Private ruling: Small business concessions
Published: March 2014
Ruling period: 1 July 2012 to 30 June 2014
Date scheme commenced: 1 July 2012

Ruling: Q3: Will the distribution of the disregarded capital gain by the liquidator on the winding up of the taxpayer be a deemed dividend for the purposes of section 47 of the Income Tax Assessment Act 1936 (ITAA 1936)? Answer No

Relevant facts and circumstances: The taxpayer operated a business for over 15 years. Business premises were purchased over 15 years ago. There are XX ordinary shares in the taxpayer, each of which carries voting, dividend and capital rights. An individual holds some shares. 25% were acquired pre-CGT and a further 25% post CGT. The individual took out a loan to acquire to second 25% of the shares. The remaining 50% of the shares were held by another individual and became the sole asset of an estate on his death over two years ago. The deceased's Will provided that the beneficiaries shall stand possessed of the assets of the trust in equal shares as tenants in common. One of the beneficiaries is the current executor/trustee (legal personal representative) of the estate. The estate is in its final stages of being administered. It has never made a distribution of income or capital to its beneficiaries. All the beneficiaries are Australian resident taxpayers. The business and its assets have never been used for other business purposes by any other entity. The taxpayer continued trading after the death of one of its shareholders until near the time the business was sold. The market value of the business was the price for which it was sold to an arm's length party. It was sold as a going concern that included other depreciable assets. The taxpayer is not a small business entity as defined by section 328-110 of the ITAA 1997. Its turnover, as reported in recent income tax returns, was more than $2 million. The taxpayer has a significant individual. He has held a small business participation percentage in the taxpayer of more than 20% from a date before 20 September 1985 until just before the CGT event that was the sale of the business, a period greater than 15 years. The significant individual has an annual leave entitlement which is a liability of the taxpayer. He also has a cash deposit listed as an asset. The business was sold in connection with the significant individual's retirement who was over the age of 55 years at the time the business was sold. The taxpayer will enter a member's voluntary liquidation and the proceeds of the sale will be distributed by the liquidator to the shareholders, being the significant individual and the deceased's estate within eighteen months of the final distribution by the liquidator.

Relevant legislative provisions: Section 106-35 of the Income Tax Assessment Act 1997 | Division 152 of the Income Tax Assessment Act 1997 | Section 152-10 of the Income Tax Assessment Act 1997 | Section 152-15 of the Income Tax Assessment Act 1997 | Section 152-20 of the Income Tax Assessment Act 1997 | Section 152-35 of the Income Tax Assessment Act 1997 | Section 152-55 of the Income Tax Assessment Act 1997 | Section 152-70 of the Income Tax Assessment Act 1997 | Section 152-75 of the Income Tax Assessment Act 1997 | Section 152-110 of the Income Tax Assessment Act 1997 | Section 328-125 of the Income Tax Assessment Act 1997 | Section 328-130 of the Income Tax Assessment Act 1997 | Division 40 of the Income Tax Assessment Act 1997 | Division 328 of the Income Tax Assessment Act 1997 | Section 47 of the Income Tax Assessment Act 1936

Reasons for decision: Summary: To qualify for the small business CGT concessions in Division 152 of the ITAA 1997, a taxpayer must satisfy the basic conditions for relief in section 152-10 of the ITAA 1997. The conditions to access the small business CGT concessions are outlined in subsection 152-10(1) of the ITAA 1997. The taxpayer is not in a partnership so subsection152-10(1) can be summarised for the taxpayer's circumstances as: (a) a CGT event happens in relation to a CGT asset of yours in an income year; (b) the event would have resulted in a capital gain; (c) at least one of the following applies: (i) you are a small business entity (defined by subdivision 328-C of the ITAA 1997) for the income year; (ii) you satisfy the maximum net asset value test; (d) the CGT asset satisfies the active asset test. A CGT event occurred with the sale of the business by the taxpayer that resulted in a capital gain. The taxpayer was not a small business entity in recent income years. Therefore to access the small business CGT concessions, it must meet the maximum net value asset test and the business must prove to be an active asset. Maximum net asset value test is described at section 152-15 of the ITAA 1997. 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)). The taxpayer owned the one asset, the business which it sold. It has a liability of for the significant individual's entitlement to annual leave which provides a net asset value of less than $6 million. It is necessary to determine who are the connected entities and affiliates of the taxpayer to complete the test. Connected entities. An entity connected with you is determined by the level of control, either directly or indirectly, that is exercised by one entity over another as described by section 328-125 of the ITAA 1997. One entity can be said to control another when it has a control percentage of at least 40%. In the case of a company, control is determined by the voting power held by a shareholder. The significant individual has held 50% of the ordinary shares in the taxpayer when the business was sold. He is a connected entity to the taxpayer because of his direct control of 50% of the shares in the taxpayer. The remaining 50% of the shares are held by the deceased estate. The executor/trustee is also a beneficiary as is the significant individual. The Will of the deceased stipulated that the beneficiaries shall stand possessed of the assets of the trust in equal shares as tenants in common. The sole asset of the estate is the shares in the taxpayer. None of the beneficiaries, except for the significant individual, has more than 40% of the voting power in the taxpayer and can be regarded as a connected entity of the taxpayer as described by section 328-125 of the ITAA 1997. Affiliates An affiliate is defined in section 328-130 of the ITAA 1997 as any individual or company that, in relation to their business affairs, acts or could reasonably be expected to act: • according to your directions or wishes, or • in concert with you. This rule can apply where: • they are an affiliate of the asset owner and the asset owner's asset is used in a business carried on by a different affiliate • one entity owns an asset that is used in a business carried on by a spouse or child, or by an entity that spouse or child owns or has an interest in, or • they are an affiliate of the partner and the partner's asset is used in the partnership business. None of the beneficiaries has used the business as an asset in a business they operate separately to that run by the taxpayer. The role of the executor/trustee of the will is to give effect to the wishes of the deceased and distribute the assets as directed in equal shares amongst the beneficiaries. We accept that in this role the executor is not acting in accordance or in concert with the taxpayer's directions or wishes. We do not consider the beneficiaries who are not significant individuals to be affiliates of the taxpayer. The meaning of 'net value of the CGT assets' is provided by section 152-20 of the ITAA 1997. It includes any liabilities that are related to the assets as well as provisions for annual leave, long service leave, unearned income and tax liabilities. Subsection 152-20(2) lists those assets that are to be disregarded. Paragraph 152-20(2)(a) disregards shares, units or other interests in another entity that is connected with the first-mentioned entity but includes any liabilities related to such shares. As subsection 152-15(b) of the ITAA 1997 includes entities that are connected with the taxpayer, the significant individual's assets and liabilities will be included in the maximum net asset value test. The value of the shares held the significant individual has already been included in the net value of assets for the taxpayer. The taxpayer's maximum net asset value is less than $6,000,000 and the requirements of section 152-15 of the ITAA 1997 are satisfied. The taxpayer has met the condition of subparagraph 152-10(1)(c)(ii) of the ITAA 1997. Active Asset test is described at section 152-35 of the ITAA 1997. The taxpayer purchased the business premises over fifteen years ago and used it continuously in the business until it was sold as a going concern recently. The taxpayer has fulfilled the requirements of paragraph 152-35(1)(b) and subsection 152-35(2). The business was an active asset when the CGT event occurred. Accordingly the taxpayer has met the condition in paragraph 152-10(1)(d) of the ITAA 1997. The taxpayer satisfies the basic conditions in Subdivision 152-A of the ITAA 1997 and is entitled to access the small business capital gains tax (CGT) concessions in Division 152, subject to meeting additional conditions for eligibility to exercise a specific CGT concession. The 15 year exemption applies to CGT events where the company (a) meets the basic conditions in Subdivision 152-A (b) continuously owned the CGT asset for the 15-year period ending just before the CGT event (c) 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 the company owned the CGT asset, and (d) the significant individual just before the CGT event was either: (i) over 55 and the event happened in connection with the individual's retirement, or (ii) permanently incapacitated. However subsection 152-110(3) of the ITAA 1997 excludes any amounts from the capital gain that are income to the taxpayer as a result of balancing adjustment events occurring for a depreciating asset whose decline in value was worked out under Division 40 of the ITAA 1997 or a deduction which was calculated under Division 328 of the ITAA 1997. The taxpayer meets the basic conditions (see question 1) and has owned the business for more than 15 years continuously. Section 152-55 of the ITAA 1997 defines a significant individual as an individual who has a small business participation percentage in the company of at least 20%. Item 1 of subsection 152-70(1) of the ITAA 1997, states that an entity's small business participation percentage in a company is determined by its 'legal and equitable interest in the shares of the company'. One shareholder has held at least 25% of the ordinary shares in the taxpayer pre-CGT and was a significant individual of the taxpayer when the business was sold. The estate holds 50% of the shares in the taxpayer. However, the executor/trustee as the legal personal representative (LPR) holds the legal, but not the equitable, interest in the shares. Therefore the LPR did not hold a direct small business participation percentage in the taxpayer when the business was sold. In the LPR's capacity as a beneficiary of the Estate, an indirect small business percentage interest pursuant to section 152-75 of the ITAA 1997, of less than 20% in the taxpayer is held. This is less than the 20% required to be held at the time the asset was sold to be regarded as a significant individual. None of the other beneficiaries was a significant individual solely because of their indirect small business percentage interest at the time the asset was sold. The taxpayer's only significant individual, was over the age of 55 when the business was sold in connection with his retirement. The taxpayer is entitled to disregard the capital gain from the sale of the business (subject to any exclusions pursuant to subsection 152-110(3)) as it fulfils the conditions of the 15 year exemption for companies listed at section 152-110 of the ITAA 1997. The taxpayer will enter voluntary liquidation. The net capital proceeds it is holding from the sale of its only asset after all liabilities have been met and exclusions made pursuant to subsection 152-110(3) of the ITAA 1997, will be distributed within eighteen months by the liquidator to its shareholders, the significant individual and the Estate of the deceased. Section 106-35 of the ITAA 1997 provides that an act done by a liquidator for CGT purposes is the same as if the act was performed by the company. Therefore, the distribution of the disregarded capital gain by the liquidator will be the same as if the taxpayer had distributed the amount to the shareholders directly. Subsection 47(1) of the ITAA 1936 provides that distributions to shareholders of a company by a liquidator in the course of winding up the company, to the extent to which they represent income derived by the company (whether before or during liquidation) other than income which has been properly applied to replace a loss of paid-up share capital, shall be deemed to be dividends paid to the shareholders by the company out of profits derived by it. Paragraph 47(1A)(b) of ITAA 1936 includes a net capital gain in the company's income using the following method statement: Step 1. Work out each capital gain (except a capital gain that is disregarded) that the company made during that year of income. Do so without indexing any amount used to work out the cost base of a CGT asset. Step 2. Total the capital gain or gains worked out under Step 1. The result is the net capital gain for that year of income. Step 1 of the method statement specifically excludes a capital gain that is disregarded. The net capital proceeds from the sale of the business is a disregarded capital gain by virtue of section 152-110 of the ITAA 1997. Being a capital gain disregarded under Step 1 of the method statement in paragraph 47(1A)(b), the 15 year exempt component is not included in the net capital gain of the company under Step 2 of that method statement and included as income derived by the company. The subsequent distribution of the 15 year exempt component by the liquidator after any liabilities are paid will not be deemed a dividend for the purposes of section 47 of the ITAA 1936.

Will the taxpayer satisfy the basic conditions to be eligible for relief under the small business Capital Gains Tax (CGT) concessions pursuant to Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997)? | Question 2: Is the taxpayer entitled to disregard the capital gain from the sale of the business pursuant to section 152-110 of the ITAA 1997 (the 15 year exemption for companies)?