Edited version of private advice

Authorisation Number: 1052033638763

Date of advice: 15 September 2022

Ruling

Subject: CGT - small business concessions

Question 1

Is Company A entitled to the 15-year exemption under section 152-110 of the Income Tax Assessment Act 1997 ('ITAA 1997)' in relation to the disposal of the Property?

Answer

Yes.

Question 2

If Company A is not entitled to the 15-year exemption under section 152-110 of the ITAA 1997, is it entitled to the small business 50% reduction under section 152-200in relation to the disposal of the Property?

Answer

No. As the 15-year exemption under Subdivision 152-B of the ITAA 1997 applies to the capital gain on the sale of the Property, the small business 50% reduction in Subdivision 152-C does not apply (section 152-215).

This ruling applies for the following period:

Year ending 30 June 20XY

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Company A

Company A was incorporated on XX/XX/19XX.

Details of the directors of Company A are as follows.

Clause X of Company A's Memorandum of Association ('MOA') stated that the capital of Company A was $XX,XXX (i.e., XX,XXX shares and $1 per share). Clause X of the Company A's Articles of Association ('AA') (deleted later) showed that the initial capital of the Company A ($XX,XXX) was divided into XX classes of shares (being $1 per share). However, not all those shares were issued and paid-up.

Details of the share register of Company A (including the current member register), was provided in your response to the further information request, which forms part of the facts.

Summary of Company A's current issued shares as follows.

The rights of each class of shares are specified in Clauses XX-XX of the Company A's Articles of Association.

The following summarises the different rights attached to the classes of shares:

•         All redeemable preference shares are redeemable at the option of Company A.

•         All redeemable preference shares do not confer any right to share in the distribution of Company A's surplus assets on liquidation.

•         Ordinary shareholders are entitled to income and excess capital distributions.

•         A Class redeemable preference shares are entitled to vote at general meetings.

•         Other redeemable preference shares have no entitlement to voting.

Relevantly, the following transactions were also identified in your further information response dated XX/XX/20XX:

The ASIC Notification of Resolution dated XX/XX/XXXX provided the details of the general meeting that altered the objects and Articles of Association. Clauses X and Y of Annexure A referred to in Form 205 Notification of Resolution stated the following:

1. a. That all unissued shares in the capital of the Company be subdivided into shares of $0.01 each, and

b. That all issued shares in the capital of the Company be cancelled simultaneously to the issue by the Company to each shareholder of 100 shares of $0.01 each for each share of $1.00 presently held.

2. That clause X of the Memorandum of Association of the Company be amended by deleting the first two lines and substituting the following:

"The Capital of the Company is $XXX,XXX.XX divided into XX,XXX,XXX shares of one cent ($0.01) each."

There were no transactions that caused a change in more than 50% in the beneficial interest that Company A shareholders have.

All current shareholders are older than 55 years.

Business activity and the Property

Company A operated in the spare parts business from 19XX to 20XX.

Company A operated its business at Address X ('the Property') from 19XX to 20XX. The Property was used as a workshop and storage. The spares were located on the Property. It was also the store front and point of contact with Company A's customers.

Company A used the Property wholly for a business purpose. Further, the Property was not a depreciating asset to which Divisions 40 or 43 of the ITAA 1997 had applied.

Between 19XX to 19XX, Company A leased the Property. On XX/XX/19XX, it acquired the Property and was registered on the title. The cost base of the Property was $XXX,XXX.

After the passing of Individual D in 20XX, Company A ceased its business and rented out the Property. This was due to the additional workload of managing a related spare parts business (i.e. Company C) and due to Individual D's substantial involvement in Company A.

The Property was rented while the stakeholders decided about the future direction of the Company. In 20XX, Company A let the premises to an unrelated party with a three-year lease with an option to extend for a further three years and a right of first refusal over the disposal of the Property.

The spare parts were transferred to Company C. Other business assets were retained and eventually sold by the Liquidator.

In 20XX, the Liquidator was appointed by court order to wind up Company A. It continued to manage the leased Property until its sale.

The Property was sold on XX/XX/20XX for $X,XXX,XXX.

Your response dated XX/XX/20XX provided that Company A currently has approximately $X,XXX,XXX of cash to be distributed by the Liquidator to shareholders. There are no other assets.

The Liquidator intends to make a capital distribution to the shareholders, which is consideration for the cancellation of those ordinary shares.

For the year ended 30 June 20XX, the Company's only income received in the ordinary course of carrying on a business was rent received amounting to $XXX,XXX.

The Company A's aggregated annual turnover for income years 20XX and 20XX were $XXX,XXX and $XXX,XXX respectively.

Company A did not have any connected entities or affiliates to include in the aggregated turnover.

Further, Company A's aggregated annual turnover never exceeded $2,000,000. Thus, Company A was a CGT small business entity for all relevant income years.

Individual C

Individual C was a director and involved in the day-to-day operations of the business, primarily managing the finances of the business.

He is older than 55 years and retiring following the sale of the Property and the winding up of the Company. He has not, and does not, intend to seek further employment.

Once the proceeds from the sale of the Property are distributed by the Liquidator, Individual C intends to utilise those funds for his retirement.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 Division 43

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 Subdivision 152-B

Income Tax Assessment Act 1997 Subdivision 152-C

Income Tax Assessment Act 1997 subsection 152-10(1)

Income Tax Assessment Act 1997 paragraph 152-10(1)(a)

Income Tax Assessment Act 1997 paragraph 152-10(1)(b)

Income Tax Assessment Act 1997 paragraph 152-10(1)(c)

Income Tax Assessment Act 1997 subparagraph 152-10(1)(c)(i)

Income Tax Assessment Act 1997 paragraph 152-10(1)(d)

Income Tax Assessment Act 1997 subsection 152-10(1AA)

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 subsection 152-35(1)

Income Tax Assessment Act 1997 subsection 152-40(1)

Income Tax Assessment Act 1997 subsection 152-40(4)

Income Tax Assessment Act 1997 subsection 152-49(1)

Income Tax Assessment Act 1997 section 152-55

Income Tax Assessment Act 1997 section 152-65

Income Tax Assessment Act 1997 section 152-110

Income Tax Assessment Act 1997 subsection 152-110(1)

Income Tax Assessment Act 1997 paragraph 152-110(1)(a)

Income Tax Assessment Act 1997 paragraph 152-110(1)(a)

Income Tax Assessment Act 1997 paragraph 152-110(1)(b)

Income Tax Assessment Act 1997 paragraph 152-110(1)(c)

Income Tax Assessment Act 1997 paragraph 152-110(1)(d)

Income Tax Assessment Act 1997 section 152-200

Income Tax Assessment Act 1997 section 152-215

Income Tax Assessment Act 1997 section 328-110

Income Tax Assessment Act 1997 subsection 328-110(1)

Reasons for decision

Question 1

Is Company A entitled to the 15-year exemption under section 152-110 of the Income Tax Assessment Act 1997 ('ITAA 1997)' in relation to the disposal of the Property?

Summary

Yes. The basic conditions in Subdivision 152-A of the ITAA 1997 have been satisfied.

The conditions in subsection 152-110(1) of the ITAA 1997 have also been met:

•         Company A continuously owned the Property for more than 15 years;

•         it had a significant individual for a total of at least 15 years during the ownership period; and

•         it had a significant individual who was over 55 just before the CGT event and the event occurred in connection with his retirement.

Therefore, Company A can choose to apply the 15-year exemption and disregard any capital gain made in relation to the disposal of the Property.

Detailed reasoning

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise stated.

Small business capital gains tax concessions

Division 152 allows a CGT small business entity to disregard a capital gain arising from a CGT asset that it has owned for at least 15 years, if it satisfies certain conditions.

Basic conditions

To qualify for the small business CGT concessions, the basic conditions as contained in Subdivision 152-A must be satisfied.

Subsection 152-10(1) contains the basic conditions. The requirements include the following:

(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 a 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

(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 that 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.

Small business entity

An entity is a CGT small business entity for an income year if:

(a)  it carries on a business in the current year, and

(b)  one or both of the following applies:

(i)    it carried on a business in the income year (the previous year) before the current year and its aggregated turnover for the previous year was less than $2 million, and

(ii)   its aggregated turnover for the current year is likely to be less than $2 million (subsections 152-10(1AA) and 328-110(1)).

Relevantly, subsection 328-110(5) also applies to the entity as if it carried on a business in an income year if:

(a)  in that year it was winding up a business it previously carried on; and

(b)  it was a small business entity for the income year in which you stopped carrying on that business.

Active asset test

Under subsection 152-35(1), a CGT asset will satisfy the active asset test if:

(a)  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, or

(b)  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 7½ years during the test period.

Further, subsection 152-40(1) provides that a CGT asset is an active asset at a time if, at that time: 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 by you, or your affiliate, or another entity that is connected with you.

Relevantly, subsection 152-49(1) also applies to an entity in an income year (the CGT event year) if:

(a)  a business that the entity previously carried on (including in partnership) is being wound up in that year; and

(b)  either:

(i)    the asset was used, or held ready for use, in the course of carrying on the business at a time in the income year in which the business stopped being carried on; or

(ii)    if the asset is an intangible asset - the asset was inherently connected with the business that was carried on at a time in the income year in which the business stopped being carried on.

Small business capital gains tax 15-year exemption

Subdivision 152-B outlines the conditions that need to be met for a capital gain to be disregarded under the small business 15-year exemption.

Under subsection 152-110(1), an entity that is a company can disregard any capital gain arising from a CGT event if all of the following conditions are satisfied:

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

(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)  an individual who was a significant individual of the company or trust just before the CGT event either:

(i)    was 55 or over at that time and the event happened in connection with the individual ' s retirement; or

(ii)   was permanently incapacitated at that time.

A significant individual is defined in section 152-55 as an individual who has a small business participation percentage in the company of at least 20%. A small business participation percentage in another entity is defined in section 152-65 as the sum of an entity's direct and indirect small business participation percentages in the other entity. Relevantly, for a company the direct small business percentage is the lower of the percentage of voting power, dividend entitlement or capital entitlement of the individual. Section 152-70(2) also provides that redeemable shares are ignored when determining the percentage that the entity has because of holding the legal and equitable interests in shares in the company.

Whether a CGT event happens in connection with an individual's retirement depends on the particular circumstances of each case. A CGT event may be in connection with an individual's retirement even if it occurs at some time before 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 do 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 in order 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 active assets 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.

Application to your circumstances

Basic conditions

•         Basic condition (a) of subsection 152-10(1) - A CGT event happens in relation to a CGT asset of yours in an income year

•         Basic condition (b) of subsection 152-10(1) - The event would have resulted in the gain

In this case, CGT event A1 happened when Company A disposed of the Property on XX/XX/20XX and it resulted in a capital gain.

Consequently, the requirements of paragraphs 152-10(1)(a) and (b) are satisfied.

•         Basic condition (c) of subsection 152-10(1) - at least one of the following applies:

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

The Company's aggregated annual turnover never exceeded $2,000,000. Thus, it was a CGT small business entity for all relevant income years. Specifically, Company A operated in the spare parts industry and carried on a business from 19XX to 20XX. It was a small business entity in the financial year it ceased business.

Even though Company A was not carrying on a business in the 20XX income year (the CGT event year), it is considered to be carrying on a business for the purpose of section 328-110. This is on the basis that a business previously carried on was being wound up and when that business stopped the Company would have been a small business entity (subsection 328-110(5)).

Thus, Company A is considered to be a CGT small business entity in the income year of the CGT event. Consequently, the CGT small business entity test in subparagraph 152-10(1)(c)(i) is satisfied.

•         Basic condition (d) of subsection 152-10(1) - the CGT asset satisfies the active asset test

Company A acquired the Property and was registered on the title on XX/XX/19XX. The Property was disposed of on XX/XX/20XX. It owned the Property for approximately XX years before it was disposed of.

The Property was used in the course of carrying on the Company's business between 19XX to 20XX (for approximately XX years). It was used as a workshop and storage. The spares were located on the Property. It was also the store front and point of contact with Company A's customers.

Even though the Property was not used in the course of carrying on the Company's business in the 20XX income year (i.e., the CGT event year), subsection 152-49(1) applies to Company A in that year because the business Company A previously carried on was being wound up in that year, and the Property was used in the course of carrying on the business in the 20XX income year which was when the business stopped being carried on.

Therefore, the Property satisfies the active asset test in subsection 152-35(1) because Company A owned the asset for more than 15 years and the asset was an active asset of it for a total of at least 7½ years during the test period. Therefore, paragraph 152-10(1)(d) is satisfied.

Small business capital gains tax 15-year exemption

•         Condition (a) of subsection 152-110(1) - the basic conditions in Subdivision 152-A

As detailed above, Company A meets the basic conditions in Subdivision 152-A in respect of the gain on the Property and, therefore, satisfies the requirement in paragraph 152-110(1)(a).

•         Condition (b) of subsection 152-110(1) - the entity continuously owned the CGT asset for the 15-year period ending just before the CGT event

Company A has continuously owned the Property for the 15-year period ending just before the CGT event (being the sale of it)and, therefore, the requirement in paragraph 152-110(1)(b) is satisfied.

•         Condition (c) of subsection 152-110(1) - the entity had a significant individual for a total of at least 15 years

Company A had a significant individual for a total of at least 15 years during which it owned the Property. Your application dated XX/XX/20XX provided that at least one of the shareholders held more than 20% of the shares in the Company, which entitled them to more than 20% of the voting rights, dividends and capital entitlements of Company A. Specifically, Individual A, Individual B and Individual C are considered a significant individual.

There are different rights attached to the separate classes of shares (as identified in Clauses XX-XX of Company A's Articles of Association). Only the ordinary shares entitled the shareholders to income and excess capital distributions. Whilst A Class redeemable preference shares entitled the shareholders to vote at general meetings.

On XX/XX/19XX, Individual A, Individual B, Individual C, and Individual D were issued with 1 ordinary share each. Each brother had 25% ownership of the ordinary shares. Although these shares were cancelled by Company A on XX/XX/19XX, each of the individuals was issued with 100 ordinary shares each on the same day. As a result, their 'direct small business participation percentage' (for the purposes of Item 1 of the table in subsection 152-70(1)) remained at 25% each (until Individual D's shares were transferred to his spouse on XX/XX/20XX as the result of his death).

The Company has issued no other ordinary shares.

Each of the Individuals held redeemable preference shares. However, redeemable shares are ignored when determining their direct small business participation percentage (subsection 152-70(2)).

Accordingly, there was at least one individual whose small business participation percentage in Company A was greater than 20% and was, therefore, a significant individual in Company A. Further, there was a significant individual for a total of at least 15 years during which Company A owned the Property (i.e., between XX/XX/19XX and XX/XX/20XX), thus, satisfying paragraph 152-110(1)(c).

•         Condition (d) of subsection 152-110(1) - an individual who was a significant individual of the company or trust just before the CGT event either:

                    (i)        was 55 or over at the time of the CGT event and the event happens in connection with the individual's retirement; or

                  (ii)        was permanently incapacitated at the time of the CGT event.

Individual C is also one of the significant individuals of the Company. He is older than 55 years and retiring following the sale of the Property and the winding up of the Company. He has not, and does not, intend to seek further employment. Individual C also intends to utilise those funds for his retirement.

Accordingly, the Property was sold in connection with the retirement of a significant individual aged over 55 years (i.e., Individual C), thus, satisfying paragraph 152-110(1)(d).

Conclusion on Subdivision 152-B

As the requirements under subsection 152-110(1) are met, Company A can disregard any capital gain arising from the sale of the Property.

Question 2

If Company A is not entitled to the 15-year exemption under section 152-110 of the ITAA 1997, is it entitled to the small business 50% reduction under section 152-200 of the ITAA 1997 in relation to the disposal of the Property?

Summary

No. As the 15-year exemption under Subdivision 152-B applies to the capital gain on the sale of the Property, the small business 50% reduction in Subdivision 152-C does not apply (section 152-215).

Detailed reasoning

As determined in Question 1, Company A can disregard any capital gain arising from the sale of the Property under Subdivision 152-B.

Section 152-215 provides that Subdivision 152-C does not apply to a capital gain to which Subdivision 152-B (15-year exemption) applies.

Accordingly, the small business 50% reduction in Subdivision 152-C cannot apply. The gain is already disregarded under Subdivision 152-B and there is no need for any further concession to apply.