Edited version of private advice

Authorisation Number: 5010082361344

Date of advice: 19 May 2022

Ruling

Subject: CGT rollovers; active asset; small business concessions

Question 1

Will a partial scrip for scrip rollover under section 124-790 of the Income Tax Assessment Act 1997 (ITAA 1997) be available to the shareholders of the company when CGT event A1 happens on the sale of the company?

Answer

Yes.

Question 2

Is the small business 50% active asset reduction and retirement exemption in Division 152 of the ITAA 1997 available to reduce and disregard the portion of the capital gain made from the ineligible proceeds received from the sale of the shares?

Answer

Yes.

This ruling applies for the following periods:

1 July 20XX to 30 June 20XX2

The scheme commences on:

XX/XX/20XX

Relevant facts and circumstances

1.            Australian residents, X and Y are the founding shareholders who hold 49% and 51% of the shareholding respectively in the company.

2.            The cost base of the shares in the company is $X per share.

3.            The company was founded in 20XX to secure and add value to exploration leases then sell these leases at a higher price to third parties.

4.            The company generates revenue from the mining industry.

5.            As at 30 June XXXX, the company's assets are a bank account with a balance of $XX,XXX, exploration leases on tenements and intellectual property. The liabilities are made up of amounts owed to the tax office and director loans.

6.            Company F, an ASX listed entity, was interested in acquiring tenements owned by the company. This resulted in a Binding Term Sheet (BTS) being entered into between the company and Company F on xx month 20xx that included entering later into a Deed of Variation. The purpose of entering into the BTS was to allow Company F to undertake legal, financial and technical due diligence on the company and the tenements, and the ability to acquire an exclusive option to acquire all the shares in the company.

7.            Company F paid the company a non-refundable due diligence fee of $X,000 to be able to carry out the due diligence which was completed on XX/XX/20XX.

8.            On expiry of the due diligence period, a clause of the BTS gave Company F the ability to be granted an option to acquire all the shares in the company. To be granted an option required Company F to give written notice and pay a non-refundable option fee of $XX,000 to the company. This allowed Company F to have the exclusive right for a period to undertake reconnaissance exploration activities on the tenements.

9.            Another clause of the BTS entitled Company F to elect to exercise the Option during the Option Period to acquire all the shares in the company for a consideration payable of $X00,000 cash and X,000,000 fully paid shares.

10.          Company F issued the Exercise Notice to acquire the company.

11.          An ASX announcement by Company F made later advised the consideration had been renegotiated to fewer shares as well as the cash consideration of $X00,000.

12.          The Company was subsequently sold to Company F and the profits distributed according to the proportion of shareholders holdings in the company. The shares were worth less at that date.

13.          The exploration leases on the tenements and cash inherently connected with the business of the company were 80% or more of the market value of all of the assets of the company for the previous four years (half the period of the ownership of the shares) before CGT event A1 occurred.

14.          The company had no subsidiaries, nor was it owned by a third company which also owned Company F.

15.          X received shares in Company F and cash proceeds of $XXX,000 for his 49% shareholding.

16.          Both shareholders have chosen partial scrip for scrip rollover relief in relation to the disposal of their shareholdings in the company for Company F shares.

17.          Based on the following, the total net value of CGT assets owned by X did not exceed $6 million just before the shares were sold to Company F.

18.          As both shareholders have at least 40% shares in the company, the company is considered a connected entity for both shareholders.

19.          X has another connected entity and an affiliate.

20.          X has carried forward capital losses from prior years.

21.          X is under the age of 55 years and has not claimed any reduction previously relating to the CGT retirement exemption limit of $500,000. He will keep a written record of any amount that he chooses to disregard.

22.          X will make a personal contribution equal to the exempt amount, to a complying superannuation fund or retirement savings account just before he chooses the retirement exemption.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 100-20(1)

Income Tax Assessment Act 1997 Section 102-5

Income Tax Assessment Act 1997 Section 102-20 Note 1

Income Tax Assessment Act 1997 Section 108-5 Note 1

Income Tax Assessment Act 1997 Subsection 108-5(1)

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(4)

Income Tax Assessment Act 1997 Subsection 104-25(2)

Income Tax Assessment Act 1997 Subsection 115-10(1)

Income Tax Assessment Act 1997 Paragraph 115-10(a)

Income Tax Assessment Act 1997 Subsection 115-25(1)

Income Tax Assessment Act 1997 Paragraph 115-100(a)(i)

Income Tax Assessment Act 1997 Subsection 116-20(1)

Income Tax Assessment Act 1997 Subsection 116-65(2)

Income Tax Assessment Act 1997 Subdivision 124-M

Income Tax Assessment Act 1997 Subsection 124-10(2)

Income Tax Assessment Act 1997 Section 124-775

Income Tax Assessment Act 1997 Subparagraph 124-780(1)(a)(i)

Income Tax Assessment Act 1997 Paragraph 124-780(1)(b)

Income Tax Assessment Act 1997 Subparagraph 124-780(2)(a)(i)

Income Tax Assessment Act 1997 Paragraph 124-780(2)(b)

Income Tax Assessment Act 1997 Paragraph 124-780(2)(c)

Income Tax Assessment Act 1997 Paragraph 124-780(3)(a)

Income Tax Assessment Act 1997 Paragraph 124-780(3)(b)

Income Tax Assessment Act 1997 Subparagraph 124-780(3)(c)(i)

Income Tax Assessment Act 1997 Paragraph 124-780(3)(d)

Income Tax Assessment Act 1997 Section 124-782

Income Tax Assessment Act 1997 Subsection 124-783(1)

Income Tax Assessment Act 1997 Subsection 124-783(6)

Income Tax Assessment Act 1997 Subsection 124-785(2)

Income Tax Assessment Act 1997 Subsection 124-785(3)

Income Tax Assessment Act 1997 Section 124-790

Income Tax Assessment Act 1997 Subsection 124-790(1)

Income Tax Assessment Act 1997 Subsection 124-790(2)

Income Tax Assessment Act 1997 Subsection 124-790(3)

Income Tax Assessment Act 1997 Division 152

Income Tax Assessment Act 1997 Subdivision 152-A

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 Paragraph 152-10(1)(d)

Income Tax Assessment Act 1997 Subsection 152-10(2)

Income Tax Assessment Act 1997 Section 152-15

Income Tax Assessment Act 1997 Subsection 152-35(1)

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

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

Income Tax Assessment Act 1997 Subsection 152-40(3)

Income Tax Assessment Act 1997 Section 152-50

Income Tax Assessment Act 1997 Paragraph 152-60(a)

Income Tax Assessment Act 1997 Section 152-70

Income Tax Assessment Act 1997 Subdivision 152-C

Income Tax Assessment Act 1997 Subdivision 152-D

Income Tax Assessment Act 1997 Subdivision 152-E

Income Tax Assessment Act 1997 Section 152-205

Income Tax Assessment Act 1997 Subsection 152-305(1)

Income Tax Assessment Act 1997 Subsection 152-310(1)

Income Tax Assessment Act 1997 Subsection 152-315(3)

Income Tax Assessment Act 1997 Subsection 152-315(4)

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

Income Tax Assessment Act 1997 Paragraph 328-125(2)(b)

Reasons for decision

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

Issue 1

Question 1

Will a partial scrip for scrip rollover under section 124-790 be available to the shareholders of the company when CGT event A1 happens on the sale of the company?

Summary

Scrip for scrip rollover is available for the capital gain made relating to the replacement interests received, but not for the cash or ineligible proceeds received.

Reasons for Decision

1.            A capital gain or capital loss may arise if a CGT event happens to a CGT asset.[1] A CGT asset is any kind of property, or a legal or equitable right that is not property.[2] Shares are specifically listed as a CGT asset.[3]

2.            CGT event A1 happens if you dispose a CGT asset.[4] You dispose of an asset when a change of ownership occurs from you to another entity.[5] Therefore, CGT event A1 happened when you disposed of your shares to Company F.

3.            You make a capital gain if the capital proceeds from the disposal are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base.[6]

4.            Usually, the time of the event is when you enter into a contract for the disposal.[7] However, if the CGT asset is an option and is being exercised, the time of the event is when you enter into the contract that results in the asset ending.[8]

5.            Under a clause of the BTS, Company F was entitled to be granted an option to acquire the company shares upon giving written notice after completion of the due diligence period, together with payment of a non-refundable option fee of $X0,000, which happened on XX Month 20XX.

6.            As your shares in the company were disposed of as a consequence of Company F exercising the option, the time of the event happened on XX/XX/20XX.

7.            The capital proceeds from a CGT event are the total of the money you have received, or are entitled to receive, and the market value of any property you have received or are entitled to receive.[9] Therefore, the cash and Company F shares you received for the sale of your company shares will form part of the amount of capital proceeds you received from the CGT event happening. As you also received a share of the option fee paid by Company F of $X0,000, your share (49%) is to be included in the capital proceeds from the disposal of your shares.[10] The total capital proceeds received by you is therefore $X00,000

8.            As the capital proceeds received is more than the cost base of your shares in the company, you made a capital gain from the disposal of the shares to Company F.

9.            Subdivision 124-M allows you to choose scrip for scrip rollover where post-CGT shares you own are replaced with other shares, provided you made a capital gain from the exchange.[11] A shareholder is able to disregard a capital gain they make from the shares disposed of in exchange for the replacement shares.[12]

10.          The conditions for rollover have been met due to the following:

(a)          you exchanged the company shares for shares in another entity, being Company F[13]

(b)          the exchange is in consequence of a single arrangement[14]

(c)           the arrangement resulted in Company F becoming a 100% owner of the company shares[15]

(d)          all the shareholders in the company were able to participate on substantially the same terms in the arrangement[16]

(e)          you acquired your company shares on or after 20 September 1985[17]

(f)            you will make a capital gain from the sale of your company shares[18]

(g)          the replacement interest is in the company that became the 100% owner of the company[19]

(h)          as you are a significant stakeholder[20] you and Company F will jointly choose to obtain the rollover[21]

11.          Where partial scrip for scrip rollover is chosen, the first element of the cost base for each replacement Company F share is worked out by reasonably attributing to it the cost base of the company shares for which it was exchanged, less so much of the cost base as is attributable to an ineligible part.[22]

Partial rollover

12.          A capital gain made will be only partially disregarded if, in addition to shares, the capital proceeds include something (ineligible proceeds) other than replacement shares.[23]

13.          As the capital proceeds you received for disposing of your shares included cash, the amount received is considered to be ineligible proceeds. Therefore, the associated capital gain made from the ineligible proceeds cannot be disregarded.

14.          The cost base of the ineligible part is that part of the cost base of your original interest as is reasonably attributable to it.[24]

15.          The cost base of your new Company F shares received as part of the scheme consideration should be equal to the cost base of the original company shares, reduced by the amount of the cost base that is reasonably attributable to the cash proceeds.[25]

16.          Your assessable income will include your net capital gain. In working out your net capital gain, the steps in section 102-5 are to be worked through. Note 2 in section 102-20 states that a capital gain or loss made may be affected by a rollover under Division 124. As scrip for scrip rollover is available to disregard part of the capital gain made by disposing of your company shares, the starting point for working out your net capital is the capital gain made from the ineligible proceeds.

17.          Working through the various steps in section 102-5:

•                     Step 1 - reduce any capital gain made by any capital losses made in the same income year, being the 2021 income year.

You did not have any current year capital losses.

•                     Step 2 - apply any previous unapplied net capital loss from earlier income years to the capital gain remaining after Step 1.

You have previous year carried forward capital losses leaving a capital gain balance remaining of $XX.

•                     Step 3 - reduce by the discount percentage each amount of a discount capital gain remaining after Step 2 of $XX.

As an Australian resident individual[26] who has held the shares for more than 12 months, you are entitled to a discount percentage of 50%[27] on your discount capital gain,[28] leaving a capital gain balance remaining of $XX.

•                     Step 4 - apply any of the small business concessions in Subdivisions 152-C, 152-D and 152-E to the remaining capital gain after Step 3.

To be determined by Question 2 below.

Question 2

Is the small business 50% active asset reduction and retirement exemption in Division 152 available to reduce and disregard the portion of the capital gain made from the ineligible proceeds received from the sale of the shares?

Summary

You meet the basic conditions in Subdivision 152-A and qualify for the small business 50% reduction and the retirement exemption on your remaining capital gain.

Reasons for Decision

18.          A capital gain you make may be reduced or disregarded under Division 152 if certain conditions are satisfied. Subsection 152-10(1) contains the basic conditions you must satisfy to be eligible to claim small business relief. These conditions are:

(a)          a *CGT event happens in relation to a *CGT asset 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; and

(iv)          the conditions 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).

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

19.          As established in Question 1, a CGT event A1 happened and a capital gain was made when you disposed of your company shares to Company F. Therefore, the first two conditions in subsections 152-10(1)(a) and (b) are satisfied.

20.          In relation to the third condition in subsection 152-10(1)(c), you are seeking to apply the maximum net asset value test.

Maximum Net Asset Value Test

21.          Section 152-15 states:

You satisfy the maximum net asset value test if, just before the *CGT event, the sum of the following amounts does not exceed $6,000,000:

(a)          the *net value of the CGT assets of yours;

(b)          the net value of the CGT assets of any entities *connected with you;

(c)           the net value of the CGT assets of any *affiliates of yours or entities connected with your affiliates (not counting any assets already counted under paragraph (b)).

22.          An entity is connected with another entity if one of the entities controls the other entity, or if the two entities are controlled by the same third entity.[29]

23.          Paragraph 328-125(2)(b) contains a general direct control test if the other entity is a company. You are taken to control the other company if you have a control percentage of at least 40% of the voting power in the company.

24.          As you have at least 40% of the voting power in the company, you are taken to control the company, resulting in the company being a connected entity to you.

25.          You have advised you have another connected entity and an affiliate.

26.          You have advised that the total net value of CGT assets of yours, your connected entities and affiliate did not exceed $6 million just before the shares were sold to Company F. Therefore, you satisfy the third condition in paragraph 152-10(1)(c).

Active asset test

27.          The fourth and final condition in in paragraph 152-10(1)(d), requires the CGT asset to pass the active asset test.

28.          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.[30]

29.          A CGT asset is an active asset at a time if 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.[31]

30.          A share in a company that is an Australian resident can also be an active asset. This is provided that the total of:

(a)          the market values of the active assets of the company or trust, and

(b)          the market value of any financial instruments of the company or trust that are inherently connected with a business that the company or trust carries on, and

(c)           any cash of the company or trust that is inherently connected with such a business,

is 80% or more of the market value of all of the assets of the company.[32]

31.          The company assets are exploration leases on tenements, intellectual property and a bank account. As more than 80% of the assets of the company are active assets or cash that is inherently connected with the business of the company, your shares are considered active assets for the last four years.

32.          You and the other shareholder have held your shares in the company and carried on a business since its inception in 2013. As you have held the shares for less than 15 years, the requirement in subsection 152-35(1)(a) has to be satisfied. That is, the shares had to be an active asset for at least half of the period of ownership. Your shares were active assets for four years, at least half the period of your ownership thereby satisfying the active asset test.

Additional basic condition for shares in a company or interests in a trust

33.          For CGT events happening on or after 8 February 2018, subsection 152-10(2) states:

The following additional basic conditions must be satisfied if the *CGT asset is a *share in a company, or an interest in a trust, (the object entity):

a)            the CGT asset would still satisfy the active asset test (see section 152-35) if the assumptions in subsection (2A) were made;

b)            if you do not satisfy the maximum net asset value test (see section 152-15) - you are carrying on a *business just before the *CGT event;

c)            either:

(i)            the object entity would be a *CGT small business entity for the income year; or

(ii)           the object entity would satisfy the maximum net asset value test (see section

(iii)          152-15);

if the following assumptions were made:

(iv)          the only CGT assets or *annual turnovers considered were those of the object entity, each affiliate of the object entity, and each entity controlled by the object entity in a way described in section 328-125;

(iv) each reference in section 328-125 to 40% were a reference to 20%;

(v) no determination under subsection 328-125(6) were in force;

d) just before the CGT event, either:

(i) you are a *CGT concession stakeholder in the object entity; or

(ii) CGT concession stakeholders in the object entity together have a *small business participation percentage in you of at least 90%.

34.          The company operated its business until it was sold. The company has no subsidiaries. Applying the modified connected entity rule, you would still satisfy the maximum net asset value test as you have already included the net assets of the company in your calculation. Your shares satisfy the modified active asset test.

35.          The company has two significant individuals,[33] as each shareholder has a direct small business participation percentage[34] of 51% and 49% respectively, which is more than the 20% percentage required to be a significant individual. Therefore, each shareholder is a CGT concession stakeholder of the company.[35]

36.          You have satisfied the basic conditions, the modified active asset test and the additional basic conditions for shares in a company when you disposed of your shares in the company. Therefore, you are entitled to apply the CGT small business concessions to the capital gain made from the disposal of the shares.

37.          The two small business concessions you wish to use at step 4 in section 102-5 are the 50% small business reduction[36] and the retirement exemption[37] in that order.

38.          The only requirement that needs to be satisfied for you to claim the 50% small business reduction is if the basic conditions in Subdivision 152-A are satisfied.[38] As you have satisfied the basic conditions, you are entitled to further reduce your capital gain after applying the 50% discount percentage at Step 3 by a further 50%. Essentially, this reduces your capital gain by 75%.

39.          You are also seeking to reduce the remaining 25% capital gain under the retirement exemption in Subdivision 152-D. For individuals, you are entitled to disregard all or part of a capital gain if the basic conditions in Subdivision 152-A are satisfied. As you are under 55 years of age, you must make a choice to contribute an amount equal to the asset's CGT exempt amount to a complying superannuation fund or a retirement savings account (RSA), and the contribution is made at the later of when you made the choice and when you received the proceeds.[39] If you make this choice, that part of the capital gain equal to its CGT exempt amount is disregarded.[40] The capital gain amount chosen to be disregarded under the retirement exemption is its CGT exempt amount.[41]

40.          For individuals, there is a lifetime CGT retirement exemption limit of $500,000 that is reduced each time you choose to disregard all or part of each capital gain made to which Subdivision 152-D applies. The individual must keep a written record to show the CGT exempt amount claimed from the lifetime limit, which you advised you would do.[42]

41.          You have advised that you will make a personal contribution equal to the CGT exempt amount, to a complying superannuation fund or RSA just before you choose the retirement exemption. As you have not previously made any claim against the CGT retirement exemption limit of $500,000, you are entitled to reduce the remaining capital gain to nil.

[1] Subsection 100-20(1)

[2] Subsection 108-5(1)

[3] Note 1 in section 108-5

[4] Subsection 104-10(1)

[5] Subsection 104-10(2)

[6] Subsection 104-10(4)

[7] Subsection 104-10(3)

[8] Subsection 104-25(2)

[9] Subsection 116-20(1)

[10] Subsection 116-65(2)

[11] Section 124-775

[12] Subsection 124-10(2)

[13] Subparagraph 124-780(1)(a)(i)

[14] Paragraph 124-780(1)(b)

[15] Subparagraph 124-780(2)(a)(i)

[16] Paragraphs 124-780(2)(b) and (c)

[17] Paragraph 124-780(3)(a)

[18] Paragraph 124-780(3)(b)

[19] Subparagraph 124-780(3)(c)(i)

[20] Subsections 124-783(1) and (6)

[21] Paragraph 124-780(3)(d) and section 124-782

[22] Subsections 124-785(2) and (3)

[23] Subsection 124-790(1)

[24] Subsection 124-790(2)

[25] Subsection 124-785(3)

[26] Paragraph 115-10(a)

[27] Paragraph 115-100(a)(i)

[28] Subsection 115-25(1)

[29] Subsection 328-125(1)

[30] Subsection 152-35(1)

[31] Subsection 152-40(1)

[32] Subsection 152-40(3)

[33] Section 152-50

[34] Section 152-70

[35] Paragraph 152-60(a)

[36] Subdivision 152-C

[37] Subdivision 152-D

[38] Section 152-205

[39] Subsection 152-305(1)

[40] Subsection 152-310(1)

[41] Subsection 152-315(3)

[42] Subsection 152-315(4)