Edited version of private advice

Authorisation Number: 1052249654315

Date of advice: 12 June 2024

Ruling

Subject: CGT - small business 15-year exemption

Question

Is the A Trust able to disregard the capital gain arising on the disposal of certain business assets to ABC Pty Ltd (the Company) in the income year ending 30 June 20YY using the small business 15-year exemption in Subdivision 152-B of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes, any capital gain arising on the disposal of a business asset (except information, plant and equipment and inventory) can be disregarded under the 15-year exemption where:

(i)    the asset satisfies the active asset test under section 152-40 of the ITAA 1997

(ii)   the asset had been continuously owned by the A Trust for the 15-year period ending just before the CGT event; and

(iii)  the A Trust had a significant individual for a total of at least 15 years during which it owned the asset.

This ruling applies for the following period:

Income year ending 30 June 20YY

Relevant facts and circumstances

A Trust is a discretionary trust that is controlled by an individual who is aged over 60. A Trust owns 100% of the shares in the Company. A Trust commenced carrying on the business in 19XX. The business was transferred to the Company on 1 July 20XX in exchange for the issue of XX shares in the Company to A Trust. This transfer was undertaken to facilitate the individual's retirement plans (discussed below) and to enable the sale of a percentage of the shares in the Company to new business partners to buy into the business.

The contract of sale of the business assets was executed on XX August 20XX with a date of effect of 1 July 20XX.

The Business Assets defined under the contract of sale included:

•         Contracts

•         Goodwill

•         Business names

•         Information

•         Plant and equipment

•         Intellectual Property

•         Statutory Licenses; and

•         Inventories.

A Trust sold X% of the shares in the Company on XX XX 20XX to a number of discretionary trusts connected to the new business partners. There is an intention of selling additional shares in the Company in the future and subsequently reducing the shareholding down to 10% within several years.

Prior to the sale of the shares in the Company, the individual worked in the business and undertook 5 patient shifts per week. He also worked an average of 45 hours per week on administrative duties relating to the running of the business. Since the sale of the shares in the Company, the individual has reduced his work hours, undertaking 3 half-day patient shifts per week and ceasing most administrative duties.

The individual does not wish to fully retire since he enjoys helping people and believes he would lose his identity. The individual has a desire to get away from the stress of running the business. Reducing his work hours to 3 shifts per week has reduced his availability and means many of the patients will choose to consult with other practitioners. As this occurs, the individual expects his personal practice will continue to contract and his hours will reduce further.

In addition to the reduced work hours and administrative duties, the individual also intends to increase the leave he takes per year from 2 to 4 weeks to 6 to 12 weeks. Overall, the individual estimates his work hours will reduce from approximately 65 hours to 20 hours per week.

Assumptions

1.    A Trust satisfied the maximum net asset value (MNAV) test under section 152-15 of the ITAA 1997 just before the CGT event.

2.    The individual will receive a distribution of at least 20% of the net income of the A Trust for the year ending 30 June 20YY and will be a significant individual of A Trust in that income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 Division 118

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Subdivision 152-A

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

Income Tax Assessment Act 1997 paragraph 152-10(1)(a)

Income Tax Assessment Act 1997 paragraph 152-10(1)(b)

Income Tax Assessment Act 1997 paragraph 152-10(1)(c)

Income Tax Assessment Act 1997 subparagraph 152-10(1)(c)(ii)

Income Tax Assessment Act 1997 paragraph 152-10(1)(d)

Income Tax Assessment Act 1997 section 152-15

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 section 152-40

Income Tax Assessment Act 1997 section 152-55

Income Tax Assessment Act 1997 section 152-65

Income Tax Assessment Act 1997 subsection 152-70(1)

Income Tax Assessment Act 1997 Subdivision 152-B

Income Tax Assessment Act 1997 subsection 152-110(1)

Income Tax Assessment Act 1997 paragraph 152-110(1)(a)

Income Tax Assessment Act 1997 paragraph 152-110(1)(b)

Income Tax Assessment Act 1997 paragraph 152-110(1)(c)

Income Tax Assessment Act 1997 paragraph 152-110(1)(d)

Reasons for decision

All subsequent legislative references are to the ITAA 1997.

Summary

On the basis that the disposal of the Business Assets was in connection with the retirement of the individual, any capital gain arising on the disposal of a Business Asset (other than information, plant and equipment and inventory) can be disregarded under the 15-year exemption in Subdivision 152-B to the extent that:

(iv)  the asset satisfies the active asset test under section 152-40

(v)   the asset has been continuously owned by A Trust for the 15-year period ending just before XX August 20XX; and

(vi)  A Trust had a significant individual for a total of at least 15 years during which it owned the asset.

Detailed reasoning

Division 152 provides CGT concessions that allow eligible taxpayers to disregard or defer some or all of a capital gain arising from the disposal of an active asset used in a small business, provided certain conditions (the basic conditions) are met. Subsection 152-10(1) sets out the basic conditions to be satisfied before a taxpayer can access the CGT concessions.

Basic conditions for small business relief

Subsection 152-10(1) states:

A capital gain (except a capital gain from CGT event K7) you make may be reduced or disregarded under this Division if the following basic conditions are satisfied for the gain:

(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;

(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).

CGT event in relation to a CGT asset resulting in a capital gain

A Trust disposed of the business and Business Assets connected to the running of the business to the Company in the income year ending 30 June 20YY.

'CGT asset' is defined in section 108-5 to include any kind of property or any legal or equitable right that is not property. All the Business Assets that were disposed are CGT assets with the exception of Information. In accordance with Taxation Determination TD 2000/33 Income tax: capital gains: is know-how a CGT asset? information or know-how is not a CGT asset.

CGT event A1 under section 104-10 occurs on the disposal of the Business Assets and this occurs when the contract for the disposal was entered into on XX August 20XX. Therefore, the condition in paragraph 152-10(1)(a) is satisfied with respect to the Business Assets.

Plant and equipment and inventory are not eligible for the CGT concessions under Division 152 since any capital gain or loss is disregarded under the exemptions in Division 118.

To the extent that the disposal of any Business Asset (other than information, plant and equipment and inventory) gives rise to a capital gain, paragraph 152-10(1)(b) is satisfied.

MNAV test

The MNAV test under section 152-15 is satisfied if, just before the CGT event, the sum of the net value of the CGT assets of the A Trust, any entities connected with A Trust and any affiliates of A Trust or entities connected with affiliates of A Trust does not exceed $6 million.

An assumption is made for the purposes of this ruling that A Trust satisfies the MNAV just before the CGT event so the condition in subparagraph 152-10(1)(c)(ii) is satisfied. A Trust therefore satisfies paragraph 152-10(1)(c) in respect to all the Business Assets.

Active asset test

The final basic condition in paragraph 152-10(1)(d) requires the CGT asset to satisfy the 'active asset test' in section 152-35.

Subsection 152-35(1) relevantly states:

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 your for a total of at least half of the period specified in subsection (2); 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 period specified in subsection (2).

Subsection 152-35(2) states the period begins when you acquired the asset and ends at the earlier of when the CGT event happens and when the relevant business ceased if that occurs in the 12 months before the CGT event happens (or any longer period the Commissioner allows).

A business asset that has been owned by A Trust for more than 15 years will satisfy the active asset test if it was an active asset of A Trust for a total of at least 7.5 years during the period starting from when it was acquired and ending on the date of the CGT event.

15-year exemption for companies and trusts

The 15-year exemption can be used to disregard the capital gain on the disposal of some of the Business Assets that have been continuously owned by A Trust for the 15 year period ending just before the CGT event happened. This includes Goodwill.

Subsection 152-110(1) states:

An entity that is a company or trust 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) the entity continuously owned the CGT asset for the 15-year period ending just before the CGT event;

Note: Section 152-115 allows for continuation of the period if there is an involuntary disposal of the asset.

(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;

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

(i) was 55 or over at the time of the CGT event and the event happens in connection with the individual's retirement; or

(ii) was permanently incapacitated at that time.

Paragraph 152-110(1)(a) - the basic conditions in Subdivision 152-A

On the assumption that A Trust satisfies the MNAV test just before the CGT event, the basic conditions in paragraph 152-110(1)(a) are satisfied for each Business Asset that satisfies the active asset and whose disposal gives rise to a capital gain.

Paragraph 152-110(1)(b) - the trust continuously owned the CGT asset for the 15-year period ending just before the CGT event

To the extent that A Trust continuously owned a Business Asset for the 15-year period ending just before the CGT event, paragraph 152-110(1)(b) is satisfied.

Paragraph 152-110(1)(c) - the trust had a significant individual for a total of at least 15 years during which the trust owned the CGT asset

Section 152-55 provides that an individual is a significant individual in a trust at a time if, at that time, the individual has a 'small business participation percentage' (SBPP) in the trust of at least 20%.

According to section 152-65, an entity's SBPP in a trust at a time is the sum of the entity's direct small business participation percentage (DSBPP) and indirect small business participation percentage at that time. Item 3 of the table in subsection 152-70(1) explains that an individual's DSBPP in a discretionary trust (a trust where entities do not have entitlements to all the income and capital of the trust) at a particular time is:

•         if the trustee makes a distribution of income during the income year in which that time occurs - the percentage of the distribution to which the entity was beneficially entitled, or

•         if the trustee makes a distribution of capital during the income year in which that time occurs - the percentage of the distribution to which the entity was beneficially entitled, or

•         if 2 different percentages are applicable, the smaller.

The third condition in paragraph 152-110(1)(c) is satisfied for each Business Asset where there was a significant individual for A Trust for a total of at least 15 years during which A Trust owned the asset.

Paragraph 152-110(1)(d) - an individual who was a significant individual of the trust just before the CGT event either:

(i)    was 55 or over at that time and the event happened in connection with the individual's retirement; or

(ii)   was permanently incapacitated at that time

The individual was over 60 years old at the time of the CGT event. There is an assumption for the purposes of this ruling that the individual will receive a distribution of at least 20% of the net income of the A Trust for the year ending 30 June 20YY and as a result will be a significant individual of A Trust just before the CGT event.

The legislation does 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.

Therefore the phrase takes on its ordinary meaning. The word 'retirement' is defined in the Macquarie Dictionary to mean:

noun

1. the act of retiring.

2. the state of being retired.

3. removal or retiring from service, office or business....

The ATO provides guidance in this regard in the Advanced guide to CGT concessions for small business stating that whether a CGT event is in connection with an individual's retirement will depend on the particular circumstances of each case. There would need to be at least a significant reduction in the number of hours the individual works or a significant change in the nature of their present activities to be regarded as a retirement. However, it is not necessary for there to be a permanent and everlasting retirement from the workforce. The guide also provides that a CGT event may be 'in connection with your retirement' even if it occurs at some time before retirement.

The Commissioner is satisfied that the individual's reduced work hours and administrative duties from the date of the sale of the shares in the Company constitutes his retirement. He is also satisfied that the transfer of the Business Assets on XX August 20XX giving rise to the CGT events are in connection with the retirement of the individual who will be a significant individual of the A Trust at that time. This is on the basis that the transfer of the Business Assets to the Company was undertaken to enable the individual to sell down his interest in the business as part of his retirement plan.

Therefore, any capital gain arising on the disposal of a Business Asset (other than information, plant and equipment and inventory) can be disregarded under the 15-year exemption to the extent that:

(i)    the asset satisfies the active asset test under section 152-40;

(ii)   the asset has been continuously owned by the A Trust for the 15-year period ending just before the CGT event; and

(iii)  the A Trust had a significant individual for a total of at least 15 years during which it owned the asset.