Edited version of private advice

Authorisation Number: 1051919433132

Date of advice: 19 November 2021

Ruling

Subject: CGT 15-year retirement exemption

Question 1

Will Individual A satisfy the basic conditions for relief pursuant to section 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997) upon the disposal of the asset?

Answer

Yes.

Question 2

If the answer to question two is yes, is Individual A eligible to apply the 15-year exemption for individuals pursuant to section 152-105 ITAA 1997 to disregard the capital gain made upon the disposal of the asset?

Answer

Yes.

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

Individual A is an Australian resident.

Company X is the trustee of the Family Trust. Individuals A and B each own 50% of the shares of in Company X and are beneficiaries of the trust.

Individuals A and B are also the beneficiaries of Trust A, however they are not the trustees nor directors or shareholders of the corporate trustee. The trustee of Trust A has never distributed any income of the trust to Individuals A or B.

The Family Trust commenced carrying on a business that utilised the CGT asset when it was acquired.

The trustee of the Family Trust distributed more than 40% of the income of the trust for a number of income years to Company X.

The Family Trust sold the business to Trust A in income year 20xx. Trust A continues to carry on the business until today.

Once the Family Trust sold the business to Trust A, Individual B commenced leasing the asset to Trust A to enable it to continue carrying on the business. Individual A and Individual B received income from the asset which they reported in their income tax returns.

Individuals A and B hold a number of CGT assets.

The Family Trust and Company X do not hold any CGT assets, however Trust A does hold some CGT assets.

Individual A is disposing of the CGT asset and will make a capital gain upon its disposal.

Individual A is currently still working in the business carried on by Trust A, however they intend to significantly reduce their involvement after the disposal of the asset.

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 subsection 152-70(4)

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

Income Tax Assessment Act 1997 subsection 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

Question 1

Summary

Individual A satisfies the basic conditions for relief pursuant to section 152-10 of the ITAA 1997 upon the disposal of the asset.

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;

Note: This condition does not apply in the case of CGT event D1: see section 152-12

(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 be discussed below.

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.

The asset 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.

The proposed disposal of the asset will be a disposal of a CGT asset pursuant to subsection 104-10(1) of the ITAA 1997 and CGT event A1 will occur.

Consequently, the requirement of 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.

In this case the requirement of paragraph 152-10(1)(b) of the ITAA 1997 is 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.

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 (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.

As per the requirement in paragraph 328-110(1)(a) of the ITAA 1997, Individual A must firstly be carrying on a business in his personal capacity to satisfy the requirements of a small business entity. Although Individual A does not carry on a business, he does lease the asset to Trust A for use in its business.

The term 'business' is defined in subsection 995-1(1) of the ITAA 1997 to include any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

Individual A is regarded as a passive investor of the asset as he receives a modest income from leasing the asset to Trust A. It is not considered that the leasing of the asset to Trust A would be regarded as a business for taxation purposes.

As Individual B jointly owns the asset with Individual A, they are also not considered to be carrying on a business of leasing the asset.

As Individual A is not carrying on a business, they do not satisfy the requirements of a small business entity as defined by section 328-110 of the ITAA 1997. Consequently paragraph 152-10(1)(c)(i) of the ITAA 1997 will not be satisfied which in turn requires paragraph 152-10(1)(c)(ii) to be considered.

(ii)          you satisfy the maximum net asset value test

Section 152-15 of the ITAA 1997 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)).

Affiliates

Subsection 328-130(1) of the ITAA 1997 provides that an individual or a company is an affiliateof 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.

One key requirement of being an affiliate in accordance with subsection 328-130(1) of the ITAA 1997 is that the individual or company must be carrying on a business.

As it has already been established that Individual A and Individual B are not carrying on a business, they cannot be affiliates of each other pursuant to subsection 328-130(1) of the ITAA 1997.

As Company X also does not carry on a business, it is also not an affiliate of Individual A. However, it is noted that as Company X does not hold any CGT assets, therefore whether it is an affiliate of Individual A is of no consequence when calculating the net value of the CGT assets of Individual A under section 152-20 of the ITAA 1997.

Consequently, Individual A does not have any affiliates in accordance with section 328-130 of the ITAA 1997.

Connected entities

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.

There are different control tests in section 328-125 of the ITAA 1997 that apply depending on what type of entity is being tested.

Subsection 328-125(3) of the ITAA 1997 states that an entity (the first entity) controls a discretionary trust if the 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.

Alternatively, an entity (the first entity) can also control a discretionary trust under subsection 328-125(4) of the ITAA 1997, 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.

As the Family Trust and Company X do not hold any CGT assets, it is not necessary to determine whether Individual A is connected with those entities under section 328-125 of the ITAA 1997 just before the transfer of the asset for the purposes of calculating the net value of the CGT assets of Individual A under section 152-20. However, as Trust A does hold CGT assets, it must be considered whether Individual A could be connected with Trust A at that time.

As Individual A has not received any distributions from Trust A, they will not be connected with that trust in accordance with subsection 328-125(4) of the ITAA 1997 just before the transfer of the asset. Accordingly, consideration must be had as to whether they are connected with Trust A in accordance subsection 328-125(3) of the ITAA 1997 at that time.

As the trustee of Trust A is Trust A Pty Ltd, it has to be determined if the trustee acts, or could reasonably be expected to act, in accordance with the directions or wishes of Individual A.

The Small Business Entity Concessions Guide provides the following guidance on how this test applies:

All the circumstances of the case need to be considered in determining whether you satisfy this test. For example, the mere presence in the trust deed of a requirement that the trustee should have no regard to such directions or wishes would not be sufficient.

The guide further explains that the following factors should be considered:

• the way in which the trustee has acted in the past
• the relationship between the trustee and the entity or its affiliates, and the relationship the trustee has with both the entity and its affiliates
• the amount of any property or services transferred to the trust by the entity or its affiliates, or by both the entity and its affiliates
• any arrangement or understanding between the entity and any person who has benefited under the trust in the past.

Based on the information provided, it is considered that Individual A does not control Trust A in accordance with subsection 328-125(3) of the ITAA 1997 as the trustee does not act, or could reasonably be expected to act, in accordance with Individual A's directions or wishes.

As it is not expected that any other events or transactions that could affect this conclusions will occur just before the asset is transferred, it is considered that Individual A will not control Trust A when the asset is transferred.

As Individual A will not control Trust A in accordance with subsection 328-125(3) of the ITAA 1997 just before the asset is transferred, they will not be connected with Trust A pursuant to subsection 325-125(1) of the ITAA 1997 at this time.

Consequently, the net value of the CGT assets of Trust A, as worked out in accordance with section 152-20 of the ITAA 1997, will not be included in the calculation of the net value of the CGT assets of Individual A for the purposes of satisfying the maximum net asset value test.

Tax law partnership

Although it has been established that Individual A and Individual B are not affiliates, they are in receipt of income jointly as they lease the asset to Trust A. These amounts have been included in the assessable income of Individual A and Individual B since they commenced leasing the asset to Trust A.

Due to this, Individual A and Individual B are a partnership as defined by section 995-1 of the ITAA 1997 as they are in receipt of ordinary income jointly, which is otherwise known as a tax law partnership.

As Individual A owns the asset jointly with Individual B, they have the right to receive more than 40% of the income and capital of the tax law partnership. Consequently, they are taken to control the partnership under subsection 328-125(2) of the ITAA 1997 and are therefore connected with the partnership under subsection 328-125(1).

Accordingly, the market value of the CGT assets of the tax law partnership, namely the assets, will be included in the calculation of the net value of the CGT assets of Individual A under section 152-20 of the ITAA 1997. This same principle applies to the amounts in the joint bank accounts that are earning interest.

It is not considered that there are any other potential entities that could be connected with Individual A under section 328-125 of the ITAA 1997.

Calculation of the net value of the CGT assets

Section 152-15 of the ITAA 1997 provides that maximum net asset value test is satisfied if the sum of the net value of the CGT assets of yours, any entities connected with you, and any of your affiliates or entities connected with your affiliates does not exceed $6,000,000.

It has been established that Individual A does not have any affiliates and the tax law partnership with Individual B is the only entity that will be connected with him just before the disposal of the asset. Therefore the net value of the CGT assets of the tax law partnership must be included in calculating whether the net value of the CGT assets of Individual A exceeds $6,000,000.

The net value of the CGT assets is defined in subsection 152-20(1) of the ITAA 1997 as the amount (whether positive, negative or nil) obtained by subtracting from the sum of the *market values of those assets the sum of:

(a) the liabilities of the entity that are related to the assets; and

(b) the following provisions made by the entity:

(i) provisions for annual leave;

(ii) provisions for long service leave;

(iii) provisions for unearned income;

(iv) provisions for tax liabilities.

Subsection 152-20(2) of the ITAA 1997 provides that the following assets should be disregarded when working out the net value of the CGT assets of an entity:

(a) disregard *shares, units or other interests (except debt) in another entity that is *connected with the first-mentioned entity or with an *affiliate of the first-mentioned entity, but include any liabilities related to any such shares, units or interests; and

(b) if the entity is an individual, disregard:

(i) assets being used solely for the personal use and enjoyment of the individual, or the individual's *affiliate (except a *dwelling, or an *ownership interest in a dwelling, that is the individual's main residence, including any adjacent land to which the main residence exemption can extend because of section 118-120); and

(ii) except for an amount included under subsection (2A), the *market value of a dwelling, or an ownership interest in a dwelling, that is the individual's main residence (including any relevant adjacent land); and

(iii) a right to, or to any part of, any allowance, annuity or capital amount payable out of a *superannuation fund or an *approved deposit fund; and

(iv) a right to, or to any part of, an asset of a superannuation fund or of an approved deposit fund; and

(v) a policy of insurance on the life of an individual.

Individual A and B's personal effects will be disregarded when calculating the net value of the CGT assets of Individual A under subsection 152-20(2) of the ITAA 1997.

As the other assets are not CGT assets that are disregarded under subsection 152-20(2) of the ITAA 1997, their market values will be included in the calculation of the net value of the CGT assets of Individual A under section 152-20.

Based on the information provided, the net value of the CGT assets of Individual A together with the entities that are connected with them, their affiliates and entities that are connected with their affiliates is less than $6,000,000. Accordingly, Individual A satisfies the maximum net asset value test under section 152-15 of the ITAA 1997.

Individual A satisfies the requirement in paragraph 152-10(1)(c)(ii) of the ITAA 1997 and consequently, it is not necessary to consider the other tests in paragraph 152-10(1)(c).

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.

As Individual A has owned the asset for more than 15 years, the asset must be an active asset of theirs for at least 7½ years during the time when they owned it.

Subsection 152-40(1) of the ITAA 1997 provides that a tangible or intangible CGT asset is an active asset if you own the asset and it 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 it has previously been established that Individual A does not carry on a business in their personal capacity it must be considered whether the asset was used or held ready for use in a business carried on by their affiliate or another entity connected with them.

As mentioned previously, an entity is connected with another entity under subsection 328-125(1) of the ITAA 1997 if either entity controls the other entity in a way described in this section or both entities are controlled in a way described in this section by the same third entity.

Subsection 328-125(2) sets out how an entity (other than a discretionary trust) directly controls another entity 'in a way described in section 328-125 of the ITAA 1997'. Broadly, an entity will be directly controlled by another entity, if that other entity, its affiliates, or that other entity together with its affiliates, own or have the right to acquire interests that carry the right to at least 40% of the income or capital of the entity.

Subsection 328-125(4) of the ITAA 1997 outlines an alternative test for establishing control of a discretionary trust in an income year. An entity controls a discretionary trust for an income year if the trustee has paid or applied at least 40% of the income or capital of the trust for any of the four income years before that year.

Subsection 328-125(7) of the ITAA 1997 also provides that if an entity (the first entity) directly controls a second entity, and that second entity also controls (directly or indirectly) a third entity, the first entity is taken to control the third entity. However, if the second entity is of the kind described in subsection 328-125(8), subsection 328-125(7) does not apply.

The trustee of the Family Trust distributed more than 40% of the income of the trust for a number of income years to Company X. Therefore, Company X controls the Family Trust in accordance with subsection 328-125(4) of the ITAA 1997 for at more than 7½ income years. Accordingly, Company X and the Family Trust were connected with each other under subsection 328-125(1) during these times.

As Individual A also held 50% of the shares in Company X for a number of income years and consequently they were entitled to at least 40% of the income and capital of the company, they controlled Company X in accordance with subsection 328-125(2) of the ITAA 1997 during that time. Accordingly, Individual A and Company X are also connected with each other under subsection 328-125(1) during those income years

As Company X controls the Family Trust, and Individual A in turn controls Company X, Individual A will also control the Family Trust in accordance with subsection 328-125(7) of the ITAA 1997. Accordingly, Individual A and the Family Trust were connected with each other for a number of income years in accordance with subsection 328-125(1).

The Family Trust carried on business utilising the asset for more than 7½ income years until it was sold.

Therefore, as the asset was used by the Family Trust in the course of carrying on a business and Individual A was connected with the Family Trust during this time, the asset is an active asset in accordance with subsection 152-40(1) of the ITAA 1997. As the Family Trust and Individual A were connected for more than 7½ years and the asset was an active asset during this time, the active asset test in section 152-35 of the ITAA 1997 is satisfied. In conclusion, as Individual A satisfies all of the requirements in subsection 152-10(1) of the ITAA 1997, they satisfies the basic conditions of relief.

Question 2

Summary

Individual A will satisfy the 15-year exemption for individuals pursuant to section 152-105 ITAA 1997 upon the disposal of the asset.

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.

Section 152-105 of the ITAA 1997 provides that an individual 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 of the ITAA 1997 are satisfied for the gain;

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

(c)    if the CGT asset is a share in a company or an interest in a trust - the company or trust had a significant individual for at least 15 years (even if the 15 years was not continuous and it was not always the same significant individual) during which you owned the CGT asset;

(d)    either:

(i)            you are 55 or over at the time of the CGT event and the event happens in connection with your retirement, or

(ii)           you are permanently incapacitated at the time of the CGT event.

Each of these requirements will be discussed below.

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

As it has been established in question one, the basic conditions in Subdivision 152-A of the ITAA 1997 are satisfied for the gain.

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

Individual A will have held the asset for more than 15 years prior to the disposal and consequently the requirement in paragraph 152-105(b) of the ITAA 1997 is satisfied.

(c) if the CGT asset is a *share in a company or an interest in a trust

This requirement is not applicable as the asset is not a share in a company or an interest in a trust.

(d) either:

    (i)        you are 55 or over at the time of the CGT event and the event happens in connection with your retirement; or

  (ii)        you are permanently incapacitated at the time of the CGT event.

Individual A will be aged over 55 at the time of the CGT event, therefore it must be established whether CGT event A1, that happens upon the disposal of the asset, happens in connection with Individual A's retirement.

The Guide to Capital Gains Tax 2021 in the section relating to 'Small business 15-year exemption' provides the following guidance on when a CGT event happen in connection with retirement:

Whether a CGT event happens in connection with an individual's retirement depends on the particular circumstances of each case. There would need to be at least a significant reduction in the number of hours the individual works or a significant change in the nature of their present activities to be regarded as a retirement. However, it isn't necessary for there to be a permanent and everlasting retirement from the workforce.

Individual A currently works in the business carried on by Trust A.

As per the guidance provided above, in the facts of this case it can be established that Individual A will retire upon a significant reduction in their involvement in the business carried on by Trust A.

Their retirement will occur at the time of the disposal of the asset, it is considered that the disposal will be in connection with their retirement and consequently they will satisfy the requirements of subparagraph 152-105(d)(i) of the ITAA 1997.

In conclusion, Individual A will satisfy all the requirements of section 152-110 of the ITAA 1997 and they will be eligible to apply the 15-year retirement exemption in Subdivision 152-B to disregard any capital gain upon the disposal of the asset.