Edited version of private advice

Authorisation Number: 1051956686588

Date of advice: 4 March 2022

Ruling

Subject: Small business CGT concession - active asset

Question 1

Is the factory land an active asset of the partners under subsection 152-40(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will the factory land be an active asset of the continuing partners under subsection 152-40(1) of the ITAA 1997 immediately following the X family trust's exit from the partnership?

Answer

Yes.

Question 3

Will parcels A, B and C be an active asset of the continuing partners under subsection 152-40(1) of the ITAA 1997 following the subdivision of the factory land and prior to the sale of those parcels?

Answer

Yes.

Question 4

Will parcels B and C satisfy the active asset test under section 152-35 of the ITAA 1997 at the time of their disposal by the continuing partners to the X family trust?

Answer

Yes.

Question 5

Will parcel A satisfy the active asset test under section 152-35 of the ITAA 1997 at the time of its future disposal by the continuing partners?

Answer

Yes.

This ruling applies for the following periods:

•                Income year ending 30 June 2022

•                Income year ending 30 June 2023

•                Income year ending 30 June 2024

The scheme commenced on:

1 July 2021

Relevant facts and circumstances

X Pty Ltd as trustee for the X family trust, Y Pty Ltd as trustee for the Y family trust, and Z Pty Ltd as trustee for the Z family trust, together constituting a partnership, entered into a Deed of Partnership in 2001.

The X family trust, Y family trust and Z family trust carry on a business of civil, industrial, commercial and domestic construction.

The partnership trades under the name of XYZ.

In 2001, the X family trust, Y family trust and Z family trust purchased the factory land via a nominee company, XYZ Pty Ltd. The factory land has been held in the name of XYZ Pty Ltd since its initial acquisition, and has been used by the partnership in the course of carrying on its business at all times since its acquisition. There has been no other use of any parts of the factory land at any time since its acquisition.

The X family trust, Y family trust and Z family trust each holds one-third of the partnership assets, including the factory land.

The factory situated on the factory land, including all building and undercover area is approximately 5% of the overall land area. The remaining land is used as storage area for the storage of building materials, equipment, vehicles, site huts, offices, storage containers as well as for prefabrication (such as joinery) and building preparation work.

No rent, annuity, royalties, interest or foreign exchange gains has been derived by the partnership from the use of the factory land at any time.

The factory land is in an industrial zone. There has been no change made to the zoning of the factory land from the time of its acquisition by the partnership.

The X family trust's proposed exit

The X family trust will be exiting the partnership, and will dispose of its interest in each of the partnership assets (including the factory land) to the Y family trust and the Z family trust (as the continuing partners) at market value.

Subsequent to the X family trust's exit from the partnership, the factory land will be subdivided into three parcels - parcel A (land with factory), parcel B (vacant land) and parcel C (vacant land).

Sometime following the subdivision of the factory land, parcels B and C will be disposed of by the continuing partners to the X family trust in satisfaction of part of the consideration payable by the continuing partners for their acquisition of the X family trust's interest in all partnership assets.

As there is a large easement running through the middle of the factory land, the proposed division of the vacant portion of the factory land into two parcels (parcels B and C) as opposed to one is for practical and council permit reasons.

The continuing partners will continue to carry on the partnership business after the X family trust's exit.

Assumptions

1.    All disposals of interests in parcels A, B and C (subsequent to the proposed subdivision) will be on capital account.

2.    The factory land will continuously be used in the course of carrying on the partnership business until the proposed subdivision.

3.    Parcels B and C will continuously be used in the course of carrying on the partnership business until their disposal to the X family trust.

4.    Parcel A will continuously be used in the course of carrying on the partnership business until its disposal by the continuing partners.

5.    No rent, interest, annuity, royalties or foreign exchange gains will be derived by the partnership in connection with the factory land or (subsequent to the proposed subdivision) parcels A, B or C.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 subsection 106-5(3)

Income Tax Assessment Act 1997 section 112-25

Income Tax Assessment Act 1997 subsection 112-25(1)

Income Tax Assessment Act 1997 subsection 112-25(2)

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Subdivision 152-A

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

Income Tax Assessment Act 1997 section 152-35

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

Income Tax Assessment Act 1997 paragraph 152-35(1)(a)

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

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

Income Tax Assessment Act 1997 subsection 152-40(1)

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

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

Income Tax Assessment Act 1997 paragraph 152-40(4)(e)

Reasons for decision

All subsequent legislative references are to the ITAA 1997.

The active asset test

Subdivision 152-A sets out the 'basic conditions' which must be satisfied in order for entities to qualify for any of the CGT small business concessions under Division 152 to reduce or disregard a capital gain they make. One of the basic conditions, at paragraph 152-10(1)(d), is that the CGT asset (in respect of which the CGT event resulting in the capital gain happened) satisfies the active asset test in section 152-35.

Subsection 152-35(1) provides that:

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) states that the period:

(a)   begins when you acquired the asset; and

(b)   ends at the earlier of:

(i)   the CGT event; and

(ii)  if the relevant business ceased to be carried on in the 12 months before that time or any longer period that the Commissioner allows - the cessation of the business.

Meaning of active asset

Subsection 152-40(1) defines an active asset as follows:

A CGT asset is an active asset at a time if, at that time:

(a)   you own the asset (whether the asset is tangible or intangible) 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:

(i)   you; or

(ii)  your affiliate; or

(iii) another entity that is connected with you; or

(b)   if the asset is an intangible asset - 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.

However, subsection 152-40(4) lists CGT assets that cannot be active assets. Of relevance, paragraph 152-40(4)(e) states that the following CGT asset cannot be an active asset:

(e)   an asset whose main use by you is to derive interest, an annuity, rent, royalties or foreign exchange gains unless:

(i)   the asset is an intangible asset and has been substantially developed, altered or improved by you so that its market value has been substantially enhanced; or

(ii)  its main use for deriving rent was only temporary.

The factory land is an active asset of the partners

All parts of the factory land, an asset owned by the partners since its acquisition in 2001, have been used in the course of carrying on the partnership's business since the time of its acquisition.

There has been no other use of any parts of the factory land since its acquisition, nor (for the purposes of paragraph 152-40(4)(e)) has the factory land been used by the partnership at any time to derive rent, an annuity, royalties, interest or foreign exchange gains.

Therefore, the factory land is an active asset of the partners pursuant to paragraph 152-40(1)(a).

The X family trust's exit from the partnership

In accordance with subsection 106-5(3), when a partner leaves a partnership, each remaining partner acquires a separate CGT asset to the extent that the remaining partner acquires a share of the departing partner's interest in a partnership asset.

At the time the X family trust exits the partnership, each of the continuing partners will therefore be treated as having acquired an additional one-sixth interest in the factory land; those additional interests constituting separate assets.

The X family trust's exit from the partnership will not, however, change the status of the factory land as an active asset of the continuing partners. This is because following the X family trust's exit:

• the continuing partners will continue to own the factory land and use it in the course of carrying on the partnership's business; and
• the factory land will not be used by the partnership to derive rent, an annuity, royalties, interest or foreign exchange gains at any time.

Subdivision of the factory land

Subsections 112-25(1) and (2) provide that if a CGT asset (the original asset) is split into 2 or more assets (the new assets), and you are the beneficial owner of the original asset and each new asset, the splitting is not a CGT event.

Consequently, pursuant to section 112-25, the subdivision of the factory land into parcels A, B and C will not result in a CGT event, as the continuing partners will be the beneficial owners of the factory land (the original asset) before the subdivision and parcels A, B and C (the new assets) after the subdivision.

Parcels A, B and C will be taken to have been acquired by the continuing partners when the factory land was acquired (see paragraph 2 of Taxation Determination TD 97/3[1]). That is, each of the continuing partners will have a 50% interest in parcels A, B and C, comprising of a one-third interest acquired in 2001 and a one-sixth interest acquired at the time of the X family trust's exit.

Parcels A, B and C will be active assets of the continuing partners pursuant to paragraph 152-40(1)(a) on the same basis and for the same reasons that the factory land was an active asset prior to the subdivision.

Disposal of parcels

CGT event A1 under section 104-10 will happen when the continuing partners dispose of parcels B and C to the X family trust. Similarly, CGT event A1 under section 104-10 will happen when the continuing partners dispose of parcel A to a third party.

Any capital gain or capital loss realised by the continuing partners from those disposals will be calculated by reference to their respective interests in those assets at the time of disposal.

At the time the continuing partners dispose parcels B and C to the X family trust and parcel A to a third party, the parcels will be an active asset of the continuing partners pursuant to paragraph 152-40(1)(a) for the entirety of the time they were held. This is because:

•                the continuing partners will have owned the parcels and used them in the course of carrying on the partnership's business until the time of their disposal; and

•                the parcels will not have been used by the continuing partners to derive rent, an annuity, royalties, interest or foreign exchange gains at any time.

As each continuing partner's one-third interest in parcels A, B and C acquired in 2001 will have been owned for more than 15 years at the time of their disposal and will have been an active asset of theirs for the entirety of the time it was held, and therefore for a total of at least 7½ years during the period specified in subsection 152-35(2), those assets will satisfy the active asset test under paragraph 152-35(1)(b).

As each continuing partner's one-sixth interest in parcels B and C acquired at the time of the X family trust's exit will have been owned for less than 15 years and will have been an active asset of theirs for the entirety of the time it was held, and therefore for a total of at least half of the period specified in subsection 152-35(2), those assets will satisfy the active asset test under paragraph 152-35(1)(a).

As each continuing partner's one-sixth interest in parcel A acquired at the time of the X family trust's exit will have been an active asset of theirs for the entirety of the time it was held, that asset will satisfy the applicable active asset test under subsection 152-35(1).

[1] Income tax: capital gains: if a parcel of land acquired after 19 September 1985 is subdivided into lots ('blocks'), do Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 treat a disposal of a block of the subdivided land as the disposal of part of an asset (the original land parcel) or the disposal of an asset in its own right (the subdivided block)?