Edited version of private advice

Authorisation Number: 1052065498211

Date of advice: 5 January 2023

Ruling

Subject: Small business concessions

Question 1

Do you meet the basic eligibility conditions for the small business capital gains tax concessions under section 152-10 of the Income Tax Assessment Act 1997(ITAA 1997) in relation to the sale of the Property?

Answer

Yes

Question 2

Are you eligible for the small business 15-year exemption under section 152-105 of the ITAA 1997, allowing you to disregard the capital gain arising from the sale of the Property?

Answer

Yes

Question 3

Can you select which 2 hectares the Property to apply the main residence exemption to under Subdivision 118-B of the ITAA 1997?

Answer

Yes. On the basis you are eligible for and choose to apply the main residence exemption.

However, as you can disregard the capital gain from the sale of the Property under the small business 15-year exemption, you do not need to apply the main residence exemption.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Person X and Person Y (collectively referred to as you) purchased the Property jointly, around XX years ago.

You recently entered into a contract to sell the Property with settlement subsequently occurring.

The Property is approximately X hectares and is on a single title.

You built your residential home on the Property shortly after acquisition, which was your main residence until the recent sale.

In addition to the residential dwelling, the Property includes:

•         The X sheds used by the Company A.

•         X internal driveways.

•         Waterway and drainage reserve that runs across the entire frontage to the south end of the Property and includes a large dam that is part of the wetlands.

Company A conducts the business of selling tools and equipment and uses mobile vans to deliver its products directly to customers.

For the past XX years the officeholders of Company A are:

•         Person X - Director and company secretary

•         Person Y - Director.

For the past XX years you have been the only shareholders of Company A, both legally and beneficially.

Company A's aggregated turnover for the 20XX-XX and 20XX-XX income years for the purpose of section 328-110 and subsection 152-10(1AA) of the ITAA 1997 was under $2 million.

You did not carry on a business in the 20XX-XX income year either alone or in partnership.

The ASIC record shows the Property as Company A's principal place of business and registered office for the last XX years.

Company A is your primary source of income. You do not own or have interests in any other businesses.

Company A has several other employees apart from you.

You will fully retire from working within a short period after the Property settled.

Following your retirement, your children will operate Company A's business. Your children and the remaining staff will take over the duties that you were responsible for in respect of running Company A.

For a period of more than XX years of your ownership period, Company A's usage of the Property has included the following:

(a)  Signage.

(b)  Deliveries of stock.

(c)   Storage of stock used in the business housed predominantly in X sheds on the Property:

(i)    Small shed.

(ii)   Large shed.

(iii)  The vacant land outside the sheds is used to store deliveries of stock that cannot be stored in the shed immediately. The stock was covered as pallets wrapped in black plastic whilst they remained on the vacant land.

(d)  Driveway access to the storage sheds from 2 adjacent roads.

(e)  The use of an office space in the house, used for administration of the business activity.

(f)    There are a few long-term customers who visit the Property to purchase and/or take delivery of the stock.

(g)  Company A's employees visit the sheds 4 or more times a day to access the stock stored. Some of the preparatory work the employees do on the Property include (but are not limited to):

(i)    Loading vehicles and the truck with stock, tools and equipment.

(ii)   Putting together toolboxes.

(iii)  Putting orders together.

(iv)  Cleaning tools and repairing tools.

(v)   Organising the sheds and storing new stock, tools and equipment delivered by suppliers.

(h)  Parking and storage of company vehicles. At one point, Company A owned X trucks and X vehicles, however Company A has since sold one truck.

The Property has security systems and modifications to allow for the storage of stock and conduct of business activities.

You are both over 55 years old.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 152-105

Income Tax Assessment Act 1997 section 118-110

Income Tax Assessment Act 1997 section 118-120

Income Tax Assessment Act 1997 section 328-125

Reasons for decision

Question 1

Summary

The basic conditions for relief in subsection 152-10(1) of the ITAA 1997 are satisfied in your case. The sale of the Property is a CGT event, that apart from the Division 152 of the ITAA 1997, would have resulted in a gain. Your connected CGT small business entity (Company A) carried on a business in the 20XX-22 income year in relation to the Property. The Property satisfies that the active asset test as it was used by Company A in the course of carrying on its business for more than 7 and a half years of your more than 15-year ownership period.

Detailed reasoning

Basic conditions for relief

Section 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997) provides the basic conditions that need to be met to apply the small business CGT concessions.

Subsection 152-10(1) states that a capital gain that you make may be reduced or disregarded if the following basic conditions are satisfied:

(a)  a CGT event happens in relation to a CGT asset of yours in an income year

(b)  the event would 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 interest in an asset of the partnership

                  (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 (passively held assets as outlined in subsections 152-10(1A) and 152-10(1B) of the ITAA 1997)

(d)  the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997.

Passively held assets

The conditions in subsection 152-10(1A) are satisfied in relation to the CGT asset in the income year if:

(a)  your affiliate, or an entity that is connected with you, is a small business entity for the income year; and

(b)  you do not carry on a business in the income year (other than in partnership); and

(c)   if you carry on a business in partnership, the CGT asset is not an interest in an asset of the partnership; and

(d)  in any case, the small business entity referred to in paragraph (a) is the entity that, at a time in the income year, carries on the business (as referred to in subparagraph 152-40(1)(a)(ii) or (iii) or paragraph 152-40(1)(b)) in relation to the CGT asset.

Entity connected with you

The meaning of connected with entity is contained in section 328-125 of the ITAA 1997.

Subsection 328-125(1) of the ITAA 1997 states 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 entity.

Subsection 328-125(2) of the ITAA 1997 states that 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 controlpercentage) that is at least 40% of the voting power in the company

Active asset

Subsection 152-35(1) of the ITAA 1997 states that a CGT asset satisfies 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 period of ownership; 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 7 1/2 years.

Section 152-40 of the ITAA 1997 provides the meaning of 'active asset'. A CGT asset will be an active asset at a time if, at that time, you own the asset and the asset was used or held ready for use in the course of carrying on a business that is carried on by you, an affiliate or by another entity that is 'connected with' you.

The issue of whether land was 'used in the course of carrying on a business,' for the purpose of section 152-40 of the ITAA 1997, is a question of degree and matter of impression. The relevant gain which is sought to be reduced or disregarded, is a gain arising from the disposal of the whole of the land (Rus v FC of T 2018 ATC 10-478 (Rus)).

In Rus where only a small portion of land was used in carrying on a business, the land was held not to be an active asset. The taxpayer and her husband purchased a 16-hectare property in June 1987. A small part of the land (1.6 hectares) contained two houses and a shed. One house was the couple's main residence while the other was the main residence of the couple's two adult children (who did not pay rent).

From the property the couple carried on a plastering/housing construction business. Only the shed and a home office in the couple's main residence was used in the running of the business, however, the majority of the business activities were conducted off site.

On review the AAT confirmed the Commissioners decision that having regard to the nature of the CGT asset, the nature of the company's business and the relationship between the CGT asset and that business, it could not be said that the CGT asset was used in the course of carrying on the company's business, therefore the property was not an active asset.

It is acknowledged that the definition of active asset does not require exclusive use of the asset for business purposes. This was discussed in the case of Eichmann v Federal Commissioner of Taxation (2020) FCAFC 155 (Eichmann).

In Eichmann, the taxpayer, who carried on a business of building, bricklaying and paving, purchased land next door to his family home and used it to store work tools, equipment and materials. The land had sheds, high walls and a gate to secure the property. Work vehicles and trailers were parked on the property, and tools and items were collected from there on a daily basis. The full federal court held that the secure storage of the tools and materials of the taxpayer's business on a daily basis was very much part of the course of the carrying on of that business. In so holding the court unanimously overturned the decision of Derrington J (2019 ATC 20-728; [2019] FCA 2155) and the view that, in order for an asset to be used "in" the course of carrying on a business; it was necessary for the use to have a direct functional relevance to the carrying on of the normal day-to-day activities of the business that were directed to the gaining or production of assessable income.

As highlighted in Eichmann, subsection 152-40(1) of the ITAA 1997 requires the asset to be used 'in the course of carrying on a business,' encompassing, necessarily, a fairly wide range of activities.

Application to your circumstance

In your case, when you entered into a contract to dispose of the Property, CGT event A1 occurred which resulted in a capital gain, satisfying paragraph (a) and (b) of subsection 152-10(1) of the ITAA 1997.

The Property has been used by Company A for its business activities. You have jointly held all shares in Company A, each of you carrying the right to exercise a control percentage that is at least 40% of the voting power of the company during the relevant period. You therefore control Company A and it is connected to you.

Company A is a CGT small business entity in the 20XX-XX income year on the basis that it operated a business and has an aggregated turnover of less than $2 million.

You did not carry on a business either alone or in partnership in the 20XX-XX income year, however Company A the CGT small business entity connected to you, carried on a business in the 20XX-XX income year in relation to the Property satisfying subsection 152-10(1A) of the ITAA 1997. It follows that you satisfy subparagraph (c)(iv) of subsection 152-10(1) of the ITAA 1997 regarding passively held assets.

With reference to Eichmann, we consider Company A's use of the Property on a daily basis, for the storage of its stock, the storage of its delivery vehicles, the preparation of its orders and the administration of the operations, are part of the course of carrying on its business.

In contrast to Rus, Company A conducted business activities on a large proportion of the Property's usable land.

Having regard to the nature of the Property, the nature of Company A's business, and the relationship between the Property and business, we are satisfied that for the required period of at least 7 and a half years, Company A used the Property in the course of carrying on its business. The Property satisfies the active asset test under section 152-35 of the ITAA 1997.

You therefore satisfy paragraph (d) of subsection 152-10(1) of the ITAA 1997, And it follows that you satisfy the basic eligibility conditions of the small business CGT concessions under section 152-10(1) of the ITAA 1997.

Question 2

Summary

You both satisfy the conditions for the small business 15-year exemption under section 152-105 of the ITAA 1997. Per question 1, the basic conditions under Subdivision 152-A of the ITAA 1997 are satisfied. You continuously owned the asset for the 15-year period ending just before the CGT event. You are both over 55 years old, and the CGT event has happened in connection with your retirement. You are entitled to disregard the gain arising from the sale of the Property under section 152-105 of the ITAA 1997.

Detailed reasoning

Section 152-105 of the ITAA 1997 states that if you are an individual, you 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)  You continuously owned the CGT asset for the 15-year period ending just before the CGT event

(c)   If the CGT asset is a share in a company or an interest in a trust - the company or trust 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 you owned the CGT asset

(d)  Either

(i)    You are 55 or over at the time of the CGT event and the event happens in connection with your retirement; or

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

In connection with retirement

There is no statutory definition of 'retirement'. The word 'retirement' is defined in the Macquarie Dictionary to mean 'the withdrawal from office, business or active life'.

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 retirement' even if it occurs at some time before retirement if it can be shown that the earlier CGT event was integral to the business operator's plan to cease their activities and retire.

Application to your circumstances

In your case, you satisfy the basic eligibility conditions for the small business CGT concessions under section 152-10 of the ITAA 1997 as set out above in the detailed reasoning in relation to question 1 of this ruling. You therefore satisfy paragraph (a) of section 152-105 of the ITAA 1997.

You continuously owned the CGT asset for the 15 year period ending just before the CGT event, so you satisfy paragraph (b) of section 152-105 of the ITAA 1997.

The CGT asset is not a share in a company or an interest in a trust, therefore paragraph (c) of section 152-105 of the ITAA 1997 is not applicable.

Your decision to sell the property was mainly to allow both of you to completely transition to retirement, now that you are in your 60s. You both plan to be fully retired from working a short period after the Property settled.

Considering the likely relevance of the capital proceeds in funding your retirement, and the integral nature of the disposal of the Property to your retirement from work, it is considered that the CGT event is connected to your retirement. Therefore, as you were both also over 55 years old at the time of the CGT event and the event happened in connection with your retirement, paragraph (d) of section 152-105 of the ITAA 1997 has been satisfied.

Consequently, you have satisfied the eligibility conditions for the small business 15 year exemption, and you can disregard the capital gain arising from your disposal of the Property.

Question 3

Summary

On the basis you are eligible for and chose to apply the main residence exemption, you can apply the main residence exemption under Subdivision 118-B of the ITAA 1997 to whichever area of the Property land you choose in addition to the land on which your dwelling was situated. However, the total of the land (including the land on which the dwelling is situated) must not exceed 2 hectares.

However, as you can disregard the capital gain underthe small business 15 year exemption, you do not need to apply the main residence exemption to the sale of the Property.

Detailed reasoning

Subdivision 118-B of the ITAA 1997 allows you to disregard the capital gain or capital loss you make from a CGT event that happens to a dwelling that is your main residence. The Basic case conditions for the main residence exemption to be applied are set in in section 118-110 of the ITAA 1997.

Section 118-120 of the ITAA 1997 applies to a dwelling's adjacent land (if the same CGT event happens to the land or your ownership interest in it) as if it were a dwelling.

Subsection 118-120(2) states that land adjacent to a dwelling is its adjacent land to the extent that the land was used primarily for private or domestic purposes in association with the dwelling.

Subsection 118-120(3) states that the maximum area of the adjacent land covered by the exemption for the CGT event (the current event) is 2 hectares, less the area of land immediately under the dwelling.

Taxation Determination TD 1999/67: Income tax: capital gains: if your land (including land on which your dwelling is situated) exceeds 2 hectares, can you select which 2 hectares the main residence exemption in Subdivision 118-B applies to, and, if so, how do you calculate any capital gain or capital loss you make on the remainder of your land? states that you can apply the main residence exemption in Subdivision 118-B of the ITAA 1997 to whichever area of land you choose in addition to the land on which your dwelling is situated, however the total of the land (including the land on which the dwelling is situated) must not exceed 2 hectares, as specified in subsection 118-120(2) of the ITAA 1997.

Application to your circumstance

As you can disregard the entire capital gain arising from the Property under the small business 15 year exemption, you do not need to apply the main residence exemption to the sale of the Property.

We have not considered your eligibility for the basic case conditions in section 118-110 of the ITAA 1997.

On the basis you are eligible for and chose to apply the main residence exemption, you can apply the main residence exemption under Subdivision 118-B of the ITAA 1997 to whichever area of the Property land you choose in addition to the land on which your dwelling was situated. However, the total of the land (including the land on which the dwelling is situated) must not exceed 2 hectares.