Edited version of private advice

Authorisation Number: 1052121762369

Date of advice: 23 May 2023

Ruling

Subject: CGT - small business concessions

Question

Did the Taxpayer's obligation to make redundancy payments to employees constitute a liability of the Taxpayer for the purposes of paragraph 152-20(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) at the time just before the CGT event?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 20XX

Relevant facts and circumstances

The Taxpayer carried on a business as a XXXXX (the Business). It manufactured XXXX parts for certain industries such as mining, quarrying, brick making, water pumping etc. by sourcing and melting iron/steel scrap, alloying the materials and then pouring it into the moulds.

The Business was conducted from the premises at the Property, which was also owned by the Taxpayer.

The Taxpayer attempted to sell both the Business and the Property but had difficulties selling the Business. A business broker tried to sell the business for several months, but a sale did not eventuate.

Accordingly, the Taxpayer decided to cease the Business and sell the Property.

The timeline for the cessation of the business was as follows:

Table 1: Timeline for the cessation of the business

The resolution to cease the Business and only sell the Property was recorded in minutes of meeting of the board of directors of the Taxpayer dated XX March 20XX.

The Contract of Sale entered into by the Taxpayer on XX April 20XX for the disposal of the Property gave rise to CGT event A1 on that date (the CGT event) pursuant to section 104-10 of the ITAA 1997.

The Taxpayer had XX employees, all employed pursuant to employment contracts, XX of whom were covered under the terms of the Enterprise Agreement 2021 (EA) and 5 of whom were covered by the obligations on the termination of the employment of an employee provided for in the National Employment Standards (NES) under the Fair Work Act 2009 (FWA).

The redundancy entitlements contained in the EA are more beneficial than those provided for in the NES of the FWA. All XX employees were paid redundancy entitlements equivalent to the provisions contained in the EA. The Taxpayer has received legal advice advising there would be a strong likelihood, that if challenged, a court would find that the X employees not covered by the EA had an implied contractual entitlement to redundancy pay calculated on the same basis as the EA.

As a result of ceasing the Business, the Taxpayer incurred a liability to make redundancy payments to employees in the order of $XXX.

A portion of this liability, totalling $XXX, was paid on XX June 20XX. The balance, totalling $XXX, was outstanding as at 30 June 20XX, recorded as a current liability of the Taxpayer in its balance sheet for the 20XX income year, and paid over July ($XXX), August ($XXX) and September ($XXX) 20XX.

All redundancy payments were funded from the cash of the Taxpayer, the source of which related to a number of CGT assets of the Taxpayer at the time, i.e. cash assets, receivables, inventory and the sale of assets, including the Property.

The following clauses in the EA and in the NES in the FWA are relevant to redundancy payments:

...

Relevant legislative provisions

Income Tax Assessment Act 1997 section104-5

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 paragraph 104-10(3)(a)

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 paragraph 152-10(1)(c)

Income Tax Assessment Act 1997 subparagraph 152-10(1)(c)(ii)

Income Tax Assessment Act 1997 section 152-15

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

Income Tax Assessment Act 1997 paragraph 152-20(1)(a)

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)

Reasons for decision

All subsequent legislative references are to the ITAA 1997.

Subdivision 152-A sets out the 'basic conditions' which must be satisfied in order for entities to qualify for any of the CGT small business concessions to reduce their capital gain pursuant to one or more of the various concessions in Division 152.

One of the basic conditions which must be satisfied is that at least one of the items in paragraph 152-10(1)(c) applies. One of the items, at subparagraph 152-10(1)(c)(ii), is that the maximum net asset value (MNAV) test in section 152-15 is satisfied by the entity that has made the capital gain.

An entity satisfies the MNAV test if, just before the CGT event, the sum of the net value of the CGT assets of the entity, the net value of the CGT assets of any entities connected with the entity and the net value of the CGT assets of any affiliates of both the entity and entities connected with the entity's affiliates does not exceed $6 million (section 152-15).

The meaning of 'net value of the CGT assets' of an entity is provided for in subsection 152-20(1), and is subject to subsections 152-20(2) to (4) which disregard certain assets from the net value of the CGT assets of an entity. Subsection 152-20(1) states:

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; and

(iv) provisions for tax liabilities.

Therefore, in order to determine whether the Taxpayer's obligation to make redundancy payments to its employees upon the cessation of its Business constituted a liability of the Taxpayer just before the CGT event for the purposes of paragraph 152-20(1)(a), it is necessary to consider whether, at that time, the redundancy payments made were both liabilities of the Taxpayer for these purposes and related to the CGT assets of the Taxpayer which are included in the MNAV calculation.

'Just before the CGT event'

The reference to 'just before the CGT event' in section 152-15 refers to just before the time of the CGT event, as set out in column 2 of the table in section 104-5 for each CGT event, rather than just before the CGT event happens (see ATO ID 2003/744.[1])

In the context of a CGT event A1 under section 104-10 relating to a disposal subject to a contract, 'just before the CGT event' in section 152-15 is therefore taken to be just before the time of entering into the contract for the disposal of the CGT asset (paragraph 104-10(3)(a)), as opposed to just before the time when there is a change of ownership of the CGT asset from one entity to another.

Meaning of 'liabilities'

The term 'liabilities' is not defined for the purposes of the 'net value of the CGT assets' definition butTaxation Determination TD 2007/14[2] (TD 2007/14) provides guidance on the term 'liabilities' in the context of subsection 152-20(1).

Paragraph 1 of TD 2007/14 provides:

The term 'liabilities' in the context of subsection 152-20(1) of the Income Tax Assessment Act 1997¹ has its ordinary meaning. 'Liabilities' extend to legally enforceable debts due for payment and to presently existing legal or equitable obligations to pay either a sum certain or ascertainable sums. It does not extend to future obligations, expectancies or liabilities that are uncertain as both a theoretical and a practical matter (Commissioner of Taxation v. Byrne Hotels Qld Pty Ltd [2011] FCAFC 127 at 122) (Byrne Hotels).

Paragraph 19G of TD 2007/14 references the Full Federal Court decision in Byrne Hotels and confirms that a liability in the context of subsection 152-20(1) could include a presently existing legal or equitable obligation where the only contingency is enforcement or an obligation that is technically, but not 'truly', contingent because the contingencies are formalities or procedural matters where nothing remains to be done by the relevant party to perfect its entitlement. Such liabilities are distinguishable from 'truly contingent' liabilities in the sense of a future or potential obligation, expectancy, or liability that is otherwise uncertain as a theoretical and practical matter, and will not be included as a liability for the purposes of subsection 152-20(1).

Liabilities that are 'related to' the assets

At paragraphs 21 and 22 of TD 2007/14, the Commissioner explains that, for the purposes of paragraph 152-20(1)(a), liabilities of the entity that will be 'related to' the assets include:

•         "liabilities directly related to particular assets that are themselves included in the calculation, for example, a loan to finance the purchase of business premises"; and

•         "liabilities that, although not directly related to one particular asset, are related to the assets of the entity more generally, for example, a bank overdraft or other short term financing facility that provides working capital for the operation of the business".

The phrase 'related to' in the context of paragraph 152-20(1)(a) signifies some defined relationship or connection between 2 subject matters; the connection between the CGT assets of an entity on the one hand and the liabilities related to those CGT assets on the other hand. The relationship or connection must be real and substantial, not remote.

Application to your circumstances

Having resolved on 31 March 20XX to cease the Business, i.e. at a time before the Taxpayer entered into the Contract of Sale in relation to the Property (on XX April 20XX), the Taxpayer had an enforceable obligation to make redundancy payments to its employees in accordance with the enforceable terms of the EA and the NES in the FWA as a direct consequence of that resolution and the resulting termination of each employee's employment.

The obligation of the Taxpayer to make redundancy payments constituted a legally enforceable debt due for payment and/or a presently existing legal or equitable obligation to pay an ascertainable amount, pursuant to the terms of the EA and the NES in the FWA. The obligation arose as soon as the Taxpayer resolved to cease the Business and remained just before the CGT event.

The only contingency relating to this obligation at that time were formalities and procedural matters where nothing remained to be done by the employees to perfect their entitlement to the payment. The obligation was therefore not 'truly' contingent.

As such, just before the CGT event the redundancy payments to be made were liabilities of the Taxpayer for the purposes of subsection 152-20(1).

As relevantly noted by the Administrative Appeals Tribunal in Case 2/2015 [2015] AATA 45, at paragraphs 70 and 71, the underlying task of the MNAV test

... is to determine the economic value of a business for the purpose of determining whether the entity satisfies a test decided by the Parliament to determine those entities that are small businesses and thus entitled to a concession in the application of the CGT provisions.

In the ordinary course of events, the balance sheet of a business should demonstrate the economic value of a business, at least in a general sense.

Here, the net assets of the Taxpayer just before the CGT event, as reflected on the balance sheet of the Taxpayer, were reduced (by $XXX). As concluded above, the resolution to cease the Business created a liability to make redundancy payments to employees. That liability was discharged by payment to the employees of cash and therefore related to the CGT assets of the Taxpayer in a general, but real, sense.

[1] Income Tax CGT small business relief: maximum net asset value test - 'just before' the time of the CGT event.

[2] Income tax: capital gains: small business concessions: what 'liabilities' are included in the calculation of the 'net value of the CGT assets' of an entity in the context of subsection 152-20(1) of the Income Tax Assessment Act 1997?