Edited version of private advice

Authorisation Number: 1052130618441

Date of advice: 16 June 2023

Ruling

Subject: Capital gains and small business relief

Question 1

Will a husband and wife (the Taxpayers) be eligible to access the small business capital gains tax concessions in respect of the future disposal of Properties 1, 2, and 3 (collectively, the Properties)?

Answer

Yes. They will be eligible to access the small business capital gains tax concessions, except for the 15-year exemption.

Question 2

Will the Taxpayers be eligible to use the small business 50% active asset reduction in respect of the future disposal of the Properties?

Answer

Yes.

Question 3

Will the Taxpayers be eligible to use the small business retirement exemption in respect of the future disposal of the Properties?

Answer

Yes.

Question 4

Will the Taxpayers be eligible to use the small business roll-over in respect of the future disposal of the Properties?

Answer

Yes.

This ruling applies for the following periods:

Income tax years ending:

30 June 202X; and

30 June 202Y.

The scheme commenced on:

1 December 201Y

Relevant facts and circumstances

We have adopted, subject only to slight change, the abbreviations and definitions set out in your application for a private ruling. Most relevant are those set out underneath.

Additional to the facts and circumstances disclosed by these definitions are those set out below.

The Company was incorporated on xxxx. A is the sole director of the Company.

The Company was incorporated in order for A to take over the family's operations following a family death.

The Company operates a business of xxxx. That business is wholly owned and operated by the Company, which has owned and operated this business since shortly after its incorporation.

The Trust has held 100% of the Company's shares since incorporation. The Trust's sole investment asset is its 100% interest in the Company.

The Partnership comprises A and B as equal partners. The Partnership does not carry on a business. Its sole activity is to derive rental income from BB.

The following table outlines pertinent details relating to ownership of the Properties:

Since acquisition, the abovementioned owners have continuously held their respective interests in each of the Properties.

Since the Company began business operations, it has continuously used the Properties in those operations consistent with and subject to unwritten rental agreements in place between the owners of the Properties and the Company.

The Company's "aggregated turnover" (as that term is defined in section 328-115 of the Income Tax Assessment Act 1997 (ITAA 1997)) was approx. $800,000 for the income year ended 30 June 2022. This comprised:

•                     Annual turnover of the Company.

•                     Plus: Annual turnover of the Partnership.

•                     Plus: Annual turnover of A.

•                     Plus: Annual turnover of B.

•                     Less: Rent paid between connected entities.

As per the Trust's 2022 income tax return, it had a tax loss of approx. $600.

As the Trust had a tax loss for the 2022 income year, the Trustee nominated the Taxpayers as controllers of the Trust for the 2022 income year (under section 152-78 of the ITAA 1997).

A was born on xxxx (i.e. she is currently xx years old).

B was born on xxxx (i.e. he is currently xx years old).

Neither of the Taxpayers carry on a business in their personal capacities and they do not reasonably expect to do so for the foreseeable future.

The Taxpayers are in the process of disposing of the Properties to an unrelated third party.

The total sale price of the Properties is expected to be approximately $x million. Due to the estimated market value of the Properties, the market value of net assets held by and controlled by the Taxpayers exceeds $6 million.

The Taxpayers are looking to acquire replacement properties.

Neither of the Taxpayers has ever previously used the small business CGT concessions in Division 152.

Assumptions

The Company will continue to carry on its business of xxxx until the Properties are sold.

The Company will continue to use the Properties in the course of carrying on this business until the Properties are sold.

The Company's "aggregated turnover" (as that term is defined in s 328-115 of the ITAA 1997) will be less than $2 million for the income year ended 30 June 2023.

The facts and circumstances as they affect control of the Company will not change in the 2024 income year.

The Taxpayers will not carry on a business - apart from as a CGT small business entity - in their personal capacities in the income year the Properties are sold.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Subdivision 328-C

Reasons for decision

Question 1

Will the Taxpayers be eligible to access the small business capital gains tax concessions in respect of their future disposal of the Properties?

Summary

Yes, the Taxpayers satisfy the basic conditions for relief under section 152-10. The sale of the Properties will be CGT events, which would (apart from the application of the small business capital gains tax concessions) result in capital gains. The conditions in subsection 152-10(1A) are satisfied, and the active asset test is satisfied because the Properties have predominantly been used by an entity connected with the Taxpayers in the course of carrying on its business during the ownership periods. Consequently, the Taxpayers can access the small business capital gains tax concessions in respect of the disposal of the Properties subject to any additional, specific conditions that must also be satisfied in relation to a particular concession. The only additional, specific condition that applies here relates to the 15-year exemption. The Taxpayers will not be eligible to access the 15-year exemption because they have not owned the Properties for 15 years.

Detailed reasoning

To help small business, the CGT small business concessions in Division 152 enable capital gains to be reduced or disregarded when certain conditions are met. The four small business concessions are:

(a)          the 15-year exemption (in Subdivision 152-B);

(b)          the 50% reduction (in Subdivision 152-C);

(c)           the retirement concession (in Subdivision 152-D);

(d)          the roll-over (in Subdivision 152-E).

Basic conditions for relief

The basic conditions for relief under the CGT small business concessions are outlined in Subdivision 152-A.

Subsection 152-10(1) provides that a capital gain you make may be reduced or disregarded 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 (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).

Basic condition (a) - A CGT event happens in relation to a CGT asset of yours in an income year

This condition is satisfied.

A CGT asset is defined in subsection 108-5(1) as any kind of property or a legal or equitable right that is not property.

Paragraph 108-5(2)(a) highlights that part of, or an interest in, an asset referred to in subsection 108-5(1) is a CGT asset. Paragraph 108-5(2)(c) further highlights that an interest in an asset of a partnership is a CGT asset.

Note 1 to section 108-5 lists land and buildings as examples of CGT assets.

The Properties are CGT assets. A owns AA and CC. A and B each own half of BB via the Partnership. For CGT purposes, partners are treated as owning partnership assets in proportion to their partnership interests. Therefore, A and B are each treated as owning half of BB.

Subsection 104-10(1) provides that CGT event A1 happens if you dispose of a CGT asset. 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. The sale of the Properties will be CGT event A1 because the Taxpayers will each dispose of their interests in the Properties to the purchaser.

Basic condition (b) - The event would have resulted in the gain

This condition is satisfied.

Subsection 104-10(4) provides that you make a capital gain from CGT event A1 if the capital proceeds from the disposal are more than the asset's cost base. The Taxpayers would make a capital gain (apart from the application of the CGT small business concessions) from the disposal of their interests in the Properties

Basic condition (c) - The conditions mentioned in subsection 152-10(1A) must be satisfied in relation to the CGT asset in the income year

This condition is satisfied.

The requirements in subsection 152-10(1A) are:

(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.

The Company is a CGT small business entity in the income year

This requirement is satisfied.

Section 152-10(1AA) provides 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.

Section 328-110 provides that you are a small business entity for an income year (the current year) if:

(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;

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

The Company will carry on its business until the Properties are sold. It will, therefore, carry on this business in the income year the Properties are sold (that will be the current year) and in the income year before they are sold (that will be the previous year). The Company's "aggregated turnover" (as that term is defined in s 328-115 of the ITAA 1997) will be less than $2 million in the previous year (i.e. in the income year ended 30 June 2022 if the Properties are sold in the income year ended 30 June 2023; or in the income year ended 30 June 2023 if the Properties are sold in the income year ended 30 June 2024).

Section 328-125 provides the meaning of "connected with" an entity.

This requirement is satisfied.

Subsection 328-125(1) provides that an entity is connected with another entity if either entity controls the other entity in a way described in that section, or both entities are controlled in a way described in that section by the same third entity.

Subsection 328-125(2) appears under the heading "Direct control of an entity other than a discretionary trust". It 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.

Subsections 328-125(3) and (4) appear under the heading "Direct control of a discretionary trust". Subsection 328-125(3) 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. Subsection 328-125(4) provides that an entity (the first entity) controls a discretionary trust 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.

Subsection 328-125(7) appears under the heading "Indirect control of an entity". It provides that section 328-125 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.

The operation of section 328-125 must be considered together with sections 152-47 and 152-78

Section 152-47

Section 152-47 is headed "Spouses or children taken to be affiliates for certain passively held CGT assets". It provides:

152-47(1) This section applies if:

(a)          one entity (the asset owner) owns a CGT asset (whether the asset is tangible or intangible); and either:

(i)            the asset is used, or held ready for use, in the course of carrying on a business in an income year by another entity (the business entity); or

(ii)           the asset is inherently connected with a business that is carried on in an income year by another entity (the business entity); and

(b)          the business entity is not (apart from this section) an affiliate of, or connected with, the asset owner.

152-47(2) For the purposes of this Subdivision, in determining whether the business entity is an affiliate of, or is connected with, the asset owner, take the following to be affiliates of an individual:

(a)          a spouse of the individual;

(b)          a child of the individual, being a child who is under 18 years.

152-47(3) If an entity is an affiliate of, or connected with, another entity as a result of subsection (2), then the spouse or child mentioned in that subsection is, in addition, taken to be an affiliate of the individual for the purposes of this Subdivision, and for the purposes of sections 328-110 to 328-125 to the extent that they relate to this Subdivision.

Section 152-78

Section 152-78 is headed "Trustee of discretionary trust may nominate beneficiaries to be controllers of the trust". It provides:

152-78(1) This section applies for the purposes of determining whether an entity is connected with you, for the purposes of:

(a)          this Subdivision; and

(b)          sections 328-110, 328-115 and 328-125 so far as they relate to this Subdivision.

152-78(2) The trustee of a discretionary trust may nominate not more than 4 beneficiaries as being controllers of the trust for an income year (the relevant income year) for which the trustee did not make a distribution of income or capital if the trust had a tax loss, or no net income, for that year.

152-78(3) A nomination under subsection (2) has effect as if each nominated beneficiary controlled the trust for the relevant income year in a way described in section 328-125.

Note: This means each nominated beneficiary is connected with the trust.

152-78(4) A nomination under subsection (2) must:

(a)          be in writing; and

(b)          be signed by the trustee and by each nominated beneficiary.

The Company is connected with the Taxpayers

The Taxpayers control the Company. This means the Company is connected with the Taxpayers. This conclusion can be reached in various ways, in different ways for each of A and B, and in different ways for different income years.

Subsection 152-10(1A) focuses on whether certain conditions are satisfied in relation to the CGT asset in a certain income year. That is, the income year when the CGT event happens. Nevertheless, our consideration of whether the Company was connected with the Taxpayers also contemplates the period of time since the Company was incorporated and began operating the business of xxxx. This wider lens is necessary for later consideration of whether the CGT assets (the Properties) satisfy the active asset test.

In relation to A, one method to conclude she controls the Company, so that the Company is connected with her, is on the basis subsection 328-125(7) applies and she has indirect control of the Company. The reasoning is set out in the following steps:

1.            The Trust owns 100% of the Company. The Trust has direct control of the Company consistent with paragraph 328-125(2)(b) because it has a control percentage of 100% (i.e. it controls all voting power).

2.            Subsection 328-125(3) provides that an entity (here A) 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 that entity (here A), its affiliates, or that entity together with its affiliates.

3.            A controls the Trust because she owns 100% of the Trustee (a company called xxxx) and is one of its directors. Therefore, the Trustee acts, or could reasonably be expected to act, in accordance with the directions or wishes of A.

4.            As A controls the Trust, and the Trust controls the Company, subsection 328-125(7) applies to mean that A also controls the Company, meaning the Company is connected with A.

In relation to B, one possible method to conclude he controls the Company, so that the Company is connected with him, is to apply section 152-47. It treats spouses or children as affiliates for certain passively held CGT assets. It applies where the business entity is not otherwise an affiliate of, or connected with, the asset owner. The reasoning is set out in the following steps:

1.            B owns a CGT asset (50% of BB).

2.            That CGT asset is used in the course of carrying on a business in an income year by the Company, and A is B's spouse, so is his affiliate.

3.            Therefore an affiliate of B's (i.e. A) controls the Trust and the Trust controls the Company.

4.            Consequently, subsection 328-125(7) applies to mean that B controls the Company, meaning the Company is connected with B.

In some years, and perhaps in all, B would control the Company, so that the Company would be connected with B, absent any reliance on section 152-47. For example, the Trustee nominated B and A as controllers of the Trust for the 2022 income year (under section 152-78 of the ITAA 1997). Therefore, the Company would have been connected with B in the 2022 income year, and section 152-47 would not have operated. Nonetheless, the analysis in the steps above shows that the Company would at all times have been connected with B, even if the mechanics of arriving at this conclusion may change.

The Company has been connected with the Taxpayers since incorporation.

The Taxpayers do not carry on a business in the income year, either in partnership or otherwise

This requirement is satisfied. The Taxpayers have not carried on a business in the 2023 income year and do not plan to carry on a business in the 2024 income year.

The Company 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

This requirement is satisfied.

The Company is connected with the Taxpayers and used the Properties in the course of carrying on its business in the 2023 income year. The Company will continue to use the Properties in the course of carrying on its business until the Properties are sold.

Basic condition (d) - the CGT asset satisfies the active asset test

This condition is satisfied.

The Taxpayers have owned the Properties for less than 15 years and the Properties have been active assets of the Taxpayers for at least half of the period between when they acquired them, and when they will sell them.

The Properties have been active assets because they have been used by the Company in the course of carrying on its business and the Company has been connected with the Taxpayers since its incorporation.

Other conditions - the 15-year exemption

Some of the concessions have additional, specific conditions that must be satisfied. The 15-year exemption requires the taxpayer to have held the asset continuously for 15 years. The Taxpayers have not owned the Properties for 15 years. They are ineligible for the small business 15-year exemption.

Questions 2, 3 and 4

Will the Taxpayers be eligible to use the small business 50% reduction; the small business retirement exemption; and the small business roll-over relief in respect of the future disposal of the Properties?

Summary

Yes, the Taxpayers are eligible to use these three concessions because:

1.            they satisfy the basic conditions for relief under section 152-10

2.            there are no additional, specific conditions that operate here to affect the Taxpayers eligibility to use the small business 50% reduction, the small business retirement exemption or the small business roll-over relief, and

3.            the Taxpayers, who are both over 55, have never before used the small business retirement exemption, meaning each still has their lifetime limit of $500,000 available.