Edited version of private advice

Authorisation Number: 1052006692773

Date of advice:18 July 2022

Ruling

Subject: CGT - small business concessions

Question

Does the property that you sold, satisfy the active asset test for the purposes of the Capital Gains Tax small business concessions in Division 152 of the Income Tax Assessment Act 1997?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You purchased the property in 20XX.

You owned the property for less than 15 years.

During the time that you owned the property, part of the building was rented to an unrelated third party and the other part of the building was utilised as the business premises for the Company A

The unrelated third party occupied 55% of the space and provided rent of less than $XXX each year.

Company A occupied 45% of the space and had a turnover in excess of $XXXX each year.

Family Trust B owns 100% of the shares in Company A.

Company C is the trustee of Family Trust B.

You have been the principal beneficiary of the Family Trust B for the past 5 years.

You are a director and 50% shareholder of Company C.

Your spouse is a director and 50% shareholder of Company C.

Your spouse is the director of Company A and manages daily business operations of the business.

All strategic business decisions for the business of Company A were made jointly by you and your spouse.

Relevant legislative provisions

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

Summary

Yes, the property is an active asset which satisfies the active asset test in section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997).

Detailed reasoning

For the small business concessions in Division 152 of the ITAA 1997 to apply to reduce or disregard a capital gain, the relevant CGT asset must satisfy the active asset test in section 152-35 of the ITAA 1997.

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 of ownership, 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 ½ years.

Subsection 152-40(1) of the ITAA 1997 provides the meaning of 'active asset'. A CGT asset will be an active asset at a time if, at that time, you own the asset and the asset was used or held ready for use in the course of carrying on a business, by you, an affiliate of yours, or by an entity that is connected with you.

However, certain assets are excluded from being active assets. Subsection 152-40(4) of the ITAA 1997 lists the CGT assets that cannot be active assets. Paragraph (e) provides that an asset whose main use by you is to derive rent cannot be an active asset unless it's main use for deriving rent was only temporary or is an intangible asset that meets certain requirements.

Affiliate or connected with

The meaning of affiliate is provided in section 328-130 of the ITAA 1997: An individual or company is an affiliate of yours if the individual or company acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the business of the individual or company.

The meaning of 'connected with' is provided in subsection 328-125(1): An entity is connected with another entity if either entity controls the other entity in the way described in this section.

Subsection 328-125(2) sets out how an entity directly controls another entity (other than a discretionary trust). Broadly, an entity will be directly controlled by another entity, if that other entity, its affiliates, or that other entity together with its affiliates, own or have the right to acquire interests that carry the right to at least 40% of the income or capital of the entity. Or in the case of a company, own or have the right to acquire equity interests that represents at least 40% of the voting power in the company.

Subsection 328-125(3) sets out one of the ways that an entity directly controls a discretionary trust. An entity directly 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 entity, its affiliates, or the entity together with its affiliates.

Subsection 328-125(4) sets out a second way that an entity directly controls a discretionary trust. If for any of the four years prior to the year in question, the taxpayer has at least 40% of the total income or capital of the trust paid or applied to them.

Subsection 328-125(7) of the ITAA 1997 also provides that if an entity (the first entity) directly controls a second entity, and that second entity also controls (directly or indirectly) a third entity, the first entity is taken to control the third entity.

Main use to derive rent

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? (TD 2006/78) provides guidance on the circumstances in which a premises used to derive rent may satisfy the active asset test. Paragraph 1 explains that it depends on the particular circumstances of each case.

Example 5 in TD 2006/78 outlines a circumstance where a taxpayer owns land of which they use 45% of the area for a business they conduct from which they derive 80% of their income, and the other 55% is leased to unrelated third parties. It concludes that an asset used partly for business purposes and partly to derive rent can be an active asset under section 152-40 of the ITAA 1997 where it is considered that the main use of the premises is not to derive rent.

In deciding if a property was mainly used to derive rent the Commissioner will consider a range of factors such as:

•         The comparative areas of use of the premises (between rent and business)

•         The comparative levels of income derived from the different uses of the asset.

Application to your circumstances

The property is a CGT asset, and it was used by Company A to carry on a business. It must be established that Company A is an affiliate of yours, or an entity connected with you.

We consider Company A to be an affiliate of yours because the company acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you. This conclusion is reached on the basis of your involvement in strategic business decisions, your spouse's involvement in the business operations, your shareholding and directorship in Company C, and your status as primary beneficiary of the Family Trust B (which owns 100% of the shares in Company A) for the past five years.

In addition, we also consider Company A to be an entity connected with you by virtue of your 50% shareholding and directorship of Company C, the corporate trustee of the 100% shareholder of Company A.

As the property was used by an affiliate of yours to carry on a business, but was also used partly to derive rental income, it must be considered whether the property's main use was to derive rent.

For the whole time the property was owned, 45% of the space was occupied by Company A to carry on the business. This business had a turnover of more than $XXXX per year. The other 55% of the space was rented to an unrelated third party, which brought in less than $XXX of rent per year. It can be seen that a substantial amount (although not the majority) of the property was used to carry on the business, and this proportion of the property derives the vast majority of the total income. This leads to the conclusion that the main use of the property was not to derive rent and accordingly, the property is not excluded from being an active asset under paragraph 152-40(4)(e) of the ITAA 1997.

Therefore, the property is an active asset under section 152-40 of the ITAA 1997. Consequently, the property also satisfies the active asset test in subsection 152-35(1) because it was an active asset for more than half the period of ownership.