Private ruling: Capital Gains - Small Business Concessions
Date of advice: 17 June 2015
Published: June 2015
Ruling period: Year ending 30 June 2015
Date scheme commenced: 1 July 2014

Ruling: Questions and Answers | 1. Is the cash held by the Company included in the Numerator of the 80% Test under paragraph 152-40(3)(b) of the ITAA 1997? | Yes | 2. Are the Term Deposits held by the Company included in the Numerator of the 80% Test under paragraph 152-40(3)(b) of the ITAA 1997? | Yes | 3. Will the Dividend Stripping Anti Avoidance rulings in section 177E of the ITAA 1936 apply to the share transfer? | No | 4. Will section 177EA of the ITAA 1936 apply to deny franking credits being applied to future distributions being paid by the Company? | No

Relevant facts and circumstances: The Company is a proprietary company incorporated in Australia. The Company is capitalised by two ordinary shares with an initial cost of $1 each. The shareholders of the Company since incorporation are person A and person B (1 share each). The Company has operated a business since incorporation. Person A and person B are both employed by the Company. It is their intention at this stage to continue operating the business and they presently have no plans to retire. At 30 June 2014, the Company had retained earnings of $X. These retained earnings have been accumulated over many years from the profitable operation of the business. The estimated market value of the share in the Company are $Y each share. This market value will be confirmed by an expert valuer's report should the proposed share transfer proceed. The Company has a primary bank account which serves as the primary working account for the business. This account receives all income and pays all expenses of the business. The cash has always been retained in the bank account, has not been used by any other party and is equitably owned by the Company. As cash builds up in the primary bank account as a result of profitable trading, the Directors transfer surplus funds into a separate Term Deposit. This has occurred in almost all of the previous 15 years. The main purpose of the funds held on Term Deposit is possible future use in the Company's business operations. The directors do not wish to borrow money for the business or cash-flow needs so therefore retain excess cash to meet all future requirements. The main use of the funds is not the interest return that is being earned; it is to have funds available should they be required by the business. The Company holds the funds in Term Deposits for capital security and having funds available at short notice (Term Deposits are generally held for no longer than 3 months). The Company has held Term Deposits as part of its general business reserve for many years. The amounts retained in cash in the business, including term deposits, is roughly equal to or less than the annual revenue amount for the business. Proposed share transfer During the year ending 30 June 2015 person A and person B wish to transfer their shares in the Company to a newly established discretionary trust. The share transfer price is to be based on the current arm's length value of the shares. Person A and person B will be the appointers, trustees and named beneficiaries of the trust. The proposed transfer will provide them with numerous estate planning, asset protection and retirement planning benefits. It is proposed to access the small business CGT concessions to deal with any capital gain that will be derived upon the transfer of the shares to the Trust. Assumptions Note

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 152-40(3)(b) | Income Tax Assessment Act 1936 Section 177E | Income Tax Assessment Act 1936 Section 177EA

Reasons for decision: Summary: Paragraph 152-40(3)(b) A capital gain only qualifies for the CGT small business concessions if the relevant asset satisfies the active asset test. Section 152-40 contains the meaning of active asset. If the CGT asset is a share in a company that is not widely held the asset will be an active asset if: • The Company is a resident of Australia; and • The total of the following is 80% or more of the market value of all the assets of the Company: • The market value of the active assets of the Company; • The market value of any financial instruments of the Company that are inherently connected with the business that the Company carries on, and • Any cash of the Company that is inherently connected with such a business. Therefore, the cash and Term Deposits held by the Company must be inherently connected with the business to count towards satisfying the 80% or more of the total value of assets of the Company. The term 'inherently connected' is not defined in the ITAA 1936 or the ITAA 1997. Therefore the term takes on its ordinary meaning. The Macquarie dictionary defines the term as Inherently: is 'existing in something as a permanent inseparable element, quality or attribute Connected: to bind or fasten together, join or unite, link. to establish communication between, (something followed by with) to put in communication (something followed by with) to associate or attach: the pleasure connected with music. (something followed by with) to associate mentally to become connected; join or unite (something followed by with) (of trains, buses etc) to run so as to make connections baseball, tennis etc, colloquial to hit the ball, especially with force. Applying the definitions of inherently and connected to 'inherently connected' with the business for Division 52 of the ITAA 1997 it means that the cash and amount in Term Deposits are available for use in the business. ATO Interpretative Decision ATO ID 2003/714 confirms the above meaning by stating that if the money in the bank account is held in trust for a client, it is not inherently connected with the business, as the business does not have an equitable interest in the cash. As the cash has been exclusively used for the running of the business, it is clear that the funds are not available to or held for any other entity and the business has an equitable interest in the cash. Hence the cash is inherently connected with the business and is therefore included in the Numerator of the 80% test. As the sole source of funds held in Term Deposits is the Company's business operations and the funds are held for the sole benefit of the Company and the Company's business, the Term Deposits are inherently connected with the business and are therefore included in the Numerator of the 80% test. Section 177E & Section 177EA Sections 177E and 177EA of the ITAA 1936 are included in Part IVA of the ITAA 1936 which is a general anti-avoidance provision that can apply in certain circumstances if a taxpayer obtains a tax benefit in connection with a scheme, and it can be concluded that the scheme, or any part it, was entered into for the dominant purpose of enabling a tax benefit to be obtained. Part IVA is a provision of last resort. It is determined that sections 177E and 177EA would not apply to the proposed share transfer.