Edited version of private advice

Authorisation Number: 1052031959563

Date of advice: 29 November 2022

Ruling

Subject: CGT - small business concession

Question

What CGT asset market values are included in the calculation of the maximum net asset value test in section 152-15 of the Income tax assessment Act 1997 (ITAA 1997)?

Answer

This ruling applies for the following period:

income year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Just before the CGT event occurred:

Individual A and Individual B are married.

Individual B does not conduct a business but works for a wage in the business of Trust A.

The holiday property is used for private purposes. No income from letting out the property has been received nor is the property ready and available for use for that purpose.

Trust A owns the business. The trustee company of Trust A is Trustee Pty Ltd. Trustee Pty Ltd's director and shareholder is Individual A. The appointor of the trust is Individual A and the named beneficiaries are Individual A and Individual B. Individual B has not received any distributions from the trust.

All distributions from the Trust A are predominantly made to Company A and the remainder are made to Individual A.

The directors of Company A are Individual A and Individual B.

The Trust B owns all the shares in the Company A.

The Trust B - the trustees and appointors are Individual A and Individual B.

The Trust B provided a loan of funds to Individual B to acquire the principal place of residence.

Individual B built an investment property. The investment property existed before the CGT event occurred. The property was available for rent in 20XX.

Both the primary place of residence and investment properties are on the same title and are in Individual B's name.

The holiday home is used for private purposes. No holiday letting income has been received nor is it ready and available for use for that purpose.

There is no formal agreement or formal relationship between the parties dictating how the parties are to act in relation to each other.

The business was operated by Individual A. All business interaction of the taxation agent advisory was with Individual A. Individual B was involved for the final year end in relation to their personal tax return representing themself as employee and investor for the investment property.

Actions of the parties indicate control of the each of the entities as follows: Trust A - being business Individual A entirely: Trust B - Individual A and Individual B jointly; Company A as beneficiary of Trust A - Individual A.

The Company A holds investments and does not conduct a business.

Company B is dormant - net assets at the time of the CGT event is $xxxx. The actions of Individual A indicate that they control the entity.

The beneficiaries of the Trust B - Primary, Individual A and Individual B and children but General beneficiaries included family of Primary beneficiary including corporates with stakeholder who is a Primary beneficiary.

The Trust B paid to, or applied for the benefit of, the beneficiary or their affiliates, or both the beneficiary and any of its affiliates, any of the income or capital for each of the previous four income years - income distributions for the 20XX income year and prior all distributions to Individual B and in relation to the 20XX approximately: 50/50 between Individual A and Individual B

Relevant legislative provisions

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 152-15

Income Tax Assessment Act 1997 paragraph 152-15 (a)

Income Tax Assessment Act 1997 paragraph 152-15 (b)

Income Tax Assessment Act 1997 paragraph 152-15 (c)

Income Tax Assessment Act 1997 paragraph 152-20 (1)

Income Tax Assessment Act 1997 paragraph 152-20 (2)

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 328-125

Income Tax Assessment Act 1997 subsection 328-125(1)

Income Tax Assessment Act 1997 paragraph 328-125(2)(a)

Income Tax Assessment Act 1997 paragraph 328-125(2)(b)

Income Tax Assessment Act 1997 subsection 328-125(3)

Income Tax Assessment Act 1997 subsection 328-125(4)

Income Tax Assessment Act 1997 subsection 328-125(7)

Income Tax Assessment Act 1997 subsection 328-125(8)

Income Tax Assessment Act 1997 subsection 328-130(1)

Income Tax Assessment Act 1997 subsection 328-130(2)

Reasons for decision

Question

Summary

For the purposes of the 'maximum net value test' in section 152-15 of the ITAA 1997 as it applies to Trust A, the value of CGT assets to be included in the calculation are the value of the CGT assets of Trust A and entities that are 'connected with' Trust A.

Detailed reasoning

Maximum Net Asset Value Test

Section 152-15 states:

152-15 You satisfy the maximum net asset value test if, just before the *CGT event, the sum of the following amounts does not exceed $6,000,000:

(a) the *net value of the CGT assets of yours;

(b) the net value of the CGT assets of any entities *connected with you;

(c) the net value of the CGT assets of any *affiliates of yours or entities connected with your affiliates (not counting any assets already counted under paragraph (b)).

Note 1: Some assets are not included in the definition of Net value of the CGT assets: see subsection 152-20(2),(3) and (4).

Note 2 The meaning of connected with is affected by section 152-78.

Connected

Subsection 328-125(1) of the ITAA 1997 provides that an entity is connected with another entity if:

(a) either entity controls the other entity in a way described in this section; or

(b) both entities are controlled in a way described in this section by the same third entity.

Subsection 328-125(2) sets out the test for determining whether an entity directly controls another entity other than a discretionary trust, as follows:

An entity (the first entity) controls another entity if the first entity, its affiliates, or the first entity together with its affiliates:

(a) except if the other entity is a discretionary trust - own, or have the right to acquire the ownership of, interests in the other entity that carry between them the right to receive a percentage (the control percentage) that is at least 40% of:

(i) any distribution of income by the other entity; or

(ii) if the other entity is a partnership - the net income of the partnership; or

(iii) any distribution of capital by the other entity; or

(b) if the other entity is a company - own, or have the right to acquire the ownership of, equity interests in the company that carry between them the right to exercise, or control the exercise of, a percentage (the control percentage) that is at least 40% of the voting power in the company.

Paragraph 328-125(2)(b) provides a specific test for determining whether an entity directly controls a company based on its control of the voting power in the company. Paragraph 2.46 of the Explanatory Memorandum to the Tax Laws Amendment (Small Business) Bill 2007 explains that this is an additional test that applies for the control by entities of companies. If either this test or the 40% ownership test is satisfied, that entity controls the company. Therefore, where an entity does not directly control a company under paragraph 328-125(2)(b), the entity will still need to consider whether direct control of the company is established under the general control tests in subparagraphs 328-125(2)(a)(i) or (iii).

Discretionary Trust

Subsection 328-125(3) of the ITAA 1997 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.

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.

Also, subsection 328-125(4) effectively deems control to certain beneficiaries of the trust:

An entity (the first entity) controls a discretionary trust for an income year if, for any of the 4 income years before that year:

(a) the trustee of the trust paid to, or applied for the benefit of:

(i) the first entity; or

(ii) any of the first entity's affiliates; or

(iii) the first entity and any of its affiliates;

any of the income or capital of the trust; and

(b) the percentage (the control percentage) of the income or capital paid or applied is at least 40% of the total amount of income or capital paid or applied by the trustee for that year.

Capital and income distributions are calculated separately. An entity's, and/or its affiliates', distributions in each relevant year are added to calculate the entity's control percentage for the relevant year. An entity can be controlled by more than one entity.

Indirect control of an entity

Subsection 328-125(7) provides for an indirect control test which applies to all entities where it states:

This section applies to an entity (the first entity) that directly controls another entity (the second entity) as if the first entity also controlled any other entity that is directly or indirectly by any other application or applications of this section, controlled by the second entity.

The application of subsection 328-125(7) is subject to certain exceptions set out in subsection 328-125(8).

Affiliates

Subsection 328-130(1) of the ITAA 1997 provides that:

328-130(1) An individual or a 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.

However, subsection 328-130(2) of the ITAA 1997 provides that:

328-130(2) An individual or a company is not your affiliate merely because of the nature of the business relationship you and the individual or company share.

...

One requirement for being an affiliate as set out in subsection 328-130(1) of the ITAA 1997 is that the individual or company must be carrying on a business.

On the facts provided, Individual B is not carrying on a business, consequently Individual B cannot be an affiliate pursuant to subsection 328-130(1) of the ITAA 1997.

In this case Individual A is the director and shareholder of the Trustee Pty Ltd the corporate trustee of Trust A. The appointor of the trust is Individual A and the named beneficiaries are Individual A and Individual B. All dealings of the trust are undertaken by Individual A. Therefore Individual A is a connected entity of the Trust A.

For the Trust B, Individual A and Individual B are the trustees and appointers of the trust. Individual A directs the business affairs of the group. Consequently, it is reasonable to expect that the trustee of the Trust B will act in accordance with the directions and wishes of Individual A. Consequently, Individual A controls the Trust B in accordance with subsection 328-125(3) of the ITAA 1997 as the trustee of that trust could be reasonably be expected to act in accordance with their direction and wishes. Therefore, it is considered that Individual A is 'connected with' Trust B.

Subsection 328-125(4) of the ITAA 1997 states that a beneficiary controls a trust if they receive at least 40% of the amount of income applied by the trustee in any of the last four years before the financial year that the CGT event occurred. In this regard Trust B has applied more than 40% of its income to Individual B in at least one of the previous four income years satisfying subsection 328-125(4) of the ITAA 1997. However, this does not connect the Trust A to Individual B. As Individual B does not carry on a business, Individual B cannot be an affiliate of Trust A.

Since Individual A controls both the Trust A and the Trust B, pursuant to subsection 328-125(1) of the ITAA 1997, Trust A is also 'connected with' Trust B.

As Trust B owns 100% of the shares in Company A which carry a right to receive a percentage that is at least 40% of any distribution of income and also has the right to exercise the, or control the exercise of, a percentage that is at least 40% of the voting power of Company A subsection 328-125(2) of the ITAA 1997 is satisfied and Trust B controls Company A.

As Individual A Controls Trust B, pursuant to subsection 328-125(7) of the ITAA 1997 Individual A also controls Company A and hence Trust A is connected with Company A.

Individual A controls Company B pursuant to subsection 328-125 of the ITAA 1997 and consequently Trust A is connected with Company B.

Consequently, pursuant to subsection 328-125(1) of the ITAA 1997, Trust A is connected with:

•         Individual A;

•         Trust B;

•         Company A; and

•         Company B.

Calculation of the net value of the CGT assets

Section 152-15 of the ITAA 1997 provides that maximum net asset value test is satisfied if the sum of the net value of the CGT assets of yours, any entities connected with you, and any of your affiliates or entities connected with your affiliates does not exceed $6,000,000.

In this case it has been established that the Trust A is 'connected with' Individual A, Trust B; Company A and Company B. Therefore, the net value of the relevant CGT assets of each of these entities must be included when calculating whether the net value of the CGT assets of the Trust A exceeds $6,000,000.

All CGT assets are included in the calculation of the net value of the CGT assets unless specifically excluded. The net value of the CGT assets is defined in subsection 152-20(1) of the ITAA 1997 as the amount (whether positive, negative or nil) obtained by subtracting from the sum of the *market values of those assets the sum of:

(a) the liabilities of the entity that are related to the assets; and

(b) the following provisions made by the entity:

(i) provisions for annual leave;

(ii) provisions for long service leave;

(iii) provisions for unearned income;

(iv) provisions for tax liabilities.

Subsection 152-20(2) of the ITAA 1997 provides that the following assets should be disregarded when working out the net value of the CGT assets of an entity:

(a) disregard *shares, units or other interests (except debt) in another entity that is *connected with the first-mentioned entity or with an *affiliate of the first-mentioned entity, but include any liabilities related to any such shares, units or interests; and

(b) if the entity is an individual, disregard:

(i) assets being used solely for the personal use and enjoyment of the individual, or the individual's *affiliate (except a *dwelling, or an *ownership interest in a dwelling, that is the individual's main residence, including any adjacent land to which the main residence exemption can extend because of section 118-120); and

(ii) except for an amount included under subsection (2A), the *market value of a dwelling, or an ownership interest in a dwelling, that is the individual's main residence (including any relevant adjacent land); and

(iii) a right to, or to any part of, any allowance, annuity or capital amount payable out of a *superannuation fund or an *approved deposit fund; and

(iv) a right to, or to any part of, an asset of a superannuation fund or of an approved deposit fund; and

(v) a policy of insurance on the life of an individual.

The definition of CGT asset is defined section 108-5 of the ITAA 1997 as:

(a) Any kind of property; or

(b) A legal or equitable right that is not property.

Based on the information provided, the net value of the CGT assets of Trust A together with the entities that are connected with them, their affiliates and entities that are connected with their affiliates to be included in the calculation are set out under the heading Answer.