Edited version of private advice

Authorisation Number: 1051936081790

Date of advice: 22 December 2021

Ruling

Subject: CGT - 15-year exemption

Question 1

Will the small business 15-year exemption in section 152-110 of Subdivision 152-B of the Income Tax Assessment Act 1997 ('ITAA 1997') apply to allow you to disregard any capital gain from the sale of Hills Business Accountants where the Capital Gains Tax (CGT) event happened in connection with the retirement of the significant individual?

Answer

Yes.

Question 2

Will the small business 15-year exemption in section 152-110 of Subdivision 152-B of the Income Tax Assessment Act 1997 ('ITAA 1997') apply to allow you to disregard any capital gain from the Deed of Surrender and Asset Purchase where the Capital Gains Tax (CGT) event happened in connection with the retirement of the significant individual?

Answer

No.

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Two businesses are being run under the company ABN.

The company is a small business entity with aggregated turnover of less than $2 million.

XXXX is a co-director and co-shareholder of the company and is over 55 years of age.

XXXX is XXXX's spouse, a co-director and shareholder of the company and over 55 years of age.

XXXX intends to retire from the company and both businesses.

Both business activities have been run for over X years.

A contract of sale has been entered into to sell Business A as a going concern where the buyer will pay upfront consideration at settlement and the remaining amount 12 months from the settlement date.

A proposed Deed of Surrender and Asset Purchase agreement between Business B and Party A is to be prepared.

The scheme is in serious contemplation and the Deed of Surrender and Asset Purchase reflects the terms on which the surrender is to occur.

Under the Deed of Surrender and Asset Purchase agreement, Party A agrees to pay a fixed payment and amounts equivalent to the Trailing payment on balance of loan book for the next X years.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 38-325

Income Tax Assessment Act 1997 section 152-15

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 152-110

Reasons for decision

Sale of Business A

To qualify for the small business 15 year exemption, several conditions must be established. Firstly, 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.

In your circumstances:

•         CGT Event A1 has occurred with the sale of the business.

•         The event resulted in a capital gain.

•         You have owned the business as an active asset for over 15 years per paragraph 152-35 (1)(b) of ITAA 1997.

•         You are a small business entity in the income year

Secondly, you must have owned the asset for the 15 year period leading up to the CGT event. You have advised you operated the business for over X years, so this condition is satisfied.

Finally, XXXX is your significant individual who worked in the business for at least 15 years, is over the age of 55 years and the CGT event occurs in connection with their retirement.

Accordingly, you satisfy all of the conditions for the small business 15-year exemption in Subdivision 152-B and can disregard any capital gain made from the sale of Business A.

Question 2

Deed of Surrender and Asset Purchase

As noted above the basic conditions under subdivision 152-A of the ITAA 1997 and the provisions under subdivision 152-B of ITAA 1997 must apply in order for the 15 year small business exemption to apply to a capital gain.

We consider that under the Franchise Agreement between yourself and Party A, no clause provides you with entitlement to an asset of the loan book. The Franchise Agreement states that any obligations Party A must pay regarding the commissions and volume bonuses cease if the agreement is terminated.

Clause XXXX provides for the ways the Franchise Agreement can be terminated. The proposed Deed of Surrender and Asset Purchase does not constitute termination under this clause.

The Deed of Surrender and Purchase of Assets ('the Deed') entered into represents a separate agreement where you surrender your right to continue to operate the franchise under the terms contained within the Franchise Agreement.

The Franchise Agreement notes that when the Franchise ends all rights, licences, trademarks, and confidential information will revert to Party A. Relevantly, you are required to immediately deliver to Party A all copies of customer information and transaction records. We consider this to include the loan book - which in its essence is a journal of customer information and transaction records. Therefore, under the Franchise Agreement you were not provided any right to the loan book beyond the agreement itself, and we cannot consider the loan book an asset you are capable of selling.

In your situation, we consider that the Deed represents the surrender of your right to continue to operate the franchise under the terms established in the Franchise Agreement between yourself and Party A. The consideration for this surrender is the payment of the surrender fee and the amounts identified in the Deed as amounts equivalent to the monthly trail payments.

The execution of the Deed of Surrender and Asset purchase constitutes a surrender of rights under the Franchise Agreement which is a CGT event C2. CGT event C2 is defined in section 104-25 of the ITAA 1997 as happening if your ownership of an intangible CGT asset ends in certain ways, including because the asset expires or is redeemed, cancelled, released, discharged, satisfied, abandoned, surrendered or forfeited.

The basic conditions within subdivision 152-A of the ITAA 1997 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

As noted above, the execution of the Deed will constitute CGT Event C2. The event will result in a gain.

However, for the basic conditions to apply, the CGT asset needs to satisfy the active asset test.

Section 152-35 of the ITAA 1997 provides that a CGT asset will satisfy the active asset test 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 least 7.5 years during the test period

The test period:

•         begins when you acquired the asset, and 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.

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

The intangible asset, being the contractual rights and entitlements under and to the Franchise Agreement, was inherently an asset used by the taxpayer in operating the business. It is therefore an active asset.

As noted previously you are a small business entity and therefore all of the basic conditions apply to the gain.

The additional considerations required to meet the 15-year exemption as noted above are:

•         You continuously own the CGT asset for the 15-year period ending just before the CGT event;

•         You had a significant individual for at least a total of 15 years during which the entity owned the CGT asset;

•         The significant individual of the company or trust just before the event either:

­   Was 55 years or older at the time and the event happened in connection with the individual's retirement; or

­   was permanently incapacitated at that time.

As noted above under question 1, you have advised you operated the business for over 17 years, so this condition is satisfied. The other criteria have also been established regarding the retirement of your significant individual.

Accordingly, you satisfy all of the conditions for the small business 15-year exemption in Subdivision 152-B and can disregard any capital gain made from the surrender of your rights by executing the Deed.