Edited version of private advice

Authorisation Number: 1051907177070

Date of advice: 8 October 2021

Ruling

Subject: CGT - small business 15-year exemption

Question 1

Under the contemplated transaction, will the capital gain made by the company be disregarded under Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Under the contemplated transaction, will the amount paid by the company be excluded from the assessable income of the shareholder under Division 152 of the ITAA 1997?

Answer

Yes.

Question 3

Under the alternative transaction, will the capital gain made by the company be disregarded under Division 152 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on

1 July 20XX

Relevant facts

Entity A (the company) was incorporated on xxxx.

On incorporation, the company had initial capital of xxxx shares of a non-descript class. By way of company resolution dated xxxx, the existing issued shares of the company were reclassified as A Class shares.

At all relevant times, the company had only A Class shares on issue and, on that basis, it's A Class shares are regarded as ordinary shares.

The historic shareholdings in the company have been provided.

Entity D and entity E are not related to entity B or entity C.

Entity B (the shareholder) is over 55 years of age and is the sole shareholder and director of the company.

No other shares were issued.

From incorporation, the company carried on a business.

On xxxx, the company acquired property (the property). The company henceforth carried on the business from the building on the property.

Other than the property and the business, the company did not have any other assets of material value.

Under Division 149 of the ITAA 1997, the property stopped being a pre-CGT asset on xxxx after the transfer of the xxxx A Class shares.

On xxxx, the company sold the goodwill of the business to an unrelated third party. From that time on, entity F leased the property from the company.

In xxxx, the xxxx shares jointly held by the shareholder and entity C were transferred so that they were then owned outright by entity C.

In xxxx, on the passing of entity C, the xxxx A Class shares in the company were bequeathed to the shareholder.

Entity F is the current lessee of the property.

An approximate market value of the property is $xxxx.

The shareholder, being over 55 years of age, is not gainfully employed and does not otherwise work. He has a medical condition.

Other than the property, the only significant asset currently owned by the shareholder is an asset as specified to the value of $xxxx.

The shareholder requires ongoing funds to cover medical expenses and other living expenses.

Under the contemplated transaction, the company is considering the disposal of the property on the open market and paying the capital proceeds to the shareholder as a dividend.

The company will pay the shareholder within two years after the CGT event, a dividend consisting of the entire net capital proceeds.

The shareholder will then use these proceeds to fund his ongoing expenses.

Under the alternative transaction, the company is considering the transfer of the property to the shareholder, after which point, the shareholder will become the direct owner of the property. The property will be transferred at market value.

The shareholder will then use his direct entitlement to the rental income of the property to fund ongoing expenses.

The company will then be deregistered.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 149

Income Tax Assessment Act 1997 Division 152

Reasons for decision

The capital gains tax (CGT) provisions provide some small business relief in Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997).

Basic conditions

To qualify for the small business CGT concessions, the basic conditions as contained in subdivision 152-A of the ITAA 1997 must be satisfied.

The basic conditions are:

•         A CGT event happens in relation to a CGT asset of yours in an income year,

•         The event would have resulted in a gain,

•         The CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997, and

•         At least one of the following applies;

-       you are a small business entity for the income year,

-       you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997,

-       you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an interest in an asset of the partnership, or

-       you do not carry on a business, but your CGT asset is used in a business carried on by a small business entity that is your affiliate or an entity connected with you.

Active asset test

A capital gains tax (CGT) asset will satisfy 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 test period, 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 test period.

Subsection 152-40(1) of the ITAA 1997 details that a CGT asset is an active asset at a time if it is used, or held ready for use, in the course of carrying on a business that is carried on by you, or your affiliate, or another entity that is connected with you.

The property has been owned by the company for more than 15 years and the property was used to carry on the company's business for more than 7.5 years. The property therefore satisfies the active asset test.

Maximum net asset value test

You satisfy the maximum net asset value test if, just before the CGT event, the sum of the net value of the CGT assets of yours, any entity connected with you and any affiliates of yours or entities connected with your affiliates does not exceed $6,000,000 (section 152-15 of the ITAA 1997).

In this case, the combined net value of the CGT assets is less than $6,000,000. Therefore the company satisfies the maximum net asset value test.

The company meets the other basic conditions for the small business CGT concessions.

15 year exemption - conditions for companies and trusts

Subdivision 152-B of the ITAA 1997 outlines the conditions that must be met for an entity to be entitled to the small business 15-year exemption.

Section 152-110 of the ITAA 1997 provides a small business 15-year exemption for companies and trusts. Under this section, a company can disregard the capital gain from the disposal of a CGT asset if:

(a)    the company satisfies the basic conditions in Subdivision 152-A of the ITAA 1997 for the small business CGT concessions;

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

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

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

-       55 or over at that time and the event happened in connection with their retirement or

-       permanently incapacitated at that time.

The company satisfies the significant individual test if it had at least one significant individual just before the CGT event.

An individual is a significant individual in a company if they have a small business participation percentage in the company of at least 20%.

An entity's direct percentage is the least of the following percentages it has:

(a) the percentage of voting power it holds in the company

(b) the percentage of any dividend that the company may pay to which it is entitled, and

(c) the percentage of any distribution of capital that the company may make to which it is entitled.

In this case, the company has satisfied the significant individual requirements. It is accepted that the significant individual of the company will be permanently incapacitated just before the CGT event. The other conditions for the 15-year exemption have been met. Therefore the capital gain made on the disposal of the property will be disregarded under subdivision 152-B of the ITAA 1997. This 15-year exemption will apply to the CGT made by the company under both the contemplated transaction and the alternative transaction.

Payment to CGT concession stakeholder

Section 152-125 of the ITAA 1997 provides that, if a capital gain made by a company is disregarded under section 152-110 of the ITAA 1997, any distribution made by the company of that exempt amount to a CGT concession stakeholder is not included in the assessable income of the CGT concession stakeholder and not deductible to the company, if the following conditions are satisfied:

• the company makes a payment within two years after the CGT event that resulted in the capital gain or, in appropriate circumstances, such further time as allowed by the Commissioner;
• the payment is made to an individual who was a CGT concession stakeholder of the company just before the CGT event; and
• the total payments made to each CGT concession stakeholder does not exceed an amount determined by multiplying the CGT concession stakeholders control percentage by the exempt amount.

Entity B is a CGT concession stakeholder as defined in section 152-60 of the ITAA 1997.

The distribution of the net capital gain to entity B within two years after the CGT event would be exempt under section 152-125 of the ITAA 1997. That is the payment is not an assessable dividend to the shareholder.