Private ruling: Small business capital gains tax concessions
Published: September 2014
Ruling period: Year ended 30 June 2015
Date scheme commenced: 1 July 2014

Ruling: Q1: Are your shares in Company A active assets? | A1: No. | Q2: Are you able to choose the small business retirement exemption to disregard all or part of the capital gain you make on the sale of your shares in Company A? | A2: No.

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: • the application for private ruling, and • the documents provided in response to the requests for further information. Company A owns a commercial building that it leases to Unit Trust B and two other unrelated third party businesses. You own 20% of company A's issued capital. The units in the Unit Trust B are held by four discretionary trusts. You are a 50% shareholder in the corporate trustee of one of the discretionary trusts. You satisfy the maximum net asset value test. You are considering selling your shares in company A.

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 152 | Income Tax Assessment Act 1997 paragraph 152-10(1)(d) | Income Tax Assessment Act 1997 section 152-35 | Income Tax Assessment Act 1997 subsection 152-35(1) | Income Tax Assessment Act 1997 subsection 152-40(1) | Income Tax Assessment Act 1997 subsection 152-40(3) | Income Tax Assessment Act 1997 paragraph 152-40(4)(e) | Income Tax Assessment Act 1997 paragraph 152-40(4A)(b) | Income Tax Assessment Act 1997 section 328-130 | Income Tax Assessment Act 1997 subsection 328-125(1) | Income Tax Assessment Act 1997 subsection 328-125(2)

Reasons for decision: Summary: A capital gain you make may be reduced or disregarded under Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997) if certain conditions are satisfied. One of these conditions is that the capital gains tax (CGT) asset satisfies the active asset test contained in section 152-35 of the ITAA 1997 (paragraph 152-10(1)(d) of the ITAA 1997). Active asset test A CGT asset will satisfy the active asset test if: (a) you have owned the asset for 15 years or less and the asset was an active asset of your for a total of at least half of the test period, or (b) you have owned the asset for more than 15 years and the asset was an active asset of your for a total of at least 7½ years during the test period (subsection 152-35(1) of the ITAA 1997). A CGT asset is an active asset at a time if it is used, or held ready for use, in the course of carrying on a business that is carried on by you, or your affiliate, or another entity that is connected with you (subsection 152-40(1) of the ITAA 1997). A share in a company that is an Australian resident can also be an active asset. This is provided that the total of: (i) the market values of the active assets of the company or trust, and (ii) the market value of any financial instruments of the company or trust that are inherently connected with a business that the company or trust carries on, and (iii) any cash of the company or trust that is inherently connected with such a business, is 80% or more of the market value of all of the assets of the company (subsection 152-40(3) of the ITAA 1997). An asset whose main use in the course of carrying on the business is to derive rent cannot be an active asset unless the main use for deriving rent was only temporary (paragraph 152-40(4)(e) of the ITAA 1997). However, in determining the main use of an asset for the purposes of paragraph 152-40(4)(e) of the ITAA 1997 you treat any use by your affiliate, or an entity that is connected with you, as your use (paragraph 152-40(4A)(b) of the ITAA 1997). Meaning of affiliate 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. However, an individual or a company is not your affiliate merely because of the nature of the business relationship you and the individual or company share (section 328-130 of the ITAA 1997). By definition only individuals and companies can be your affiliate; trusts, partnerships and superannuation funds cannot be your affiliate. However, a trust, partnership or superannuation fund may have an affiliate who is an individual or company. Whether an individual or company acts, or could be reasonably expected to act, in accordance with your directions or wishes, or in concert with you is a question of fact dependent on all the circumstances of your particular case. No single factor will necessarily be determinative. Relevant factors that may support a finding that an individual or company acts in such a manner include: • the existence of a close family relationship between the parties, • the lack of any formal agreement or formal relationship between the parties dictating how the parties are to act in relation to each other, • the likelihood that the way the parties act, or could reasonably be expected to act, in relation to each other would be based on the relationship between the parties rather than on formal agreements or legal or fiduciary obligations, and • the actions of the parties. Meaning of connected with an entity An entity is connected with another entity if either entity controls the other entity, or both entities are controlled by the same third entity (subsection 328-125(1) of the ITAA 1997). An entity controls a partnership, company or trust (except a discretionary trust) if it or its affiliate (or all of them together): • beneficially owns or has the right to acquire beneficial ownership of, interests in the other entity that give the right to receive at least 40% of any distribution of income or capital by the other entity, or • 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(2) of the ITAA 1997). An entity controls a discretionary trust if the trustee either acts, or might reasonably be expected to act, in accordance with the directions or wishes of the entity or the entity's affiliates. Some factors which might be considered include: • the way in which the trustee has acted in the past, • the relationship between the trustee and the entity or its affiliates, and the relationship the trustee has with both the entity and its affiliates, • the amount of any property or services transferred to the trust by the entity or its affiliates, or both the entity and its affiliates, and • any arrangement or understanding between the entity and any person who has benefited under the trust in the past. This entity may control a discretionary trust in addition to any beneficiary with control. | Detailed Reasoning - Application to your circumstances: In your case, the CGT asset you intend on selling is shares in company A. Therefore, 80% of the assets of company A must be active for your shares to pass the active asset test. The only asset of company A is the commercial premises. For this CGT asset to be considered an active asset it must be owned and used, or held ready for use, in the course of carrying on a business by company A, its affiliates, or an entity connected with it. Company A is not carrying on a business using the premises, but instead leases them to the Unit Trust B and two other unrelated third parties. Regardless of whether it is accepted that you are an affiliate of company A, the main use of the commercial premises is to derive rent. As company A does not carry on a business the only way that the main use to derive rent exclusion in paragraph 152-40(4)(e) of the ITAA 1997 would not apply is if Unit Trust B is an affiliate of, or connected with, company A. By definition, Unit Trust B cannot be an affiliate of company A, as it is not an individual or company. As Unit Trust B and company A do not hold any interests in each other they need to be controlled by the same third entity for them to be connected. However, based on the information provided, no third entity (either alone or with its affiliates) beneficially owns or has the right to acquire beneficial ownership of, interests in Unit Trust B that give the right to receive at least 40% of any distribution of income or capital by Unit Trust B. As such, there is no third entity that controls Unit Trust B. Therefore, Unit Trust B and company A cannot be connected. The commercial premises do not satisfy the active asset test as they are not used, or held ready for use, in the course of carrying on a business by company A, its affiliates, or an entity connected with it. The main use to derive rent exclusion in paragraph 152-40(4)(e) of the ITAA 1997 applies, and therefore, at least 80% of the assets held by company A are not active. As such, your shares in company A cannot be considered active assets. As your shares in company A are not active assets you do not satisfy the basic conditions for the small business capital gains tax concessions. Therefore, you cannot choose the small business retirement exemption to disregard all or part of the capital gain you make on the sale of your shares.