Edited version of private advice

Authorisation Number: 1052263218137

Date of advice: 16 August 2024

Ruling

Subject: CGT - small business concessions

Question 1

Does the Property satisfy the active asset test pursuant to section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997) and the meaning of active asset pursuant to section 152-40 of the ITAA 1997?

Answer

Yes.

Question 2

When you sell the Property and make a capital gain, will you satisfy the basic eligibility conditions for the small business capital gains tax (CGT) concessions under s.152-10 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

All legislative references are to the Income Tax Assessment Act 1997 ('ITAA 1997') unless otherwise stated.

Relevant facts and circumstances

Ownership - connected entities/affiliates

1.         You own an industrial property (Property) located in Australia.

2.         You have continuously owned the Property for a period of XX Years.

3.         The Property is used in the business of a Trust, and a Company.

4.         You have leased the Property to the Trust since DDMMYYYY at commercial rates.

5.         The Trust has continuously operated a self-storage business at the Property for the past XX years.

6.         The Trust is a discretionary trust that has a Corporate Trustee that operates the storage business in its capacity of trustee.

7.         The Corporate Trustee does not conduct a separate business outside its role of trustee.

8.         On DDMMYYYY, the Company became the owner of the adjoining site to the Property. Since that date (more than X years ago), the Company has operated a business. It also uses a small portion of the Property for business purposes but no formal lease has been executed in relation to that use.

9.         You have a spouse who does not carry on a business in their own name.

10.      Your spouse has been the sole director and shareholder of the Corporate Trustee.

11.      Your spouse is a beneficiary of the Trust.

12.      You are a beneficiary of the Trust and do not carry on a business in your own name.

13.      No nominations have been made for the purposes of section 152-78 of the ITAA 1997 for the Trust.

14.      The Trust distributions (with amounts and percentage of total) to You and your spouse for income years 20XX to 20XX were provided.

15.      Your percentage of the Trust distributions was less than 40% of the total amount of income paid or applied by the trustee for the relevant years.

16.      You together with your spouse received a percentage of Trust distributions that added up to greater than 40% of the total amount of income paid or applied by the trustee for the relevant years.

17.      You are one of the 2 directors and a 50% shareholder in the Company.

18.      Your spouse is the other director and 50% shareholder in the Company.

19.      You control the Company as joint director with your spouse and you are a 50% shareholder.

20.      On DDMMYYYY you became a director and 50% shareholder of the Corporate Trustee.

21.      The respective turnovers of the Company and the Trust were provided.

22.      The aggregated turnover of the Company and Trust was less than $X million for the 20XX and 20XX income years.

23.      You plan to sell the property in the 20XX income year.

24.      The storage business owned by the Trust is a very small business that has always been run by you and your spouse.

25.      Your spouse actively manages the business onsite.

26.      You work at least one day per week in the business.

27.      You are both on call 24 hours per day, 7 days per week.

28.      You have managed all the legal issues and are involved in the strategic decisions made in relation to the business.

29.      You influence the day-to-day operations of the business as well as the long-term strategic decisions of the business.

30.      The Property is used by the Trust in its self-storage business.

31.      The Property comprises XX,XXX square metres of land. Approximately 75% of the area is utilised by the Trust in carrying on the storage hire business.

32.      In the 20XX income year, the total income generated from the Property was approximately $XXX,XXX. The proportion attributable to the storage business was more than 93%.

33.      In 20XX income year the total income generated from the Property was approximately $XXX,XXX. The proportion attributable to the storage business was more than 90%.

34.      You plan to sell the Property.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 subsection 104-10(1)

Income Tax Assessment Act 1997 subsection 104-10(2)

Income Tax Assessment Act 1997 subsection 104-10(3)

Income Tax Assessment Act 1997 subsection 104-10(5)

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 section 152-10

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)(iv)

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

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

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

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

Income Tax Assessment Act 1997 section 152-35

Income Tax Assessment Act 1997 paragraph 152-35(1)(a)

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

Income Tax Assessment Act 1997 section 152-40

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

Income Tax Assessment Act 1997 paragraph 152-40(1)(b)

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

Income Tax Assessment Act 1997 subsection 152-40(4A)

Income Tax Assessment Act 1997 paragraph 152-40(4A)(b)

Income Tax Assessment Act 1997 section 152-47

Income Tax Assessment Act 1997 section 152-48

Income Tax Assessment Act 1997 section 328-110

Income Tax Assessment Act 1997 subsection 328-110(1)

Income Tax Assessment Act 1997 paragraph 328-110(1)(a)

Income Tax Assessment Act 1997 section 328-115

Income Tax Assessment Act 1997 section 328-120

Income Tax Assessment Act 1997 subsection 328-120

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

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

Income Tax Assessment Act 1997 subsection 328-125(3)

Income Tax Assessment Act 1997 subsection 328-125(4)

Income Tax Assessment Act 1997 section 328-130

Income Tax Assessment Act 1997 section 328-130

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 ('ITAA 1997') unless otherwise stated.

Question 1 and 2

Summary

You satisfy the basic conditions for the CGT small business concessions in section 152-10 in relation to the disposal of the property.

The Property satisfies the active asset test because it was used in the business for the period specified in subsection 152-35(2):

•         by the Company as a connected entity

•         by the Trust an entity connected with you, as a result of the operation section 152-47 deeming your spouse to be an affiliate.

The use of your Property by the connected entities in their respective businesses is the relevant use for the purposes of section 152-40. This means that the Property is not excluded as an active asset on the basis that it is a rental property in your hands. The condition in paragraph 152-10(d) is satisfied.

Detailed reasoning

Basic conditions in Subdivision 152-A of the ITAA 1997

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

Subsection 152-10(1) sets out the basic conditions.

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;

Note: This condition does not apply in the case of CGT event D1: see section 152-12.

(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 (see section 152-15 );

(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).

To be eligible to apply the small business CGT concessions you must satisfy all four of the basic conditions above.

The following requirements are relevant in these circumstances:

The first and second basic conditions - paragraphs 152-10(1)(a) and (b)

When you dispose of the Property which is a CGT asset, in the 20XX income year, it will trigger CGT event A1. Where this results in a capital gain, the first 2 basic conditions in paragraphs 152-10(1)(a) and (b) will be met.

The third basic condition - paragraph 152-10(1)(c)

Of the 2 basic conditions remaining, the condition in paragraph 152-10(1)(c) requires that at least one of the requirements in subparagraphs 152-10(1)(c)(i) to 152-10(1)(c)(iv) applies.

One of these requirements is that the conditions in subsection 152-10(1A) or (1B) are satisfied in relation to the CGT asset in the income year. Of relevance is subsection 152-10(1A) about passively held assets used by affiliates and entities connected with you.

Subsection 152-10(1A) states:

The conditions in this subsection are satisfied in relation to the *CGT asset in the income year if:

(a) your *affiliate, or an entity that is *connected with you, is a *CGT small business entity for the income year; and

(b) you do not carry on a *business in the income year (other than in partnership); and

(c) if you carry on a business in partnership - the CGT asset is not an interest in an asset of the partnership; and

(d) in any case - the CGT small business entity referred to in paragraph (a) is the entity that, at a time in the income year, carries on the business (as referred to in subparagraph 152-40(1)(a)(ii) or (iii) or paragraph 152-40(1)(b)) in relation to the CGT asset.

You do not carry on a business in your personal capacity. Therefore, it is necessary to consider if the Property is used in a business carried on by your affiliate, or an entity that is connected with you.

Affiliates

An affiliate is defined by section 328-130 as being an individual or company who acts or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the business affairs of that individual or company.

An individual or company can only be an affiliate if they are carrying on a business.

The Trust is not an affiliate of yours as it is not a company or individual.

Connected Entity

The meaning of connected with an entity is contained in section 328-125 which provides that an entity is connected with another entity if:

a)     either entity controls the other entity in the way described in this section, or

b)     both entities are controlled by the same third entity in a manner described in this section.

Direct control- Company

Section 328-125 sets out the various ways an entity is taken to control another entity, including the circumstances in which beneficiaries of a discretionary trust are taken to control the trust.

The direct control of an entity other than a discretionary trust is set out in Subsection 328-125(2) as follows:

An entity (the first entity) controls another entity if the first entity, its affiliates, or the first entity together with its affiliates:

(a) except if the other entity is a discretionary trust - own, or have the right to acquire the ownership of, interests in the other entity that carry between them the right to receive a percentage (the control percentage) that is at least 40% 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; or

(b) if the other entity is a company - own or have the right to acquire the ownership of, equity interests in the company that carry between them the right to exercise, or control the exercise of, a percentage (the control percentage) that is at least 40% of the voting power in the company.

Application of connected entity - Company

As a 50% shareholder of the Company your ownership interest in the company is greater than 40% so it is accepted that you have direct control of the company under subsection 328-125(2). Therefore, the Company is a connected entity under subsection 328-125(1).

Direct control - Discretionary Trust

The meaning of direct control of a discretionary trust is set out in subsections 328-125(3) and (4).

Subsection 328-125(3) states:

An entity (the first entity) controls a discretionary trust if a trustee of the trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the first entity, its affiliates or the first entity together with its affiliates.

Subsection 328-125(4) provides:

An entity (the first entity) controls a discretionary trust for an income year if, for any of the 4 income years before that year:

(a) the trustee of the trust paid to, or applied for the benefit of:

(i) the first entity; or

(ii) any of the first entity's *affiliates; or

(iii) the first entity and any of its affiliates;

any of the income or capital of the trust; and

(b) the percentage (the control percentage) of the income or capital paid or applied is at least 40% of the total amount of income or capital paid or applied by the trustee for that year.

Spouse as affiliate

Relevantly to your situation the operation of section 328-125 must be considered together with section 152-47.

Section 152-47 provides that spouses or children are taken to be affiliates for certain passively held CGT assets:

152-47(1)

This section applies if:

(a) one entity (the asset owner) owns a CGT asset (whether the asset is tangible or intangible); 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.

152-47(2)

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) a spouse of the individual;

(b) a child of the individual, being a child who is under 18 years.

152-47(3)

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.

The rule is applied in two stages. The first stage treats an individual's spouse or child (under 18 years of age) as their affiliate, for the purposes of Subdivision 152-A, when determining whether the entity that uses the CGT asset, or holds it ready for use, in its business is an affiliate of, or is connected with, the entity that owns the CGT asset.

If the conditions of the first stage are met, the second stage will apply to treat the spouse as an affiliate of the individual for the purposes of Subdivision 152-A and for the purposes of sections 328-110 to 328-125 to the extent that these sections relate to Subdivision 152-A.

Application of connected entity test -Trust

The Trust which uses the Property is not (apart from section 157-47) an affiliate of or connected with you.

Since the Trust is not otherwise an affiliate of or connected to you, section 152-47 deems your Spouse to be your affiliate for the purpose of establishing the connection.

As a result, your Spouse's distribution from the Trust can be used for the purposes of the direct control test in subparagraph 328-125(4)(a)(iii).

In your case, you, together with your spouse, have received greater than 40% of the distribution of income for the past 8 years which is sufficient for you to control the Trust under subsection 328-125(4).

As you have controlled the Trust for at least an 8-year period, you are connected to it under paragraph 328-125(1)(a).

Small business entity

Paragraph 152-10(1A)(a) requires your *affiliate, or an entity that is *connected with you, must be a *CGT small business entity for the income year. In your case this means the Trust and the Company who are using your Property must each be a CGT small business entity.

Subsection 152-10(1AA) states:

You are a CGT small business entity for an income year if:

a)     you are a small business entity for the income year; and

b)     you would be a small business entity for the income year if each reference in section 328-110 to $10 million were a reference to $2 million.

As defined in section 995-1, a small business entity has the meaning given by subsection 328-110(1), as follows:

You are a small business entity for an income year (the current year) if:

a)     you carry on a business in the current year; and

b)     one or both of the following applies:

i) you carried on a business in the income year (the previous year) before the current year and your aggregated turnover for the previous year was less than $10 million;

ii)      your aggregated turnover for the current year is likely to be less than $10 million.

Aggregated turnover

Subsection 328-115(1) states:

Your aggregated turnover for an income year is the sum of the relevant annual turnovers (see subsection (2)) excluding any amounts covered by subsection (3).

Section 328-115(2)

The relevant annual turnovers are:

a)    your annual turnover for the income year; and

b)     the annual turnover for the income year of any entity (a relevant entity) that is connected with you at any time during the income year; and

c)      the annual turnover for the income year of any entity (a relevant entity) that is an affiliate of yours at any time during the income year.

Subsection 328-115(3)

Your aggregated turnover for an income year does not include the following amounts:

a)    amounts derived in the income year by you or a relevant entity from dealings between you and the relevant entity while the relevant entity is connected with you or is your affiliate;

b)     amounts derived in the income year by a relevant entity from dealings between the relevant entity and another relevant entity while each relevant entity is connected with you or is your affiliate;

c)      amounts derived in the income year by a relevant entity while the relevant entity is not connected with you and is not your affiliate.

Section 328-120 sets out the meaning of annual turnover as;

An entity's annual turnover for an income year is the total ordinary income that the entity derives in the income year in the ordinary course of carrying on a business.

...

Application of the small business entity test

It is accepted that the Trust and the Company who are using your asset to conduct their activities, satisfy the requirement to carry on a business for the purposes of paragraph 328-110(1)(a).

Given that the Trust and the Company are controlled by you, both entities are controlled by the same third entity which means these entities are themselves connected entities under paragraph 328-125(1)(b). You have provided that their aggregated turnover is $XXX,XXX for the 20XX income year and $XXX,XXX for 20XX income year, which is below the $2 million threshold.

As a result, the Trust and the Company both meet the definition of a CGT small business entity for the purposes of section 152-10(1AA).

Conclusion - third basic condition - paragraph 152-10(1)(c)

Together these factors indicate that your Property is a passively held asset used in the business carried on by a small business entity connected with You for the purposes of section 152-10(1A). You therefore satisfy the condition in subparagraph 152-10(1)(c)(iv) and in turn the third basic condition in paragraph 152-10(1)(c).

Fourth basic condition - paragraph 152-10(1)(d)

Active asset test

The final basic condition is for the CGT asset to satisfy the active asset test in section 152-35.

For the disposal of your Property to qualify for the CGT small business concessions, your interest, must satisfy the active asset test.

Under subsection 152-35(1), a CGT asset will satisfy 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(2) provides that the relevant period begins when you acquired the asset and ends at the earlier of the CGT event or the cessation of the business.

The term 'active asset' is defined at section 152-40. Subsection 152-40(1) provides that a CGT asset is an active asset at a given time if, at that time, you own it and:

• it is used (or held ready for use) in the course of carrying on a business by you, your affiliate or an entity connected with you (paragraph 152-40(1)(a)); or
• it is an intangible asset that is inherently connected with a business that is carried on by you, your affiliate, or an entity connected with you (paragraph 152-40(1)(b)).

The combined effect of sections 152-35 and 152-40 is that the asset will meet the active asset test if the asset was used, or held ready for use, in the course of carrying on a business by you, a connected entity or affiliate for at least half of the time period it was owned. This is subject to any exceptions in subsection 152-40(4).

Relevantly, paragraph 152-40(4)(e) excludes, among other things, assets whose main use is to derive rent. Such assets are excluded even if they are used in the course of carrying on a business.

As you have not used the Property directly in a business of your own, you need to rely on the business use of your asset by connected entities.

Subsection 152-40(4A) 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.

Application of paragraph 152-10(1(d)

The test in paragraph 152-35(1)(a) relates to an asset that has been owned for less than 15 years. In your case, it is necessary to establish whether the Property was active for a total of at least half of the test period (from when you acquired the Property in YYYY to YYYY) and whether the Trust and the Company (being the entities that used the Property in carrying on their business) are entities connected with the you during that time.

As already concluded, the Company is an entity connected with you for the relevant period.

Similarly, due to the operation of section 152-47, the Trust is an entity connected with you for the relevant period.

Given that your Property has been used in the course of carrying on a business by other entities (the Trust and the Company) who are both entities connected with you, for the period specified in subsection 152-35(2), the Property satisfies the active asset test.

Although under paragraph 152-40(4)(e), an asset whose main use is to derive rent cannot be an active asset, for the purposes of section 152-40, paragraph 152-40(4A)(b) provides it is the use of the asset by the Company and the Trust in their respective businesses that is relevant. Therefore, the condition in paragraph 152-10(d) is satisfied.

Conclusion - fourth basic condition - paragraph 152-10(1)(d)

Since your Property satisfies the active asset test, the final basic condition in paragraph 152-10(1)(d) is satisfied for the gain.

Conclusion

You satisfy the basic conditions for the CGT small business concessions in section 152-10 in respect to the disposal of the Property.

The Property satisfies the active asset test because it was used in the business for the period specified in subsection 152-35(2):

•         by the Company as a connected entity

•         by the Trust an entity connected with you, as a result of the operation section 152-47 deeming your Spouse to be an affiliate.

The use of your Property by the connected entities in their respective businesses is the relevant use for the purposes of section 152-40. This means that the Property is not excluded as an active asset on the basis that it is a rental property in your hands. The condition in paragraph 152-10(d) is satisfied.