Private ruling: CGT small business concessions.
Date of advice: 17 August 2018
Published: October 2018
Ruling period: Income Year ended 30 June 2019
Date scheme commenced: 1 July 2018

Ruling: Q1: Will the disposal of the Land by the Taxpayer satisfy the basic conditions for relief pursuant to section 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes. | Q2: If the answer to Question 1 is yes, will the disposal of the Land by the Taxpayer satisfy the 15 year exemption for individuals pursuant to section 152-105 of the ITAA 1997? | A2: Yes.

Relevant facts and circumstances: The Taxpayer (and their Spouse) acquired various parcels of land (Land) more than 15 years ago. A Partnership currently operates a business on the Land, and has carried on that business for more than seven and a half years. The Taxpayer is a partner of the Partnership, along with their Spouse and two other family members. Each partner holds a 25% stake in the Partnership. The cost base of the Land is considered to be nominal in nature compared to the current market value due to the passing of time since the Land was acquired. The Land is solely used for business purposes, and has been since it was acquired. A small percentage of the Land is currently mined by a third party that pays a royalty on a price per cubed metre basis. The revenue received from the third party is a small percentage compared to the total revenue received from the business run by the Partnership on the Land. Except for the parcel of land that is mined, the Land has never been used by the Taxpayer to derive rental income or otherwise any other passive income during its ownership. As part of succession planning for the business and as part of their transition to retirement, the Taxpayer intends to transfer the Land to a Trust. The Taxpayer and the Trust will enter into an arrangement where the Trust will provide the consideration for the land to the Taxpayer in instalments over a number of years on commercial terms equal to the market value of the land. The Taxpayer, their Spouse and family, the Partnership and the Trust are Australian residents for tax purposes. The Taxpayer is over 55 years of age. The net value of the CGT assets as defined by section 152-20 of the ITAA 1997 of the Taxpayer, their Spouse, the Partnership and the Trust is less than $6,000,000. The Taxpayer currently has an active involvement in the business carried on by the Partnership, and has recently reduced their working hours. After the proposed transfer of the Land takes place, the Taxpayer intends to further reduce the amount of hours they are involved in the business.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 104-10 | Income Tax Assessment Act 1997 Section 108-5 | Income Tax Assessment Act 1997 Subsection 108-5(1) | Income Tax Assessment Act 1997 Section 110-25 | Income Tax Assessment Act 1997 Section 116-20 | Income Tax Assessment Act 1997 Section 116-30 | Income Tax Assessment Act 1997 Subdivision 152-A | Income Tax Assessment Act 1997 Section 152-10 | Income Tax Assessment Act 1997 Section 152-15 | Income Tax Assessment Act 1997 Section 152-20 | Income Tax Assessment Act 1997 Section 152-35 | Income Tax Assessment Act 1997 Section 152-40 | Income Tax Assessment Act 1997 Section 152-105 | Income Tax Assessment Act 1997 Subdivision 152-B | Income Tax Assessment Act 1997 Section 328-125 | Income Tax Assessment Act 1997 Section 328-130 Question 1 | Summary | The disposal of the Land by the Taxpayer will satisfy the basic conditions for relief pursuant to section 152-10 of the ITAA 1997. | Detailed reasoning | The basic conditions for relief under the small business CGT concessions are outlined in section 152-10 of the ITAA 1997. These conditions are: | (a) a *CGT event happens in relation to a *CGT asset of yours in an income year; | [This condition does not apply in the case of CGT event D1.] | (b) the event would (apart from this Division) have resulted in the gain; | (c) at least one of the following applies: | (i) you are a *CGT small business entity for the income year; | (ii) you satisfy the maximum net asset value test (see section 152-15); | (iii) you are a partner in a partnership that is a CGT small business entity for the income year and the CGT asset is an interest in an asset of the partnership; | (iv) the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year; | (d) the CGT asset satisfies the active asset test (see section 152-35). | Basic condition (a) - A CGT event happens in relation to a CGT asset of yours in an income year | A CGT asset is defined in subsection 108-5(1) of the ITAA 1997 as any kind of property or a legal or equitable right that is not property. Note 1 to subsection 108-5(1) of the ITAA 1997 lists land and buildings as an example of a CGT asset. | The Land is clearly property, and therefore it is a CGT asset as defined by section 108-5 of the ITAA 1997. It is recognised that each parcel of land will be a separate CGT asset. | Subsection 104-10(1) of the ITAA 1997 provides that CGT event A1 happens if you dispose of a CGT asset. You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. | As the Land will be disposed of via the proposed transfer from the Taxpayer to the Trust, then this will be a disposal of a CGT asset pursuant to subsection 104-10(1) of the ITAA 1997 and CGT event A1 will occur. | Consequently, the requirements of paragraph 152-10(1)(a) of the ITAA 1997 will be satisfied. | Basic condition (b) - The event would have resulted in the gain | Subsection 104-10(4) of the ITAA 1997 provides that you make a capital gain from CGT event A1 if the capital proceeds from the disposal are more than the asset's cost base. | As defined in section 116-20 of the ITAA 1997, capital proceeds from a CGT event are the total of the money and the market value of any property received or entitled to be received in respect of the event happening. It is further noted that section 103-10 of the ITAA 1997 relevantly provides that if you will not receive money or other property in relation to a CGT event until a time after the CGT event, including where money is payable by instalments, then, for the purposes of the CGT provisions, you are treated as if you are entitled to receive that money or property. | It is proposed that the Taxpayer will receive the capital proceeds from the transfer of the Land in instalments from the Trust over a number of years on commercial terms equal to the market value of the Land. The total amount that they are entitled to receive over those years will be the capital proceeds pursuant to section 116-20 of the ITAA 1997. | It has been provided that the cost base of the Land under section 110-25 of the ITAA 1997 is considered to be nominal. As the capital proceeds from the transfer of the Land will be more than the cost base of the Land, the Taxpayer will make a capital gain upon the disposal of the Land to the Trust. | Consequently, the requirements of paragraph 152-10(1)(b) of the ITAA 1997 will be satisfied. | Basic condition (c) - at least one of the following applies: | Subparagraph 152-10(1)(c)(ii)- you satisfy the maximum net asset value test | In the current circumstances, the maximum net asset value test in subparagraph 152-10(1)(c)(ii) of the ITAA 1997 is the most relevant test of those contained in paragraph 152-10(1)(c) of the ITAA 1997. | Section 152-15 of the ITAA 1997 outlines the requirements to satisfy the maximum net asset value test. It provides that 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)). | In the current circumstances, to determine whether the maximum net asset value test is met, it is initially necessary to determine which entities may be connected with the Taxpayer. This in turn requires it to be determined whether the Taxpayer has any affiliates, and if there are any entities connected with those affiliates. | Affiliates | Subsection 328-130(1) of the ITAA 1997 provides 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. | Whether a person acts, or could reasonably be 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 the particular case. Relevant factors 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 | ● the actions of the parties. | The Taxpayer and their Spouse are both partners in the Partnership and have owned the land jointly for many years. There is an existence of a close family relationship between the Taxpayer and their Spouse. There is nothing that the Taxpayer and their Spouse have done in the past to suggest that their actions are inconsistent with their personal relationship. They have always decided matters together. | Accordingly, based on the information provided, it is expected that the Taxpayer and their Spouse would act in accordance with the directions of each other, or act in concert in relation to their business affairs and consequently the Taxpayer and their Spouse are affiliates of each other pursuant to section to 328-130 of the ITAA 1997. | It is further noted that, if the Taxpayer and their Spouse were not affiliates of each other pursuant to section 328-130 of the ITAA 1997 (and connected with the Partnership), it is likely that section 152-47 of the ITAA 1997 may apply, which deems a spouse to be affiliate of an individual for the purposes of Subdivision 152-A of the ITAA 1997 in determining whether the Partnership is connected with the Taxpayer and their Spouse. | Consideration must also be had as to whether the Taxpayer has any other affiliates. An affiliate can only be a company or an individual, so as the Taxpayer is not associated with any companies, regard must be had as to whether they have any further affiliates which are individuals, namely their other family members that are also partners in the Partnership. | Although they are partners in the same partnership as the Taxpayer, pursuant to subsection 328-130(2) of the ITAA 1997, this is not enough on its own to conclude that they are affiliates. It must be determined if they would act in accordance with the directions or wishes of the Taxpayer. | It would not be expected that the other family members would act in accordance with the directions or wishes with the Taxpayer. They are adults and have their own family and lives and it is not reasonable to merely assume they will act in accordance with the Taxpayer. Moreover there is no fact or circumstance that can be identified which positively suggests they would act in concert. | Therefore, based on the information provided, the other family members are not affiliates of the Taxpayer under section 328-130 of the ITAA 1997. The only affiliates that the Taxpayer and their Spouse have are each other. | Connected entities | Subsection 328-125(1) of the ITAA 1997 provides 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. | There are different control tests in section 328-125 of the ITAA 1997 that apply depending on what type of entity is being tested. | ● Is the Taxpayer connected with the Trust? | As the Trust is a discretionary trust, the tests in subsections 328-125(3) and 328-125(4) of the ITAA 1997 apply to determine if the Taxpayer is connected with the Trust. | Subsection 328-125(3) of the ITAA 1997 states that an entity (the first entity) controls a discretionary trust if the 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. | The Guide to Capital Gains Tax 2017 provides the following guidance on how this test applies: | All the circumstances of the case need to be considered in determining whether you satisfy this test. For example, the mere presence in the trust deed of a requirement that the trustee should have no regard to such directions or wishes would not be sufficient. | The guide further explains that the following factors should be considered: | ● 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 by both the entity and its affiliates | ● any arrangement or understanding between the entity and any person who has benefited under the trust in the past. | The trustee of the Trust is a corporate trustee. Therefore to determine if the Taxpayer is connected with the Trust under subsection 328-125(3) of the ITAA 1997, it has to be determined if the corporate trustee acts, or could reasonably be expected to act, in accordance with the directions or wishes of the Taxpayer. | In the current circumstances, based on the information provided, it does not appear that trustee acts, or could reasonably be expected to act, in accordance with the directions or wishes of the Taxpayer and accordingly the Trust would not be connected with the Taxpayer under subsection 328-125(3) of the ITAA 1997. | However, consideration should also be had to the control test in subsection 328-125(4) of the ITAA 1997. Under this subsection, 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. | All the prior distributions from the Trust have been made to other family members, the Trust has never made any distributions to the Taxpayer. Consequently, the control test in subsection 328-125(4) of the ITAA 1997 is not satisfied as the Taxpayer has not received any income or capital of the Trust. | Based on the above analysis, the Taxpayer is not connected with the Trust under section 328-125 of the ITAA 1997, however it should be noted that, whether the Trust is connected with the Taxpayer has no material effect to the application of the CGT small business concessions (and in particular whether the maximum net asset value test is satisfied). | ● Is the Taxpayer connected with the Partnership? | As the Partnership is not a discretionary trust, the ‘direct control test’ in subsection 328-125(2) of the ITAA 1997 will apply to determine if the Taxpayer is connected to the Partnership. Subsection 328-125(2) of the ITAA 1997 states: | An entity (the first entity) controls another entity if the first entity, its *affiliates, or the first entity together with its affiliates: | (a) except if the other entity is a discretionary trust - own, or have the right to acquire the ownership of, interests in the other entity that carry between them the right to receive a percentage (the control percentage) that is at least 40% of: | (i) any distribution of income by the other entity; or | (ii) if the other entity is a partnership - the net income of the partnership; or | (iii) any distribution of capital by the other entity; or | (b) if the other entity is a company - own, or have the right to acquire the ownership of, *equity interests in the company that carry between them the right to exercise, or control the exercise of, a percentage (the control percentage) that is at least 40% of the voting power in the company. | Applying the rule in subsection 328-125(2) of the ITAA 1997, the Taxpayer is the first entity. This rule requires the Taxpayer and their affiliate, their Spouse, to own or have the right to acquire the ownership of interests in the Partnership that carry between them the right to receive at least 40% of net income of the Partnership. | The Taxpayer and their Spouse each own 25% of the ownership interests in the Partnership, so combined they will own more than 40% of those interests. | Consequently the Taxpayer will be connected with the Partnership under subsection 328-125(2) of the ITAA 1997. | Calculation of the maximum net assets value | As mentioned above, section 152-15 of the ITAA 1997 provides that maximum net value asset test is satisfied if the sum of the net value of the CGT assets of yours, any entities connected with you, and any of your affiliates or entities connected with your affiliates does not exceed $6,000,000. | It has been established that the affiliates and connected entities of the Taxpayer are their Spouse and the Partnership. | The net value of the CGT assets is defined in subsection 152-20(1) of the ITAA 1997 as the amount (whether positive, negative or nil) obtained by subtracting from the sum of the *market values of those assets the sum of: | (a) the liabilities of the entity that are related to the assets; and | (b) the following provisions made by the entity: | (i) provisions for annual leave; | (ii) provisions for long service leave; | (iii) provisions for unearned income; | (iv) provisions for tax liabilities. | Subsection 152-20(2) of the ITAA 1997 notes however that the following assets should be disregarded when working out the net value of the CGT assets of an entity: | (a) disregard *shares, units or other interests (except debt) in another entity that is *connected with the first-mentioned entity or with an *affiliate of the first-mentioned entity, but include any liabilities related to any such shares, units or interests; and | (b) if the entity is an individual, disregard: | (i) assets being used solely for the personal use and enjoyment of the individual, or the individual's *affiliate (except a *dwelling, or an *ownership interest in a dwelling, that is the individual's main residence, including any adjacent land to which the main residence exemption can extend because of section 118-120); and | (ii) except for an amount included under subsection (2A), the *market value of a dwelling, or an ownership interest in a dwelling, that is the individual's main residence (including any relevant adjacent land); and | (iii) a right to, or to any part of, any allowance, annuity or capital amount payable out of a *superannuation fund or an *approved deposit fund; and | (iv) a right to, or to any part of, an asset of a superannuation fund or of an approved deposit fund; and | (v) a policy of insurance on the life of an individual. | Subsection 152-20(3) of the ITAA 1997 also states that in working out the net value of the CGT assets of your affiliate or an entity that is connected with your affiliate: | include only those assets that are used, or held ready for use, in the carrying on of a *business by you or another entity *connected with you (whether the business is carried on alone or jointly with others). | It has been confirmed that that the net value of the CGT assets as defined by section 152-20 of the ITAA 1997 of the Taxpayer, their Spouse and the Partnership combined is less than $6,000,000. Therefore the maximum net asset value test in section 152-15 of the ITAA 1997 will be satisfied. | Accordingly, this satisfies the requirements of subparagraph 152-10(1)(c)(ii) of the ITAA 1997 and in turn paragraph 152-10(1)(c) of the ITAA 1997. | Basic condition (d) - the CGT asset satisfies the active asset test | Pursuant to subsection 152-35(1) of the ITAA 1997, a CGT asset satisfies the active asset test if: | (a) 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 specified in subsection (2); or | (b) 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 7½ years during the period specified in subsection (2). | Subsection 152-35(2) of the ITAA 1997 provides that the test period is from when the asset is acquired until the CGT event. If the business ceases within the 12 months before the CGT event (or such longer time as the Commissioner allows) the relevant period is from acquisition until the business ceases. | Subsection 152-40(1) of the ITAA 1997 provides that a tangible CGT asset is an active asset if it is owned by you and is used or held ready for use in a business carried on (whether alone or in partnership) by you, your affiliate, or an entity connected with you. | To determine if the active asset test in section 152-35 of the ITAA 1997 is satisfied, it first has to be determined if the Land is an active asset. | The Land has been used by the Partnership in carrying on the business since its inception. As the Taxpayer holds an interest in the Partnership and is connected with the Partnership, the Land is an active asset of the Taxpayer during this period, in accordance with paragraph 152-40(1)(a) of the ITAA 1997. | However, certain assets are excluded from being active assets under subsection 152-40(4) of the ITAA 1997. The relevant exclusion in this situation is paragraph 152-40(4)(e) of the ITAA 1997, which provides that a CGT asset cannot be an active asset if its main use is to derive interest, an annuity, rent, royalties or foreign exchange gains. This exclusion does not apply to certain intangible assets and in situations where the asset’s main use for deriving rent was only temporary. | Taxation Determination TD 2006/78 Income tax: capital gains: are there any circumstances in which the premises used in a business of providing accommodation for reward may satisfy the active asset test in section 152-35 of the Income Tax Assessment Act 1997 notwithstanding the exclusion in paragraph 152-40(4)(e) of the Income Tax Assessment Act 1997 for assets whose main use is to derive rent? discusses whether there are circumstances in which a premises used in a business of providing accommodation for reward may satisfy the active asset test in section 152-35 of the ITAA 1997, notwithstanding the exclusion in paragraph 152-40(4)(e) of the ITAA 1997. The taxation determination explains that whether an asset's main use is to derive rent will depend on the particular circumstances of each case. Paragraph 26 of TD 2006/78 provides the following discussion on this matter: | If an asset is used partly for business and partly to derive rent at any given time, it will be a question of fact dependent on all the circumstances as to whether the main use of the asset at that time is to derive rent. No one single factor will necessarily be determinative, and resolving the matter is likely to involve a consideration of a range of factors such as: | ● the comparative areas of use of the premises (between deriving rent and other uses); and | ● the comparative levels of income derived from the different uses of the asset. | A small percentage of a section of the Land has been recently mined by a third party who pays a royalty on a price per cubed metre basis. The income generated from the mining represents a small percentage of the total revenue generated from that parcel of land. | These small percentages are not considered to be the main use of the Land. Therefore this exclusion is not applicable in this situation and will not prevent the Land from being an active asset. | The Land has been held by the Taxpayer for greater than 15 years. As established previously, the Land has been an active asset of the Taxpayer since the Partnership started carrying on its business. When the Land is transferred to the Trust, the Land would have been an active asset for more than seven and half years prior to the transfer. | Consequently, the Land will satisfy the active asset test in section 152-35 of the ITAA 1997. | In conclusion, as the Taxpayer will satisfy all of the requirements in subsection 152-10(1) of the ITAA 1997, they will satisfy the basic conditions for relief. | Question 2 | Summary | The disposal of the Land by the Taxpayer will satisfy the 15-year exemption for individuals pursuant to section 152-105 of the ITAA 1997. | Detailed reasoning | The 15-year exemption in Subdivision 152-B of the ITAA 1997 allows a CGT small business entity to disregard a capital gain arising from a CGT asset that it has owned for at least 15 years if certain conditions are met. | Section 152-105 of the ITAA 1997 provides that an individual can disregard any capital gain arising from a CGT event if all of the following conditions are satisfied: | (a) the basic conditions in Subdivision 152-A of the ITAA 1997 are satisfied for the gain; | (b) you continuously owned the CGT asset for the 15-year period ending just before the CGT event; | (c) if the CGT asset is a share in a company or an interest in a trust - the company or trust had a significant individual for at least 15 years (even if the 15 years was not continuous and it was not always the same significant individual) during which you owned the CGT asset; | (d) either: | (i) you are 55 or over at the time of the CGT event and the event happens in connection with your retirement, or | (ii) you are permanently incapacitated at the time of the CGT event. | (a) the basic conditions in Subdivision 152-A are satisfied for the gain | As per the answers provided in question one, the basic conditions in Subdivision 152-A of the ITAA 1997 will be satisfied for the gain. | (b) you continuously owned the *CGT asset for the 15-year period ending just before the CGT event; | The Taxpayer has continuously held the Land since it was acquired more than 15 years ago. | Consequently, the requirements of paragraph 152-105(b) of the ITAA 1997 will be satisfied. | (c) if the CGT asset is a *share in a company or an interest in a trust… | This requirement is not applicable as the Land is not a share in a company or an interest in a trust. | (d) either: | (i) you are 55 or over at the time of the CGT event and the event happens in connection with your retirement; or | (ii) you are permanently incapacitated at the time of the CGT event. | It is not expected that the Taxpayer will be permanently incapacitated at the time of the CGT event. Therefore subparagraph 152-105(1)(d)(ii) of the ITAA 1997 will not apply and consideration must be had to subparagraph 152-105(1)(d)(i) of the ITAA 1997. | The Taxpayer will be 55 or over at the time of the CGT event so therefore it must be established whether the CGT event, being CGT event A1 upon the transfer of the Land, happens in connection with their retirement. | The Guide to Capital Gains Tax 2017 in the section relating to ‘Small business 15-year exemption’ provides the following guidance on when a CGT event happen in connection with retirement: | Whether a CGT event happens in connection with an individual's retirement depends on the particular circumstances of each case. There would need to be at least a significant reduction in the number of hours the individual works or a significant change in the nature of their present activities to be regarded as a retirement. However, it isn't necessary for there to be a permanent and everlasting retirement from the workforce. | The Guide also provides that following discussion and example in relation to situations where retirement occurs after the sale of the CGT asset: | A CGT event may be ‘in connection with your retirement’ even if it occurs at some time before retirement. Whether particular cases satisfy the conditions depends very much on the facts of each case. | Example: Sale of assets prior to retirement | Hannah is a small business operator who is over 55 years old. She sells some business assets as part of a wind-down in business activity ahead of selling the business. Within six months, she sells the business and ends her present activities. | If it can be shown that the earlier CGT event was integral to Hannah's plan to cease her activities and retire, the CGT event may be accepted as happening in connection with retirement. | The proposed transfer of the Land to the Trust is being undertaken for succession planning purposes and to allow for the retirement of the Taxpayer. | The Taxpayer currently has an active involvement in the business carried on by the Partnership, and has recently reduced their working hours. After the proposed transfer of the Land takes place, the Taxpayer intends to further reduce the amount of hours he is involved in the business. | Accordingly, taking into consideration the guidance provided above, it is considered that the CGT event (relating to the disposal of the Land) is in connection with the Taxpayer’s retirement. | The Taxpayer may continue to undertake other activities in the community and receive passive income following the transfer of the Land however it is considered that these attributes will not detract from a conclusion, reflected in the reduction in the Taxpayer’s active involvement in the business, which indicate that the CGT event is in connection with their retirement. | Consequently the requirements of subparagraph 152-105(d)(i) of the ITAA 1997 will be satisfied. | Therefore the Taxpayer will satisfy all of the requirements of section 152-105 of the ITAA 1997 and will be entitled to disregard a capital gain arising from the transfer of the Land.