Edited version of private advice

Authorisation Number: 1052091176773

Date of advice: 24 February 2023

Ruling

Subject: CGT - small business concessions

Question 1

Did Person A control the Trust within the meaning of subsection 328-125(3) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes, Person A controlled the Trust within the meaning of subsection 328-125(3) of the ITAA 1997.

Question 2

If the answer to Question 1 is Yes, will the Trust be eligible for the 15 year exemption to disregard the capital gain on the sale of the licences?

Answer

Yes, the Trust is eligible for the 15 year exemption to disregard the capital gain on the sale of the licences.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

The Asset Trust ("the Trust") was settled pre-CGT. The Trust is a discretionary trust.

The Trustee is Trustee Pty Ltd which was incorporated pre-CGT. Currently the directors of the Trustee company are Persons A, B and C. Person C is the parent of Persons A and B.

Person C was the Appointor and Guardian of the Trust when the Trust was established. There have been a series of amendments to the Trust Deed, including a change of the Appointor and variations to amend succession to the Guardian, as part of family succession. In the last amendment to the Trust Deed, Persons A and B were appointed as joint Appointors of the Trust.

The Trust owned two main assets, being a pre-CGT farm, and licences which were acquired post-CGT. The Trust carried on its business from the 19XXs to the 20XXs and used the licences in its business for that period.

After the Trust ceased business in the 20XXs, the licences were used by the Person A Family Trust in carrying on a business of the same activity. There was no lease agreement in place between the Trust and Person A Family Trust and no lease fees were paid to the Trust.

Person A Family Trust is a discretionary trust established in 19XX. This family trust was controlled by Person A, who is the Guardian and Appointor of this trust. The trustee is Second Trustee Pty Ltd. Person A and spouse are directors and equal shareholders of Second Trustee Pty Ltd.

The annual turnover of Person A Family Trust for the 20XX income year was under $2 million.

The farmland owned by the Trust has been leased out by Person B's related entity. There were no lease fees paid to the Trust. Person B has full control of how the farm was used.

Person B operates separate businesses through two related entities which both had an annual turnover of under $2 million in the 20XX income year. These entities are controlled by Person B.

There are no other entities related to the Trust or the family group that are carrying on a business.

Person C initially financed the purchase of the licences and the farm for Persons A and B. The farm was purchased for Person B and the licences were purchased for Person A. For asset protection purposes these assets were held in the Trust.

As Persons A and B made profits from their respective businesses, they repaid the money to Person C for the purchase of the farm and licences. As the loans were repaid, Persons A and B had full control of how each of the assets were used.

This arrangement continued until the previous year when legal advice was received that the Trust Deed for the Trust did not allow for a replacement of Guardian, being Person C, and that no distribution of trust property could be made by the Trust after the Guardian's death.

Based on this advice, Persons A and B each made their own choice as to what they wanted to do with the assets held in the Trust. Person A decided to sell the licences and wanted to retire as they were approaching retirement age.

Person A conducted all negotiations and made decisions on the sale of licences. Under the direction of Person A, the Trustee entered into a sale contract in 20XX to sell the licences. Settlement occurred in the 20XX financial year.

The settlement proceeds from the sale were initially banked into the Trust's bank account. The net settlement proceeds, after repayments of certain loans and unpaid present entitlements to the beneficiaries, were paid to Person A a few days after settlement.

The Trust did not make a trust distribution of income or capital between 20XX and 20XX as the Trust had no trust income and made losses during this period. The Trust made a trust distribution of income including the capital gain on the sale of the licences to Person A and spouse equally for the 20XX income year.

The Person A Family Trust operated the business until the sale of the licences by the Trust in 20XX. The Person A Family Trust ceased to operate the business after the licences were sold.

Person A has retired after the sale of the licences. They were aged XX at the time of the CGT event, when the contract of sale of the licences was entered into.

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 152-55

Income Tax Assessment Act 1997 section 152-65

Income Tax Assessment Act 1997 section 152-70

Income Tax Assessment Act 1997 section 152-75

Income Tax Assessment Act 1997 section 152-110

Income Tax Assessment Act 1997 subsection 328-152(3)

Reasons for decision

Subsection 328-125(3) of the ITAA 1997 provides that an entity (the first entity) controls a discretionary trust if a trustee of the trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the first entity, its affiliates, or the first entity together with its affiliates.

The Explanatory Memorandum to the Tax Law Amendment (Small Business) Bill 2007 provides guidance in relation to determining control under subsection 328-125(3) of the ITAA 1997:

2.52 Whether a trustee is accustomed or might reasonably be expected to act in accordance with the directions or wishes of another, is determined having regard to all the circumstances of the case. For example, the mere presence in the trust deed of a requirement that the trustee should have no regard to such directions or wishes would not prevent the examination of the actual circumstances to determine whether an entity controls the trust.

2.53 Some factors which might be considered include:

•         the way in which the trustee has acted in the past;

•         the relationship between the entities and the trustee;

•         the amount of any property or services transferred to the trust by the entities; and

•         any arrangement or understanding between the entities and a person or persons who have benefited under the trust in the past.

Section 152-110 of the ITAA 1997 provides that an entity that is a ... trust can disregard any capital gain arising from a capital gains tax (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.

Section 152-10 of the ITAA 1997 provides the basic conditions for small business relief. Subsection 152-10(1) provides that a capital gain ... may be reduced or disregarded under this Division if the following basic conditions are satisfied for the gain:

(a)  a CGT event happens 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

                    iii.        you are a partner in a partnership that is a CGT small business entity for the income year and the CGT asset is an interest in 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.

Subsection 152-10(1A) provides that the conditions in this subsection 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 CGT 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 CGT 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.

Section 152-40 of the ITAA 1997 provides the meaning of active asset. Subsection 152-40(1) provides that a CGT asset is an active asset at 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.

Section 152-35(1) of the ITAA 1997, 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 7 ½ years during the period specified in subsection (2).

Section 152-55 of the ITAA 1997 provides that an individual is a significant individual in a company or a trust at a time if, at that time, the individual has a small business participation percentage in the company or trust of at least 20%. Section 152-65 provides that an entity's small business participation percentage in another entity at a time is the percentage that is the sum of:

(a)  the entity's direct small business participation percentage in the other entity at that time; and

(b)  the entity's indirect small business participation percentage in the other entity at that time.

Direct and indirect small business participation percentages are defined in subsections 152-70 and 152-75 of the ITAA 1997 respectively.

In the case of a discretionary trust, an entity's direct small business participation percentage in the trust is:

•         if the trustee makes distributions of income during the income year, the percentage of the distribution to which the entity was beneficially entitled; or

•         if the trustee makes distributions of capital during the income year, the percentage of the distributions to which the entity was beneficially entitled;

or, if the two percentages are applicable, the smaller.

Subsection 152-70(4) of the ITAA 1997 provides that subsections (5) and (6) apply for the purpose of working out the direct small business participation percentage in an entity in connection with a CGT event that happened in an income year (the CGT event year), if:

(a)  the entity is a trust (where entities do not have entitlements to all the income and capital of the trust); and

(b)  during the relevant year mentioned in item 3 of the table in subsection (1) (disregarding subsection (5)), the trustee mentioned in that item:

                      i.        does not make a distribution of income; and

                     ii.        does not make a distribution of capital.

Subsection 152-70(5) provides that you treat the references in that item to the relevant year as being references to:

(a)  if the trustee made a distribution of income or capital during the CGT event year - the CGT event year; or

(b)  otherwise - the last income year before the CGT event year in which the trustee did make a distribution of income or capital.

Application to your circumstances

Person A controlled the use and application of the major asset of the Trust, being the licences. The asset had been used by the Person A Family Trust in carrying on its business since the 20XXs. There was no lease agreement in place and there were no lease fees paid to the Trust for the use of its asset by Person A Family Trust. This indicates that there was no formal agreement and the Trustee acted in accordance with the direction of Person A.

The directors of the Trustee company are family members. There was a close family relationship between them. There was an understanding that the Trustee acted based on their close family relationship rather than any formal agreement. This indicates that the Trustee would be expected to act in accordance with the direction of Person A.

There was an arrangement between the family members that Person A had full control and enjoyment of the licences and that Person A had the capacity to deal with the asset in whichever way they wish. The arrangements between the parties indicate that the Trustee acted in accordance with the directions of Person A.

The sale of the licences was a major decision concerning the Trust's affairs. The decision was made in pursuit of Person A's own business and personal goals. Person A made the decisions to sell the licences and conducted all the negotiations on the sale. The Trustee executed the sale contract under the direction of Person A.

Person A is the ultimate beneficiary who benefited from the asset of the Trust, as the net proceeds were paid to them. This decision concerning the Trust's affairs was made by Person A. This indicates that the Trustee acted in accordance with the directions of Person A.

Accordingly, it is considered that Person A controlled the Trust within the meaning of subsection 328-125(3) of the ITAA 1997 for the 20XX income year.

The Trust was not a CGT small business entity for the 20XX income year. The Trust did not pass the $6 million net asset value test. As such, for the Trust to satisfy the relevant conditions and eligibility for the 15 year exemption, the passively held assets rule in subsection 152-10(1A) of the ITAA 1997 must be satisfied.

Person A controls the Person A Family Trust as they are the controller and decision maker concerning this family trust's affairs. Person A controls their family trust within the meaning of subsection 328-125(3) of the ITAA 1997.

As Person A controls both the Trust and the Person A Family Trust, the Person A Family Trust is a connected entity of the Trust.

The Person A Family Trust had an aggregated turnover for the 20XX income year of less than $2 million. The Person A Family Trust carried on a business during the 20XX income year until the licences were sold in December 20XX. As such, the Person A Family Trust is a CGT small business entity for the 20XX income year.

The Trust did not carry on a business in the 20XX income year. The licences were used in carrying on a business by the Person A Family Trust which was a CGT small business entity for the 20XX income year.

The licences, acquired post-CGT, were intangible assets used by the Trust in carrying on a business from the 19XXs until the 20XXs. The licences were then used by the connected family trust in carrying on its business from the 20XXs until the Trust sold the asset in December 20XX. The Trust owned the licences for a continuous period of more than 15 years.

The Trust did not make any distributions of income or capital between 20XX and 20XX because it did not have trust income and had tax losses.

The Trust made a distribution of income to Person A and spouse equally in the year of the CGT event. The rules in subsections 152-70(4) and (5) apply to treat Person A and spouse as having a small business participation percentage in the Trust of 50% each in those earlier loss years where no trust distributions were made. As such, the Trust has a significant individual for at least 15 years.

Person A decided to sell the licences as they wished to retire. The business operated by the family trust ceased after the licences were sold. The net sale proceeds were made to Person A to fund their retirement. The sale of licences was an integral part of Person A's retirement plan. The CGT event happened in connection with the significant individual's retirement.

The Trust is eligible for the 15 year exemption. As a result, the entire capital gain on the sale of the licences can be disregarded.