Edited version of private advice

Authorisation Number: 1052238063968

Date of advice: 3 April 2024

Ruling

Subject: Deceased estate and small business CGT concessions

Question 1

Are you eligible to access the small business 15 year exemption in respect of the disposal of the first 50% interest held in the property, acquired in YYYY?

Answer

Yes

Question 2

Are you eligible to access the small business capital gains tax concessions in respect of the disposal of the second 50% interest held in the property, acquired in 20YY?

Answer

No

This ruling applies for the following period:

Year ending 30 June 20YY

The scheme commenced on:

1 July 20YY

Relevant facts and circumstances

You and your late spouse together acquired 100% of the interest in property A in 19XX for $X.

Your spouse passed away in 20XX.

Your spouse continuously held their 50% interest in property A from the original acquisition date until their date of death.

Probate was granted in 20XX. Your spouse's 50% interest in property A passed to you.

Since acquisition, property A been used continuously as follows:

•        2/3 used for Y business, and

•        1/3 used for Z business

Property A is currently used as follows:

You lease the land to an unrelated third party who owns and operates the Z business. There is a lease agreement in place.

From 20XX you engaged company A to manage the Y business and oversee the Z lessee for a management fee.

For the Y business, since 20XX, company A has allowed only long-term stays and occupants are usually there for at least 12 months or longer (with limited exceptions, such as if the occupant passes away).

In addition, the agreement entered into with each occupant provides that occupants have a right to occupy the site, subject to certain conditions.

You attend and chair meetings with the directors of company A, authorise all payments, undertake inspection of the property and authorise non-routine maintenance and repairs to Y business and Z business.

Company A was incorporated in 19XX. The directors are individual A and individual B.

The company is owned 50% by individual A and 50% by individual B.

Company A operates two businesses as follows:

•        management services for the Y business, and

•        operating a home village at property B.

Property B is 100% owned by you.

You lease property B to company A and company B derives the rental income.

Company B was incorporated in 19XX and you are the sole director.

You own 100% of the shares in company B, having acquired 50% of the shares shortly after incorporation and then acquiring 50% of the shares in 20XX pursuant to your spouse's Will.

At different points in time since its incorporation during your spouse's lifetime, company B was actively involved in Y business.

There are no formal written agreements between you, company A and company B.

Since acquiring property A, Y business and Z business have been operated as follows:

Y business

Z business

The aggregated turnover of the business for the 20XX income year was $X, which represents the total of the following turnovers:

•        You: $X

•        Company A: $X, and

•        Company B: $X

You marketed the property for sale of an unrelated third party, and have accepted an offer of $X for disposal of the property.

It is expected the sale of land contract will be exchanged within the 20XX income year.

You intend to stop working entirely following the disposal of the property.

You are over the age of 55.

You have not used the small business capital gains tax concessions in the past.

Relevant legislative provisions

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

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 subsection 152-35(1)

Income Tax Assessment Act 1997 subsection 152-35(2)

Income Tax Assessment Act 1997 subsection 152-40(1)

Income Tax Assessment Act 1997 subparagraph 152-40(4)(e)(ii)

Income Tax Assessment Act 1997 section 152-80

Income Tax Assessment Act 1997 subsection 152-80(3)

Income Tax Assessment Act 1997 section 152-105

Income Tax Assessment Act 1997 subsection 328-125(1)

Income Tax Assessment Act 1997 subsection 328-125(2)

Income Tax Assessment Act 1997 section 328-130

Reasons for decision

Question 1

Basic conditions

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

Small business entity

You are a CGT small business entity for the purposes of the CGT concessions if you are an individual that:

•        carries on a business

•        has an aggregated turnover of less than $2 million (section 328-110)

Aggregated turnover is your annual turnover plus the annual turnovers of any business entities that are your affiliates or connected with you.

Connected entity

Under subsection 328-125(1) of the ITAA 1997, an entity is connected with another entity if either entity controls the other entity.

Subsection 328-125(2) of the ITAA 1997 provides that an entity controls another entity if it or its affiliate (or all of them together):

(a)   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:

(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

(b)           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

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.

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 beings 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) provides that a CGT asset is an active asset at a time if, at that time:

(a)  you 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

However, an asset whose main use by you is to derive rent cannot be an active asset unless its main use for deriving rent was only temporary (subparagraph 152-40(4)(e)(ii) of the ITAA 1997).

15 year exemption

Under section 152-105 of the ITAA 1997, an entity can disregard a capital gain from a CGT event happening to a CGT asset if:

•        the basic conditions are satisfied

•        the asset has been continuously owned for the 15 year period ending just before the CGT event happened.

If you are an individual, you must also meet the following conditions:

•        when the CGT event happened you were permanently incapacitated or at least 55 years old and the event happened in connection with your retirement

Application to your circumstances

In this case, a CGT event will occur when you sell property A. The 50% interest in the property you acquired in 19XX has been owned for more than 15 years. You are a small business entity as you carry on a business and your aggregated turnover for the 20XX income year was less than $2 million.

Company B is a connected entity of yours as you own 100% of the company. Company A is an affiliate of yours as the company acts in accordance with your directions in relation to the Y business and there are no formal agreements in place between you and the company.

From 19XX to 19XX, company B carried on Y business on property A and the sites were used for short term stays.

From 19XX until 19XX, you and your late spouse carried on Z business on property A and the rooms were used for short term stays.

As you (in partnership with your late spouse) and your connected entity company B carried on business for more than 7 ½ years of the ownership period and Y business and Z business were used for short terms stays during this period, the property will meet the active asset test.

You are over the age of 55 years at the time the property will be sold and as you intend on not working once the property sells, the CGT event will occur in connection with your retirement.

Therefore, you meet the basic conditions and additional conditions for the 15 year exemption and are entitled to claim the 15 year exemption.

Question 2

Deceased estate and small business CGT concessions

Under section 152-80 of the ITAA 1997, the legal personal representative or beneficiary of the deceased estate will be eligible for the small business CGT concessions where:

•        the asset is disposed of within two years of the date of death, and

•        the asset would have qualified for the small business CGT concessions if the deceased had disposed of the asset immediately before their death.

Under subsection 152-80(3) the two year time limit prescribed under section may be extended by the Commissioner in certain circumstances. In determining whether a longer period will be allowed, the Commissioner will consider a range of factors such as:

•        whether there is evidence of an acceptable explanation for the period of extension requested and whether it would be fair and equitable in the circumstances to provide such an extension

•        whether there is any prejudice to the Commissioner if the additional time is allowed, however the mere absence of prejudice is not enough to justify the granting of an extension

•        whether there is any unsettling of people, other than the Commissioner, or of established practices

•        fairness to people in like positions and the wider public interest

•        whether there is any mischief involved, and

•        the consequences of the decision.

Inherited assets and CGT

Division 128 of the ITAA 1997 sets out what happens when an individual dies and a CGT asset they owned just before they passed away devolves to either a legal personal representative or beneficiary of their estate.

Subsection 128-15(2) of the ITAA 1997 states that the legal personal representative, or beneficiary, is taken to have acquired the asset on the day you died. Acquired is a defined term in section 995-1 of the ITAA 1997:

(a)a CGT asset: you acquire a CGT asset (in its capacity as a CGT asset) in the circumstances and at the time worked out under Division 109 (including under a provision listed in Subdivision 109-B );

Subdivision 109-B of the ITAA 1997 contains signposts to other acquisition rules. Specifically, item 2 of section 109-55 sets out the acquisition date if a CGT asset passes to you as beneficiary in the estate of an individual. You acquire the asset when the individual died as per section 128-15 of the ITAA 1997.

Application to your circumstances

In this case, a CGT event will occur when you sell property A. The 50% interest formed part of the estate of your late spouse who passed away in 20XX. The 50% interest transferred to you under the Will.

Your late spouse would have been entitled to reduce or disregard a capital gain from a CGT event under the small business concessions immediately before their death. However, the CGT event will not occur within two years of your late spouse's death and therefore in order to reduce or disregard any capital gain from the CGT event the discretion under subsection 152-80(3) will be required.

The two year time limit prescribed may be extended by the Commissioner in certain circumstances, where there is evidence of an acceptable explanation for the period of extension requested and whether it would be fair and equitable to provide such an extension. You intend to sell the property in the 20XX income year (approximately X years after your late spouse passed away). The delay was not due to factors outside your control. An extension would not be granted to others in similar circumstances. Accordingly, the Commissioner will not exercise the discretion in subsection 152-80(3) of the ITAA 1997 to extend the two year time limit.

As section 152-80 does not apply, the acquisition date of your 50% interest in the property acquired from your late spouse is reset to 20XX.

You will meet the small business entity test as you were carrying on a business in the 20XX income year and your aggregated turnover was less than $2 million in the 20XX income year.

As the acquisition date has been reset to 20XX your period of ownership will be approximately X years, as you intend to sell the property in the 20XX income year. To meet the active asset test, the property has to be an active asset for at least half the ownership period and the property also has to be used in the course of carrying on a business during that time. However, the main use of the asset cannot be to derive rent, unless its main use for deriving rent is only temporary.

For the period you owned the property, it has been used by Y business for long term stays for periods of 12 months or longer (with limited exceptions, such as if the occupant passes away) and by Z business on long term lease to a third party.

As the property has been used to derive rent for the period you owned the property, it does not meet the active asset test under paragraph 152-40(4)(e)(ii) of the ITAA 1997 and you do not meet the basic conditions for the small business CGT concessions. You are therefore not eligible to claim any of the small business CGT concessions.