Edited version of private advice

Authorisation Number: 1052236934779

Date of advice: 28 June 2024

Ruling

Subject: CGT - small business 15-year exemption

Question

Can individual R and individual S apply the small business 15-year exemption in section 152-105 of the Income Tax Assessment Act 1997 (ITAA 1997) to disregard the capital gain from the sale of interest A in the property?

Answer

No.

Question 2

Will individual R and individual S be eligible to apply the small business retirement exemption to any capital gain made on the sale of interest A in the property under section 152-300 of the ITAA 1997?

Answer

Yes.

Question 3

Can individual R and individual S apply the small business 15-year exemption in section 152-105 of the ITAA 1997 to disregard the capital gain from the sale of interest B in the property?

Answer

No.

This ruling applies for the following periods:

Year ending 30 June 2024

Year ending 30 June 2025

The scheme commenced on:

1 July 2023

Relevant facts and circumstances

In 20XX, the property was purchased by individual R and individual S and individual W and individual V and leased to the company.

At the time of the property purchase, there were 2 shareholders in the company with one share each, individual R and individual W. Individual R had 2 voting rights and Individual W had 1.

From 20XX to 20XX individual R and individual S owned a combined interest of 50% (interest A) in the property.

Individual R and individual S acquired individual V and individual W combined 50% interest (interest B) in the property.

Individual R acquired individual W share in the company and owned both company shares for 3 years.

Individual S acquired a class B share in the company 2 years before the company ceased both individual R and individual S share had voting rights.

The company was operated from the property between for a total of XX years.

individual R and individual S fully retired and closed the company in 20XX.

From 20XX to the time of this application the property has been leased to a third-party tenant.

Both individual R and individual S will be over the age of 55 when the CGT event occurs.

Interest A in the property has been owned by individual R and individual S for more than XX years and was used in the company for XX years.

Interest B in the property has been owned by individual R and individual S for less than XX years and was used in the company for less than half of the ownership period.

Individual R and individual S will satisfy the maximum net asset value test just before the CGT event.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 Subdivision 152-B

Income Tax Assessment Act 1997 Subdivision 152-D

Income Tax Assessment Act 1997 section 328-110

Income Tax Assessment Act 1997 section 328-125

Income Tax Assessment Act 1997 section 328-130

Reasons for decision

Question 1

Can individual R and individual S apply the small business 15-year exemption in section 152-105 of the Income Tax Assessment Act 1997 (ITAA 1997) to disregard the capital gain from the sale of interest A in the property?

Summary

No. Individual R and individual S satisfy the basic conditions for small business relief in respect to the disposal of interest A in the property. Individual R and individual S have owned interest A for 15 years and will be at least 55 years at the time the proposed CGT event happens. However, both individual R and individual S retired and then sold interest A in the property some 5 years later therefore we do not consider the sale of the property to be in connection with individual R or individual S's retirement and the conditions in subparagraph 152-105(d)(i) are not satisfied. Subsequently individual R and individual S are unable to apply the small business 15-year exemption to the sale of interest A in the property under section 152-105 of the ITAA 1997.

Detailed reasoning

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 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 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 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.

Active asset test

Subsection 152-35(1) states that a CGT asset satisfies the active asset test if:

•         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 of ownership, or

•         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 ½ years.

Subsection 152-35(2) provides that the test period begins when you acquired the asset and ends at the earlier of:

(i)    the time of the CGT event; and

(ii)   when the business ceased, if the business in question ceased in the 12 months before the CGT event (or such longer time as the Commissioner allows).

Meaning of Active asset

Subsection 152-40(1) of the ITAA 1997 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 (whether alone or in partnership) by you, or your affiliate, or another entity that is connected with you.

In this case, as individual R and individual W used the property to carry on a business in a connected entity (the company), use is considered directly for the purpose of the active asset test. However, as individual S was only a shareholder in the company for 2 years after acquisition of both interests in the property, we need to consider individual S's affiliation or connection to the company for the purpose of the active asset test.

Passively held asset

The basic conditions allow you to access the concessions for a CGT asset you own where you are not carrying on a business, but that CGT asset is used in the business of your affiliate, or an entity connected with you. The basic conditions can also apply where your asset is held ready for use in, or is inherently connected with, the business of your affiliate or entity connected with you.

Meaning of when an entity is connected with you

Section 328-125 of the ITAA 1997 provides the meaning of connected with an entity. An entity is connected with another entity if:

•         either entity controls the other entity; or

•         both entities are controlled by the same third entity.

An entity controls another entity if it or its affiliate (or all of them together) when:

•         owns, or has the right to acquire ownership of, interests in the other entity that give the right to receive at least 40% (the control percentage) of any distribution of income or capital by the other entity, or

•         if the other entity is a company - owns, or has the right to acquire ownership of, equity interests in the company that give at least 40% of the voting power in the company.

In this case individual R has owned at least 50% of the shares in the company and has had at least 40% of voting power in the company throughout the ownership period. As individual S did not have at least 40% voting rights for a period of at least 7 ½ years for the purpose of the active asset test we need to consider how they are affiliated with the company.

Affiliates

Subsection 328-130(1) of the ITAA 1997 states that 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. 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.

There is also a note to section 328-130 of the ITAA 1997 which relevantly flags that for small business relief purposes, a spouse or a child under 18 years may also be an affiliate under section 152-47.

Subsection 152-47(1) of the ITAA 1997 applies if:

(a)  one entity (the asset owner) owns a CGT asset; 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.

Subsection 152-47(2) of the ITAA 1997 states that for the purposes of 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.

In this case, if individual S was not an affiliate of individual R under subsection 328-130(1) of the ITAA 1997, individual S is deemed an affiliate under section 152-47 of the ITAA 1997 because:

(a)  Individual S owns an interest in the CGT asset being their ownership interest in the property; and

(b)  The property was used in the course of carrying on a business by individual R; and

(c)   Individual S, is not otherwise an affiliate of or connected to individual R; and

(d)  Individual R is individual S's spouse.

In this case, individual S is considered an affiliate of individual R and the company as individual S is individual R's spouse. Therefore, individual S's interest in the CGT asset interest A will also satisfy the active asset test.

15-year exemption

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

Section 152-105states 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.

In this case, we need to consider whether disposal of the property is 'in connection with' individual R and individual S's retirement, in accordance with the condition in paragraph 152-105(d)(i) of the ITAA 1997.

In connection with retirement

The phrase in connection with your retirement is not defined in the legislation and, as such, it takes its ordinary meaning.

The Macquarie Dictionary defines retirement as 'removal or retiring from service, office or business'. The question then arises as to whether a mere withdrawal from a position or business with the ability to commence involvement in another position or business would be sufficient; otherwise, there may have to be a complete withdrawal from the workforce.

In the context of the purpose and effect of the provision, merely moving from one position or business to another would not be sufficient. However, there does not need to be a complete withdrawal from the workforce. For example, staying on for a limited period to assist a new owner during a transitional period should be acceptable. Also, working the equivalent of a couple of days per week in the former business or elsewhere should not jeopardise the exemption.

The phrase in connection with your retirement can be given a relatively wide interpretation to mean that the relevant CGT event would not necessarily have to occur contemporaneously with the retirement. Therefore, the CGT event could occur either in anticipation of, or after, the retirement.

While it may be a question of fact, the essential element will be to demonstrate that the CGT event happens as part of an actual retirement plan. Thus, if there is no relevant connection with the small business operator's retirement, the requirement would not be satisfied.

Application to your circumstances

A CGT event will occur when individual R and individual S dispose of the 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 just before the CGT event when the property will be disposed of, therefore paragraph 152-10(1)(c) will be satisfied.

The property was an active asset of individual R and individual S for the period 20XX - 20XX, on the basis that it was used by individual S's affiliate individual R to carry on a business and individual R held at least 40% voting rights throughout the entire active asset period.

Individual R and individual S acquired interest A in 20XX, and have owned interest A for more than 15 years and it was used by the company for more than 7 ½ years of the ownership period, therefore interest A will satisfy the active asset test under subsection 152-35 of the ITAA.

Individual R and individual S will satisfy all the requirements for the basic conditions for relief in Subdivision 152-A for the disposal of interest A in the property. Consequently, the first requirement for the 15-year exemption in paragraph 152-105(a) will be satisfied.

As both individual R and individual S have continuously owned interest A in the property, for more than 15 years just before the proposed CGT event, the requirement in paragraph 152-105(b) is satisfied.

Both individual R and individual S will be over the age of 55 when they dispose of the property. However, both individual R and individual S fully retired from the workforce in 20XX when the company ceased activity, over 5 years before the proposed disposal of the property, therefore we do not consider the sale of the property to be in connection with either individual R and individual S's retirement and the conditions in subparagraph 152-105(d)(i) are not satisfied.

Consequently, the relevant requirements in section 152-105 are not satisfied, and individual R and individual S will not be entitled to apply the small business 15-year exemption to disregard any capital gain made on the disposal of interest A in the property.

Question 2

Will individual R and individual S be eligible to apply the small business retirement exemption to any capital gain made on the sale of interest A in the property under section 152-300 of the ITAA 1997?

Summary

Yes. As individual R and individual S satisfy the basic conditions for interest A in the property and will be over 55 years of age at the time of the CGT event there is no requirement to pay any amount to a complying super fund or RSA. Both individual R and individual S are eligible to reduce the gain by applying the small business retirement exemption up to your lifetime limit of $500,000 for interest A.

Detailed reasoning

Retirement exemption

Section 152-300 of the ITAA 1997 contains the small business retirement exemption. Under section 152-305(1) as an individual, you may choose to disregard all or part of a capital gain under the small business retirement exemption if:

•         you satisfy the basic conditions,

•         you keep a written record of the amount you chose to disregard.

There is no requirement to make a contribution to your superannuation fund if the individual is over 55 years of age, however, the amount of the capital gain that you choose to disregard must not exceed your CGT retirement exemption limit. Under section 152-320 of the ITAA 1997, an individual's lifetime CGT retirement exemption limit is $500,000, reduced by any previous CGT exempt amounts the individual has disregarded under the retirement exemption.

Application to your circumstances

As discussed in question 1, Interest A in the property will satisfy the four of the basic conditions when individual R and individual S dispose of the property, both individual R and individual S will be over 55 years of age at the time of the CGT event, therefore, there is no requirement to pay any amount to a complying super fund or RSA to meet the requirements of the small business retirement exemption and they will not exceed their lifetime CGT retirement exemption limit of $500,000.

Individual R and individual S will be entitled to choose to apply the small business CGT retirement exemption as all the required conditions under subsection 152-300 will be satisfied.

Question 3

Can individual R and individual S apply the small business 15-year exemption in section 152-105 of the ITAA 1997 to disregard the capital gain from the sale of interest B in the property?

Summary

No. A CGT event will occur when the property is disposed of, the maximum net asset test will be satisfied just before the CGT event, both individual R and individual S have owned interest B for 9 years and 7 months and the property was used by the company for 4 years and 7 months which is less than half of the ownership period, therefore interest B in the property is not an active asset under Subdivision 152-A and does not satisfy the basic conditions for relief. Subsequently individual R and individual S are unable to apply the small business 15-year exemption to the sale of interest A in the property under section 152-105 of the ITAA 1997.

Detailed reasoning

Application to your circumstances

As discussed, a CGT event will occur when individual R and individual S dispose of the 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 just before the CGT event when the property will be disposed of, therefore paragraph 152-10(1)(c) will be satisfied.

Individual R and individual S acquired their additional interest (interest B) of 50% in the property in 20XX, and have owned interest A for 9 years and 7 months and was used by the company for less than half of the ownership period, therefore interest B does not satisfy the active asset test under subsection 152-35 of the ITAA.

As the requirements for the basic conditions for relief in Subdivision 152-A for the disposal of interest B in the property are not satisfied, individual R and individual S will not be entitled to apply the small business concessions for relief for the disposal of interest B in the property. Subsequently both individual R and individual S are unable to apply the small business 15-year exemption to the sale of interest B in the property under section 152-105 of the ITAA 1997.