Edited version of private advice

Authorisation Number: 1051963497484

Date of advice: 25 March 2022

Ruling

Subject: Capital gains tax

Question

Does the Company satisfy the conditions to be able to choose the small business 15 year exemption in Subdivision 152-B of the Income Tax Assessment Act 1997 (ITAA1997)?

Answer

Yes

Question 2

Will the payments from the Company to the CGT concession stakeholders be exempt under subparagraph 152-125(1)(a)(iii) of the ITAA 1997?

Answer

Yes

This ruling applies for the following period(s)

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on

1 July 20XX

Relevant facts and circumstances

The Company was incorporated on XX/XX/XXXX for the purpose of acquiring property A.

There are X current individual shareholders and X trust shareholders.

The Company owns two properties, Property B is used solely for residential rent:

Property A is a pre-CGT asset.

When Property A was purchased, it comprised of:

(a)          xxxx on the X floor

(b)          a licenced boarding house on level X and level X (Boarding House).

A planning report prepared stated:

According to Council records the property is currently licensed as a boarding house. The earliest record they have of it being licensed as a boarding house is XXXX. Council files show that there has been an ongoing renewal and operation of the premises as a boarding house and the current license.

The Company has rented the X floor of Property A to various commercial tenants from XXXX.

The remaining two-thirds of Property A (X and X floors) has been registered as a licensed boarding house since XXX with the Council.

Since XXXX, the Boarding House has been registered under the Boarding House Act 2012 (XXXX) (Boarding House Act) as a 'registrable boarding house'. It is also noted that the State Fair Trading Boarding House Register sets out that the boarding house is a 'General Registrable Boarding House'.

In relation to the X and X floors of Property A during XXXX - XXXX:

(a)          the Company operated the X and X floors of Property A as a Boarding House

(b)          Property A was licensed as a boarding house with the Council

(c)           the Boarding House consisted of a number of bedrooms, bathrooms (including shared bathrooms), shared kitchen, shared laundry, and other shared areas

(d)          the bedrooms were furnished and included beds and wardrobes. New mattress protectors were also provided for each boarder

(e)          the Company did not have any employees and its affairs of were managed by its directors, and

(f)            members of the families were involved in the operation of the Boarding House. For example:

                                 i.                as the Boarding House rooms became vacant, they would purchase new shower curtains and mattress protectors for future boarders; and

                               ii.                until one of the shareholder's/director's sold their Business, they were onsite to talk to the boarders of the Boarding House regarding any problems that needed attending to (e.g., reporting any issues in the common areas that needed fixing).

The Company advised that from XXXX until XXXX the X and X floors of Property A continued to be used as a Boarding House in the same manner as it had previously, and members of the families continued to be involved in the management of the Xxxx Property.

From XXXX until XXXX, the family did not take such an active role in the day to day boarding house business and the rooms were rented on an exclusive possession rental agreement under the Residential Tenancies Act 2010.

During XXXX, the Council issued a fire compliance notice which required the Company to undertake certain major fire upgrades of the building on the Property A. As part of the discussions with the Council, project manager and architect, the Company agreed to:

(a)          complete the necessary major fire upgrades for the existing building (including the installation of a sprinkler system, fireproof gyprock and fire doors)

(b)          convert the Boarding House from XX rooms (with a shared kitchen) to XX self-contained boarding house rooms (each with their own kitchenette and bathroom) with a common room, and

(c)           include one of the rooms as a manager's residence.

The significant fire upgrades and renovations commenced in XXXX and were completed in or around early XXXX.

Since the required renovations were completed, the top X floors of the property has operated as a boarding house business and the rooms have been rented using occupancy agreements under the Boarding Houses Act.

In or around XXX, the Company appointed a resident manager to assist with the day to day operations of the Boarding House (including providing cleaning and managerial services). The manager is employed by the Company and resides in one of the rooms in the Boarding House (so that he or she can be available to address any issues or special requests from the boarders).

Following the completion of the renovations in XXXX, the families continued to manage the boarding house with the assistance of the resident manager and a real estate company.

As a result of the global COVID-19 pandemic hitting Australia, the gross income generated by the Boarding House was reduced.

As the shareholders hold more than 40% of the ordinary shares in the Company, they are 'connected entities' with the Company.

The Company does not have any affiliates under section 328-130.

There are noother entities that are controlled by the shareholders.

No shareholders carry on a business.

Given the shareholders ages, and their desire to retire, it is intended for the Company:

(a)          to sell property A within the next X months

(b)          to sell property B within the next X months

(c)           to be wound up, with a liquidator being appointed within the next X months.

(d)          the Company's annual turnover for the previous financial year was under $2 million.

Information provided

You have provided information in a number of documents in relation to the ruling request including:

(a)          your private ruling application.

(b)          supplementary information.

Assumption(s)

The indirect shareholder is a fixed trust.

The Company's annual turnover will be less than $2 million for the financial year ending 30 June 20XX.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

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

Income Tax Assessment Act 1997 subsection 104-10(3)

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 section 152-10(1)

Income Tax Assessment Act 1997 subparagraph 152-10(1)(c)(i)

Income Tax Assessment Act 1997 subsection 152-10(1AA)

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

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

Income Tax Assessment Act 1997 section 152-55

Income Tax Assessment Act 1997 section 152-60

Income Tax Assessment Act 1997 section 152-70

Income Tax Assessment Act 1997 section 152-75

Income Tax Assessment Act 1997 Subdivision 152-B

Income Tax Assessment Act 1997 section 152-110

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

Income Tax Assessment Act 1997 subsection 152-125(1)

Income Tax Assessment Act 1997 paragraph 152-125(1)(a)

Income Tax Assessment Act 1997 subparagraph 152-125(1)(a)(iii)

Income Tax Assessment Act 1997 paragraph 152-125(1)(b)

Income Tax Assessment Act 1997 paragraph 152-125(1)(c)

Income Tax Assessment Act 1997 subsection 328-110(1)

Income Tax Assessment Act 1997 subsection 328-115(1)

Income Tax Assessment Act 1997 subsection 328-120(1)

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated.

Question 1

Does the Company satisfy the conditions to be able to choose the small business 15 year exemption in Subdivision 152-B?

Summary

The Company can choose to apply the small business 15-year exemption in Subdivision 152-B, as it has satisfied the conditions.

Detailed reasoning

Eligibility for small business relief

An entity may choose to apply the small busines relief set out in Division 152 to reduce or disregard a capital gain if the basic conditions set out in Subdivision 152-A are satisfied.

Subsection 152-10(1) provides the basic conditions as follows:

(a)          a *CGT event happens in relation to a CGT asset of yours in an income year;

(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)

Disposal of property - time of CGT event A1

CGT event A1 happens if you dispose of a CGT asset.[1] The event happens when you enter into the contract for disposal, or if there is no contract when the change of ownership occurs.[2]

The Company proposes to sell Property A in the near future. A sale contract is intended to be entered into. CGT event A1 will happen when you enter into the sale contract. The Company will make a capital gain in the income year the sale contract is entered into.

CGT small business entity

You are a 'CGT small business entity' for an income year if:[3]

(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.

You are a 'small business entity' for an income year (the current year) if: [4]

(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, and

                            ii.                your aggregated turnover for the current year is likely to be less than $10 million

The following information has been provided to show that the Company is operating a boarding house business in the current income year:

(a)          since carrying out significant fire upgrades and renovations required to be carried out by Council were completed in early XXXX the top X floors of the property has continued to be operated as a boarding house business by the Company

(b)          (b) all boarders enter into an Occupancy Agreement as required by the Boarding Houses Act

(c)           (c) the Boarding House has at all relevant times been licenced by (and registered with) the Council as a boarding house, inspected annually by the Council as a boarding house and (since the enactment of the Boarding Houses Act) registered as a boarding house with Fair Trading.

(d)          (d) the Boarding House consisted of a number of single rooms for boarders, bathrooms (including shared bathrooms), a shared kitchen and various shared areas.

(e)          (e) the common areas (shared kitchen, shared laundry, corridors and two shared roof decks) were provided, cleaned and maintained by the Company for boarders to use. The Company provided weekly cleaning for all common areas and paid for most of the utilities for the Boarding House.

Your 'aggregated turnover' for an income year is the sum of the relevant annual turnovers. The 'relevant annual turnovers' are your annual turnover for the income year plus the annual turnovers of any connected or affiliated entities of yours during the income year. An entity's aggregated turnover is the same as its annual turnover if there are no other entities connected with or affiliated with it.

Section 328-125 provides 'control' tests which govern when an entity will be deemed to be 'connected with' another entity.

Subsection 328-125(1) states:

An entity is connected with another entity if:

(a)          either entity controls the other 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.

Both the individual shareholders and the Trust hold more than 40% of the ordinary shares in the Company. Therefore, both control the Company and are connected with the Company.

In relation to entities other than discretionary trusts (i.e., companies and fixed trusts), the relevant control test is set out in subsection 328-125(2) as follows:

(a)          an entity (the first entity) 'controls' another entity if the first entity, its affiliates, or the first entity together with its affiliates own or have the right to acquire 40% of the other entity's:

                             i.                income distribution

                            ii.                capital distribution, or

                           iii.                if the entity is a company - 40% of its voting rights.

You have stated that the Trust is a fixed trust and not a discretionary trust as the terms of the Will does not provide the trustees with the discretion to distribute income and capital flexibly.

The Individual 2 shareholder has the right to receive 100% of any distribution of income by the Trust during their lifetime. Therefore, as the shareholder is entitled to more than 40% of the income distribution of the trust, the Individual 2 shareholder controls Trust and is connected to the Company.

You have stated that the Company does not have any affiliates under section 328-130 and that there are noother entities that are controlled by and of the shareholders.

The relevant annual turnover for the Company consists of:

(a)          the Company's annual turnover

(b)          the Trust's annual turnover

(c)           Individual 1 shareholder's annual turnover, and

(d)          Individual 2 shareholder's annual turnover.

An entity's 'annual turnover' for an income year is the total ordinary income that the entity derives in the income year in the ordinary course of carrying on a business.

'Ordinary income' is defined in section 6-5 as income according to ordinary concepts. An entity's annual turnover therefore includes all income according to ordinary concepts derived in the ordinary course of carrying on a business.

You have stated that the shareholders do not carry on a business, therefore their annual turnover would be zero.

The Company's annual turnover for the XXXX income year was $X.

You have also stated that the Company's annual turnover will be less than $2 million for the XXXX income year.

The Company will therefore satisfy the definition of a CGT small business entity in subparagraph 152-10(1)(c)(i).

Active asset test

A CGT asset is an active asset at a given time if, at that time:[5]

(a)          you own the asset (whether tangible or intangible) and it is used, or held ready for use in the course of carrying on a business (whether alone or in partnership) by:

                             i.                you; or

                            ii.                your *affiliate; or

                           iii.                another entity *connected with you; or ....

A CGT asset satisfies the active asset test if:[6]

(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 of ownership 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 for at least 7.5 years during the period specified in subsection (2).

The Company has owned Property A since XXXX and operated a boarding house business during the period XXXX to XXXX and then from early XXXX. Running a boarding house business on Property A will make it an active asset. As the Company has owned the active asset for more than 15 years and it was used as an active asset for at least 7.5 years, The Company will satisfy the active asset test.

Conclusion on satisfying the basic conditions

Based on the facts provided, the basic conditions for relief have all been satisfied.

Small business 15-year exemption

Subdivision 152-B contains the small business 15-year exemption that allows a small business to disregard a capital gain arising from a CGT asset that it has owned for at least 15 years.

Subsection 152-110(1) sets out the following conditions that companies and trusts must satisfy before claiming the 15-year exemption:

An entity that is a company or trust can disregard any *capital gain arising from a CGT event if all 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 you 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 the time of the CGT event and the event happened in connection with the individual's retirement; or

(ii) was permanently incapacitated at that time.

Where all of these conditions are satisfied, the entity can disregard any capital gain arising from the CGT event.

It has already been established that the Company will satisfy the basic conditions in Subdivision 152-A for the capital gain that is to be made when Property A is sold.

The Company has owned Property A since XX/XX/XXXX. Therefore, the Company has continuously owned Property A for more than 15 years.

The third requirement is the Company had a significant individual for a total of at least 15 years during its ownership period.

An individual is a 'significant individual' in a company or a trust at a time if, at that time, the individual has a small business participation percentage in the company or trust of at least 20%.[7]

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.[8]

The current Company shareholders are:

(a)          Individual 1 who directly owns X%, and

(b)          Individual 2 who directly owns X% and indirectly X% through the Trust.

The Company has two significant individuals in the individuals, as they both have, directly or indirectly, a X% small business participation percentage in the Company.

Both Individual shareholders will be over 55 when the CGT event will happen.

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.[9]

You have stated that once Property A has been sold, the Company will no longer be conducting any active business operations, as the second property is a residential rental property. Therefore, after the Property A is sold, the time that the individuals would spend as directors will dramatically decrease.

As the Company will have two significant individuals who will be over 55 at the time of the CGT event and this event will happen in connection with their retirement, the final requirement is subsection 152-110(1) will be satisfied.

Based on the information provided, the Company should satisfy all the conditions in subsection

152-110(1) and be entitled to claim the small business 15 year exemption to disregard the capital gain that is expected to arise from the sale of Property A.

Question 2

Will the payments from the Company to the CGT concession stakeholders be exempt under subparagraph 152-125(1)(a)(iii)?

Summary

The payments from the Company to the CGT concession stakeholders will be exempt.

Detailed reasoning

Payments to company's CGT concession stakeholders are exempt

Section 152-125(1) applies if:

(a)          One or more of the following apply:

                             i.                Under section 152-110, a *capital gain (the exempt amount) of a company or trust is disregarded;

                            ii.                Under section 152-110, an amount of income (the exempt amount) is *non-assessable non-exempt income of a company it trust;

                           iii.                Subparagraph (i) of this paragraph would have applied to the amount (the exempt amount) except that the capital gain was disregarded anyway because the relevant *CGT asset was *acquired before 20 September 1985;

                           iv.                Subparagraph (i) of this paragraph would have applied to an amount (the exempt amount) if subsection 149-30(1A) and section 149-35 had not applied to the relevant asset; and

(b)          the company or trust makes one or more payments relating to the exempt amount to an individual (whether directly or indirectly through one or more interposed entities) before the later of:

(i) 2 years after the relevant *CGT event; and

(ii) if the relevant CGT event happened because the company or trust *disposed of the relevant CGT asset - 6 months after the latest time a possible *financial benefit becomes or could become due under a *look-through earnout right relating to that CGT asset and the disposal; and

(c)           the individual was a *CGT concession stakeholder of the company or trust just before the relevant CGT event.

Question 1 ascertained that the capital gain to made by the Company from the proposed sale of Property A is to be disregarded under section 152-110. As the Company has owned Property A continuously since XX/XX/XXXX, any capital gain that would have been made by the Company would be disregarded, as the property was acquired before 20 September 1995.[10] Therefore, the requirement in paragraph

152-125(1)(a) will be satisfied

You have advised that the Company will make the payments of the sale proceeds to its shareholders in accordance with their shareholdings within two years from the sale of Property A. Therefore, the requirement in paragraph 152-125(1)(b) will be satisfied if this happens.

An individual is a 'CGT concession stakeholder' of a company if the individual is a significant individual in the company.[11] Question 1 established that the individuals are significant individuals in the Company. Therefore, the individuals are CGT concession stakeholders of the Company and the requirement in paragraph 152-125(1)(c) will be satisfied

The Company will therefore satisfy all the conditions in subsection 152-125(1) and the payments made by the Company to the CGT concession stakeholder's will be exempt.

[1] Subsection 104-10(1)

[2] Subsection 104-10(3)

[3] Subsection 152-10(1AA)

[4] Subsection 328-110(1)

[5] Subsection 152-40(1)

[6] Subsection 152-35(1)

[7] Section 152-55

[8] Sections 152-65, 152-70 and 152-75

[9] Refer to the Guide to Capital Gains Tax 2021

[10] Subparagraph 152-125(1)(a)(iii)

[11] Section 152-60