Edited version of private advice

Authorisation Number: 1052118989563

Date of advice: 25 May 2023

Ruling

Subject: CGT - partial main residence exemption and small business concessions

Question 1

Are you entitled to a partial main residence exemption in relation to the disposal of the Property under subsection 118-190 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will any capital gain on the sale of the Property be a discount capital gain with a discount amount of 50% under Division 115 of the ITAA 1997?

Answer

Yes.

Question 3

Will you satisfy the basic conditions under Subdivision 152-A of the ITAA 1997 for small business relief upon the sale of the Property?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You purchased a business with your former spouse more than 25 years ago. You ran the business in partnership with your former spouse (the Business).

You initially leased the Property for use in the Business for the first two years of operation before purchasing the Property with your former spouse and continuing to use it in the Business.

The Property consists of two levels. The ground level used for the Business, contains a commercial premises providing the street frontage in a commercial business area. There is a residence on the upper level.

You have been living upstairs in the Property as your main residence since the time of purchase.

After more than 10 years of operating the Business and also owning the Property, you removed yourself from the Business due to the breakdown of your marriage.

A short time later your former spouse's share of the Property was transferred into your name as part of a divorce settlement.

After this time, you leased out the ground level commercial premises, while continuing to reside on the upper level.

The commercial premises and upstairs residence each have approximately the same floor area.

The net value of the assets you own is less than $X million and you are not connected to or affiliated with any business entities.

You are over 55 years old.

You intend on selling the Property and will make a capital gain from the sale.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 118-110

Income Tax Assessment Act 1997 section 118-190

Income Tax Assessment Act 1997 Division 115

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 subsection 152-40(1)

Income Tax Assessment Act 1997 subsection 152-40(4)

Income Tax Assessment Act 1997 section 152-205

Income Tax Assessment Act 1997 section 152-305

Reasons for decision

Question 1

Main residence exemption

Section 102-20 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a taxpayer makes a capital gain or loss as a result of a capital gains tax (CGT) event happening to a CGT asset. CGT assets include real estate acquired on or after 20 September 1985.

Section 118-110 of the ITAA 1997 provides that you can disregard a capital gain or capital loss made from a CGT event that happens to a dwelling that is your main residence. To qualify for full exemption, the dwelling must have been your main residence for the whole period you owned it and must not have been used to produce assessable income.

For the purposes of the main residence exemption, a dwelling includes a unit of accommodation that is a building, or is contained in a building, and consists wholly or mainly of residential accommodation, a unit of accommodation that is a caravan, houseboat or other mobile home, and any land immediately under the unit of accommodation (section 118-115 of the ITAA 1997).

Section 118-190 of the ITAA 1997 outlines that taxpayer's will only get a partial exemption for a CGT event that happens in relation to their ownership interest in a dwelling if:

•         the dwelling was acquired after 20 September 1985, and it was used as the taxpayer's main residence,

•         the taxpayer used any part of the dwelling to produce income during all or part of the period they owned the dwelling; and

•         the taxpayer would have been allowed a deduction for interest incurred in relation to money borrowed to acquire the dwelling if they had incurred it (interest deductibility test).

In your case, you cannot claim the full main residence exemption, as part of the dwelling has been used to produce assessable income. Therefore, in accordance with section 118-190 of the ITAA 1997, you are entitled to a partial main residence exemption. You will need to calculate this on a reasonable basis taking into account your use of the property for both main residence and income producing purposes. Apportioning on the basis of the floor area used for each purpose is appropriate in most cases as set out in paragraph 4 of Taxation Determination TD 1999/66 Income tax: capital gains: what factors should be taken into account in determining the 'amount that is reasonable' in applying subsection 118-190(2) of the Income Tax Assessment Act 1997?

Question 2

Discount capital gains

Division 115 of the ITAA 1997 provides the conditions for a discount capital gain.

You make a discount capital gain if the following requirements are satisfied:

•         you are an individual

•         a CGT event happens to a CGT asset of yours after 11:45am (by legal time in the Australian Capital Territory) on 21 September 1999

•         you acquired the CGT asset at least 12 months before the CGT event, and

•         you do not choose to use the indexation method.

For Australian resident individuals the discount percentage is 50%. However, you can only reduce your capital gain after applying all your capital losses for the year and any unapplied net capital losses from earlier years.

In your case, you meet all of the above conditions and therefore are entitled to reduce your capital gain using the discount method under Division 115 of the ITAA 1997.

Question 3

Basic conditions for the small business concession

Section 152-10 of the ITAA 1997 provides the basic conditions that need to be met to apply the small business CGT concessions.

Subsection 152-10(1) of the ITAA 1997 states that a capital gain that you make may be reduced or disregarded under Division 152-A of the ITAA 1997 if the following basic conditions are satisfied:

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

(b)  the event would have resulted in a gain

(c)   at least one of the following applies

                    (i)        you are a 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 small business entity for the income year and the CGT asset is an interest in an asset of the Partnership

                  (iv)        you do not carry on a business, but your CGT asset is used in a business carried on by a small business entity that is your affiliate, or an entity connected with you (passively held assets as outlined in subsections 152-10(1A) and 152-10(1B) of the ITAA 1997), and

(d)  the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997.

Maximum net asset value test

You satisfy the maximum net asset value test if the total net value of CGT assets owned by certain entities does not exceed $6 million just before the CGT event that results in the capital gain for which the concessions are sought. You must include the net value of CGT assets owned by:

• you
• any entities connected with you
• any of your affiliates and entities connected with your affiliates.

This figure includes the net value of assets of your affiliates, and entities connected with your affiliates, only if the assets are used, or held ready for use, in a business carried on by you or an entity connected with you. However, you don't include an asset if it is used in the business of an entity that is connected with you only because of your affiliate.

You have advised that the value of CGT assets you own is less than $6 million. As you are separated from your spouse, they are not deemed to be an affiliate of yours and you have no other affiliates or connected entities. Based on this information, you satisfy the maximum net asset value test for the purpose of accessing the CGT small business concessions.

Active asset test

The active asset test is satisfied if:

• 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 test period detailed below, or
• 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 7.5 years during the test period.

The test period:

•         begins when you acquired the asset, and

•         ends at the earlier of

o   the CGT event, and

• when the business ceased, if the business in question ceased in the 12 months before the CGT event (or such longer time as the Commissioner allows).

The asset does not need to be an active asset just before the CGT event.

Under subsection 152-40(1) of the ITAA 1997, a CGT asset is an active asset if it is owned and used, or held ready for use, by you, your affiliate or another entity that is connected with you in the course of carrying on a business that is carried on (whether alone or in partnership).

However, subsection 152-40(4) of the ITAA 1997 lists CGT assets that cannot be active assets. Most relevantly to real property, a CGT asset whose main use is to derive rent cannot be an active asset unless the main use for deriving rent was only temporary.

It is acknowledged that the definition of active asset does not require exclusive use of the asset for business purposes. However, in Rus and FCT [2018] AATA 1854; 108 ATR 212, the taxpayers purchased a 16-hectare and used a minor portion to carry on a plastering/housing construction business, however, the majority of the business activities were conducted off site.

On review the AAT found that having regard to the nature of the CGT asset, the nature of the business and the relationship between the CGT asset and that business, it could not be said that the CGT asset was used in the course of carrying on the business.

If you were a transferee of a CGT asset as a result of a result of a marriage or relationship breakdown, subsection 152-45(2) of the ITAA 1997 allows you to choose that the active asset test in section 152-35 of the ITAA 1997 applies as if:

(a)  you had acquired the asset when the transferor acquired the asset; and

(b)  the asset had been an active asset of yours at all times when the asset was an active asset of the transferor; and

(c)   the asset had not been an active asset of yours at all times when the asset was not an active asset of the transferor.

During the period that you used the Property in your business you also use the upper level for your main residence. However, your circumstances were distinct from those in Rus. The nature of the Property is predominantly commercial in nature with street frontage in a commercial business area. We note also that the Business was carried on exclusively from the Property. Despite your use of the Property as your main residence, for the purpose of the active asset test, we are satisfied that Property was used in the course of carrying on the business.

You held your original 50% in the Property since X April 19XX, a period of more than 15 years. This interest was used in the Business you carried on in partnership from 19XX until 20XX a period of more than 7 1/2 years. Therefore, the active asset test in 152-35 of the ITAA 1997 is satisfied for your original interest in the Property.

You didn't own the 50% remaining interest in the Property during the time it was used by you to carry on the Business in partnership. However, by using the choice available in subsection 152-45(2) of the ITAA 1997, for the purpose of the active asset test, you can treat the Property as if it had been:

•         acquired by you when your former spouse acquired the asset in 19XX (providing an ownership period of more than 15 years), and

•         an active asset of yours at all times when the asset was an active asset of your former spouse (from 19XX until 20XX - a period of more than 7 1/2 years).

As a result of utilising this choice the interest acquired from your former spouse will also satisfy the active asset test in section 152-35 of the ITAA 1997.

You satisfy the basic conditions under Subdivision 152-A of the ITAA 1997 for small business relief upon the sale of the Property. Consequently, you are entitled to further reduce the discounted capital gain using the small business 50% asset reduction. Further to this, as you are over 55 years of age, you can disregard any remaining gain under the small business retirement exemption up to a lifetime limit of $500,000.