Edited version of private advice

Authorisation Number: 1052258323209

Date of advice: 7 June 2024

Ruling

Subject: CGT - small business concessions

Question 1

Does the property satisfy the active asset test under section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Are you eligible for the retirement exemption under Subdivision 152-D of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

Year Ended 30 June 20YY

The scheme commenced on:

1 July 20YY

Relevant facts and circumstances

You bought the property in June 20XX.

You sold the property in December 20XX.

The residence was used by your spouse as their office to operate their accounting and tax agent practice for the entire ownership period.

The office comprised all of the upstairs area which was accessible to clients by an exclusive external stairway. There was also an internal stairwell connecting the upstairs area to a downstairs office.

Extensive, secure file storage for files was maintained in a double garage and a "3 Bay" shed located on the property.

The property was also used as parking for the employees' cars and clients' cars when they attended the office for work or meetings respectively.

Total office floor area comprised around a third of the house floor area.

The rest of the property was private residence.

The business has been conducted exclusively from the property since 20XX. No other premises were used to conduct the business.

The practice has an annual turnover of under $2 million.

The practice ceased in November 20XX.

You and any connected entities and affiliates have net assets of less than $6 million.

You were over 55 years old at the time of sale.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-15

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 section 152-40

Income Tax Assessment Act 1997 section 152-47

Income Tax Assessment Act 1997 Subdivision 152-D

Reasons for decision

Question 1

Active asset test

The active asset test outlined in section 152-35 of the ITAA 1997. The active asset test is satisfied 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 test period. Therefore, the active asset test is satisfied.

The test period beings when you acquired the asset and ends at the earlier of the CGT event and if the relevant business ceased to be carried on in the 12 months before that time - the cessation of the business.

Section 152-40 of the ITAA 1997 explains that a CGT asset is an active asset if it is owned by you and is used or held ready for use in a business carried on (whether alone or in partnership) by you, your affiliate, your spouse or child, or an entity connected with you.

Personal use

Subsection 152-40(4A) of the ITAA 1997 says, in determining the main use of an asset: disregard any personal use or enjoyment of the asset by you and treat any use by your affiliate, or an entity that is connected with you, as your use.

Spouse as affiliate

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

(a) The asset owner owns a CGT asset (whether the asset is tangible or intangible); and

(b) either 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 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 says for the purposes of this Subdivision, in 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 spouse of the individual or a child of the individual, being a child who is under 18 years.

Subsection 152-47(3) of the ITAA 1997 says if an entity is an affiliate of, or connected with, another entity as a result of subsection (2), then the spouse or child mentioned in that subsection is, in addition, taken to be an affiliate of the individual for the purposes of this Subdivision, and for the purposes of sections 328-110 to 328-125 to the extent that they relate to this Subdivision.

Incidental Use

The meaning of an active asset in section 152-40 requires the asset to be used, or held ready for use, in the course of carrying on a business that is carried on. This issue was explored in Eichmann v FCT [2020] FCAFC 155 (Eichmann case), where the taxpayer, who carried on a business of building, bricklaying and paving, purchased land next door to his family home and used it to store work tools, equipment and materials. The land had sheds, high walls and a gate to secure the property. Work vehicles and trailers were parked on the property, and tools and items were collected from there on a daily basis.

The full court held that the secure storage of the tools and materials of the taxpayer's business on a daily basis was very much part of the course of the carrying on of that business. In so holding, the court unanimously overturned the decision of Derrington J ( 2019 ATC 20-728 ; [2019] FCA 2155 ) and the view that, in order for an asset to be used " in " the course of carrying on a business, it was necessary for the use to have a direct functional relevance to the carrying on of the normal day-to-day activities of the business that were directed to the gaining or production of assessable income. The court said that, since s 152-40(1)(a) is beneficial in nature, its language should be construed so as to give the most complete remedy that is consistent with the actual language employed and to which its words are fairly open.

The ATO has since issued an Impact Statement on the full court's decision in Eichmann, which states that, while the full court made it clear that "the legislature has not used language which might confine these inquiries", it remained the case that the asset must be used at some point in the carrying on of an identified business. Accordingly, the Commissioner will continue to closely examine matters such as the way in which an asset has been employed in the business and the extent to which the asset has been so employed in considering whether the asset meets the active asset test.

However, passively storing old records in containers placed on a property was not regarded as using the land in the course of carrying on a business in Karapanagiotidis & Anor v FC of T 2007 ATC 2746 and, therefore, the property did not qualify as an active asset.

In Rus and Commissioner of Taxation (Taxation) [2018] AATA 1854 (Rus case), most of the business activities were conducted off site and only a small portion of land was used in carrying on a business. The land in this case was held not to be an active asset.

In this case your spouse used the property exclusively for the entire ownership period to run their accounting practice. No other office or premises was used. Therefore, it is not incidental use and would be considered to be used in carrying on a business.

Application to your circumstance

You have owned the property for less than 15 years. Your spouse used the property for the entire ownership period to run their business. As you own the property that your spouse used to carry on a business, they will be considered your affiliate. They ran the business exclusively from the property. As all personal use or enjoyment by you is disregarded and all use by your spouse is treated as your use for the determining if the property is an active, the property therefore satisfies the active asset test under subsection 152-35 of the ITAA 1997.

Question 2

Basic Conditions

A capital gain that you make may be reduced or disregarded under Division 152-A of the ITAA 1997 if the following basic conditions are satisfied:

•         a CGT event happens in relation to a CGT asset of yours in an income year

•         the event would have resulted in a gain

•         the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997, and

•         at least one of the following applies;

o   you are a small business entity for the income year

o   you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997

o   you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an interest in an asset of the partnership, or

o   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.

Active asset test

The active asset test outlined in section 152-35 of the ITAA 1997. The active asset test is satisfied 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 test period. Therefore, the active asset test is satisfied.

The test period beings when you acquired the asset and ends at the earlier of the CGT event and if the relevant business ceased to be carried on in the 12 months before that time - the cessation of the business.

Section 152-40 of the ITAA 1997 explains that a CGT asset is an active asset if it is owned by you and is used or held ready for use in a business carried on (whether alone or in partnership) by you, your affiliate, your spouse or child, or an entity connected with you.

In this case you sold your property and made a capital gain. You owned your property for less than 15 years and it was used by your husband for its entire ownership period to carry on a business. Therefore, the property satisfies the active asset test as mentioned above. You satisfy the maximum net value asset test because you and any connected entities and affiliates have net assets of less than $6 million.

Retirement exemption

Subdivision 152-D of the ITAA 1997 sets out the conditions for the small business retirement exemption. If you are an individual, you can choose to disregard all or part of a capital gain under this provision if:

•         you satisfy the basic conditions

•         you keep a written record of the amount you chose to disregard (the CGT exempt amount), and

•         if you were under 55 years of age just before you choose to use the retirement exemption, you make a personal contribution equal to the exempt amount to a complying superannuation fund or retirement savings account (RSA).

The contribution must be made:

•         when you made the choice to use the retirement exemption, or when you received the proceeds (whichever is later), or

•         if the relevant event is CGT event J2, J5 or J6 - when you made the choice to use the retirement exemption.

If you are 55 or older when you make the choice to access the retirement exemption, there is no requirement to pay any amount to a complying superannuation fund or RSA even though you may have been under 55 years of age when you received the capital proceeds.

An individual's CGT retirement exemption limit is $500,000 reduced by the CGT exempt amounts of CGT assets specified in choices previously made by or for the individual under subdivision 152-D of the ITAA 1997.

Application to your circumstances

In this case as you satisfy the basic conditions, you are eligible to apply the retirement exemption in Subdivision 152-D of the ITAA 1997. As you are over 55 years old there is no requirement to pay the exempt amount into a complying superfund or RSA. Note there is a retirement exemption lifetime limit of $500,000. You should keep a written record of the amount you choose to disregard.