Private ruling: Small business CGT concessions - 15 year exemption
Published: June 2013
Ruling period: Year ending 30 June 2013 | Year ending 30 June 2014 | Year ending 30 June 2015 | Year ending 30 June 2016
Date scheme commenced: 1 July 2012

Ruling: Q1: Will the company meet the basic conditions for the small business concessions in relation to the sale of shop A? | A1: Yes | Q2: If so, will the company qualify for the small business 15 year exemption in relation to the sale of shop A? | A2: Yes

Relevant facts and circumstances: The company has three directors and shareholders, each holding one of the three ordinary shares in the company: · X · Y · Z There has been no change to the company ownership structure since incorporation. Y and Z have a family relationship. X does not have a family relationship with Y and Z. The company purchased a number of detached premises. From the date of acquisition, X leased shop A from the company where they operated their business. X continued to do so for a period of time until they became ill. The remaining premises have been leased for the entire period of ownership: · One to a family member of Y and Z who used the premise for storage of the stock associated with their nearby business · One to W Pty Ltd for storage of stock used in its business. Y and Z are directors and shareholders of W Pty Ltd A family member of X, re-opened X's business to the public at shop A. They continued to operate from shop A for a period of time. The combined period shop A was actively used to operate a business was more than 7.5 years. Throughout the entire period, no formal lease was in place between the company and either X or their family member and market rent was not paid. X paid council and water rates relating to shop A. Building insurance was paid by the company. Similarly, the remaining premises were leased without formal lease agreements and only nominal amounts of rent was paid to the company. Shop A is currently vacant and requires major renovations. The company intends to sell shop A to X's family member for its current market value. The company will make a capital gain on the sale. At the same time it is intended that X's share in the company will be transferred to Y and Z for current market value. Following this transfer, X will retire as director of the company. The company will retain ownership of the other shops. X was not engaged in any other full time employment for a period of time. However, X had maintained their role as director of the company and was required to carry out duties in this role. The company's net assets, for the purposes of the maximum net asset value test, taking into account assets of its affiliates and connected entities is less than $6 million.

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 152 | Income Tax Assessment Act 1997 Section 152-10 | Income Tax Assessment Act 1997 Section 152-15 | Income Tax Assessment Act 1997 Section 152-35 | Income Tax Assessment Act 1997 Paragraph 152-40(4)(e) | Income Tax Assessment Act 1997 Section 152-110 | Income Tax Assessment Act 1997 Paragraph 152-110(1)(d) | Income Tax Assessment Act 1997 Subsection 328-130(2) Basic conditions | A capital gain that you make may be reduced or disregarded under Division 152 of the Income Tax Assessment Act 1997 (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. | In this case, when shop A is sold, a CGT event will occur in relation to a CGT asset owned by the company and it is expected that this event will result in a capital gain. Additionally, the company satisfies the maximum net asset value test. The active asset test will be considered below. | Active asset test | The active asset test is contained in section 152-35 of the ITAA 1997. Where you have owned the asset for more than 15 years, the active asset test is satisfied if the asset was an active asset of yours for a total of at least 7.5 years of the test period detailed below. | The test period: | · begins when you acquired the asset, and | · ends at the earlier of | o the CGT event, and | o when the business ceased, if the business in question ceased in the 12 months before the CGT event (or such longer time as the Commissioner allows). | A CGT asset is an active asset if it is owned by you and is used or held ready for use in a business carried on (whether alone or in partnership) by you, your affiliate, your spouse or child, or an entity connected with you. | However, paragraph 152-40(4)(e) of the ITAA 1997 states that an asset whose main use in the course of carrying on the business is to derive rent can not be an active asset unless the main use for deriving rent was only temporary. This exclusion may not apply to a CGT asset leased to an affiliate or connected entity. In these cases, it is the use of the asset in the affiliate's or connected entity's business that will determine the active asset status of the asset. | An affiliate is an individual or a company that, in relation to their business affairs, acts or could be reasonably expected to act in accordance with your directions or in concert with you. | The Advanced guide to capital gains tax concessions for small business 2011-12 (NAT 3359) ( Advanced Guide ), provides a number of relevant factors that may support a finding that a person is an affiliate of a taxpayer: | · the existence of a close family relationship between the parties | · the lack of any formal agreement or formal relationship between the parties dictating how the parties are to act in relation to each other | · the likelihood that the way the parties act, or could reasonably be expected to act, in relation to each other would be based on the relationship between the parties rather than on formal agreements or legal or fiduciary obligations, and | · the actions of the parties. | However, subsection 328-130(2) of the ITAA 1997 points out that an individual or company is not your affiliate merely because of the nature of the business relationship. Companies and trusts are not affiliates of their directors and trustees respectively, and vice versa, merely because of the positions held. | In this case, X used shop A in their business for a period of time. During this time, no formal lease agreement was ever put in place and X paid below the market rate of rent. Additionally, X paid some property expenses such as council and water rates. The fact that no formal agreement was ever put in place supports the notion that the way the parties acted in relation to each other was likely due to their relationship and not a legal or fiduciary obligation. | Taking the above factors into account, we accept that X was an affiliate of the company. We consider that due to X's shareholding in the company, it is reasonable to expect that X in their capacity, would act in accordance or in concert with the company. | Similarly, X's family member used shop A in their business for a period of time. Again, no formal lease agreement was ever put in place. | We accept that X's family member was also an affiliate of the company due to the lack of formal agreements between the two parties and the close family relationship between them and a shareholder in the company. | Although the company leased shop A to X and their family member, these entities are both considered to be affiliates of the company. Therefore it is the use in their businesses that will determine if shop A is an active asset. As they did not derive rent from shop A the exclusion contained in paragraph 152-40(4)(e) of the ITAA 1997 does not apply. | The asset will be active for the period that is was used in X and their family member's respective businesses, and as this period is more than 7.5 years, the active asset test will be satisfied. | Accordingly, the company meets all the basic conditions for the small business concessions. | Small business 15 year exemption | For a company to be eligible for the small business 15-year exemption it must satisfy the basic conditions and three further conditions: | · the company continuously owned the CGT asset for the 15-year period ending just before the CGT event happened, and | · the 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), and | · the individual who was a significant individual just before the CGT event was | o at least 55 years old at that time and the event happened in connection with their retirement, or | o permanently incapacitated at that time. | Shop A was purchased by the company and has been held continuously for more than 15 years. | 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%. X has held more than 20% of the shares in the company since its incorporation. Accordingly, X is a significant individual. | 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 your retirement even if it occurs at some time before retirement. | 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 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) of the ITAA 1997. | In this case, although X has not been undertaking full time work for some time, they have maintained their role and duties as the director of the company. Following the sale of the property, it is intended that X will dispose of their shares in the company and retire as director. Accordingly, there will be a significant change in the nature of X's activities in the company. | X is over 55 years of age and it is accepted that the CGT event will be in connection with their retirement. | Accordingly, the company meets the additional requirements and is entitled to the small business 15 year exemption.