Edited version of private advice

Authorisation Number: 1052117739258

Date of advice: 31 May 2023

Ruling

Subject: CGT - small business concessions - 15-year exemption

Question

Does Subdivision 152-B of the Income Tax Assessment Act 1997 (ITAA 1997) apply to disregard the capital gain arising from the transfer of the land by Person A to the Landholding Trust?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2023

Year ended 30 June 2024

The scheme commenced on:

1 July 2022

Relevant facts and circumstances

The land to be transferred by Person A to the Landholding Trust comprises three lots. Person A acquired the first lot in 1990 and the second and third lots in 1995. The land has been used in a primary production business carried on in partnership between the following parties:

Table 1: Primary production business carried on in partnership between the following parties:

Operating Entity Pty Ltd was incorporated in 2017. Person A has been the sole director since incorporation with the sole shareholder being the Holding Trust (as distinct from the Landholding Trust). The turnover of Operating Entity Pty Ltd for the 2022 income year was less than $2m.

The Holding Trust is a discretionary trust established in 2017, of which Person A has always been the sole trustee.

It is proposed that the land will be transferred from Person A to the Landholding Trust for consideration equal to the current market value of the land. The Landholding Trust is a discretionary trust established in 1995, of which Person A is the sole trustee.

It is also proposed that the Landholding Trust will borrow from the bank for the acquisition of the land with the balance to be funded by a loan from Person A to the trust.

When Person A receives the funds from the Landholding Trust at settlement they will contribute these funds to a self managed superannuation fund of which they are a member.

Person A is over 55 years of age, and intends to retire in the next few months, at which time the land, together with other land held by the Landholding Trust will be leased to an unrelated party. Having the properties owned by the Landholding Trust will allow distributions to be made to Person A, their current partner and other family members.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 section 152-10

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

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

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

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 Subdivision 152-B

Income Tax Assessment Act 1997 section 152-105

Income Tax Assessment Act 1997 Subdivision 328-C

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(2)

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

Income Tax Assessment Act 1997 subsection 328-125(7)

Reasons for decision

Section 152-105 of the ITAA 1997 provides that if you are an individual, you can disregard any capital gain arising from a CGT event if all of the following conditions are satisfied:

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

(b)  you continuously owned the CGT asset for the 15-year period ending just before the CGT event;

(c)   if the CGT asset is a share in a company or an interest in a trust - the company or trust 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 you owned the CGT asset;

(d)  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.

Subsection 152-10(1) of the ITAA 1997 provides that a capital gain ... you make 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) of the ITAA 1997 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.

Subsection 152-10(1AA) of the ITAA 1997 provides that 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.

Subsection 152-40(1) of the ITAA 1997 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.

Subsection 152-35(1) of the ITAA 1997 provides that 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).

Subsection 152-35(2) of the ITAA 1997 provides 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.

Establishing control

Subsection 328-125(1) of the ITAA 1997 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.

The Explanatory Memorandum to the Tax Laws Amendment (2013 Measures No. 1) Act 2013 discusses that, by virtue of the amendments made by this Act, to satisfy section 328-125(2) of the ITAA 1997 (about direct control of entities other than discretionary trusts) it is not necessary that shares in a company be held beneficially to establish control:

1.14 These amendments ensure that the connected entity and stakeholder tests apply having regard only to the legal ownership of the relevant interests, rather than to who benefits from the ownership. As a result, the tests apply to interests held by life insurance companies, superannuation funds and trusts in the same way that they apply to other types of entities. [Schedule 1, items 1 to 4, 7 and 8, paragraphs 124-783(6)(b) and (c), note in subsection 124-783(6), subsection 124-783(7), paragraphs 124-783(9)(b) and (c), and (10)(a) and (b), 328-125(2)(a) and (b), and 328-125(8)(e)]

Direct control of a discretionary trust

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.

Direct control of an entity other than a discretionary trust

Subsection 328-125(2) of the ITAA 1997 provides that an entity (the first entity) controls another entity if the first entity, its affiliates, or the first entity together with its affiliates:

(a)  except if the other entity is a discretionary trust - own, or have the right to acquire the ownership of, interests in the other entity that carry between them the right to receive a percentage (the control percentage) that is at least 40% of:

(i)    any distribution of income by the other entity; or

(ii)   if the other entity is a partnership - the net income of the partnership; or

(iii)  any distribution of capital by the other entity; or

(b)  if the other entity is a company - own, or have the right to acquire the ownership of, equity interests in the company that carry between them the right to exercise, or control the exercise of, a percentage (the control percentage) that is at least 40% of the voting power in the company.

Indirect control of an entity

Subsection 328-125(7) of the ITAA 1997 provides that this section applies to an entity (the first entity) that directly controls another entity (the second entity) as if the first entity also controlled any other entity that is directly, or indirectly by any other application or applications of this section, controlled by the second entity.

In connection with retirement

As noted above, to disregard a capital gain under the 15-year exemption in Subdivision 152-B of the ITAA 1997, paragraph 152-105(d) requires that either you are 55 or over at the time of the CGT event and the event happens in connection with your retirement; or you are permanently incapacitated at the time of the CGT event.

The Explanatory Memorandum to the New Business Tax System (Capital Gains Tax) Bill 1999 makes the following comments about the requirement to be permanently incapacitated, or retiring, as one of the conditions for the concession:

Requirement to be permanently incapacitated or retiring

1.68 One of the requirements of this concession for an individual small business taxpayer is that they must be either permanently incapacitated at the time of the CGT event, or at least 55 years old and using the capital proceeds for their retirement.

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 is not 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. Whether particular cases satisfy the conditions depends very much on the facts of each case.

Application to your circumstances

Person A is over 55 and is planning to retire in the next few months, at which time the land, together with other land held by the Landholding Trust, will be leased to an unrelated party. The land was used in the partnership of Person A and their former spouse from 2001 to 2015, satisfying the active asset test. Person A will contribute proceeds from the sale of the land to their self managed superannuation fund; further, the income stream from the leasing of the land will also provide for their retirement.

Person A, as sole trustee of the Holding Trust, controls the trust because the trust could reasonably be expected to act in accordance with the directions or wishes of Person A as trustee. The Holding Trust holds all shares non-beneficially in Operating Entity Pty Ltd, and therefore the Holding Trust controls Operating Entity Pty Ltd. Person A is considered to control, and therefore be connected with, Operating Entity Pty Ltd.

Person A does not carry on business alone or in partnership. Operating Entity Pty Ltd is the CGT small business entity carrying on business in the relation to the CGT asset, being the land; and Operating Entity Pty Ltd is connected to Person A. Operating Entity Pty Ltd has turnover of less than $2 million.

Conclusion

The relevant provisions in Divisions 152 and 328 of the ITAA 1997 are satisfied such that Person A can disregard the capital gain made from the transfer of the land to the Landholding Trust by way of the small business 15-year exemption.