Edited version of private advice

Authorisation Number: 1052055970319

Date of advice: 11 November 2022

Ruling

Subject: CGT - small business concessions

Question 1

Is the company subject to capital gains tax (CGT) on the disposal of depreciating assets in accordance with section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will the company meet the basic conditions under section 152-10 of the ITAA 1997 to apply the small business capital gains tax (CGT) concessions on the sale of the intellectual property?

Answer

Yes.

Question 3

Does the company satisfy the conditions for the small business 50% active asset reduction pursuant to section 152-205 of the ITAA 1997 in relation to the sale of the intellectual property?

Answer

Yes.

Question 4

Does the company meet the conditions to apply the small business retirement exemption to any capital gain made on the sale of the intellectual property under subdivision 152-D of the ITAA 1997?

Answer

Yes. As you satisfy the basic conditions you are eligible for the small business retirement exemption up to a lifetime limit of $500,000. As the CGT concession stakeholder is under 55 years of age at the time of the CGT event, the exempt payment must be paid into a complying superannuation fund or retirement savings account within 7 days you make the choice to disregard the capital gain.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The company (You) carried on a business of emergency services.

You created procedure manuals and asset records (intellectual property) to assist in the use of the business.

You sold all of the equipment and the rights to use the proprietary material that was necessary to operate the business in the 20XX financial year.

You satisfy the $6 million MNAV test.

The Trust owns 100% shares of the company.

Individual A receives a distribution of 40% or more in any one year over the past 4 years from the Trust.

Individual A is under 55 years of age.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-10

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 152-55

Income Tax Assessment Act 1997 section 152-205

Income Tax Assessment Act 1997 section 152-305

Reasons for decision

Treatment of depreciating assets

Division 40 of the ITAA 1997 outlines the tax treatment of depreciating assets.

The assets in this case have been used for a taxable purpose and are regarded as depreciating assets under Division 40 of the ITAA 1997.

As relevantly outlined in subsection 40-295(1) of the ITAA 1997, a balancing adjustment event occurs for a depreciating asset when:

a) you stop holding the asset; or

b) you stop using it for any purpose and you expect never to use it, or

c) you have not used it and:

(i) if you have had it installed ready for use - you stop having it so installed; and

(ii) you decide never to use it.

The calculation of the assessable gain or loss, i.e. the balancing adjustment arising under section 40-285 as a result of the balancing adjustment event that occurs under section 40-295 on the disposal of a depreciating asset, is worked out by comparing the asset's termination value and its adjustable value at the time of the balancing adjustment event.

Section 40-300 provides the meaning of termination value of a depreciating asset. Generally, the termination value of the asset is the amount the taxpayer received or is entitled to receive for the balancing adjustment event (per section 40-305). There are specified termination values that may apply in preference to the general rule, as set out in the table in subsection 40-300(2).

Intellectual property

Section 995-1 of the ITAA 1997 states that an item of intellectual property consists of the rights (including equitable rights) that an entity has under a Commonwealth law as:

•         the patentee, or a licensee, of a patent, or

•         the owner, or a licensee, of a registered design, or

•         the owner, or a licensee, of a copyright.

Subsection 108-5(1) of the ITAA 1997 states that a CGT asset is:

•         any kind of property; or

•         a legal or equitable right that is not property.

The definition of a CGT asset is very broad and encompasses intangible assets. As a result, the intellectual property in this case would be a CGT asset. A subsequent disposal of the CGT asset would cause CGT event A1 to occur under section 104-10 of the ITAA 1997. The time of the CGT event would be the date when a contract to end the ownership of the asset is entered into.

Basic conditions

To qualify for the small business CGT concessions, the basic conditions as contained in subdivision 152-A of the ITAA 1997 must be satisfied.

The basic conditions are:

•         A CGT event happens in relation to a CGT asset of yours in an income year,

•         The event would have resulted in a gain,

•         The CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997, and

•         At least one of the following applies;

o   you are a small business entity for the income year,

o   you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997,

o   you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an interest in an asset of the partnership, or

o   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.

You satisfy the maximum net asset value test.

Small Business Entity

Section 152-10 of the ITAA 1997 states a small business entity is:

•         carrying on a business, and

•         has an aggregated turnover of less than $2 million.

Active asset test

Section 152-35 of the ITAA 1997 states that a CGT asset satisfies the active asset test 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 by you, your affiliate or another entity that is connected with you 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 owned; 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.

Section 152-40 of the ITAA 1997 explains the meaning of an active asset. A CGT asset is an active asset at a time if, at that time:

a)    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, your affiliate or another entity that is connected with you or if the asset is intangible asset, you own it and it is inherently connected with a business that is carried on by you, your affiliate, or another entity that is connected with you.

b)    if the asset is an intangible asset - you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you.

The intellectual property of the Company is a CGT asset and it is an active asset as defined in section 152-40. The intellectual property of the business was created in ???, therefore the active asset test in subsection 152-35 is satisfied because the asset has been owned for 15 years or less and the asset was an active asset of yours for a total of at least half of the ownership period.

Retirement Exemption

Subsection 152-305(2) of the ITAA 1997 provides that a company or trust can disregard any capital gain arising if:

(a) the basic conditions are satisfied;

(b) the significant individual test is satisfied under section 152-50 of the ITAA 1997;

(c) the company or trust conditions in section 152-325 of the ITAA 1997 are satisfied.

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.

Subsection 152-70(1) of the ITAA 1997 provides that an entity holds a direct small business participation percentage at the relevant time in an entity equal to the percentage worked out as below:

An entity's direct small business participation percentage in a company is the percentage of:

•         voting power that the entity is entitled to exercise,

•         any dividend payment that the entity is entitled to receive, or

•         any capital distribution that the entity is entitled to receive, or

•         if they are different, the smallest of the three percentages above.

All classes of shares are taken into account in determining an entity's participation percentage in a company.

An indirect small business participation percentage in a company or a trust is calculated by multiplying together the entity's direct participation percentage in an interposed entity, and the interposed entity's total participation percentage (both direct and indirect) in the company or trust.

Company Requirements

Section 152-325 of the ITAA 1997 provides that a company or trust must further satisfy the following conditions in order to be eligible to disregard all or part of a capital gain:

•         you keep a written record of the amount you choose to disregard (the exempt amount) and, if there is more than one CGT concession stakeholder, each stakeholder's percentage of the exempt amount,

•         you make a payment to at least one of your CGT concession stakeholders worked out by reference to each individual's percentage of the exempt amount,

•         the payment is equal to the exempt amount or the amount of capital proceeds, whichever is less, and

•         where you receive the capital proceeds in instalments, you make a payment to a CGT concession stakeholder for each instalment in succession (up to the asset's CGT exempt amount).

You must make payments if you choose the retirement exemption for an event 7 days after you choose to disregard the capital gain or seven days and seven days after you receive the capital proceeds from the CGT event.

If a CGT concession stakeholder is under 55 years old just before a payment is made in relation to them, the company must make the payment to the CGT concession stakeholder by contributing it to a complying superannuation fund or retirement savings account (RSA) on their behalf. The company must notify the trustee of the fund or RSA at the time of the contribution that the contribution is being made in accordance with the requirements of the retirement exemption.

There is no requirement to make this contribution if the stakeholder was 55 years old or older.

Conclusion

In your case, you sold your depreciating assets and intellectual property of the business to an unrelated party. The disposal of the depreciating assets will be treated as a balancing adjustment event. The sale of the intellectual property will trigger CGT event A1 and may result in a capital gain. You carried on a business of emergency services and you satisfied the maximum net asset value test. The intellectual property of the business has been used in the business for a total of at least half of the ownership period, therefore the active asset test in subsection 152-35 is satisfied.

Since you satisfy all the basic conditions, you may be eligible for the CGT small business concessions in Division 152 to reduce the capital gain made on the disposal of the intellectual property of the company.

Active asset reduction

To apply the small business 50% active asset reduction, you need satisfy only the basic conditions. There are no further requirements. Since you satisfy the basic conditions as outlined above, you are eligible to apply the small business 50% reduction contained in section 152-205 of the ITAA 1997.

Small business retirement exemption

As the CGT concession stakeholder is under the age of 55 years you will be required to keep a written record of the amount they choose to disregard (the CGT exempt amount). You will also be required to contribute the exempt amount to a complying superannuation fund or retirement savings account within 7 days of making the choice, however the amount must not exceed the lifetime retirement limit of $500,000.