Private ruling: Capital gains tax – small business relief – 50% reduction – 15 year exemption
Date of advice: 13 April 2018
Published: June 2018
Ruling period: Year ended 30 June 2017
Date scheme commenced: 1 July 2016

Ruling: Q1: Did the Company satisfy the conditions for the small business 15-year exemption pursuant to Subdivision 152-B in relation to the sale of the Property? | A1: Yes. | Q2: Did the Company satisfy the conditions for the small business 50% reduction pursuant to Subdivision 152-C in relation to the sale of the Property? | A2: No, as Subdivision 152-B applies to the sale of the Property.

Relevant facts and circumstances: 1. The Company and Connected Company are Australian resident companies. 2. The Company and Connected Company have had the same common shareholders, who have always each held more than 20% of the shareholdings, since they were first registered more than 15 years prior to the CGT event, discussed below. 3. A property (the Property) was purchased by the Company more than 15 years prior to the CGT event. 4. The Property was rented by and used by Connected Company, in the carrying on if its business for more than 10 years. 5. Connected Company is connected with the Company as both are controlled by mutual shareholders and directors. 6. There is no written rental/lease agreement as the entities shared common directors and a formal agreement was not considered necessary in these circumstances. 7. The Company and Connected Company were both placed into voluntary liquidation. 8. Due to the liquidation the Company and Connected Company did not carry on business in the 2017 income year. 9. A liquidator was appointed for the Company and Connected Company on DDMMYY. 10. The Property was sold by the liquidator of the Company by contract of sale on DDMMYY, with settlement occurring on DDMMYY. 11. At least one of the shareholders was more than 55 year of age at the time the Property was sold. 12. The Company and Connected Company had aggregated turnovers of below $2m for the income year ended 30 June 2015 and for the period 1 July 2016 to DDMMYY. 13. The Property was always intended for use in connection with the retirement of one of the shareholders who was more than 55 years of age at the time the Property was sold and following the liquidation, the individual retired.

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 152 | Income Tax Assessment Act 1997 Subdivision 152-B | Income Tax Assessment Act 1997 Subdivision 152-C | Income Tax Assessment Act 1997 Section 152-10 | Income Tax Assessment Act 1997 Section 152-35 | Income Tax Assessment Act 1997 Section 152-40 | Income Tax Assessment Act 1997 Section 152-49 | Income Tax Assessment Act 1997 Section 152-55 | Income Tax Assessment Act 1997 Section 152-65 | Income Tax Assessment Act 1997 S ection 152-110 | Income Tax Assessment Act 1997 Section 152-205 | Income Tax Assessment Act 1997 Section 328-110 | Income Tax Assessment Act 1997 Subsection 152-110(1) | Income Tax Assessment Act 1997 Subsection 152-10(1A) | Income Tax Assessment Act 1997 Subsection 152-110(1AA) | Income Tax Assessment Act 1997 Subsection 328-110(5)

Reasons for decision: Summary: Summary 1. The small business 15-year exemption under Subdivision 152-B applies to the capital gain in relation to the sale of the Property. Detailed reasoning | Detailed Reasoning - Basic conditions for relief: 2. Section 152-10 of the ITAA 1997 relevantly provides that the basic conditions for CGT relief under Division 152 in relation to a capital gain for an income year are that in that year: a. the conditions mentioned in subsection (1A) are satisfied, and b. the CGT asset satisfies the active asset test. 3. Subsection 152-10(1A) is satisfied in relation to the CGT asset in the income year if: a. an entity connected with you is: i. a CGT small business entity for the income year, and ii. carries on business, at a time in the income year, in relation to the CGT asset, and b. you do not carry on business in the income year. Note 3 to the subsection states that for business that are winding up, to see section 152-49 and subsection 328-110(5). 4. A small business entity, as defined by section 328-110, is an entity that carries on business in the current year, and either carried on business in the previous year with an aggregated turnover (the turnover of the entity and its connected entities and affiliates, excluding intra group transactions) for that year was less than $10m or its aggregated for the current year is likely to be less than $10m. A CGT small business entity, as defined by subsection 152-110(1AA), is as above with a previous year or expected aggregated turnover of less than $2m. 5. A CGT asset will satisfy the active asset test, pursuant to section 152-35, if the asset was an active asset for at least the lower of half or 7.5 years of the relevant period. 6. The relevant period for the active asset test is given in paragraph 152-35(2) as the time from when the entity acquired the asset to the earlier of the CGT event or, if the CGT event happened within 12 months after the cessation of the relevant business, the cessation of the relevant business. 7. An active asset is defined in section 152-40 as an asset an entity owns that is used, or held ready for use, in the course of carrying on a business by you, your affiliate or an entity connected with you. 8. Section 152-49 provides that where a business is winding up and the asset was used in the course of carrying on the business at a time in the income year in which the business stopped being carried on, that the entity will be taken to be carrying on a business at a time in the CGT event year and the asset will be taken to be used in the course of carrying on a business at that time. 9. Subsection 328-110(5) states: This Subdivision applies to you as if you carried on a *business in an income year if: (a) in that year you were winding up a business you previously carried on; and (b) you were a *small business entity for the income year in which you stopped carrying on that business. | Detailed Reasoning - Small business 15-year exemption: 10. Subsection 152-110(1) relevantly provides that the 15-year exemption for a company may be available where: a. the basic conditions for relief are satisfied, b. the company continuously owned the CGT asset for the 15 year period ending just before the CGT event, c. the entity had a significant individual for a total of at least 15 years during which the entity owned the CGT asset, d. an abovementioned significant individual was 55 years or over at the time of the CGT event, and e. the CGT event happened in connection with a significant individual’s retirement. 11. A significant individual is defined in section 152-55 as an individual who has a small business participation percentage in the company of at least 20%. A small business participation percentage in another entity is defined in section 152-65 as the sum of an entity’s direct and indirect small business participation percentages in the other entity. Relevantly, for a company the direct small business percentage is the lower of the percentage of voting power, dividend entitlement or capital entitlement of the individual. 12. Whether a CGT event happens in connection with an individual’s retirement depends on the particular circumstances of each case. A CGT event may be in connection with an individual’s retirement even if it occurs at some time before retirement. 13. The Explanatory Memorandum (EM) to the New Business Tax System (Capital Gains Tax) Bill 1999 makes the following comments about the requirement to be permanently incapacitated or retiring as one of the conditions for the concession: 1.68 One of the requirements of this concession for an individual small business taxpayer is that they must be either permanently incapacitated at the time of the CGT event, or at least 55 years old and using the capital proceeds for their retirement. 14. The provisions relating to the small business 15-year exemption do not define what is meant by the phrase ‘in connection with a taxpayer’s retirement’, nor does it give any indication of the degree of retirement required in order to take advantage of this concession. It could be argued that the phrase ‘in connection with retirement’ means that the capital gain arising from the disposal of active assets is to be used to provide funds for a person’s retirement rather than to precipitate retirement at the time of the CGT event. The words used in the EM support this interpretation. 15. The Advanced guide to capital gains tax concessions for small business 2013-14 (NAT 3359) also supports this view. It makes it clear that it is not necessary for there to be a permanent and everlasting retirement from the workforce. However, there would need to be at least a significant reduction in the number of hours worked or a significant change in the nature of the activities to be regarded as a retirement for the purposes of paragraph 152-110(1)(d)(i) of the ITAA 1997. | Detailed Reasoning - Small business 50% reduction: 16. An entity is entitled to the small business 50% reduction under section 152-205 if the basic conditions for relief are satisfied. 17. This reduction applies if the small business 15-year exemption does not apply. | Detailed Reasoning - Application to your circumstances: 18. The Company did not carry on business in any of the relevant income years. 19. Connected Company did not carry on a business in the 2017 income year. However, it was in the process of winding up after previously carrying on business, satisfying paragraph 328-110(5)(a). 20. Connected Company’s aggregated turnover for the 2016 income year, the year in which it stopped carrying on its business, was less than $10m, making it a small business entity for that income year for that year as per section 328-110, and satisfying paragraph 328-110(5)(b). Thus, Connected Company will be treated as if it carried on business in the 2017 income year. 21. As the Company’s annual turnover for the 2015 income year was less than $2m, they are a CGT small business entity for the 2016 income year as defined by subsection 152-10(1AA). 22. Additionally, as the Property was being used in the course of carrying on the business at a time in the income year in which the business stopped being carried on, Connected Company is taken to carry on the business at a time in the 2017 income year and the Property is taken to be used in the course of carrying on the business at that time pursuant to section 152-49. 23. Therefore, subsection 152-10(1A) is satisfied for the 2017 income year. 24. As the Property was disposed of within 12 months of the business ceasing, according to paragraph 152-35(2), the relevant period for the active asset test is the time from when it acquired the property to when the relevant business ceased. Thus, the relevant period is the date on which the Company acquired the Property to the date on which the business ceased. 25. The Property was used in the carrying on of the business of the Company’s connected entity, Connected Company, for more than 7.5 years of the relevant period. Thus the property satisfies the active asset test pursuant to section 152-35. 26. As the conditions mentioned in subsection 152-10(1A) are satisfied and the Property satisfies the active asset test in subsection 152-35, the basic conditions of relief pursuant to section 152-10 are satisfied in relation to the sale of the Property. 27. The Company continuously owned the Property for the 15 year period ending just before the CGT event, being the sale of the Property. 28. At least one of the shareholders held more than 20% of the shares in the Company which entitled them to more than 20% of the voting rights, dividends and capital entitlements of the Company. This is true from the time the Company was registered until the sale of the Property, totalling more than 15 years. Thus there was at least one individual whose small business participation percentage in the Company was greater than 20% and was therefore a significant individual in the Company. Thus, there was a significant individual for a total of at least 15 years during which the entity owned the Property, satisfying paragraph 152-110(1)(c). 29. The Property was sold in connection with the retirement of a significant individual aged over 55 year, thus satisfying paragraph 152-110(1)(d). 30. As the requirements under subsection 152-110(1) are met, the Company can disregard any capital gain arising from the sale of the Property. | Detailed Reasoning - Question 2: 31. As the 15-year exemption applies to the capital gain on the sale of the Property, the small business 50% reduction in Subdivision 152-C does not apply, pursuant to section 152-215.

Subject: Capital gains tax – small business relief – 50% reduction – 15 year exemption: All legislative references refer to the Income Tax Assessment Act 1997 unless otherwise indicated.