Edited version of private advice

Authorisation Number: 1052166929344

Date of advice: 13 September 2023

Ruling

Subject: CGT - active asset test

Question 1

Do the interests you hold in the Commercial Property, satisfy the active asset test pursuant to section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will the small business 15-year exemption in Subdivision 152-B apply in relation to the proposed disposal of the Commercial Property?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 2024

The scheme commenced on:

1 July 2023

Relevant facts and circumstances

Your family operates a business in a discretionary family trust (the Family Trust).

You are a beneficiary of the Family Trust with your spouse.

You work in the business carried on by the Family Trust.

The Family Trust has operated the business from the Commercial Property for more than XX years.

Parts of the Commercial Property are leased to other unrelated businesses. Most of the rental income derived from the Commercial Property has come from these third-party businesses in recent years

You own 50% of the Commercial Property as tenants in common with your self-managed superannuation fund (the SMSF).

You acquired your original interest in the Commercial Property more than 20 years ago.

You acquired an additional interest in the Commercial Property more than 15 years ago.

Prior to approximately 15 years ago, more than half of the Commercial Property was occupied by the Family Trust for its business use with the remainder rented to unrelated third parties.

Since approximately 15 years ago, additional buildings were constructed on the Commercial Property and the rental tenancy increased to more than half of the Commercial Property by floor area.

Your rental income from the Commercial Property is returned via a partnership (the Partnership) with the other owners. In addition to the unrelated third party, the Family Trust also pays rent to Partnership for its business use of the Commercial Property.

For the 8-year period form 1 July 2014 to 30 June 2022 the following information was relevant for your use of the Commercial Property:

•         The business income generated by the Family Trust's use was 9 times the amount of rental income derived from the Commercial Property.

•         You received no capital distributions from the Family Trust.

•         Your income distributions from the Family Trust were less than 40% of the income Distributions from the Family Trust.

•         You together with your spouse received more than 40% of the distributions from the Family Trust in all but one of the years.

You propose to dispose of your interests in the Commercial Property to the SMSF, with income derived from the SMSF funding your retirement.

You are aged over 55 and will retire at the time of disposing of your interests in the Commercial Property.

You will reduce your working hours from 30 currently to a maximum of 7 hours per week after the disposal of the Commercial Property.

You will satisfy the maximum net asset value test (MNAV) under section 152-15 of the ITAA 1997 in the financial year the Commercial Property will be disposed of.

It is proposed that the disposal of the Commercial Property will take place in the 2023-24 financial 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 section 152-10

Income Tax Assessment Act 1997 section 152-15

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 152-105

Income Tax Assessment Act 1997 section 328-125

Reasons for decision

Question 1

Do the interests you hold in the Commercial Property satisfy the active asset test pursuant to section 152-35?

Summary

The active asset test under section 152-35 is satisfied as the interests you held in the Commercial Property were owned by you for more than 15 years and they were an active asset of yours for more than 7½ years during your ownership period.

Detailed reasoning

Active asset

For the disposal of your interests in the Commercial Property to qualify for the CGT small business concessions, your interests, must satisfy the active asset test.

Under subsection 152-35(1), a CGT asset will satisfy 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 test period, 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 test period.

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 by you, or your affiliate, or another entity that is connected with you.

Application to your circumstances

You acquired your original interest in the Property more than XX years ago and acquired an additional interest more than 15 years ago, bringing your total interest in the property to 50%. Both interests need to be considered separately for the purpose of the active asset test.

You have held each of your ownership interests in the Commercial Property for a period of more than 15 years. To confirm the active asset test is satisfied, we need to establish that each ownership interest was an active asset for a period of more than 7½ years.

Connected Entity

As you have not used the Commercial Property directly in a business of your own, we will need to establish that you were connected to the Family Trust in order for its business use to be considered for the purpose of the active asset test.

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

An entity is connected to another entity if either entity controls the other entity in way described in section 328-125 (paragraph 328-125(1)(a)).

Subsection 328-125(4) An entity (the first entity) controls a discretionary trust for an income year if, for any of the 4 income years before that year:

(a)  the trustee of the trust paid to, or applied for the benefit of:

                            (i)        the first entity; or

                           (ii)        any of the first entity ' s *affiliates; or

                          (iii)        the first entity and any of its affiliates;

any of the income or capital of the trust; and

(b)  the percentage (the control percentage) of the income or capital paid or applied is at least 40% of the total amount of income or capital paid or applied by the trustee for that year.

Relevantly to your situation the operation of section 328-125 must be considered together with section 152-47.

Section 152-47 provides that spouses or children taken to be affiliates for certain passively held CGT assets:

152-47(1)

This section applies if:

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

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

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

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

152-47(2)

For the purposes of Subdivision 152-A, 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;

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

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

Application to your circumstances

You have received less than 40% of the income distributions and no capital distributions from the Family Trust for the 8-year period from 1 July 2014 until 30 June 2022. You did not control the Family Trust under subsection 328-125(4) and therefore were not connected to it under paragraph 328-125(1)(a) without consideration of your affiliate's distributions.

As you are not otherwise connected to the Family Trust during the 8-year period 1 July 2014 until 30 June 2022, section 152-47 deems your spouse to be your affiliate for the purpose of establishing the connection. You together with your spouse have received sufficient income distributions for you to control the Family Trust for the 8-year period from 1 July 2014 until 30 June 2022 under subsection 328-125(4).

As you have controlled the Family Trust for at least the 8-year period outlined above, you have been connected to it for the same period under paragraph 328-125(1)(a).

Mixed use of a property

Notwithstanding your connection to the Family Trust outlined above, subsection 152-40(4) lists CGT assets that cannot be active assets that needs to be considered.

Under paragraph 152-40(4)(e), an asset whose main use is to derive rent cannot be an active asset unless the main use for deriving rent was only temporary.

If the main use of the Commercial Property was to derive rent at any time, the Property was not an active asset at that time.

As stated in subsection 152-40(4A), for the purposes of paragraph 152-40(4)(e), 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.

This means for the purpose of the analysis of whether the rental exclusion applies, the business use Commercial Property by the Family Trust is considered as your business use regardless of whether or not the Family Trust paid rent for its use.

As the Commercial Property was used partly to derive business income by the Family Trust and partly to derive rental income from unconnected third parties, it will be a question of fact depending on all the circumstances as to whether the main use of the asset, during some or all of the ownership period was to derive rent.

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? (TD 2006/78) 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 in TD 2006/78 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).

Application to your circumstances

As mentioned above no one single factor will necessarily be determinative, resolving the matter involves a consideration of:

• the comparative areas of use of the Commercial Property (between deriving rent and other uses), and
• the comparative levels of income derived from the different uses of the Commercial Property.

The critical issue is whether the main use of your interests in the Commercial Property was to derive rent.

During each of the 8 financial years starting 1 July 2014 until 30 June 2022, the Family Trust's use of the Commercial Property for its business purposes was less than the area used by third part tenants.

However, during the same period, the Family Trust's business operations turnover contributed 9 times more income than the rental income derived.

On the basis of the business use income far exceeding rental income, our view is that the main use of the Commercial Property has not been to derive rent and the rental exclusion in paragraph 152-40(4)(e) does not apply for at least the 8-year period considered.

Conclusion

We have established your connection to the Family Trust and confirmed the rental exclusion does not apply for the 8-year period from 1 July 2014 to 30 June 2022. By doing this we have established that both of your interests in the Commercial Property were active assets during this period.

As you owned your two interests in the Commercial Property for more than 15 years and the interests were an active asset of yours for at least 7½ years during your ownership period, both or your interests satisfy the active asset test in section 152-35.

Question 2

Will the small business 15-year exemption in Subdivision 152-B apply in relation to the proposed disposal of the Commercial Property?

Summary

You will be entitled to disregard your capital gain from the proposed disposal of your interests in the Commercial Property as the required conditions in subsection 152-110(1) will be satisfied:

Detailed reasoning

Section 152-105 outlines the conditions required for the 15-year exemption where the CGT asset is owned by an individual.

Section 152-105 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;

(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.

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 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)        you do not carry on a business, but your CGT asset is used in a business carried on by a CGT 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.

Application to your circumstances

A CGT event will occur when you dispose of the Commercial Property which will result in a capital gain satisfying paragraphs 152-10(1)(a) and (b).

The maximum net asset test under section 152-15 will be satisfied in the financial year the Commercial Property is disposed of, therefore paragraph 152-10(1)(c) will be satisfied.

As per the answer to question 1, the active asset test in section 152-35 is satisfied for both or your interest in the Commercial Property. It follows that paragraph 152-10(1)(d) will be satisfied.

You will satisfy all the requirements for the basic conditions for relief in Subdivision 152-A for the proposed disposal of your interests in the Commercial Property. Consequently, the first requirement for the 15-year exemption in paragraph 152-105(a) will be satisfied.

You acquired your initial interest in the Commercial Property more than 20 years ago and your subsequent interest more than 15 years ago. As you will have continuously owned each of your interests in the Commercial Property for more than 15 years just before the proposed CGT event, the requirement in paragraph 152-105(b) is satisfied.

Your interests in the Commercial Property are not shares in a company or interests in a trust, paragraph 152-105(c) will not apply.

You will be over 55 and will retire at the time you proceed with the disposal of your interests in the Commercial Property. You will significantly reduce your working hours from 30 hours per week currently to 7 hours per week after the disposal. You will satisfy the condition in paragraph 152-105(d).

As you will satisfy all the relevant requirements of section 152-105, you will be entitled to apply the small business 15-year exemption to disregard any capital gain made upon the proposed disposal of your interests in the Commercial Property.

Other relevant comments

You have asked whether an in-specie contribution of the of the Commercial Property to your SMSF will count towards the transfer balance cap. A transfer balance account is started when a person begins a pension in theretirement phase. A person's transfer balance account is credited when they start an income stream and debited when they commute a pension and remove the money from pension phase.

There are a few other occasions when a debit event occurs, such as a family law split, loss due to fraud or a structured settlement from a personal injury payment. A CGT exempt amount contributed to superannuation is not a circumstance giving rise to a debit on a person's transfer balance account. So, any amount from the contribution of the Property included in a pension in retirement phase will count towards your transfer balance cap.