Edited version of private advice

Authorisation Number: 5010087319400

Date of advice: 29 November 2022

Ruling

Subject: 15-year CGT retirement exemption

Question

Does the Taxpayer satisfy the requirement in paragraph 152-105(d)(i) of the Income Tax Assessment Act 1997 (ITAA 1997) that the sale of his shares in A Pty Ltd (the Company) is 'in connection with' his retirement?

Answer

Yes.

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

1.            X (the Taxpayer) operated a business through A Pty Ltd (the Company).

2.            The Company was incorporated on XX/XX/XXXX with 2 ordinary shares, with one ordinary share issued to the Taxpayer and the other to his business partner, Y.

3.            In XXXX, different classes of shares (other than ordinary shares) were issued to both the Taxpayer, Y and other parties. These shares were redeemed on XX/XX/XXXX. After this date, the only shares on issue were the 2 ordinary shares.

4.            In 20XX when Y retired, the Taxpayer's family trust acquired his ordinary share in the Company.

5.            The Taxpayer has held his one ordinary share in the Company from incorporation up to the date it was sold.

6.            On XX/XX/XXXX both the Taxpayer and Taxpayer's Family Trust sold their ordinary shares in the Company to K Pty Ltd (the Buyer).

7.            Prior to the sale of the ordinary shares in the Company to the Buyer, the Taxpayer worked in the business on a full-time basis, which often meant working very long days and varying hours according to the needs of the business.

8.            Through his direct and indirect shareholding in the Company, the Taxpayer as the key decision maker and business owner spent a substantial amount of time providing services and undertaking significant practice management and administration work (including human resources, pay, rosters, purchasing, advertising and various back-end tasks).

9.            From XX/XXXX, the business was experiencing understaffing issues, with the loss of one staff member. This resulted in the Taxpayer significantly increasing his working hours per week, including regularly providing services on weekends.

10.          In the year prior to selling his shares in the Company to the Buyer, the Taxpayer spent the following approximate weekly hours on the Company's business:

(a)          at least 25 - 30 hours per week in the business, plus:

(b)          after-hours work: quite variable, e.g., on average as 2 hours per week

(c)           emails relating to running business: daily 1 - 2 hours

(d)          business management: ordering, repairs, buying goods required in the business but not available through suppliers, liaising with suppliers - 3 hours per week

(e)          staff management: liaise with staff, organise and be the replacement cover for staff on leave, managing workforce during COVID-19 - 3 hours per week

(f)            banking: 1 hour per week

(g)          gardening at office - 1 hour per month

11.          The Taxpayer and his wife made the decision to sell his and the Z Family Trust's shares in the Company to prepare and plan for their retirement.

12.          It was a condition under the sale agreement of the Company shares, that the Taxpayer enter into an employment contract with the Buyer, working as a senior in the business. The Taxpayer has stated this was to assist with the successful transition of the business to its new owners, including to ensure the Company's longstanding staff and customers are appropriately looked after and not out of any specific desire to remain in the workforce. The Taxpayer also stated that by agreeing to this condition contributed to the higher sale price of the Company shares to the Buyer.

13.          The employment agreement states the Taxpayer will work for the Buyer on a part-time basis as a Director for a transitional period of 2 years, reporting to the Area Manager of the Buyer. The employment contract requires the Taxpayer to work on average 120 hours over 4 weeks (approximately 30 hours per week) providing mainly services.

14.          The Taxpayer's duties as Director do not include him being an actual company director of either A Pty Ltd (a position he resigned on the sale) or any other K Pty Ltd entity. The senior position at the business is called the ' Director'. The position requires the Taxpayer:

(a)           to undertake some minor administrative and management functions

(b)           be named as the Superintendent of the business

(c)           to be the main point of contact as a team leader between K Pty Ltd Area manager, Regional Manager and other departments.

15.          The employment agreement entered into between the Taxpayer and the Buyer, automatically ends at the end of its 2 year term. However, either party can terminate the agreement earlier by giving the required notice (as set out in the relevant Award) of one month. The agreement also allows the parties to extend the employment agreement by mutual agreement.

16.          Despite the employment agreement stating that it can be extended by mutual agreement between the parties, the Taxpayer has confirmed that he has no plans to return to the workforce after he has served out his 2 year term under the employment agreement. That is, the Taxpayer will fully retire after completing the 2 year term under the employment agreement.

17.          After the sale of the Company to the Buyer, the Taxpayer's scope of work is mainly limited to performing services as a part-time employee, with some minor administrative and management functions as part of his role as Director. The Taxpayer is not involved in any strategic decision making functions for which he had responsibility before the sale.

18.          The Taxpayer will transfer a portion of the sale proceeds from the sale of the Company shares to his self-managed superannuation fund (subject to the superannuation cap) with the intention of funding his retirement.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 152-105

Income Tax Assessment Act 1997 paragraph 152-105(d)(i)

Reasons for decision

1.            The 15-year CGT exemption for individuals is stated in section 152-105 as follows:

Section 152-105: 15-year exemption for individuals

If you are an individual, you can disregard any *capital gain arising from a CGT event if all of the following conditions are satisfied:

(a) the basic conditions in Subdivision 152-A are satisfied for the gain;

(b) you continuously owned the *CGT asset for the 15-year period ending just before the CGT event;

Note: Section 152-115 allows for continuation of the period if there is an involuntary disposal of the asset.

(c) if the CGT asset is a share in a company or an interest in a trust - the company or 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 you owned the CGT asset;

(d) either:

(i) you are 55 or over at the time of the CGT event and the event happens in connection with your retirement; or

(ii) you are permanently incapacitated at the time of the CGT event.

2.            The Taxpayer has asked whether the sale of his Company shares is 'in connection with' his retirement, in accordance with the condition in paragraph 152-105(d)(i). The scope of this ruling will be limited to whether this condition will be satisfied.

3.            The courts consider that the words 'in connection with' have a wide meaning but are to be interpreted in the context of the statute in which they are contained. Davies J stated in Hatfield v. Health Insurance Commission (1987) 15 FCR 487 at 491; 77 ALR 103 at 106-107 states:

Expressions such as 'relating to', 'in relation to', 'in connection with' and 'in respect of' are commonly found in legislation but invariably raise problems of statutory interpretation. They are terms which fluctuate in operation from statute to statute...

The terms may have a very wide operation but they do not usually carry the widest possible ambit for they are subject to the context in which they are used, to the words with which they are associated and to the object or purpose of the statutory provision in which they appear.

4.            The ITAA 1997 does not provide a definition of when a CGT event happens in connection with the retirement of an individual and as such the interpretation of that phrase takes on its ordinary meaning. The word 'retirement' is defined in the Macquarie Dictionary to mean:

noun

1.            the act of retiring.

2.            the state of being retired.

3.            removal or retiring from service, office or business. ...

5.            Whether a CGT event happens in connection with an individual's retirement for the purposes of the small business 15-year exemption depends on the particular circumstances of each case. The guide to the Capital gains tax concessions for small business makes it clear that it is not necessary for there to be a permanent and everlasting retirement from the workforce. However, there needs 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 'in connection with your retirement' for the purposes of paragraph 152-105(1)(d).

6.            A CGT event may be 'in connection with your retirement' even if it occurs some time before retirement.

7.            Prior to the sale of his Company shares, the Taxpayer's working hours was on a full time basis, providing not only services, but also doing significant management and administrative duties as well. He also had extra responsibility and duties when the business was short-staffed, so that his total working hours in an average week were not fixed and could alter significantly. After the sale of the Company shares, the Taxpayer's working hours only required him to work on average 120 hours over 4 weeks (approximately 30 hours per week).

8.            Whilst the sale of the Company did not result in a significant reduction in the hours worked, there has been a significant change in the nature of the Taxpayer's activities compared to the period prior to the sale. Prior to the sale, the Taxpayer effectively owned the Company, via his and his family trust's ownership interests in the Company. This meant the Taxpayer was performing not only services but also key management, ownership, administrative and other tasks.

9.            After the sale of the Company shares, the Taxpayer ceased to have any, direct or indirect, ownership in the business. While the Taxpayer's role as Director does involve some minor administrative and management functions, these activities represent only a fraction of what the Taxpayer did when he was previously responsible as the practice owner and principal. The main scope of the Taxpayer's work as Director is providing services as a part-time employee of the Buyer.

10.          The Taxpayer has stated he has no plans to return to the workforce after completing his 2 year term under the employment agreement. That is, the Taxpayer will fully retire and his expected working hours after this date will be nil.

11.          Based on the information provided, it is considered the Taxpayer's sale of his Company shares has led to a significant change in the nature of his activities that is to be regarded as 'in connection with' his retirement for the purpose of satisfying the condition in paragraph 152-105(1)(d).