Private ruling: Active asset test
Date of advice: 1 June 2016
Published: July 2016
Ruling period: Year ending 30 June 2016 | Year ending 30 June 2017 | Year ending 30 June 2018
Date scheme commenced: 1 July 2015

Ruling: Q1: Is Company B an affiliate of Company A under section 328-130 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes. | Q2: Does the asset owned by Company A which is used in the business operated by Company B qualify as an active asset of Company A on the basis that it is used in an affiliate's business in accordance with subsection 152-40(1) of the ITAA 1997? | A2: Yes. | Q3: Are the shares owned by Person X and Trust Z in Company A, active assets of the respective shareholders under subsection 152-40(3) of the ITAA 1997? | A3: Yes. | Q4: Do the shares owned by Person X and Trust Z satisfy the active asset test in subsection 152-35 of the ITAA 1997? | A4: Yes.

Relevant facts and circumstances: Person X has owned shares in Company A and Company B since they were incorporated. They are the sole director of both companies. They are also the sole director of Trust Z. Trust Z also owns shares in Company A and Company B. Trust Z and Person X have provided guarantees to banks which have provided finance to Company A. Company C is the trustee of Trust Z. Person X is the sole director of the company. Company A acquired an asset that was purpose-fitted to be used in Company B's business. Company B has used the asset in the course of carrying on its business. Company A charges Company B to use the asset; however the charge is less than the market rate. Company A was incorporated for the specific purpose of acquiring the asset and developing it for use in Company B's business while Company B was incorporated for the specific purpose of carrying on a business. You advise that the property is held by Company A for asset protection purposes. Company A has also made additional modifications to the asset at the request of Company B. Company A and Company B have regularly paid expenses on behalf of each other and have subsequently been reimbursed. The asset has represented at least 80% of the market value of all the assets owned by Company A since it first started to be used in the course of Company B's business.

Relevant legislative provisions: Income Tax Assessment Act 1997 - Section 152-35 | Income Tax Assessment Act 1997 - Section 152-40 | Income Tax Assessment Act 1997 - Subsection 328-120(1)

Reasons for decision: Detailed Reasoning - Active asset test: For the small business concessions in Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997) to apply to reduce or disregard a capital gain, the relevant CGT asset must satisfy the active asset test in section 152-35 of the ITAA 1997. The active asset test is satisfied if: • 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 detailed below, or • 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. 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). The meaning of an active asset is set out in section 152-40 of the ITAA 1997. It must first satisfy one of the 'positive tests' in subsection 152-40(1) of the ITAA 1997 and then also not be excluded by one of the exceptions in subsection 152-40(4) of the ITAA 1997. Under subsection 152-40(1) of the ITAA 1997, a CGT asset is an active asset (subject to the exclusions) if it is owned and used, or held ready for use, in the course of carrying on a business by you or your small business CGT affiliate or another entity that is connected with you under paragraph 152-40(1)(c) of the ITAA 1997. The combined effect of sections 152-35 and 152-40 of the ITAA 1997 is that the asset will meet the active asset test if the asset was used, or held ready for use, in the course of carrying on a business for at least half of the time period it was owned, subject to the exclusions in subsection 152-40(4) of the ITAA 1997. In situations where the assets being disposed of are shares in a company, the definition of an active asset is modified. Under subsection 152-40(3) of the ITAA 1997, the shares must be shares in a company that is an Australian resident to qualify as active assets. In addition, the total of the following must be 80% or more of the market value of all of the assets of the company: • the market values of the active assets of the company, and • the market value of any financial instruments of the company that are inherently connected with a business that the company carries on, and • any cash of the company or trust that is inherently connected with such a business. In this case, you wish to ascertain whether the shares in Company A owned by Trust Z and Person X satisfy the active asset test. To do so, it is necessary to identify the period of time that the shares are considered to have been active assets. Company A is an Australian company. You advise that the asset owned by the company has always accounted for more than 80% of the market value of the assets of the company since it started being used in the course of Company B's business. Accordingly, the shares in Company A will be considered active assets for the same period of time that the asset itself has been an active asset of Company A. Although Company A does not carry on a business, you advise that the property is used in the course of carrying on a business by Company B. Company B is not a connected entity of Company A. Accordingly, it is necessary to consider whether Company B is an affiliate of Company A. | Detailed Reasoning - Affiliates: According to subsection 328-120(1) of the ITAA 1997, an affiliate is an individual or company that in relation to their business affairs, acts or could reasonably be expected to act: • in accordance with your directions or wishes, or • in concert with you Broadly, acting 'in concert with you' in relation to their business affairs means there is a substantial degree of dependence on, or connection with you. Whether an entity acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes, or in concert with the taxpayer in question is a matter of fact dependent on the circumstances of a particular case. No one factor will necessarily be determinative. Relevant factors that may support a finding that a person acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes, or in concert with the taxpayer, include: • the existence of a close family relationship between the parties, • the nature and extent of the commercial dealings between the parties, • one entity's involvement in the managerial decisions and day-to-day management of the other, • financial interdependencies (for example, financial support or shared banking arrangements), • any common ownership of capital backing, • the likelihood that the way the parties act, or could reasonably be expected to act, in relation to each other would be based on the relationship between the parties rather than on formal agreements or legal or fiduciary obligations, and • the actions of the parties. However, a person is not your affiliate merely because of the nature of a business relationship you and the person share. For example, companies and trusts are not affiliates of their directors and trustees respectively and vice versa, merely because of the positions held. In this case, Company A and Company B have the same sole managing director in Person X, although this of itself is not determinative. Person X also holds substantial ownership interests in both companies. They hold direct interests in both companies in their own name. In addition, they also have indirect interests in both companies as a beneficiary of Trust Z. A level of dependency between the two companies is evident in the fact that Company A's primary asset is used in Company B's business. The fact that the asset has been fitted out to be used in Company B's business is also relevant. You also advise that it was always intended that the asset owned by Company A be used in Company B's business. Both companies were incorporated within a short time frame of each other. Company A was incorporated for the specific purpose of acquiring the asset and developing it while Company B was incorporated for the specific purpose of operating the asset for use in its business. The property is held by Company A for asset protection purposes. The actions and past behaviour of the entities also point to the fact that they are affiliates. Company B has made modifications to the asset in the past at the request of Company A. Company A and Company B have also regularly paid expenses on behalf of the other company and have subsequently been reimbursed. Furthermore, while Company A charges Company B rent to use the property, the rent charged by Company A is lower than the market rate. Accordingly, it is considered that Company B is an affiliate of Company A. Therefore, Company A can include Company B's use of the property in considering whether the property is an active test. Because the property has been used in the course of carrying on a business of Company B, it will be considered to have been an active asset over this period subject to it not being excluded from being considered an active asset under subsection 152-40(4) of the ITAA 1997. | Detailed Reasoning - Asset used to derive rent: Even though the asset is used in the course of carrying of a business of an affiliate of Company A, subsection 152-40(4) of the ITAA 1997 provides a list of exceptions and outlines which CGT assets cannot be active assets. Paragraph 152-40(4)(e) of the ITAA 1997 excludes, among other things, assets whose main use is to derive rent (unless such use was only temporary). Such assets are excluded even if they are used in the course of carrying on a business. However, for the purposes of the exclusion in paragraph 152-40(4)(e), attributing use of an asset by an affiliate or connected entity to a taxpayer means that any business use by an affiliate or connected entity is treated as business use by the taxpayer. This is the case even if the taxpayer rents the asset to an affiliate or connected entity for use in the affiliate or connected entity's business. In this case, Company A charges Company B rent to use the property. However, because the two companies are affiliates, the rent that Company A receives from Company B is not treated as rent for the purposes of determining Company A's main use of the asset. Accordingly, the asset can be considered to have been an active asset since it started being used in Company B's business. | Detailed Reasoning - Conclusion: Company A is an Australian company. You advise that the asset owned by Company A has always accounted for more than 80% of the value of all assets owned by the company since it was acquired. The property is considered to have been an active asset of the company since it first started being used by Company B to carry on a business shortly after it was incorporated. Accordingly, the shares in Company A have been active assets for the same period of time. Person X acquired their shares in Company A in 2XXX. Their shares satisfy the active asset test because the shares have been active assets for over half their period of ownership. The Company A shares owned by Trust Z also satisfy the active asset test as the shares have been active assets throughout the trust's entire period of ownership that began in 2XXX.