15 years prior to when the sale contract was entered into.

However, a mere intention to start carrying on the business activity will not be sufficient. The actual commencement of a business must be distinguished from activities which are merely preparatory to commencing a business.

Insufficient evidence has been provided to show when the minimum level of business assets were acquired by Company X to allow the business activity to be carried on.

Similarly, insufficient evidence has been provided to show when the business operations actually commenced

As a result, based on the information provided, the Commissioner cannot be satisfied when the relevant business commenced and therefore cannot accept that any associated goodwill acquired and owned by Company X was continuously held for more than 15 years prior to the business sale.

Accordingly, based on the information provided, the Commissioner cannot be satisfied that Company X owned any of the CGT assets disposed of under the sale contract for the 15-year period ending just before the relevant CGT event.

(c) the company had a significant individual for a total of at least 15 years during which the company owned the CGT asset

As per the discussion above on paragraph 152-110(1)(b) of the ITAA 1997, based on the information provided, the Commissioner cannot be satisfied that Company X owned any of the CGT assets disposed of under the sale contract for at least 15 years.

Accordingly, this requirement cannot be satisfied.

(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 that time and the event happened in connection with the individual ' s retirement; or

(ii) was permanently incapacitated at that time.

To determine whether paragraph 152-110(1)(d) of the ITAA 1997 has been satisfied, it must be determined whether Company X had a significant individual, just before the contract to sell the business was entered into.

Section 152-55 of the ITAA 1997 provides that an individual will be a significant individual of Company X at a time, if at that time the individual has a small business participation percentage in Company X of at least 20%.

Section 152-65 of the ITAA 1997 provides that an entity's small business participation percentage in another entity at a time is the percentage that is the sum of the entity's direct and indirect small business participation percentage in the other entity at that time.

The table in subsection 152-70(1) of the ITAA 1997 provides that an entity's direct small business participation percentage in a company at the relevant time is the percentage of the voting power, entitlement to dividends and capital an entity has because of the shares it holds in the company. If these amounts are different, the smallest amount is used.

As 100% of the shares in Company X were held by the Family Trust just before the business sale, the trust will have a direct small business participation percentage in Company X of 100% at that time.

However, paragraph 152-110(1)(d) and section 152-55 of the ITAA 1997 requires the entity that has the small business participation percentage in Company X of more than 20% to be an individual. This then requires us to consider the indirect small business participation percentage that individuals Y and Z may have in Company X at this time via their interest in the Family Trust.

Section 152-75 of the ITAA 1997 provides that an entity's indirect small business participation percentage in a company is calculated by multiplying together the entity's direct participation percentage in an intermediate entity, and the intermediate entity's total participation percentage (both direct and indirect) in the company.

The table in subsection 152-70(1) of the ITAA 1997 provides that an entity's direct small business participation percentage in a trust at the relevant time where entities do not have entitlements to all the income and capital of the trust, is the percentage of any distribution to which the entity was beneficially entitled if the trustee made distributions of income or capital during an income year. If these amounts are different, the smallest amount is used.

Subsections 152-70(4), (5) and (6) of the ITAA 1997 provide a special rule for discretionary trusts if the trustee does not make a distribution of income or capital in an income year. The Family Trust is a discretionary trust to which these special rules apply.

Under subsections 152-70(4) and (5) of the ITAA 1997, if the trustee made a distribution in the CGT event year, the distribution percentage in that year is used, or otherwise the distribution percentage of the last income year before the CGT event year where it did make a distribution is used.

However, paragraph 152-70(6)(a) of the ITAA 1997 provides that the small business participation percentage in a discretionary trust is zero if the trust had net income and no tax loss in an income year and the trustee did not make a distribution in that income year. The percentage will also be zero under paragraph 152-70(6)(b) if the trustee has never made a distribution in the income years up to and including the CGT event year.

The Family Trust has never had any net income and tax losses and therefore the trustee has never made any distributions to the beneficiaries of the trust. Due to this, all the beneficiaries of the trust will hold a direct small business participation percentage of 0% in the Family Trust in accordance with paragraph 152-70(6) of the ITAA 1997. Consequently, their indirect small business participation in Company X will also be 0% as worked out via the formula outlined in section 152-75.

As individuals Y and X's indirect small business participation in Company X will be less than 20%, they will not be significant individuals of Company X just before the relevant CGT event. Accordingly, the requirement in paragraph 152-110(1)(d) of the ITAA 1997 cannot be satisfied.

Conclusion

As detailed above, based on the information provided, the requirements in paragraphs 152-110(b), (c) and (d) of the ITAA 1997 are not satisfied and therefore Company X will not be eligible for the 15-year retirement exemption under Subdivision 152-B of the ITAA 1997.