Private ruling: Capital gains tax
Published: December 2014
Ruling period: Year ended 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Q1: Can the small business 15 year exemption in Subdivision 152-B of the Income Tax Assessment Act 1997 (ITAA 1997) be applied to the capital gain from the sale of the asset? | A1: Yes.

Relevant facts and circumstances: The property was purchased more than 15 years ago. The owners of the property were A and B. The property consisted of a shop at the front which was approximately X square meters and an attached residence at the back of Y square meters. As soon as practical after initial repairs were completed, the shop was occupied by the company. The residence part of the property has always been rented to unrelated parties. The company was owned and operated by A and B who were equal directors, shareholders and employees. The company is a small business entity with a turnover of less than $2 million. The asset holding of A and B and related entities are less than $6 million. Due to the ill health of A the property was sold in the relevant financial year in contemplation of retirement of both A and B. A and B retired on 30 June 2014 and were over 60 years of age. The company operated their business until the death of A on dd/mm/yyyy.


Reasons for decision: Summary: Section 152-10 of the ITAA 1997 contains the basic conditions you must satisfy to be eligible for the small business CGT concessions. These conditions are: (a) a CGT event happens in relation to a CGT asset in an income year. (b) the event would have resulted in the gain (c) at least one of the following applies: (i) you are a small business entity for the income year (ii) you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997 (iii) you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership or (iv) the conditions in subsection 152-10(1A) or (1B) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year. (a) the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997. Section 104-10 of the ITAA 1997 provides that CGT event A1 occurs when your ownership in a CGT asset (eg. land or buildings) is transferred to another entity. Section 152-40 of the ITAA 1997 provides the meaning of 'active asset'. A CGT asset will be an active asset at a time if, at that time, you own the asset and the asset was used or held ready for use by you, an affiliate of yours, or by another entity that is 'connected with' you, in the course of carrying on a business. However, subsection 152-40(4) explains that an asset whose main use is to derive rent cannot be an active asset. Paragraph 152-40(4A)(b) of the ITAA 1997 provides that to determine the main use of an asset, treat any use by your affiliate, or an entity that is connected with you, as your use. Subsection 152-35(1) of the ITAA 1997 states that a CGT asset satisfies the active asset test 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 period of ownership, 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 and a half years. Connected with test Subsection 328-125(1) of the ITAA 1997 explains that an entity is connected with another entity if: a) either entity controls the other entity in a way described in this section; or b) both entities are controlled in a way described in this section by the same third entity. Subsection 328-125(2) of the ITAA 1997 provides that an entity (the first entity) controls another entity if the first entity, its affiliates, or the first entity together with its affiliates: if the other entity is a company - beneficially owns, or has the right to acquire beneficial ownership of, equity interests in the company that give at least 40% of the voting power in the company. A and B each held 50% of the shares in the company, therefore the company is connected with both A and B. Main use to derive rent Taxation Determination TD 2006/78 considers, amongst other issues, the situation where there is part business and part rental use of an asset. It states that an asset owned by the taxpayer and used partly for business purposes and partly to derive rent can be an active asset under section 152-40 of the ITAA 1997 where it is considered that the main use of the premises is not to derive rent. In deciding if the property was mainly used to earn rent the Commissioner will consider a range of factors such as: • the comparative areas of use of the premises (between rent and business) • the comparative levels of income derived from the different uses of the asset. In this case, the owners satisfied the maximum net asset value test. A and B owned a property that was used in the course of carrying on a business by a connected entity. As part of the property has been used to produce rental income, we must consider whether the main use of the asset is to derive rent. The majority of the income from the property is business income generated by an entity connected with you. In regards to the floor area, approximately 40% was utilised by your connected entity and the remaining 60% was used to produce rental income up until the end of the 2009-10 financial year. From this point forward, the entire property was rented to unrelated entities. As the vast majority of the income generated form the property is business income, we do not consider that the main use of the property is to derive rent. Given the asset has been used in the course of carrying on a business by a connected entity for more than 7 and a half years during the ownership period, it will satisfy the active asset test. Therefore, A and B satisfy the basic conditions for the small business CGT concessions. 15 year exemption You can disregard a capital gain from a CGT event happening to a CGT asset you have owned for at least 15 years if you: • satisfy the basic conditions for the small business CGT concessions and • continuously owned the CGT asset for the 15-year period ending just before the CGT event happened. If you are an individual: • when the CGT event happened • you were permanently incapacitated, or • you were 55 years old or older, and the event happened in connection with your retirement. Whether a CGT event happens in connection with an individual's retirement depends on the particular circumstances of each case. There would need to be at least a significant reduction in the number of hours the individual works or a significant change in the nature of their present activities to be regarded as a retirement. | Detailed Reasoning - Application to your circumstances: In this case, A and B satisfied the basic conditions and were both over 55 years of age at the time of the sale. Both A and B each owned a 50% interest in the property for more than 15 years. We accept that the CGT event happened in connection with the retirement of both A and B. Therefore, A and B are entitled to disregard the capital gain under the small business 15 year exemption.