Private ruling: Capital gains tax implications on disposal of water entitlements
Published: June 2012
Ruling period: Year ended 30 June 2010
Date scheme commenced: 1 July 2007

Ruling: Q1: Are you entitled to disregard any capital gain made on the sale of your interest in an asset by applying the small business 15 year exemption concession? | A1: No | Q2: Are you entitled to reduce the capital gain made on the sale of your interest in an asset by applying the small business 50% active asset reduction concession? | A2: Yes | Q3: Are you entitled to further reduce the capital gain made on the sale of your interest an asset by applying the capital gains tax (CGT) 50% discount for individuals? | A3: Yes

Relevant facts and circumstances: A property has been used in a family partnership for farming since the 1976-77 financial year. The members of the partnership included X members of a family. Each partner held a Y% share in the partnership. In the 1981-82 financial year, a family member left the partnership, the remaining partners then held a Z% share in the partnership. In the 1995-96 financial year, your spouse entered the partnership, the partners now hold a Y% share in the partnership. In the 2002-03 financial year, you and your spouse, as a new partnership, purchased the property (including entitlements and improvements) from the family farming partnership. You and you partner hold a 50% interest in the new partnership. The farming business continued to operate in the same manner as previously. You state that the asset has been used as an active asset in the partnership for the entire time that it has been held. In the 2007-08 financial year, the property was sold, providing a capital loss. The entitlement was also sold, making a capital gain. You and your spouse were under 55 in both the 2007-08 financial year and the 2008-09 financial year. Neither you, nor your spouse, were permanently incapacitated at the time of the CGT event. You state that the maximum net asset value test has been satisfied. You state that the active asset test has been satisfied.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 152-10 | Income Tax Assessment Act 1997 Section 152-15 | Income Tax Assessment Act 1997 Subsection 152-10(1A) | Income Tax Assessment Act 1997 Section 152-35 | Income Tax Assessment Act 1997 Section 152-40 | Income Tax Assessment Act 1997 Section 328-125 | Income Tax Assessment Act 1997 Section 104-10 | Income Tax Assessment Act 1997 Section 152-105 | Income Tax Assessment Act 1997 Section 115-25 | Income Tax Assessment Act 1997 Section 106-5 | Income Tax Assessment Act 1997 Section 102-5

Reasons for decision: Summary: You are not entitled to entirely disregard the capital gain made on the sale of the water entitlements as you do not satisfy the necessary conditions to apply the 15 year exemption small business concession. You are entitled to the 50% active asset reduction in relation to the capital gain made on the sale of the water entitlements as you satisfy the basic conditions required to access the small business concessions. You are entitled to a further 50% capital gains tax (CGT) discount in relation to the capital gain made on the sale of the water entitlements as you have held the CGT asset for over 12 months. | Detailed Reasoning - Small business CGT concession eligibility and the active asset test: 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 capital gains tax (CGT) concessions. These conditions are: · a CGT event happens in relation to a CGT asset in an income year. · the event would have resulted in the gain · at least one of the following applies: · you are a small business entity for the income year · you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997 · 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 · 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. · the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997. 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. Section 152-35 of the ITAA 1997 explains that an asset will be an active asset if you have owned the asset for more than 15 years and it was an active asset for a total of at least 7 ½ years from the time when you acquired the asset until the CGT event. Or, 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 time from when you acquired the asset until the CGT event. Section 328-125 of the ITAA 1997 provides the meaning of 'connected with' an entity. Under this provision, an entity will be connected with you if either entity controls the other entity or, both entities are controlled by the same third entity. In the case of a partnership, an entity controls another entity if it beneficially owns interest in the other entity that gives the right to receive at least 40% of any distribution of income or capital by the other entity. In your case, CGT event A1 (section 104-10 of the ITAA 1997) relating to the disposal of an asset (the entitlement), has occurred. The event has resulted in a capital gain and, you state that you satisfy the maximum net asset value test. The partnership was not controlled by either of the new partners until the 2002-03 financial year when each held a 50% interest in the partnership. Before this time each individual held less than a controlling interest in the partnership. As such, the partnership has been a connected entity of each individual only since the 2002-03 financial year. You state that the entitlement asset has been an active asset in the partnership since it has been held. Therefore, the entitlement has been an active asset for approximately X years as it has been used for this time in the course of carrying on a business by a connected entity, the partnership. Based on the information provided, you have satisfied the basic conditions required to be eligible for the small business CGT concessions. Accordingly, you are automatically entitled to the 50% active asset reduction for the capital gain made on the disposal of the entitlement. | Detailed Reasoning - 15 year exemption: Subsection 152-105 of the ITAA 1997 provides that an individual can disregard any capital gain if all of the following conditions are satisfied: · you satisfy the basic conditions · you continuously owned the CGT asset for the 15-year period ending just before the CGT event · you are either: · 55 or over at the time of the CGT event and the event happens in connection with your retirement; or · you are permanently incapacitated at the time of the CGT event. In your case, neither you, nor your spouse, were 55 or over at the time of the CGT event and neither individual was permanently incapacitated. Accordingly, neither individual may disregard the capital gain under the 15 year exemption concession. | Detailed Reasoning - 50% CGT discount: A 50% discount may be applied to a discount capital gain realised by an individual. In order to be considered a discount capital gain, the asset that gave rise to the capital gain must have been owned for a period of at least 12 months prior to the CGT event (section 115-25 of the ITAA 1997). In your case, the entitlement was acquired in the 2002-03 financial year and disposed of in the 2007-08 financial year. Therefore the CGT asset has been held for over 12 months at the time of the CGT event, therefore, the 50% discount can be applied to your capital gain. | Detailed Reasoning - Calculating your capital gain: Section 106-5 of the ITAA 1997 discusses capital gains in relation to partnerships. It provides that any capital gain from a CGT event happening to a partnership asset is made by the partners individually, with each partner's gain calculated by reference to the partnership agreement, or partnership law if there is no agreement. Each partner has a separate cost base for the partner's interest in the CGT asset of the partnership. Section 102-5 of the ITAA 1997 outlines a method statement for calculating a net capital gain. This amount is then included in the taxpayer's assessable income. A net capital gain is essentially the result of the following process: · the sum of the taxpayer's individual capital gains for the income year · less any capital losses made in the income year and previously unapplied net capital losses from earlier income years · adjusting for any concessions (such as the discount capital gain concession and the small business concessions). After applying any capital losses, individuals eligible for both the CGT discount and the small business 50% active asset reduction can reduce a capital gain by 75% (that is, by 50% then 50% of the remainder). Example: Ken is a small business operator who sells an active asset that he has owned for more than 12 months. He makes a capital gain of $20,000. Ken also has a separate capital loss of $4,000. Assuming he satisfies all the conditions for the CGT discount and the small business 50% active asset reduction, Ken calculates his net capital gain as follows: Capital gain Capital loss Take the loss away from the gain. $20,000 $4,000 $16,000 Apply 50% CGT discount. $8,000 $8,000 Apply 50% small business active asset reduction Reduced capital gain $4,000 $4,000

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