Private ruling: Capital Gains Tax and Small business concessions
Date of advice: 28 September 2017
Published: February 2018
Ruling period: 1 July 2017 to 30 June 2018
Date scheme commenced: 1 July 2017

Ruling: Q1: Will Partnership X satisfy the basic conditions in subdivision 152-A of the Income Tax Assessment Act 1997 (ITAA 1997), to be eligible for the Small Business CGT Concessions in Division 152 of the ITAA 1997? | A1: No | Q2: Will the taxpayers be entitled to the CGT small business 15 year exemption in subdivision 152-B of the ITAA 1997 on the sale of their farm land if they retire after settlement? | A2: Not applicable | Q3: Will the taxpayers be entitled to the CGT small business 15 year exemption in subdivision 152-B of the ITAA 1997 on the sale of their farm land if they acquire a new business and oversee a manager appointed to run the business, or work in it personally for significantly less hours than they work in the current business? | A3: Not applicable | Q4: If the answer to question 2 or 3 is ‘no’ will the taxpayers be entitled to the Small business roll-over in subdivision 152-E of the ITAA 1997 on the sale of their farm land? | A4: Not applicable | Q5: Will the compensation received by the taxpayers for the decrease in value of the farm land, cause a capital gain to arise to the taxpayers? | A5: Yes | Q6: If the answer to 5 is ‘yes’, will the taxpayers be entitled to the CGT small business 15 year exemption in subdivision 152-B of the ITAA 1997 on receipt of the compensation? | A6: Not applicable | Q7: If the answer to question 5 is ‘yes’ and question 6 is ‘no’ will the taxpayers be entitled to the CGT small business concession in subdivision 152-C of the ITAA 1997 on receipt of the compensation? | A7: Not applicable | Q8: If the answer to question 5 is ‘yes’ and question 6 is ‘no’ will the taxpayers be entitled to the CGT small business concession in subdivision 152-D of the ITAA 1997 on receipt of the compensation? | A8: Not applicable | Q9: If the answer to question 5 is ‘yes’ and question 6 is ‘no’ will the taxpayers be entitled to the Small business roll-over in subdivision 152-E of the ITAA 1997 on receipt of the compensation? | A9: Not applicable

Relevant facts and circumstances: 1. Taxpayer Y and Taxpayer Z (the taxpayers) jointly acquired farm land and have lived on and carried on a primary production activity in partnership on the farm land since they acquired it. The partnership is registered for GST. Taxpayer Y works approximately 35 hours per week in the business and Taxpayer Z works approximately 15 hours per week in the business. 2. The initial intention of the taxpayers to run a profitable business did not work to plan as the costs increased dramatically. These costs included purchasing special supplies and transportation costs. A drought also affected the profitability of the farm. 3. After conducting research (which included engaging a consultant), the taxpayers decided to pursue a stud farm business. This decision was not made lightly as significant expenditure was required to establish the stud. 4. These capital costs included: ● Building stables to house and show stud cattle; ● Special bull fencing; ● Purchase of bulls; ● Purchase of embryos and semen; ● Purchase of special grain mixing machine to make special feed; ● Purchase of stud females. 5. The council rezoned the land and so rates rapidly increased. 6. The taxpayers have carried on their farming activity in an organised way including: ● Keeping financial records; ● They have a separate office in their farmhouse; ● They consider new ways to improve their activity by undertaking research via the internet, subscription to farming magazines, liaising with livestock agents; ● Working 7 days a week; ● All livestock purchases and sales are through livestock agents. 7. The activity is carried on in a manner like other farming business with capital improvements being made and regular activities such as: ● Feeding livestock; ● Repairing fences; ● Repairing water troughs and windmills; ● Checking water levels in troughs; ● Cropping; ● Drenching; ● Castrating; ● Injections to livestock; ● Tagging livestock; ● Meetings with livestock agents; ● Selling livestock; ● Burying dead livestock; ● Maintaining fire breaks etc. 8. Sometime after acquiring the farm land it became subject to a Public Acquisition Overlay. 9. The taxpayers entered into a contract to sell all the farm land (except a portion which they will continue to own and live on). 10. A plan of subdivision has been lodged by the purchaser for registration and if registered the purchaser will develop the land. 11. When the land is transferred to the purchaser the taxpayers will cease carrying on the activity and will retire. 12. Although the taxpayers intend to retire they may purchase another business. The taxpayers would own the business but would not work in the business as they have been doing. They would engage a manager to run, and work in the business. 13. The taxpayers would oversee the business operations and the manager. This would require regular meetings with the manager. The taxpayers may personally do some work in the business but it would be minor and only on a casual basis. 14. The W Family Trust (the Trust) is a discretionary trust associated with the taxpayers. The trustee of the Trust is Company V and the taxpayers are its only directors and shareholders. 15. The Taxpayers are members of a self-managed superannuation fund. 16. Apart from the above no other entities are connected with the taxpayers. The taxpayers do not have any affiliates. 17. Due to the land being subject to a Public Acquisition Overlay the value of the land decreased dramatically and as a result the taxpayers could only sell it for a price that was significantly below the price they could have sold it without the Public Acquisition Overlay. 18. The amount of loss was determined by a valuation. 19. The taxpayers have lodged a claim based on a loss on sale assessment plus the costs and expenses of the claim. 20. The partnership has generated losses for the past 7 income years. 21. Based on Projected Cash Flow Statements provided, the partnership has projected losses from the primary production activity for the next 4 income years. 22. The taxpayers do not have a business plan for the primary production activity and no information or documentation has been provided to demonstrate how a profit will be made in the future from the activity.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 110-25 | Income Tax Assessment Act 1997 Division 152 | Income Tax Assessment Act 1997 Subdivision 152-A

Reasons for decision: Summary: The Partnership will not satisfy the basic conditions in subdivision 152-A of the ITAA 1997, because the Partnership is not a small business entity for the purposes of section 328-110 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: 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 test You will be a small business entity if you are an individual, partnership, company of trust that is carrying on a business and had an aggregate turnover of less than $2 million. The meaning of carrying on a business of primary production is comprehensively considered in Taxation Ruling TR 97/11 (TR 97/11). Paragraph 12 of TR 97/11 makes the point that 'whilst each case might turn on its own particular facts, the determination of the question is generally the result of a process of weighing all the relevant indicators'. There is no single test of whether a business is being carried on. Paragraph 17 of TR 97/11 states that subject to the circumstances of a case, where an overall profit motive appears absent and the activity does not look like it will ever produce a profit, it is unlikely that the activity will amount to a business . Paragraph 18 of TR 97/11 includes the following table that outlines the main indicators of carrying on a business. The last three items shown are factors which support the main indicators. | Detailed Reasoning - Indicators which suggest a business is not being carried on: a significant commercial activity not a significant commercial activity purpose and intention of the taxpayer in engaging in the activity no purpose or intention of the taxpayer to carry on a business activity an intention to make a profit from the activity no intention to make a profit from the activity the activity is or will be profitable the activity is inherently unprofitable repetition and regularity of activity little repetition or regularity of activity activity is carried on in a similar manner to that of the ordinary trade activity carried on in an ad hoc manner activity organised and carried on in a businesslike manner and systematically - records are kept activity not organised or carried on in the same manner as the normal ordinary business activity - records are not kept size and scale of the activity small size and scale not a hobby, recreation or sporting activity a hobby, recreation or sporting activity a business plan exists there is no business plan commercial sales of product sale of products to relatives and friends taxpayer has knowledge or skill taxpayer lacks knowledge or skill The facts of each case will determine whether an entity’s activities relate to an identified enterprise. | Detailed Reasoning - (a) Significant commercial purpose:: The 'significant commercial purpose or character' indicator is closely linked to the other indicators and is a generalisation drawn from the interaction of the other indicators. It is particularly linked to the size and scale of activity, the repetition and regularity of activity and the profit indicators. | Detailed Reasoning - (b) Intention of the taxpayer:: The carrying on of a business is not a matter merely of intention. It is a matter of activity. It is appropriate to look at when the activities started and whether they add up to more than a mere intention to conduct a business. Determining whether a business has commenced or not is a complex issue but we consider that the main indicators of commencement are: ● purpose, intention and decision; ● acquisition of a business structure; and ● commencement of business operations. Brennan J in Inglis v FC of T 80 ATC 4001 at 4004-4005; (1979) 10 ATR 493 at 496-497 said that: The carrying on of a business is not matter merely of intention. It is a matter of activity. At the end of the day, the extent of activity determines whether the business is being carried on. That is a question of fact and degree. In this case the intention of the taxpayers to carry on a business is demonstrated by the purchase of the land, the establishment of a business structure in the partnership, and the commencement of operations such as the purchase of capital equipment and livestock. | Detailed Reasoning - (c) Prospect of profit:: Paragraph 48 of TR 97/11 states that it is important that the taxpayer is able to show how the activity can make a profit. It also states that it is not necessary for the primary production activities to make a profit in every year of income in order to classify the activities as a business of primary production. Thus, a taxpayer may be carrying on a business of primary production even though there is a small profit or a loss in any given year of income. Paragraph 50 of TR 97/11 states that: Where an activity is carried on and the objective evidence is that it is unlikely a profit will ever be made, this fact in itself does not necessarily mean that a business is not being carried on, if the taxpayer believes that the activity will become profitable. However, where a business is not profitable, paragraph 50 of TR 97/11 also states that: Taxpayers need to show that the other indicators of business are present in sufficient strength to outweigh any objective view that the activity may be inherently unprofitable. A number of Board of Review and Administrative Appeals Tribunal decisions show that a taxpayer in this situation bears a heavy onus: see Case M50 80 ATC 349; 24 CTBR (NS) Case 24 ; Case K9 78 ATC 98; 22 CTBR (NS) Case 29 ; Case L16 79 ATC 84; 23 CTBR (NS) Case 20 and Case L22 79 ATC 106; 23 CTBR (NS) Case 25 . In this case the partnership has incurred losses for the last 7 income years. Also, based on projected cash flows for the next 4 income years, the partnership is not expected to make a profit in the next 4 income years. Further, while some indictors of business are present, it is considered that they are not present in sufficient strength to outweigh the view that the primary production activity is inherently unprofitable. It is acknowledged that the taxpayers took action to change the activity, and this involved conducting research, engaging a consultant, and incurring expenditure required to establish the new activity. However, no information has been provided to demonstrate how the new activity was to become profitable, and losses continued to be made for the primary production activity up to the current financial year. | Detailed Reasoning - (d) Repetition and regularity: The taxpayer should undertake at least the minimum activities necessary to maintain a commercial quantity and quality of product for sale. It is a feature of any business that similar sorts of activities need to be carried out on a regular basis. This repetition leads to the carrying on of a business. In this case, based on the information supplied, the partnership has carried out the activity over a period of several years and the operations have been carried out with repetition and regularity. | Detailed Reasoning - (e) Is the activity of the same kind and carried on in a manner that is characteristic of the industry?: Paragraph 64 of Taxation Ruling TR 97/11 lists a number of factors which might be compared to others engaged in the same type of business: ● the manner and volume of sales ● the types of customers the taxpayer sells their product to ● what sort of expenses are incurred by the taxpayer ● the amount invested in capital items ● previous experience of the taxpayer Based on the information supplied the primary production activity is of the same kind and carried on in a manner that is characteristic of the industry. However, the activity has been carried out in a manner that has been unable to produce profits over the past 7 income years and that is projected to make further losses over the next 4 income years. The past losses and future projected losses, and the lack of investment in capital, are not consistent with a profitable primary production business. | Detailed Reasoning - (f) Organisation in a business like manner and the use of system.: A business should be characteristically carried on in a systematic and organised manner rather than on an ad hoc or disorganised way. An activity should generally conform with ordinary commercial principles to amount to the carrying on of a business. In this case, based on the information supplied, there has been a degree of system and organisation employed in the conduct of the activity. | Detailed Reasoning - (g) Size and scale of the activity: This is merely an indicator and not a determinative test. The larger the scale of the activity the more likely the taxpayer will be carrying on a business of primary production, although this may not always be the case. An activity carried out on a small scale may constitute the carrying on of a business if the taxpayer has the purpose of making a profit, there is repetition and regularity in the taxpayer's activities, the taxpayer informed himself of market conditions and the taxpayer organises his activities in a business-like way; FC of T JR Walker 85 ATC 4179; (1985) 16 ATR 331. It is clear enough that activities may be said to be a business even though carried on in a small way but nonetheless before such activities can be said to be a business it must be possible to attribute some significant commercial purpose or character to the activity; Thomas v FC of T 72 ATC 4094 at 4099; (1972) 3 ATR 165 at 171. Based on the information provided it is considered that the taxpayers did initiate the activity with the intention of making a profit, and the activity was carried out with a degree of organisation and with a degree of repetition and regularity. However, it is also considered that the size and scale of the activity was insufficient to generate profits in previous income years, taking into account the fixed costs and other expenditure required to undertake the activity. Also, based on the projected cash flows provided, this situation is not expected to change in the next 4 income years. | Detailed Reasoning - (h) Hobby or recreation: Paragraph 87 of Taxation Ruling TR 97/11 lists a number of factors which indicate that the taxpayer is often conducting a hobby: ● It is evident that the taxpayer does not intend to make a profit from the activity; ● Losses are incurred because the activity is motivated by personal pleasure and not to make a profit and there is no plan in place to show how a profit can be made; ● The transaction is isolated and there is no repetition or regularity of sales; ● Any activity is not carried on in the same manner as a normal, ordinary business activity; ● There is no system to allow a profit to be produced in the conduct of the activity; ● The activity is carried on a small scale; ● There is an intention by the taxpayer to carry on a hobby, a recreation or a sport rather than a business; ● Any produce is sold to friends and relatives and not to the public at large. In this case, the taxpayers have stated that the activity has not been undertaken for a hobby or for recreational purposes. However, based on the information provided, it is considered that there is no plan in place to demonstrate how a profit will be made in the future from the activity, and the activity is carried out on a small scale considering the fixed costs and other expenditure associated with conducting the activity. These are factors that indicate that an activity is not being carried out for a business purpose. | Detailed Reasoning - Outcome: In this case it is accepted that the activity was commenced with an intention to make a profit. Also, the activity has been carried out with repetition and regularity, there has been a degree of system and organisation employed in the conduct of the activity, and the activity is of the same kind and carried on in a manner that is characteristic of the industry. However, as the activity has incurred only losses for that past 7 years, and as the activity has projected losses for the next 4 income years, it is considered that the activity does not have a prospect of profit. It is also noted that there is no business plan for the activity and no information or documentation has been provided to demonstrate how a profit will be made in the future from the activity. Further, it is unclear how capital expenditure in earlier income years could result in realised profits. It is considered that the activity is lacking the level or organisation that would be required of a profitable business. The size and scale of the activity, taking into account the fixed costs and other expenditure associated with conducting the activity, is considered to be too small to be profitable. Overall, the indicators of business referred to above are not present in sufficient strength to outweigh the objective view that the activity is inherently unprofitable. As a result, it is concluded that the activity does not a have a significant commercial purpose as required by TR 97/11. Therefore, the taxpayers are not carrying on a business of primary production. As a result, the Partnership will not satisfy the basic conditions in subdivision 152-A of the ITAA 1997, because the Partnership is not a small business entity for the purposes of section 328-110 of the ITAA 1997. | Detailed Reasoning - Question 2: Not applicable | Detailed Reasoning - Question 3: Not applicable | Detailed Reasoning - Question 4: Not applicable | Summary: The compensation received by the taxpayers for the decrease in value of the farm land will cause a capital gain to arise to the taxpayers. The capital gains tax event will be C2. | Detailed Reasoning - Detailed reasoning: The taxpayers have made a claim for compensation. This was in response to the Land being subject to a Public Acquisition Overlay that the taxpayers say caused them loss in value of the Land. This claim has not yet been resolved. In this instance, the claim was made after both the sale of the relevant Land and closure of the relevant financial year. The Commissioner’s view of the treatment of compensation receipts is contained in Taxation Ruling TR 95/35 (TR 95/35). The relevant methods available for consideration of how any receipt of compensation by the taxpayers will be treated under the tax law are either the ‘underlying asset’, ‘compensation for permanent damage’ or ‘right to seek compensation’ approaches: see, further TR 95/35 at paragraphs 4 to 13. Although this ruling relies upon legislative references which have now been repealed and replaced by Part III of the ITAA 1997, they have equal application to this case. Underlying asset approach This approach is adopted by the Commissioner to identify the most relevant asset which generates the compensation receipt. This is also referred to as the ‘look through’ approach. It applies when there has been a disposal or destruction of the underlying asset and compensation is received in whole or in part in compensation for that disposal or destruction. In this instance, it is possible that the underlying asset is the Land because planning overlays were placed on the Land. However, the underlying asset approach is one which operates when the underlying asset is still property of the relevant taxpayer. On the facts of this case, the underlying asset has already been sold after any application was made for compensation. Further, no compensation has yet been received from any claim made by the taxpayers. Therefore, the taxpayers no longer hold rights in the land for that land to be considered the most relevant asset which generated the compensation receipt. Compensation for permanent damage approach On the facts, this approach does not apply as the Land has been sold such that there can be a recoupment in its acquisition cost. Right to seek compensation approach The right to seek compensation is a CGT asset. In this instance, the cause of action available to the taxpayers is a statutory action for compensation. The acquisition of the right to seek compensation and therefore the acquisition of the CGT asset occurs after the disposal of the land because the statutory right to seek compensation is only available after sale. CGT event C2 will occur if and when the taxpayers decide to settle, forfeit or give-up their claim, or alternatively, if that claim is determined by a decision of a tribunal or court. | Detailed Reasoning - Question 6: Not applicable | Detailed Reasoning - Question 7: Not applicable | Detailed Reasoning - Question 8: Not applicable | Detailed Reasoning - Question 9: Not applicable