Edited version of private advice

Authorisation Number: 1052142039516

Date of advice: 14 July 2023

Ruling

Subject: CGT - small business 15 year exemption

Question 1

Is X eligible to apply the small business 15-year exemption under Subdivision 152-B of the Income Tax Assessment Act 1997 (ITAA 1997) on the sale of property acquired before 20 September 1985?

Answer

Yes.

Question 2

Will the Commissioner exercise the discretion to extend the time period under subsection 152-125(4) of the ITAA 1997 for payments of any exempt amounts to be made to the Capital Gains Tax (CGT) concession stakeholder?

Answer

Yes.

This ruling applies for the following periods

1 July 20xx to 30 June 20xx

The scheme commences on

x Date

Relevant facts and circumstances

"X" Pty Ltd

1.    X was incorporated in June 198x.

2.    X issued 1 share each to the wife and husband. The wife (Y) acquired the share of the husband (W) as beneficiary of his deceased estate.

Background

3.    X commenced trading as a D retailer (D business) in 198x.

4.    X purchased business real property in x 198x.

5.    The Property included a fully constructed retail premises, consisting of multiple shopfronts. The Property could be used as one large site or single units.

6.    This versatility allowed X to use different areas of the property at various times to conduct its business operations. All shopfronts were used exclusively by X to conduct its business operations for part of the relevant period, and at times minor portions of shopfronts were leased to third parties.

7.    Income generated from X's business operations in all relevant periods far exceeded income from leasing the minor portions of shopfronts on the Property that were not used in X's business.

Property sale

8.    X sold the Property.

Property improvements

9.    Over the years minor improvements were made to the Property.

CGT concession stakeholder

10.  The sale of the Property was connected with Y's retirement, who has not worked since that time.

11.  X will be wound up following the distribution of the capital proceeds from the CGT event to Y.

Asset values

12.  Combined, the net asset values of the CGT assets of the entity and any affiliates and connected entities are below $6 million, at the relevant time.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 108

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 Subdivision 152-B

Reasons for decision

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

Question 1

Summary

X is eligible to apply the Small Business 15-Year exemption under Subdivision 152-B in relation to the Property.

Detailed reasoning

In accordance with section 152-125, if a capital gain made by a company is disregarded under the small business 15-year exemption (subparagraph 152-125(1)(a)(i)), or would have been except that the capital gain was disregarded anyway because the relevant CGT asset was acquired before September 1985 (subparagraph 152-125(1)(a)(iii)), any distribution made by the company of that exempt amount to a CGT concession stakeholder is:

•         not included in the assessable income of the CGT concession stakeholder

•         not deductible to the company or trust, and

•         not considered a dividend or frankable distribution.

This means the total capital gain, comprising the actual pre-CGT gain and actual post-CGT gain, is treated as a post-CGT gain for the purposes of allowing that capital gain to be an exempt amount under subsection 152-125(1).

Certain additional conditions in section 152-125 must also be satisfied, these being that:

•         the company must make a payment within two years after the CGT event that resulted in the capital gain

•         the payment must be made to an individual who was a CGT concession stakeholder of the company just before the CGT event, and

•         the total payments made to each CGT concession stakeholder must not exceed an amount determined by multiplying the CGT concession stakeholder's control percentage by the exempt amount.

In the current circumstances, it is initially necessary to determine whether X would have been able to disregard the capital gain from the disposal of the pre-CGT interest in the Property under the small business 15-year exemption, had it not been disregarded anyway because the relevant CGT asset was acquired before 20 September 1985.

For completeness, major capital improvements to a CGT asset that was acquired before 20 September 1985 that are related to each other, are taken to be a separate CGT asset under subsection 108-70(3) when a CCT event happens to the original asset if:

• the improvements original cost is:

o   more than 5% of the capital proceeds from the event, and

o   more than the improvement threshold for the income year in which the event happened.

In this case, the expenditure incurred to improve the Property while it was owned by X was not more than 5% of the capital proceeds from the event and not more than the relevant improvement threshold. Therefore, no major capital improvements were made to the Property.

15-year exemption - conditions for companies and trusts

The 15-year exemption in Subdivision 152-B allows an entity to disregard a capital gain arising from a CGT asset that it has owned for at least 15 years if certain conditions are met.

Subsection 152-110(1) provides that a company 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. 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 either:

(i) was 55 or over at that time and the event happened in connection with the individual's retirement; or

(ii) was permanently incapacitated at that time.

Paragraph 152-110(1)(a) - the basic conditions in Subdivision 152-A are satisfied for the gain

The basic conditions for relief under the small business CGT concessions are outlined in subsection 152-10(1). These conditions are:

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 (MNAV) 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 152-10(1A) or 152-10(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).

Consideration of each of these requirements in the current circumstances is discussed below.

Basic condition - a CGT event happens in relation to a CGT asset of yours in an income year Paragraph 152-10(1)(a)

X disposed of the pre-CGT interest in the Property via the sales contract with an unrelated third party. X's pre-CGT interest in the Property is a CGT asset (as defined in subsection 108-5(1)) and CGT event A1 (in section 104-10) happened upon entering into the sales contract on 22 January 2021.

Consequently, the requirements of paragraph 152-10(1)(a) are satisfied.

Basic condition - the event would have resulted in the gain Paragraph 152-10(1)(b))

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.

X made a capital gain from the disposal of their pre-CGT interest in the Property under section 104-10 (although this capital was disregarded under paragraph 104-10(5)(a)).

Consequently, the requirements of paragraph 152-10(1)(b) are satisfied.

Basic condition - Paragraph 152-10(1)(c) - at least one of the following applies:

CGT small business entity for the income year 152-10(1)(c)(i)

Subsection 152-10(1AA) 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 328-110(1) provides that you are a small business entity for an income 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.

Subsection 328-110(4) further provides an additional rule: based on aggregated turnover worked out as at the end of the current income year; 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) your aggregated turnover for the current year, worked out at the end of that year, is less than $10 million.

X did not carry on a business in its own right during the income year ended 30 June 20xx and, therefore did not satisfy the definition of a small business entity (as described by subsections 328-110(1) and 328-110(4)).

Consequently, the CGT small business entity test in subparagraph 152-10(1)(c)(i) will not be satisfied.

The MNAV test 152-10(1)(c)(ii)

Section 152-15 provides that you satisfy the Maximum Net Asset Value (MNAV) test if, just before the CGT event, the sum of the following amounts does not exceed $6 million:

a. the net value of the CGT assets of yours

b. the net value of the CGT assets of entities connected with you

c. the net value of the CGT assets of any affiliates of yours or entities connected with your affiliates (not counting any assets already counted under paragraph (b)).

When determining whether the $6 million MNAV test is satisfied, a taxpayer must include the net value of the CGT assets of any entities connected with them.

Subsection 328-125(1) 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 direct 'control' tests which are contained in section 328-125 differ according to whether the entity is a discretionary trust or not.

X is not a discretionary trust and therefore the direct 'control' test in subsection 328-125(2) will apply. This test states:

An entity (the first entity) controls another entity if the first entity, it's *affiliates or the first entity together with its affiliates:

(a)  except if the other entity is a discretionary trust beneficially own, or have the right to acquire the beneficial 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 - beneficially own, or have the right to acquire the beneficial 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.

During the relevant income year Y controlled X as she owned 100% of the ordinary shares in this company.

As X was controlled by Y they are 'connected entities' as per subsection 328-125(1).

Combined, there is below $6 million in net assets of X and Y at the time of the CGT event. Therefore, it is considered that X satisfies the MNAV test in section 152-15 and in turn subparagraph 152-10(1)(c)(ii).

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 152-10(1)(c)(iii)

This requirement is not applicable as X is not a partner in a partnership and the relevant asset is not an interest in a partnership asset.

The conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year 152-10(1)(c)(iv)

Paragraph 152-10(1)(c) states that at least one of the requirements listed at subparagraphs (i) to (iv) must apply. As you have satisfied one of the conditions, (being the MNAV test in 152-10(1)(c)(ii)), we have not considered the other conditions further.

Basic condition of Paragraph 152-10(1)(d) - the CGT asset satisfies the active asset test

Paragraph 152-10(1)(d) refers to subsection 152-35(1). 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 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 7½ years during the period specified in subsection (2).

Subsection 152-35 provides that the test period is from when the asset is acquired until the CGT event. If the business ceases within 12 months before the CGT event (or such time as the Commissioner allows) the relevant period is from acquisition until the business ceases.

X acquired the pre-CGT interest in the Property before 20 September 1985.

X owned the pre-CGT interest in the Property for more than 15 years and therefore, to pass the active asset test, the property will need to be an active asset for a total of at least 7½ years.

Subsection 152-40(1) provides that a tangible or intangible asset is an active asset if you own the asset and it is used or held ready for use in a business carried on (whether alone or in partnership) by you, your affiliate, or an entity connected with you.

However, paragraph 152-40(4)(e) provides that an asset whose main use is to derive rent cannot be an active asset unless:

(i)...[relates to intangible assets]; or

(ii) its main use for deriving rent was only temporary.

The legislation provides an example that includes where a company uses a house purely as an investment property and rents it out. The house is not an active asset because the company is not using the house in the course of carrying on a business

Mixed use of a property

Taxation Determination TD 2006/78 - Income Tax: capital gains: are there any circumstances in which the premises used in a business of providing accommodation for reward may satisfy the active asset test in section 152-35 of the Income Tax Assessment Act 1997 notwithstanding the exclusion in paragraph 152-40(4)(e) of the Income Tax Assessment Act 1997 for assets whose main use is to derive rent? considers the active asset test and the main use to derive rent concept.

Paragraph 26 of TD 2006/78 states:

If an asset is used partly for business and partly to derive rent at any given time, it will be a question of fact depended on all the circumstances as to whether the main use of the asset at the time is to derive rent. No one single factor will necessarily be determinative, and resolving the matter is likely to involve a consideration of a range of factors such as:

•         the comparative areas of use of the premises (between deriving rent and other uses); and

•         the comparative levels of income derived from the different uses of the asset.

Example 5 considers the mixed use of a property and states:

Mick owns land on which there are a number of industrial sheds. He uses one shed (45% of the land by area) to conduct a motorcycle repair business. He leases the other sheds (55% of the land by area) to unrelated third parties. The income derived from the motorcycle repair business is 80% of the total income (business plus rentals) derived from the use of the land and buildings.

In determining if the main use of the land is to derive rent, it is appropriate to consider a range of factors. In this case, a substantial (although nevertheless not a majority) proportion by area of the land is used for business purposes. As well, the business proportion of the land derives the vast majority (80%) of the total income. In all the circumstances, the Tax Office considers the main use of land in this case is not to derive rent and accordingly the land is not excluded from being an active asset by paragraph 152-40(4)(e) of the ITAA 1997.

Application to this case

All of the Property was used by X to conduct its business operations during certain periods and in other periods the Property had mixed use i.e. it was partly used to derive business income and rent.

Comparative use by floor area (between deriving rent and other uses)

During the relevant period X occupied a majority of the floor area as an active asset.

Comparative levels of income derived from the property

The income generated from X's business operations far exceeded the income received from leasing some shopfronts during the relevant period

Conclusion on paragraph 152-10(1)(d) active asset test

It is acknowledged that the definition of active asset does not require exclusive use of the asset for business purposes, only that the asset is used in the course of carrying on a business. It is therefore accepted that the property meets the definition of an active asset under section 152-40. The exclusion in paragraph 152-40(4)(e) does not apply in these circumstances.

X owned the pre-CGT interest in the Property for more than 15 years and the CGT asset was an active asset of the entity because it was directly used in the business operations for at least 7½ years during the period of ownership. The relevant CGT asset satisfies the active asset test and paragraph 152-10(1)(d).

Conclusion on Subdivision 152-A

As detailed above, X meets the basic conditions in Subdivision 152-A in respect of the gain on the pre-CGT interest in the Property and therefore satisfies the requirements in paragraph 152-110(1)(a).

Condition of Paragraph 152-110(1)(b) - the entity continuously owned the CGT asset for the 15 year period ending just before the CGT event

CGT A1 happened on when X entered into the sales contract to dispose of their pre-CGT interest in the Property.

Prior to disposing the pre-CGT interest and the CGT event, X continuously owned the pre-CGT interest in the Property for more than 15 years (since before 20 September 1985) and therefore, the requirements in paragraph 152-105(b) are satisfied.

Condition of Paragraph 152-110(1)(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

The term 'significant individual' is defined in section 152-55. An individual is a significant individual in a company or a trust at a time if, at that time, the individual has a 'small business participation percentage' in the company or trust of at least 20%.

Under section 152-65, an entity's small business participation percentage in another entity is the sum of the entity's direct and indirect small business participation percentages in the other entity.

The table in subsection 152-70(1) provides that an entity's direct small business participation percentage in a company at the relevant time is the percentage of the voting power, entitlement to dividends and capital an entity has because of the shares it holds in the company. If these amounts are different, the smallest amount is used.

X had a significant individual as required in both W and Y which each had a small business participation percentage of 50% in X as they each owned 50% of the ordinary shares in this company.

Upon W's passing and the deceased estate settlement, W's ordinary share was transferred to Y. From then Y was the significant individual as she owned 100% of the ordinary shares in X and, therefore had a small business participation percentage of 100%.

As a consequence, X will satisfy paragraph 152-110(1)(c ) because it had a significant individual for the required time.

Condition of Paragraph 152-110(1)(d) - an individual who was a significant individual of the company or trust just before the CGT event either:

(i) was 55 or over at the time and the event happened in connection with the individual's retirement; or

(ii) was permanently incapacitated at that time.

Y was a significant individual just before the CGT event and was over 55 at the time.

The event was connected with her retirement. Y has not worked since the CGT event.

The requirements in paragraph 152-110(1)(d) are satisfied.

Conclusion

Based on the above analysis, X satisfies the conditions in Subdivision 152-B. Therefore, they would have been able to disregard the capital gain from the disposal of the pre-CGT interest in the Property under the small business 15-year exemption, had it not been disregarded anyway because the relevant CGT asset was acquired before 20 September 1985. It therefore satisfies the requirements in subparagraph 152-125(1)(a)(iii).

Question 2

Summary

The Commissioner will exercise the discretion to extend the time period under subsection 152-125(4) for payments of any exempt amounts to be made to the CGT concession stakeholder.

Detailed reasoning

Section 152-125 has certain additional conditions that must be satisfied for a payment to be exempt under this provision. These additional conditions are that:

•         the company must make a payment relating to the exempt amount within two years after the CGT event that resulted in the capital gain

•         the payment must be made to an individual who was a CGT concession stakeholder of the company just before the CGT event, and

•         the total payments made to each CGT concession stakeholder must not exceed an amount determined by multiplying the CGT concession stakeholder's participation percentage by the exempt amount.

In respect of the additional conditions, it is noted that:

•         The first condition above cannot be satisfied without the Commissioner's discretion as the two years for company to make the payment to Y after CGT event A1 happened has passed. This is further discussed below.

•         As Y was a CGT concession stakeholder of X just before the CGT event, the second condition will be satisfied.

•         Y's stakeholder control percentage is 100%, and therefore the payment of the exempt amount will satisfy the last condition above.

The Commissioner may exercise his discretion under subsection 152-125(4) and allow further time to make payments to the CGT concession stakeholder considering the individual circumstances of each case. The range of factors that the Commissioner will consider in allowing an extension of time include:

•         whether there is an acceptable explanation for the period of extension requested and whether it would be fair and equitable in the circumstances to provide such an extension

•         whether there is any prejudice to the Commissioner if the additional time is allowed (however, the mere absence of prejudice is not enough to justify the granting of an extension)

•         whether there is any unsettling of people, other than the Commissioner, or of established practices

•         the need to ensure fairness to people in like positions and wider public interest

•         whether there is any mischief involved, and

•         the consequences of the decision.

The relevant CGT event occurred when X entered into the sales contract for the disposal of the pre-CGT interest in the Property. Therefore, paragraph 152-125(1)(b) requires the payment to be made to Y on or before x date.

You lodged your Application for a Private Binding Ruling prior to x date asking the Commissioner to consider the matter of the 15-year exemption to your circumstances.

Based on the above, the Commissioner will extend the time limit in paragraph 152-125(1)(b) in accordance with subsection 152-125(4). This discretion will be granted until x date.

Conclusion

Accordingly, the payment of the capital gain made from the disposal of the X pre-CGT interest in the Property by X to Y will be exempt under section 152-125.