Edited version of private advice

Authorisation Number: 1051973163766

Date of advice: 1 June 2022

Ruling

Subject: CGT - 15-year exemption for companies and trusts - permanently incapacitated

Question

Does ABC Pty Ltd (ABC) satisfy the criteria under subsection 152-110(1)(d)(ii) of the Income Tax Assessment Act 1997 (ITAA 1997) in regard to a significant individual of the company being permanently incapacitated at the time of the Capital Gains Tax (CGT) events that are the disposal of CGT assets in relation to franchises it operated/operates?

Answer

Yes

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

XX Month 20XX

Relevant facts and circumstances

1.         ABC is a company that carries on a business of operating franchises.

2.         Ordinary shares in ABC are held as follows:

a)    Mr X - XX shares acquired on XX Month 20XX

b)    XYZ as trustee for a family trust (XYZ Investments) - XX shares, acquired XX Month 20XX[1] (Mr X is the 100% shareholder of XYZ Investments)

3.         There are no other classes of shares in ABC on issue, and no proposal to issue any further shares in ABC.

4.         ABC acquired seven franchises (the Franchises) more than 15 years ago.

5.         ABC has recently sold three of the Franchises, and two are currently under contract. Details of these are:

a)    Franchise A - Contract date was XX Month 20XX

b)    Franchise B - Contract date was XX Month 20XX

c)    Franchise C - Contract date was XX Month 20XX

d)    Franchise D - Contract date was XX Month 20XX

e)    Franchise E - Contract date was XX Month 20XX

6.         The two remaining franchises, Franchise F and H, are likely to take a while to sell. Mr X has been in discussions with staff of those remaining two franchises to see if they will purchase the franchises on vendor finance terms over 12-18 months.

Mr X

7.         Mr X was diagnosed with a medical condition when he was XX years of age. He is now XX years old.

8.         Mr X's medical practitioner, Dr W, has been treating Mr X for almost 8 years and has, in a medical report dated XX Month 20XX, stated that he views Mr X as having been permanently incapacitated since before XX Month 20XX.

9.         Recognising the increasing difficulties he was having remaining actively involved in the Franchises, and that he cannot continue in the industry, Mr X has been trying to sell ABC's Franchises. Due to the economic conditions caused by COVID, prospective buyers are finding it hard to obtain finance and so it has not been possible to sell all the Franchises to a single purchaser. As above, ABC has recently sold three franchises and two more franchises are under contract.

10.      Mr X has been in discussions with staff of the two remaining franchises to see if they will purchase them on vendor finance terms over 12-18 months.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 Subdivision 152-B

Income Tax Assessment Act 1997 Section 152-50

Income Tax Assessment Act 1997 Section 152-55

Income Tax Assessment Act 1997 Section 152-65

Income Tax Assessment Act 1997 Section 152-110

Income Tax Assessment Act 1997 Paragraph 152-110(1)(c)

Income Tax Assessment Act 1997 Subparagraph 152-110(1)(d)(ii)

Reasons for decision

Legislative references from herein are to the Income Tax Assessment Act 1997, unless otherwise stated.

10.      Subdivision 152-B provides a small business 15-year exemption as part of the CGT small business relief provisions. If you qualify for the small business 15-year exemption, the capital gain is entirely disregarded, and it is unnecessary to apply any other concessions.

11.      To qualify for the small business CGT concessions, you must satisfy several conditions that are common to all the concessions. These are called the 'basic conditions'. The 15-year exemption also has further requirements that you must satisfy for the concessions to apply.

12.      One of those conditions is that 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 the entity owned the CGT asset

13.      The other condition is that the individual who was a significant individual of the company just before the CGT event either was 55 or over at that time and the event happens in connection with their retirement; or the individual was permanently incapacitated at the time.

Small business 15-year exemption

14.      The rules covering the small business 15-year exemption are contained in Subdivision 152-B.

Conditions to be satisfied

15.      Subsection 152-110(1) provides a small business 15-year exemption for companies and trusts. Under this section, ABC can disregard the capital gain from the disposal of the business, being CGT event A1 happening to the asset, if the company:

(a)  satisfies the basic conditions in Subdivision 152-A for the small business CGT concessions

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

(c)  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 the company owned the CGT asset; and

(d)  an individual who was a significant individual of the company just before the CGT event was:

(i)    55 or over at that time and the event happened in connection with their retirement; or

(ii)   permanently incapacitated at the time.

16.      In your application, you have asked us to rule as to whether, in relation to ABC, the condition in subsection 152-110(1)(d)(ii) is satisfied in regard to a significant individual of the company being permanently incapacitated at the time of each of the Capital Gains Tax (CGT) events that is the disposal of a CGT asset in relation to the Franchises. Therefore, the ruling will consider only whether a significant individual, Mr X, is permanently incapacitated for the purposes of paragraph 152-110(1)(d)(ii). The ruling will not consider the other requirements of section 152-110.

Significant individual

17.      Section 152-55 explains the meaning of a significant individual to mean the individual has a 'small business participation percentage' in the company of at least 20 per cent.

18.      The small business participation percentage is the total of the direct and indirect small business participation percentages (section 152-65).

19.      The direct small business participation percentage is calculated in accordance with section 152-70.

Permanent incapacitation test

20.      Where the taxpayer is a company, the permanent incapacitation alternative will be satisfied where, just before the CGT event, the taxpayer had a significant individual, and the significant individual was permanently incapacitated at that time.

21.      The Explanatory Memorandum (EM) to the New Business Tax System (Capital Gains Tax) Bill 1999 states the following 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.

22.      The term 'permanently incapacitated' is not defined for the purpose of the CGT provisions. However, the term has been used in relation to the retirement and superannuation provisions which provide some indication of its meaning for the purposes of the CGT 15-year exemption. The ATO outlines this view on its website (QC 52288) where it states:

'Whether an individual is permanently incapacitated at the time of the CGT event depends on the particular circumstances of each case. Based on the meaning of the term 'permanent incapacity' in retirement and superannuation law, an indicative description is:

§  Ill health (whether physical or mental), where it is reasonable to consider that the person is unlikely, because of the ill health, to engage again in gainful employment for which the person is reasonably qualified by education, training or experience. The incapacity does not necessarily need to be permanent in the sense of everlasting.'

Application to your circumstances

23.      From the facts provided, Mr X has a small business participation percentage of at least 51% and has held this participation percentage since XX March 20XX and therefore meets the requirement of paragraph 152-110(1)(c) to be a significant individual for at least 15 years.

24.      Mr X (the significant individual) has been diagnosed by his medical practitioner as permanently incapacitated since XX August 20XX, and as a result, is no longer able to work in the Franchises to the level required.

25.      Thus, the Commissioner is of the view that Mr X, the significant individual in relation to ABC, is 'permanently incapacitated' for the purposes of subsection 152-110(1)(d)(ii).

26.      Accordingly, the condition in subsection 152-110(1)(d)(ii) is or will be satisfied at the time of each disposal on or after XX August 20XX by ABC of CGT assets in relation to the Franchises.

[1] XYZ Investments acquired these shares from Mrs X (Mr X's spouse), and are not beneficially held by the company. Mrs X acquired the shares from Mr Y, Mr X's father, on XX Month 20XX when Mr Y retired, and Mrs X disposed of them on XX Month 20XX to XYZ Investments. Mrs X was also not a beneficial owner of the shares.