Edited version of private advice

Authorisation Number: 1052222930330

Date of advice: 24 May 2024

Ruling

Subject: CGT - 15-year exemption

Unless otherwise stated, all legislative references below are to the Income Tax Assessment Act 1997.

Question

Can company A disregard the capital gain made on the disposal of its goodwill, intellectual property and contracts pursuant to section 152-110 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes, the basic conditions in subsection 152-10(1) of the ITAA 1997 are satisfied, the maximum net asset test under section 152-15 was satisfied just before the CGT event and the business had a significant individual for at least 15 years, the significant individual was at least 55 years old at that time and the event happened in connection with their retirement. Therefore, company A satisfies the requirements to allow the company to apply the small business 15-year exemption to the sale of its assets.

This ruling applies for the following period:

Year ending 30 June 202X

The scheme commenced on:

1 July 202Y

Relevant facts and circumstances

Company A is a company that started to operate XX years ago

Since 20XX, the individual has been the sole shareholder, director and principal employee of company A. Prior to that the shares were held jointly with their former spouse both owing 50% each.

Company A wholly owns all the shares in another company, company B - pursuant to a restructure and acquisition several years ago. Company B owns intellectual property that is licensed to various external parties. The individual is not an employee of company B.

Company B is a subsidiary company of company A and subsequent to the sale company B has changed its name to company C.

The aggregated turnover of company A for the 202Y income year was below $2 million.

Company A will meet the $X million maximum net asset value test just before the CGT event.

The Individual has been a significant individual of company A for at least 15 years, having sole ownership since 20XX.

Company A and company B (collectively the 'seller') entered into a business purchase agreement in the financial year 202Y-2X the purchaser whereby the purchaser has agreed to buy from company A the goodwill, intellectual property and contracts (assets).

The assets have been continuously owned by company A for a period of 15 years and were an active asset for at least 7½ years during the ownership period the ruling will only cover assets owned by company A and not company B.

Certain employees of company A were offered continuing employment in the business within the purchaser with, the individual as one of those employees.

Prior to the sale, the individual estimated they worked approximately 50 - 60 hours a week and more when working overseas in the business inclusive of managerial duties.

The Individual is the director, and 100% shareholder of company A and is currently over the age of 55, their intention post sale of the business was to contribute a substantial portion of the sale proceeds to superannuation and retire. However, as part of a condition of the sale, the individual will be the General manager and is required to work for 38 - 40 hours a week for the period of three years following settlement.

It was within the best interests of company A for the individual to agree to this contractual requirement as the sale of the business contains an earnout component based on income of the business derived during the earnout period of three years from 20XX to 20XX.

The individual's responsibilities prior to the sale of company A were:

• Managed all areas of running the business.
• Manage staff including 1 located in the overseas
• All sales
• Supply chain management
• license negotiations
• Rights applications.

The individual's responsibilities post sale during the earnout period:

• Supply chain manager.

The individual intends to fully retire from working three years from the date of sale in the financial year 2026-27.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 Subdivision 152-B

Reasons for decision

15-Year Exemption

The 15-year exemption in Subdivision 152-B can be used to disregard the gain from arising from a CGT asset it owned for more than 15 years if certain conditions have been met.

Section 152-110 provides a small business 15-year exemption for companies and trusts. Under this section, the company or trust can disregard the capital gain from the disposal of a CGT asset if:

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

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

(c)   the entity 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 the entity owned the CGT asset; and

(d)  an individual who was a significant individual of the company or trust just before the CGT event was either:

(i)    at least 55 years old at that time and the event happened in connection with their retirement or

(ii)   permanently incapacitated at that time.

Significant individual

An individual is a significant individual in a company or trust if they have a small business participation percentage in the company or trust of at least 20% (section 152-55). The small business participation percentage can be made up of direct and indirect percentages (section 152-65).

The direct small business participation percentage is provided by section 152-70. As the taxpayer is a company, item 1 of the table in section 152-70 is relevant. It provides that an entity has because of holding the legal and equitable interests in *shares in the company:

(a)  the percentage of voting power in the company; or

(b)  the percentage of any dividend that the company may pay; or

(c)   the percentage of any distribution of capital that the company may make;

or if they are different, the smaller or the smallest.

In connection with retirement

Whether a CGT event happens in connection with an individual's retirement depends on the particular circumstances of each case. A CGT event may be in connection with your retirement even if it occurs at some time before or after retirement.

The Explanatory Memorandum (EM) to the New Business Tax System (Capital Gains Tax) Bill 1999 makes the following comments about the requirement to be permanently incapacitated or retiring as one of the conditions for the concession:

1.68 One of the requirements of this concession for an individual small business taxpayer is that they must be either permanently incapacitated at the time of the CGT event, or at least 55 years old and using the capital proceeds for their retirement.

The provisions relating to the small business 15-year exemption do not define what is meant by the phrase 'in connection with a taxpayer's retirement', nor does it give any indication of the degree of retirement required in order to take advantage of this concession. It could be argued that the phrase 'in connection with retirement' means that the capital gain arising from the disposal of active assets is to be used to provide funds for a person's retirement rather than to precipitate retirement at the time of the CGT event. The words used in the EM support this interpretation.

The Advanced guide to capital gains tax concessions for small business 2013-14 (NAT 3359) also supports this view. It makes it clear that it is not necessary for there to be a permanent and everlasting retirement from the workforce. However, there would need to be at least a significant reduction in the number of hours worked or a significant change in the nature of the activities to be regarded as a retirement for the purposes of paragraph 152-105(d) of the ITAA 1997.

The EM and the guide provide that the retirement does not need to occur immediately following the event, however whether a particular case satisfies the conditions depends very much on the facts of the case.

Application to your circumstances

A CGT event occurred when the goodwill, intellectual property and contracts of company A were disposed of, which resulted in a capital gain satisfying paragraphs 152-10(1)(a) and (b).

The maximum net asset test under section 152-15 is satisfied in the financial year the assets of company A were disposed of, therefore paragraph 152-10(1)(c) is satisfied.

The active asset test under section 152-35 of the ITAA 1997 is satisfied as company A owned the assets for more than 15 years and they were active assets for more than 7.5 years during the ownership period, therefore subparagraph 152-10(1)(d) is satisfied.

All the requirements are satisfied for the basic conditions for relief in Subdivision 152-A for the sale of company A's assets. Consequently, the first requirement for the 15-year exemption in paragraph 152-110(1)(a) will be satisfied.

The company has been owned by the individual and operating since 19XX, as the assets have continuously been owned for more than 15 years just before the CGT event, the requirement in paragraph 152-110(1)(b) is satisfied.

The individual has owned 100% of the total ordinary shares issued in company A since 20XX and therefore holds a 100% direct small business participation percentage in company A pursuant to item 1 of the table in subsection 152-70(1) of the ITAA 1997. The individual therefore holds a small business participation percentage in company A of 100% and was a significant individual in company A for a total of at least 15 years during the ownership period, subsequently satisfying paragraph 152-110(1)(c).

The individual was 55 years or older at the time of the CGT event and their duties and responsibilities have significantly changed subsequent to the sale of company A. Although the individual will remain as General Manager, they are no longer responsible for the financial and strategic management of company A. The individual's continued service was a requirement of the sale that was stipulated by the purchaser to ensure that the goodwill of company A was protected. The individual's working hours are reduced from XX to XX hours per week to XX to XX hours per week in the three years following the sale of company A then they will retire completely satisfying paragraph 152-110(d).

It is considered that there will be a clear link between the sale of company A and the retirement of the individual and that the sale of company A was integral to the retirement plans of the individual. Accordingly, the CGT event when company A was sold is considered to happen in connection with the individual's retirement in accordance with paragraph 152-110(1)(d).

As company A satisfies all the relevant requirements of section 152-110, the company is entitled to apply the small business 15-year exemption to disregard any capital gain made upon the disposal of its assets.