Edited version of private advice

Authorisation Number: 1052112175181

Date of advice: 27 April 2023

Ruling

Subject: Capital gains tax and small business relief

Question 1

Are you eligible to claim the small business 50% reduction under section 152-205 of the Income Tax Assessment Act 1997 (ITAA 1997) to the capital gain realised on the disposal of a portion of your property?

Answer

Yes

Question 2

Are you eligible to claim the small business 50% retirement exemption under section 152-305 of the ITAA 1997 to the capital gain realised on the disposal of a portion of your property?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

01 July 20XX

Relevant facts and circumstances

1.            Coy A acquired a property in 20XX for $X.

2.            You own 100% of Coy A. The purchase was funded via a loan from your spouse and a loan from Coy B, a company owned and controlled by your spouse.

3.            Prior to the original acquisition of the property, you and your spouse sought specialist tax advice and, acting on that advice, purchased the property in the name of the company.

4.            Coy A commenced operating a primary production business and you and your spouse lived in the house on the property.

5.            An approach was made by another party (Person A) to acquire or lease a portion of the property.

6.            You and your spouse sought tax advice that resulted in the property being transferred to a new partnership (the partnership).

7.            On XX/XX/20XX an independent valuation was carried out on the property and was valued at $X.

8.            On XX/XX/20XX, a contract of sale for the property was entered into between Coy A and the partnership.

9.            The partnership paid the tax value of $ X and Coy A realised a capital loss on this sale of $X.

10.          The partnership continued to operate the primary production business.

11.          On XX/XX/20XX, a call option with Person A was entered into relating to a boundary adjustment between the 2 properties.

12.          A call option fee of $X was not receivable until after certain requirements were met and the call option fee was not returned as a capital gain made under CGT event D2 in either your or your spouse's relevant tax returns.

13.          The Person A's boundary adjustment application was approved by the local council, subject to certain conditions.

14.          The call option was exercised on XX/XX/20XX, that resulted in a sale contract being entered into with the Person A on the same date.

15.          A contract for the sale and purchase was entered into on XX/XX/20XX between the Person A and the partnership. The total amount paid for part of the property was $X.

16.          The amount of capital gain made by the partnership was $X.

17.          You have advised that you are a small business entity, as your aggregated turnover is less than $2 million.

18.          Following the transfer of the primary production business by Coy A to the partnership, the company's only source of income for the relevant income year was interest and dividends.

19.          Your spouse owns 100% of the issued capital of Coy B. During 20XX-20XX the company did not carry on any business activities and its sole source of income was interest and dividends.

20.          During 20XX-20XX, other than the primary production business operated by the partnership, no other business activities were carried on.

21.          Other than the entities mentioned above, you and your spouse are not connected to, nor are either of you affiliates of any other entity.

22.          At the time of lodging your 20XX tax return, you were over 55 years of age.

23.          You have not used the small business retirement exemption previously.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-5(1)

Income Tax Assessment Act 1997 subsection 104-10(1)

Income Tax Assessment Act 1997 subsection 104-10(3)

Income Tax Assessment Act 1997 section 104-40

Income Tax Assessment Act 1997 section 104-40(2)

Income Tax Assessment Act 1997 section 104-40(3)

Income Tax Assessment Act 1997 subsection 104-40(5)

Income Tax Assessment Act 1997 section 116-65

Income Tax Assessment Act 1997 section 134-1

Income Tax Assessment Act 1997 subsection 134-1(1)

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 subsection 152-10(1)

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 subparagraph 152-10(1)(c)(i)

Income Tax Assessment Act 1997 subsection 152-10(1AA)

Income Tax Assessment Act 1997 subsection 152-15

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)(a)

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

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

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

Income Tax Assessment Act 1997 Subdivision 152-C

Income Tax Assessment Act 1997 section 152-205

Income Tax Assessment Act 1997 subsection 152-210(1)

Income Tax Assessment Act 1997 Subdivision 152-D

Income Tax Assessment Act 1997 subsection 152-300

Income Tax Assessment Act 1997 subsection 152-305(1)

Income Tax Assessment Act 1997 subsection 152-310(1)

Income Tax Assessment Act 1997 paragraph 152-315(2)(a)

Income Tax Assessment Act 1997 subsection 152-320(1)

Income Tax Assessment Act 1997 subsection 328-110(1)

Income Tax Assessment Act 1997 subsection 328-115(1)

Income Tax Assessment Act 1997 subsection 328-120(1)

Income Tax Assessment Act 1997 section 328-125

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

Reasons for decision

All legislative references are to the ITAA 1997 unless otherwise stated.

Question 1

Are you eligible to claim the small business 50% reduction under section 152-205 to the capital gain realised on the disposal of a portion of their property?

Summary

You can choose to apply the small business 50% reduction, as the requirements in section 152-205 are satisfied.

Question 2

Are you eligible to claim the small business 50% retirement exemption under section 152-305 to the capital gain realised on the disposal of a portion of their property?

Summary

You can choose to apply the small business retirement exemption, as the conditions in subsection 152-305(1) are satisfied.

Detailed reasoning

Eligibility for small business relief

1.             An entity may choose to apply the small business relief set out in Division 152 to reduce or disregard a capital gain if the basic conditions set out in Subdivision 152-A are satisfied.

2.             Subsection 152-10(1) provides the basic conditions as follows:

(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 (see section 152-15);

                                                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 (see section 152-35)

Disposal of property - time of CGT event A1

3.             The partnership entered into a call option contract for sale with Person A, dated XX/XX/20XX, to affect a boundary adjustment between the two properties.

4.             CGT event D2 in section 104-40 happened when the call option was granted and a capital gain should have been returned when the option was granted. You advised no capital gain was returned by you, as the call option fee was not received until after council requirements were satisfied.

5.             The call option was exercised on XX/XX/20XX. Any capital gain or capital loss you make from the grant of the option is disregarded if the option is exercised. As you did not return any capital gain from the grant of the option, there is no amount of capital gain required to be disregarded,

6.             Section 134-1 sets out the consequences of an option that is exercised. As the call option was exercised, the property was required to be disposed to Person A. Item 1 in subsection 134-1(1) refers to section 116-65 which states that the capital proceeds for disposing the property includes any payment for granting the option.

7.             Where a call option is exercised, the CGT asset the subject of the option is disposed of by the grantor. CGT event A1 happens where a CGT asset is disposed of.[1] The event happens when a contract for disposal is entered into, or where there is no contract when the change of ownership occurs.[2]

8.             As the partnership entered into a sale contract on XX/XX/20XX, to dispose of part of the property to Person A, CGT event A1 happened when the sale contract was entered into. A capital gain was made from this disposal and the call option fee was included in working out the capital gain made. Therefore, the basic conditions in paragraphs 152-10(1)(a) and (b) will be satisfied.

CGT small business entity

9.             The third basic condition in paragraph 152-10(1)(c) requires the business to be a 'CGT small business entity'. You are a 'CGT small business entity' for an income year if:[3]

(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.

10.          You are a 'small business entity' for an income year (the current year) if: [4]

(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, and

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

11.          The partnership operated a primary production business on the property.

12.          The 'aggregated turnover' for an income year is the sum of the relevant annual turnovers.[5] The 'relevant annual turnovers' are you and your spouse's annual turnover for the income year plus the annual turnovers of any connected or affiliated entities of your and you spouse during the income year. An entity's aggregated turnover is the same as its annual turnover if there are no other entities connected with or affiliated with it.

13.          Section 328-125 provides 'control' tests which govern when an entity will be deemed to be 'connected with' another entity.

14.          Subsection 328-125(1) states:

An entity is connected with another entity if:

(a)          either entity controls the other 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.

15.          You are connected with Coy A. Your spouse is connected with Coy B. You have advised that neither you nor your spouse control or are affiliates with any other entity.

16.          The relevant annual turnover for the partnership consists of:

(a)          the partnership's annual turnover

(b)          Coy A

(c)           Coy B

(d)          your annual turnover, and

(e)          your spouse's annual turnover.

17.          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.[6]

18.          'Ordinary income' is defined in section 6-5 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.

19.          Neither Coy A nor Coy B carry on a business, therefore both of the company's annual turnover would be zero.

20.          You and your spouse do not carry on a business, therefore both individuals annual turnovers would be zero.

21.          The partnership's annual turnover for 20XX-20XX was $XX,XXX and $XX,XXX for 20XX-20XX.

22.          The partnership will therefore fall within the definition of a 'small business entity', and also fall within the definition of a 'CGT small business entity', as the aggregated turnover is less than $2 million. Consequently, the requirement in subparagraph 152-10(1)(c)(i) will be satisfied.

Active asset test

23.          The final basic condition in paragraph 152-10(1)(d) requires the property to satisfy the active asset test. A CGT asset is an active asset at a given time if, at that time:[7]

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

(i) you; or

(ii) your affiliate; or

(iii) another entity connected with you; or ....

24.          A CGT asset satisfies the active asset test if:[8]

(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 of ownership 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 for at least 7.5 years during the period specified in subsection (2).

25.          The period:[9]

(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.

26.          As the partnership carried on a business on the property, the property will meet the requirement to be an active asset.[10] As the partnership has owned the property for less than 15 years and has carried on the business for the entirety of the ownership period, the partnership will satisfy the active asset test[11] and therefore the final basic condition in paragraph 152-10(1)(d).

Conclusion on satisfying the basic conditions

27.          Based on the facts provided, all the basic conditions for small business relief in subsection 152-10(1) have been satisfied.

Subdivision 152-C - Small business 50% reduction

28.          You are entitled to the small business 50% reduction if the basic conditions in Subdivision 152-A are satisfied for the gain.[12]

29.          As the partnership satisfied all the basic conditions in subsection 152-10(1), you are eligible to the small business 50% reduction to reduce the amount of capital gain remaining after applying Step 3 of the method statement in subsection 102-5(1).

Subdivision 152-D Small business retirement exemption

30.          You may also be entitled to use the small business retirement exemption after applying the small business 50% reduction to further reduce the capital gain made from disposing of part of the property.[13]

31.          The small business retirement exemption is contained in Subdivision 152-D.

32.          According to section 152-300, you can choose to disregard a capital gain from a CGT event happening to a CGT asset of your small business if the capital proceeds from the event are used in connection with your retirement and there is a lifetime limit of $500,000 for all choices made in respect of an individual.

33.          Subsection 152-305(1) sets out the requirements for individuals who choose to apply the small business retirement exemption, and states:[14]

If you are an individual, you can choose to disregard all or part of a capital gain if:

(a) the basic conditions in Subdivision 152-A are satisfied for the gain; and

(b) if you are under 55 just before you make the choice - you contribute an amount equal to the asset's CGT exempt amount to a complying superannuation fund or an RSA; and

(c) the contribution is made:

(i) if the relevant CGT event is CGT event J2, J5 or J6 - when you made the choice; or

(ii) otherwise - at the later of when you made the choice and when you received the proceeds.

34.          As the basic conditions in Subdivision 152-A have been satisfied for the capital gain made on disposal of part of the property, and you are over 55 years of age at the time the choice is to be made, the requirements in subsection 152-305(1) will be satisfied, entitling you to choose to apply the small business retirement exemption.

35.          Where an individual makes the choice to apply the small business retirement exemption, the amount of capital gain chosen will be disregarded from your assessable income.[15]

36.          The choice made must be made in a way that ensures the individual does not exceed the CGT retirement exemption limit.[16]

37.          Subsection 152-320(1) states:

An individual's CGT retirement exemption limit at a time is $500,000 reduced by the CGT exempt amounts of CGT assets specified in choices previously made by or for the individual under this Subdivision.

38.          You have advised that they have not made a choice previously under this Subdivision.

39.          You are therefore entitled to choose to disregard the remaining amount of capital gain made up to the CGT retirement exemption limit of $500,000, after taking into account the steps in the method statement in subsection 102-5(1).

[1] Subsection 104-10(1)

[2] Subsection 104-10(3)

[3] Subsection 152-10(1AA)

[4] Subsection 328-110(1)

[5] Subsection 328-115(1)

[6] Subsection 328-120(1)

[7] Subsection 152-40(1)

[8] Subsection 152-35(1)

[9] Subsection 152-35(2)

[10] Paragraph 152-40(1)(a)

[11] Paragraph 152-35(1)(a)

[12] Section 152-205

[13] Subsection 152-210(1)

[14] Subsection 152-305(1)

[15] Subsection 152-310(1)

[16] Paragraph 152-315(2)(a)