Private ruling: Capital gains tax concessions for small business
Published: July 2013

Ruling: Q1: Will Mr X and Mrs X, as partners in a partnership, be considered affiliates of each other for the purposes of the X Trust satisfying the maximum net asset value (MNAV) test under Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1:  | Q2: When calculating whether X Trust satisfies the MNAV test, is it only the value of the individual interests of Mr X and Mrs X in the partnership assets (and not the value of the assets of the partnership as a whole) that will be included in the calculation? | A2:  | Q3: Does X Trust satisfy the basic conditions necessary to be eligible for the capital gains tax (CGT) concessions for small business under Division 152 of the ITAA 1997? | A3: This ruling applies for the following period Year ending 30 June 2013 The scheme commenced on 1 July 2012

Relevant facts and circumstances: The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are: your application for private ruling attachments A - N (which include the financials of the entity/related entities) a calculation of the maximum net asset (MNAV) test for X Trust (attachment I) Company X as trustee for X Trust owned 50% of the shares in Company A. The remaining 50% of shares in Company A were owned by an unrelated private company. The shares in Company A were acquired in the late 1990's. You state that Mr Y is not an affiliate or 'connected with' X Trust. You state that Company C is not an affiliate or 'connected with' X Trust. You state that more than 80% of the assets of Company A are active. You state that the asset position of the company has been similar in prior years and have confirmed that more than 80% of the assets of Company A were active assets for the 7 year period prior to their disposal. Mr X and Mrs X own 50% each of the shares in Company X. Mr X and Mrs X were employed by Company A on a full-time basis. X Trust is a discretionary trust. Historical beneficiaries of X Trust include: Mr X Mrs X J and K (Mr and Mrs X's children) Company Y Mrs X owns 99.97% of the ordinary shares in Company Y and Mr X owns .03% of the ordinary shares. Company Y received over 40% of the distributions from X Trust from the 2007-08 financial year to the 2011-12 financial year. J received over 40% of the distribution from X Trust in the 2007-08 and 2008-09 financial years. However, you state that J does not hold any significant assets. Mr X, Mrs X and K have each received less than 40% of the distributions from X Trust from the 2007-08 financial year to the 2011-12 financial year. Mr X and Mrs X hold three properties as joint tenants (25% each) with Mr Y as a tenant in common (50%) as follows: Mr X, Mrs X and Mr Y registered a partnership and leased the properties to Company A. You state that even though there is a partnership registered for income tax and GST purposes, Mr X, Mrs X and Mr Y do not have a formal partnership business and are not carrying on a rental property business, but rather co-own the investment properties and leased it to Company A. You state that Mr X, Mrs X and Mr Y are not controlled by another person and do not act in accordance with each other's directions or wishes, or in concert with another person. The shares held by A Trust and Mr Y, in Company A, were sold to a third party pursuant to a sale agreement. When A Trust disposed of the shares, it triggered a capital gain. You propose to distribute the capital gain to Mr X and Mrs X (50% each). You state that any income derived by A Trust will be distributed 50/50 to Mr X and Mrs X in the 2012-13 financial year.

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 152-40 | Income Tax Assessment Act 1997 Section 152-60 | Income Tax Assessment Act 1997 Section 152-55 | Income Tax Assessment Act 1997 Section 152-65 | Income Tax Assessment Act 1997 Section 152-70 | Income Tax Assessment Act 1997 Section 152-75 | Income Tax Assessment Act 1997 Section 995-1 | Income Tax Assessment Act 1997 Section 328-130 | Income Tax Assessment Act 1997 Section 328-125 | Income Tax Assessment Act 1997 Section 152-20

Reasons for decision: Detailed Reasoning - Detailed reasoning: Small business CGT concession eligibility 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 capital gains tax (CGT) concessions. These conditions are: · a CGT event happens in relation to a CGT asset in an income year. · the event would have resulted in the gain · at least one of the following applies: · you are a small business entity for the income year · you satisfy the maximum net asset value test (MNAV) in section 152-15 of the ITAA 1997 · 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 · 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. · the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997. Subsection 152-10(2) of the ITAA 1997 provides that if the CGT asset is a share in a company or an interest in a trust (the object company or trust), one of these additional basic conditions must be satisfied just before the CGT event: you are a CGT concession stakeholder in the object company or trust; or CGT concession stakeholders in the object company or trust together have a small business participation percentage in you of at least 90%. A Trust disposed of shares in Company A to a third party, accordingly, CGT event A1 has occurred. The disposal has resulted in a capital gain and therefore you meet conditions (a) and (b) of the basic conditions. Therefore, we need to establish whether A Trust satisfies the MNAV test (condition (c)), the active asset test (condition (d)) and one of the additional conditions relating to shares in a company as listed in subsection 152-10(2) of the ITAA 1997. 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. 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. Subsection 152-40(3) of the ITAA 1997 provides that a share in a company that is an Australian resident can also be an active asset. This is provided that the total of: the market values of the active assets of the company; and the market value of any financial instruments of the company that are inherently connected with a business that the company carries on; and any cash of the company that is inherently connected with such a business; is 80% or more of the market value of all of the assets of the company. As the active asset test requires a CGT asset to have been an active asset for at least half of a particular period, as outlined earlier, in order 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 (subsection 152-40(3B) of the ITAA 1997), and in circumstances where it is reasonable to conclude that the 80% threshold has been passed (subsection 152-40(3A) of the ITAA 1997), such as when there have been no significant changes to the assets or liabilities of the company. Importantly, an interest in an entity that itself holds interests in another entity that operates a business may be an active asset, depending on the successive application of the 80% test at each level. In your case, A Trust acquired the shares in Company A in the late 1990's. Therefore A Trust has owned the shares for less than 15 years and it has been confirmed that the 80% test has been satisfied by for over half of this time. Accordingly, the shares will satisfy the active asset test. CGT concession stakeholder Section 152-60 of the ITAA 1997 provides that an individual is a CGT concession stakeholder of a company or trust at a time if the individual is a significant individual in the company or trust, or the spouse of a significant individual where the spouse has a small business participation percentage in the company or trust at that time that is greater than zero. Section 152-55 of the ITAA 1997 explains that an individual is a significant individual in a company or trust if the individual has a small business participation percentage in the trust of at least 20%. The 20% can be made up of direct and indirect percentages. A company or trust satisfies the significant individual test if it had at least one significant individual just before the CGT event. Section 152-65 of the ITAA 1997 provides that an entity's small business participation percentage in another entity at a time is the percentage that is the sum of: the entity's direct small business participation percentage in the other entity at that time; and the entity's indirect small business participation percentage in the other entity at that time. Subsection 152-70(1) of the ITAA 1997 explains that an entity's direct small business participation percentage in a trust, where entities do not have entitlements to all the income and capital of the trust (such as occurs in a non-fixed trust), and the trust makes a distribution of income or capital, is the percentage of: · distributions of income that the entity is beneficially entitled to during the income year, or · distributions of capital that the entity is beneficially entitled to during the income year. · Subsection 152-75(1) of the ITAA 1997 states that you work out the indirect small business participation percentage that an entity (the holding entity) holds at a particular time in another entity (the test entity) by multiplying: · the holding entity's direct small business participation percentage (if any) in another entity (the intermediate entity) at that time; by the sum of: the intermediate entity's direct small business participation percentage (if any) in the test entity at that time; and the intermediate entity's indirect small business participation percentage (if any) in the test entity at that time (as worked out under one or more other applications of this section). When testing an intermediate entity's indirect small business participation percentage in another entity, the intermediate entity becomes the holding entity. In your case, the CGT asset in question is the shares in Company A. A Trust owns 50% of the shares in Company A. Mr and Mrs X will receive 50% each of the distribution of income and capital of A Trust in the year in which the CGT event (the disposal of shares) happens. Therefore, both Mr and Mrs X will each have a direct participation percentage in A Trust of 50%. Further, as A Trust has a 50% participation percentage in Company A, both Mr and Mrs X will have a 25% indirect participation percentage in Company A (50% x 50%). Accordingly, as Mr and Mrs X each hold a 25% small business participation percentage in Company A, they will be significant individuals and CGT concession holders in Company A. As Mr X and Mrs X are both CGT concession holders in Company A and together they will receive 100% of the distributions from A Trust, they will have a small business participation percentage in A Trust of at least 90%, thereby satisfying the additional basic condition required to access the capital gains tax concessions for small business. Is the activity carried on between Mr X, Mrs X and Mr Y that of co-owners of investment properties or, partners carrying on a rental property business? Taxation Ruling TR 93/32 provides that a partnership, for the purposes of general law, is the relationship that exists between persons carrying on business in common with a view to profit. For income tax purposes, however, the definition of 'partnership' (section 995-1 of the ITAA 1997) not only encompasses a partnership in that sense, but also an association of persons in receipt of income jointly. Thus, the joint owners of property who share income from the property, whether as joint tenants or tenants in common, will be partners for income tax purposes, even though they may not be partners under general law. Most rental activities are a form of investment and do not amount to carrying on a business. A person who simply co-owns an investment property or several investment properties is usually regarded as an investor who is not carrying on a rental property business, either alone or with the other co-owners. This is because of the limited scope of the rental property activities and the limited degree to which a co-owner actively participates in rental property activities. Further, co-owners of rental property will generally hold the property as joint tenants or tenants in common. These tenancies are a further classification of the co-owners' interests. In your case, Mr X and Mrs X hold three properties as joint tenants (25% each) with Mr Y as a tenant in common (50%). The three properties are all leased to Company A. The income and expenses relating to the properties are shared in the same proportion as their ownership interests, that is, 50% to Mr Y and 25% each to Mr X and Mrs X. Further, Mr and Mrs X are both fulltime employees of Company A. Based on this information, it is reasonable to conclude that Mr X, Mrs X and Mr Y are not carrying on a rental property business in partnership and are therefore not a partnership at general law. This is because there are only three properties in question (which are let to the one tenant) and the co-owners do not actively participate in rental property activities. However, as the definition of a 'partnership' includes an association or persons in receipt of income jointly, Mr X, Mrs X and Mr Y's activities will constitute a 'partnership' for income tax purposes. Accordingly, the assets of the 'partnership' will be included in the calculation of the MNAV test if the partnership is 'connected with' A Trust in terms of the 40% distribution control test. However, if the partnership is not 'connected with' A Trust, it will only be the individual's interests in the partnership (the interests of Mr and Mrs X) that will be included in the MNAV test. Affiliate Subsection 328-130(1) of the ITAA 1997 explains that 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. Trusts, partnerships and superannuation funds cannot be your affiliates. However a trust, partnership or superannuation fund may have an affiliate who is an individual or company. However, subsection 328-130(2) of the ITAA 1997 explains that a person is not your affiliate merely because of the nature of a business relationship you and the person share. For instance, if you are a partner in a partnership, another partner is not your affiliate merely because you act, or could reasonably be expected to act in accordance with their directions or wishes, or in concert with the second partner, in relation to the affairs of the partnership. Whether a person acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes, or in concert with the taxpayer is a question of fact dependent on all the circumstances of the particular case. No one factor will necessarily be determinative. Are Mr X, Mrs X and Mr Y affiliates of each other? As already discussed, Mr X and Mrs X (along with Mr Y) are considered to be partners in a partnership for income tax purposes. However, they are not considered to be 'carrying on a business' together. As Mr X, Mrs X and Mr Y do not carry on a business together they would not normally be considered affiliates. In any case, subsection 328-130(2) of the ITAA 1997 provides that affiliates do not include partners who act in accordance with the direction of another partner or in concert with each other 'in relation to the affairs of the partnership'. Therefore, Mr X, Mrs X and Mr Y would not be considered affiliates of each other. Are Mr X, Mrs X and Mr Y considered to be affiliates of A Trust? In your case, Mr X and Mrs X and Mr Y will not normally be your affiliates as they are not considered to be 'carrying on a business' together. Therefore, they can not reasonably be expected to act in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the partnership. Further, as Mr and Mrs X each hold 50% of the shares of the trustee company of A Trust it is more likely that the trustee and therefore A Trust, would act in accordance with the directions or wishes of Mr X and/or Mrs X. You have also stated that Mr Y is not controlled by another person and does not act in concert with another person. In addition, there is no indication (from the facts provided) that A Trust has any influence over Mr Y in any separate business he may conduct individually. Therefore, Mr X, Mrs X and Mr Y would not be considered affiliates of A Trust. Accordingly, there are no affiliates whose net assets need to be included in the calculation of the MNAV test for A Trust. An entity that is 'connected with' you Subsection 328-125(1) of the ITAA 1997 explains that an entity is connected with another entity if: either entity controls the other entity in a way described in this section; or 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: or 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 328-125(3) of the ITAA 1997 explains that 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. Subsection 328-125(4) of the ITAA 1997 provides that an entity (the first entity) controls a discretionary trust for an income year if, for any of the 4 income years before that year: the trustee of the trust paid to, or applied for the benefit of: the first entity; or any of the first entity's affiliates; or the first entity and any of its affiliates; any of the income or capital of the trust; and 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. Subsection 328-125(7) states that the section applies to an entity (the first entity) that directly controls another entity (the second entity) as if the first entity also controlled any other entity that is directly, or indirectly by any other application or applications of this section, controlled by the second entity. Are Mr X and Mrs X entities that are 'connected with' the partnership? As already established, the partnership of Mr X, Mrs X and Mr Y is considered a 'partnership' for income tax purposes. As co-owners of the investment properties, it has been established that the ownership interests in the properties is that of tenants in common with 50% interest owned by Mr Y and the remaining 50% interest owned as joint tenants between Mr X and Mrs X (25% equal interest). Further, it has also been established that Mr X, Mrs X and Mr Y are not affiliates of each other. Accordingly, while Mr Y may be considered to be connected with the partnership (due to his 50% interest), Mr X and Mrs X only individually hold a 25% interest in the partnership. Therefore, Mr X and Mrs X are not entities 'connected with' the partnership. Is Company A an entity that is 'connected with' A Trust? A Trust holds 50% of the voting power in Company A, accordingly, Company A is an entity that is connected with A Trust. Is Mr X an entity that is 'connected with' A Trust? Mr X has not received 40% or more of the distribution of income or capital of the last four years before the CGT event, accordingly, Mr X is not an entity that is connected with A Trust. However, it may be that Company X, as the trustee company for A Trust, acts or could reasonably be expected to act, in accordance with the directions or wishes of Mr X as he holds 50% of the shares in the trustee company. Based on the information provided, and the fact that your calculation of whether A Trust satisfies that maximum net asset value (MNAV) test has included the value of Mr X's net assets, it is reasonable to expect that Mr X is an entity that is connected with A Trust. Is Mrs X an entity that is 'connected with' A Trust? Mrs X holds 99.97% of the shares in Company Y. As such, Mrs X is an entity connected with Company Y. Company Y received 61.3% of the distribution from A Trust in 2012. Therefore, Mrs X indirectly controls A Trust as her share of the distribution totals approximately 61% (61.3% x 99.97%). Accordingly, Mrs X is an entity connected with A Trust. Is J an entity that is 'connected with' A Trust? J has received more than 40% of the distribution of income of the trust for 2008 and 2009, accordingly, J will be an entity connected with A Trust. Is the partnership of Mr X, Mrs X and Mr Y an entity that is 'connected with' A Trust? As already established, Mr X, Mrs X and Mr Y are not considered affiliates of each other. Further, Mr X, Mrs X and Mr Y are not considered affiliates of A Trust. Therefore, A Trust does not control the partnership as it does not beneficially own interests in the partnership (alone or together with its affiliates) that give the right to receive a least 40% of any distribution of the net income of the partnership. Accordingly, the partnership is not an entity connected with A Trust. Is Company Y an entity that is 'connected with' A Trust? Company A has received more than 40% of the distribution of income of the trust for the prior 4 years, accordingly, Company Y will be an entity connected with A Trust. Based on the information provided, the following entities are considered to be entities connected with A Trust: Company A Mrs X Mr X J, and Company Y Maximum net asset value (MNAV) test Section 152-15 of the Income Tax Assessment Act 1997 (ITAA 1997) explains that you satisfy the MNAV test if, just before the CGT event, the sum of the following amounts does not exceed $6,000,000: the net value of the CGT assets of yours; the net value of the CGT assets of any entities connected with you; the net value of the CGT assets of any affiliates of yours or entities connected with your affiliates (not counting any assets already counted under paragraph (b)). Importantly, the Commissioner takes the view, in ATO Interpretative Decision ATO ID 2003/166, that cash or Australian currency is a CGT asset for the purposes of the MNAV test Subsection 152-20(1) of the ITAA 1997 provides that the net value of the CGT assets of an entity is the amount (whether positive, negative or nil) obtained by subtracting from the sum of the market values of those assets the sum of: the liabilities of the entity that are related to the assets; and the following provisions made by the entity: · provisions for annual leave; · provisions for long service leave; · provisions for unearned income; · provisions for tax liabilities. Subsection 152-20(2) of the ITAA 1997 provides that in working out the net value of the CGT assets of an entity: disregard shares, units or other interests (except debt) in another entity that is connected with the first-mentioned entity or with an affiliate of the first-mentioned entity, but include any liabilities related to any such shares, units or interests; and if the entity is an individual, disregard: assets being used solely for the personal use and enjoyment of the individual, or the individual's affiliate (except a dwelling, or an ownership interest in a dwelling, that is the individual's main residence, including any adjacent land to which the main residence exemption can extend because of section 118-120); and except for an amount included under subsection (2A), the market value of a dwelling, or an ownership interest in a dwelling, that is the individual's main residence (including any relevant adjacent land); and a right to, or to any part of, any allowance, annuity or capital amount payable out of a superannuation fund or an approved deposit fund; and a right to, or to any part of, an asset of a superannuation fund or of an approved deposit fund; and a policy of insurance on the life of an individual. Subsection 152-20(3) of the ITAA 1997 states that in working out the net value of the CGT assets of: your affiliate; or an entity that is connected with your affiliate; include only those assets that are used, or held ready for use, in the carrying on of a business by you or another entity connected with you (whether the business is carried on alone or jointly with others). In your case, you should include the net assets of the following entities: · A Trust · Company A · Mrs X · Mr X · J, and · Company Y Based on the information provided, you have calculated the MNAV test for A Trust including the value of the net assets of each of the entities listed above. The value calculated is less than the $6 million MNAV threshold. Accordingly, A Trust satisfies the MNAV test.