Private ruling: CGT - small business concessions - active asset - 15 year - significant individual
Date of advice: 15 July 2019
Published: September 2019
Ruling period: Year ending 30 June 2019 | Year ending 30 June 2020
Date scheme commenced: 1 July 2018

Ruling: Q1: Does the property satisfy the active asset test for the purpose of the capital gains tax small business concessions? | A1: Yes | Q2: Has the company had a significant individual for 15 years as required under paragraph 152-110(1)(c) of the Income Tax Assessment Act 1997 (ITAA 1997)? | A2: No

Relevant facts and circumstances: B Pty Ltd (the company) was incorporated on XX August 19XX. M and O have been Directors of the company since incorporation. The company acquired a residential property (the property) on XX September 19XX. The property was occupied by M and O and has been used in M's business since XX July 20XX. The company intends to dispose of the property which will result in a capital gain. The share structure of the company is as follows: The Directors may determine whether a dividend is payable and fix the amount, the timing and the method of payment (as per clause XX of the Company Constitution). Distributions of profits and capitalised profits may be made to one or more class of share or classes of shares to the exclusion of the shares of any other class of share or classes of shares (as per clause XX of the Company Constitution). Ordinary shares possess voting rights and Classes B-E shares have no voting rights (as per clause XX of the Company Constitution).

Relevant legislative provisions: Income Tax Assessment Act 1997 subsection 152-35(1), | Income Tax Assessment Act 1997 section 152-40, | Income Tax Assessment Act 1997 subsection 152-40(4), | Income Tax Assessment Act 1997 paragraph 152-40(4A)(b), | Income Tax Assessment Act 1997 section 152-55, | Income Tax Assessment Act 1997 section 152-60, | Income Tax Assessment Act 1997 paragraph 152-110(1)(c), | Income Tax Assessment Act 1997 subsection 328-125(1), and | Income Tax Assessment Act 1997 subsection 328-125(2).

Reasons for decision: Summary: The property satisfies the active asset test and is therefore considered an active asset for the purposes of the small business capital gain concessions. The company does not have a significant individual, subsequently the requirement contained in paragraph 152-110(1)(c) of the ITAA 1997 has not been met. | Detailed Reasoning - Detailed reasoning: Active asset test Subsection 152-35(1) of the Income Tax Assessment Act 1997 (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. 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. However, subsection 152-40(4) explains that an asset whose main use is to derive rent cannot be an active asset. Paragraph 152-40(4A)(b) of the ITAA 1997 provides that to determine the main use of an asset, treat any use by your affiliate, or an entity that is connected with you, as your use. Subsection 328-125(1) of the ITAA 1997 explains that an entity is connected with another entity if: a) either entity controls the other entity in a way described in this section; or b) 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: 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. In your case, the property was used by a connected entity, M in the course of carrying on their business. M is one of the directors of the company, holding XX% of the voting power in the company. The asset was used in M's business for more than 7.5 years of the ownership period of more than 15 years, satisfying the timing requirements under subdivision 152-35(1) of the ITAA 1997 for an active asset. The property satisfies the active asset test and is therefore considered an active asset for the purposes of the small business capital gains concessions. Significant individual As per section 152-60 of the ITAA 1997 an individual is a CGT concession stakeholder of a company if they are a significant individual or the spouse of a significant individual, where the spouse has a small business participation percentage in the company at that time that is greater than zero. Under section 152-55 of the ITAA 1997 an individual is a significant individual in a company or trust if they have a small business participation percentage in the company or trust of at least 20%. This 20% can be made up of direct and indirect percentages. An entity's direct small business participation percentage in a company is the percentage of: · voting power that the entity is entitled to exercise · any dividend payment that the entity is entitled to receive · any capital distribution that the entity is entitled to receive, or · if they are different, the smallest of the three definitions above. In order to apply the 15 year exemption to a capital gain, paragraph 152-110(1)(c) of the ITAA 1997 requires that a company had a significant individual for a total of at least 15 years of the whole period of ownership (even if it was not the same significant individual during the whole period). Taxation Determination TD 2006/77 provides that all classes of shares must be taken into account in determining if a company has a significant individual. It follows that a shareholder that holds more than 20% of one class of shares in a company will not be a significant individual if their right to any distribution of income or capital from the company is dependent on a discretion to make distributions to any class of shares to the exclusion of the other classes of shares. A shareholder must be capable of receiving at least 20% of any distribution regardless of how a discretion is exercised. TD 2006/77 provides the following example: Bedrock Co has two different classes of shares, A and B, which have equal distribution rights. Only the A class shares have voting rights. Each class of shares is held by different shareholders - the A class shares being held in equal proportions by Fred and Barney and the B class shares being held in equal proportions by their respective wives, Wilma and Betty. The directors of Bedrock Co can decide to make a distribution of income or capital to either class of shares to the exclusion of the other class of shares. There is the possibility of any of the shareholders receiving 50% of a distribution from the company, depending on the exercise of the directors' discretion. In this situation, Bedrock Co does not have a significant individual. There is no specific individual who has the right to receive at least 20% of any distribution the company may make. Fred and Barney (who each hold 50% of the voting power) might receive 50% of a distribution or they might not receive anything at all, depending on how the directors exercise their discretion. In this case, M holds Ordinary shares and Class B shares; O holds Ordinary shares and Class C shares and C and N hold Class D and E shares respectively. Clause XX of the Company Constitution provides that distributions of profits and capitalised profits may be made to any one or more class of share or classes of shares to the exclusion of the shares of any other class or classes of shares. In accordance with TD 2006/77, M is not a significant individual as their small business participation percentage in the company was zero as M's right to a distribution of income from the company was dependent on how the directors exercised their discretion. There is no specific individual who has the right to receive at least 20% of any distribution the company may make. While M is a Director and holds voting power to determine the final distribution of dividends, M may choose to distribute dividends to the other classes of shareholders to the exclusion of Ordinary or Class B shareholders. The historical distribution of dividends is not taken into account when determining if a company had a significant individual at a point in time. Accordingly, M will not be a CGT concession stakeholder immediately before the CGT event and the company does not have any significant individuals for a total of at least 15 years of the whole period of ownership. Subsequently the requirement contained in paragraph 152-110(1)(c) of the ITAA 1997 has not been met.