Edited version of private advice

Authorisation Number: 1052205272079

Date of advice: 18 December 2023

Ruling

Subject: Active asset reduction and retirement exemption

Question 1

Can you apply the active asset reduction and retirement exemption to the X% sale of the property in relation to the X% interest you acquired in 1997?

Answer

Yes.

This private ruling applies for the following period:

Year ended 30 June 2023

The scheme commenced on:

1 July 2022

Relevant facts and circumstances

Trust A was established in 19YY and is a discretionary trust.

The appointor at that time was individual A.

The trustee was company A. You were a director and individual A was secretary.

Trust A conducted a business which began in 19YY and continues to run today.

In 19YY company A was removed as trustee of trust A and company B was appointed as trustee of trust A.

In 19YYa property was purchased by you and individual A as joint tenants.

The property was then used by trust A to conduct the business.

In 19YY the trustee of trust A changed from company B to company C.

In 20YY individual A resigned as the appointor of trust A and individual B was appointed as the new appointor. Individual A and you also resigned as directors and secretary of the trustee of trust A in 20YY. The business continued to operate and a new lease for the property was created and remains in operation even today.

In 20YY individual A passed away and you are now the 100% owner of the property.

In the 20YY income year a contract was created and signed to sell X% of the property owned by you to the trustee for trust B.

Individual C, the spouse of individual B is the appointor of trust B.

The property is still being leased to the business.

The trust is a small business with a turnover of less than $2 million.

The net assets of you, your connected entities and affiliates are less than $6 million.

During the time individual A was the appointor of the trust the income distributions were all made to you and individual A.

You were over 55 years old and at the time the X% of the property was sold and you retired from the business when individual A passed away in 20YY.

Relevant legislative provisions

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 subsection 328-125

Income Tax Assessment Act 1997 subsection 328-130

Reasons for decision

Basic conditions

Subdivision 152-A of the ITAA 1997 contains the basic conditions that must be satisfied for small business CGT relief. The basic conditions, as set out in subsection 152-10(1) of the ITAA 1997 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 interest in an asset of the partnership, or

(iv)   you do not carry on a business, but your CGT asset is used in a business carried on by a small business entity that is your affiliate or an entity connected with you.

(d)  the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997

Maximum net asset value test

You satisfy the maximum net asset value 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 asset of yours

(b)  the net value of the CGT assets of any entities connected with you, and

(c)  the net value of the CGT assets of any affiliates of yours or entities connected with your affiliates (section 152-15 of the ITAA 1997).

Active asset test

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 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 152-35(1) of the ITAA 1997).

The test period begins when you acquired the asset and ends at the time of the CGT event (subsection 152-35(2) of the ITAA 1997).

Subsection 152-40(1) of the ITAA 1997 details 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.

Connected entity

The term 'connected with' is defined in subsection 995-1(1) of the ITAA 1997 as:

'an entity is connected with you in the circumstances described in section 328-125.'

Subsection 328-125(1) of the ITAA 1997 states 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.

Direct control of a discretionary trust may be established via either of two paths: subsection 328-125(3) or subsection 328-125(4) of the ITAA 1997.

Subsection 328-125(3) of the ITAA 1997 provides that an entity controls a discretionary trust if the trustee of that trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the entity, its affiliates, or the entity together with its affiliates.

Subsection 328-125(4) provides, in part, that an entity directly controls a discretionary trust for an income year if, for any of the preceding four income years, the discretionary trust distributed at least 40% of any income or capital paid for that year to either the entity, its affiliates, or to the entity together with any of its affiliates.

Affiliate

The definition of affiliate is contained in section 328-130 of the ITAA 1997 and is set out below:

(1)  An individual or a company is an affiliate of yours if the individual or company acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the business of the individual or company.

(2)  However, an individual or a company is not your affiliate merely because of the nature of the business relationship you and the individual or company share.

Trusts cannot be your affiliate. A trust may have an affiliate who is an individual.

Retirement exemption

Provided the basic conditions are met, an individual who is over 55 at time of CGT event, needs to ensure the amount disregarded does not exceed the $500,000 retirement exemption lifetime limit. An individual must also keep a written record of the amount chosen to be disregarded.

Application to the circumstances

In this case, a CGT event occurred when you sold X% of the property. The property was owned for more than 15 years.

The property was used in the business carried on by trust A. Trust A is not an affiliate of yours, however it is a connected entity of yours from 19YY when you and individual A controlled the trust as directors of the trustee company B up to 20YY when you and individual A ceased as directors of the trustee at that time company C. From 20YY, you also ceased receiving any distributions from trust A. Therefore, you did not control trust A after 20YY.

As trust A was a connected entity of yours for a 10 year period and the CGT asset was used by the business trust A carried on, it was an active asset for at least 7 ½ years and meets the requirements of the active asset test.

The net assets of you, your affiliates and connected entities were less than $6 million just before the CGT event.

You have not previously used any of the $500,000 retirement exemption limit.

Therefore, the basic conditions for the small business CGT concessions have been satisfied and the additional condition for the retirement exemption also satisfied. You are entitled to apply the active asset reduction and retirement exemption to your original X% interest acquired in the property in 1997.