Private ruling: Capital gains tax concessions for small business
Published: June 2013
Ruling period: Year ending 30 June 20ZZ
Date scheme commenced: 1 July 20YY

Ruling: Q1: Do you satisfy the basic conditions, under Subdivision 152-A of the Income Tax Assessment Act 1997 (ITAA 1997), for the purposes of accessing the capital gains tax (CGT) concessions for small business in relation to the sale of your shares in Company B? | A1: Yes | Q2: Will the anti-avoidance provisions in Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the transaction to deny access to the CGT concessions for small business? | A2: No

Relevant facts and circumstances: The X Trust (the Trust) is a discretionary trust and is an Australian resident for income tax purposes. Company A was incorporated in Australia and is the trustee for the trust. A is the sole director and shareholder of Company A. Company A is a dormant trustee company. The company is connected with the Trust but derives no business income. The beneficiaries of the Trust include A and their family. The appointor of the Trust is A. The Trust purchased some ordinary shares in Company B in a particular year and some further shares in 20YY. Company B was incorporated in Australia and is an Australian resident for income tax purposes. The company is an Australian public company limited by shares. In 20ZZ, the Trust sold all its shares in Company B. All shares in B carry the same voting, dividends and capital distribution rights. A is an Australian resident for tax purposes. The Trust did not have any interest in any trusts during the 20ZZ income year. The Trust owned 100% of Company C. Company C solely owns passive investments and does not carry on a business. The company owned shares in some listed companies. A and their spouse owned shares in some listed companies. You state that you, Company C, A and their spouse hold less than a 40% interest in these companies. You state that A and their spouse have received all distributions from you in the prior specific financial years. A and their spouse did not earn any business income in their personal names as sole traders or as partners during the 20ZZ income year. During 20ZZ, the trust acquired a business as a going concern. The business was acquired from an unrelated third party. You state that the business was acquired as you were looking for an investment and the business appeared as a good opportunity. The business is still being carried on and A still works in the business. The business is operating in accordance with its business plan and revised cash flow and development schedules. The Trust's turnover from the date of acquiring the business was $xxx. The Trust is registered for GST. Your calculation of Company B's active assets for in a particular year, 20XX, 20YY finds that a percentage of its total assets are active assets. You state that all property, plant and equipment is used in the course of carrying on Company B's business. Intangible assets relate to acquired goodwill. You state that the 20ZZ accounts for Company B have not yet been prepared; however, a similar active asset percentage is expected for the year ended 30 June 20ZZ. In the financial year ended 30 June 20ZZ, a percentage of the income and capital distributions were made to A with the remaining percentage made to A's spouse.

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 152-35 | Income Tax Assessment Act 1997 Section 152-40 | Income Tax Assessment Act 1997 Section 152-60 | Income Tax Assessment Act 1997 Section 152-55 | Income Tax Assessment Act 1997 Section 152-65 | Income Tax Assessment Act 1997 Section 152-70 | Income Tax Assessment Act 1997 Section 152-75 | Income Tax Assessment Act 1997 Section 328-130 | Income Tax Assessment Act 1997 Section 328-125 | Income Tax Assessment Act 1997 Section 328-110 | Income Tax Assessment Act 1997 Section 328-120 | Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 995-1 | Income Tax Assessment Act 1936 Section 177A | Income Tax Assessment Act 1936 Section 177F | Income Tax Assessment Act 1936 Section 177C | Income Tax Assessment Act 1936 Section 177D

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 capital gains tax (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 (MNAV) 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. Subsection 152-10(2) of the ITAA 1997 provides that if the CGT asset is a share in a company or an interest in a trust (the object company or trust), one of these additional basic conditions must be satisfied just before the CGT event: (a) you are a CGT concession stakeholder in the object company or trust; or (b) CGT concession stakeholders in the object company or trust together have a small business participation percentage in you of at least 90%. You disposed of your shares in Company B, accordingly, CGT event A1 has occurred. The disposal has resulted in a capital gain and therefore you meet conditions (a) and (b) of the basic conditions. It now needs to be established whether you satisfy the small business entity test (condition (c)), the active asset test (condition (d)) and one of the additional conditions relating to shares in a company, as listed in subsection 152-10(2) of the ITAA 1997. | Detailed Reasoning - Active asset test: 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. 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. Subsection 152-40(3) of the ITAA 1997 provides that a share in a company that is an Australian resident can also be an active asset. This is provided that the total of: • 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 that is inherently connected with such a business; is 80% or more of the market value of all of the assets of the company. As the active asset test requires a CGT asset to have been an active asset for at least half of a particular period, as outlined earlier, in order for a share in an Australian resident company to meet this requirement, the company must satisfy the 80% test for that same period. The 80% test will be taken to have been met: • where breaches of the threshold are only temporary in nature (subsection 152-40(3B) of the ITAA 1997), and • in circumstances where it is reasonable to conclude that the 80% threshold has been passed (subsection 152-40(3A) of the ITAA 1997), such as when there have been no significant changes to the assets or liabilities of the company. Importantly, an interest in an entity that itself holds interests in another entity that operates a business may be an active asset, depending on the successive application of the 80% test at each level. In your case, you acquired ordinary shares in Company B. All the shares you held in Company B were sold. You have held the majority of the shares for approximately 3 years. It has been confirmed that the 80% test has been satisfied by Company B for the 20AA-BB, 20BB-XX and 20XX-YY financial years and you have stated that it is expected that the 80% test will also be satisfied for the 20YY-13 financial year. Therefore the shares are active asset of yours for a total of at least half of the period of ownership, and accordingly, the shares will satisfy the active asset test. | Detailed Reasoning - CGT concession stakeholder: Section 152-60 of the ITAA 1997 provides that an individual is a CGT concession stakeholder of a company or trust at a time if the individual is a significant individual in the company or trust, or the spouse of a significant individual where the spouse has a small business participation percentage in the company or trust at that time that is greater than zero. Section 152-55 of the ITAA 1997 explains that an individual is a significant individual in a company or trust if the individual has a small business participation percentage in the company or trust of at least 20%. The 20% can be made up of direct and indirect percentages. A company or trust satisfies the significant individual test if it had at least one significant individual just before the CGT event. 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 trust, where entities do not have entitlements to all the income and capital of the trust (such as occurs in a non-fixed trust), and the trust makes a distribution of income or capital, is the percentage of: • distributions of income that the entity is beneficially entitled to during the income year, or • distributions of capital that the entity is beneficially entitled to during the income year. Subsection 152-75(1) of the ITAA 1997 states that you work out the indirect small business participation percentage that an entity (the holding entity) holds at a particular time in another entity (the test entity) by multiplying: (a) the holding entity's direct small business participation percentage (if any) in another entity (the intermediate entity) at that time; by (b) the sum of: i. the intermediate entity's direct small business participation percentage (if any) in the test entity at that time; and ii. the intermediate entity's indirect small business participation percentage (if any) in the test entity at that time (as worked out under one or more other applications of this section). When testing an intermediate entity's indirect small business participation percentage in another entity, the intermediate entity becomes the holding entity. In your case, you (the trust) hold over 25% of the shares in Company B. A will receive 90% of the distribution of income and capital of the trust in the year in which the CGT event (the disposal of shares) happens. Therefore A will have a small business participation percentage in Company B of over 20% (90% x 25%). Accordingly, they will be a significant individual of the company and subsequently a CGT concession stakeholder in the company. As A is a CGT concession holder in Company B and they will receive 90% of the distributions from you, they will have a small business participation percentage in you of at least 90%, thereby satisfying the additional basic condition required to access the capital gains tax concessions for small business. | 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. Trusts, partnerships and superannuation funds cannot be your affiliates. However a trust, partnership or superannuation fund may have an affiliate who is an individual or company. However, subsection 328-130(2) of the ITAA 1997 explains that a person is not your affiliate merely because of the nature of a business relationship you and the person share. For instance, if you are a partner in a partnership, another partner is not your affiliate merely because you act, or could reasonably be expected to act in accordance with their directions or wishes, or in concert with the second partner, in relation to the affairs of the partnership. Whether 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 is a question of fact dependent on all the circumstances of the particular case. No one factor will necessarily be determinative. In your case, the listed companies that you, or entities that you are 'connected with', hold shares in are not considered to be your affiliates as it is unlikely that they would act according to your directions or wishes, or in concert with you, as you do not hold a controlling interest in them. This is also considered to be the case for Company B. Therefore, based on the information provided, there are no entities that are considered to be your affiliate. | Detailed Reasoning - An entity that is '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: a) beneficially owns, or have the right to acquire the beneficial ownership of, interests in the other entity that give the right to receive a least 40% (the control percentage) of any distribution of income or capital by the other entity: or b) 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. Subsection 328-125(3) of the ITAA 1997 explains that an entity (the first entity) controls a discretionary trust if a trustee of the trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the first entity, its affiliates, or the first entity together with its affiliates. Subsection 328-125(4) of the ITAA 1997 provides that an entity (the first entity) controls a discretionary trust for an income year if, for any of the 4 income years before that year: a) the trustee of the trust paid to, or applied for the benefit of: i. the first entity; or ii. any of the first entity's affiliates; or iii. the first entity and any of its affiliates; any of the income or capital of the trust; and b) the percentage (the control percentage) of the income or capital paid or applied is at least 40% of the total amount of income or capital paid or applied by the trustee for that year. Subsection 328-125(7) states that the section applies to an entity (the first entity) that directly controls another entity (the second entity) as if the first entity also controlled any other entity that is directly, or indirectly by any other application or applications of this section, controlled by the second entity. In your case, you are not connected with any of the listed companies that you, or entities that you are 'connected with', hold shares in, as you do not hold the required 40% interest in these entities. You hold over 20% but less than 40% of the shares in Company B, therefore you do not hold the required controlling percentage in the company and accordingly, Company B is also not an entity that is 'connected with' you. Therefore, based on the information provided, the only entities you are 'connected with' are; • A • A's spouse • Company A • Company C | Detailed Reasoning - Are you a small business entity?: Section 328-110 of the ITAA 1997 provides that you will be a small business entity if you are an individual, partnership, company or trust that: • is carrying on a business, and • has an aggregated turnover of less than $2 million. | Detailed Reasoning - What is aggregated turnover?: Aggregated turnover is your annual turnover plus the annual turnovers of any business entities that are your affiliates or that are connected with you. There are aggregation rules help you determine whether you need to include the annual turnover of another business entity (a relevant entity) when calculating your aggregated turnover. A relevant entity is an entity that is your affiliate or is 'connected with' you. | Detailed Reasoning - What is annual turnover?: Section 328-120(1) of the ITAA 1997 provides that an entity's annual turnover for an income year is the total ordinary income that the entity derives in the income year in the ordinary course of carrying on a business. Ordinary income is defined in subsection 6-5(1) of the ITAA 1997 as income according to ordinary concepts. The definition of "annual turnover" looks solely at the entity's business turnover. The turnover does not take into account any other types of ordinary income such as salary and wages, rental income or interest income (unrelated to the business). Nor does the definition include statutory income, such as capital gains and trust distributions. The expression "in the ordinary course of carrying on a business" is not defined in the Assessment Act and therefore takes its ordinary meaning. Generally, income is derived in the ordinary course of carrying on a business in the following circumstances: (a) the income is of a kind that is regularly or customarily derived by an entity in the course of carrying on its business, arising out of no special circumstance or unusual event; and (b) the income, although not regularly derived, is derived as a direct result of the normal activities of the business. An entity can derive ordinary income in the ordinary course of carrying on a business even if the income is not the entity's main type of ordinary income. | Detailed Reasoning - Are you in business?: Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not occupation as an employee'. The question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the facts. Taxation Ruling TR 97/11 provides the Commissioners view of the factors used to determine if you are in business for tax purposes. In the Commissioner's view, the factors that are considered important in determining the question of business activity are: • whether the activity has a significant commercial purpose or character, • whether the taxpayer has more than just an intention to engage in business, • whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity, • whether there is regularity and repetition of the activity, • whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business, • whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit, • the size, scale and permanency of the activity, and • whether the activity is better described as a hobby, a form of recreation, or sporting activity. TR 97/11 states that the indicators must be considered in combination and as a whole and whether a business is being carried on depends on the 'large or general impression gained' from looking at all of the indicators, and whether these factors provide the operations with a 'commercial flavour'. However, the weighting to be given to each indicator may vary from case to case. In your case, you have purchased a business as a going concern in 20ZZ. The business is operating in accordance with its business plan and revised cash flow and development schedules. The turnover of the business, in your hands, for 20ZZ totalled $XXX. Therefore, all the documentation suggests that you are operating a bona-fide business. In addition, there has been no business income derived by your connected entities, or affiliates, which will need to be aggregated with your annual turnover. Accordingly, you are considered to be carrying on a business, with the aggregated turnover from the business totalling $XXX, therefore you will be a small business entity in the year of the CGT event. | Detailed Reasoning - Application of Part IVA: Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance provision that can apply in certain circumstances. Part IVA gives the Commissioner the power to cancel a 'tax benefit' (or part of a 'tax benefit') that has been obtained, or would, but for section 177F of the ITAA 1936, be obtained, by a taxpayer in connection with a scheme to which Part IVA applies. In broad terms, Part IVA will apply where the following requirements are satisfied: • there is a scheme (see section 177A); • a taxpayer has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme (see section 177C); and • the dominant purpose of a person who entered into or carried out the scheme, or any part of the scheme, was to enable the relevant taxpayer to obtain a tax benefit in connection with the scheme, or to enable the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (paragraph 177D(b)). The application of Part IVA depends on a careful weighing of all the relevant facts and surrounding circumstances of each case. In your case, what you are proposing is a 'scheme' capable of attracting the operation of Part IVA. However, when considered in conjunction with the factors in paragraph 177D(b) of the ITAA 1936, all these factors either point against the application of Part IVA or are neutral. Therefore, Part IVA will not apply to this arrangement.