Private ruling: capital gains tax concessions for small business
Published: August 2013
Ruling period: Year ending 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Q1: Is any profit made on the disposal of equipment, as part of the sale of the business, assessable as ordinary income? | A1:  | Q3: Are you eligible to reduce any remaining capital gain made (after applying the 50% active asset reduction concession) on the disposal of the goodwill of the business under the CGT retirement exemption concession, provided you make a payment of the disregarded amount to the superannuation fund of your CGT concession stakeholder/s by the required time? | A2:  | Q4: Are you eligible to entirely disregard any capital gain made on the disposal of the goodwill of the business under the CGT 15-year exemption concession for small business? | A3:  | Q5: Are you eligible disregard the capital gain made on disposal of the goodwill of the business under the CGT small business rollover concession? | A4:  | Q6: If you fail to meet the conditions of the CGT small business rollover concession by the end of the replacement asset period will you make a capital gain equal to the amount of the capital gain previously disregarded under the CGT small business rollover concession? | A5: 

Relevant facts and circumstances: The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are: o your application for private ruling o copy of sale contract You ran a franchise for approximately 14 years. The business was sold. The proceeds received were attributed to goodwill and equipment. Of the amount received, the franchisor deducted a commission. You state that the amount received was the highest price offered for the business. It was purchased by another franchisee. The sales contract included a restraint of trade clause. No amount of the proceeds was specifically allocated to the restraint. Mr X and Mrs X are the only shareholders of the company, each holding 1 ordinary share. Mr X and Mrs X are CGT concession stakeholders in the company. Mr X and Mrs X are both under 55 years of age. You state that the company is a small business entity. You state that the company satisfies the maximum net asset value test. You state that there are no other affiliates or entities 'connected with' the company.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 108-5 | Income Tax Assessment Act 1997 Section 104-10 | Income Tax Assessment Act 1997 Section 40-30 | 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 152-110 | Income Tax Assessment Act 1997 Section 152-305 | 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 152-410 | Income Tax Assessment Act 1997 Section 152-415 | Income Tax Assessment Act 1997 Section 104-197

Reasons for decision: Detailed Reasoning - Disposal of goodwill (non-depreciating asset): Subsection 108-5(1) of the Income Tax Assessment Act 1997 (ITAA 1997) provides that a capital gains tax (CGT) asset is: a) any kind of property; or b) a legal or equitable right that is not property. Subsection 108-5(2) of the ITAA 1997 defines a CGT asset to include 'goodwill'. Section 104-10 of the ITAA 1997 provides that CGT event A1 occurs when your ownership in a CGT asset (eg. goodwill of a business) is transferred to another entity. The time of the event is when you enter into a contract for the disposal, or, if there is no contract, the time of disposal is taken to be the time when the change in ownership occurs (not when settlement or payment occurs). Taxation Ruling TR 1999/16 discusses capital gains and the goodwill of a business. Paragraph 143 of the ruling explains that if a business owner disposes of their entire business; a part of their business (that could be considered a discrete business in its own right); or an interest in their business, goodwill may be transferred with that disposal. In your case, you have disposed of a CGT asset (goodwill), when you entered into a contract for disposal in late 2011. Accordingly, any capital gain made on disposal of the goodwill is taken to have occurred in the 2011-12 financial year. | Detailed Reasoning - Restrictive covenant: Taxation Ruling TR 1999/16, at paragraph 31, provides that a restrictive covenant includes an agreement between a vendor and a purchaser for the sale of a business, or in a separate agreement, by which the vendor agrees not to compete in business or to attract clients of the business. Further, at paragraphs 32 and 33 of TR 1999/16, it states that: If on a sale of a business a restrictive covenant is entered into, the restrictive covenant is a CGT asset created and vested in the purchaser separate in its own right from the goodwill acquired by the purchaser. A restrictive covenant given by a vendor of a business …is inextricably linked to the value of any goodwill disposed of. If a vendor and purchaser dealing at arm's length in a sale of a business (and its associated goodwill) do not allocate a specific part of the sale proceeds in the contract of sale to the covenant, for Part 3-1 purposes we will treat the giving of the covenant as being ancillary to the disposal of the goodwill of the business and no part of the proceeds will be attributed to the grant of the restrictive covenant. Therefore, as there is no indication that you were not dealing at arm's length in entering into the sale agreement and, no proceeds were specifically allocated to a restrictive covenant, we will treat the granting of the covenant as being ancillary to the goodwill of the business. Accordingly, we accept that no part of the capital proceeds received for the goodwill is attributable to the restrictive covenant. | Detailed Reasoning - Disposal of equipment (depreciating assets): Section 40-30 of the ITAA 1997 defines a depreciating asset as an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used, but does not include intangible assets such as goodwill. If you use a depreciating asset for a taxable purpose (for example, in a business) any gain you make on the disposal of it is treated as ordinary income and any loss as a deduction. It is only when a depreciating asset has been used for a non-taxable purpose (for example, used privately) that you can make a capital gain or capital loss on it. The disposal of a depreciating asset is a balancing adjustment event. You must compare the asset's termination value with its adjustable value at that time. If the two figures are different, the difference is the balancing adjustment amount. Generally, the termination value is the amount you receive for the asset on its disposal. It also includes the market value of any non-cash benefits such as goods or services you receive for the asset. The termination value is reduced to exclude GST payable if the disposal is a taxable supply. A depreciating asset's adjustable value at a particular time is generally its cost less its decline in value up to that time. The balancing adjustment amount is applied as follows: · if the termination value of a depreciating asset is more than its adjustable value, the difference is included in your assessable income · if the termination value is less than its adjustable value, the difference is an allowable deduction. The small business CGT concessions do not apply to a gain made from the disposal of a depreciating asset, because a capital gain only arises in respect of the use of the depreciating asset for non-taxable purposes (for example, to the extent it is used for private purposes). Accordingly, the equipment sold on disposal of the business are considered depreciating assets and therefore any gain (or loss) on the sale of the equipment is assessed as ordinary income (or is a deduction). | 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 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 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 152-40(1) of the ITAA 1997 provides that an asset is an active asset if the asset is an intangible asset you own and is inherently connected with a business that is carried on (whether alone or in partnership) by you, your affiliate, or an entity connected with you. Goodwill is an asset that is considered to be inherently connected with 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. In your case, you disposed of the goodwill and equipment of your business. As already established, it is only the gain made on disposal of the goodwill that will result in a capital gain, as any profit made on disposal of the equipment will be included in your ordinary income. You are a small business entity. The asset, goodwill, has been used in the course of carrying on a business by you for 14 years and is considered to be an active asset for this period of time. Accordingly, you satisfy the basic conditions necessary to be eligible for the CGT concessions for small business. Therefore, you are automatically entitled to the 50% active asset reduction on the capital gain made in relation to the disposal of goodwill. | Detailed Reasoning - Small business 15-year exemption: The small business 15-year exemption takes priority over the other small business concessions and the CGT discount. If the small business 15-year exemption applies, you entirely disregard the capital gain so there is no need to apply any further concessions. Further, you do not reduce the capital gain by any capital losses before you apply the 15-year exemption concession. Subsection 152-110 of the ITAA 1997 provides that an entity that is a company or trust can disregard any capital gain arising from a CGT event if all of the following conditions are satisfied: a) the basic conditions are satisfied for the gain; b) the entity continuously owned the CGT asset for the 15-year period ending just before the CGT event; c) the entity 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 entity owned the CGT asset; d) an individual who was a significant individual of the company or trust just before the CGT event either: i. was 55 or over at that time and the event happened in connection with the individual's retirement; or ii. was permanently incapacitated at that time. In your case, you satisfy the basic conditions, however, you have not continuously owned the asset (goodwill) for 15 years. Accordingly, you do not satisfy all the conditions necessary to be eligible for the CGT small business 15-year exemption concession. | Detailed Reasoning - Small business retirement exemption: You may choose to disregard all or part of a capital gain under the small business retirement exemption if you satisfy certain conditions. Subsection 152-305(2) of the ITAA 1997 provides that a company or a trust can choose to disregard all or part of a capital gain if: · you satisfy the basic conditions · you satisfy the significant individual test · you keep a written record of the amount you choose to disregard (the exempt amount) and, if there are more than one CGT concession stakeholders, each stakeholder's percentage of the exempt amount (one may be nil, but together they must add up to 100%) · you make a payment to at least one of your CGT concession stakeholders worked out by reference to each individual's percentage of the exempt amount · the payment is equal to the exempt amount or the amount of capital proceeds, whichever is less, and · where you receive the capital proceeds in instalments, you make a payment to a CGT concession stakeholder for each instalment in succession (up to the asset's CGT exempt amount). If a CGT concession stakeholder is under 55 years old just before receiving a payment, an amount equal to that payment must be immediately paid to a complying superannuation fund or RSA on their behalf. The company or trust must notify the trustee of the fund or the RSA at the time of the contribution that the contribution is being made in accordance with the requirements of the retirement exemption. There is no requirement to make this contribution if the stakeholder was 55 years old or older. You must make payments: · seven days after you choose to disregard the capital gain if you choose the retirement exemption for a J2, J5 or J6 event, or · in any other case, by the later of o seven days after you choose to disregard the capital gain, and o seven days after you receive the capital proceeds from the CGT event. Therefore, if you choose the retirement exemption after you have received the capital proceeds (for example, when you lodge your tax return) there is no requirement to make any payment until you have made the choice. Accordingly, you may use the capital proceeds for other purposes before choosing. However, once you choose, you must make the payment by the end of seven days after making the choice. Payments made to an employee by a company or trust of an amount exempted under the retirement exemption are deemed to be payments in respect of the termination of employment of the employee - there is no need for an actual termination of employment. Where such payments are made by a company or trust to a CGT concession stakeholder who is not an employee, the stakeholder is not required to cease any activity or office holding. The amount of the capital gain that you choose to disregard (that is, the CGT exempt amount) must not exceed your 'CGT retirement exemption limit' or, in the case of a company or trust, the CGT retirement exemption limit of each CGT concession stakeholder receiving a payment. An individual's lifetime CGT retirement exemption limit is $500,000, reduced by any previous CGT exempt amounts the individual has disregarded under the retirement exemption. This includes amounts disregarded under former (repealed) retirement exemption provisions. For a company or trust with eight CGT concession stakeholders (four significant individuals and their four spouses where the spouse has a business participation percentage greater than zero), the limit is effectively $4 million - that is, $500,000 for each stakeholder. CGT concession stakeholder and significant individual 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 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 company is the percentage of: · voting power that the entity is entitled to exercise (except for jointly owned shares) · any dividend payment that the entity is entitled to receive, or · any capital distribution that the entity is entitled to receive, or · if they are different, the smaller of the three definitions above. In your case, based on the information provided: · you satisfy the basic conditions, and · you satisfy the significant individual test Therefore, provided you keep a record of the amount you wish to disregard and make the contribution to a superannuation fund of your CGT concessions stakeholder/s by the time detailed above, you will satisfy the necessary conditions to be eligible for the small business retirement exemption. | Detailed Reasoning - Small business rollover concession: Section 152-410 of the ITAA 1997 provides that you can choose to obtain a roll-over under this Subdivision for a capital gain if the basic conditions in Subdivision 152A of the ITAA 1997 are satisfied for the gain. Section 152-415 of the ITAA 1997 explains that if you choose the roll-over, you can choose to disregard all or part of each capital gain to which this Subdivision applies. To qualify for the small business rollover, you need to satisfy the basic conditions that apply to all the CGT small business concessions. There are rollover conditions that must also be met. There are rollover conditions that must be satisfied by the end of the replacement asset period. This period starts one year before and ends two years after the last CGT event that occurs in the income year for which you choose the roll over. If the rollover conditions are not met within the replacement asset period, the gain will become assessable. You satisfy the rollover conditions where you meet all the following conditions: · you acquire one or more CGT assets as replacement assets or make a capital improvement to one or more existing assets, or both, within the replacement asset period · the replacement asset, or the asset to which the capital improvement was made, is an active asset at the end of the replacement asset period (a depreciating asset such as plant can be a replacement asset) · if the replacement asset is a share in a company or an interest in a trust, at the end of the replacement asset period: - you, or an entity connected with you, are a CGT concession stakeholder in the company or trust, or - CGT concession stakeholders in the company or trust have a small business participation percentage in the interposed entity of at least 90% · the capital gain that is being rolled over is not more than the sum of the following - the amount paid to acquire the replacement asset (that is, the first element of the cost base of the replacement asset) - any incidental costs incurred in acquiring that asset, which can include giving property (that is, the second element of the cost base of the replacement asset), and - the amount expended on capital improvements to one or more assets that were acquired or already owned (that is, fourth element expenditure). In your case, as you satisfy the basic conditions you will be eligible for the small business roll-over concession. To satisfy the conditions you must acquire a replacement asset within 2 years of the date of the contract. | Detailed Reasoning - Consequences of failing to meet the conditions of the small business roll-over concession by the end of the replacement asset period.: CGT event J5 - Failure to acquire a replacement asset and make a capital improvement after a rollover Section 104-197 of the ITAA 1997 provides that CGT event J5 happens if you choose to obtain a rollover, and by the end of the replacement asset period: · you have not acquired a replacement asset, and have not made a capital improvement to an existing asset · the replacement or capital improved asset is not your active asset (for example you have sold it, it has become your trading stock, or it is no longer used in the business), or · where the replacement asset is a share in a company or an interest in a trust o the share or trust interest fails the 80% test (unless the failure is only of a temporary nature) o you, or an entity connected with you, are not a CGT concession stakeholder in the company or trust, or o CGT concession stakeholders in the company or trust do not have a small business participation percentage in the interposed entity of at least 90%. Consequences of CGT event J5 When CGT event J5 happens, you make a capital gain equal to the amount of the capital gain previously disregarded under the small business rollover. The time of the event is at the end of the replacement asset period. The Commissioner may extend the replacement asset period. A capital gain from CGT event J5 may be eligible for the retirement exemption if you meet the relevant conditions. You don't need to meet the basic conditions again but you must meet the retirement exemption conditions. However, you cannot apply the 50% discount, small business 50% active asset reduction or the 15-year exemption to reduce this gain. Example: In September 2006, Luke makes a capital gain of $80,000 on an active asset and meets the maximum net asset value test. Luke disregards the whole capital gain under the small business rollover. In September 2008, Luke does not have any replacement or capital improved assets by the end of the two-year period. CGT event J5 happens and Luke makes a capital gain of $80,000 in September 2008. | Detailed Reasoning - Replacement asset: A replacement asset can include an asset that is otherwise exempt from CGT on disposal (eg. a car or business equipment), provided it is or becomes and active asset of the taxpayer. This is because the effect of any reinstatement of the gain under CGT event J5 is to reinstate the originally rolled over gain, and not any gain on the exempt replacement asset itself. Goodwill acquired on the acquisition of a new business would also satisfy the requirement of a acquiring a replacement asset, this is because goodwill is considered an active asset of a business.

Question 2: Do you satisfy the basic conditions necessary to be eligible for the capital gains tax (CGT) concessions for small business, which therefore automatically entitles you to apply the 50% active asset reduction concession to any capital gain made on disposal of the goodwill of the business?