Private ruling: Capital gains tax
Date of advice: 10 March 2016
Published: May 2016
Ruling period: Year ending 30 June 2016 | Year ending 30 June 2017 | Year ending 30 June 2018 | Year ending 30 June 2019 | Year ending 30 June 2020
Date scheme commenced: 1 July 2015.

Ruling: Q1: When you sell your property will the small business 15-year exemption apply to exempt you from paying capital gains tax? | A1: No.

Relevant facts and circumstances: Several years ago you purchased a property with your former spouse. You ran your business downstairs and you lived upstairs. Later you and your former spouse separated. You removed yourself from the business. Later your former spouse's share of the property was transferred into your name as part of a financial settlement. The CGT marriage breakdown rollover applied at this time. You have not been working since you removed yourself as a partner in the business. The net value of the assets you own is less than $6 million.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 152-105, | Income Tax Assessment Act 1997 Section 152-40, | Income Tax Assessment Act 1997 Subsection 152-40(1), | Income Tax Assessment Act 1997 Subsection 152-40(4) and | Income Tax Assessment Act 1997 Section 152-35.

Reasons for decision: Summary: Subdivision 152-B of the Income Tax Assessment Act 1997 (ITAA 1997) provides a small business 15-year exemption as part of the CGT small business relief provisions. If you qualify for the small business 15-year exemption, the capital gain is entirely disregarded and it is unnecessary to apply any other concessions. To qualify for the small business CGT concessions, you must satisfy several conditions that are common to all the concessions. These are called the 'basic conditions'. The 15-year exemption also has further requirements that you must satisfy for the concession to apply. This is provided for under section 152-105 of the ITAA 1997 which states that you can disregard the capital gain from the disposal of your property, being CGT event A1 happening to the asset, if you: (a) satisfy the basic conditions in subdivision 152-A of the ITAA 1997 for the small business CGT concessions. (b) continuously owned the asset for the 15-year period ending just before the CGT event happened and (c) you are: (i) at least 55 years old at that time and the event happened in connection with your retirement or (ii) permanently incapacitated at the time. | Detailed Reasoning - Condition (a): The basic conditions for the small business capital gains tax concessions in subdivision 152-A of the ITAA 1997 (as relevant to this case) are: • maximum net asset value test • the active asset test Maximum net asset value test There is a limit of $6 million on the net value of CGT assets that you and certain entities can own and still qualify for the small business CGT concessions. This $6 million limit is called the maximum net asset value test. It is not indexed for inflation. You satisfy the maximum net asset value test if the total net value of CGT assets owned by certain entities does not exceed $6 million just before the CGT event that results in the capital gain for which the concessions are sought. You must include the net value of CGT assets owned by: • you • any entities 'connected with you', • any of your 'affiliates' and entities connected with your affiliates This figure includes the net value of assets of your affiliates, and entities connected with your affiliates, only if the assets are used, or held ready for use, in a business carried on by your or an entity connected with you. You have advised that the value of CGT assets you own is less than $6 million. You are no longer connected to your former business. Based on this information, you would pass the maximum net asset value test. Active asset test The active asset test is satisfied 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 test period detailed below, 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 7.5 years during the test period. The test period: • begins when you acquired the asset, and • ends at the earlier of • the CGT event, and • when the business ceased, if the business in question ceased in the 12 months before the CGT event (or such longer time as the Commissioner allows). The asset does not need to be an active asset just before the CGT event. The meaning of an active asset is set out in section 152-40 of the ITAA 1997. It must firstly satisfy one of the 'positive tests' in subsection 152-40(1) of the ITAA 1997 and then also not be excluded by one of the exceptions in subsection 152-40(4) of the ITAA 1997. Under subsection 152-40(1) of the ITAA 1997, a CGT asset is an active asset (subject to the exclusions) if it is owned and used, or held ready for use, in the course of carrying on a business by you or your small business CGT affiliate or another entity that is connected with you under paragraph 152-40(1)(c) of the ITAA 1997. The combined effect of sections 152-35 and 152-40 of the ITAA 1997 is that the asset will meet the active asset test if the asset was used, or held ready for use, in the course of carrying on a business for at least half of the time period it was owned, subject to the exclusions in subsection 152-40(4) of the ITAA 1997. In your case, you have held 50% of the asset for several years. The remaining share of the asset was transferred to you later as part of a financial settlement with your former spouse. Your business ceased. With regards to your original share of the asset that you acquired, because you have held it for over 15 years and the asset was an active asset of yours for over 7.5 years during the test period, it satisfies the active asset test. If the other share is taken to have been acquired later it would not satisfy the active asset test, however there are modified rules to determine if the active asset test is satisfied for CGT assets acquired or transferred under the rollover provisions relating to assets acquired through marriage breakdown (subdivision 126-A of the ITAA 1997). If you have a CGT asset transferred to you because of a marriage breakdown, and the capital gain arising from that transfer was rolled over under the marriage breakdown rollover provisions, for the purposes of the active asset test you can choose whether to: • include the ownership and active asset periods of your former spouse, or • commence the ownership and active asset periods from the time the asset was transferred to you. If you choose to include your former spouse's ownership and active asset periods of the CGT asset, that asset is treated as if it had been: • acquired by you when your former spouse acquired the asset, and • was an active asset of yours at all times when the asset was an active asset of your former spouse. As a result, both of your shares in the asset can be taken to have been acquired several years ago satisfying the active asset test. | Detailed Reasoning - Small business 15 year exemption: Because you satisfy both the maximum net asset value test and the active asset test, the basic conditions for the small business concessions are satisfied. As for the conditions specific to the 15-year exemption, condition (b) is satisfied because you have owned the asset for over 15 years. | Detailed Reasoning - Condition (c): Condition (c) of the 15 year exemption applies if when the CGT event happened: • you were permanently incapacitated, or • you were 55 years or older, and the event happened in connection with your retirement. Whether a CGT event happens in connection with an individual's retirement depends on the particular circumstances of each case. There needs to be at least a significant reduction in the number of hours that you work or a significant change in the nature of your present activities to be regarded as a retirement. However, it is not necessary for there to be a permanent and everlasting retirement from the workforce. The provisions relating to the small business 15-year exemption do not define what is meant by the phrase 'in connection with a taxpayer's retirement', nor does it give any indication of the degree of retirement required in order to take advantage of this concession. The words 'in connection with' can also apply where the CGT event occurs sometime after retirement. This type of case would depend on its own particular facts, and would need to be considered on a case-by-case basis. The Advanced guide to capital gains tax concessions for small business 2014-15 provides the following example: A small business operator 'retires' and his children take over the running of the business. Within six months, they sell some business assets and make a capital gain. Several reasons may have prompted the sale of the assets. If there is no relevant connection with the small business operator's business, the requirement would not be satisfied. However, if it can be shown that the reason for the disposal of the assets is connected to retirement and the later sale is integral to the small business operator's retirement plan, the sale may be accepted as happening in connection with retirement. In your case, you advise that you have not been working since you ceased running the business with your former spouse. Even though you continue to derive some income from letting your property, you have retired completely from the workforce. Although the Advanced Guide provides that retirement can occur sometime before the CGT event, there would still need to be a connection between your retirement and the sale of the land. Because you ceased working a significant period of time before the planned disposal of the property, it is not considered that there is a connection with your retirement and the disposal of the property. As you have not satisfied this condition, you are not entitled to the small business 15 year exemption.