Edited version of private advice

Authorisation Number: 1052269736709

Date of advice: 4 September 2024

Ruling

Subject: CGT - active asset

Question 1

Does the 50% interest held by the taxpayer in the property and water rights satisfy the active asset test pursuant to section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes. The property and water rights are active asset in accordance with Division 152 of the ITAA 1997 as the taxpayer owned the property and water rights for more than 15 years and they were used in the businesses of entities connected with the taxpayer for more than 7 ½ years. As a result, the property and water rights are considered to be an active asset.

This ruling applies for the following period:

Year Ending 30 June 2023

The scheme commenced on:

1 July 2022

Relevant facts and circumstances

Over XX years ago the taxpayer acquired 50% interest in the property and water rights along with individual A and B (25% each), as tenants in common.

In 20XX the taxpayer's sibling, purchased individual A and B's 50% share in the property and water rights.

From the acquisition date until 20XX, the taxpayers 50% interest was used in carrying on a farming business by the Family Trust.

The trustee for the Family Trust made tax losses during the years ended 30 June 20XX, 30 June 20XX and 30 June 20XX. No distributions of income or capital were made between 20XX and 20XX. The trustee and the taxpayer elected in writing that for those three income years, the taxpayer was a controller of the Family Trust.

The taxpayer worked fulltime in the business ran by the Family Trust between November 20XX and May 20XX. The taxpayer was driving tractors, irrigating fields, managing farms as well as being involved in cashflow management.

The taxpayer was a director of the trustee company of the Family Trust between December 20XX and March 20XX.

The taxpayer and their affiliates have never received 40% or more of the income or capital distributions made by the Family Trust. However, the taxpayer is an eligible beneficiary of the Family Trust.

In 20XX, the taxpayer commenced a finance broking business through the W Trust and the W Trust used the taxpayer's 50% interest in the property for growing crops.

Crop proceeds from the sale of crops were received by the W Trust from 30 June 20XX until the taxpayer's interest in the property and water rights were sold to the taxpayer's sibling on 30 June 20XX.

Water allocation related to the taxpayer's water rights was used for irrigation purposes by the Family Trust and the W Trust and was not used to derive income from the sale of water rights to third parties.

No rental income was received or paid between the co-owners of the property and water rights.

The remaining 50% of the property was used by the other co-owners for their own purposes. None of the co-owners shared any profits jointly and no partnerships were formed between any of the co-owners.

The use of the property by the Family Trust and the W Trust was made under an informal agreement.

The aggregated annual turnover of the W Trust, entities connected with the taxpayer and affiliates of the taxpayer amounted to less than $Xm during the year ended 30 June 20XX.

The net asset value of the taxpayer's assets and the net asset values of entities connected with the taxpayer and affiliates of the taxpayer exceeded $X million at the time of the CGT event.

Since 20XX the taxpayer manages the entire business and is the sole director of the trustee company of the W Trust.

The property was being used by the W Trust in carrying on a crop farming business at the time the taxpayer's interest in the property and water rights were sold to their sibling.

The taxpayer does not carry on a business in their own right.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 Subdivision 152-B

Income Tax Assessment Act 1997 section 152-105

Income Tax Assessment Act 1997 Subdivision 328-C

Income Tax Assessment Act 1997 section 328-130

Reasons for decision

Subdivision 152-A of the ITAA 1997sets out the 'basic conditions' which must be satisfied in order for small business entities to qualify for any of the CGT small business concessions to reduce their capital gain by the various concessions in Division 152 of the ITAA 1997.

Active assets

For the small business concessions in Division 152 of the ITAA 1997 to apply to reduce or disregard a capital gain, the relevant CGT asset must satisfy the basic conditions in section 152-10 and the active asset test in section 152-35.

Subsection 152-35(1) of the ITAA 1997 states that a CGT asset satisfies the active asset test if:

(a) you have owned the asset for XX 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

(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 7 and a half years.

For a CGT asset to be an active asset for the purposes of Subdivision 152-A of the ITAA, it must firstly satisfy one of the 'positive tests' in subsection 152-40(1), and then also not be excluded by one of the exceptions in subsection 152-40(4).

Under paragraph 152-40(1) of the ITAA a CGT asset is an active asset (subject to the exclusions) if it 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, an affiliate of yours or an entity connected with you, or

•           it is an intangible asset that is inherently connected with a business you, your affiliate or another entity that is connected with you, carries on.

Meaning of CGT asset

Under subsection 108-5(1) of the ITAA 1997 a CGT asset is any kind of property or a legal or equitable right that is not property.

Application to the taxpayer's circumstances

The taxpayer acquired 50% interest in the property in the financial year ending 30 June 20XX. The taxpayer has held their ownership interest in the property and water rights for a period of more than 15 years. We will need to establish that the ownership interest was an active asset for a period of more than 7 ½ years.

Connected entity

As the taxpayer has not used the property or water rights directly in a business of their own, we will need to establish that the taxpayer was connected to the Family Trust and W Trust in order for the trusts business use to be considered for the purpose of the active asset test. We will need to establish this connection for the period of at least 7 ½ years to pass the test.

Direct control of a discretionary trust

Subsection 328-125(3) of the ITAA provides that 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) of the ITAA provides that 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.

Section 152-78 of the ITAA explains a trustee of discretionary trust may nominate beneficiaries to be controllers of the trust. It provides that the trustee of a discretionary trust may nominate not more than 4 beneficiaries as being controllers of the trust for an income year (the relevant income year) for which the trustee did not make a distribution of income or capital if the trust had a tax loss, or no net income, for that year. A nomination under this section has effect as if each nominated beneficiary controlled the trust for the relevant income year in a way described in section 328-125.

The taxpayer's connection to the Family Trust

The taxpayer received less than 40% of the income distributions and no capital distributions from the Family Trust between 20XX and 20XX. Accordingly, the taxpayer did not control the Family Trust under subsection 328-125(4) of the ITAA and therefore was not connected to it under paragraph 328-125(1)(a) without consideration of being nominated a controller under section 152-78.

However, the Family Trust will be connected with the taxpayer for the years ended 30 June 20XX, 30 June 20XX and 30 June 20XX (i.e., for 3 income years) for the purposes of section 328-125 of the ITAA by virtue of the nomination that was executed under section 152-78, nominating the taxpayer as a controller of the Family Trust.

The taxpayer's connection to the W Trust

Between 20XX and June 20XX, the farming business carried out on the taxpayers 50% interest in the property was carried on by the W Trust. In order for the property to be considered to be an active asset of the taxpayer the W Trust must be connected with the taxpayer in respect of any one or more of those income years.

The W Trust is controlled by the taxpayer under subsection 328-125(3) of the ITAA the taxpayer is the sole director and appointor of the trustee and can therefore be reasonably expected to act in accordance with their own directions or wishes. Accordingly, the W Trust was connected with the taxpayer for the purposes of section 328-125 for the period during which the business was carried on by the W Trust from the financial year ending 30 June 20XX to 30 June 20XX for at a total of 5 years.

Use of water rights

At the time the taxpayer acquired their 50% interest in the property, attached to the property was a water allocation. These water rights are separate CGT assets from the land. The water rights have been exclusively used to irrigate crops on the property in relation to farming businesses carried on by related entities.

Application to the taxpayer's water rights

The water rights are a CGT asset.

The water rights are an active asset because the Family Trust and the W Trust used the water rights to irrigate crops on the property. The crop production is considered to be part of the primary production businesses carried on by entities connected to the taxpayer.

None of the exceptions in subsection 152-40(4) of the ITAA 1997 will apply to the water rights.

Accordingly, the water rights are an intangible asset that was inherently connected to a business carried on by the business entities (the Family Trust and the W Trust) that were connected with the taxpayer for at least 8 income years.

Application to the taxpayer's circumstances

The taxpayer owned their 50% interest in the property and water rights for more than XX years and the property and water rights were active asset of the taxpayers for at least 7 ½ years of the ownership period. The property and water rights were used by the Family Trust and the W Trust in the course of carrying on a business and the Family Trust was connected to the taxpayer for at least X years and the W Trust was connected to the taxpayer for at least X years, together they were connected with the taxpayer for a total of X years. Neither the property nor the water rights were used to derive rent therefore exceptions in subsection 152-40(4) of the ITAA do not apply.

As the taxpayer owned their interests in the property and water rights for more than XX years and the interests were active assets of the taxpayer for at least 7½ years during their ownership period, we consider that their interests in the property and water rights satisfy the active asset test in section 152-35 of the ITAA.