Edited version of private advice

Authorisation Number: 1052115629739

Date of advice: 29 June 2023

Ruling

Subject: CGT - maximum net asset value test - total permanent disability

Question

Is the right to receive the permanent disability compensation a CGT asset to be included in the calculation for the maximum net asset value test in section 152-15 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes - the market value of the asset is to be distinguished from the compensation received with respect to the claim for compensation.

This ruling applies for the following period:

year ended 30 June XXXX

Relevant facts and circumstances

On [Contract Date], the Trustee for the Trust sold its 50% interest in a private company.

An entity 'connected with' (as defined in section 328-125 of the ITAA 1997) the Trust is an individual who made a Total and Permanent Disability Insurance claim and was assessed in relation to that claim as having a permanent disability from his occupation on [before the Contract date].By letter dated [after the Contract date] the insurer acknowledged that they had accepted the claim and paid the sum insured on that day.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 108-5

Income Tax Assessment Act 1997 subsection 108-5(1)

Income Tax Assessment Act 1997 subsection 108-5(2)

Income Tax Assessment Act 1997 section 152-15

Income Tax Assessment Act 1997 section 152-20

Income Tax Assessment Act 1997 subsection 152-20(1)

Income Tax Assessment Act 1997 subsection 152-20(2)

Income Tax Assessment Act 1997 subsection 152-20(3)

Income Tax Assessment Act 1997 subsection 152-20(4)

Income Tax Assessment Act 1997 section 152-78

Income Tax Assessment Act 1997 section 328-125

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

Income Tax Assessment Act 1997 subsection 328-125(3)

Income Tax Assessment Act 1997 subsection 328-125(4)

Income Tax Assessment Act 1997 subsection 960-100(1)

Reasons for decision

Summary

The 'maximum net asset value test' in section 152-15 of the ITAA 1997 is applied 'just before the CGT event' that resulted in the capital gain happened. To meet the test, the total net value of relevant CGT assets owned by you, entities connected with you, affiliates and entities connected with your affiliates must not exceed $6 million. In this case the individual is connected with the Trust and the right to the Total and Permanent Disability Insurance claim is an asset for which its market value is included in the calculation for the purposes of whether the 'maximum net asset value test' is met. The market value of the asset is to be distinguished from the amount of compensation received by the individual with respect to their claim for compensation.

Detailed reasoning

A basic condition for small business relief in Division 152 of the ITAA 1997 is that the maximum net asset value test in section 152-15 of the ITAA 1997 is satisfied.

Maximum net asset value test

Relevantly, the term 'maximum net asset value test' is defined in section 152-15 of the ITAA 1997 as:

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)).

Note 1:

Some assets are not included in the definition of net value of the CGT assets: see subsections 152-20(2), (3) and (4) .

Note 2:

The meaning of connected with is affected by section 152-78.

Relevantly, the term 'entity' is defined in subsection 960-100(1) of the ITAA 1997 to include 'an individual'.

Subsection 152-20(1) of the ITAA 1997 sets out the meaning of net value of the CGT assets as:

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.

Subsection 152-20(2) of the ITAA 1997 sets out the assets to be disregarded as:

In working out the net value of the CGT assets of an entity:

(a) disregard *shares, units or other interests (except debt) in another entity that is *connected with the first-mentioned entity or with an *affiliate of the first-mentioned entity, but include any liabilities related to any such shares, units or interests; and

(b) if the entity is an individual, disregard:

(i) assets being used solely for the personal use and enjoyment of the individual, or the individual's *affiliate (except a *dwelling, or an *ownership interest in a dwelling, that is the individual's main residence, including any adjacent land to which the main residence exemption can extend because of section 118-120); and

(ii) except for an amount included under subsection (2A), the *market value of a dwelling, or an ownership interest in a dwelling, that is the individual's main residence (including any relevant adjacent land); and

(iii) a right to, or to any part of, any allowance, annuity or capital amount payable out of a *superannuation fund or an *approved deposit fund; and

(iv) a right to, or to any part of, an asset of a superannuation fund or of an approved deposit fund; and

(v) a policy of insurance on the life of an individual.

Note:

The meaning of connected with is affected by section 152-78.

Subsection 328-125(1) of the ITAA 1997 relevantly provides that an entity is connected with another entity if:

(a) either entity controls the other entity 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.

There are different control tests in section 328-125 of the ITAA 1997 that apply depending on what type of entity is being tested.

Subsection 328-125(3) of the ITAA 1997 states that an entity (the first entity) controls a discretionary trust if the 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.

Alternatively, an entity (the first entity) can also control a discretionary trust under subsection 328-125(4) of the ITAA 1997, for an income year if, for any of the 4 income years before that year:

(a) the trustee of the trust paid to, or applied for the benefit of:

(i) the first entity; or

(ii) any of the first entity's *affiliates; or

(iii) the first entity and any of its affiliates; any of the income or capital of the trust; and

(b) the percentage (the control percentage) of the income or capital paid or applied is at least 40% of the total amount of income or capital paid or applied by the trustee for that year.

As per the facts provided, the individual is connected with the Trust just before the CGT event happened for the purposes of calculating the net value of the CGT assets of the Trustee under section 152-20 of the ITAA 1997.

Under subsection 108-5 of the ITAA 1997 a CGT asset is any kind of property or a legal or equitable right that is not property as follows:

108-5(1)

A CGT asset is:

(a) any kind of property; or

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

108-5(2)

To avoid doubt, these are 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).

Note 1:

Examples of CGT assets are:

•         land and buildings;

•         shares in a company and units in a unit trust;

•         options;

•         debts owed to you;

•         a right to enforce a contractual obligation;

•         foreign currency.

Note 2:

An asset is not a CGT asset if the asset was last acquired before 26 June 1992 and was not an asset for the purposes of former Part IIIA of the Income Tax Assessment Act 1936: see section 108-5 of the Income Tax (Transitional Provisions) Act 1997.

In Taxation Ruling TR 95/35 Income tax: capital gains: treatment of compensation receipts the Commissioner explains that the right to seek compensation is the right of action arising at law or in equity and vesting in the taxpayer on the occurrence of any breach of contract, personal injury or other compensable damage or injury. A right to seek compensation is an asset for the purposes of Part IIIA. The right to seek compensation is acquired at the time of the compensable wrong or injury, and includes all of the rights arising during the process of pursuing the compensation claim. The right to seek compensation is disposed of when it is satisfied, surrendered, released or discharged.

Relevantly, CGT event A1 happens if you dispose of a CGT asset (subsection 104-10(1) of the ITAA 1997):

SECTION 104-10 Disposal of a CGT asset: CGT event A1

104-10(1)

CGT event A1 happens if you *dispose of a *CGT asset.

104-10(2)

You dispose of a *CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner.

Note:

A change in the trustee of a trust does not constitute a change in the entity that is the trustee of the trust (see subsection 960-100(2) ). This means that CGT event A1 will not happen merely because of a change in the trustee.

104-10(3)

The time of the event is:

(a) when you enter into the contract for the *disposal; or

(b) if there is no contract - when the change of ownership occurs.

...

In this case the individual's right to enforce a contractual obligation under the insurance contract (i.e. the right to seek compensation with respect to their permanent disability) is the relevant CGT asset.

The sale of the Trustee of the Trust's 50% interest in the private company results in CGT event A1 happening at that time.

The individual has been assessed for the Total and Permanent Disability Cover and found to have a claim. The right to enforce a contractual obligation under the insurance contract is a CGT asset that was held by the individual just before the happening of CGT event A1.

It is noted that this right may not be capable of assignment, and this effects the market value of the asset (i.e. as a consequence, it may be nominal or negligible).

The right to enforce a contractual obligation with respect to the Total and Permanent Disability Cover is not an excluded asset pursuant to subsections 152-20(2) to (4) of the ITAA 1997. Therefore, the market value of the right to enforce a contractual obligation with respect to the individual's permanent disability is included in the calculation for the purposes of the 'maximum net asset value test' in section 152-15 of the ITAA 1997.