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

Ruling: Q1: Is the land which you intend to renew a lease for, under capital gains tax (CGT) event F2, considered an active asset for the purposes of the CGT concessions for small business? | A1: Yes | Q2: Are you eligible to disregard any capital gain made on renewal of the lease under the CGT 15-year exemption concession for small business? | A2: Yes

Relevant facts and circumstances: You own some land on which you run a business in partnership. You each hold a 50% interest in the land. The land was purchased in the early 90's and has been used in the business since this time. The main source of assessable income for the business is from livestock sales. You also receive annual lease income from an unrelated company for use of part of your land. The original lease commenced in the late 90's. You intend to renew the lease for a term over 50 years. The lease payment is to be received up-front. You state that that this will trigger capital gains tax (CGT) event F2. You state the business is a small business entity. You state that you only wish to establish whether the land that will be subject to the lease is an active asset and you are satisfied that you meet the other required basic conditions to access the small business concessions. You are both aged over 55 years. You state that the event will happen in connection with your retirement as you will be winding everything down, possibly within the financial year.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 104-115 | 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 328-125 | Income Tax Assessment Act 1997 Section 152-105

Reasons for decision: Detailed Reasoning - CGT event F2: Section 104-115 of the Income Tax Assessment Act 1997 (ITAA 1997) explains that CGT event F2 happens if: (a) a lessor grants a lease over land (whether or not the lessor owns an estate in fee simple in the land), or renews or extends a lease over land; and (b) the lease, renewal or extension is for at least 50 years and: i. at the time of the grant, renewal or extension, it was reasonable to expect that it would continue for at least 50 years; and ii. the terms of the lease, renewal or extension as they apply to the lessee are substantially the same as those under which the lessor owned the land or held a lease of the land; and (c) the lessor chooses to apply this section instead of section 104-110 (about CGT event F1). In your case, you state that you intend to renew a lease over a part of your land, the length of the lease is to be for over 50 years and CGT event F2 will happen. | Detailed Reasoning - Small business CGT concession eligibility: 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 (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. ATO Interpretative Decision ATO ID 2004/650 discusses small business concessions and the grant or renewal of leases. It explains that the first condition in paragraph 152-10(1)(a) of the ITAA 1997 requires that the CGT event happens in relation to a CGT asset of the taxpayer. It is considered the words 'in relation to' in paragraph 152-10(1)(a) of the ITAA 1997 are wide enough to allow reference to an underlying asset such as the premises over which a lease has been granted. Further, the note to ATO ID 2004/650 states: It is the underlying asset premises that must satisfy the active asset test in terms of paragraph 152-10(1)(d) of the ITAA 1997. Accordingly, a CGT event F2 capital gain may qualify for small business CGT relief on the basis that the event happens in relation to the underlying premises. In your case, you state that you already satisfy most of the conditions and only wish to establish whether the land that is subject to CGT event F2 will satisfy the active asset test under section 152-35 of the ITAA 1997. | Detailed Reasoning - Active asset test: 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: beneficially owns, or have the right to acquire the beneficial ownership of, interests in the other entity that give the right to receive a least 40% (the control percentage) of any distribution of income or capital by the other entity: 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. Taxation Determination TD 2006/78 considers, amongst other issues, the situation where there is part business and part rental use of an asset. It states that an asset owned by the taxpayer and used partly for business purposes and partly to derive rent can be an active asset under section 152-40 of the ITAA 1997 where it is considered that the main use of the asset is not to derive rent. In deciding if the property was mainly used to earn rent the Commissioner will consider a range of factors such as: · the comparative areas of use of the premises (between rent and business) · the comparative levels of income derived from the different uses of the asset. The use of the asset to derive rent from a third party will be considered use to derive rent, even if that entity uses the asset in their business. This is because the use of the asset by the asset owner is to derive rent. However, use of the asset by a relevant entity is treated as the use by the asset owner, even if the asset owner receives rent from the relevant entity for the use of that asset. This means, if the relevant entity uses the asset: · in its business, that use is treated as use by the asset owner to carry on business · to derive interest, rent, royalties, or foreign exchange gains from an entity that is a third party, that use is treated as use by the asset owner to derive passive income. In your case, you each hold a 50% interest in some land that you acquired in the early 90's. The land has been used by a partnership in the course of carrying on a business since you acquired it. The partnership is an entity that is 'connected with' you as you each hold a 50% controlling interest in the partnership. The renewal of the lease to an unrelated third party, will mean that there will be part business use (that part used by the partnership for farming) and part rental (that part leased to the unrelated third party). In determining whether the asset's main use is to derive rent, it can be noted that: · the main source of income from the use of the land is business income · of the total hectares that make up the land, less than 1% is used to earn lease income. Therefore, based on the information provided, the main use of the land is not to derive rent, accordingly, the land will satisfy the active asset test. | 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 · you are aged over 55 · the event will happen in connection with your retirement Accordingly, you satisfy all the conditions necessary to be eligible for the small business 15-year exemption concession.