Private ruling: Non-concessional contributions cap - small business CGT concession.
Published: July 2014
Ruling period: Year ending 30 June 2015
Date scheme commenced: 1 July 2014

Ruling: Questions and answers | 1. Is the Taxpayer entitled to apply the 15 year exemption to the capital gain from the transfer of the Property? | Yes. | 2. Will the in specie contribution to a complying superannuation fund be a non-concessional contribution under section 292-100 of the Income Tax Assessment Act 1997 (ITAA 1997)? | No, provided the conditions in section 292-100 of the ITAA 1997 will be met.

Relevant facts and circumstances: The Taxpayer and his spouse are members of a self-managed superannuation fund (the Fund). The Taxpayer is the sole owner of a property that was originally built as a residence (the Property) which was acquired in 19XX. The Taxpayer has leased the Property since 19XX to a business (the business). The Taxpayer has advised the Property is used wholly and exclusively as a specific business. The business is a small business entity. The Taxpayer holds over 40% of the shares issued in the business. The Taxpayer wishes the Fund to acquire the Property and intends to contribute (to the Fund) the proceeds of the sale utilising the lifetime CGT cap of $1.315 million. The Taxpayer wishes to transfer the Property as in specie contributions into the Fund. The Property is valued at X and the Taxpayer will realise a capital gain of Y upon disposal. The Taxpayer is over 60 years of age and currently works 45 hours per week providing care to clients. Within three to six months of the CGT event, the Taxpayer plans to retire.

Relevant legislative provisions: Income Tax Assessment Act 1997 subsection 116-20(1) | Income Tax Assessment Act 1997 section 116-30 | Income Tax Assessment Act 1997 subdivision 152-B | Income Tax Assessment Act 1997 subdivision 152-C | Income Tax Assessment Act 1997 subsection 152-10(1A) | Income Tax Assessment Act 1997 section 152-15 | Income Tax Assessment Act 1997 section 152-35 | Income Tax Assessment Act 1997 subsection 152-40(1) | Income Tax Assessment Act 1997 section 285-5 | Income Tax Assessment Act 1997 subsection 292-90(2) | Income Tax Assessment Act 1997 section 292-100 | Income Tax Assessment Act 1997 section 292-105 | Income Tax Assessment Act 1997 subsection 328-125(2) ATO Interpretative Decision 2003/559 Income Tax: Disposal of a CGT asset to a trust: application of CGT event A1 or CGT event E2 | Advanced guide to capital gains tax concessions for small business 2011-12

Reasons for decision: Summary: The Taxpayer has satisfied the basic conditions and the specific requirements to access the 15 year exemption under the small business CGT concessions. If the proposed contribution is made by way of an in specie transfer of a CGT asset to the Fund, it will be excluded from being a non-concessional contribution provided the market value of the asset is below the CGT cap for the relevant income year and the other conditions in section 292-100 of the ITAA 1997 are satisfied. | Detailed Reasoning - Small business CGT concessions: To qualify for the small business capital gains tax (CGT) concessions, you must satisfy several conditions that are common to all the concessions. These are called the basic conditions. Subdivision 152-C of the ITAA 1997 applies the small business 50% active asset reduction provided the basic conditions are satisfied. A capital gain that you make may be reduced or disregarded under Division 152 of the ITAA 1997 if the following basic conditions are satisfied: • A CGT event happens in relation to a CGT asset of yours in an income year • The event would have resulted in a gain • The CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997, and • At least one of the following applies; • you are a small business entity for the income year • you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997 • you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an interest in an asset of the partnership, or • you do not carry on a business, but your CGT asset is used in a business carried on by a small business entity that is your affiliate or an entity connected with you. CGT event E2 CGT event E2 happens if you transfer a CGT asset to an existing trust. The time of the event is when the asset is transferred. You make a capital gain if the capital proceeds from the transfer are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base. If you are the trustee of the trust and no beneficiary is absolutely entitled to the asset as against you (disregarding any legal disability), the first element of the asset's cost base and reduced cost base in your hands is its market value when the asset is transferred. CGT event E2 does not happen if you are the sole beneficiary of the trust and: (a) you are absolutely entitled to the asset as against the trustee (disregarding any legal disability); and (b) the trust is not a unit trust. As per subsection 102-25(1) of the ITAA 1997, if more than one CGT event can happen, you need to select the event that is the most specific to your situation. ATO ID 2003/559 states that: CGT event A1 is considered the most specific event whenever the parties are unconnected. It would be inappropriate for a different CGT event to apply depending on whether the vendor knew the capacity in which the purchaser was acquiring the asset. On the other hand, CGT event E2 will be the most specific event if, for example, an asset is transferred to a trust of which the transferor or an associate is a beneficiary or object. In this case, the Taxpayer plans to transfer the property in specie to an SMSF of which they are one of two beneficiaries. As such, it cannot be said that the parties are unconnected. Therefore, the most relevant event in this case is CGT event E2. The CGT event will occur when the Taxpayer transfers the asset to the SMSF. Passively-held assets The conditions in subsection 152-10(1A) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year if: (a) your affiliate, or an entity that is connected with you, is a small business entity for the income year; and (b) you do not carry on a business in the income year (other than in partnership); and (c) if you carry on a business in partnership - the CGT asset is not an interest in an asset of the partnership; and (d) in any case - the small business entity referred to in paragraph (a) is the entity that, at a time in the income year, carries on the business (as referred to in subparagraph 152-40(1)(a)(ii) or (iii) or paragraph 152-40(1)(b)) in relation to the CGT asset. Connected entity An entity is connected with another entity if either entity controls the other entity, or both entities are controlled by the same third entity. Under subsection 328-125(2) of the ITAA 1997, an entity controls a partnership company or trust (except a discretionary trust) if it: • beneficially owns or has the right to acquire beneficial ownership of, interest in the other entity that give the right to receive at least 40% of any distribution of income or capital by the other entity, or • 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. Active asset test A CGT asset will satisfy the active asset test if: 1) 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, or 2) 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 7½ years during the test period. The test period begins when you acquired the asset and ends at the earlier of the CGT event and if the relevant business ceased to be carried on in the 12 months before that time - the cessation of the business. Subsection 152-40(1) of the ITAA 1997 details that a CGT asset is an active asset at a time if it is used, or held ready for use, in the course of carrying on a business that is carried on by you, or your affiliate, or another entity that is connected with you. | Detailed Reasoning - Application to the taxpayer's circumstances: In this case, when the property is transferred in specie to the Taxpayer's SMSF a CGT event will occur and the Taxpayer will make a capital gain. The Taxpayer currently leases the property to a company which uses it in the course of carrying on their business. In order to determine whether the property is an active asset we first need to consider whether the company is connected with the Taxpayer. As the Taxpayer holds more than 40% of the shares issued in the business, they are connected with the business. The Taxpayer began leasing the property to the business in 19XX. The business has used the property in the course of carrying on a business for more than 7 and a half years during the ownership period. Therefore, the property will satisfy the active asset test and the basic conditions have been satisfied. | Detailed Reasoning - The 15 year exemption: Subdivision 152-B of the ITAA 1997 provides a small business 15 year exemption as part of the capital gains tax (CGT) small business relief provisions. If you qualify for the small business 15 year exemption, the capital gain is entirely disregarded and it is unnecessary to apply any other concessions. If you are an individual, you can disregard any capital gain arising from a CGT event if all of the following conditions are satisfied: (a) the basic conditions are satisfied (b) you continuously owned the CGT asset for the 15 year period ending just before the CGT event (c) if the CGT asset is a share in a company or an interest in a trust, the company or trust had a significant individual for a total of at least 15 years (d) either: (i) you are 55 or over at the time of the CGT event and the event happens in connection with your retirement, or (ii) you are permanently incapacitated at the time of the CGT event. | Detailed Reasoning - Application to the Taxpayer's circumstances: In this case, the Taxpayer has satisfied the basic conditions for the small business concessions. They have continuously owned the CGT asset for more than 15 years and they are more than 55 years of age. We consider that the event will happen in connection with the Taxpayer's retirement as they intend to stop working within three to six months of the CGT event. Therefore, the taxpayer is entitled to apply the small business 15 year exemption. | Detailed Reasoning - Other relevant comments: 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. 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. The Advanced guide to capital gains tax concessions for small business 2011-12 (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 paragraphs 152-105(d) or 152-110(1)(d) of the ITAA 1997. The guide also provides that a CGT event may be 'in connection with your retirement' even if it occurs at some time before retirement. Although there is a delay between the CGT event and the individual's retirement, when taking their age and future plans into account, it is considered that there is a clear link between the sale of the business and the individual's retirement. | Detailed Reasoning - In specie contributions: Provided it is permitted in the trust deed, a superannuation fund can accept in specie contributions. Generally, in specie contributions are subject to the same caps that apply to cash contributions. This means that an in specie contribution for which a tax deduction has been claimed will count towards the concessional contribution cap. Similarly, an in specie contribution made as a personal after-tax contribution will count towards the non-concessional contribution cap. However, under subsection 292-90(2) of the ITAA 1997 certain contributions are excluded from the definition of non-concessional contributions for an income year. In particular, subparagraph 292-90(2)(c)(iii) of the ITAA 1997 excludes a contribution covered under section 292-100 of the ITAA 1997 to the extent that it does not exceed the CGT cap amount when the contribution is made. The CGT cap will be discussed in due course. To qualify for the CGT concession under section 292-100 of the ITAA 1997 certain conditions must be met. These are: (a) the contribution is made by you to a *complying superannuation plan in respect of you in a financial year; and (b) the requirement in subsection (2), (4), (7) or (8) is met; and (c) you choose, in accordance with subsection (9), to apply this section to an amount that is all or part of the contribution In this case, the relevant requirements that must be met for the purposes of paragraph 292-100(1)(b) of the ITAA 1997 are set out in subsection 292-100(2) of the ITAA 1997. These requirements will be met if: (a) the contribution is equal to all or part of the *capital proceeds from a *CGT event for which you can disregard any *capital gain under section 152-105 (or would be able to do so, assuming that a capital gain arose from the event); and (b) the contribution is made on or before the later of the following days: (i) the day you are required to lodge your *income tax return for the income year in which the CGT event happened; (ii) 30 days after the day you receive the capital proceeds In accordance with subsection 292-100(9) of the ITAA 1997, to make a choice, a taxpayer must: (b) make the choice in the approved from; and (b) give it to the superannuation fund trustee on or before the time the contribution is made. Subsection 292-100(2) of the ITAA 1997 makes reference to 'capital proceeds from a CGT event'. However in this case, rather than disposing the CGT asset to a third party and then contributing the capital proceeds to the Fund, the Taxpayer intends to make an in specie contribution by transferring the CGT asset to the Fund. A contribution mentioned in Part 3-30 of the ITAA 1997 can be, or can include, a transfer of property in accordance with subsection 285-5(1) of the ITAA 1997. (It should be noted that while the term property is not defined, a CGT asset can be accepted as property.) If the contribution is, or includes, a transfer of property, the amount of the contribution is the market value of the property, reduced by the value of any consideration given for the transfer of the property sunder subsection 285-5(3) of the ITAA 1997. The definition of 'market value' is contained in subsection 995-1(1) of the ITAA97. The term 'capital proceeds', when used in section 292-100 of the ITAA 1997, has the same meaning as in Division 116 of the ITAA 1997. The capital proceeds from a CGT event are defined by subsection 116-20(1) of the ITAA 1997 as the total of (a) the money you have received, or are entitled to receive, in respect of the event happening; and (b) the market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event). Section 116-30 of the ITAA 1997 outlines the market value substitution rule, the first modification to the general rules about capital proceeds. If you receive no capital proceeds from a CGT event, you are taken to have received the market value of the CGT asset, worked out as at the time of the CGT event. With regards to CGT event E2 (discussed previously), the market value substitution rule in section 116-30 of the ITAA 1997 applies so that the Taxpayer receives capital proceeds equal to the market value of the CGT asset at the time of the transfer of the CGT asset. Further, there is no provision contained in subdivision 152-B of the ITAA 1997 that would preclude the market value substitution rule in section 116-30 from applying to claims for the 15 year exemption. Therefore the contribution the Taxpayer intends to make, which takes the form of an in specie transfer of a CGT asset to the Fund, constitutes capital proceeds for the purposes of paragraph 292-100(2)(c) of the ITAA 1997. The capital proceeds in this instance will be the market value of the CGT asset pursuant to section 116-30 of the ITAA 1997. Having established this, section 292-105 of the ITAA 1997 will apply where a taxpayer has chosen under section 292-100 of the ITAA 1997 for the contribution to come under their CGT cap. The CGT cap amount, which is indexed at the start of each income year, is $1,355,000 for the 2014-15 income year. According to the facts the market value of property is X. Based on the above analysis, the capital proceeds for the purposes of paragraph 292-100(2)(a) of the ITAA 1997 are taken to be X. As this is below the CGT cap, the in specie contribution will be excluded from being a non-concessional contribution provided in the relevant income year: • the contribution is made to a complying superannuation fund; • the contribution is made within the timeframe specified in paragraph 292-100(2)(b) of the ITAA 1997; • the choice to make the contribution is made in the approved form under subsection 292-100(9); and • the form is given to the superannuation fund on or before the contribution is made. When an asset is transferred in specie in to a superannuation fund the effective date of the contribution will be when the fund acquires beneficial ownership of the asset. Beneficial ownership is transferred when the fund obtains a properly executed transfer in a registrable form, together with any title deeds and other necessary documents to enable registration of the fund as the legal owner. As the CGT cap is a lifetime cap, it is important to note that if the taxpayer makes the choice in accordance with subsection 292-100(9) of the ITAA 1997, the CGT cap will be reduced by the contribution (being the capital proceeds) just after the time the contribution is made under subsection 292-105(2) of the ITAA 1997. This reduced CGT cap will apply to the next future CGT transaction.