Private ruling: Small Business CGT Rules
Date of advice: 7 October 2016
Published: December 2016
Ruling period: DDMMYY to DDMMYY
Date scheme commenced: The disposal of the taxpayer's shares in A.

Ruling: Q1: Which of the following entities are connected with the taxpayer under section 328-125 of the Income Tax Assessment Act 1997 (ITAA 1997): (a) A Pty Ltd (A) (b) B Pty Ltd as trustee for the B Family Trust (BFT) (c) Individual C (C) (d) Individual D (D) (e) Individual E (E) (f) Individual F (F) (g) Individual G (G) | A1: Of the above entities named, only A and BFT are connected entities of the taxpayer under section 328-125 of the ITAA 1997. | Q2: Is the $X loan by C and D to the taxpayer a liability related to the assets of the taxpayer for the purposes of section 152-20 of the ITAA 1997? | A2: Yes. | Q3: Are the unpaid present entitlements and loans totalling $Y, termed 'beneficiary loans' in the BFT's Detailed Balance Sheet as at DDMMYY, liabilities related to the BFT's assets for the purposes of section 152-20 of the ITAA 1997? | A3: Yes. | Q4: Is a tax law partnership (i.e. the joint ownership of the rental property by G and the BFT) an 'entity' for the purposes of section 152-15 and section 328-125? If yes, must the entire value of the rental property jointly owned by G and the BFT be included in the maximum net asset value calculation? | A4: Yes to both questions. | Q5: If the partnership is an 'entity' then is the loan by the BFT to the partnership, and used by the partnership to assist with the purchase of the rental property, a liability related to the assets of the partnership for the purposes of section 152-20 and thus taken into account when calculating the net value of the CGT assets of the partnership? If not, is the loan a capital contribution by the BFT to the partnership and so disregarded by the BFT as an interest in a commercial entity? | A5: Yes, the loan is a liability related to the assets of the partnership for the purposes of section 152-20 of the ITAA 1997. | Q6: Would the taxpayer's shares in A satisfy the active asset test under section 152-35 of the ITAA 1997? | A6: Yes.

Relevant facts and circumstances: 1. XYZ Pty Ltd (XYZ) is the trustee of the X Unit Trust (the taxpayer). 2. The directors of XYZ are C and D, who are siblings. 3. The taxpayer owns shares (being 100%) in A. 4. The taxpayer acquired XXX,XXX shares in A on DDMMYY. The taxpayer acquired the final share in ZZZZ. 5. The directors of A are C, D, and some of their children. 6. C and D lent half each of the total amount of $X to the taxpayer. In a letter to the ATO dated DDMMYY, the agent stated that the $X loan was entered into in early YY, so that the taxpayer could acquire shares in A. No written loan agreement was entered into and each loan is interest free repayable on demand with no repayments being made to date. 7. C is married to E. 8. D is married to F. 9. Since DDMMYY, A has carried on a business. Between YY and YY, A carried on a different business. C and D have worked in these various businesses since the first one was established in YY. Their children also work in the business and have done so for several years. 10. For at least X of the years that the taxpayer has owned the shares in A, the total market value of the active assets of A and the market value of financial instruments and cash in A inherently connected with its business has been 80% or more of the market value of all its assets. 11. The value of the business, and thus the value of the shares in A is approximately $Z. 12. XXX% of the units in the taxpayer are owned by the BFT and acquired in YY. B Pty Ltd ('B') is the trustee company for the BFT. The directors of B are C, D, E, F and G (who is a parent of C and D). 13. The taxpayer has advised that none of the directors of B (C, D, E, F and G) are affiliates (as defined in section 328-130) of each other, as none of them carry on a business as individuals. 14. The taxpayer affirms that all decisions regarding the BFT are made jointly by the individuals making up the board of the trustee company B and that the trustee does not act and is not reasonably expected to act, in accordance with the directions or wishes of any one individual. 15. The BFT is an investor of properties and has never carried on a business. 16. For the income years YY to YY, the taxpayer has advised that: • C, E, D & F were the main income beneficiaries, and • no one beneficiary received income distributions equal to or exceeding 40% of the total income of the trust. 17. In an email dated to the ATO, the agent also confirmed that there were no capital distributions to any of the BFT's beneficiaries for the income years YY to YY. 18. The BFT's Detailed Balance Sheet as at DDMMYY records amounts termed 'Beneficiary Loans' owed to D, P, E, F, G and C totalling $Y. 19. The agent has stated that the amount of $ is made up of the following: • unpaid present entitlements (UPE's) owed to six of BFT's beneficiaries over several years , and • loans from D, E, F, G and C, lent interest free and repayable on demand over a number of years. These beneficiary loans were termed 'Loans from other persons' in BFT's Detailed Balance Sheets in years prior to YY. 20. The taxpayer also has attested that the $Y amount is related to the assets of BFT, because this money was used by BFT solely for its investments. In a letter dated DDMMYY, the agent also confirmed that none of the unpaid present entitlement amounts to the beneficiaries: • are held on sub-trust for the sole benefit of any specific beneficiary; or • allow any of the beneficiaries to obtain absolute entitlement to one or more BFT assets. 21. In the YY financial year the BFT and G jointly acquired a property as tenants in common (50:50) that is rented to A and used by A in its business. As the owners receive income jointly, there is a partnership for tax purposes. 22. In or about MMYY BFT lent $T to the partnership to help purchase the property. 23. C and D wish to retire from the business run by A. They wish to pass control and ownership of A to their children PP, Q and RR and to retire as directors of A. 24. As part of C and D's retirement plan, the taxpayer intends to: • transfer one third of its shares to PP or an entity controlled by him or her • transfer one third of its shares to Q or an entity controlled by him or her, and • transfer one third of its shares to R or an entity controlled by him or her. 25. Each transfer will be made for no consideration.

Relevant legislative provisions: Income Tax Assessment Act 1997 (ITAA) section 152-15 ITAA section 125-20 | ITAA section 152-35 | ITAA section 328-125 | ITAA section 328-130

Reasons for decision: Summary: 1. Based on the information provided, the BFT and A are connected entities of the taxpayer for the purposes of section 328-125 of the ITAA 1997. C, D, E, F and G are not connected entities with the taxpayer for the purposes of section 328-125. | Detailed Reasoning - Detailed reasoning: 2. Subsection 328-125(1) of the ITAA 1997 states 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. 3. As the taxpayer is a unit trust, subsection 328-125(2) of the ITAA 1997 requires examination, as it describes when an entity directly controls another entity other than a discretionary trust. Subsection 328-125(2) 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. 4. The meaning of 'affiliate' is set out in section 328-130 of the ITAA 1997 as: (1) 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. (2) However, an individual or company is not your affiliate merely because of the nature of the business relationship you and the individual or company share. | Detailed Reasoning - (a) A: 5. The Commissioner is of the view that A is a connected entity of the taxpayer under subsection 328-125(2), as the taxpayer owns 100% of the shares in A and therefore controls more than 40% of any: • income and capital distributions of A, and • voting rights in A. | Detailed Reasoning - (b) B Pty Ltd atf the BFT: 6. The Commissioner is of the view that the BFT is a connected entity of the taxpayer, as the BFT owns 100% of the units in the taxpayer and therefore controls more than 40% of any: • income and capital distributions in the taxpayer, and • voting rights in the taxpayer. | Detailed Reasoning - (c) to (g) C, D, E, F and G: 7. As the BFT owns 100% of the taxpayer and is a connected entity, the question that arises is whether any entity controls the BFT. As the BFT is a discretionary trust the following subsections in section 328-125 of the ITAA 1997 needs to be examined: (3) An entity (the first entity ) controls a discretionary trust if a 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. (4) An entity (the first entity ) controls a discretionary trust for an income year if, for any of the 4 income year 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. 8. C, D, E, F and G comprise the board of directors of B, who is the trustee for the BFT. The agent has stated that the board make decisions regarding BFT jointly, and that the trustee does not act and is not reasonably expected to act in accordance with the directions or wishes of any one individual. Therefore, neither C, nor D, nor E, nor F, nor G are considered to be a connected entity to the BFT under subsection 328-125(3) of the ITAA 1997, and none of the individuals are considered affiliates of one another: see section 328-130 of the ITAA 1997. 9. The agent has stated that B atf the BFT has not distributed at least 40% of the income in any of the past X income years to one beneficiary, nor made any distributions of capital in any the past X income years. Accordingly, neither C, nor D, nor E, nor F, nor G are considered to be a connected entity to the BFT under subsection 328-125(4) of the ITAA 1997. 10. Based on the above, the Commissioner's view is that D, C, E, F and G are not connected entities of either the BFT or the taxpayer for the purposes of section 328-125 of the ITAA 1997. | Summary: 11. The $X loan by C and D to the taxpayer is a related liability to the assets of the taxpayer, for the purposes of section 152-20 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: 12. In early YY, C and D was said to have lent the taxpayer a total of $X, with each lending half the total amount, and that this loan was used by the taxpayer to acquire shares in A. 13. Based on the information provided, the loan is a liability related to an asset of the taxpayer for the purposes of subsection 152-20(1) of the ITAA 1997. | Summary: 14. Based on the information provided, the unpaid present entitlements and loans totalling $Y, and termed 'beneficiary loans' in the BFT's Detailed Balance Sheet as at DDMMYY are liabilities related to the BFT's assets for the purposes of section 152-20 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: 15. The agent has stated that the 'beneficiary loans' account balance of $Y arose as a result of: • B BFT resolving to distribute income to X beneficiaries during a number of different income years and those distributions not being actually paid to those beneficiaries (i.e. the amounts are unpaid present entitlements); and • Loans made by some of the beneficiaries. Moreover, all the monies from these loans have been used by the BFT towards its investments. 16. Unpaid present entitlements (not forming part of a sub-trust or where a beneficiary was absolutely entitled to a specific trust asset) are deemed to be liabilities of the trust within the meaning of paragraph 152-20(1)(a) of the ITAA 1997. This is supported by paragraph 53 of TR 2015/4 (CGT small business concessions: unpaid present entitlements and the maximum net asset value test), which states: Where the amount of a connected beneficiary's UPE has not been placed on sub-trust and the connected beneficiary is not absolutely entitled to any trust asset, all that exists is an equitable obligation on the trustee to pay the connected beneficiary an amount of trust income or capital. That is a presently existing equitable obligation to pay a sum certain or an ascertainable sum that is a 'liability' within the meaning of paragraph 152-20(1)(a). 17. The agent has stated that none of the UPE's: • are held on sub-trust for the sole benefit of any specific beneficiary; or • allow any of the beneficiaries to obtain absolute entitlement to one or more BFT assets. 18. The agent has also stated D, E, F, G and C made separate loans over a number of years to the BFT (described originally as 'Loans from other persons' that are now included in the amount described as 'beneficiary loans'). 19. Based on the above, it is the Commissioner's view that the stated 'beneficiary loans' to the BFT that total $Y, as recorded in the Detailed Balance Sheet as at DDMMYY, are liabilities related to the assets of the BFT for the purposes of section 152-20 of the ITAA 1997. | Summary: 20. A tax law partnership is an 'entity' for the purposes of sections 152-15 and 328-125 of the ITAA 1997. The entire value of the rental property and building jointly owned by G and the BFT has to be included for the purposes of the maximum net asset value test under section 152-15. | Detailed Reasoning - Detailed reasoning: 21. The taxpayer has contended that a tax law partnership is not an 'entity' for the purposes of section 152-15 and section 328-125 of the ITAA 1997. The taxpayer argues that only a general law partnership operating a small business can be a connected entity for the purposes of section 328-125. This view is premised on the fact that subparagraph 152-10(1)(c)(iii) and subsection 152-10(1B) refers to a partnership that is a small business entity and that the connected entity rules are contained in the same Subdivision in the ITAA 1997 which defines what is a small business entity, which requires the entity to be carrying on a business. 22. The Commissioner does not agree with the above taxpayer view for the following reasons. 23. A general law partnership is a relationship between parties carrying on a business with a view to a profit. 24. The term 'entity' is defined in section 960-100 of the ITAA 1997 as including a 'partnership'. The term 'partnership' is defined in subsection 995-1(1) of the ITAA 1997 as: (a) an association of persons (other than a company or a limited partnership) carrying on business as partners or in receipt of ordinary income or statutory income jointly. 25. The first limb of paragraph (a) of the above definition of 'partnership' refers to 'an association of persons (other than a company or a limited partnership) carrying on business as partners ' and therefore reflects the general law definition of a partnership. The second limb of paragraph (a) which includes as a partnership entities which are ' in receipt of ordinary income or statutory income jointly' refers to a tax law partnership. 26. It is the Commissioner's opinion that the BFT and G, as co-owners who receive rental income jointly from the rental property they own, would fall within the second limb of paragraph (a) and therefore be a tax law partnership. 27. In the Commissioner's opinion, the taxpayer's view that only a general law partnership (and not a tax law partnership) can be considered a relevant 'entity' for the purposes of section 152-15 and the connected entity test under 328-125 of the ITAA 1997, has no legal basis. 28. Section 152-15 of the ITAA 1997 states: You satisfy the maximum net asset value test is, just before the *CGT event, the sum of the following amounts does not exceed $6,000,000: (a) the *net value of the CGT asset 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 your or entities connected with your affiliates (not counting any assets already counted under paragraph (b)). 29. The meaning of 'connected with' an entity is set out in subsection 328-125(2) as follows: An entity (the first entity) controls another entity, if the first entity or 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) … (ii) if the other entity is a partnership - the net income of the partnership; or … 30. In the Commissioner's opinion, there is no reference, express or implied, in either section 152-15 or section 328-125 that the term 'partnership' is limited only to general law partnerships. Indeed, in the Commissioner's view, to limit the term 'partnership' in section 328-125 to only general law partnerships, would be contrary to the clear wording of the legislation and if the draftsman intended to limit the term they could have easily have used the words general law partnership instead of partnership. 31. The Commissioner also points out that neither the Explanatory Memorandum ( Tax Laws Amendment (Small Business) Bill 2007 ) to section 328-125 or any case law supports the contention made by the taxpayer. 32. It is also the Commissioner's view that the taxpayer's reference to subparagraph 152-10(1)(c)(iii) and subsection 152-10(1B) has no relevance, as these provisions only establishes that a partnership that is a small business entity would meet one of the basic conditions in section 152-10. These provisions do not have any relevance as to which entities are connected with another entity for the purposes of sections 152-15 and 328-125 of the ITAA 1997. 33. As the BFT is entitled to more than 40% of the net income of the partnership, it is the Commissioner's view that the partnership is a connected entity of the BFT for the purposes of subparagraph 328-125(2)(a)(ii) of the ITAA 1997. As the BFT is a connected entity of the taxpayer (as it owns all its units), the partnership is also a connected entity of the taxpayer under paragraph 328-125(1)(b) of the ITAA 1997. 34. As the partnership is a connected entity of the taxpayer for the purposes of section 328-125, the entire net value of the partnership's CGT assets has to be included in determining if the maximum net asset value test in section 152-15 of the ITAA 1997 has been satisfied. This is in accordance with the plain wording of section 152-15, which requires ' the net value of the CGT assets of any entities connected with you' to be included in determining whether the $6 million threshold has been exceeded. 35. The ATO document 'Capital gains tax concessions for small business 2016' supports the above view with the inclusion of the following example: If you are a partner in a partnership and the CGT event happens in relation to an asset of yours or a CGT asset of the partnership (for example, disposal of a partnership asset) the maximum net asset value test would include: • all the assets of the partnership if you are connected with it , and you would exclude the value of your interest in the partnership, or • only your interest in the partnership if you are not connected with it, and you would not count the assets of the partnership as a whole. 36. It is therefore the Commissioner's view that the partnership's entire net value of its CGT assets (ie the rental property and factory that it owns) needs to be included in the maximum net value asset test in section 152-15 of the ITAA 1997 in order to determine whether this test has been satisfied and whether the taxpayer is eligible to claim any concession within Division 152. | Summary: 37. The $T loan by the BFT to the partnership is a liability related to the assets of the partnership for the purposes of section 152-20 of the ITAA 1997. The loan is also an asset of the BFT for the purposes of section 152-15 and section 152-20. | Detailed Reasoning - Detailed reasoning: 38. The agent has stated that the BFT lent $T to the partnership to assist the partnership in purchasing the rental property. As the loan was used solely by the partnership to help purchase the rental property, it is a liability which relates to an asset of the partnership for the purposes of paragraph 152-20(1)(a) of the ITAA 1997. Accordingly, this liability can be taken into account when calculating the net value of CGT assets held by the partnership. 39. However, the $T loan to the partnership would still count as a CGT asset to the BFT. This would have to be taken into account in calculating the net CGT asset value of the BFT, as a debt is expressly included as an asset in determining the net value of the CGT assets of an entity: see paragraph 152-20(2)(a) of the ITAA 1997. | Summary: 40. The taxpayer's shares in A would satisfy the active asset test under section 152-35 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: 41. Subsection 152-35(1) of the ITAA 1997 states: 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 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 71/2 years during the period specified in subsection (2). 42. In subsection 152-35(2) of the ITAA 1997, the relevant period begins when you acquired the asset and ends at the earlier of the CGT event or the cessation of the business. 43. Under subsection 152-40(1) of the ITAA 1997, a CGT asset is an active asset at a time if, at that time, you own the asset and it is used, or held ready for use, in the course of carrying on a business that is carried on by you, your affiliate, or another entity that is connected with you. 44. Subsection 152-40(3) of the ITAA 1997 states: A *CGT asset is also an active asset at a given time if, at that time, you own it and: (a) it is either a *share in a company that is an Australian resident at that time or an interest in a trust that is a *resident trust for CGT purposes for the income year in which that time occurs; and (b) 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 or trust. 45. Based on the information provided, the Commissioner is of the view that the taxpayer's share in A would fall within the meaning of an active asset in subsection 152-40(3) of the ITAA 1997 as: • A is an Australian resident company; • A is a connected entity of the taxpayer; • A has carried on a business from DDMMYY and prior to that, a different business from YY to DDMMYY; and • The agent has confirmed that the market value of 80% or more of A's assets are active assets and that A does not own any passive assets. 46. The Commissioner is also of the view that the taxpayer's shares in A would pass the active asset test in section 152-35 of the ITAA 1997 as The agent has confirmed that: • it has owned the A shares for more than 15 years, and • the A shares have been an active asset for more than 71/2 years from the period the taxpayer first owned the shares to the date the shares will be disposed (the taxpayer has affirmed that A's business will continue BFT after it has disposed of its shares in A).