Edited version of private advice

Authorisation Number: 1052033339387

Date of advice: 15 September 2022

Ruling

Subject: CGT - small business concessions

Question 1

Are the small business capital gains tax (CGT) concessions, specifically the 15-year exemption, applicable to the land used for operating the forestry enterprise?

Answer

Yes

Question 2

Will the unfelled trees be subject to CGT and will the small business CGT concessions be applicable?

Answer

No

Question 3

Is the main residence exemption available to the taxpayers in relation to a two hectare portion of the property being sold?

Answer

Not applicable, as the 15-year exemption applies to the whole property.

Question 4

Is the main residence CGT exemption available to the taxpayers for the Cottage, in relation to the sale of the property?

Answer

Not applicable, as the 15-year exemption applies to the whole property.

This ruling applies for the following period:

The year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Taxpayers acquired a property in two parcels:

•         The first parcel was acquired in June 19XX; and

•         The second parcel was acquired in June 19XX

•         The two parcels were then combined as part of a boundary re-alignment.

The property was sold by the taxpayers with a contract date in the 20XX-XX income year.

The taxpayers were both over the age of 55 at the time.

The property was used as a main residence as well as for a forestry enterprise.

The taxpayers operated the forestry enterprise in a partnership.

The partnership planted and tended trees. This involved pre-planting activities, site preparation activities, plantation management activities

Between 19XX and 20XX over XX trees were planted in varying densities, to be progressively thinned and to enhance timber growth and pruned to produce knot-free wood and therefore enhance market value.

Water storages were built along drainage lines and surrounding areas were mowed and aerated to increase their water holding capacity.

Harvesting was planned to be undertaken mainly by contractors.

No sales were made of thinned trees or mature trees during the time the taxpayer owned the property.

The partnership's turnover was less than $2 million.

The taxpayers obtained a valuation of the plantation which estimated the total current value of the standing timber to be $XXX.

The taxpayers operated the forestry activities up until the sale of the property.

The estimated number of hours worked by each taxpayer just prior to the sale exceeded 'full time' hours.

The contract for the sale of the property made no special provision made for the value of the timber plantation.

Other forestry related assets were sold and invoiced separately to the buyers of the property.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 70-85

Income Tax Assessment Act 1997 Section 70-90

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Section 328-110

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 Subdivision 152-B

Reasons for decision

Question 1

Basic conditions in Subdivision 152-A of the ITAA 1997

Section 152-10 of the ITAA 1997 provides the following basic conditions which are a pre-requisite to all the small business CGT concessions:

(a)  A CGT event happens in relation to a CGT asset in an income year.

(b)  The CGT event would have resulted in a capital gain.

(c)   At least one of the following applies:

(i)    You are a CGT small business entity for the income year.

(ii)   You satisfy the maximum net asset value test.

(iii)  You are a partner in a partnership that is a CGT small business entity for the income year and the CGT asset is an interest in an asset of the partnership.

(iv)  The conditions in subsections (1A) or (1B) are satisfied in relation to the CGT asset in the income year (about passively held assets).

(d)  The CGT asset satisfies the active asset test.

In this case, conditions (a) and (b) are satisfied because CGT event A1 happened on the contract date when the taxpayers sold the property, and that CGT event would have resulted in a capital gain.

Condition (c) requires consideration of whether the taxpayers were a CGT small business entity. Condition (d) requires the CGT asset to satisfy the active asset test. These two conditions are considered below.

CGT small business entity

An individual or a partnership is a CGT small business entity if the requirements of subsection 152-10(1AA) and subsection 328-110(1) of the ITAA 1997 are met:

(a)  You carry on a business in the income year; and

(b)  Your aggregated turnover in the previous income year or the current income year is, or is likely to be, less than $2 million.

Whether or not the taxpayers were carrying on a business in the 20XX-XX income year is a question of fact. Taxation Ruling 95/6 Income tax: primary production and forestry (TR 95/6) at paragraph 14 states that the planting, tending and felling of trees will only be forest operations if those activities amount to the carrying on of a business.

Paragraphs 86 to 89 of TR 95/6 provide guidelines from the case law for determining whether a taxpayer is carrying on a business. The Commissioner has considered these factors against the facts provided by the taxpayers and has concluded that the taxpayers were carrying on a business of forestry in partnership in the relevant income year.

As the taxpayers' aggregated turnover was less than $2 million, it is concluded that the partnership was a small business entity in the 20XX-XX income year.

Active asset test

Under section 152-40, a CGT asset is an active asset if you own the asset and it is used, or held ready for use, in the course of carrying on a business that is carried on, whether alone or in partnership, by you, your affiliate or another entity that is connected with you. This is subject to the exceptions in subsection 152-40(4).

An active asset will pass the active asset test in section 152-35 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 test period detailed below; 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 during the test period detailed below.

Under subsection 152-35(2) the test period:

•         begins when you acquired the asset, and

•         ends at the earlier of:

-       the CGT event, and

-       when the business ceased, if the business ceased in the 12 months before the CGT event

In this case, the taxpayers owned the property for over 15 years. The property was used by the taxpayers in partnership to carry on a forestry business beginning in 19XX and ending on the sale of the property in 20XX. This means that the property was an active asset for over 7.5 years and accordingly, the property satisfies the active asset test.

Therefore, it is concluded that the taxpayers meet the basic conditions for the small business CGT concessions in relation to the capital gain on the sale of the property.

The next step is to consider whether the additional requirements of the 15-year exemption are met in relation to the property.

The 15-year exemption

To be eligible for the 15-year exemption in Subdivision 152-B, the taxpayers must each meet the following requirements in relation to the property:

(a)  The basic conditions in Subdivision 152-A are satisfied for the gain.

(b)  You continuously owned the CGT asset for the 15-year period prior to the CGT event.

(c)   You were over 55 at the time of the CGT event, and the event happened in connection with your retirement, or you were permanently incapacitated at the time of the CGT event.

Conditions (a) and (b) are met, as we have established above that the basic conditions are satisfied in relation to the capital gain made on the sale of the property, and the taxpayers owned the property for more than 15 years immediately prior to selling it.

In relation condition (c) above, the taxpayers were both over 55 at the time they sold the property, and have provided facts to show that the sale of the property happened in connection with their retirement, because both taxpayers experienced a significant reduction in working hours and a significant change in their everyday activities as a consequence of selling the property and discontinuing the forestry business.

Conclusion

Both the taxpayers are entitled to apply the 15-year exemption to disregard the capital gain arising from the disposal of their share of the property, because all the relevant conditions in Subdivision 152-A and 152-B have been met.

Question 2

Section 70-90 of the ITAA 1997 provides that where an item of trading stock, which is an asset of a business you are carrying on, is disposed of outside the ordinary course of that business, the market value of that trading stock on the day of disposal is included in your assessable income.

Section 70-85 of the ITAA 1997 defines trading stock, for the purposes of section 70-90, to include trees planted and tended for sale.

TR 95/6 summarises these rules in paragraph 22 as follows:

'A disposal of trees owned by a taxpayer and which have been planted (not necessarily by the taxpayer) and tended for the purpose of sale may result in the value of those trees being included in the taxpayer's assessable income under subsection 36(1) [the predecessor to section 70-90 of the ITAA 1997], in the year the disposal takes place. This may be so whether or not the taxpayer is carrying on a business of forest operations, so long as the taxpayer is carrying on a business and the disposal is not in the ordinary course of carrying on that business. What is required is that the trees constitute the whole or part of the assets of that business.'

In the current circumstances, the taxpayers have disposed of standing trees that they planted and tended for sale. These standing trees are considered to be an asset of the forestry business which the taxpayers were carrying on. The sale of the land on which the trees were growing is a disposal outside the ordinary course of the taxpayers' business.

Therefore, the taxpayer will be required to include their share of the market value of the standing timber on the day of disposal, in their assessable income for the 20XX-XX financial year.

Questions 3 and 4

The taxpayers have satisfied the eligibility requirements for the 15-year exemption and may disregard the entire capital gain made on the sale of the property. Therefore there is no need to consider a further exemption under the main residence exemption.