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

Ruling: Q1: 1. Do you satisfy the maximum net asset value test contained in section 152-15 of the Income Tax Assessment Act 1997 (ITAA 1997)? | 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: • your application for private ruling Company A (the company) is a private company for income tax purposes. X is over 55 years of age and is the sole director and secretary of the company and holds 100% of the ordinary share holding and C class shares in the company. The ordinary shareholder has voting rights and the right to all payments of dividends and capital distributions. The C class shareholder has the right to payment of dividends only at the direction of the sole director, X. XY holds a share in the company which has no rights attached to it other than to replace X in the scenario of the estate and is for estate planning purposes only. XY is the spouse of X and does not carry on a business in his/her own right. The children of X do not carry on a business in their own right. The company acquired % of the shares in Company B. The company held its shares in Company B on capital account, not as trading stock. The company disposed of its shareholding in Company B in the 2013-14 financial year. Primarily, all the assets of Company B were used in the business that it carried on. X is also the sole ordinary share holder of Company C. The ordinary shareholder has the right to all payments of dividends and capital distributions. The A, B and C class shareholders have the right to dividends only at the direction of the sole director, X. The company holds % of the income units in A Trust (the trust). The company's aggregated turnover for the last two financial years is in excess of $2 million. X has not previously utilised the retirement exemption. You have provided a calculation of less than $6 million for the maximum net asset value test for the company which includes: • The net assets of the company • The net assets of Company C • The net assets of the trust • The net assets of X • The value of the company's shareholding in Company B, and • The value of the company's unit holding in the trust

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 152-20 | Income Tax Assessment Act 1997 Section 152-305

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. In your case, the company is not a small business entity as its aggregated income is in excess of $2 million dollars in both the prior year and the year of the CGT event. | Detailed Reasoning - Additional basic conditions for shares and units: 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 %. A company cannot satisfy the condition in paragraph (a) because a CGT concession stakeholder in the object company must be an individual. Therefore, paragraph (b) will apply in this particular case. You disposed of your shares in Company B, accordingly, CGT event A1 happened. The disposal has resulted in a capital gain and as such you meet conditions (a) and (b) of the basic conditions. Therefore, we only now need establish whether you satisfy the active asset test (condition (d)), the MNAV test (condition (c)) 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 (condition (d)): 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. In your case, the company acquired shares in Company B. The shares were disposed of in the 2013-14 financial year. You have confirmed that the 80% test has been satisfied by the company for over half the period of your share ownership. You have stated that all of the assets of Company B have been used in the business activities of Company B and that Company B does not hold passive assets. Accordingly, the shares will satisfy the active asset test. | Detailed Reasoning - CGT concession stakeholder (additional condition): Under section 152-60 of the ITAA 1997, an individual is a CGT concession stakeholder of a company or trust if they are a significant individual 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. This participation percentage can be held directly or indirectly through one or more interposed entities. The percentages are worked out in the same way as for the significant individual test. | Detailed Reasoning - Significant individual test: Under section 152-55 of the ITAA 1997, an individual is a significant individual in a company or trust if they have a small business participation percentage in the company or trust of at least %. This % 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. 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) or • 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 smallest of the three percentages above. Section 152-75 of the ITAA 1997 details that an entity's indirect SBPP in a company or trust is calculated by multiplying together the entity's direct participation percentage in an interposed entity, and the interposed entity's total participation percentage (both direct and indirect) in the company or trust. In your case, the CGT asset in question is the shares in Company B. The company held % of the shares in Company B. X holds % of the ordinary shares in the company. Therefore, X has a % small business participation percentage in Company B and accordingly, will be a significant individual and consequently a CGT concession stakeholder in Company B. X holds all the voting power in the company and is entitled to receive all dividend payments and any capital distribution made by the company, accordingly, he/she has a small business participation in the company of over 90% and therefore you satisfy one of the additional basic conditions necessary to access the small business concessions. | Detailed Reasoning - An entity that is 'connected with' you: An entity is connected with another entity if either entity controls the other entity, or both entities are controlled by the same third entity. Under subsection 328-125(2) of the ITAA 1997, an entity controls a partnership, company or trust (except a discretionary trust) if it: • beneficially owns or has the right to acquire beneficial ownership of, interest 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. The way in which an entity can directly control a company has been expanded from 2007-08 by replacing the term shares with equity interests. The meaning of an equity interest includes, but is not limited to a share in a company. In your case, X holds % of the ordinary shares on issue in the company and Company C, accordingly, X and Company C will be entities connected with the company as both Company C and the company are controlled by X. Therefore,% of the net value of the CGT assets of Company C and X will need to be included in the calculation of the MNAV test. The company holds % of the ordinary shares in Company B and therefore Company B would not be an entity that is connected with the company. Accordingly, it is only the value of your % shareholding that will need to be included in the calculation of the MNAV test. | 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. You have stated that X's spouse would not be an affiliate of the company as while he/she holds a share in the company, the share does not carry any rights (either voting or for entitlements to distributions). Further, you have stated that X's children are not affiliates of the company as they have no involvement with the company and do not carry on a business in their own right. The company holds % of the units in the Trust, therefore it is considered unlikely that the Trust would act, or reasonably be expected to act, in accordance with the company's directions or wishes, or in concert with the company. Accordingly, the Trust would not be considered your affiliate and it is only the value of your % unit holding that will need to be included in the calculation of the MNAV test. | Detailed Reasoning - Maximum net asset value (MNAV) test (condition (c)): Section 152-15 of the ITAA 1997 explains that you satisfy the MNAV 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)). Subsection 152-20(1) of the ITAA 1997 provides that the net value of the CGT assets of an entity is 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(3) of the ITAA 1997 states that in working out the net value of the CGT assets of: (a) your affiliate; or (b) 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). Subsection 152-20(4) of the ITAA 1997 explains that you disregard assets under subsection (3) that are used, or held ready for use, in the carrying on of a business by an entity that is connected with you only because of your affiliate. Accordingly, you should include the net assets of the following entities in the calculation of the MNAV test: • the company • Company C, and • X Further, you will also need to include the following in your calculation: • Market value of your % shareholding in Company B, and • Market value of your % unit holding in the Trust Based on the information provided, you have calculated the MNAV test including the value of the net assets of each of the entities listed above and the market value of percentage share/unit holdings. The value calculated is less than the $6 million MNAV threshold. Accordingly, you satisfy the MNAV test. | Detailed Reasoning - Small business 50% active asset reduction: As you satisfy the all required basic conditions, you are automatically entitled to apply the 50% active asset reduction to your capital gain made from the disposal of the shares is Company B. | 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 • seven days after you choose to disregard the capital gain, and • 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. 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. In your case, you have stated that you intend to make the choice to apply the retirement exemption in writing and make a payment (up to $500,000) to CGT concession stakeholder, X (who is over 55 years of age), by the required date. Further, you satisfy all the basic conditions and the significant individual test, accordingly, you satisfy all the necessary conditions to be eligible to apply the retirement exemption.

2. Do you satisfy the active asset test contained in section 152-35 of the ITAA 1997? | 3. Do you satisfy the capital gains tax (CGT) concession stakeholder test in section 152-60 for the purposes of subsection 152-10(2) of the ITAA 1997? | 4. Do you satisfy the basic conditions to access the CGT concessions in section 152-10 of the ITAA 1997? | 5. Are you eligible for the retirement exemption in subdivision 152-C of the ITAA 1997?