Edited version of private advice

Authorisation Number: 1051991151211

Date of advice: 17 June 2022

Ruling

Subject: Active Asset Test

Question

Does the property satisfy the active asset test under section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997) to apply the small business capital gains tax concessions?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2022

Year ended 30 June 2023

The scheme commences on:

1 June

Relevant facts and circumstances

Person A (A) and Person B (B) owned Company XYZ (the Company), a rental business.

The company was held in equal shares since 19xx.

In the 20xx income year, A and B purchased a property (the Property).

A and B do not carry on a business in their personal capacity. They owned the shares in the Company until the end of the 20xx income year.

In the 20xx income year, A and B's children, Person C (C) and Person D (D) together with their respective spouses Person E (E) and Person F (F) acquired all the shares in the Company.

The Company continues to operate the business until present day.

When C, D E and F acquired the shares in the Company, it was agreed that A and B would stay on for an additional period to complete the handover of the business. During this handover period, A and B retained control of all matters relating to the business.

These matters included, but were not limited to:

•                conducting a monthly management meeting with C, D, E and F. In this meeting, they would make decisions surrounding upcoming marketing campaigns, review and set budgets for projects, sign off on invoices, review staffing schedules/rosters, interview and recruit new staff, review and set pricing structures.

•                on a weekly basis, A would prepare the business banking. Both A and B had full access to the bank accounts for the period.

•                on a daily basis, A and B would delegate the staff to their respective tasks.

During the period, A and B continued to live on-site and remain available full time for the business.

A and B were employed as managers of the business for 3 months in the 20xx income year.

D and F have since retired from the business.

In the 20xx income year, D and E acquired all shares in Company XYZ.

A and B are currently negotiating to sell the property to C and E in the 20xx income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 328-125

Income Tax Assessment Act 1997 section 328-130

Reasons for decision

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.

An entity controls another entity if it or its affiliate (or all of them together):

•                owns, or has the right to acquire ownership of, interests in the other entity that give the right to receive at least 40% (the control percentage) of any distribution of income or capital by the other entity, or

•                if the other entity is a partnership - the net income of the partnership, or

•                if the other entity is a company, owns, or has the right to acquire ownership of, equity interests in the company that give at least 40% of the voting power in the company.

Meaning of affiliate

Section 328-130 of the ITAA 1997 explains that an affiliate is an individual who, 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 be 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.

A spouse nor a child is not automatically your affiliate. You must consider whether they are acting according to your directions or wishes, or in concert with you, in relation to their business affairs.

Active Asset Test

Subsection 152-35(1) of the ITAA 1997 states that a CGT asset satisfies 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 period owned; or

•                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 7.5 years.

Subsection 152-40(1) of the ITAA 1997 explains that a CGT asset is an active asset when you own the asset and it is used or ready to use in the course of carrying on a business that is carried on by you, your affiliate, or another connected entity.

Subsection 152-40(4) of the ITAA 1997 explains that not all CGT assets are active assets. In particular, paragraph 152-40(4)(e) of the ITAA 1997 explains that an asset whose main use by you is to derive rent is not an active asset, as it is not used in the course of carrying on a business. Taxation Determination TD 2006/78: Income tax: capital gains: are there any circumstances in which the premises used in a business of providing accommodation for reward may satisfy the active asset test in section 152-35 of the Income Tax Assessment Act 1997 notwithstanding the exclusion in paragraph 152-40(4)(e) of the Income Tax Assessment Act 1997 for assets whose main use is to derive rent explains that in certain circumstances, the premises used in business of providing accommodation for reward will satisfy the active asset test in section 152-35 of the ITAA 1997, but it will depend on the particular circumstances of each case.

Application to your circumstances

In the 20xx income year, the Company acquired the property. The Company has been using the property in carrying on its business from the acquisition date to current date. At the time of acquisition, A and B were the directors of the company. In the 20xx income year, C, D, E and F acquired all the shares of the Company from A and B.

They acquired the shares with the condition that A and B would retain control of all aspects of the Company for an agreed additional period. A and B continued to live on-site and remain available full time for the business. They had effectively remained in control of decisions concerning the business operations. The Company has acted in accordance with A and B 's directions in relation to the affairs of the business.

As A and B were in control of the business affairs, the Company is an entity that is connected with A and B between the 20xx income year and the 20xx income years. Subsequently, for the additional period in the 20xx income year, the Company is an affiliate of A and B as the business was operated in concert with them.

Notwithstanding the exclusion in paragraph 152-40(4)(e) of the ITAA 1997, the relationship between the business ran by A and B and their customers are not that of a landlord/tenant, under a lease agreement. Accordingly, the income derived is not rent.

A and B have owned the property for more than 15 years. The property has been used in the business carried on by Company XYZ for at least 7.5 years. Accordingly, the property is an active asset of A and B for the purpose of section 152-10(1)(d) of the ITAA 1997.

Further issues for consideration

This ruling has not fully considered your eligibility for the small business CGT concessions. You should ensure that you satisfy the relevant basic conditions for the concessions. More information is available on our website www.ato.gov.au using keywords 'concessions for small business' to search.