Edited version of private advice

Authorisation Number: 1052146861349

Date of advice: 10 August 2023

Ruling

Subject: CGT - small business concessions

Question 1

Do you satisfy the basic conditions in Subdivision 152-A of the Income Tax Assessment Act 1997 (ITAA 1997) for small business relief upon the disposal of your interest in Property A, Property B and Property C?

Answer

Yes.

Question 2

Are you entitled to apply the 15-year exemption in Subdivision 152-B in relation to the disposal of your interest in Property A?

Answer

Yes.

Question 3

Are you entitled to apply the 15-year exemption in Subdivision 152-B in relation to the disposal of your interest in Property B and Property C?

Answer

No.

Question 4

Are you entitled to apply the 50% active asset reduction in Subdivision 152-C in relation to the disposal of your interests in Property B and Property C?

Answer

Yes.

Question 5

Are you entitled to apply the retirement concession in Subdivision 152-D in relation to the disposal of your interest in Property B and Property C?

Answer

Yes.

This ruling applies for the following period:

Income year ending 30 June 2022

The scheme commenced on:

1 July 2021

Relevant facts and circumstances

You and your spouse jointly (50% each) owned Property A, Property B and Property C collectively the Properties.

You and your spouse conducted a business via Partnership A, which used the Properties for more than 15 years.

Partnership A, comprised three Partners, you, your spouse and Trust A.

Trust A is a discretionary trust of which Company A is the trustee.

Your spouse is the sole shareholder and sole director of Company A.

The Properties were all sold to an unrelated third party pursuant to contracts entered into in the 2021-22 income year.

You and your spouse were both under 55 at the time of the sale of the Properties.

The Partnership commenced using Property A, Property B, and Property C on the same date (the Commencement Date).

The Commencement Date occurred more than 15 years before the date of the contract of sale of the Properties.

The following events which facilitated the Partnership's use of the Properties occurred on the Commencement Date:

•         You and your spouse entered into the contract to acquire Property A with the purchase contract allowing the right to occupy upon exchange.

•         You and other Lessees entered 5-year lease agreements for Property B and Property C (the Lease), with immediate possession occurring upon signing.

The Lease did not provide an option to purchase the leased properties. The Lease required the Lessees to pay rent.

You and other Grantees entered a Deed of Option in relation to Property B and Property C on the Commencement Date.

The Option allowed you and other the Grantees the right to acquire Property B and Property C at any time in the subsequent 5 years (the Option).

The Grantees placed a caveat over the titles of Property B and Property C approximately 2 years after signing the Option. The caveat listed the Option as interest over the land prohibiting the relevant state authority from recording any dealings in Property B and Property C apart from in relation to the Option.

You and the other Grantees notified the Grantor of the intention to exercise the option on Property B and Property C. approximately midway through the option period.

Approximately four years after the Commencement Date you and other Grantees exercised the Option to purchase Property B and Property C. The Contract or Purchase for Property A and Property B was subsequently entered by you less than 15 years before the contract for their sale.

A major reason for the sale of the Properties was the continuing decline in your physical health. You had suffered an injury requiring several surgeries. The surgeon determined that you were permanently incapacitated in terms of your ability to undertake an occupation for which you are suitably qualified.

If you are entitled to make a choice to apply the retirement exemption in Subdivision 152-D, and make that choice, you will contribute an amount equal to the CGT exempt amount from the sale of Property A and Property to a complying superannuation fund or RSA by the time you make the choice in satisfaction of paragraph's 152-305(1)(b) and (c) of the ITAA 1997.

The Partnership's aggregated turnover for the purpose of subsection 152-10(1AA) was less than $X million for the 2020-21 financial year.

You did not carry on a business other than via the Partnership in the 2021-22 income year.

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-C

Income Tax Assessment Act 1997 Subdivision 152-D

Income Tax Assessment Act 1997 subsection 152-10(1)

Income Tax Assessment Act 1997 subsection 152-10(1AA)

Income Tax Assessment Act 1997 subsection 152-10(1B)

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-105

Income Tax Assessment Act 1997 paragraph 152-305(1)(b)

Income Tax Assessment Act 1997 paragraph 152-305(1)(c)

Income Tax Assessment Act 1997 subsection 328-110(1)

Reasons for decision

Question 1.

Summary

You satisfy the basic conditions in Subdivision 152-A for all three Properties. A CGT event happened to each property resulting in a gain in each case. You were a partner in the Partnership, a CGT small business entity that used the Properties as active assets for a period including the CGT event year and sufficient to satisfy the active asset test.

Detailed reasoning

Basic conditions

Subdivision 152-A contains the basic conditions that must be satisfied for small business CGT relief. The basic conditions, as set out in subsection 152-10(1) 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 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)        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 in section 152-35.

Small business entity

Subsection 328-110(1), states the requirements of a small business entity for an income year as:

(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

Passively held assets - partnership

The conditions in this subsection are satisfied in relation to the CGT asset in the income year if:

(a)  you are a partner in a partnership in the income year; and

(b)  the partnership is a CGT small business entity for the income year; and

(a)  you do not carry on a business in the income year (other than in partnership); and

(b)  the CGT asset is not an interest in an asset of the partnership; and

(c)   the business you carry on as a partner in the partnership referred to in paragraph (a) is the business that you, at a time in the income year, carry on (as referred to in subparagraph 152-40(1)(a)(i) or paragraph 152-40(1)(b)) in relation to the CGT asset.

CGT small business entity

Subsection 152-10(1AA) provides that you are 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.

Active asset test

Section 152-35 outlines the active assets test, as follows in 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 of yours 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(2) of the ITAA 1997 outlines that the period:

(a)  begins when you acquired the asset; and

(a)  ends at the earlier of:

                    (i)        the CGT event; and

                   (ii)        if the relevant business ceased to be carried on in the 12 months before that time or any longer period that the Commissioner allows - the cessation of the business.

Subsection 152-40(1) states that a CGT asset is an active asset at a time if, at that time:

(a)  you own the asset (whether the asset is tangible or intangible) and it is used, or held ready for use, in the course of carrying on a business that is carried on (whether alone or in partnership) by:

                    (i)        you; or

                   (ii)        your affiliate; or

                  (iii)        another entity that is connected with you; or

Basic Conditions

CGT event A1 happened to the Properties when you sold your interest in the Properties in the 2021-22 income year satisfying paragraph 152-10(1)(a).

The CGT events resulted in a capital gain from each of the Properties satisfying paragraph 152-10(1)(b).

The Partnership carried on a business in the 2020-21 income year and its aggregated turnover was less than $2 million. It was a CGT small business entity under 152-10(1AA) at the time the CGT events happened to the Properties.

You satisfied the conditions of subsection 152-10(1B) in the income year of the CGT events (2021-22 income year) on the following basis:

(a)  You were a partner in the Partnership.

(b)  The Partnership was a CGT small business entity.

(c)   You did not carry on a business other than via the Partnership.

(d)  The Properties were not an interest in an asset of the Partnership.

(e)  The business you carried on as a partner in the Partnership is the business that, at a time in the income year was carried on in relation to the Properties.

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

You used all three Properties during your ownership period in the course of carrying on the business by the Partnership. The Properties were therefore active assets during your entire ownership period, a sufficient period to satisfy the active asset test in section 152-35. As the active asset test is satisfied for each of the Properties the final basic condition in 125-10(1)(d) is satisfied.

As you satisfy all the requirements in subsection 152-10(1) in relation to the sale of all three properties, you satisfy the basic conditions for CGT relief under Subdivision 152-A.

Question 2 and 3

Summary

You satisfy all the necessary conditions to apply the 15-year exemption in section 152-105 to the sale of the Property A. However, as you had not owned the legal title of Property A and Property B for a period of 15 years just before the CGT event, the 15-year exemption cannot be applied to the sale of Property B and Property C.

Detailed reasoning

Section 152-105 sets out the requirements for the 15-year exemption.

An individual can disregard a capital gain from a CGT event happening to a CGT asset if the following conditions are satisfied:

(a)  The basic conditions in Subdivision 152-A are satisfied for the gains

(b)  You continuously owned the CGT asset for the 15-year period ending just before the CGT event happened.

(a)  Paragraph 152-10(c) relates to the sale of a share in a company or an interest in a trust, is not relevant to your circumstances.

(b)  Either:

                    (i)        You were at least 55 years old, and the CGT event happened in connection with your retirement, or

                   (ii)        You were permanently incapacitated at the time of the CGT event.

You satisfy the basic conditions, subsection 152-105(a) is satisfied for each of the Properties.

Permanent incapacity

Permanent incapacity is defined on ato.gov.au as follows:

Also called 'permanent disability'. This is when an individual is deemed to be unlikely to be gainfully employed in a job, they are currently qualified due to ill health.

The ATO view on this matter is provided in the publication Advanced guide to capital gains tax concessions for small business 2011-12 (NAT 3359). It provides that a broadly indicative description of permanent incapacity is:

ill health (whether physical or mental), where it is reasonable to consider that the person is unlikely, because of the ill-health, to engage again in gainful employment for which the person is reasonably qualified by education, training or experience. The incapacity does not necessarily need to be permanent in the sense of everlasting.

We accept that your injury has resulted in you being permanently incapacitated for the purposes of the 15-year exemption, paragraph 152-105(d) is satisfied.

Ownership period and the relevant CGT asset

The phrase 'continuously owned' nor the term 'owned' is defined in the legislation.

The concept of ownership is discussed in Halsbury's Laws of England, 4th ed, Vol 35:

Ownership consists of innumerable rights over property, for example the rights of exclusive enjoyment, of destruction, alteration and alienation, and of maintaining and recovering possession of the property from all other persons. Those rights are conceived not as separately existing, but as merged in one general right of ownership.

Each of the innumerable rights over property is potentially capable of being a CGT asset in its own right and may therefore be capable of being owned for the purposes of a CGT provision.

Full legal ownership of property, leasehold interest in property and an option to purchase property are all CGT assets under the description provided in subsection 108-5(1).

Paragraph 104-10(3)(a) provides that the time of the CGT event A1 is when a contract for the disposal is entered.

If you acquire a CGT asset as a result of CGT event A1, subsection 109-5(2) deems that you acquire the asset at the time the disposal contract was entered into.

Paragraph 152-105(1)(b) requires the 15-years of continuous ownership to be just before the CGT event. It follows that any period of ownership after you have entered a contract for the sale of a CGT asset (being the date of the CGT event happening to this asset) is not relevant to the 15-year period. This is despite the fact that the legal and beneficial ownership of the asset may continue until the settlement date.

Property A ownership period

You continuously owned Property A for more than 15 years prior to the CGT event date, being when you signed the contract for its disposal in the 2021-22 income year.

You satisfy all the necessary conditions to apply the 15-year exemption in section 152-105 to the sale of the Property A.

Property B and Property C ownership period

The contract for the purchase of Property B and Property C was signed less than 15 years before the contract of sale. By simple analysis you fail the continuous ownership requirements for these properties.

You contend that you had a continuing interest in these Properties for more than 15 years, due to the combination of the Option, Lease and the carrying on of a business on the Properties for a period of more than 15 years.

You have considered extraneous materials where a different term "held" is used, rather than "owned" as follows. In paragraph 1.6 of the Explanatory Memorandum New Business Tax System (Capital Gains Tax) Act 1999 (the Explanatory Memorandum)which uses the term held in explaining the new law being the 15-year exemption:

This is a new exemption for capital gains arising from the disposal of assets held for at least 15 years by a small business entity and the disposal is related to a person retiring or becoming permanently incapacitated.

While in his second reading speech to the Bill, the Minister stated:

The key measures included in this bill are ... the introduction of a CGT exemption where a small business taxpayer sells an active asset which has been held for at least 15 years and the taxpayer is at least 55 years of age and intends to retire or is incapacitated.

However, paragraph 1.5 and 1.58 of the Explanatory Memorandum, which discuss the 15-year exemption in more detail, both use the terms ownership and continuous ownership. Our view is the extraneous materials you have referenced does not signal a different intention in the legislation, with the term continuous ownership referred to in paragraph 152-105(b) carrying its ordinary meaning.

You have contended that a caveat is a proprietary interest in land, that it is a right to own property and preventing the property from being sold or being dealt with in any other way by the grantor of the option.

Our contrary view is that the Option was not an ownership interest in the land rather a right to acquire the ownership interest. The Option was a separate CGT asset and ended by CGT event C2, when you exercised your right to acquire the legal title in these Properties.

Similarly, the Lease was an intangible interest being a right to use of the land rather than an ownership interest in the land. The lease was a separate CGT asset which ended by CGT event C2 upon the cancellation of the lease.

Our view is that the CGT asset relevant for the purpose of continuous ownership period for the 15-year exemption was the legal title interest in these Properties. These assets were acquired by you less than 15 years before you disposed of them.

CGT event B1

Subsection 104-15(1) provides:

CGT event B1 happens if you enter into an agreement with another entity under which:

(a)  the right to the use and enjoyment of a CGT asset you own passes to the other entity; and

(b)  title in the asset will or may pass to the other entity at or before the end of the agreement.

The table in subsection 109-5(2) states that where a CGT event B1 occurs you acquire the asset when you first obtain the use and enjoyment of the asset.

As outlined to Tax Determination TD 1999/78 Income tax: capital gains: for the purposes of CGT event B1, what is meant by the expression 'at the end of an agreement' in section 104-15 of the Income Tax Assessment Act 1997? (TD 1999/78), for CGT event B1 to occur, the relevant agreement must be one under which both the right to the use and enjoyment and the title in the asset will or may pass to the other entity.

TD 1999/78 provides the examples

Example 2

8. Bill leases a parcel of land, giving him use and enjoyment of the land. As part of the agreement with the lessor, Bill is granted a right of first refusal for the acquisition of the land, so that if the lessor decides to sell the property, he has to offer it to Bill first. This situation is not covered by CGT event B1 because the agreement is not one under which title will or may pass at the end of the agreement.

Example 3

9. Jim owns a boat that his neighbour, Ken, is interested in buying but Ken wants to try out the boat first. Jim agrees to hire the boat to Ken and the agreement provides that Ken will buy the boat at the end of three years unless Ken decides to buy the boat sooner. Jim agrees that, if Ken does buy it, Jim will apply the hire fees against the agreed purchase price. Some months later, Ken inherits some money and approaches Jim to take the boat. The sale is concluded. Because there was an agreement under which Ken had a right to the use and enjoyment of the boat and under that agreement title to it would or might pass to Ken when the hire purchase agreement ends - which could be after three years or within that period - CGT event B1 occurs when Ken first obtained the use and enjoyment of the boat and not when Jim actually transferred the boat to him. Had the three years passed without Ken buying the boat, any capital gain or capital loss Jim made from the CGT event would be disregarded.

Alternatively, you contend that the combination of the Lease and Option, in conjunction with the purchase contract for Property A which referred to the Lease, gave rise to CGT Event B1. On the basis that CGT event B1 did occur, you are taken to have acquired the relevant CGT asset at the time you first obtained the use and enjoyment of it.

Although it is acknowledged that the Contract of Purchase was contingent upon the Lease of Property A and Property B, our view is that the Lease and Option are separate agreements. The lease providing use and enjoyment and separately the Option providing the right to acquire ownership of the legal title upon exercise.

An option to purchase was not provided within the lease agreement being specifically addressed as not applicable on the Lease. Although both the Lease and Option acknowledge the other respective agreement, our view is that this merely provides for the cessation of the Lease upon exercise of the Option.

The Lease required you to pay rent for the use of these Properties. Our view is that it was the Lease agreement, (particularly your rental payment obligation under it) which provided you with the use and enjoyment of these Properties prior to the contract for their purchase was entered.

The Option provided you with the option to purchase Property B and Property C, being the separate agreement upon which the title in these Properties was able to pass. The Lease payments did not contribute toward the purchase consideration for the Properties.

Conditions in the Lease provided the Lessor with renumeration for your use of the land as well as several clauses which set out to ensure the asset's value was not diminished. It is evident from these conditions that the Lessor's ownership of the Properties was maintained until the date you exercised the Option and entered the contract for their purchase.

As the Lease and Option are separate agreements the conditions of subsection 104-15(1) were not satisfied and CGT event B1 did not happen upon their signing. Consequently, you did not acquire ownership of the relevant CGT asset being the legal title in Property B and Property C at the time.

Conclusion

We do not agree that the interests you held prior to entering the purchase contract for Property B and Property C contributed to your continuous ownership period for the purpose of paragraph 152-105(b). Your acquisition of the full fee simple ownership of Property B and Property C remains the date of you entered the contract for their purchase.

You do not satisfy paragraph 152-105(b) for the CGT events being the sale of Property B and Property C as you did not continuously own the full legal title to these properties for a continuous period of 15 years just before the CGT event. Consequently, you cannot disregard the capital gain from these properties under the 15-year exemption.

Question 4

Summary

As you satisfy the basic conditions in Subdivision 152-A for the sale of Property B and Property C and the 15-year exemption does not apply, the small business 50% discount will apply unless you choose not to apply it.

Detailed reasoning

Small business 50% reduction

Under Section 152-205 the amount of a capital gain remaining after applying step 3 of the method statement in subsection 102-5(1) is reduced by 50%, if the basic conditions in Subdivision 152-A are satisfied for the gain.

However, you may choose not to apply the reduction mentioned in section 152-205 to a particular capital gain (section 152-220).

Also, the small business 50% reduction will not apply to a capital gain to which the 15-year exemption applies (section 152-215).

Application to your circumstances

As you satisfy the basic conditions in Subdivision 152-A for the sale of Property B and Property C and the 15-year exemption does not apply, the small business 50% discount will apply unless you choose not to apply it.

Question 5

Summary

You satisfy the required conditions and are therefore entitled to choose to disregard the remaining amount of capital gain made in relation to the disposal of your interest in Property B and Property C, up to the CGT retirement exemption limit of $500,000.

Detailed reasoning

Subsection 152-305(1) provides that if you are an individual, you can choose to disregard all or part of a capital gain if:

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

(b)  if you are under 55 just before you make the choice - you contribute an amount equal to the asset's CGT exempt amount to a complying superannuation fund or an RSA; and

(c)   the contribution is made:

                    (i)        if the relevant CGT event is CGT event J2, J5 or J6 - when you made the choice; or

                   (ii)        otherwise - at the later of when you made the choice and when you received the proceeds.

Where an individual makes the choice to apply the small business retirement exemption, the amount of capital gain chosen will be disregarded from your assessable income (subsection 152-310(1)).

The choice made must be made in a way that ensures the individual does not exceed the CGT retirement exemption limit (paragraph 152-315(2)(a)).

Subsection 152-320(1) states an individual's CGT retirement exemption limit at a time is $500,000 reduced by the CGT exempt amounts of CGT assets specified in choices previously made by or for the individual under Subdivision 152-E.

Application to your circumstances

The basic conditions in Subdivision 152-A have been satisfied for the capital gain made on disposal of your interest in Property B and Property C. Although you were under 55 years of age at the time the choice is to be made, if you make the choice, you will contribute an amount equal to the asset's CGT exempt amount to a complying superannuation fund or an RSA. On this basis the requirements in subsection 152-305(1) will be satisfied, entitling you to choose to apply the small business retirement exemption.

You have not previously utilised any amount of your CGT retirement exemption limit of $500,000.

You are therefore entitled to choose to disregard the remaining amount of capital gain made up to the CGT retirement exemption limit of $500,000, after taking into account the steps in the method statement in subsection 102-5(1).