Edited version of private advice

Authorisation Number: 1052140189537

Date of advice: 3 August 2023

Ruling

Subject: CGT - small business - basic conditions

Question 1

Did the Estate satisfy the basic conditions for relief in Subdivision 152-A of the Income Tax Assessment Act 1997 (ITAA 1997) in relation to the sale of the Property?

Answer

Yes.

Question 2

Did the Estate have a significant individual for at least 15 years for the purpose of the small business 15-year exemption in Subdivision 152-B of the ITAA 1997?

Answer

No.

Question 3

Can the Estate use the small business retirement exemption reduction in Subdivision 152-D of the ITAA 1997 in relation to the sale of the Property?

Answer

Yes.

This ruling applies for the following period:

Year Ending 30 June 2022

The scheme commenced on:

1 July 2021

Relevant facts and circumstances

The deceased died in the financial year ending approximately 30 years ago.

Probate of the Will was granted to siblings Individual A, Individual B, and Individual C as executors shortly after the deceased death.

At the time of their death, the deceased owned the Property.

The Property was acquired by the deceased before 20 September 1985.

The deceased had used the Property in a business conducted in partnership with their spouse from the date the Property was acquired, until their death.

The Will provided the following instructions:

•         The deceased spouse was to have the use and occupation of the residence on the Property during their lifetime.

•         Individual A was to have the use occupation and enjoyment of the Property other than the residence for a stipulated period (the Contingent Period) from the date of the deceased death.

•         During the Contingent Period, if Individual A died or decided to sell the Property other siblings or their offspring were entitled to the sale proceeds of the Property.

•         After the Contingent Period, the Will stipulated that Individual A was entitled half the income and capital from the Property with the remaining half of income and capital to be distributed in equal shares to Individual A's siblings or their children.

The deceased spouse died approximately 10 years ago.

Individual A operated a business as a sole trader on the Property for approximately 10 years during the Contingent Period following the deceased death.

The Property was subsequently leased by Individual A to third parties.

The Property was sold several years after the Contingent Period had ended.

In accordance with the Will net sale proceeds from the sale of the Property is to be distributed to the beneficiaries as follows:

(a)  Individual A - 50%

(b)  Individual B - 10%

(c)   Individual C - 10%

(d)  Individual D - 10%

(e)  Individual E - 10%

(f)    Individual F - 10%

The Estate satisfied the maximum net asset value test in section 152-15 of the ITAA 1997 in the year the Property was sold.

If eligible, and it chooses to apply the retirement exemption in Subdivision 152-D of the ITAA 1997, the Estate will keep the necessary records and make the necessary payments to satisfy the conditions under section 152-325 of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 Subdivision 152-B

Income Tax Assessment Act 1997 Subdivision 152-D

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 subsection 152-40(1)

Income Tax Assessment Act 1997 section 152-50

Income Tax Assessment Act 1997 section 152-55

Income Tax Assessment Act 1997 section 152-65

Income Tax Assessment Act 1997 subsection 152-70(1)

Income Tax Assessment Act 1997 section 152-110

Income Tax Assessment Act 1997 section 152-305

Income Tax Assessment Act 1997 section 152-320

Income Tax Assessment Act 1997 section 152-325

Income Tax Assessment Act 1997 subsection 328-130(1)

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise specified.

Question 1

Did the Estate satisfy the basic conditions for relief in Subdivision 152-A in relation to the sale of the Property?

Summary

The basic conditions in subsection 152-10(1) are satisfied. A CGT event occurred when the Estate sold the Property which resulted in a capital gain. The maximum net asset test under section 152-15 is satisfied. The active asset test under section 152-35, is satisfied as the asset was owned for more than 15 years and was an active asset for more than 7 ½ years during the ownership period.

Detailed reasoning

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 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 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;

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

Active Asset

Subsection 152-35(1) states that a CGT asset satisfies the active asset test 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 period of ownership, 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 ½ years.

Subsection 152-35(2) provides that the test period begins when you acquired the asset and ends at the earlier of:

(a)  the time of the CGT event; and

(b)  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).

Subsection 152-40(1) provides that a CGT asset is an active asset at a time if it is used, or held ready for use, in the course of carrying on a business that is carried on (either alone or in partnership) by you, or your affiliate, or another entity that is connected with you.

Affiliate

Subsection 328-130(1) states that an individual or a company is an affiliate of yours if the individual or company acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the business of the individual or company. However, an individual or a company is not your affiliate merely because of the nature of the business relationship you and the individual or company share.

Application to your circumstances

A CGT event occurred when the Estate sold the Property which resulted in a capital gain satisfying paragraph's 152-10(1)(a) and (b).

The maximum net asset test under section 152-15 is satisfied, therefore paragraph 152-10(1)(c) of the basic conditions is satisfied.

Individual A used the Property to carry on a business as a sole trader for 10 years during the Contingent Period. This business use is relevant for the purpose of the active asset test if they were either an affiliate or connected to the Estate during the period of their business use.

During the time of their business use, Individual A was an executor of the Estate along with their two siblings, Individual B and Individual C. You have contended that, collectively the Executors were influential on Individual A's business. They provided expertise and business advice, having an active interest in the business operations, working in concert with Individual A to ensure the Property was looked after for the benefit of the Estate and its beneficiaries.

Based on the relationship between the Executors of the Estate and Individual A, we accept that it was reasonably expected that Individual A would have acted in accordance with the Estate's directions or wishes, or in concert with the Estate in relation to the affairs of their business during the period they used the Property for their sole trader business. Therefore, Individual A is considered to be an affiliate of the Estate during this period under subsection 328-130(1).

The Property was used in the course of business activities of Individual A, who was an affiliate of the Estate. The Property was used for this purpose for more than 7 ½ years of the ownership period of more than 15 years. The Property satisfies the active asset test under section 152-35 and the final basic condition in paragraph 152-10(1)(d) is also satisfied.

Question 2

Did the Estate have a significant individual for at least 15 years for the purpose of the small business 15-year exemption in Subdivision 152-B?

Summary

The Estate did not have a significant individual for at least 15 years and therefore does not satisfy the requirements to allow the Estate to apply the small business 15-year exemption to the sale of the Property.

Detailed reasoning

The 15-year exemption in Subdivision 152-B can be used to disregard the gain from arising from a CGT asset it owned for more than 15 years if certain conditions have been met.

Section 152-110 provides a small business 15-year exemption for companies and trusts. Under this section, the company or trust can disregard the capital gain from the disposal of a CGT asset if:

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

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

(c)   the entity 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 the entity owned the CGT asset; and

(d)  an individual who was a significant individual of the company or trust just before the CGT event was either:

(i)    at least 55 years old at that time and the event happened in connection with their retirement or

(ii)   permanently incapacitated at that time.

Significant individual

An individual is a significant individual in a company or trust if they have a small business participation percentage in the company or trust of at least 20% (section 152-55). The small business participation percentage can be made up of direct and indirect percentages (section 152-65). As the terms of the Will stipulated the entitlement to all the income and capital distributions, item 2 of the table in section 152-70 is relevant. It provides that an entity holds a direct small business participation percentage equal to the following:

(a)  the percentage of any distributions of income that the trustee may make to which the entity would be beneficially entitled; or

(b)  the percentage of any distributions of capital that the trustee may make to which the entity would be beneficially entitled;

or if they are different, the smaller.

Application to your circumstances

During the Contingent Period stipulated in the Will, Individual A had entitlements to 100% of any distributions of income the Estate may have made, but 0% of any capital distributions. As Individual A's capital distributions were 0%, their small business participation percentage was 0%.

During the Contingent Period other beneficiaries had combined entitlements to 100% of capital distributions but 0% of the income distributions. Each of their small business participation percentages was also 0% during this time.

As none of the beneficiaries had a small business participation percentage of at least 20%, there was no significant individual of the Estate during this period.

Upon termination of the Contingent Period, Individual A had entitlements to 50% of both the income and capital distributions providing them with a small business participation percentage of 50% in the Estate. Individual A was a significant individual of the Estate from the termination of the Contingent Period until the CGT event year, however this was a period of less than 15 years.

Therefore, the Estate did not have a significant individual for at least 15 years and does not satisfy the conditions under section 152-110 to apply 15-year exemption on the sale of the Property.

Question 3

Can the Estate use the small business retirement exemption reduction in Subdivision 152-D in relation to the sale of the Property?

Summary

The Estate can choose to disregard all or part of the capital gain from the sale of the interest in the Property under the small business retirement exemption in section 152-305.

Detailed reasoning

Retirement Exemption

Subsection 152-305(2) provides that a company or trust can disregard any capital gain arising if:

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

(b)  the significant individual test is satisfied under section 152-50;

(c)   the company or trust conditions in section 152-325 are satisfied.

An entity satisfied the significant individual test if the entity had at least one significant individual just before the CGT event (section 152-50).

Application to your circumstances

As per question 1, the Estate satisfied the basic conditions in Subdivision 152-A for the capital gain from the sale of the Property satisfying paragraph 152-305(2)(a).

From the time the Contingent Period ended, Individual A had entitlements to 50% of any income and capital distributions from the Estate and was a significant individual. This continued until the time of the CGT event. The Estate had a significant individual at the time of the CGT event and satisfied the significant individual test in section 152-50 and therefore paragraph 152-305(2)(b) is satisfied for the purpose of the retirement exemption.

The Estate will satisfy the additional requirements in section 152-325 by keeping records and making the required payments of the exempt amounts, consequently paragraph 152-305(2)(c) will be satisfied.

The Estate is entitled to choose to apply the small business CGT retirement exemption as the required conditions under subsection 152-305(2) are satisfied.