Edited version of private advice

Authorisation Number: 1052281114932

Date of advice: 29 July 2024

Ruling

Subject: CGT - small business concessions

Question 1

Did the trust meet the basic eligibility condition to qualify for the small business CGT concessions under subdivision 152-A of the Income Tax Assessment Act 1997 (ITAA 1997) in relation to the sale of the property?

Answer

Yes.

Question 2

Is the trust eligible for the small business 15-year exemption under section 152-110 of the ITAA 1997, allowing it to disregard the capital gain arising from the sale of the property?

Answer

Yes.

This ruling applies for the following period:

Year Ended 30 June 2023

The scheme commenced on:

1 July 2022

Relevant facts and circumstances

After September 1985, the corporate trustees of the trust purchased a property.

The property is zoned for farming. The property is basalt stone country on which native grass grows extensively and is less palatable to cattle and a low source of energy. The soil tends to be dry which reduces the carrying capacity for cattle.

After acquisition the trust installed on the property a laneway, cattle yards and suitable fencing in preparation for primary production activities.

Since acquisition, the property was used to carry on primary production activities including backgrounding, raising cattle, managing the land, grazing, producing fodder reserves and agistment.

The land has been primarily used for backgrounding (feeding purchased cattle on pasture before on-selling to saleyards, abattoirs or feedlots). Backgrounding was chosen as the means of income due to the poor state of the land for intensive grazing purposes.

Person A and Person B, who have accounting qualifications have employed a systematic approach to the keeping of business records.

The trust engages a professional accounting firm to produce financial records and financial statements with livestock accounts.

The trust makes investments into the property to ensure that the land is sustained including new watering equipment, storage tanks, fencing and cattle yards.

From 20XX to 20XX the property was used for agistment.

In 20XX the property was rezoned. The rezoning and development around the property impacted the primary production activities which included cattle escaping through damaged fences by trespassers on bikes or other vehicles, and littering. As a result of the trespassers and other issues, the taxpayer reduced stock numbers.

In 20XX Person A started working elsewhere as an employee as well as spending time on the property.

In 20XX Person A entered into an option agreement with Company A to purchase the property.

From 20XX to 20XX the farming operation was impacted by drought, bushfires, the covid-19 pandemic and flooding.

In the years affected by drought, the trust engaged in supplementary feeding and frequent water cartage to maintain the cattle on its property despite the prices increasing due to more demand.

During covid-19 the trust's ability to look after their farming operation was affected.

An experienced livestock agent continually advised the trustee on cattle farming over many years. Their advice addressed the market outlook, forecast weather and climatic conditions, the suitability of the property for backgrounding, and the identification of relevant markets in which the cattle could be sold.

The advice provided by the livestock agent and heeded by the trustee was to destock entirely or substantially reduce head of cattle during drought periods in order to reduce trading losses resulting from substantial supplementary feeding expenses which materialised between early 20XX and July 20XX. For this reason, the property was substantially destocked during late 20XX and allowed to recover from the drought and over-depleted natural feed resources until late 20XX.

After the drought Person A allowed time for the pasture to recover as the cattle depleted all available feed resources and degraded the soil. They allowed this time by transporting the cattle to a different lot on the property.

The advice received from the livestock agent from early 20XX was to avoid restocking because cattle prices had risen substantially from early 20XX as a result of large cattle kills within the Australian eastern seaboard markets which had depleted available cattle for farmers looking to restock at feasible prices.

In 20XX about XX% of the property became subject to rural conservation zoning, and the taxpayer further reduced stock numbers.

The livestock agent has also consistently advised the trust on the purchasing and selling of its cattle at the best price which led to purchases of cattle by the trustee in the 20XX financial year after the property had a period of time to regenerate from the natural disasters.

The trust also engaged the services of a person for Veterinary Surgery and a person for cow calf artificial insemination and ultrasound service.

The raising and selling of livestock depended on repetition and regularity. Every year or season cattle were purchased, monitored, rotated around the property; monitored the weather, feed levels and pricing, water levels and pricing, and the market on when to sell the cattle.

When cattle were sold to the public it was always in conventional, commercial markets at market price with the purpose of making a gain.

Person A worked approximately XX hours per week on the property and Person B worked approximately XX hours per week on the property.

Person A has had XX years of experience is cattle farming across different properties.

In March 20XX, Company A issued a notice to the trust to exercise its right to purchase the property.

The contract date of sale was March 20XX and settlement occurred in April 20XX.

The trustee entered into a Grazing Licence Deed with Company A over a portion of the property to continue its cattle farming operations until 31 December 20XX.

Thereafter, the trustee is permitted to continue to carry out its primary production activities on the property on a month-to-month basis, unless the parties agree to a longer term.

As at the date of ruling the property is still being leased to be used for primary production activities.

The trust has an aggregated turnover of less than $2 Million in 2023.

Person A is over 55 years old at time of sale.

After the sale of the property Person A stopped working elsewhere in May 20XX and reduced his hours on the property by half.

In the income years ended 30 June 20XX and prior years the trust had no net income or incurred a tax loss.

The trust distributed no income or capital for 20XX and prior.

The trust distributions from 20XX to 20XX were as follows:

Table 1: The trust distributions from 20XX to 20XX were as follows:

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 152-A

Income Tax Assessment Act 1997 section 152-10

Income Tax Assessment Act 1997 section 152-35

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 section 152-70

Income Tax Assessment Act 1997 section 152-110

Income Tax Assessment Act 1997 section 328-110

Reasons for decision

Question 1

Did the trust meet the basic eligibility condition to qualify for the small business CGT concessions under subdivision 152-A of the Income Tax Assessment Act 1997 (ITAA 1997) in relation to the sale of the property?

Detailed reasoning

Basic Conditions

A capital gain that you make may be reduced or disregarded under Division 152-A of the Income Tax Assessment Act 1997 (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 CGT 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 is contained in section 152-35 of the ITAA 1997. Where you have owned the asset for more than 15 years, the active asset test is satisfied if the asset was an active asset of yours for a total of 7.5 years of the test period detailed below.

The test period:

• begins when you acquired the asset, and
• ends at the earlier of
  • the CGT event, and
  • when the business ceased, if the business in question ceased in the 12 months before the CGT event (or such longer time as the Commissioner allows).

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.

Section 328-110 defines the meaning of a small business entity to be:

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 $2 million;

(ii) your aggregated turnover for the current year is likely to be less than $2 million.

Application to your circumstances

The trust owned the property for more than 15 years. The trust carried on a business of primary production and had a turnover of less than $2 million in the CGT event year. Although the property was agisted for XX years, the property is still considered to be used in a business carried on for more than the required 7.5 years, during 19XX to 20XX. Therefore, the property satisfies active asset test under subsection 152-35 of the ITAA 1997. As the trust is a small business entity for the income year which the property sold and sale resulted in a capital gain, the trust therefore satisfies the basic conditions under Division 152-A of the ITAA 1997.

Question 2

Is the trust eligible for the small business 15-year exemption under section 152-110 of the ITAA 1997, allowing it to disregard the capital gain arising from the sale of the property?

Detailed reasoning

15-year exemption

Section 152-110 of the ITAA 1997 says that for the trust to be eligible for the small business 15-year exemption it must satisfy the basic conditions and three further conditions:

• the trust continuously owned the CGT asset for the 15-year period ending just before the CGT event
• the trust 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 trust owned the CGT asset
• either:

o   the significant individual is 55 or over at the time of the CGT event and the event happens in connection with their retirement; or

o   the significant individual is permanently incapacitated at the time of the CGT event.

Whether a CGT event happens in connection with an individual's retirement depends on the particular circumstances of each case. A CGT event may be in connection with your retirement even if it occurs at some time before retirement.

Significant Individual

Section 152-55 of the ITAA 1997 defines a significant individual in a company or a trust at a time if, at that time, the individual has a small business participation percentage in the company or trust of at least 20%.

Section 152-65 of the ITAA 1997 says an entity's small business participation percentage in another entity at a time is the percentage that is the sum of:

(a) the entity's direct small business participation percentage in the other entity at that time; and

(b) the entity's indirect small business participation percentage in the other entity at that time.

The table in subsection 152-70(1) of the ITAA 1997 helps to work out an entity's direct small business participation percentage.

For a trust (where entities do not have entitlements to all the income and capital of the trust) the direct small business participation percentage:

(a) if the trustee makes distributions of income during the income year (the relevant year) in which that time occurs - the percentage of the distributions to which the entity was beneficially entitled; or

(b) if the trustee makes distributions of capital during the relevant year - the percentage of the distributions to which the entity was beneficially entitled.

or, if 2 different percentages are applicable, the smaller.

Discretionary trusts

Subsection 152-70(4) of the ITAA 1997 states:

Subsections (5) and (6) apply for the purpose of working out the direct small business participation percentage in an entity in connection with a CGT event that happened in an income year (the CGT event year), if:

(a) the entity is a trust (where entities do not have entitlements to all the income and capital of the trust); and

(b) during the relevant year mentioned in item 3 of the table in subsection (1) (disregarding subsection (5)), the trustee mentioned in that item:

(i) does not make a distribution of income; and

(ii) does not make a distribution of capital.

Subsection 152-70(5) of the ITAA 1997 states:

Treat the references in that item to the relevant year as being references to:

(a) if the trustee made a distribution of income or capital during the CGT event year - the CGT event year; or

(b) otherwise - the last income year before the CGT event year in which the trustee did make a distribution of income or capital.

Application to your circumstance

In 20XX to 20XX income years the trust did not make any distributions so paragraph 152-70(4)(b) of the ITAA 1997 says that you apply subsection 152-70(5) of the ITAA 1997. For the 20XX to 20XX income years there was no distribution, so we look at the last year distribution was made which was 20XX.

In the 20XX income year the distribution went 50% to Person A, 30% to Person B and 20% to Person D so Person A, Person B and Person D are all considered to have a 50%, 30% and 20%, respectively, small business participation percentage in the trust in the 20XX income year.

Applying paragraph 152-70(5)(b) of the ITAA 1997, Person A, Person B and Person D would be considered to have a 50%, 30% and 20% small business participation percentage in the trust in the 20XX to 20XX income years as well.

In the 20XX to 20XX and 20XX to 20XX Person A received 100% distribution for the trust so would be considered to have received 100% small business participation in the trust in those years. In 2016 Person A received a 30% distribution and Person C received a 70% distribution. In 2017 Person C received a 100% distribution.

This means that either Person A or Person C is considered to have a 30% or higher small business percentage in 20XX to 20XX resulting in there being a significant individual of the trust for 15 years.

In conclusion the property was continuously owned by the trust for over 15-years. The trust satisfies the basic conditions under Division 152-A of the ITAA 1997. The trust is considered to have a significant individual for 15 years and one of those significant individuals, Person A was over 55 years old when the property sold and they stopped working elsewhere in May 20XX and reduced their hours on the property by half as a result of the sale. Therefore, the trust is entitled to the small business 15-year exemption.