Private ruling: CGT concessions and Part IVA
Published: May 2013
Ruling period: Year ending 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Q1: 1. Do you qualify for the capital gains tax (CGT) small business 50% active asset reduction? | A3: No.


Relevant legislative provisions: Income Tax Assessment Act 1997 - section 104-10 | Income Tax Assessment Act 1997 - Division 115 | Income Tax Assessment Act 1997 - Subdivision 152A | Income Tax Assessment Act 1997 - Subdivision 152C | Income Tax Assessment Act 1997 - Subdivision 152E | Income Tax Assessment Act 1997 - section 152-10 | Income Tax Assessment Act 1997 - section 152-35 | Income Tax Assessment Act 1997 - section 152-40 | Income Tax Assessment Act 1936 - section 177A | Income Tax Assessment Act 1997 - section 177C | Income Tax Assessment Act 1997 - section 177D

Reasons for decision: Detailed Reasoning - Discount capital gain: CGT event A1 in section 104-10 of the Income Tax Assessment Act 1997 , relating to the disposal of a CGT asset, will happen when you dispose of the property. You will make a capital gain if the capital proceeds from the disposal are more than the cost base. You will make a capital loss of those capital proceeds are less than the reduced cost. You will be eligible for the discount capital gains where: · you are an individual · the CGT event happened after 21 September 1999 · the capital gain must be calculated without any reference to indexation of the cost base; and · the CGT asset was acquired more than 12 months the CGT event. The discount percentage is 50%. Where a capital gain meets these requirements, that capital gain is a discount capital gain. Generally, the discount percentage is applied to the discount capital gain, to arrive at your net capital gain. Based on the facts, you will be eligible for the discount capital gains of 50% if your capital gain is calculated without any reference to indexation of the cost base. | Detailed Reasoning - Small business CGT concessions: Section 152-10 of the 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 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. If the CGT asset is a share in a company, one of these additional basic conditions must be satisfied just before the CGT event: · the entity claiming the concession must be a CGT concession stakeholder in the company or trust, or · CGT concession stakeholders in the company or trust together have a small business participation percentage in the interposed entity of at least 90% (the 90% test). In this case, company A's directors/shareholders intend to dispose of their shares in the company, a CGT event, and the sale will result in a gain. | Detailed Reasoning - Active asset: 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. A share in an Australian resident company is also CGT active asset at a given time if you own it and the total of the following is 80% or more of the market value of all of the assets of the company: · the market values of the active assets of the company or trust, and · 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 · any cash of the company or trust that is inherently connected with such a business. Cash and financial instruments are not active assets, but they count towards the satisfaction of the 80% test provided they are inherently connected with the business. The active asset test requires a CGT asset to have been an active asset for at least half of the ownership period. 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, and · in circumstances where it is reasonable to conclude that the 80% threshold has been passed. In this case, company A satisfies the 80% test and the shares pass the active assets test. | Detailed Reasoning - Further requirement for shares: If the CGT asset is a share in a company, one of these additional basic conditions must be satisfied just before the CGT event: · the entity claiming the concession must be a CGT concession stakeholder in the company or trust, or · CGT concession stakeholders in the company or trust together have a small business participation percentage in the interposed entity of at least 90% (the 90% test). An individual is a CGT concession stakeholder of a company if they are a significant individual and they are a significant individual in a company if they have a small business participation percentage in the company of at least 20%. An individual'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) · 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 smaller of the three definitions above. In this case, each shareholder has a 50% interest in company A and are both significant individuals and CGT concession stakeholders of company A. | Detailed Reasoning - 50% active asset reduction: Unlike the other small business concessions, the small business 50% active asset reduction applies automatically if the basic conditions are satisfied, unless you choose for it not to apply. To apply the small business 50% active asset reduction, you need to satisfy only the basic conditions. There are no further requirements. In this case, you satisfy all the basic conditions and the small business 50% active asset reduction will apply. | Detailed Reasoning - Rollover provisions: The conditions surrounding the small business rollover are contained in subdivision 152-E of the ITAA 1997. The small business rollover allows an entity to defer all or part of a capital gain made from a CGT event happening to an active asset. There are rollover conditions that must be satisfied by the end of the replacement asset period. This period starts one year before and ends two years after the last CGT event that occurs in the income year for which you choose the roll over. If the rollover conditions are not met within the replacement asset period, the gain will become assessable. You will satisfy the rollover conditions where you meet all the following conditions: · you acquire one or more CGT assets as replacement assets within the replacement asset period · the replacement asset is an active asset at the end of the replacement asset period · if the replacement asset is a share in a company, at the end of the replacement asset period: - you, or an entity connected with you, are a CGT concession stakeholder in the company or trust, or - CGT concession stakeholders in the company or trust have a small business participation percentage in the interposed entity of at least 90% · the capital gain that is being rolled over is not more than the sum of the following - the amount paid to acquire the replacement asset (that is, the first element of the cost base of the replacement asset) - any incidental costs incurred in acquiring that asset, which can include giving property (that is, the second element of the cost base of the replacement asset), and - the amount expended on capital improvements to one or more assets that were acquired or already owned (that is, fourth element expenditure). In this case, you intend to acquire shares in company B as replacement assets within the replacement asset period. Company B will satisfy the 80% test and the shares will pass the active assets test. The rollover will result in the individual shareholders holding a percentage each of company B while the family trusts will hold the remaining shares. In order for the individual shareholders to be CGT concession stakeholders in company B, they will need to be 'connected with' at least one of the family trusts. An entity is connected with another entity if either entity controls the other entity, or both entities are controlled by the same third entity. A beneficiary is taken to control a discretionary trust only if, for any of the four income years before the year for which relief is sought for a CGT event: · the trustee paid to, or applied for the benefit of, the beneficiary or their affiliates, or both the entity and any of it's affiliates, any of the income or capital of the trust, and · the amounts paid or applied were at least 40% (the control percentage) of the total amount of income or capital paid or applied for that income year (subject to the Commissioner's discretion where the control percentage is between 40% and 50%). In this case, the individual shareholders have always received at least 40% of the distributions made from the family trusts and are taken to control their respective family trusts. They are considered to be connected with the trusts which will be CGT concession stakeholders of company B. The capital gain to be rolled over will not exceed the cost base of the replacement asset. Therefore, the rollover conditions will be satisfied. | Detailed Reasoning - Please note:: If an entity chooses the rollover concession, all or part of the capital gain will not be included in their assessable income until a change in circumstances happens, for example the replacement asset is sold. Under subsection 104-185(1) of the ITAA 1997 CGT event J2 happens if an entity chooses the rollover concession and a change in circumstances happens. When the change occurs, the deferred capital gain will crystallise. When an entity disposes of a replacement asset, CGT event A1 happens in addition to CGT event J2. Any capital gain made from the A1 event on the disposal of the replacement asset may qualify for any of the small business CGT concessions if the relevant conditions are satisfied. | Detailed Reasoning - Application of Part IVA: Part IVA of the ITAA 1936 is a general anti-avoidance provision that can apply in certain circumstances if a tax benefit is obtained in connection with a scheme, and it can be concluded that the scheme, or any part of it, was entered into for the dominant purpose of enabling a tax benefit to be obtained. Part IVA is a provision of last resort. The application of Part IVA depends on the facts of the particular case. In order for Part IVA to apply, the following questions must be addressed: · Is there a scheme as defined by section 177A of the ITAA 1936? · Is there a tax benefit which was obtained in connection with the scheme as defined by section 177C of the ITAA 1936? · Is the scheme a scheme to which Part IVA applies, as determined by section 177D of the ITAA 1936, where it would be concluded that your main or dominant purpose of entering into the scheme was to obtain the tax benefit? | Detailed Reasoning - Is there a scheme?: For Part IVA to apply, the identified scheme must fall within the following wide definition of 'scheme'. The definition applies to any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and any scheme, plan, proposal, action, course of action or course of conduct (subsection 177A(1) of the ITAA 1936). In the present case, there is a 'scheme' as defined in section 177A of the ITAA 1936, being the following arrangement: · both shareholders of company A will sell their to the newly formed company B · each of the two Family Trusts will purchase a percentage of the shares in company B, and · the two original company A shareholders will each purchase a percentage of the shares in company B as a roll over of their capital gain. | Detailed Reasoning - Is there a tax benefit?: The identification of a tax benefit necessarily requires consideration of the income tax consequences, but for the operation of Part IVA, of an 'alternative hypothesis' or a 'counterfactual. This is what would have happened or might reasonably be expected to have happened if the particular scheme had not been entered into or carried out. This alternative arrangement also forms the background against which the objective ascertainment of the dominant purpose of a person occurs in accordance with section 177D of the ITAA 1936. The counterfactual would involve both X and Y transferring a portion of their interests in company A to their respective family trusts. The transfer would result in a capital gain. As discussed above, the shareholders of company A would be entitled to apply the 50% capital gain discount and the small business active asset reduction and rollover concession under the small business CGT concessions to reduce any capital gain to nil. The counterfactual results in no tax benefit. | Detailed Reasoning - Objective purpose test: Section 177D of the ITAA 1936 provides that Part IVA applies to a scheme in connection with which you have obtained a tax benefit if, after having regard to eight specified factors, it would be concluded that a person who entered into or carried out the scheme, or any part of it, did so for the purpose of enabling you to obtain the tax benefit. As discussed above, any capital gain resulting from the disposal of the shares would be reduced to nil under the small business CGT concessions, result in a nil tax benefit. Therefore, Part IVA will not apply to this arrangement.

2. Do you qualify for the CGT active asset rollover concession? | 3. Will Part IVA apply to the arrangement? | Relevant facts: Company A is a private company owned by X and Y in equal shares. X and Y are also directors of company A. | The shares have been held by both parties for more than 12 months. | The company A has been independently valued. | Company A's directors/shareholders wish to plan ahead for asset protection and estate planning by: | · each shareholder selling their shares to a newly formed company B | · the X and Y Family Trusts will each purchase a percentage of the shares in company B, and | · X and Y will each purchase a percentage of the shares in company B as a roll over of their capital gain. | All the assets of company A and company B are active assets and the company is a small business entity. | The Family Trusts are discretionary trusts with corporate trustees. | X and Y have always received at least 40% of the distributions made from their respective family trusts. | The restructure will allow the business (company A) to be protected against personal risks such as personal litigation, bankruptcy and etcetera. | It will also allow the imputation credits to be safe from business risk in the company B. | The shares being held in the family trusts will facilitate future specie contributions to self managed super funds of the directors and spouses. | Currently the directors/shareholders are receiving franked dividends and director's fees from company A. After the restructure, the directors/shareholders will still receive franked dividends as distributions from the family trust and will still receive director's fees from company A. | The family trusts have young children as beneficiaries. Some trust distributions may occur to these and other beneficiaries of the family trusts. Any tax advantage as a result of these distributions will be minimal.