Edited version of private advice

Authorisation Number: 1052079387692

Date of advice: 19 January 2023

Ruling

Subject: CGT - small business relief

Question

Does the Property satisfy the active asset test pursuant to section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

This ruling applies for the following period:

Period ended XX XX 20XX

The scheme commences on:

YY YY 20YY

Relevant facts and circumstances

1.    The Trust, together with Trust A and Trust B as 3 equal partners forming the Property Partnership, purchased the Property on YY YY 20YY.

2.    The Property was used from its acquisition on YY YY 20YY to ZZ ZZ 20ZZ by the Old Business operated by Trust C, Trust D and Trust E as 3 equal partners forming the Old Business Partnership.

3.    Taxpayer A is a common individual in both the Property Partnership and the Old Business Partnership. He is the sole director of the Trust's trustee company and was appointed by Trust C as its representative.

4.    Majority of the interest in the Old Business was sold to a third-party on ZZ ZZ 20ZZ.

5.    The business began to operate as the New Company from ZZ ZZ 20ZZ.

6.    The Property was leased to the New Company for use in their business on ZZ ZZ 20ZZ, until the Property was sold on AA AA 20AA.

7.    Taxpayer A was involved in drawing up and negotiation of the lease agreement with the New Company. Taxpayer A was also involved in maintaining and inspecting the Property.

8.    Taxpayer A is a director of the New Company.

9.    Trust C holds is a minority shareholder of the New Company.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 328-125

Income Tax Assessment Act 1997 section 328-130

Reasons for decision

The Property is not an active asset of the Trust, its affiliate or another entity connected with it.

Detailed reasoning

10.  Section 152-35 outlines the requirements for the active asset test. Relevantly, paragraph 152-35(1)(a) provides that a CGT asset satisfies the active asset test 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 ownership period.

11.  Section 152-40 provides the definition of an active asset. Paragraph 152-40(1)(a) provides that an asset is an active asset if it is used, or held ready for use, in the course of carrying on a business (whether alone or in a partnership) by:

(i)    you (the owner of the asset); or

(ii)   your affiliate; or

(iii)  another entity that is connected with you.

Asset used by you

12.  Under subparagraph 152-40(1)(a)(i) the Trust itself is required to have used the Property, or held it for use, in the course of it carrying on a business.

13.  Subsection 152-40(4) provides a number of exceptions of types of assets which cannot be active assets. Most relevant to the Trust's circumstances, paragraph 152-40(4)(e) provides that an asset that is mainly used for the purpose of collection of rent cannot be an active asset.

Application to your circumstances

14.  You have stated that the Trust, as a partner in the Property Partnership, leased the Property to the Old Business Partnership from its acquisition on YY YY 20YY until ZZ ZZ 20ZZ.

15.  Following that, the Trust as a partner in the Property Partnership, leased the Property to the New Company from ZZ ZZ 20ZZ until the property was sold on AA AA 20AA.

16.  It is considered that the Property cannot meet the requirements of an active asset used, or held ready for use, in the course of carrying on a business that is carried on by the Trust or the Property Partnership under subparagraph 152-40(1)(a)(i) as the Property was leased to the Old Business Partnership and the New Company for use in the business they carried on throughout the Property ownership period.

17.  Please note, even if it were suggested that the Trust is carrying on a business of renting out investment properties, paragraph 152-40(4)(e) would still exclude the Property from being active assets - seeExample 1 in Taxation Determination TD 2006/78 Income tax: capital gains: are there any circumstances in which the premises used in a business of providing accommodation for reward may satisfy the active asset test in section 152-35 of the Income Tax Assessment Act 1997 notwithstanding the exclusion in paragraph 152-40(4)(e) of the Income Tax Assessment Act 1997 for assets whose main use is to derive rent?.

18.  Therefore, the Property is not an active asset of the Trust under subparagraph 152-40(1)(a)(i).

Asset used by your affiliate

19.  Under subparagraph 152-40(1)(a)(ii) an affiliate of the Trust is required to have used, or held ready for use, the Property in the course of carrying on a business.

20.  The definition of an "affiliate" is provided in section 328-130. Subsection 328-130(1) provides that an individual or company is an affiliate of yours if the former acts or could reasonably be expected to act in accordance with your directions, wishes or in concert with you in relation to the affairs of the individual or company.

21.  A person is not an affiliate merely because of the nature of a business relationship you and the person share. In accordance with the example provided in subsection 328-130(2) if you are a partner in a partnership, another partner is not your affiliate merely because they act, or could reasonably be expected to act, in accordance with your directions or wishes in relation to the affairs of the partnership.

22.  Similarly, companies and trusts are not affiliates of their directors and trustee respectively, and vice versa, merely because of the positions held.

23.  Pursuant to section 328-130 only individuals and companies can be affiliates of entities. Whilst trusts and partnerships can have affiliates, they are not capable of being affiliates to other entities themselves.

24.  In relation to the New Company, whether a person acts, or could reasonably be expected to act, in accordance with the Trust's directions or wishes, or in concert with the Trust, is a question of fact dependent on the circumstances of each case. Relevant factors include:

•         The existence of a close family relationship between the parties

•         The lack of any formal agreement or formal relationship between the parties dictating how the parties are to act in relation to each other

•         The likelihood that the way the parties act, or could reasonably be expected to act, in relation to each other would be based on the relationship between the parties rather than on formal agreements or legal or fiduciary obligations

•         The actions of the parties

25.  Generally, another business would not be acting in concert with you if they:

•         Have different employees

•         Have different business premises

•         Have separate bank accounts

•         Do not consult you on business matters

•         Conduct their business affairs independently

26.  In order to satisfy the active asset test under this subparagraph, the Commissioner must be satisfied that the New Company acts or could reasonably be expected to act in accordance with the Trust's directions or wishes, or in concert with the Trust, in relation to the affairs of their business.

Application to Your Circumstances

27.  As discussed above, a partnership cannot be considered an affiliate of an entity. Therefore, the Old Business Partnership cannot be considered an affiliate the Trust. As a result, the use of the Property by the Old Frosty Boy Partnership is not considered use of the Property by an affiliate of the Trust.

28.  You have stated that Taxpayer A, a common individual involved in the Trust, New Company and the Trust C, is a director of the New Company, as well as holding approximately XX% of shares in the company indirectly through Trust C. The Trust itself, has no involvement in the business affairs of the New Company.

29.  The relationship between Taxpayer A, the Trust, the New Company and Trust C is not sufficient to show that an affiliate relationship exists between the New Company and the Trust. It is our view that from the facts provided, there are no circumstances that would indicate that the New Company acts or could reasonably be expected to act in accordance with the directions or wishes of the Trust itself. As a result, the use of the Property by the New Company is not considered use of the Property by an affiliate of the Trust.

30.  Please note that in order for Taxpayer A to be considered an affiliate of the Trust in his own right, the Commissioner would need to be satisfied that Taxpayer A is conducting a business, and that they operate their business in accordance with the Trust's directions or wishes, or in concert with the Trust. Additionally, even if Taxpayer A was undertaking a business and was considered an affiliate, they are not the party who have been utilising the Property. The active asset test under subparagraph 152-40(1)(a)(ii) would not be satisfied where Taxpayer A is an affiliate of the Trust.

31.  Therefore, the Property is not an active asset of an affiliate of the Trust under subparagraph 152-40(1)(a)(ii).

Asset used by an entity connected to you

32.  Under subparagraph 152-40(1)(a)(iii), an entity connected with the Trust is required to have used the Property in the course of carrying on a business.

33.  The definition of when an entity is "connected with" another is outlined in section 328-125. Under subsection 328-125(1):

(a)  either entity controls the other entity, or

(b)  both entities are controlled by the same third entity.

34.  Subsection 328-125(2) provides that an entity controls another entity if the first entity owns or has the right to acquire the ownership of interests in another entity that is at least 40% (control percentage) of the net income, distributions or equity of the second entity.

35.  In order to satisfy the active asset test under this subparagraph, the Commissioner must be satisfied that the Trust holds a control percentage of the net income, distributions, or equity of the New Company or that both the Trust and the New Company are controlled by the same third entity.

Application to Your Circumstances

36.  On the facts provided, prior to the sale of the Property the Trust held a XX% interest in the Property Partnership. As a result, it is considered that the Trust is not connected with the Property Partnership as its interest in the Property Partnership is below the control percentage throughout the ownership period of the Property.

37.  Further, after the sale of the majority of the interest in the Old Business to a third party, Taxpayer A, indirectly through the Trust C, holds less than 40% of shares in the New Company. The Trust itself does not hold any interest in the New Company.

38.  It is our view that the New Company is not connected with the Trust as:

•         the Trust itself does not hold at least a 40% interest in the New Company;

•         the New Company does not hold at least a 40% interest in the Trust;

•         a third entity does not hold at least a 40% interest in both the Trust and the New Company.

39.  Therefore, the Property is not an active asset of an entity connected with the Trust under subparagraph 152-40(1)(a)(iii).

Conclusion

40.  As demonstrated above, at no time does the Property meet any of the definitions of an active asset of the Trust in paragraph 152-40(1)(a). Therefore, the Property does not satisfy the active asset test under section 152-35.