Edited version of private advice

Authorisation Number: 1052011506053

Date of advice: 3 August 2022

Ruling

Subject: CGT - 15 year exemption

Question

Will the small business 15-year exemption in section 152-110 of the Income Tax Assessment Act 1997 (ITAA 1997) apply to allow you to disregard any capital gain from the sale of the business where the Capital Gains Tax (CGT) event happened in connection with the retirement of the significant individual?

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

In January 20XX, Company XYZ (the Company) commenced operating a business.

Person A (Person A), and Person B (Person B), born in 19XX, are spouses. They are also the trustees for the ABC Trust (the ABC trust).

From January 20XX, the ABC trust and the EFG Family trust, each hold a percentage of the shares in the company.

In June 20XX, the ABC trust acquired 100% shareholdings of the company.

Both Person A and Person B can be considered significant individuals of the Company. They intend to sell the business (the Sale) to an unrelated third party (the Purchaser) and transition to retirement.

As part of the Sale, the Purchaser wishes to retain the services of Person B for a set amount of time on an agreed salary for an agreed number of days per week, in order to provide the Purchaser with training and a smooth transition of clients.

If the Purchaser did require Person B for additional time, they would agree to further reduce their working days. It is anticipated that Person B would not continue his employment with the Purchaser for more than a reasonable amount of time after settlement.

The parties have agreed a restraint of trade clause of multiple years on the basis that Person B is retiring and has no intention of continuing the business.

At the proposed date of the CGT event, Person B will be over 55 years of age and Person A will be under 55 years of age.

The Company is not a CGT small business entity as the aggregated turnover is more than $X million.

The Company is connected to other entities in the business group. The net asset value position at the time of application is under $X million across the group. The Company satisfies the maximum net asset value test.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-15

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 152-50

Income Tax Assessment Act 1997 section 152-70

Income Tax Assessment Act 1997 section 152-105

Income Tax Assessment Act 1997 section 152-110

Reasons for decision

Summary

Yes, you can disregard a capital gain from a CGT event happening to a CGT asset if you satisfy the basic conditions listed under section 152-10 of the ITAA 1997, you have owned a portion of the asset for at least 15 years and satisfy the additional conditions under section 152-110 of the ITAA 1997. The additional conditions include having a significant individual for at least a total of 15 years for the whole period of ownership that is over the age of 55 years old and the event happens in connection with their retirement. The Company will satisfy the basic conditions under section 152-10 of the ITAA 1997 when the sale of the business or the CGT event happens. Person B has been the significant individual for at least a total of 15 years and will be over the age of 55 when the proposed CGT event occurs. As the event happens in connection with their retirement and the additional conditions will be satisfied, the Company will be entitled to apply the small business 15 year exemption under section 152-110 of the ITAA 1997 to the relevant capital gain.

Detailed reasoning

Basic Conditions

Section 152-10 of the ITAA 1997 contains the basic conditions that must be satisfied to be eligible to apply the 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 would (apart from this Division) have 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 a 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.

Maximum Net Asset Value Test

Section 152-15 of the ITAA 1997 provides that you satisfy the maximum net asset value test if, just before the CGT event, the sum of the net value of the CGT assets of yours, any entities connected with you and any affiliates of yours or entities connected with your affiliates does not exceed $6 million.

15-year exemption

Subsection 152-110(1) of the ITAA 1997 provides that a company or trust can disregard any capital gain arising from a CGT event if all of the following conditions are satisfied:

(a) the basic conditions are satisfied;

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

(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 the entity owned the CGT asset

(d) the individual who was the significant individual of the company or trust just before the CGT event was 55 or over at the time of the CGT event and the event happens in connection with your retirement

Significant Individual

Section 152-50 of the ITAA 1997 provides that an entity satisfies the significant individual test if the entity had a least one significant individual just before the CGT event. An individual is a significant individual in a company or trust if they have a small business participation percentage in the company or trust of at least 20% (section 152-55 of the ITAA 1997). The 20% can be made up of direct or indirect percentages.

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 asset 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

The basic conditions have been satisfied when the CGT event happens and results in a gain. The Company is not a CGT small business entity for the purpose of satisfying subparagraph 152-10(1)(c)(i) of the ITAA 1997 due to having an aggregated turnover of more than $2 million. Nevertheless, the Company satisfies the maximum net asset value test in section 152-15 of the ITAA 1997 which states the company, any connected and affiliate entities must have net value asset of $6 million or less before the CGT event. The Company is connected with other entities in the relevant business group. Combined, the net asset value position is under $6 million across the group. Therefore, the maximum net asset value test has been satisfied. The relevant share of the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997 as it has been held for more than 15 years and has been an active asset for at least a total of 7.5 years. Subsequently, the basic conditions are satisfied under section 152-10 of the ITAA 1997.

The Company has continuously held a portion of the business for 15 years prior to the CGT event. Person B, as the Company's significant individual has been a significant individual of the business for at least 15 years and will be over the age of 55 at the time of the CGT event. The CGT event is in connection with retirement as Person B will be working reduced hours of for a period no longer than approximately 12 months as the Purchaser does not have experience in the business. This is part of the sale agreement to ensure a smooth transition for current clients.

Accordingly, the Company satisfies all of the conditions for the small business 15-year exemption in section 152-110 of the ITAA 1997 and can disregard the relevant capital gain made from the sale the business.