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

Ruling: Q1: Are you entitled to the 50% active asset reduction on the capital gain you made on transfer of the asset to your shareholder? | A1: Yes | Q2: Are you entitled to disregard the remainder of the capital gain you made on transfer of the asset to your shareholder, due to the utilisation of the 'retirement exemption' small business concession? | A2: No | Q3: Is the capital redemption reserve taxable as a deemed dividend on distribution to your shareholders when the company is liquidated? | A3: Yes

Relevant facts and circumstances: In the 2011-12 financial year, the company transferred an asset to a shareholder as an in-specie contribution. This asset was acquired in 1990. The shareholder who received the asset was under 55 years of age at the time of the transfer. You state that the shareholder will not pay any money for the property. You state that you satisfy the maximum net asset value test You state that the property was used in the course of carrying on a business by a connected entity. You state that the property has been owned by the company for more than 15 years, and for at least 7.5 of those years it was an active asset. You state that the company and the connected entity are connected entities as a shareholder controlled both entities through his more than 40% interest in both entities. This interest was later transferred to another shareholder who then controlled both entities as he had more than 40% interest in both entities. You state that shareholder is a significant individual of the company (and thereby a CGT concession stakeholder) as he held more than 20% of the voting, dividend and winding up rights. You state that the company met the 'company and trust conditions' relating to the retirement exemption small business concession as: · the transfer did not result in a J2, J5 or J6 CGT event · the company did not receive any capital proceeds from the disposal of the property and therefore did not make any payment · the capital gain was under $500,000 The company has a capital redemption reserve (as at 30 June 2010). The amount first appeared in the company's accounts in 1993. You state the company has only ever issued ordinary shares. You advise that there is no record of any redeemable preference shares ever being issued or redeemed.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 152-10 | Income Tax Assessment Act 1997 Section 152-15 | Income Tax Assessment Act 1997 Subsection 152-10(1A) | Income Tax Assessment Act 1997 Subsection 152-10(1B) | 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 104-10 | Income Tax Assessment Act 1997 Subsection 152-305(2) | Income Tax Assessment Act 1997 Section 152-325 | Income Tax Assessment Act 1997 Section 152-55 | Income Tax Assessment Act 1997 Section 152-65 | Income Tax Assessment Act 1997 Subsection 152-325(1) | Income Tax Assessment Act 1997 Section 152-60 | Income Tax Assessment Act 1997 Subsection 152-325(7) | Income Tax Assessment Act 1997 Subsection 152-325(4) | Income Tax Assessment Act 1997 Subsection 116-30(1) | Income Tax Assessment Act 1997 Subsection 152-305(2) | Income Tax Assessment Act 1997 Section 104-25 | Income Tax Assessment Act 1936 Subsection 47(1) | Income Tax Assessment Act 1936 Subsection 47(1A) | Income Tax Assessment Act 1936 Subsection 44(1) | Income Tax Assessment Act 1997 Section 118-20

Reasons for decision: Summary: You are entitled to the 50% active asset reduction for the capital gain made on disposal of the asset, as you are eligible for the small business CGT concessions and the asset meets the active asset test. You are not entitled to disregard the remaining capital gain made on the disposal of the asset as you have not satisfied the conditions required for the retirement exemption concession to apply. The capital redemption reserve is sourced from company profits and therefore it is considered income derived by the company. Accordingly, the funds in the capital redemption reserve will be deemed to be a dividend on distribution to shareholders. | Detailed Reasoning - 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 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 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. 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. Section 152-35 of the ITAA 1997 explains that an asset will be an active asset if you have owned the asset for more than 15 years and it was an active asset for a total of at least 7 ½ years from the time when you acquired the asset until the CGT event. Section 328-125 of the ITAA 1997 provides the meaning of 'connected with' an entity. Under this provision, an entity will be connected with you if either entity controls the other entity or, both entities are controlled by the same third entity. In the case of a company, an entity controls another entity if it beneficially owns interest in the other entity that gives the right to receive at least 40% of any distribution of income or capital by the other entity. In your case, CGT event A1 (section 104-10 of the ITAA 1997) relating to the disposal of an asset has occurred. The event has resulted in a capital gain and, you state that you satisfy the maximum net asset value. You state you have owned the asset since 1990 and it has been an active asset for at least 7 ½ years as it has been used in the course of carrying on a business by a connected entity. You state that the shareholder controlled both the company and the connected entity as he held 40% interest in both entities. This interest was later transferred to another entity who now controls both entities as he has more than 40% interest in both entities Based on the information provided, you have satisfied the basic conditions required to be eligible for the small business CGT concessions. Accordingly, you are automatically entitled to the 50% active asset reduction for the capital gain made on the disposal of the asset. | Detailed Reasoning - Retirement exemption: Subsection 152-305(2) of the ITAA 1997 provides that a company can disregard all or part of a capital gain if: · it satisfies the basic conditions · it satisfies the significant individual test · it satisfies the company conditions under section 152-325 of the ITAA 1997. Section 152-55 of the ITAA 1997 explains that an individual is a significant individual in a company if the individual has a small business participation percentage in the company or trust of at least 20%. Section 152-65 of the ITAA 1997 provides that the small business participation percentage in the company (for an entity) includes the percentage of voting power the entity is entitled to exercise and, any dividend payment or capital distribution the entity is entitled to receive. Subsection 152-325(1) of the ITAA 1997 states that a company must make a payment to at least one of its CGT concession stakeholders if the company receives an amount of capital proceeds from the CGT event which occurs under the retirement exemption choice. A CGT concession stakeholder is a significant individual in the company (section 152-60 of the ITAA 1997). Subsection 152-325(7) explains that if a CGT concession stakeholder is under 55 just before a payment is made under this section in relation to him or her, the company or trust must make the payment to the CGT concession stakeholder by contributing it to a complying superannuation fund or a retirement savings account (RSA) in respect of the stakeholder. The company must also notify the trustee of the fund that the contribution is made in accordance with a retirement exemption. Subsection 152-325(4) of the ITAA 1997 provides that the payment must be made by the later of: · 7 days after the company or trust makes the choice; and · 7 days after the company or trust receives an amount of capital proceeds from the CGT event. Subsection 116-30(1) of the ITAA 1997 states that if you did not receive any capital proceeds from a CGT event, you are taken to have received the market value of the asset that is the subject of the event. The retirement exemption is still available to a taxpayer when no capital proceeds are received however, in order to access the exemption, the company must make a payment of the disregarded capital gain to its CGT concession stakeholder (and in the case of a stakeholder that is under 55, a payment to their superannuation fund or RSA). In your case, you transferred the asset to your shareholder. No capital proceeds were received for the asset and therefore you are taken to have received the market value of the asset as capital proceeds. As such, in order to claim the retirement exemption, the company was required to make a payment to a CGT concession stakeholder, and if the stakeholder was under 55 just before the time of payment, the payment was required to be made to the stakeholder's superannuation fund or RSA. As you have not made any payment to your CGT concession stakeholder's superannuation fund or RSA, you have failed to satisfy the conditions required under subsection 152-305(2) of the ITAA 1997 and therefore the retirement exemption concession will not be available. Accordingly, you can not disregard the capital gain remaining after the application of the 50% active asset reduction concession. | Detailed Reasoning - Distribution on company liquidation: Taxation Determination TD 2001/27 discusses the treatment of a final distribution made by a liquidator. Paragraph 1 of TD 2001/27 states: The full amount of a final distribution made by a liquidator on the winding-up of a company constitutes capital proceeds from the ending of the shareholder's shares in the company for the purposes of capital gains or capital losses made on the happening of CGT event C2 (about cancellation, surrender and similar endings) in section 104-25 of the ITAA 1997. After the winding-up of a company, CGT event C2 happens to the shares when the company ceases to exist in accordance with the Corporations Act 2001. However, subsection 47(1) of the Income Tax Assessment Act 1936 (ITAA 1936) states that distributions made by a liquidator to shareholders of the company when winding up the company, as long as it is not to replace paid-up share capital, is deemed to be a dividend if it is from income derived by the company. Therefore, to the extent that the payment represents a return of capital actually contributed by the shareholders, they are not assessable as dividends. Subsection 47(1A) of the ITAA 1936 extends the meaning of 'income' for the purposes of subsection 47(1) to include: · An amount (other than a net capital gain) that is included in the company's assessable income for the year; and · A net capital gain that would be included in the company's assessable income for the year. For this purpose the capital gain is calculated without regard to indexation and any capital losses are ignored. Therefore, the portion of the distribution that represents profits of the company will be assessable in terms of subsection 47(1) of the ITAA 1936 as a deemed dividend. This portion includes any capital gain from investments and property that arise in the year the company is wound up. The balance will be a capital receipt and CGT event C2 will occur on cancellation or surrender of the shares. As the capital redemption reserve is sourced from company profits, it is considered income derived by the company. Further, as the reserve first appeared in the accounts of the company in 1993, the amount is considered to be post CGT. Accordingly, the funds in the capital redemption reserve will be deemed to be a dividend on distribution to shareholders. If all or part of a final distribution made by a liquidator of a company is deemed by subsection 47(1) of the ITAA 1936 to be a dividend paid out of profits, it will be assessable income of the shareholder of the company under subsection 44(1) of the ITAA 1936. Importantly, section 118-20 of the Income Tax Assessment Act 1997 (ITAA 1997) reduces a capital gain made from a CGT event by any amount which is assessable outside of the CGT provisions. Therefore, any capital gain or loss made by the shareholders under CGT event C2 will be reduced by the part of the final liquidator's distribution that is taxed as a dividend. This prevents this part of the distribution from being taxed twice. Please note, section 47 of the ITAA 1936 applies when the company deregisters voluntarily, as long as the company is deregistered within a period of three years after the distribution.

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