Edited version of private advice

Authorisation Number: 1052076259811

Date of advice: 20 January 2023

Ruling

Subject:CGT - small business concessions

Question 1

Does Trust A satisfy the active asset test in section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Does Trust A satisfy the requirements in section 152-110 of the ITAA 1997 to apply the 15-year exemption to disregard the capital gain made on the sale of the Property?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

All entities mentioned below are Australian residents.

Trust A

Trust A is a discretionary family trust settled by a Trust Deed.

Individual One and Individual Two are spouses and are both beneficiaries of Trust A.

Trust A acquired a Property after 20 September 1985 (the Property).

Trust A has held the Property since its acquisition after 20 September 1985 until its sale in Month 20XX.

Trust A has no other major assets.

Company Z

Since its acquisition, Trust A had leased the Property to Company Z.

Company Z is in business.

The shareholders of Company Z are:

•         Individual One,

•         Individual Two; and

•         Trust A.

For at least seven-and-a-half-years between the acquisition date of the Property and the sale date of the Property, Company Z was entitled to and received at least 40% or more of the distributions made by Trust A for at least one of the four previous income years.

The Property

For at least seven-and-a-half-years between the acquisition date of the Property and the sale date of the Property, the Property was used in the business of Company Z.

Trust A sold the Property in Month 20XX and made a gross capital gain.

Individual One and Individual Two

Individual One and Individual Two were both over 55 years of age at the time the Property was sold.

Either Individual One and/or Individual Two were beneficially entitled to and received at least 20% of the distributions of Trust A for at least 15 years during the Property ownership period.

On the sale of the Property, Individual One and Individual Two commenced their retirement.

The capital proceeds from the sale of the Property were paid by Trust A to Individual One and Individual Two and is providing funding for their retirement.

The total capital gain made by Trust A was distributed entirely to Individual One and Individual Two who were made specifically entitled.

Relevant legislative provisions

Income Tax Assessment Act 1997

Income Tax Assessment Act 1997 subdivision 152-B

Income Tax Assessment Act 1997 section 152-10

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 paragraph 152-10(1)(d)

Income Tax Assessment Act 1997 section 152-35

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

Income Tax Assessment Act 1997 paragraph 152-35(1)(b)

Income Tax Assessment Act 1997 subsection 152-35(2)

Income Tax Assessment Act 1997 paragraph 152-40(1)(a)

Income Tax Assessment Act 1997 subparagraph 152-40(1)(a)(iii)

Income Tax Assessment Act 1997 paragraph 152-40(1)(b)

Income Tax Assessment Act 1997 paragraph 152-50

Income Tax Assessment Act 1997 section 152-55

Income Tax Assessment Act 1997 section 152-65

Income Tax Assessment Act 1997 subsection 152-70(1)

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

Income Tax Assessment Act 1997 section 328-125

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

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

Reasons for decision

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

Question 1

Summary

Trust A satisfies the active asset test.

Detailed reasoning

Active asset test

For the small business concessions in Division 152 to apply to reduce or disregard a capital gain, the relevant CGT asset must satisfy the active asset test in section 152-35. The active asset test requires the relevant CGT asset to be an active asset:

•         for a total of at least half of the period specified in subsection 152-35(2) if you have owned the asset for 15 years or less (paragraph 152-35(1)(a)); or

•         for a total of at least 7 ½ years during the period specified in subsection 152-35(2) if you have owned the asset for more than 15 years (paragraph 152-35(1)(b)).

Subsection 152-35(2) provides that the test period begins when you acquired the asset and ends at the earlier of

(i)    the time of the CGT event; and

(ii)   when the business ceased, if the business in question ceased in the 12 months before the CGT event (or such longer time as the Commissioner allows).

Active asset

The term 'active asset' is defined at section 152-40. subsection 152-40(1) provides that a CGT asset is an active asset at a given time if, at that time, you own it and:

•         it is used (or held ready for use) in the course of carrying on a business by you, your affiliate or an entity connected with you (paragraph 152-40(1)(a)); or

•         it is an intangible asset that is inherently connected with a business that is carried on by you, your affiliate, or an entity connected with you (paragraph 152-40(1)(b)).

However, paragraph 152-40(4)(e) excludes, among other things, assets whose main use is to derive rent. Such assets are excluded even if they are used in the course of carrying on a business. Of course, if the activities carried on do not amount to the carrying on of a business, it is unnecessary to consider whether the main use of the asset is to derive rent.

There is no requirement that the asset needs to be an active asset just before the CGT event.

Connected with

Section 328-125 provides guidance on how to assess whether an entity is connected to another entity. Subsection 328-125(1) defines 'connected with an entity' as

(1)  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(4) provides one of the tests in determining whether an entity has control of a discretionary trust. That subsection provides

(4)  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.

In Trust A's circumstances

Trust A is connected with Company Z. Company Z used the Property in the course of operating their business. The Commissioner is satisfied that, in accordance with paragraph 152-40(1)(a), the Property has been mainly used in the course of carrying on a business by an entity connected with Trust A.

The Property has been owned by Trust A for more than 15 years and the Property has been used in the business of Company Z for at least seven and a half years.

Trust A satisfied the active asset test.

Question 2

Summary

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:

•         Trust 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 their retirement.

Therefore, Trust 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

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 trust 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 discretionary trust, section 152-70 provides that the direct small business percentage is the lower of the percentage of distributions of income or distributions of capital to the individual.

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.

In Trust A's circumstances

The Commissioner considers that the basic conditions in section 152-10 are satisfied for the gain made by Trust A on the sale of the Property. Paragraph 152-110(1)(a) is satisfied.

Trust A continuously owned the Property for the 15-year period ending just before the CGT event, being the sale of the Property. Paragraph 152-110(1)(b) is satisfied.

Trust A had a significant individual, being Individual One or Individual Two, for a total of more than 15 years, during which Trust A owned the Property. Paragraph 152-110(1)(c) is satisfied.

Individual One and Individual Two were both significant individuals of Trust A just before the CGT event happened. They were also both over 55 years old just before the sale of the Property. Paragraph 152-110(1)(d)(i) is satisfied.

The question then arises as to whether the CGT event happened in connection with either Individual One or Individual Two's retirement.

In connection with 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. Accordingly, whether a CGT event happens in connection with an individual's retirement depends on the particular circumstances of each case.

Following the sale of the Property, the capital proceeds were paid by Trust A to Individual One and Individual Two and is providing funding for their retirement. Additionally, there has been a significant reduction in the number of hours worked by both Individual One and Individual Two.

The Commissioner considers there is a clear link between the disposal of the property and Individual One and Individual Two's retirement. It is considered that the disposal of the property is integral to their retirement plans. Paragraph 152-110(1)(d) is satisfied.

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