Private ruling: Small business capital gains tax concessions
Date of advice: 7 September 2015
Published: September 2015
Ruling period: Year ended 30 June 2015
Date scheme commenced: 1 July 2014

Ruling: Q1: Would the deceased have been entitled to apply the small business capital gains tax (CGT) 15 year exemption concession had they sold the Property and their share of the Business prior to their death? | A1: No. | Q2: Would the deceased have been entitled to apply the small business CGT 50% active asset reduction and retirement exemption concessions had they sold their share of the Business prior to their death? | A2: No. | Q3: Would the deceased have been entitled to apply the small business CGT 50% active asset reduction and retirement exemption concessions to the total amount of the capital gain had they sold the Property prior to their death? | A3: No. | Q4: Would the deceased have been entitled to apply the small business CGT 50% active asset reduction and retirement exemption concessions to a portion of the capital gain had they sold the Property prior to their death? | A4: Yes. | Q5: Will the Commissioner exercise his discretion under subsection 152-80(3) of the Income Tax Assessment Act 1997 (ITAA 1997) to extend the time limit to 30 June 2015 to allow the small business CGT concessions to be applied in relation to a portion of the capital gain resulting from the sale of the Property? | A5: Yes.

Relevant facts and circumstances: The deceased acquired two portions of a property prior to 20 September 1985 (Portion A and Portion B), Portion C in 199X and Portion D in 200X. The Property is a multi-level commercial building. The ground floor (approximately 25% of the total floor area) is leased to an arm's length party under a commercial lease. The upper floors are used for a boarding house business ('the Business') which was jointly owned and operated by the deceased and their spouse. The Business commenced prior to 20 September 1985. The Business was always operated by the deceased and their spouse together with caretakers who staffed the management office. The management office was located on the Property and was continuously occupied by the deceased, their spouse or a staff member at any given time (day or night) excluding Sunday mornings. Rooms were rented for various lengths of time. All boarders entered into an Occupancy Agreement which contained a listing of 'House Rules'. Under these: • only people listed on the occupancy agreement were allowed to stay at the premises • the deceased and their spouse retained the right to enter the rooms, with appropriate notice, for inspections, cleaning or maintenance issues • the agreement could be terminated by both the occupant and the proprietor with appropriate notice although there were situations where termination could be immediate without notice, such as those involving violence or threats of violence, wilful damage, continued or serious breach of house rules, and • boarders had access to a communal bathroom and kitchenette The deceased and their spouse • paid for all utilities • provided fresh towels and linen weekly and arranged for their cleaning, and • furnished the rooms with a bed, side table and chair which could not be removed by boarders. The deceased passed away in 20XX aged over 55 years of age. On their death their spouse became the sole owner of the Property and received the deceased's one half share of the Business as beneficiary under their will. The spouse continued to carry on the Business with the intention of selling it within two years of the deceased's death. In 20XX the Council wrote to the owner of the Property ('the Council Order') and stated the building was considered to be in an unsafe condition setting out a substantial amount of work required to ensure the building was compliant with the relevant legislation. The spouse commenced repairs and renovations to the Property to comply with the Council Order in 20XX. In 20YY the spouse contracted a real estate agent to commence the marketing campaign for the sale of the Property. At this point there was still substantial work to be performed in relation to the Council Order. An auction took place and no bids were taken. The marketing campaign continued but there was a lack of interest due to the uncompleted work on the Property and the difficulties in selling a boarding house. The spouse continued to complete the remaining requirements under the Council Order. Due to the substantial work and costs involved this was not completed until the relevant year. A contract for sale of the Property and the Business was entered into and settled in the subsequent income year. The total gross income for the Business and the rental of the ground floor of the Property in the 2011-12 financial years was less than $2 million per annum. Prior to their death, the deceased's sole income was from the Business and the Property.

Relevant legislative provisions: Income Tax Assessment Act 1997 Subsection 104-10(5) | Income Tax Assessment Act 1997 Subsection 128-15(4) | Income Tax Assessment Act 1997 Subdivision 152-A | Income Tax Assessment Act 1997 Subdivision 152-B | Income Tax Assessment Act 1997 Subdivision 152-C | Income Tax Assessment Act 1997 Subdivision 152-D | Income Tax Assessment Act 1997 Subdivision 152-E | Income Tax Assessment Act 1997 Section 152-35 | Income Tax Assessment Act 1997 Paragraph 152-40(4)(e) | Income Tax Assessment Act 1997 Section 152-80

Reasons for decision: Summary: The small business CGT concessions cannot be applied to the capital gain resulting from the sale of the deceased's share of the Business, Portion A and Portion B of the Property as these are pre-CGT assets. As such, any capital gain would have been disregarded by Division 104 of the ITAA 1997 and not Division 152 of the ITAA 1997 as required. The Commissioner has granted an extension of time to apply the small business 50% asset reduction and the small business retirement exemption to the capital gain resulting from the sale of Portion C and Portion D of the Property. | Detailed Reasoning - Detailed reasoning: Section 152-80 of the ITAA 1997 allows either the legal representative of an estate or the beneficiary to apply the small business CGT concessions in respect of the sale of the deceased's CGT assets in certain circumstances. Specifically, the following conditions must be met: • the asset devolves to the legal personal representative or passes to a beneficiary • the deceased would have been able to apply the small business concessions themselves if they had disposed of the asset immediately prior to their death, and • a CGT event happens within 2 years of the deceased's death unless the Commissioner extends the time period in accordance with subsection 152-80(3) of the ITAA 1997. | Detailed Reasoning - Small business CGT concessions - basic conditions: To qualify for the small business CGT concessions, you must satisfy several conditions that are common to all the concessions. These are called the basic conditions. The basic conditions for the small business CGT concessions in Subdivision 152-A of the ITAA 1997 (as relevant to this case) are: • the small business entity test and • the active asset test. Small business entity You will be a small business entity if you are an individual, partnership, company or trust that is carrying on a business and has an aggregated turnover was less than $2 million. In this case, from the information provided is accepted that the deceased was a member of a partnership which operated a business with a turnover of less than $2 million. The Property was used in this business activity. The small business entity test has been met. Active asset test The active asset test is contained in section 152-35 of the ITAA 1997. The active asset test is satisfied 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 test period detailed below; 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 7.5 years during the test period. The test period is from when the asset is acquired until the CGT event. If the business ceases within the 12 months before the CGT event (or such longer time as the Commissioner allows) the relevant period is from acquisition until the business ceases. A CGT asset is an active asset if it is owned by you and is used or held ready for use in a business carried on (whether alone or in partnership) by you, your affiliate, your spouse or child, or an entity connected with your. Paragraph 152-40(4)(e) of the ITAA 1997 states, however, that an asset whose main use in the course of carrying on the business is to derive rent cannot be an active asset unless the main use for deriving rent was only temporary. Taxation Determination TD 2006/78 discusses the circumstances in which premises used in the business of providing accommodation for reward can be active assets notwithstanding the exclusion in paragraph 152-40(4)(e) of the ITAA 1997. TD 2006/78 states: 22. Whether an asset's main use is to derive rent will depend on the particular circumstances of each case. The term 'rent' has been described as follows: • the amount payable by a tenant to a landlord for the use of the leased premises ( C.H. Bailey Ltd v. Memorial Enterprises Ltd [1974] 1 All ER 1003 at 1010, United Scientific Holdings Lrd v. Burley Borough Council [1977] 2 All ER 62 at 78, 86, 93, 99); • a tenant's periodical payment to an owner or landlord for the use of land or premises (T he Australian Oxford Dictionary , 1999, Oxford University Press, Melbournt); and • recompense paid by the tenant to the landlord for the exclusive possession of corporeal hereditaments. ….. The modern conception of rent is a payment which a tenant is bound by contract to make to his landlord for the use of the property let (Halsbury's Laws of England 4 th Edition Reissue, Butterworths, London 1994, Vol 27 (1) 'Landlord and tenant', paragraph 212 23. A key factor therefore in determining whether an occupant of premises is a lessee is whether the occupier has a right to exclusive possession ( Radaich v. Smith (1959) 101 CLR 209; Tingari Village North Pty Ltd v. Commissioner of Taxation [2010] AATA 233 at paragraphs 44-46 … If, for example, premises are leased to a tenant under a lease agreement granting exclusive possession, the payments involved are likely to be rent and the premises not an active asset. On the other hand, if the arrangement allows the person only to enter and use the premises for certain purposes and does not amount to a lease granting exclusive possession, the payments involved are likely to be rent. 24. If premises are operated as a boarding house, the issue arises as to whether an occupant of part of the premises is a tenant or alternatively only a lodger/boarder with a licence to occupy. The Property was used for two purposes. The ground floor was leased to an unrelated party who operated a restaurant from it. The remaining floors were used for the boarding house business. The income derived from the leasing of the ground floor is rent within its' meaning of the amount paid by a lessee to a lessor for the use of the leased premises. We need to examine whether the income received from the Business constitutes 'rent' for the purposes of the active asset test. Paragraphs 8 to 10 of TD 2006/78 provide an example of a boarding house which is an active asset: 8. David owns an 8 bedroom property which he operates as a boarding house. He resides on the premises. Boarders enter into arrangements to occupy single rooms with an average length stay being 4-6 weeks. No notice is required to quit the rooms. There are rules requiring visitors to leave the premises by a certain time and David retains the right to enter the rooms. David pays for all utilities (gas, electricity, water) and provides the following services and facilities to boarders: • room cleaning and general maintenance; • linen and towels; and • common areas such as a TV/lounge room, kitchen, bathrooms, laundry and a recreation area. 9. In this example, the services and facilities provided to boarders are relatively significant and the average length of stay is relatively short. David retains a significant degree of control over the premises through being on the premises most of the time. The arrangements entered into indicate that those staying in the boarding house do not have the right to exclusive possession of a room but rather only a right to occupy the room. 10. These circumstances indicate that the relationship between David and those staying at the boarding house is not that of landlord/tenant under a lease agreement. Accordingly, the income derived is not 'rent' and therefore paragraph 152-40(4)(e) exclusion does not apply. If David's activities amount to the carrying on of a business, the boarding house will be an active asset under section 152-40 of the ITAA 1997. The boarding house business operated is similar to the above example from TD 2006/78 as: • the management office was located on the Property and continuously occupied by the deceased, their spouse or a staff member at any given time excluding Sunday mornings • boarders entered into an occupancy agreement • boarders were required to abide by house rules • only people listed on the occupancy agreement were allowed to stay at the premises • the rooms were furnished with a bed, side table and chair which could not be removed by boarders • all utilities were paid for by the deceased and their spouse • fresh towels and linen were provided weekly and cleaned by the deceased and their spouse • all cleaning and maintenance was arranged for by the deceased and their spouse • boarders had access to a communal bathroom and kitchenette, • the deceased and their spouse retained the right to enter the rooms, with appropriate notice, for inspections, cleaning or maintenance issues. It is considered that people staying in the boarding house had a right to occupy the room and not the right to exclusive possession of the room. Therefore the relationship between the deceased and their spouse and those staying at the boarding house is not that of landlord/tenant under a lease arrangement. Accordingly, the income derived from the use of the Property in the Business is not 'rent' and paragraph 152-40(4)(e) of the ITAA 1997 does not apply. As the majority of the floor area of the Property is used in the Business and a similar portion of the income is derived from the boarding house operations, it is considered that the main use of the Property was not to derive rent. Therefore the Property and the Business were an active assets during the period it was owned by the deceased. | Detailed Reasoning - Small business 15 year exemption: An individual can disregard a capital gain from a CGT event happening to a CGT asset they have owned for at least 15 years if they: • satisfy the basic conditions for the small business CGT concessions • continuously owned the CGT asset for the 15 year period ending before the CGT event happened, and • when the CGT event happened: • they were permanently incapacitated, or • they were 55 years or older and the event happened in connection with their retirement. The beneficiary of a deceased estate will be eligible for the 15 year exemption to the same extent that the deceased would have been just prior to their death, except that: • the CGT event does not need to be in connection with the retirement of the deceased, and • the deceased needs to have been 55 or older immediately before their death, rather than at the time of the CGT event. As stated above, there are multiple CGT assets which are the subject of this ruling. Each will be examined separately. | Detailed Reasoning - The deceased's business share: The deceased's business share was acquired prior to 20 September 1985 and is considered to be a pre-CGT asset. Capital gains from the sale of a pre-CGT asset are disregarded under subsection 104-10(5) of the ITAA 1997. Whilst the deceased continuously owned their business share for more than 15 years and it was an active asset, had they disposed of their business share prior to their death, any resultant capital gain would have been disregarded under subsection 104-10(5) of the ITAA 1997 and not Division 152 of the ITAA 1997. As the deceased would not have been entitled to reduce or disregard the capital gain under Division 152 as required by paragraph 152-80(1)(c) of the ITAA 1997, section 152-80 of the ITAA 1997 does not apply. Therefore the small business 15 year exemption cannot be applied to capital gain resulting from the sale of the deceased's business share. | Detailed Reasoning - The Property: Taxation Determination TD 2000/31 states that if a taxpayer owns an interest in a CGT asset and they acquire another interest in the asset, the interests remain separate CGT assets. If you then sell your interests in the CGT asset together, the 15 year exemption applies only to interests in the asset that you have owned continuously for at least 15 years. The exemption does not apply to any interest you have owned for less than 15 years. The deceased acquired portions of the Property over a number of years. Each share will be examined separately to determine if the deceased would have been entitled to the 15 year exemption in relation to each share. (a) Portion A and Portion B The deceased acquired both Portion A and Portion B in the Property prior to 20 September 1985. Thus, both shares are considered to be pre-CGT assets. Whilst the deceased continuously owned these Property shares for more than 15 years and the Property was an active asset, had they disposed of the shares prior to their death, any resultant capital gain would have been disregarded under subsection 104-10(5) of the ITAA 1997 and not Division 152 of the ITAA 1997. As the deceased would not have been entitled to reduce or disregard the capital gain under the small business CGT concessions contained in Division 152 as required by paragraph 152-80(1)(c) of the ITAA 1997, section 152-80 of the ITAA 1997 does not apply. Therefore the small business 15 year exemption cannot be applied to capital gains resulting from the sale of Portion A or Portion B of the Property. (b) Portion C The deceased acquired Portion C of the Property in 199X and they passed away in 20XX. Had the deceased sold Portion C of the Property just prior to their death they would not have been entitled to apply the 15 year exemption to the capital gain resulting from its sale as they Portion C of the Property for less than 15 years. (c) Portion D The deceased acquired Portion D of the Property in 200X. Had the deceased sold Portion D of the Property just prior to their death they would not have been entitled to apply the 15 year exemption to the capital gain resulting from its sale as they owned this share for less than 15 years. Summary of the 15 year exemption in relation to the Property Had the deceased disposed of the Property prior to their death they would not have been entitled to disregard the resultant capital gain using the small business 15 year exemption concession as either: • the capital gain relating to Portion A and Portion B of the Property are disregarded under another provision of the legislation as they were pre-CGT assets, and • the deceased did not hold Portion C or Portion D of the Property for 15 years. | Detailed Reasoning - Small business 50% active asset reduction concession: If you do not qualify for the small business 15 year exemption, the small business 50% active asset reduction may apply to reduce the capital gain (Subdivision 152-C of ITAA 1997). The small business 50% active asset reduction applies automatically if the basic conditions are satisfied, unless you choose for it not to apply. As discussed above, both the Property and the deceased's share of the Business meet the basic conditions for small business CGT concessions. However, as the deceased's share of the Business, Portion A and Portion B of the Property are pre-CGT assets, any capital gain that resulted from the sale of these assets, had the deceased sold them prior to their death, would not have been eligible for the small business 50% active asset reduction. This is because resultant capital gain would have been exempt under a Division 104 of the ITAA 1997 and not Division 152 of the ITAA 1997. The deceased would have been entitled to apply the small business 50% active asset reduction to a capital gain resulting from the sale of Portion C and Portion D of the Property had they been sold prior to the deceased's death as they are post CGT assets. | Detailed Reasoning - Small business retirement exemption: If you are an individual, over 55 years of age, you can choose to disregard all or part of a capital gain, under division 152-D of the ITAA 1997, if: • you satisfy the basic conditions, and • you keep a written record of the amount you choose to disregard (the CGT exempt amount) The CGT exempt amount must not exceed $500,000 reduced by any previous CGT exempt amounts you have disregarded under the retirement limit. As the deceased was over 55 year of age at the time of their death and the basic conditions were met for both the Property and their share of the Business. Similar to the small business 50% active asset reduction, the deceased would have not have been eligible to apply the small business retirement exemption to the capital gain from the sale of the Business, Portion A or Portion B of the Property had the assets been sold prior to the deceased's death. The deceased would have been entitled to apply the small business retirement exemption to the capital gain from the sale of Portion C and Portion D of the Property had the assets been sold prior to the deceased's death. | Detailed Reasoning - Small business rollover: 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. Again, the deceased would not have been entitled to apply the small business rollover concession had they sold the Property and their share of the Business prior to their death with the intention of acquiring a replacement property and business as the information provided in the ruling indicates the deceased was seeking to retire and would not have taken this action. Therefore the deceased would not have been entitled to apply the small business rollover concession. | Detailed Reasoning - Extension to apply small business CGT concessions: The deceased was entitled to apply the small business 50% active asset reduction and retirement exemptions to the capital gain resulting from the sale of Portion C and Portion D of the Property. The beneficiary of the deceased's estate may apply the small business CGT concessions in respect any capital gain resulting from the sale of Portion C and Portion D of the Property. However, this may only occur where the Property was sold within two years of the deceased's death unless the Commissioner extends the time period in accordance with subsection 152-80(3) of the ITAA 1997. The deceased passed away in 20XX but the Property was not sold until 20ZZ income year. This is longer than the two year limit required by paragraph 152-80(1)(d) of the ITAA 1997. The Commissioner may exercise his discretion to allow an extension of time under subsection 152-80(3) of the ITAA 1997 in situations where: • there is a significant delay in obtaining probate • the will is contested or challenged • the complexity of a deceased estate delays the completion of administration of the estate • a trustee or beneficiary is unable to attend to the deceased estate due to unforeseen or serious personal circumstances arising during the two-year period (for example, the taxpayer or a family member has a severe illness or injury), or • settlement of a contract of sale is unexpectedly delayed or falls through for circumstances outside the beneficiary or trustee's control. In determining whether the discretion to allow further time would be exercised, the Commissioner considers the following factors: • evidence of an acceptable explanation for the period of the extension requested and whether it would be fair and equitable in the circumstances to provide such an extension • prejudice to the Commissioner which may result from the additional time being allowed but the mere absence of prejudice is not enough to justify the granting of an extension • unsettling of people, other than the Commissioner, or of established practices • fairness to people in like positions and the wider public interest • whether any mischief is involved, and • consequences of the decision. The spouse attempted to sell the Property and the Business within two years of the deceased passing away. The Property did not sell due to the extensive work required to be performed under the Council Order. Work performed in accordance with the Council Order was nearing completion when the spouse received an offer for the sale of both the Property and the Business. Given the extensive work required to be performed under the Council Order and the reluctance of potential purchasers to purchase a property requiring significant repair and renovation, the delay in selling the Property is considered to be reasonable. Therefore the Commissioner has exercised his discretion under subsection 152-80(3) of the ITAA 1997 to extend the time limit to 30 June 20ZZ to allow the small business 50% active asset reduction and retirement exemption to be applied in relation to the capital gain from the sale of Portion C and Portion D in the Property. An extension will not be granted in relation to the sale of the Business or Portion A and Portion B of the Property as they do not meet the requirements for any of the small business CGT concessions had they been sold prior to the deceased's death.