Edited version of private advice

Authorisation Number: 1052087925382

Date of advice: 15 February 2023

Ruling

Subject: CGT - small business concessions

Question:

Is the property located at XXX an active asset in accordance with Division 152 of the Income Tax Assessment Act 1997 ('ITAA 1997')?

Answer:

Yes

This ruling applies for the following periods

DD MM YYYY to DD MM YYYY

Relevant facts and circumstances

Background information

1.      The Applicant was born on DD MM YYYY and is presently XX years of age.

2.      The Applicant owned and operated a business as a sole trader from their home located at XXX since MM 20YY.

3.      The above-mentioned property was partly used to display stock to potential customers, store sample stock, as well as used for business administration.

4.      The Applicant and their partner purchased the property as joint tenants in MM 20YY for $X.

5.      The Applicant and their partner subsequently disposed of the property on DD MM 20YY (contract date) for $X. Settlement date of the property was DD MM 20YY.

6.      Since acquiring the property in MM 20YY, the premises has continuously been used to carry on the Applicant's business.

7.      The total building size is approximately X m2. Of this building size, X% has been calculated as used directly in conjunction with carrying on the business, ie. X rooms of the house were dedicated to carrying on the business (X rooms were fitted out as showrooms and the last room was used as an office).

8.      The premises is also equipped with a customer car park which is located at the rear of the property, which is accessible from XXX.

9.      The remaining building is used as the Applicant's and their parnter's main residential residence.

Information provided

10.   You have provided several documents containing detailed information in relation to the Applicant, including:

•                     Private Binding Ruling ('PBR') Application, dated DD MM 20YY

11.   We have referred to the relevant information within these documents in applying the relevant tests to your circumstances.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 Subdivision 152-B

Income Tax Assessment Act 1997 section 152-1

Income Tax Assessment Act 1997 section 152-5

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 152-47

Income Tax Assessment Act 1997 section 152-205

Income Tax Assessment Act 1997 section 995-1

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 ('ITAA 1997') unless otherwise stated.

Question:

Is the property situated at XXX an active asset in accordance with Division 152 of the Income Tax Assessment Act 1997 ('ITAA 1997')?

Summary

The property situated at XXX is an active asset in accordance with Division 152 of the Income Tax Assessment Act 1997.

Detailed reasoning

12.   As stated in section 152-1 ITAA 1997, subdivision 152-A of the ITAA 1997 sets out the 'basic conditions' which must be satisfied in order for small business entities to qualify for any of the CGT small business concessions to reduce their capital gain by the various concessions in Division 152 of the ITAA 1997.

Basic conditions for small business concessions

13.   Subsection 152-10(1) of the ITAA 1997 sets out the basic conditions which must be satisfied for a capital gain to be reduced or disregarded under this Division, as follows:

A capital gain (except a capital gain from CGT event K7) you make may be reduced or disregarded under this Division if the following basic conditions are satisfied for the gain:

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

(b)          the event would (apart from this Division) have resulted in the gain;

(c)           at least one of the following applies:

(i)            you are a CGT small business entity for the income year;

(ii)           you satisfy the maximum net asset value test (see section 152-15);

(iii)         you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership;

(iv)         the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year;

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

CGT Events and Assets

14.   As defined in section 995-1 of the ITAA 1997, a CGT event means any of the CGT events described in Division 104 of the ITAA 1997. A CGT event described by number (eg. CGT event A1) refers to the relevant event in that Division.

15.   Subsection 108-5(1) of the ITAA 1997, outlines a CGT asset to be:

(a) any kind of property; or

(b) a legal or equitable right that is not property.

16. To avoid doubt, subsection 108-5(2) lists the following as CGT assets:

(a) part of, or an interest in, an asset referred to in subsection (1);

(b) goodwill or an interest in it;

(c) an interest in an asset of a partnership;

(d) an interest in a partnership that is not covered by paragraph (c).

CGT small business entity

17.   As defined in section 995-1 of the ITAA 1997, a CGT small business entity has the meaning given by subsection 152-10(1AA), as follows:

You are a CGT small business entity for an income year if:

(a) you are a small business entity for the income year; and

(b) you would be a small business entity for the income year if each reference in section 328-110 to $10 million were a reference to $2 million.

18.   As defined in section 995-1 of the ITAA 1997, a small business entity has the meaning given by subsection 328-110(1), as follows:

You are a small business entity for an income year (the current year) if:

(a) you carry on a business in the current year; and

(b) one or both of the following applies:

(i) you carried on a business in the income year (the previous year) before the current year and your aggregated turnover for the previous year was less than $10 million;

(ii) your aggregated turnover for the current year is likely to be less than $10 million.

19.   As defined in section 995-1 of the ITAA 1997, a business includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

20.   As defined in subsection 328-115 of the ITAA 1997, aggregated turnover is defined as the sum of all relevant annual turnovers. The relevant annual turnovers are outlined in subsection 328-155(2) and exclude any amounts covered by subsection 328-155(3).

21.   Section 328-120 of the ITAA 1997 sets out the meaning of annual turnover as follows:

An entity's annual turnover for an income year is the total ordinary income that the entity derives in the income year in the ordinary course of carrying on a business.

22.   The term ordinary income is defined in section 6-5 of the ITAA 1997 as 'income according to ordinary concepts'. An entity's annual turnover therefore, includes all income according to ordinary concepts derived in the ordinary course of carrying on a business.

23.   The term 'in the ordinary course of carrying on a business' is not defined in the ITAA 1997. The term therefore, takes its ordinary meaning.

24.   In Doutch v FC of T [2016] FCAFC 166, which was an appeal against the decision of the AAT in respect of small business entity concessions, the Full Federal Court confirmed the following reasoning provided by the Tribunal:

70 The phrase "in the ordinary course of carrying on a business", as it appears in

s 328-120(1) of the ITAA 1997, is not defined in the ITAA 1997 and it is necessary to construe those words. In engaging in the exercise of statutory construction, the Court is to consider the text of the statute in context. The High Court in Commissioner of Taxation v Consolidated Media Holdings Ltd (2012) 250 CLR 503 observed as follows at [39]:

"This Court has stated on many occasions that the task of statutory construction must begin with a consideration of the [statutory] text" [Alcan (NT) Alumina Pty Ltd v Commissioner of Territory Revenue [2009] HCA 41; (2009) 239 CLR 27 at 46 [47]]. So must the task of statutory construction end. The statutory text must be considered in its context. That context includes legislative history and extrinsic materials. Understanding context has utility if, and in so far as, it assists in fixing the meaning of the statutory text. Legislative history and extrinsic materials cannot displace the meaning of the statutory text. Nor is their examination an end in itself.

25.   The extrinsic materials to which the High Court referred includes an explanatory memorandum, as follows:

72 The definition of "annual turnover" in s 328-120(1) of the ITAA 1997 was inserted into the ITAA 1997 by Tax Laws Amendment (Small Business) Act 2007 (TLASBA 2007). The "Explanatory Memorandum" to the Tax Laws Amendment (Small Business) Bill 2007 (EM), which Bill was ultimately enacted as the TSLABA 2007, commencing from the 2008 income year, states:

What does 'in the ordinary course of carrying on a business' mean?

2.15 In general, income is derived in the ordinary course of carrying on a business if the income is of a kind that is regularly or customarily derived by the entity in the course of carrying on its business, arising out of no special circumstance or event. Similarly, the income is derived in the ordinary course of carrying on a business if the income although not regularly derived, is a direct result of the normal activities of the business.

26.   Therefore, according to the EM, income is derived in the ordinary course of carrying on a business where:

(a) the income is of a kind that is regularly or customarily derived by an entity in the course of carrying on its business, arising out of no special circumstance or unusual event; and

(b) the income, although not regularly derived, is derived as a direct result of the normal activities of the business.

Maximum net asset value test

27.   The term maximum net asset value test is defined in section 152-15 of the ITAA 1997 as follows:

You satisfy the maximum net asset value test if, just before the CGT event, the sum of the following amounts does not exceed $6,000,000:

(a) the net value of the CGT assets of yours;

(b) the net value of the CGT assets of any entities *connected with you;

(c) the net value of the CGT assets of any *affiliates of yours or entities connected with your affiliates (not counting any assets already counted under paragraph (b)).

28.   Section 152-20 of the ITAA 1997 sets out the meaning of net value of the CGT assets as follows:

The net value of the CGT assets of an entity is the amount (whether positive, negative or nil) obtained by subtracting from the sum of the market values of those assets the sum of:

(a) the liabilities of the entity that are related to the assets; and

(b) the following provisions made by the entity:

(i) provisions for annual leave;

(ii) provisions for long service leave;

(iii) provisions for unearned income;

(iv) provisions for tax liabilities.

Active asset test

29.   Section 152-35 of the ITAA 1997 outlines the active assets test, as follows in subsection 152-35(1):

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 specified in subsection (2); 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 7½ years during the period specified in subsection (2).

30.   Further, subsection 152-35(2) of the ITAA 1997 outlines that the period:

(a) begins when you acquired the asset; and

(b) 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.

31.   Section 152-40 of the ITAA 1997 outlines the meaning of active asset at subsection 152-40(1) as follows:

A CGT asset is an active assetat a time if, at that time:

(a) you own the asset (whether the asset is tangible or intangible) and it is used, or held ready for use, in the course of carrying on a business that is carried on (whether alone or in partnership) by:

(i) you; or

(ii) your affiliate; or

(iii) another entity that is connected with you; or

(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.

Affiliate

32.   Paragraph 152-47(2) of the ITAA 1997 outlines that in determining whether the business entity is an affiliate of, or is connected with, the asset owner, take the following to be affiliates of an individual:

(a) a spouse of the individual;

(b) a child of the individual, being a child who is under 18 years.

33.   Under section 328-130 of the ITAA 1997, an individual is an affiliate of yours if the individual acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the business of the individual.

34.   Relevant factors that may support a finding that a person acts in such a manner 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; and

•                     the actions of the parties.

35.   A spouse is not automatically your affiliate. However, where you own an asset that your spouse uses in a business they carry on as an individual, they will be taken to be your affiliate for the purposes of the active asset test and the aggregated turnover test under section 152-47 of the ITAA 1997.

36.   Paragraph 152-40(4A)(b) of the ITAA 1997 provides that to determine the main use of an asset, treat any use by your affiliate, or an entity that is connected with you, as your use. If an asset is used by the taxpayer's affiliate or an entity connected with the taxpayer, that use is treated as being the taxpayer 's use. This means that all the uses of the asset (except for personal use by the taxpayer, an affiliate or a connected entity) will be taken into account in determining the asset's main use.

Application to your circumstances

37.   For the purpose of this private ruling, a determination is to be made whether the property located at XXX satisfies the 'active asset test' for the CGT small business concessions pursuant to section 152.35 of the ITAA 1997 when the property is sold.

38.   In applying the criteria of Subdivision 152-A of the ITAA 1997 as authority, as outlined above in the 'Detailed Reasoning' section, the basic conditions as set out in subsection 152-10(1) of the ITAA 1997 will be assessed regarding the Applicant's circumstances.

39.   There are a number of basic conditions which must be satisfied for a capital gain to be reduced or disregarded under this Division.

40.   Firstly, pursuant to paragraph 152-10(1)(a), a CGT Event must have happened in relation to a CGT asset in the relevant income year. The property held by the Applicant satisfies the definition of a CGT asset as defined by paragraph 108-5(1)(a) of the ITAA 1997. When the property was sold by the Applicant on DD MM 20YY, the sale constituted a CGT Event A1 as described in Division 104 of the ITAA 1997. Therefore, the basic condition outlined in paragraph 152-10(1)(a) is satisfied.

41.   Secondly, pursuant to paragraph 152-10(1)(b), the CGT Event must have, apart from this Division, have resulted in the gain. The CGT Event A1, the sale of the property by the Applicant, did result in the gain by the taxpayer.

42.   Thirdly, pursuant to paragraph 152-10(1)(c), at least one of the following must apply for the basic conditions to be satisfied:

i.              Pursuant to subparagraph 152-10(1)(c)(i), the entity must be a CGT small business entity for the relevant income year;

ii.             Pursuant to subparagraph 152-10(1)(c)(ii), the entity must satisfy the maximum net asset value test;

iii.            Pursuant to subparagraph 152-10(1)(c)(iii), the entity must be a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership; or

iv.           Pursuant to subparagraph 152-10(1)(c)(iv), the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year.

43.   Addressing the criteria set out in subparagraph 152-10(1)(c)(i), the entity must be a CGT small business entity for the relevant income year. The Applicant carried on a business for the DD MM 20YY to DD MM 20YY financial year, their aggregated turnover for the 20YY financial year was $X and their aggregated turnover for the 20YY financial year was $X. The aggregated turnover amounts are less than the threshold amount of $2million, so the Applicant satisfies this criterion and is a CGT small business entity for the 20YY financial year.

44.   Addressing the criteria set out in subparagraph 152-10(1)(c)(ii), the entity must satisfy the maximum net asset value ('MNAV') test, by having the net value of all business assets not exceed $6million, just before the CGT Event. The Applicant's net value of all their business assets is approximately $X ($X vehicle and $X office assets). This amount falls well within the limit of $6million, so the Applicant satisfies this criterion and satisfies the MNAV test.

45.   As outlined in paragraph 152-10(1)(c) of the ITAA 1997, at least one of the four criteria need to be satisfied for the basic conditions for small business concessions to apply. The Applicant has satisfied two of the criteria as set out at subparagraphs 152-10(1)(c)(i) and 152-10(1)(c)(ii), so satisfies this requirement.

46.   Finally, pursuant to paragraph 152-10(1)(d), the CGT asset must satisfy the active asset test as outlined in section 152-35 of the ITAA 1997. To satisfy the active asset test, the CGT asset must have been owned for 15 years or less and was an active asset for a total of at least half of that period; or, the CGT asset must have been owned for more than 15 years and was an active asset for a total of at least 7.5 years during that period. To satisfy being an active asset, as outlined at section 152-40, the CGT asset must have been used, or held ready for use, in the course of carrying on a business.

47.   The Applicant satisfies these criteria as the property was used as the business premises in the carrying on of the Applicant's business. The property was purchased in MM 20YY by the Applicant and their partner as joint tenants, therefore the property has been owned for 15 years or less and was an active asset for a total of at least half of that period, so therefore satisfies the active asset test as set out at section 152-35 of the ITAA 1997.

48.   In accordance with paragraph 152-47(2)(a) of the ITAA 1997, the Applicant's spouse is taken to be the Applicant's 'affiliate', as their interest in the property was used in the course of carrying on a business by their spouse.

49.   Relevantly, on ato.gov.au, QC52285 provides the following:

Neither your spouse nor child (that is, your child under 18) is automatically your affiliate. You must consider whether they are acting according to your directions or wishes, or in concert with you, in relation to their business affairs.

However, where you own an asset that your spouse or child uses in a business they carry on as an individual, they will be taken to be your affiliate for the purposes of the:

•                     active asset test

•                     $6 million maximum net asset value test, and

•                     $2 million aggregated turnover test.

Your spouse or child may also be taken to be your affiliate where:

•                     an asset is owned by you and that asset is used in a business carried on by an entity that your spouse (or child) owns or has an interest in, or

•                     an asset is owned by an entity that you own or have an interest in, and that asset is used in a business carried on by your spouse (or child), or an entity that your spouse or child has an interest in.

Your spouse or child is treated as your affiliate when working out whether the entity that owns the asset is an affiliate of, or connected with, the entity that uses the asset in their business. If by treating your spouse or child as your affiliate the result is that the business entity is taken to be an affiliate of, or connected with, the entity that owns the asset, then the affiliate rule will also apply to treat the spouse or child as an affiliate of the individual for the purposes of the small business CGT concessions in relation to:

•                     all the basic conditions for eligibility, and

•                     calculating aggregated turnover and net asset value.

This rule only applies in relation to eligibility for the small business CGT concessions, and not the other small business entity concessions.

If this second stage of the affiliate rule applies, it will also apply for any gain that arises from any asset that either the asset owner or the business entity, or the individual or their spouse or child, owns. This affiliate rule works both ways, so that the individual is also taken to be an affiliate of their spouse or child. However, it only applies for as long as:

•                     the person is their spouse, or the child is under 18 years, and

•                     any asset is being passively held.

This affiliate rule for spouses and children also has application for the meaning of active asset.

This affiliate rule applies only if the business entity is not already an affiliate of, or connected with, the asset-owner.

50.   In conclusion, the property located at XXX owned by the Applicant satisfies the 'active asset test' for the CGT small business concessions pursuant to section 152-35 of the ITAA 1997 when the property is sold.

51.   Consequently, the Applicant will qualify for a small business concession to reduce their capital gain. Any capital gain may be disregarded as the basic conditions in Subdivision 152-A are satisfied, the CGT asset has been continuously owned for 15 years or less and was an active asset for a total of at least half of that period and the Applicant is aged over 55 years and the sale of the assets has occurred in connection with the Applicant's retirement.