Edited version of private advice

Authorisation Number: 1052155019124

Date of advice: 11 August 2023

Ruling

Subject: CGT - small business 15-year exemption

Question 1

Will the sale of the property by the Taxpayer be exempt under the Small Business ('SB') 15-year Capital Gains Tax ('CGT') exemption under section 152-105 of the Income Tax Administration Act 1997 ('ITAA 1997')?

Answer

Yes.

Question 2

If the Taxpayer cannot claim the 15-year CGT exemption in their individual capacity, will the Commissioner extend the two-year time limit available to claim the exemption after the Taxpayer's spouse dies?

Answer

Not applicable, as the Taxpayer can claim the 15-year CGT exemption in their individual capacity.

This ruling applies for the following periods:

DD MM YYYY to DD MM YYYY

RELEVANT FACTS AND CIRCUMSTANCES

Background information

1.      The Taxpayer, of XYZ, was born on DD MM YYYY and is presently xx years of age.

2.      The commercial property ('the Property') was originally owned by the Taxpayer's spouse, her mother-in-law, and her sister-in-law from YYYY to YYYY.

3.      During the period YYYY to YYYY, the Taxpayer's spouse owned a xx% interest in the Property. This interest was registered in his name.

4.      The Taxpayer's spouse died unexpectedly in MM YYYY at the age of xx. Following his death, the Taxpayer struggled with the administration and management of her investments, as her spouse managed these during his lifetime.

5.      The COVID pandemic hit during the two year time frame following the death of the Taxpayer's spouse, which resulted in great economic uncertainty, particularly in the property market, so the Taxpayer delayed making a decision about selling the Property due to these circumstances which were outside of her control.

Use of Property

6.      The Property was used in the family business during the period of ownership from YYYY to YYYY.

7.      The Property was used fulltime for the family business, run via a company structure for 15 years (Company A). The Taxpayer's spouse was a director and shareholder in the company.

8.      The family business was sold in YYYY, and the Property was transferred into the joint ownership of the Taxpayer and her spouse on DD MM YYYY for a consideration of $xyz. The Taxpayer's mother-in-law and her sister-in-law transferred their ownership interests to The Taxpayer and her spouse via a 'Transfer of Land' and Transfer Duty was paid on the transfer.

9.      The Property was leased to an unrelated party for the period between YYYY and YYYY.

10.    In YYYY, the Taxpayer and her spouse owned another business, and this business moved into the Property and the Property was used as their business premises until YYYY (a 6 year period), when the second business was sold.

11.    From YYYY to YYYY, the Property was used (full time) as the business premises for a new business owned by the Taxpayer and her spouse (Company B). The Taxpayer and her spouse owned xx% of Company B.

12.    The Property was then rented to an unrelated party from YYYY until YYYY.

13.    The Taxpayer's spouse died unexpectedly in MM YYYY, and the Taxpayer then became the sole owner of the Property. The Taxpayer acquired her spouse's xx% interest as a surviving joint tenant.

14.    The Property was rented to an unrelated party from YYYY until the date of sale (DD MM YYYY).

15.    The Property was used in a business owned by the Taxpayer and her spouse for a period of 6 years during their period of joint ownership.

16.    The Taxpayer's spouse satisfied the Maximum Net Asset Value test in YYYY.

Sale of Property

17.    The Taxpayer sold the commercial property on DD MM YYYY.

Retirement

18.    The Taxpayer is aged xx years (over xx) of age and is retired. The Taxpayer's Maximum Net Asset Value is less than $6 million.

Information provided

19.    You have provided several documents containing detailed information in relation to the Taxpayer, including:

•           Private Binding Ruling ('PBR') Application, dated DD MM YYYY

•           Information provided as an appendix to the ruling application

20.    We have referred to the relevant information within these documents in applying the relevant tests to your circumstances.

Assumption(s)

Not applicable.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 Subdivision 152-B

Income Tax Assessment Act 1997 Subsection 108-5(1)

Income Tax Assessment Act 1997 Subsection 108-5(2)

Income Tax Assessment Act 1997 Section 152-1

Income Tax Assessment Act 1997 Section 152-10

Income Tax Assessment Act 1997 Section 152-15

Income Tax Assessment Act 1997 Section 152-20

Income Tax Assessment Act 1997 Section 152-35

Income Tax Assessment Act 1997 Section 152-40

Income Tax Assessment Act 1997 Section 152-47

Income Tax Assessment Act 1997 Section 152-105

Income Tax Assessment Act 1997 Section 328-130

Income Tax Assessment Act 1997 Section 995-1

Further issues for you to consider

Not applicable.

REASONS FOR DECISION

All legislative references are to the Income Tax Assessment Act 1997 ('ITAA 1997') unless otherwise stated.

SUMMARY - QUESTION 1:

The sale of the property by the Taxpayer will be exempt under the Small Business 15-year Capital Gains Tax ('CGT') exemption under section 152-105 of the ITAA 1997.

SUMMARY - QUESTION 2:

Not applicable, as the Taxpayer can claim the 15-year CGT exemption in their individual capacity.

DETAILED REASONING

21.    As stated in section 152-10 of the ITAA 1997, subdivision 152-A of the ITAA 1997 sets out the 'basic conditions' which must be satisfied in order for small business entities to qualify for any of the CGT small business concessions to reduce their capital gain by the various concessions in Division 152 of the ITAA 1997.

Basic conditions for small business concessions

22.    Subsection 152-10(1) of the ITAA 1997 sets out the basic conditions which must be satisfied for a capital gain to be reduced or disregarded under this Division, as follows:

A capital gain (except a capital gain from CGT event K7) you make may be reduced or disregarded under this Division if the following basic conditions are satisfied for the gain:

(a)    a CGT event happened 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 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.

CGT Events and Assets

23.    As defined in section 995-1 of the ITAA 1997, a CGT event means any of the CGT events described in Division 104 of the ITAA 1997. A CGT event described by number (eg. CGT event A1) refers to the relevant event in that Division.

24.    Subsection 108-5(1) of the ITAA 1997, outlines a CGT asset to be:

(a) any kind of property; or

(b) a legal or equitable right that is not property.

25.    To avoid doubt, subsection 108-5(2) lists the following as CGT assets:

(a) part of, or an interest in, an asset referred to in subsection (1);

(b) goodwill or an interest in it;

(c) an interest in an asset of a partnership;

(d) an interest in a partnership that is not covered by paragraph (c).

CGT small business entity

26.    As defined in section 995-1 of the ITAA 1997, a CGT small business entity has the meaning given by subsection 152-10(1AA), as follows:

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.

27.    As defined in section 995-1 of the ITAA 1997, a small business entity has the meaning given by subsection 328-110(1), as follows:

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.

28.    As defined in section 995-1 of the ITAA 1997, a business includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee.

29.    As defined in subsection 328-115 of the ITAA 1997, aggregated turnover is defined as the sum of all relevant annual turnovers. The relevant annual turnovers are outlined in subsection 328-155(2) and exclude any amounts covered by subsection 328-155(3).

30.    Section 328-120 of the ITAA 1997 sets out the meaning of annual turnover as follows:

An entity's annual turnover for an income year is the total ordinary income that the entity derives in the income year in the ordinary course of carrying on a business.

31.    The term ordinary income is defined in section 6-5 of the ITAA 1997 as 'income according to ordinary concepts'. An entity's annual turnover therefore, includes all income according to ordinary concepts derived in the ordinary course of carrying on a business.

32.    The term 'in the ordinary course of carrying on a business' is not defined in the ITAA 1997. The term therefore, takes its ordinary meaning.

33.    In Doutch v FC of T [2016] FCAFC 166, which was an appeal against the decision of the AAT in respect of small business entity concessions, the Full Federal Court confirmed the following reasoning provided by the Tribunal:

70 The phrase "in the ordinary course of carrying on a business", as it appears in

s 328-120(1) of the ITAA 1997, is not defined in the ITAA 1997 and it is necessary to construe those words. In engaging in the exercise of statutory construction, the Court is to consider the text of the statute in context. The High Court in Commissioner of Taxation v Consolidated Media Holdings Ltd (2012) 250 CLR 503 observed as follows at [39]:

"This Court has stated on many occasions that the task of statutory construction must begin with a consideration of the [statutory] text" [Alcan (NT) Alumina Pty Ltd v Commissioner of Territory Revenue [2009] HCA 41; (2009) 239 CLR 27 at 46 [47]]. So must the task of statutory construction end. The statutory text must be considered in its context. That context includes legislative history and extrinsic materials. Understanding context has utility if, and in so far as, it assists in fixing the meaning of the statutory text. Legislative history and extrinsic materials cannot displace the meaning of the statutory text. Nor is their examination an end in itself.

34.    The extrinsic materials to which the High Court referred includes an explanatory memorandum, as follows:

72 The definition of "annual turnover" in s 328-120(1) of the ITAA 1997 was inserted into the ITAA 1997 by Tax Laws Amendment (Small Business) Act 2007 (TLASBA 2007). The "Explanatory Memorandum" to the Tax Laws Amendment (Small Business) Bill 2007 (EM), which Bill was ultimately enacted as the TSLABA 2007, commencing from the 2008 income year, states:

What does 'in the ordinary course of carrying on a business' mean?

2.15 In general, income is derived in the ordinary course of carrying on a business if the income is of a kind that is regularly or customarily derived by the entity in the course of carrying on its business, arising out of no special circumstance or event. Similarly, the income is derived in the ordinary course of carrying on a business if the income although not regularly derived, is a direct result of the normal activities of the business.

35.    Therefore, according to the EM, income is derived in the ordinary course of carrying on a business where:

(a) the income is of a kind that is regularly or customarily derived by an entity in the course of carrying on its business, arising out of no special circumstance or unusual event; and

(b) the income, although not regularly derived, is derived as a direct result of the normal activities of the business.

Maximum net asset value test

36.    The term maximum net asset value test is defined in section 152-15 of the ITAA 1997 as follows:

You satisfy the maximum net asset value test if, just before the CGT event, the sum of the following amounts does not exceed $6,000,000:

(a) the net value of the CGT assets of yours;

(b) the net value of the CGT assets of any 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)).

37.    Section 152-20 of the ITAA 1997 sets out the meaning of net value of the CGT assets as follows:

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;

(iv) provisions for tax liabilities.

Active asset test

38.    Section 152-35 of the ITAA 1997 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 7.5 years during the period specified in subsection (2).

39.    Further, subsection 152-35(2) of the ITAA 1997 outlines that the period:

(a) begins when you acquired the asset; and

(b) 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.

40.    Section 152-40 of the ITAA 1997 outlines the meaning of active asset at subsection 152-40(1) as follows:

A CGT asset is an active assetat 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

(b) if the asset is an intangible asset - you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you.

41.    Paragraph 152-40(4)(e) of the ITAA 1997 outlines that the following CGT assets cannot be active assets:

(e)  An asset whose main use by you is to derive interest, an annuity, rent, royalties or foreign exchange gains unless:

(i)     the asset is an intangible asset and has been substantially developed, altered or improved by you so that its market value has been substantially enhanced; or

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

42.    For the purposes of paragraph 152-40(4)(e) above, subsection 152-40(4A) of the ITAA 1997, in determining the main use of an asset:

(a)    Disregard any personal use or enjoyment of the asset by you; and

(b)    Treat any use by your affiliate, or an entity that is connected with you, as your use.

15-year exemption for individuals

43.    As stated in section 152-100 of the ITAA 1997, subdivision 152-B of the ITAA 1997 sets out that a CGT small business entity can disregard a capital gain arising from a CGT asset that it has owned for at least 15 years if certain conditions are met.

44.    Section 152-105 of the ITAA 1997 outlines the 15-year exemption for individuals as follows:

If you are an individual, you 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)    you continuously owned the CGT asset for the 15-year period ending just before the CGT event;

Note: Section 152-115 allows for continuation of the period if there is an involuntary disposal of the asset.

(c)    if the CGT asset is a share in a company or an interest in a trust-the company or trust 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 you owned the CGT asset;

(d)    either:

(i)     you are 55 or over at the time of the CGT event and the event happens in connection with your retirement; or

(ii)    you are permanently incapacitated at the time of the CGT event.

Meaning of Affiliate

45.    Under subsection 328-130(1) of the ITAA 1997, an individual or a company is an affiliate of yours if the individual 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.

46.    However, under subsection 328-130(2) of the ITAA 1997, 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.

47.    For small business relief purposes, a spouse or a child under 18 years of age may also be an affiliate under section 152-47 of the ITAA 1997. Spouses or children are taken to be affiliates for certain passively held CGT assets, as follows:

(1)    This section applies if:

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

(b) 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

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

Note: The meaning of connected with an entity is affected by section 152-78.

(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.

(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.

Example: The spouse or child mentioned in subsection (2) is taken to be an affiliate of the individual for the purposes of working out which entities are affiliates of or connected with entities under section 152-48.

(4) To avoid doubt, subsection (2) applies:

(a) for the purposes of reducing or disregarding, under this Division, any capital gain from any CGT asset; but

(b) only while:

(i) a spouse remains a spouse; or

(ii) a child remains a child who is under 18 years.

48.    'Small business affiliates' are defined as any individual or company that, in relation to their business affairs, acts or could reasonably be expected to act either:

•           according to your directions or wishes

•           in concert with you.

49.    If entities are considered a taxpayer's affiliate, this will affect the:

•           calculation of their aggregated turnover

•           calculation of the maximum net asset value test

•           the application of the active asset test.

50.    Whether a person acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, depends on the circumstances of the case.

51.    Relevant factors that may support a finding that a person acts in such a manner include:

•           the existence of a close family relationship between the parties;

•           the lack of any formal agreement or formal relationship between the parties dictating how the parties are to act in relation to each other;

•           the likelihood that the way the parties act, or could reasonably be expected to act, in relation to each other would be based on the relationship between the parties rather than on formal agreements or legal or fiduciary obligations; and

•           the actions of the parties.

Spouse or children taken to be Affiliates for certain passively held CGT assets

52.    Subsection 152-47(2) of the ITAA 1997 outlines that 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.

APPLICATION TO YOUR CIRCUMSTANCES

Question 1:

53.    For the purpose of this private ruling, a determination is to be made whether the commercial property, ('the Property') owned by the Taxpayer satisfies the 'active asset test' for the CGT small business concessions pursuant to section 152-35 of the ITAA 1997 when the Property was sold in the YYYY financial year (sold DD MM YYYY).

54.    Section 152-35 of the ITAA 1997 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 7.5 years during the period specified in subsection (2).

55.    Section 152-40 of the ITAA 1997 outlines the meaning of active asset at subsection 152-40(1) as follows:

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...

56.    Taxation Ruling TR 97/11 Income Tax: am I carrying on a business of primary production? ('TR 97/11') provides the Commissioner's view of the factors used to determine if a taxpayer is in business for tax purposes. Its principles are not restricted to questions of whether a primary production business is being carried on.

57.   Paragraph 13 of TR 97/11 provides an overview of the Commissioner of Taxation's (the 'Commissioner') view of the factors used to determine if you are in business for tax purposes. Paragraph 13 notes that:

"The courts have held that the following indicators are relevant:

•           whether the activity has a significant commercial purpose or character; this indicator comprises many aspects of the other indicators;

•           whether the taxpayer has more than just an intention to engage in business;

•           whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity;

•           whether there is repetition and regularity of the activity;

•           whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business;

•           whether the activity is planned, organised and carried on in a business-like manner such that it is directed at making a profit;

•           the size, scale and permanency of the activity; and

•           whether the activity is better described as a hobby, a form of recreation or a sporting activity."

58.    The period for determining if the Taxpayer's Property satisfies the active asset test begins in YYYY, when the Taxpayer acquired the Property and ends at the time of the CGT event occurring at the time the Taxpayer disposes of the Property (DD MM YYYY). Therefore, the applicable period is in excess of 24 years (YYYY - YYYY).

59.    The Property will qualify as an active asset at a time when the Taxpayer owned the Property and used it, or held it ready for use, in the course of carrying on a business that was carried on (whether alone or in partnership) by the Taxpayer unless the Property's main use was to derive rent.

60.    For approximately x years (YYYY - YYYY), xx years (YYYY - YYYY) and x years (YYYY - YYYY), the Property was leased to other parties and therefore did not qualify as an active asset for that period of xx years.

61.    The Property was used by the Taxpayer's spouse in running the family business from YYYY - YYYY for a total of 15 years (in his capacity of xx% ownership), and jointly by the Taxpayer and her spouse in running another family business from YYYY - YYYY for a total of 6 years (as xx% joint ownership).

62.    The predominant use of the Property at all material times from YYYY has been as follows:

•           YYYY-YYYY (xx years) - Property used in family business

•           YYYY-YYYY (xx years) - Property leased to other party

•           YYYY-YYYY (xx years) - Property used in family business

•           YYYY-YYYY (xx years) - Property leased to other party

•           YYYY-YYYY (xx years) - Property leased to other party

63.    The ownership details of the Property at all material times from YYYY has been as follows:

•           YYYY-YYYY (xx years) - Taxpayer's spouse had xx% ownership

•           YYYY-YYYY (xx years) - Taxpayer and spouse had xx% ownership each (xx% total)

•           YYYY-YYYY (xx years) - Taxpayer had xx% ownership

64.    Subsection 152-47(2) of the ITAA 1997 outlines that the Taxpayer's spouse is taken to be an 'Affiliate' of the Taxpayer for the purposes of the basic conditions.

65.    Paragraph 152-40(4A)(b) of the ITAA 1997 allows the Taxpayer to treat any use of the Property by her affiliate as her own use for the purposes of the active asset test. The Property satisfies the active asset test as it was used in a business by an entity connected with the Taxpayer's spouse for 15 years (between YYYY-YYYY) and then used in a business carried on by the Taxpayer and her spouse for 6 years (between YYYY-YYYY), a total of xx years. Therefore, the Property was an active asset for the Taxpayer.

66.    The basic conditions are all satisfied, and the Taxpayer satisfies the Maximum Net Asset Value Test of less than $6 million.

67.    The conditions applicable to the 15-year exemption for individuals are contained in section 152-105 of the ITAA 1997, which are as follows:

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

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

c) If the CGT asset is a share in a company or an interest in a trust - the company or trust 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 you owned the CGT asset;

d) Either:

i. You are 55 or over at the time of the CGT event and the event happens in connection with your retirement; or

ii. You are permanently incapacitated at the time of the CGT event.

68.    At the time of sale of the Property, the Taxpayer is over 55 and will have owned the Property for the 15-year period ending just before the CGT event (sale). The Taxpayer was entering retirement at the time of the CGT event.

69.    Consequently, the Taxpayer will satisfy all the relevant conditions as set out in section 152-105 of the ITAA 1997. The Taxpayer is eligible to access the 15-year exemption and disregard the capital gain she will make on the sale of the Property in full.

QUESTION 2:

Question 2 is not applicable, as the Taxpayer can claim the 15-year CGT exemption in their individual capacity.