Private ruling: Capital gains tax concessions for small business
Published: October 2013
Ruling period: Year ended 30 June 2012
Date scheme commenced: 1 July 2011

Ruling: Q1: Do you satisfy the basic conditions necessary to be eligible for the capital gains tax (CGT) for small business? | A1: Yes | Q2: Are you eligible to disregard any capital gain made on disposal of the property under the CGT 15-year exemption concession for small business? | A2: Yes

Relevant facts and circumstances: You were equal shareholders in a company, Company A. The business ran for approximately 20 years. You were directors and employees of Company A. In the early 90's you purchased a property as joint owners. You leased the property to Company A to conduct their business. The property was continuously leased to Company A for X years. Later the business of Company A was sold to an employee of the company, who then ran the business from their own company, Company B. You state that the sale of the business and intended sale of the property was in connection with your retirement. You state that you effectively retired when the business was sold. A deed, attached to the contract for the sale of the business states that Company A and Company B will agree to enter into a contract for the sale of the property, provided it is entered into within three months of the date of the deed. If the contract for the sale of the property was not entered into within 3 months, then Company A agrees to grant a three year lease for the use of the property to Company B (within an option for a further three years). You state that while it was not written into the contract, it was the understanding of parties to the contract that the property was only to be sold or leased to Company B. Company B could not raise sufficient funds in which to purchase the property (as well as the business) at the time the business was sold. As no contract of sale was entered into within three months of the date of the deed, the property was leased to Company B. Company B leased the property from you from when the business was sold to the date of disposal of the property to Company B. In the relevant financial year, Company B purchased the property. You were both aged over 55 years of age in when the business was sold. You state that you satisfy the maximum net asset value test. You state that the company still exists but is now just an investment company. You don't receive any fees or wages from the company, but you are still directors.

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 104-10 | Income Tax Assessment Act 1997 Section 152-40 | Income Tax Assessment Act 1997 Section 328-125 | Income Tax Assessment Act 1997 Section 152-105

Reasons for decision: 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 104-10 of the ITAA 1997 provides that CGT event A1 occurs when your ownership in a CGT asset (eg. land or buildings) is transferred to another entity. 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. However, subsection 152-40(4) explains that an asset whose main use is to derive rent can not be an active asset. Paragraph 152-40(4A)(b) of the ITAA 1997 provides that to determine the main use of an asset, treat any use by your affiliate, or an entity that is connected with you, as your use. Subsection 328-125(1) of the ITAA 1997 explains 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. Subsection 328-125(2) of the ITAA 1997 provides that an entity (the first entity) controls another entity if the first entity, its affiliates, or the first entity together with its affiliates: 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 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. Importantly, the asset does not need to be an active asset just before the CGT event. In your case, you disposed of the property to Company B and the event resulted in a capital gain. The property was leased to Company A to use in the course of carrying on a business for over 7 ½ years of your ownership period of over 15 years. Company A is an entity that is 'connected with' you as you each hold 50% of the voting power in the company. As such, Company A's use of the asset is considered to be your use of the asset. Further, you state that you satisfy the maximum net asset value test. Accordingly, you satisfy the active asset test and therefore you meet all the basic conditions necessary to be eligible for the CGT small business concessions. As you satisfy all the basic conditions, you automatically qualify for the 50% active asset reduction concession. | 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 152-105 of the ITAA 1997 provides that an individual can entirely disregard any capital gain if all of the following conditions are satisfied: (a) you satisfy the basic conditions (b) you continuously owned the CGT asset for the 15-year period ending just before the CGT event (c) you are either: i. 55 or over at the time of the CGT event and the event happens in connection with your retirement; or ii. permanently incapacitated at the time of the CGT event. In your case: · you satisfy the basic conditions · you have owned the asset for over 15 years, and · you are aged over 55 Therefore, it only needs to be established whether the disposal of the property, several years after the sale of the business, could be considered to be '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 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. The words 'in connection with' can apply where the CGT event occurs sometime after retirement. An example discussing whether a CGT event occurring after retirement could be considered 'in connection with' your retirement is provided in the Advanced guide to capital gains tax concessions for small business 2011-12 states as follows: 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 have stated that the taxpayers had retired when the business was sold. While the company (your connected entity) that ran the business originally still exists, you do not receive any salary and wages income from the company, with the company now being merely an investment company. The deed to the contract of sale of the business stated that it was the intention of both the seller and the buyer of the business for the buyer to purchase the property within three months of the date of the deed, although, this did not eventuate due to the buyer not being able to raise sufficient funds for the acquisition of both the business and the property at that time. In addition, since the business was sold to Company B, the property has always been leased to Company B Pty Ltd for use in its business (the business that you sold) until it could raise the required funds to acquire it. Based on the information provided, your situation has similarities to the example in the guide (apart from the period of time mentioned). Therefore, while there has been a significant amount of time between when the business was sold to when the property was sold, it appears that later disposal of the property was part of your retirement plan from the time the business was sold. As such, we accept that the disposal of the property is 'in connection with' your retirement and accordingly, you satisfy the required conditions to be eligible for the 15-year exemption concession.