Edited version of private advice

Authorisation Number: 1052294191749

Date of advice: 20 August 2024

Ruling

Subject: Small business 15-year exemption

Question

Does the Taxpayer satisfy the requirements in section 152-110 of the Income Tax Assessment Act 1997 (ITAA 1997) to apply the 15-year exemption in relation to the sale of its business goodwill in the year ended XXXX?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June XXXX

The scheme commenced on:

XXXX XXXX

Relevant facts and circumstances

The Taxpayer has continuously owned and operated a business since XXXX.

The Taxpayer is a privately owned company with sole ownership held by the managing director (Person 1) who has maintained full shareholder control throughout the entirety of the Taxpayer's operation.

In XXXX, the Taxpayer entered into a contract to sell its business for a total of $XXXX.

The contract of sale specifies that of the total consideration of $XXXX, $XX is allocated to plant & equipment, with the remaining $XXXX attributed to the goodwill of the business.

Pursuant to the contract of sale, the deposit amount was specified as $XX, with the remaining $XXXX being payable to the Taxpayer. The amount of $XXXX was payable by the purchaser at the date of settlement.

The outstanding balance of $XXXX is to be paid in quarterly instalments of $XX over a 2-year period. There is no earn-out arrangement. The outstanding balance constitutes vendor financing.

The Taxpayer incurred agent's fees of $XX and legal fees of $XX in selling its business.

The decision to sell the Taxpayer's business was made in connection with Person 1's retirement.

At the time of entering the contract of sale, Person 1 was over XX years old.

Person 1 has retired and has ceased all employment and ceased involvement in the Taxpayer's business. Person 1 has no intention to return to work.

For the XXXX to XXXX income years the Taxpayer's aggregate turnover during this period equated to XXXX amount per year.

Prior to the COVID-19 pandemic, on average the Taxpayer's typical turnover was XXXX amount per period.

A number of unforeseen factors affected the Taxpayer's turnover in recent income years.

The Taxpayer's competitors, located within close proximity to the Taxpayer's business, temporarily closed. As a result, the Taxpayer experienced an unusual increase in business during this period.

Additionally, increased promotion within the media (not undertaken by the Taxpayer) after the COVID pandemic contributed to a substantial increase in the Taxpayer's business. As a result, in the XXXX income year, the Taxpayer had substantially higher amounts of business than the average.

It is contended that the higher turnover figures in the XXXX income year are not indicative of a sustained trend, with a significant decrease in business observed in the XXXX income year, after the Taxpayer's competitor businesses reopened.

For the period from 1 July XXXX to date of settlement, the Taxpayer recorded an aggregate turnover of $XXXX, which included revenue from business through to the end of XXXX.

The purchaser of the business confirmed that the turnover for the remainder of the XXXX financial year was approximately XXXX.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 100-25

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 108-5

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 152-55

Income Tax Assessment Act 1997 section 152-65

Income Tax Assessment Act 1997 section 152-70

Income Tax Assessment Act 1997 section 152-75

Income Tax Assessment Act 1997 section 152-110

Income Tax Assessment Act 1997 section 152-125

Income Tax Assessment Act 1997 section 160M

Income Tax Assessment Act 1997 section 160U

Income Tax Assessment Act 1997 section 328-110

Income Tax Assessment Act 1997 section 328-125

Income Tax Assessment Act 1997 section 995-1

Does IVA apply to this private ruling?

No

Reasons for decision

Small business 15-year retirement exemption for companies

Subdivision 152-B outlines the small business 15-year exemption. Under this subdivision, a CGT small business entity can choose to disregard a capital gain arising from a CGT asset that it has owned for at least 15 years if certain conditions are met.

Section 152-110 provides that a company can disregard any gain arising from a CGT event if all of the following conditions are satisfied:

a.             the basic conditions of Subdivision 152-A are satisfied

b.             the company continuously owned the CGT asset for the 15-year period ending just before the CGT event

c.             the company had a significant individual for a total of at least 15 years during which the company owned the CGT asset

d.             the significant individual of the company 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 significant individual's retirement; or

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

Subdivision 152-A of the ITAA 1997 - basic conditions for relief

The basic conditions for relief under the CGT small business concessions are outlined in subdivision 152-A.

Subsection 152-10(1) provides that a capital you make may be reduced or disregarded if the following basic conditions are satisfied:

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

b.             the event would have resulted in a 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 as specified in 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.            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 any entity connected with you.

d.             the CGT asset satisfies the active asset test pursuant to section 152-35.

CGT event giving rise to a capital gain

Section 102-20 stipulates that a capital gain or loss is made if a CGT event happens to a CGT asset.

As defined in section 108-5, a CGT asset is:

a.             any kind of property; or

b.             a legal or equitable right that is not property.

Additionally, subsection 100-25(3) stipulates goodwill as being a CGT asset.

Relevantly, under subsection 104-10(1), CGT event A1 happens if you dispose of a CGT asset.

Subsection 104-10(2) provides that you dispose of a CGT asset when a change of ownership occurs from you to another entity. However, a change of ownership does not occur if you cease being the legal owner of an asset but continue to be its beneficial owner.

Pursuant to subsection 104-10(4), the effect of CGT event A1 happening is that you make a capital gain if the capital proceeds from the disposal of the asset are more than the asset's cost base, or alternatively, a capital loss if those capital proceeds are less than the asset's reduced cost base.

Subsection 104-10(3) defines that the time of the CGT event is when you enter into the contract for the disposal, or, if there is no contract, when the change of ownership occurs.

CGT small business entity

Under subsection 152-10(1AA), you are a 'CGT small business entity' for an income year if:

a.             you are 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 $XXXX were a reference to $XXXX.

Section 995-1 defines that a small business entity has the meaning given in Subdivision 328-C - subject to the winding up exception under subsection 328-110(5), the entity must:

a.             be carrying on a business; and

b.             satisfy any 1 of 3 tests based on turnover, being:

i.              the entity carried on a business in the income year (the previous year) before the current year and the entity's aggregate turnover for the previous year was less than $XXXX[1];

ii.             the entity's aggregate turnover for the current year is likely to be less than $XXXX provided the turnover when the business was carried on in both the 2 previous years not $XXXX or more[2]; or

iii.            the aggregated turnover for the entity for the current year (worked out as at the end of that year) is less than $XXXX.[3]

Pursuant to subsection 328-110(5) an entity is a small business entity if:

a.             the entity is winding up a business it formerly carried on; and

b.             it was a small business entity in the income year that it stopped carrying on the business.

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 7.5 years during the test period.

Under subsection 152-35(2), the test period:

a.             begins when you acquired the asset; and

b.             end at the earlier of:

i.              the CGT event; and

ii.             if the relevant business ceased to be carried on in the 12 months before that time or any longer period that the Commissioner allows - the cessation of the business.

Paragraph 152-40(1)(a) provides that a CGT asset is an active asset at a time if, at that time you own the asset and it is used, or held ready for use, in the course of carrying on a business that is carried on by you, or your affiliate, or another entity that is connected with you.

Alternatively, if the CGT asset is an intangible asset, then it is an active asset if you own it and it is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or another entity that is connected with you.[4]

It is noted that an intangible asset, such as the goodwill of a business, need satisfy only paragraph 152-40(1)(a) or paragraph 152-40(1)(b) to be an active asset.

Connected with

Pursuant to subsection 328-125(1), an entity is connected with another entity if:

a.             either the entity controls the other entity, or

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

Control may be direct or indirect

Relevantly, an entity will control another entity where the first entity or its affiliates, or the first entity and its affiliates between them, beneficially own, or have the right to acquire the beneficial ownership of, interests in the other entity that between them give the right to receive at least 40% of any distribution of either, paragraph 328-125(2)(a):

a.             income

b.             the net income of the partnership (if the other entity is a partnership); or

c.             capital.

Continuously owned the CGT asset

In Taxation Determination TD 94/89 Income tax: capital gains: in what year of income is a taxpayer required for tax purposes to include a capital gain or loss in relation to land disposed of under a contract which is made in one year of income, but which is settled in a later year of income? (TD 94/89) the Commissioner explains that, generally for CGT purposes, ownership in relation to the disposal of property is determined with reference to settlement. Paragraph 3 of TD 94/89 states:

However, a taxpayer is not required to include any capital gain or loss in the appropriate year until an actual change of ownership occurs. Settlement effects a change of ownership and a disposal (subsection 160M(1)) which then triggers the operation of subsection 160U(3). When settlement occurs, the taxpayer is then required to include any capital gain or loss in the year of income in which the contract was made (subsection 160U(3)). If an assessment has already been made for that year of income, the taxpayer may need to have that assessment amended.

However, whether an entity has continuously owned the CGT asset for the 15-year period set out in paragraph 152-105(1)(b), this is determined with reference to when the CGT asset commences to be owned by the entity to just before the CGT event (in the case of CGT event A1, the date of the contract for the sale of the CGT asset).

Significant individual

Pursuant to section 152-55, an individual is a significant individual in a company at a time if, at that time, the individual has a small business participation percentage in the company of at least 20%.

Section 152-65 defines 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.

Direct small business participation percentage

Relevantly, Subsection 152-70(1) provides that an entity's direct small business participation percentage in a company is the least of the following percentages it has:

a.             the percentage of voting power it holds in the company

b.             the percentage of any dividend that the company may pay; and

c.             the percentage of any distribution of capital that the company may make.

It is noted that these percentages must arise because of the legal and equitable interest the entity holds in shares in the company, other than redeemable shares as stipulated in subsection 152-70(2).

Indirect small business participation percentage

An entity's indirect small business participation percentage in a company is the entity's direct participation percentage in an interposed entity multiplied by the interposed entity's total participation (both direct and indirect) in the company.

In order to work out the indirect small business participation percentage that an entity holds at a particular time in another entity, subsection 152-75(1) instructs to:

a.             calculate the direct small business percentage (if any) that the holding entity has in another entity (the intermediate entity) at that time (paragraph 152-75(1)(a)), and multiply that by the sum of:

i.              intermediate entity's direct small business participation percentage (if any) in the test entity at that time[5], and

ii.             the intermediate entity's indirect small business participation percentage (if any) in the test entity at that time (as worked out under one or more other applications of this section).[6]

In connection with retirement

The provisions relating to the small business 15-year exemption do not provide a definition on the meaning of the phrase 'in connection with their retirement'. Furthermore, the legislation does not give any indication of the degree of retirement for the purposes of the concession.

A consideration of the particular facts of each case is required in determining whether a CGT event happens in connection with an individual's retirement.

The Explanatory Memorandum to the New Business Tax System (Capital Gains Tax) Bill 1999 provides the following description around the requirement to be retired or permanently incapacitated as one of the conditions for the concession:

1.68 One of the requirements of this concession for an individual small business taxpayer is that they must be either permanently incapacitated at the time of the CGT event, or at least 55 years old and using the capital proceeds for their retirement.

The term 'retirement' is not defined in the legislation. Therefore, the word takes its ordinary meaning.

The Macquarie Dictionary defines 'retirement' as 'removal or retiring from service, office, or business, especially in reaching the end of one's working life'.

In relation to the words 'in connection with', the question of what kind of relationship will be sufficient to establish the connection as contemplated by the legislation will be one of fact and degree.

In Collector of Customs v Pozzolanic Enterprises Pty Ltd (1993) 43 FCR 280 (Pozzolanic), the court observed that:

The words 'connected with' are capable of describing a spectrum of relationships ranging from the direct and immediate to the tenuous and remote. As Sheppard and Burchett JJ observed in Australian National Railways Commission v Collector of Customs (SA) [(1985) 69 ALR 367 at 377-378; 8 FCR 264, at 265] the meaning of the word 'connection' is wide and imprecise, one of its common meanings being 'relation between things one of which is bound up with, or involved in, another': Shorter Oxford English Dictionary.

In Claremont Petroleum NL v Cummings (1992) 110 ALR 239 (Claremont), the court, in considering whether payments made were in connection with the retirement of certain individuals, made the following observations regarding the phrase 'in connection with':

The phrase "in connection with" is one of wide import, as I had occasion to observe in a different context in Our Town FM Pty Ltd v Australian Broadcasting Tribunal (1987) 16 FCR 465 at p479-80; 77 ALR 577 at pages 591-2:

The words 'in connexion with'...do not necessarily require a causal relationship between the two things: see Commissioner for Superannuation v Miller (1985)8 FCR 153 at 154, 160, 163; 63 ALR 237at 238, 244, 247. They may be used to describe a relationship with a contemplated future event: see Koppen v Commissioner for Community Relations (1986) 11 FCR 360 at 364, Johnson v Johnson [1952] P 47 at 50-1. In the latter case the United Kingdom Court of Appeal applied a decision of the British Columbia Court of Appeal, Re Nanaimo Community Hotel Ltd [1945] 3 DLR 225, in which the question was whether a particular court, which was given 'jurisdiction to hear and determine all questions that may arise in connection with any assessment made under this Act', had jurisdiction to deal with a matter which preceded the issue of an assessment. The trial judge held that it did, that the phrase 'in connection with' covered matters leading up to, or which might lead up to an assessment. He said...: 'One of the very generally accepted meanings of "connection" is "relation between things one of which is bound up with or involved in another"; or, again "having to do with". The words include matters occurring prior to as well as subsequent to or consequent upon so long as they are related to the principal thing. The phrase "having to do with" perhaps gives as good a suggestion of the meaning as could be had.'

Having regard to the context of subparagraph 152-110(d)(i) of the ITAA 1997, the Commissioner considers that it would be reasonable to adopt the meaning given to the phrase 'in connection with' in Claremont such that it is not necessary for there to be a permanent and everlasting retirement from the workforce. However, there would need to be at least a significant reduction in the number of hours worked or a significant change in the nature of the activities to be regarded as a retirement for the purposes of paragraph 152-110(d)(i).

Applications to these circumstances

The basic conditions for relief in Subdivision 152-A are satisfied as discussed below.

The Taxpayer's goodwill is a CGT asset for the purposes of section 108-5. The sale of the Taxpayer's business goodwill resulted in a capital gain for the purpose of CGT event A1. The conditions in paragraphs 152-10(1)(a) and 152-10(1)(b) are satisfied.

The following factors indicated that the current year aggregated turnover is likely to be less than $XXXX:

a.             The aggregate turnover in the year ended 30 June XXXX being less than $XXXX.

b.             The change in the pattern and amount of business coinciding with the closing and subsequent reopening of the Taxpayer's direct competitors.

c.             The prospect of increased competition with the Taxpayer's competitors reopening their businesses.

d.             The amount of business for the year ended 30 June XXXX reducing significantly compared to previous income years.

e.             The Taxpayer's aggregated turnover from 1 July XXXX to the end of XXXX was $XXXX.

f.              The purchaser of the business confirmed the turnover for the business was approximately $XXXX for the remainder of the income year.

As the Taxpayer operated its business for the year ended 30 June 20XX and the aggregated turnover for the income year, on the balance of probabilities, is likely to be less than $XXXX, the requirements of a CGT small business entity, for the purposes of subsection 152-10(1AA) and paragraph 328-110(1)(b), are satisfied.

In respect of paragraph 328-110(1)(b), the exception contained in subsection 328-110(3) was not triggered. Though the Taxpayer carried on a business in each of the 2 income years before the year ended 30 June 20XX, the aggregate turnover for only one of those income years was greater than $XXXX.

It is also noted by the Commissioner that the Taxpayer would have likely satisfied the requirements to be a CGT small business entity pursuant to subsections 328-110(4) and 152-10(1AA), for the year ended 30 June 2024, given that the Taxpayer's aggregated turnover for the entire year ended 30 June 2024, worked out as at the end of that year, was less than $XXXX.

Accordingly, the Taxpayer was a CGT small business entity for the income year ended 30 June 2024, satisfying paragraph 152-10(1)(c)(i).

The Taxpayer's business goodwill satisfies the active asset test as it was owned by the Taxpayer and it was inherently connected with the Taxpayer's business for the period specified in section 152-35. The condition in paragraph 152-10(d) is satisfied.

The Taxpayer has continuously owned and operated the same business from 20XX, when the goodwill originated, and therefore Taxpayer has continuously owned the CGT asset (i.e. the goodwill) for the 15-year period ending just before the CGT event, therefore satisfying paragraph 152-110(1)(b).

The Taxpayer is connected with Person 1. Relevantly, Person 1 controls the Taxpayer as Person 1 owned 100% equity interest, which carried the right to exercise a 100% of the voting power in the company for the purposes of paragraph 328-125(2)(b).

Having regard to the activities and the purpose of profit, the Taxpayer is considered to be carrying on a business for the purposes of section 328-110.

Regarding the significant individual requirement, for the purposes of paragraph 152-110(1)(c), Person 1 has held 100% beneficial ownership of the shares issued in the Taxpayer since XXXX. Therefore, Person 1 has a small business participation percentage of the company of at least 20% during the relevant period and thus meets the definition of a 'significant individual' under section 152-55. Person 1 was a significant individual of the company for more than 15 years during which the Taxpayer owned the CGT asset (i.e. the goodwill).

For the purposes of subparagraph 152-110(1)(d)(i), Person 1, as the significant individual of the company just before the CGT event (i.e. when the Taxpayer entered into the contract for sale of its business), was over the age of XX at the time the CGT event happened and has retired. It is accepted that the sale of Taxpayer's business happened in connection with the retirement of Person 1.

The conditions for relief in Subdivision 152-B have been satisfied as the basic conditions in Subdivision 152-A are satisfied; the Taxpayer continuously owned the CGT asset (i.e. the business goodwill) for the 15-year period ending just before the CGT event; the Taxpayer had a significant individual (i.e. Person 1) for the 15-year period during which the Taxpayer owned the CGT asset; The significant individual, Person 1, just before the CGT event was over the age of 55 at the time of the CGT event; and the event happened in connection with the retirement of Person 1.

As such, the Commissioner accepts that in these circumstances the Taxpayer satisfies the requirements in section 152-110 to apply the 15-year exemption in relation to the sale of its business goodwill.

Under section 152-125, payments made by a company to its CGT concession stakeholders are exempt up to the limit stipulated in subsection 152-125(2). The first requirement under subparagraph 152-125(1)(a)(i) is satisfied as the capital gain of the Taxpayer is disregarded under section 152-110. The second requirement will be satisfied if the Taxpayer makes one or more payments relating to the exempt amount to an individual who was a CGT concession stakeholder of the company just before the CGT event and within the relevant time period listed within paragraph 152-125(1)(b).

[1] Subparagraph 328-110(1)(b)(i)

[2] Subparagraph 328-110(1)(b)(ii) and subsection 328-110(3)

[3] Subsection 328-110(4)

[4] Paragraph 152-40(1)(b)

[5] Sub-subparagraph 152-75(1)(b)(i)

[6] Sub-subparagraph 152-75(1)(b)(ii)