Edited version of private advice

Authorisation Number: 1052082617712

Date of advice: 13 February 2023

Ruling

Subject: CGT - small business concessions

Question 1

Did the commercial property (the Property) satisfy the active asset test in subsection 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Can you disregard the capital gain from the sale of your interest in the Property under the small business 15-year exemption in section 152-105 of the ITAA 1997?

Answer

Yes

Question 3

If the answer to question 2 is no, in respect of the capital gain that arose from the sale of your interest in the Property, can you apply the small business 50% reduction in subsection 152-205 of the ITAA 1997?

Answer

N/A

Question 4

If the answer to question 2 is no, can you choose to disregard all or part of the capital gain from the sale of your interest in the Property under the small business retirement exemption in section 152-305 of the ITAA 1997?

Answer

N/A

This private ruling applies for the following period:

Income year ended 30 June YYYY

The scheme commenced on:

1 January YYYY

Relevant facts and circumstances

In YYYY, you and your spouse purchased the Property in joint names.

Your intention and main purpose for acquiring the Property was for your spouse to operate a business from the upstairs floor. The fact that the downstairs floor could be leased to derive additional income was incidental, or secondary, purpose for the Property.

The Property consisted of two floors of similar floor area.

In or around MMM YYYY, you and your spouse sold the Property. At this time, you repurchased a 50% interest in the Property as an equal tenant in common.

In MMM YYYY, your spouse reacquired a 50% interest in the Property and, from this time, you and your spouse wholly owned the Property as tenants in common.

In MMM YYYY, you and your spouse entered into a contract to sell the Property. Settlement of the sale took place in MMM YYYY.

Income from the Property

The downstairs floor was rented to independent tenants, that were not 'affiliates' or 'entities connected with' you under sections 328-125 or 328-130 of the ITAA 1997.

The rent received from the downstairs-floor tenants prior to DD MMM YYYY was around $X per annum. In the YYYY to YYYY income years, the rent received from the downstairs-floor tenants was:

Your spouse and an unrelated individual carried on business in partnership (the Partnership) using the upstairs floor area of the Property until the Partnership was dissolved on DD MMM YYYY.

The rent paid by the Partnership until DD MMM YYYY was approximately $X per annum.

The fees income generated by the Partnership from the YYYY income year to the YYYY income year was between $X and $X per annum.

From DD MMM YYYY, your spouse used the upstairs floor of the Property as the sole proprietor of a business.

In the YYYY to YYYY income years, your spouse's business paid rent of $X per annum. Your spouse's total business income during this time was as follows:

•         YYYY: $X

•         YYYY: $X

•         YYYY: $X

•         YYYY: $X

•         YYYY: $X.

Other relevant facts

Your spouse acted in concert with you in relation to your spouse's business affairs.

The basic conditions in paragraphs 152-10(1)(a), (b) and (c) of the ITAA 1997 were satisfied for the capital gain made from the sale of the Property.

Your date of birth is DD MMM YYYY.

You were not permanently incapacitated at the time of the CGT event.

You retired in MMM YYYY and do not intend to return to the workforce.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 108-7

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 section 152-10

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

Income Tax Assessment Act 1997 section 152-35

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

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

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

Income Tax Assessment Act 1997 subsection 152-40(2)

Income Tax Assessment Act 1997 paragraph 152-40(4)(e)

Income Tax Assessment Act 1997 paragraph 152-40(4A)(b)

Income Tax Assessment Act 1997 Subdivision 152-B

Income Tax Assessment Act 1997 section 152-105

Income Tax Assessment Act 1997 paragraph 152-105(a)

Income Tax Assessment Act 1997 paragraph 152-105(b)

Income Tax Assessment Act 1997 paragraph 152-105(c)

Income Tax Assessment Act 1997 paragraph 152-105(d)

Reasons for decision

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

Question 1 - Active asset test - subsection 152-35

Summary

Your ownership interest in the Property satisfied the active asset test in subsection 152-35.

Detailed reasoning

A capital gain you make may be reduced or disregarded under Division 152 if the basic conditions in paragraphs 152-10(1)(a) to (d) are satisfied for the gain.

As stated in the facts, the basic conditions in paragraphs 152-10(1)(a), (b) and (c) were satisfied for the capital gain made from the sale of the Property. As such, only paragraph 152-10(1)(d), which requires that the CGT asset satisfies the 'active asset' test, set out in section 152-35, is considered below.

Paragraph 152-35(1)(b) sets out that a CGT asset satisfies the active asset test if 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 seven and a half years during the period specified in subsection 152-35(2).

According to subsection 152-35(2), the relevant period:

(1)  begins when you acquired the asset; and

(2)  ends at the earlier of:

(i)     the CGT event; and

(ii)    if the relevant business ceased to be carried on in the 12 months before that time or any longer period that the Commissioner allows - the cessation of the business.

For the purposes of the CGT provisions, individuals who own a CGT asset as joint tenants are treated as if they each owned a separate CGT asset constituted by an equal interest in the asset and as if each of them held that interest as tenants in common (section 108-7).

A (you) acquired your ownership interest in the Property in YYYY as a joint tenant with your spouse. You and your spouse sold your joint tenancy interests in the Property in or around MMM YYYY, and you reacquired a 50% ownership interest in the Property at that time (as a tenant in common) and continued to hold that interest until the sale of the Property.

Although the ownership of the Property changed, it is considered that you have continued to own your ownership interest in the Property since you acquired it in YYYY. As such, to satisfy the active asset test, your interest in the Property had to be an 'active asset' for a total of at least seven and a half years of the period beginning in YYYY and ending in MMM YYYY.

Your interest in the Property was an 'active asset', under subsection 152-40(1), at any time when you owned it, and it was used in the course of a business that was carried on (whether alone or in partnership) by:

         (i)       you; or

        (ii)       your affiliate; or

      (iii)       another entity that is connected with you.

An individual is your 'affiliate' if they act, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to their business affairs (subsection 328-130).

Assets that are used mainly to derive rent cannot be active assets (paragraph 152-40(4)(e)).

In determining the 'main' use of your interest in the Property for the purpose of paragraph 152-40(4)(e), any personal use of an asset is disregarded and any use by your affiliate, or an entity connected with you, is treated as your use (paragraph 152-40(4A)(b)).

Further, paragraph 26 of 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? explains that where an asset is used for mixed purposes:

•         the 'main' use at any given time is a question of fact, dependent on the circumstances,

•         no one single factor will necessarily be determinative, and

•         resolving the question is likely to involve a consideration of factors such as:

-       the comparative areas of use of the premises (between deriving rent and other uses); and

-       the comparative levels of income derived from the different uses of the asset.

Since you acquired your interest in the Property, the Property has been used both to derive rent and by your spouse in carrying on business activities, initially in partnership and later as a sole practitioner.

As set out in the facts, your spouse acted in concert with you in relation to your spouse's business affairs. As such, your spouse is your 'affiliate' and, in accordance with paragraph 152-40(4A)(b), for determining 'your main use' of the Property, your spouse's use of the Property is treated as your use.

Based on the facts, it is considered that although the rent paid by the downstairs floor tenants was, at times, more than the rent paid for the upstairs floor, the total business income produced by your spouse's business activities in each year significantly outweighed the rent derived from the downstairs floor tenants. Your main use of the Property was not to derive rent.

In your circumstances, your ownership interest in the Property satisfied the active asset test in subsection 152-35.

Question 2 - Small business 15-year exemption - Subdivision 152-B

Summary

As the conditions in section 152-105 are satisfied, you are entitled to disregard the capital gain arising from the sale of your interest in the Property under the small business 15-year exemption.

Detailed reasoning

Under the small business 15-year exemption, you can disregard any capital gain arising from a CGT event if the four conditions in section 152-105 are satisfied.

In your circumstances:

•         paragraph 152-105(a) was satisfied as the basic conditions in Subdivision 152-A were satisfied (as set out in the facts and discussed in question 1),

•         paragraph 152-105(b) was satisfied as you owned your interest in the Property since YYYY, and

•         paragraph 152-105(c) does not apply to you as the CGT asset was not a share in a company or an interest in a trust.

Paragraph 152-105(d) requires that 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.

When you sold the Property in MMM YYYY, you were not permanently incapacitated and so subparagraph (ii) does not apply. However, although you were over 55 years of age at the time of the sale, for the purpose of subparagraph 152-105(d)(i), it is necessary to determine whether the sale happened 'in connection with your retirement'.

In connection with your retirement

The phrase 'in connection with your retirement' is not defined in the legislation and, as such, it takes its ordinary meaning. Guidance about when a CGT event is 'in connection with retirement' is provided on the ATO website, ato.gov.au (refer Small business 15-year exemption page, quick search code QC 52288), which states:

Whether a CGT event happens in connection with an individual's retirement depends on the particular circumstances of each case. There would need to be at least a significant reduction in the number of hours the individual works or a significant change in the nature of their present activities to be regarded as a retirement. However, it isn't necessary for there to be a permanent and everlasting retirement from the workforce...

A CGT event may be 'in connection with your retirement' even if it occurs at some time before retirement...

Similarly, the words 'in connection with' can apply where the CGT event occurs sometime after retirement. Again this would depend on the particular facts, and would need to be considered on a case-by-case basis.

Example: Sale of assets after retirement

A small business operator retires and his children take over the running of the business. Within six months, they sell some business assets and make a capital gain.

Several reasons may have prompted the sale of the assets. If there is no relevant connection with the small business operator's retirement, the requirement would not be satisfied. However, if it can be shown that the reason for the disposal of the assets is connected to retirement and the later sale is integral to the small business operator's retirement plan, the sale may be accepted as happening in connection with retirement [Emphasis added].

In your case, it is considered that the sale of the Property was in connection with your retirement and paragraph 152-105(d) was satisfied.

As the conditions in section 152-105 were satisfied you are entitled to disregard the capital gain arising from the sale of your interest in the Property under the small business 15-year exemption.