Edited version of private advice

Authorisation Number: 1051971541562

Date of advice: 30 June 2022

Ruling

Subject: CGT - small business concessions

Question 1

Will Person A (A) and Person B (B) be connected with the XYZ Trust (XYZ) from 20XX-20XX to enable the active asset test pursuant to section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will A satisfy the basic conditions under section 152-10 of the ITAA 1997 to apply the small business capital gains tax (CGT) concessions to the disposal of the property?

Answer

Yes.

Question 3

Does B satisfy the basic conditions under section 152-80 of the ITAA 1997 to apply the small business CGT concessions immediately prior to their death?

Answer

Yes.

Question 4

Will the disposal of the property satisfy the 15 year exemption pursuant to section 152-105 of the ITAA 1997?

Answer

Yes.

Question 5

Will A satisfy the basic conditions under section 152-10 to the ITAA 1997 to apply the small business CGT concessions to the disposal of the property to Person F (F) and/ or nominees for no consideration?

Answer

Yes.

Question 6

Will the disposal of the property to F and/ or nominees for no consideration satisfy the 15 year exemption pursuant to section 152-105 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

year ending 30 June 20XX

year ending 30 June 20XX

year ending 30 June 20XX

The scheme commences on:

3 March 20XX

Relevant facts and circumstances

Person A (A) was born in 19XX.

Person B (B) was born in 19XX.

A and B were married in 19XX and have 3 children; Person F (F), Person (G) and Person H (H).

A is a long-time business person. B had assisted A's business and activities since their marriage.

In 20XX, A and B acquired property (the Property) as joint tenants.

In 19XX the CDE Family Trust (CDE) was settled. LM Pty Ltd (LM) is the trustee of CDE. A and B have each owned equal shares in CDE. A is the sole appointor of the CDE and both A and B are beneficiaries of the trust.

CDE commenced carrying on a business on the property.

A worked as a manager of the business carried on by CDE, along with assistance from B. B assisted with the physical work earlier on as required, and later progressed to doing all the bookwork, banking and related activities.

The property has been used by CDE to operate a business from date of acquisition until June 20XX. Subsequently, it has been utilised by XYZ Pty Ltd as trustee for the XYZ Trust (XYZ).

XYZ was established on 29 June 20XX with XYZ Pty Ltd as trustee. The shareholders of XYZ Pty Ltd are F and their spouse Person J (J). They are also both appointors of XYZ.

F and J are the primary beneficiaries of XYZ, with A and B being included as general beneficiaries due to being the parents of F. The trustee of XYZ has never distributed any income of the trust to A or B.

The trustee of NOP trust (NOP Trust) distributed more than 40% of the income of CDE for the 1998 to 2005 income years to LM.

On 30 June 20XX, CDE sold the business to XYZ. XYZ has continued to carry on the business until today. The property is presently utilised in a similar business as A and B operated.

The sale of the business to XYZ was vendor financed and the capacity to repay the loan was dependant on the success of the business. Repayment was made in August 20XX.

In 20XX, under the advice and guidance of A, XYZ beneficiary F commenced responsibility of learning the business and undertaking business activities.

In June 20XX, A reduced their weekly working hours by approximately 20 hours per week by sharing responsibility of the daily tasks.

After the disposal of the property, A intends to further reduce their weekly working hours significantly to approximately 4 hours per week.

XYZ is a connected entity of A and B since at least July 20XX to August 20XX.

A valuation issued in 20XX determined that the market value of the property as of was over $X million.

The current net assets of A and B are less than $X million.

A, B, CDE, LM, F, G and H are all Australian residents for tax purposes.

Given the age of A, the broader family have been considering the intergenerational disposal that will occur upon a passing of either (or both) of A and B.

B passed away in April 20XX.

A no longer wants to work in the family business and intends to dispose of the property within 2 years.

Having regard to such issues, it has been decided that the land will be transferred to F and/ or nominees for nil consideration to achieve the following outcomes:

•         undertaking a key financial step in advance of A's intended retirement plan,

•         ensure the property, being a long-term legacy of the family name, is retained in a secure vehicle which can be retained for the benefit of future generations,

•         the property is transferred in advance of A and B's passing such that it does not form part of their respective estates and therefore avoids any undesired conflict between F, G, and H.

Relevant legislative provisions

Income Tax Assessable Act 1997 Section 104-10

Income Tax Assessable Act 1997 Section 109-5

Income Tax Assessable Act 1997 Section 116-30

Income Tax Assessable Act 1997 Section 128-50

Income Tax Assessable Act 1997 Section 152-10

Income Tax Assessable Act 1997 Section 152-15

Income Tax Assessable Act 1997 Section 152-20

Income Tax Assessable Act 1997 Section 152-35

Income Tax Assessable Act 1997 Section 152-50

Income Tax Assessable Act 1997 Section 152-55

Income Tax Assessable Act 1997 Section 152-60

Income Tax Assessable Act 1997 Section 152-70

Income Tax Assessable Act 1997 Section 152-80

Income Tax Assessable Act 1997 Section 152-105

Income Tax Assessable Act 1997 Section 152-300

Income Tax Assessable Act 1997 Section 328-130

Reasons for decision

Summary

The basic conditions will be satisfied when the property is disposed of. The property was acquired by A and B more than XX years ago. As A and B held the property as joint tenants, B's interest passes to A as the surviving tenant. CDE used the property in their business from 20XX to 20XX before selling the business to XYZ. F and J are the Directors of XYZ and used the property from 20XX-20XX. A and B were connected with the business during 20XX to 20XX. The property has been held for more than 15 years and an active asset for at least 7.5 years, and therefore satisfies the active asset test. A has been in control for more than 15 years of the total period of ownership. At the time of disposal, A will be over the age of 55, subsequently satisfying the 15 year CGT concession.

A CGT event will occur when disposing the property to F and/or nominees. When the property is disposed of for no consideration by transferring ownership of the property to F and/or nominees, CGT event A1 happens by the way of sale or gift. When no capital proceeds are received, it is taken that you have received the market value of the CGT asset at the time of the event and can continue to satisfy the conditions set out in Division 152 of the ITAA 1997.

Detailed reasoning

Question 1

An asset passes the active asset test if it is used in a business carried on by you, or an entity connected to you for half of its ownership period (or if owned for over 15 years, at least 7.5 years). In this case, A and B have owned the relevant property for more than 15 years. Accordingly, we will need to consider if it has been active for at least 7.5 years.

Section 328-125 of the ITAA provides when an entity is connected with another entity for the purposes of the active asset test (and other relevant tests and conditions).

From the date of acquisition on XX March 20XX to 30 June 20XX the property was used in a business carried on by CDE.

In June 20XX, the business was sold to XYZ who carried on the same business on the property. XYZ Pty Ltd is the corporate trustee of XYZ and is controlled by A and B's child, F. A and B are not shareholders or directors of XYZ and did not receive any distributions from XYZ from 20XX to 20XX. Accordingly, the only relevant test we can consider is the test contained in subsection 328-125(3) of the ITAA 1997, which states;

An entity (the first entity ) controls a discretionary trust if a 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.

This test should be considered for the relevant period (i.e., 20XX-20XX), not at the time of the CGT event (as would be relevant for the maximum net asset value test). In considering whether an entity controls a discretionary trust in accordance with subsection 328-125(3) of the ITAA 1997, the following factors are relevant:

•                     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.

In this case, we know that A and B continued to have an active role in the business following the sale in 20XX for a transitional period - given F's lack of experience. Similarly, the sale of the business was vendor financed, and the capacity to repay the loan was dependant on the success of the business. Repayment was not made until August 20XX.

Accordingly, it is reasonable to expect, that XYZ Pty Ltd (the trustee of the XYZ of which F was a shareholder/director) would act in accordance with A and B's wishes during the transitional period of 20XX-20XX. The property will therefore meet the active asset test during the 20XX-20XX period.

Consideration of earlier PW ruling

It should be noted that PW issued a ruling that stated A and B did not control the XYZ for the purposes of the MNAV test as it was applied on the sale of a different block of land.

Our ruling will not be in conflict with that decision as the PW ruling only considered the control test with respect of the XYZ at the time immediately before the relevant CGT event for that ruling in the 20XX FY. In the PW case, the land in question satisfied the active asset test through use by connected entities in earlier years (19XX-20XX), and therefore A's and B's connection to the XYZ was not relevant for the purposes of the active asset test.

The level of involvement of A and B during the period we are considering (i.e., 20XX-20XX) is vastly different from the level of involvement in the 20XX FY.

Question 2

Basic Conditions

Section 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997) contains the basic conditions that must be satisfied to be eligible to apply the capital gains tax (CGT) small business concessions. These conditions are:

(a) a CGT event happens in relation to a CGT asset in an income year.

(b) the event resulted in the gain.

(c) at least one of the following applies:

(i) you are a small business entity for the income year

(ii) you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997.

(iii) you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership or

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

(d) the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997.

Meaning of affiliate

Section 328-130 of the ITAA 1997, explains an affiliate is an individual that, in relation to their business affairs, acts or could reasonably be expected to act in accordance with your directions or wishes, or in concert with you. Whether a person acts, or could reasonably expected to act, in accordance with the taxpayer's directions or wishes, or in concert with the taxpayer is a question of fact dependent on all the circumstances of the particular case. No single factor will necessarily be determinative. In certain circumstances an individual can be taken to be your affiliate.

Meaning of when an entity is connected with you

Section 328-125 of the ITAA 1997, provides the meaning of connected with an entity. An entity is connected with another entity if:

•         either entity controls the other entity; or

•         both entities are controlled by the same third entity.

Subsection 328-125(3) of the ITAA 1997, states direct control of a discretionary trust is when an entity (the first entity) controls a discretionary trust, or the trust acts, or could reasonably be expected to act, in accordance with the directions and/or wishes of the first entity, its affiliates, or the first entity together with its affiliates.

Joint tenants

Section 128-50 of the ITAA 1997 provides if a CGT asset is owed by joint tenants and one of them dies, the survivor is taken to have acquired the individuals interest in the asset on the day that the individual dies.

If the individual who died acquired their interest in the asset on or after 20 September 1985, the first element of the cost base of the interest each survivor is taken to have acquired is:

Cost base of the interest of the individual who died (worked out on the day the individual died)

Number of survivors

Application to your circumstances

A CGT event will occur when A disposes of the property, it is expected that the disposal will result in a gain. A and B satisfy the maximum net asset test as together with all affiliates and connected entities, they have a net asset value of less than $X million. A and B purchased the property in 20XX as joint tenants.

The property was used in CDE's business from 20XX until 20XX. In line with section 328-125 of the ITAA 1997, A is connected with the trust and the property is used in business carried on by CDE. LM Pty Ltd (LM) is the trustee of CDE. A and B each owned equal shares in LM. A is the sole appointor of the CDE and both A and B are beneficiaries and CGT concession stakeholders of the CDE.

CDE continuously used the property in carrying on their business from 20XX to 20XX. A and B being the trustees and beneficiaries of CDE, subsequently, sold the property to XYZ. In line with section 328-125 of the ITAA 1997, A and B were connected with XYZ from 20XX to 20XX as determined in question 1. As the property was held for more than 15 years and an active asset for at least 7.5 of those years, the property satisfies the active asset test.

Subsequently, upon disposal of the property, the basic conditions under section 152-10 of the ITAA 1997 will have been satisfied for A.

Question 3

Section 152-80 of the ITAA 1997 allows for when a CGT asset was owned by joint tenants and one of them dies.

Where an interest in the asset is acquired by the surviving joint tenant as mentioned in section 128-50 of the ITAA 1997, that tenant can apply the CGT small business concessions when a CGT event happens within two years of the deceased's death (with the exception of subsection 152-80(3) of the ITAA 1997, where the Commissioner can allow an extension of time) and where the deceased was over the age of 55 years old or permanently incapacitated at the time of the CGT event.

Under Division 152 of the ITAA 1997, the surviving tenant is entitled to reduce or disregard a capital gain, in the same way as the deceased individual would have been entitled.

Application to your circumstances

The property was held by both A and B as joint tenants. B passed away in April 20XX. As per section 128-50 of the ITAA 1997, as they held the property as joint tenants, the land is transferred to A as the surviving tenant from B's date of death. If the property is disposed of within 2 years from B's date of death, the basic conditions will be satisfied under section 152-80 of the ITAA 1997.

Question 4

15-year exemption

Section 152-105 of the ITAA 1997 provides that an individual can entirely disregard any capital gain you make if you meet the requirements of the following conditions:

(a) you satisfy the basic conditions

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

(d) when the CGT event happened

(i) you were 55 years old or over and the event happened in connection with your retirement.

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

In connection with your 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 retirement.

The Explanatory Memorandum (EM) to the New Business Tax System (Capital Gains Tax) Bill 1999 makes the following comments about the requirement to be permanently incapacitated or retiring as one of the conditions for the concession:

1.68 One of the requirements of this concession for an individual small business taxpayer is that they must be either permanently incapacitated at the time of the CGT event, or at least 55 years old and using the capital proceeds for their retirement.

The provisions relating to the small business 15-year exemption does not define what is meant by the phrase 'in connection with a taxpayer's retirement', nor does it give any indication of the degree of retirement required to take advantage of this concession.

It could be argued that the phrase 'in connection with retirement' means that the capital gain arising from the disposal of an active assets is to be used to provide funds for a person's retirement rather than to precipitate retirement at the time of the CGT event. The words used in the EM support this interpretation.

The guide to the Capital gains tax concessions for small business also supports this view. It makes it clear that it is not necessary for there to be a permanent and everlasting retirement from the workforce. However, there needs to be at least a significant reduction in the number of hours worked, or a significant change in the nature of the activities, to be regarded as 'in connection with your retirement' for the purposes of paragraph 152-105(1)(d) of the ITAA 1997.

Whether a particular case satisfies the conditions depends very much on the facts of each case.

Application to your circumstances

As per question 2, the basic conditions will be satisfied when the property is disposed. The property was acquired on 20XX and is currently still owned by A, resulting in the property being held for over 15 years. A intends to hold their interest of the land until it transfers, therefore, any future sale will satisfy that the property is held for at least the minimum of a 15 year period.

A and B acquired the property in 20XX, CDE continuously used the property in carrying on their primary production business. Thereafter, the property was utilised in an identical form of business by XYZ. A and B's child F and J took on responsibility of learning the business. At that point in time from 20XX until 20XX, A's weekly hours reduced, by approximately 20 hours per week. After disposing of the property, A intends to significantly reduce his working hours to approximately 4 hours per week.

Paragraph 152-105(1)(d) of the ITAA 1997 requires that the CGT event happened in connection with your retirement. It is considered that you retire when you significantly reduce your working hours. Furthermore, noting that A is over the age of 55 years of age, and A's intentions to significantly reduce their hours after disposal of the property, A satisfies the conditions under section 152-105 of the ITAA 1997 to apply the CGT small business concessions 15-year exemption.

As B would have been entitled to apply the CGT small business 15 year exemption to disregard the capital gain from the disposal of the property immediately prior to their death and the conditions under section 152-80 of the ITAA 1997 have been satisfied, A is able to disregard on the disposal of B's interest in the property if the disposal occurs within 2 years of B's death.

Question 5 and 6

No consideration

Subsection 104-10(3) of the ITAA 1997 provides that the time of the CGT A1 event is when you enter into the contract for the disposal of the asset and if there is no contract, when a change of ownership occurs. Subsection 104-10(4) of the ITAA 1997 explains you make a capital gain if the capital proceeds from the disposal of the asset is more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base.

Subsection 116-30(1) of the ITAA 1997 provides the market value substitution rule. If you receive no capital proceeds from a CGT event, you are taken to have received the market value of the CGT asset that is the subject of the event. For example, if you give a CGT asset to another entity, you are taken to have received the market value of the CGT asset, you substitute the market value of the asset as the proceeds for the purpose of calculating your capital gain or capital loss upon disposal of the CGT asset.

Application to your circumstances

When A disposes of the property for no consideration by transferring the property to F and/or nominees, CGT event A1 will happen.

As A will not receive any capital proceeds from the disposal of the property, section 116-30 of the ITAA 1997 will operate to apply the market value substitution rule. A will be taken to have received the market value of the property on the date the property is transferred to F and/or nominees. The market value of the property will be used to calculate the capital gain or capital loss upon the disposal of the property.

The application of the market value substitution rule has no impact on the application of Division 152 of the ITAA 1997 and as such you will continue to satisfy the conditions to apply the CGT small business concessions as determined in question 1 and question 2 of this ruling.