Private ruling: Capital gains tax concessions for small business
Published: July 2013
Ruling period: Year ending 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q1: Is property 1 considered an active asset of the company for the purposes of the capital gains tax (CGT) concessions for small business? | A1: No | Q2: Is property 2 considered an active asset of the company for the purposes of the CGT concessions for small business? | A2: No | Q3: Are you eligible to entirely disregard any capital gain made on the disposal of both properties under the CGT 15-year exemption concession for small business? | A3: No

Relevant facts and circumstances: You are a company. You issued a number of ordinary shares, 60% were held by X and 40% were held by XY. XY's 40% holding was transferred to X due to marriage breakdown. A Trust is a unit trust which was established in the early ninety's. You are the sole unit holder. A Trust started trading in the early ninety's. The trustee of A Trust is A Company. A Company was also established in the early ninety's. The company issued ordinary shares, Z% was held by X, and V% held by XY. XY's V% holding was transferred to X due to marriage breakdown. The entity started trading in the early ninety's. You bought property 1. The land area is X sqm and consists of: · a house. The house is rented to an unrelated third party, so is 100% for private use. · a storage shed and vacant land occupying the remaining sqm. This area is used by A Trust and A Company to house various plant and equipment for their business. No rental income is received from A Trust and A Company. You bought property 2. The land area is X sqm and consists of: · a house occupying X sqm. The top floor is rented privately to X. · the bottom floor of the house is used as a meeting room and office for A Trust since its inception. A Trust also uses vacant land and the garage to store equipment. No rental payment is received from A Trust for its use. You state that the rental income and expenses are included in the company's tax return each year. You state that no rental income has been received by A Trust or A Company for their use of the premises. The main reason is that both you and A Company are beneficiaries of A Trust and increasing the rental income to you will only reduce the distribution amounts from A Trust to you. You intend to dispose of the properties. You state that X; · has been the significant individual in your company for more than 15 years · will be retiring on disposal of the properties · is over 55 years of age Aggregated turnover for the relevant financial year for you, A Trust and A Company is under $2 million. You state that X is not your affiliate.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 152-10 | Income Tax Assessment Act 1997 Section 152-15 | Income Tax Assessment Act 1997 Section 152-40 | Income Tax Assessment Act 1997 Section 152-35 | Income Tax Assessment Act 1997 Section 328-125 | Income Tax Assessment Act 1997 Section 328-130 | Income Tax Assessment Act 1997 Section 152-110 | Income Tax Assessment Act 1997 Section 152-55 | Income Tax Assessment Act 1997 Section 152-65 | Income Tax Assessment Act 1997 Section 152-70

Reasons for decision: Detailed Reasoning - Small business CGT concession eligibility: Section 152-10 of the Income Tax Assessment Act 1997 (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. (d) the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997. In your case, you intend to dispose of two properties, triggering CGT event A1. The event will result in a capital gain and you are a small business entity for the income year. As you satisfy conditions a), b) and c), it now needs to be determined whether the properties in question satisfy the active asset test. | Detailed Reasoning - Active asset: 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. | Detailed Reasoning - Entity 'connected with' you: 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: beneficially owns, or has the right to acquire beneficial ownership of, interest in the other entity that give the right to receive at least 40% (the control percentage) of any distribution of income or capital by the other 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. In your case, you hold all the units in A Trust, therefore A Trust is an entity that is 'connected with' you. X holds all the shares in your issued shares and all the issued shares in A Company. Therefore, X controls both entities. Accordingly, as you and A Company are both controlled by the same third entity, A Company will be an entity that is 'connected with' you. | Detailed Reasoning - Affiliate: Subsection 328-130(1) of the ITAA 1997 explains that an individual or a company is an affiliate of yours if the individual or company acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the business of the individual or company. You have stated that X is not your affiliate. | Detailed Reasoning - Active asset test: 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. Importantly, subsection 152-40(4) of the ITAA 1997 provides 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. Notably, personal use of the asset by you or your affiliate is ignored in determining its main use. 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 times of use of the premises (between rent and business), and · the comparative levels of income derived from the different uses of the asset. | Detailed Reasoning - Property 1: Approximately X% of the total floor area of the property is used to derive rent from a private rental with the remaining X% used by an entity connected with you in carrying on a business. The income derived from the property is rental income from the unrelated party, there is no rental income from your connected entity. Therefore, as X% of the floor area is used to derive rent and 100% of the income derived from the property is rental income, we consider that the main use of the property is to derive rent. Accordingly as the main use of the property is to derive rent, it cannot be an active asset. | Detailed Reasoning - Property 2: Approximately X% of the total floor area of the property is used to derive rent from X with the remaining X% used by an entity connected with you in carrying on a business. The rental income derived from the property is rent from X, there is no rental income from your connected entity. X is not your affiliate, and as such, their personal use of the asset cannot be ignored. Therefore, as X% of the floor area is used to derive rent and 100% of the income derived from the property is rental income, we consider that the main use of the property is to derive rent. Accordingly, as the main use of the property is to derive rent, it cannot be an active asset. | Detailed Reasoning - 15-year exemption: Section 152-110 of the ITAA 1997 provides that a company can disregard any capital gain made on the disposal of an asset if all of the following conditions are satisfied: a) you satisfy the basic conditions b) you continuously owned the CGT asset for the 15-year period ending just before the CGT event c) you had a significant individual for a total of at least 15 years of the whole period of ownership (even if the 15 years was not continuous and it was not always the same significant individual), and d) the individual who was a significant individual just before the CGT event was: · at least 55 years old at that time and the event happened in connection with their retirement, or · permanently incapacitated at that time. Section 152-55 of the ITAA 1997 explains that an individual is a significant individual in a company if the individual has a small business participation percentage in the company of at least 20%. The 20% can be made up of direct and indirect percentages. A company satisfies the significant individual test if it had at least one significant individual just before the CGT event. The small business 15-year exemption further requires a company to have a significant individual for periods totalling at least 15 of the years of ownership of the CGT asset. Section 152-65 of the ITAA 1997 provides that an entity's small business participation percentage in another entity at a time is the percentage that is the sum of: a) the entity's direct small business participation percentage in the other entity at that time; and b) the entity's indirect small business participation percentage in the other entity at that time. Subsection 152-70(1) of the ITAA 1997 explains that an entity's direct small business participation percentage in a company is the percentage of: · voting power that the entity is entitled to exercise · any dividend payment that the entity is entitled to receive, or · any capital distribution that the entity is entitled to receive. In your case, you do not satisfy the basic conditions necessary to access the capital gains tax concessions for small business. Therefore, as you do not satisfy the basic conditions, you can not access the 15-year exemption concession.