Edited version of private advice

Authorisation Number: 1052367633152

Date of advice: 27 February 2025

Ruling

Subject: CGT - assessable income

Question 1

Is Individual A a significant individual of A Pty Ltd under section 152-50 and section 152-55 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer 1

Yes.

Question 2

Is Individual B a significant individual of A Pty Ltd under section 152-50 and section 152-55 of the ITAA 1997?

Answer 2

No.

Question 3

Does A Pty Ltd satisfy subparagraph 152-110(1)(d)(i) of the ITAA 1997?

Answer 3

Yes.

This ruling applies for the following period:

30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

Individual A is XX years of age.

Individual B is A's spouse.

A is the sole director of A Pty Ltd (Company).

Prior to the incorporation of the Company, A was operating a business providing services as a sole trader (Business).

B also worked in the Business alongside A.

B managed the administration aspects of the Business, such as bookkeeping, payroll function and working with external accountants on lodgement obligations.

A managed the sale function of the Business, such as meeting with clients and sourcing business opportunities.

In 20XX they decided to expand the Business by acquiring another business and incorporated the Company.

At the time of incorporation, the Company had XX ordinary shares on issue and A was the sole director and sole shareholder.

B continued to work in the Business.

In 20XX the Company issued 1 ordinary share and 1 Y Class share to B, and 1 Z Class share to A.

The Company's Constitution allows for the issue of ordinary shares and various classes of shares including Y Class and Z Class.

The Constitution provides that Y Class and Z Class shares have voting rights, the rights to participate in dividends and paid issue price in the event of winding up. Z Class share also has the right to participate in surplus assets and profits of the Company on winding up and Y Class share does not.

Y Class and Z Class are not redeemable preference shares.

The Constitution is silent on the rights of ordinary shares.

The Constitution does not contain any provision giving the directors a discretion to make distributions of income or capital to one class of shareholders to the exclusion of another.

A and B was each paid a salary by the Company commensurate with the value of each's input into the Business.

They received equal dividend distributions every year for more than XX years.

In 20XX the Business was sold to a third party.

A was required to work for the new owner as a part-time employee for X days a week for X months. This was one of the conditions of the sale of the Business.

During these X months A worked about X hours a week.

Prior to the sale A worked about X hours a week.

The X-month period has ended and A has retired permanently.

The Company made a capital gain on the sale of the Business and wishes to access the SB CGT relief under Subdivision 152-B of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 152-50

Income Tax Assessment Act 1997 section 152-55

Income Tax Assessment Act 1997 section 152-60

Income Tax Assessment Act 1997 section 152-70

Income Tax Assessment Act 1997 section 152-110

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 unless otherwise stated.

Division 152 provides CGT relief to some small business (SB) taxpayers if the conditions for relief are satisfied. There are four SB CGT concessions available, one of which and relevant for the purpose of this ruling is the X-year exemption under Subdivision 152-B.

The X-year exemption requires a significant individual of a company or trust for any period or periods totalling X years during the period of ownership.

Under section 152-50 an entity satisfies the significant individual test if the entity had at least one significant individual just before the CGT event.

Under section 152-55 an individual is a significant individual in a company or a trust at a time if, at that time, the individual has a SB participation percentage in the company or trust of at least X%. The X% can be made up of direct and indirect SB participation percentage (section 152-65).

Where a company has more than one class of shares all classes (other than redeemable shares) must be taken into account in determining if the company has a significant individual (subsection 152-70(2)).

Taxation Determination TD 2006/77: Income tax: capital gains: are all classes of shares (other than redeemable shares) issued by a company taken into account in determining if the company has a significant individual under section 152-55 of the Income Tax Assessment Act 1997? (TD 2006/77) provides that all classes of shares must be taken into account in determining if a company has a significant individual. It follows that a shareholder that holds more than 20% of one class of shares in a company will not be a significant individual if their right to any distribution of income or capital from the company is dependent on a discretion to make distributions of income or capital to one class of shareholders to the exclusion of another.

Application to the facts of this case

CGT event A1 happened when the Company disposed of the Business to the new owner in 2024 and the Company made a capital gain. The time of the event is when the sale agreement was entered into.

Indirect SB participation percentage is not relevant in this case.

Table item 1 of subsection 152-70(1) states that an entity's direct SB participation percentage in a company is:

a. the percentage of the voting power in the company, or

b. the percentage of any dividend that the company may pay, or

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

or if they are different, the smaller or smallest.

Prior to the share issue in 20XX the Company had XX ordinary shares on issue and A was the sole shareholder.

As the sole shareholder of the Company, A had X% voting power, right to receive dividends and capital distributions from the Company.

In 20XX, B was issued with 1 ordinary share and 1 Y Class share. A was issued with 1 Z Class share.

The Constitution does not give Y Class and Z Class shares preferential rights over ordinary shares. The mere issue of these shares in 20XX would not have had the effect of cancelling all the rights attached to ordinary shares already on issue. In the absence of evidence to the contrary, the ordinary shares carry the same rights before and after 20XX.

The shareholders' right to any distribution of income or capital from the Company is not dependent on a director's discretion to make distributions of income or capital to one class of shareholders to the exclusion of another.

Therefore, the ordinary shares carry voting right, the right to participate in dividend and capital distributions and all shares on issue are taken into account in determining if the Company has a significant individual.

It has been contended that the Company had made dividend distributions equally between A and B for more than X years from the time of incorporation to the sale of the Business in accordance with a verbal agreement between themselves that they would be equal owners of the Business, both having founded and become involved in the Business from its commencement in complementary capacities. It is their understanding that the additional shares issued in 20XX would make them both shareholders with equal rights in all aspects, including having equal voting power, dividend distribution and capital distribution rights. Their conducts over the last X years demonstrated that they justifiably considered each other to be equal owners with equal rights. Each of A's and B's SB participation percentage should be X%.

However, the SB participation percentage for the purpose of section 152-50 is to be determined at the relevant time, which is just before the CGT event giving rise to the relevant capital gain. It is the percentage of any dividend that the Company may pay immediately before of the sale of the Business in 20XX.

The Constitution does not contemplate any limitation on the right to participate in dividends of ordinary shares and Y Class and Z Class shares.

The 'percentage' under subsection 152-70(1) is the percentage 'the entity has because of holding the legal and equitable interests in shares in the company'. For the purpose of working out the direct SB participation percentage, the Commissioner cannot rely on a verbal agreement between shareholders where that agreement has the effect of changing their respective ownership interests in a company.

All shares on issue are taken into account in determining if the Company has a significant individual. A's and B's SB participation percentages will be determined on this basis.

Conclusion

For the purpose of section 152-55 of the ITAA 1997, A is a significant individual because just before the CGT event A's percentage of the voting power in the Company, the percentage of any dividend the Company may pay and the percentage of any distribution of capital the Company may pay, are the same and are more than X%.

The Company also had a significant individual for a total of at least X years during which the Company owned the Business as A was a significant individual during the whole period.

B is not a significant individual as B's SB participation percentage is less than X%.

The CGT event also happened in connection with A's retirement. Although A worked in the Business after the sale this was one of the conditions for the sale to take place and A's working hours and duties were significantly reduced. A has since retired completely after the X month's employment contract ended.

The Company satisfies the condition in subparagraph 152-110(1)(d)(i) as A was a significant individual, was over X just before the CGT event and the event happened in connection with A's retirement.