Edited version of private advice

Authorisation Number: 1052209997799

Date of advice: 17 January 2024

Ruling

Subject: CGT - small business concessions

Question 1

Will capital gains tax (CGT) event D2 under subsection 104-40(1) of the Income Tax Assessment Act 1997 (ITAA 1997) happen when you grant an option under the Deed of Option?

Answer

Yes.

Question 2

If the Additional Fees are paid, will CGT event C2 happen to you under section 104-25 of the ITAA 1997?

Answer

Yes.

Question 3

Are you entitled to access the small business concession - 15-year exemption in Subdivision 152-B of the ITAA 1997 if the sale of the Property proceeds?

Answer

Yes.

This ruling applies for the following periods

Year ending 30 June 2023

The scheme commenced on

1 July 2022

Relevant facts and circumstances

You and your Spouse acquired the Property in 19XX.

The Property is your main residence and is owned as joint proprietors.

You and your Spouse run a Partnership on the Property and have done continuously since 19XX.

The Partnership runs a primary production business.

You and your Spouse intend to sell the Property to the Purchaser.

The Purchaser must obtain various approvals for this contract to proceed.

You and your Spouse have agreed to grant the Purchaser an option to call upon a purchase of the Property.

A call option deed (the Deed of Option) has been executed that establishes the conditions to be met prior to entering into a formal contract.

Under the Deed of Option, the Purchaser will pay Call Option Fees, and if certain conditions are met, Additional Fees may be paid.

The Property sales will be in connection with your retirement and results in a cessation of the primary production business.

The Partnership is a small business entity (SBE) in the relevant income year in which the Property is sold.

In the year in which the Property is sold, you are a partner in the Partnership, which is an SBE, and you do not carry on a business in that income year (other than in partnership).

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 103-10

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 section 104-40

Income Tax Assessment Act 1997 section 112-20

Income Tax Assessment Act 1997 section 116-20

Income Tax Assessment Act 1997 section 116-25

Income Tax Assessment Act 1997 section 116-45

Income Tax Assessment Act 1997 section 116-65

Income Tax Assessment Act 1997 Subdivision 152-B

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

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

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-105

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

Income Tax Assessment Act 1997 section 328-125

Income Tax Assessment Act 1997 section 328-130

Reasons for decision

Question 1

Summary

CGT event D2 occurred when you entered into the Deed of Option.

Detailed reasoning

Capital gains tax (CGT) is the tax you pay on certain gains you make. You make a capital gain or capital loss as a result of a CGT event happening (section 102-20 of the ITAA 1997).

There are two CGT events that will be relevant to your circumstances, CGT event D2 and CGT event A1.

Granting an option to sell your property constitutes a CGT event D2 (subsection 104-40(1) of the ITAA 1997).

The subsequent sale from the exercising of the option will be a CGT event A1 (subsection 104-10(1) of the ITAA 1997).

Granting an option

CGT event D2 occurs if you grant an option to an entity (section 104-40 of the ITAA 1997).

Section 104-40 of the ITAA 1997 provides, where relevant:

(1) CGT event D2 happens if you grant an option to an entity, or renew or extend an option you had granted.

(2) The time of the event is when you grant, renew or extend the option.

(3) You make a capital gain if the capital proceeds from the grant, renewal or extension of the option are more than the expenditure you incurred to grant, renew or extend it. You make a capital loss if those capital proceeds are less.

Exceptions

(5) A capital gain or capital loss you make from the grant, renewal or extension of the option is disregarded if the option is exercised.

CGT event D2 occurred when you entered into the Deed of Option.

Under subsection 104-40(2) of the ITAA 1997, the timing of the event is when the call option was granted.

Subsection 104-40(3) of the ITAA 1997 varies the normal provision regarding the capital gain or the capital loss. This is because the cost base of the option is restricted to the expenditure you incurred to grant it.

The capital gain will therefore be the amount of the call option fee less any expenditure incurred to grant the option.

The capital proceeds for the event are the amount you received or are entitled to receive under the Deed of Option. In this case, you received an amount and will receive further amounts on certain conditions being met.

The 'capital proceeds' from a CGT event are defined in subsection 116-20(1) of the ITAA 1997 as the total of:

(a) the money you have received, or are entitled to receive, in respect of the event happening; and

(b) the market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event).

An entitlement to the receipt of money or property is defined in section 103-10 of the ITAA 1997. Paragraph 103-10(2)(b) states that if a taxpayer will not receive money or other property in relation to a CGT event until a time after the CGT event, including a situation where money is payable by instalments, then the taxpayer is treated as if they are entitled to receive that money or property.

The Deed of Option assigned by you to the Purchaser is an entitlement to a receipt of money relating to a CGT event; therefore, it will satisfy the purposes of section 103-10 of the ITAA 1997. This will in turn form part of the 'capital proceeds' as per subsection 116-20(1) of the ITAA 1997. Therefore, the capital proceeds for the granting of the option will include the total amount you are entitled to receive.

In consideration for the grant of option to purchase, the Purchaser agrees to pay the Call Option Fees. Therefore, the amount of the total capital proceeds is your portion of the amount that you are entitled to receive.

The cost base of the call option will be the amount of expenditure you incurred in granting the option. Any capital gain made will be required to be included in your taxation return for the 2023 income year.

The capital gains tax consequences of exercising an option

The Deed of Option provides that the Call Option may be exercised by the Purchaser at any time during the Call Option Period. Therefore, it may be the following year or a subsequent year before the option is exercised.

The date of disposal of the Property will be the date that the Call Option is exercised and the subsequent sale of the land from exercising the option will be a CGT event A1, under section 104-10 of the ITAA 1997.

Under subsection 104-40(5) of the ITAA 1997 if the option is exercised, the capital gain or capital loss you make from the grant of the option is disregarded.

Under the modifications to the general rules for capital proceeds, section 116-65 of the ITAA 1997 provides that if you dispose of a CGT asset because another entity exercises an option you granted in relation to the asset, the capital proceeds from the disposal include any payment you received for granting the option. This means that the capital proceeds from the CGT event A1 on the sale of the land includes any payment you received for granting the option.

Therefore, where an option is granted in one financial year and exercised in another financial year, an amendment to the assessment for the year in which the option was granted will be required to exclude the amount you received that relates to CGT event D2.

If the option is exercised (or terminated) during the Call Option Period, prior to the payment of any of the Call Option Fees, an amendment to the assessment for the year in which the option was granted will be required to exclude the amounts relating to the CGT event D2 that were included as proceeds for the CGT event D2, but not received. The table in section 116-25 of the ITAA 1997 sets out the modifications to the general rules. It provides that the non-receipt rule under section 116-45 can modify the capital proceeds under CGT event D2.

Question 2

Summary

If the Additional Fees are paid to you, CGT event C2 will happen under section 104-25 of the ITAA 1997.

Detailed reasoning

CGT event C2

CGT event C2 under section 104-25 of the ITAA 1997 happens when the ownership of an intangible CGT asset (such as contractual rights) ends. The time of the event is when the asset ends. There are a number of ways such an asset can end including being released, discharged, redeemed, cancelled, abandoned, surrendered or forfeited.

Under subsection 104-25(2) of the ITAA 1997, the time of the event is:

a)    when you enter into the contract that results in the asset ending; or

b)    if there is no contract - when the asset ends.

CGT event C2, under section 104-25 of the ITAA 1997, will happen to you in relation to your right to an additional payment pursuant to the relevant clause in the Call Option Deed.

The right to the payment of the Additional Fees (additional payment rights) commences to be owned and is acquired when certain conditions are met as per the Call Option Deed. The additional payment right will come to an end when satisfied by the payment of the amount during the Call Option Period determined under the Call Option Deed. CGT event C2 happens at this time, and you will include a capital gain or loss in the year of income in which the payment is made.

Under subsection 104-25(3) of the ITAA 1997, you make a capital gain if the capital proceeds from the ending are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset' reduced cost base.

The capital proceeds from a CGT event are calculated in accordance with the rules set out in Division 116 of the ITAA 1997. The general rule regarding capital proceeds is outlined in subsection 116-20(1) which provides that capital proceeds are equal to the total of the money a taxpayer received, or is entitled to receive, in respect of the event happening and the market value of any other property the taxpayer has received, or is entitled to receive, in respect of the event happening.

Question 3

Summary

You are entitled to access the small business concession - 15-year exemption in Subdivision 152-B of the ITAA 1997, if the sale of the Property proceeds.

Detailed reasoning

Basic conditions for small business concessions

To qualify for the CGT small business concessions, you must satisfy several conditions that are common to all the concessions.

Subsection 152-10(1) of the ITAA 1997 contains the following basic conditions you must satisfy to be eligible for the small business CGT concessions:

(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 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 (1A) or (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).

To be eligible to apply the small business CGT concessions you must satisfy all four of the basic conditions above.

Paragraph 152-10(1)(c) of the ITAA 1997, states that at least one of the requirements listed at subparagraphs (i) to (iv) must apply. For the purposes of this ruling we are considering subparagraph 152-10(1)(c)(iv). For section 152-10(1)(c)(iv) of the ITAA 1997 to apply the conditions mentioned in subsection 152-10(1A) or (1B) must be satisfied in relation to the CGT asset in the income year. Subsection 152-10(1A) is not relevant in this case.

The conditions in subsection 152-10(1B) of the ITAA 1997 are satisfied 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

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

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

(e)  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)) in relation to the CGT asset.

CGT Small Business Entity

To be considered a CGT small business entity in subparagraph 152-10(1)(c)(i) of the ITAA 1997, the entity needs to meet the following definition subsection 152-10(1AA) of the ITAA 1997:

(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) of the ITAA 1997 states:

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; and

(ii)   your aggregated turnover for the current year is likely to be less than $10 million.

Active asset test

The fourth basic condition to be met is for the CGT asset to satisfy the active asset test in section 152-35 of the ITAA 1997.

Subsection 152-35(1) of the ITAA 1997 states:

A *CGT asset satisfies the active asset test if:

...

(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 and a half years during the period specified in subsection (2).

Subsection 152-35(2) of the ITAA 1997 states:

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.

Subsection 152-40(1) of the ITAA 1997 relevantly states:

A *CGT asset is an active asset at a time if, at that time you:

(a) 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.

The active asset test is subject to the exclusions in subsection 152-40(4) of the ITAA 1997, under paragraph 152-40(4)(e) an asset whose main use is for deriving rent is specifically excluded from being an active asset.

Under subsection 328-125(1) of the ITAA 1997 an entity is connected with another entity if:

(a) one entity controls the other entity or

(b) both entities are controlled by the same third entity.

Under subsection 328-125(2) of the ITAA 1997:

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

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

Under subsection 328-130(1) of the ITAA 1997, 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 the you, in relation to the affairs of the business of the individual or company.

However, the meaning of affiliate can be extended for a spousal relationship. For the purposes of determining whether an individual's spouse is an affiliate for the purpose of Subdivision 152-A of the ITAA 1997, section 152-47 of the ITAA 1997 can be applied. This provision deems an affiliate relationship with an individual's spouse where an asset owned by one entity is used in the course of carrying on a business by another entity, and the business entity is not otherwise an affiliate of or connected with the asset owner (subsection 152-47(1)).

Application to your circumstances

152-10(1)(a)

The Property will satisfy the definition of a CGT asset provided in subsection 108-5(1) of the ITAA 1997.

152-10(1)(b)

CGT event A1 will happen on the sale of the Property (section 104-10 of the ITAA 1997). The event will result in a capital gain for you, but for the application of Division 152 of the ITAA 1997.

Therefore, the first two basic conditions in section 152-10 of the ITAA 1997 are satisfied.

152-10(1)(c)

Basic condition 152-10(1)(c)(iv) of the ITAA 1997

Paragraph 152-10(1)(c) of the ITAA 1997, states that at least one of the requirements listed at subparagraphs (i) to (iv) must apply. For the purposes of this ruling we are considering subparagraph (iv):

(iv) the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year;

For subparagraph 152-10(1)(c)(iv) of the ITAA 1997 to apply the conditions mentioned in subsection 152-10(1A) or (1B) must be satisfied in relation to the CGT asset in the income year. Subsection 152-10(1A) of the ITAA 1997 is not relevant in this case. Subsection 152-10(1B) is discussed below.

The conditions in subsection 152-10(1B) of the ITAA 1997 will be satisfied as:

(a)   you will be a partner in a partnership in the income year in which the Blocks of Land will be sold; and

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

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

(d)   The Property is not an interest in an asset of the partnership; and

(e)   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, will carry on (as referred to in subparagraph 152-40(1)(a)(i) or paragraph 152-40(1)(b)) in relation to the Blocks of Land.

Therefore, you will satisfy the third requirement of the basic conditions for the year in which the Property will be sold.

152-10(1)(d) - Active asset test

During the period between 199X and 202X the Property was used or held ready for use in the course of carrying on a business, that was carried on by an entity connected with you. You are connected to the Partnership under subsection 328-125(2) of the ITAA 1997 having received at least 40% of the net income of the Partnership.

The combined effect of sections 152-35 and 152-40 of the ITAA 1997 is that the Property will meet the active asset test as it was used, or held ready for use, in the course of carrying on a business, that was carried on by you, your associate or another entity connected with you, for at least 7 and a half years and it was owned by you for more than 15 years.

Conclusion on basic conditions

In conclusion, the Property will satisfy the active asset test, therefore you will satisfy all of the basic conditions for small business relief under section 152-10 of the ITAA 1997.

Small business 15 year exemption

Under section 152-105 of the ITAA 1997, you can disregard any capital gain arising from the disposal of the asset, if all of the following conditions are satisfied:

(a) the basic conditions in Subdivision 152-A of the ITAA 1997 are satisfied for the gain;

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

...

(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.

Whether there is a 'retirement' for the purposes of the 15-year exemption will depend on the circumstances of each particular case. It is considered for the term to be satisfied, there must at least be a significant reduction in the number of hours the individual is engaged in present activities, or a significant change in the nature of present activities.

Connection with retirement

In this case, the sale of the Property will be in connection with your retirement where the sale can be seen to be integral to your retirement plans.

Based on your age and the fact that sale of the Property will end the farming enterprise and immediately decrease your working hours and responsibilities, the sale of the Property will be integral to your retirement plans and therefore connected with your retirement.

Conclusion

In regard to section 152-105 of the ITAA 1997:

• the basic conditions in Subdivision 152-A of the ITAA 1997 will be satisfied for the gain.
• You owned your interest in the Property for over 15 years.
• You are over 55 years of age, and the event will happen in connection with your retirement.

As a result, you satisfy the conditions for the 15-year exemption and can disregard any capital gain you will make on the sale of the Property.