Private ruling: CGT and the small business concessions
Published: February 2013
Ruling period: Year ending 30 June 2013 | Year ending 30 June 2014
Date scheme commenced: 1 July 2012

Ruling: Q1: 1. Does the company meet the basic conditions to be entitled to apply the CGT small business concessions to any potential capital gain on the sale of a commercial property? | A2: No.

Relevant facts and circumstances: The company was incorporated over 40 years ago. There are three classes of shares in the company: · Shares A · Share B · Ordinary shares Under the company's Articles of Association, the rights and privileges of shares A and B are outlined as follows: · Shares A - whilst held by shareholder Y, shall confer on him/her the right to the whole management and control of the company and, in the case of an ordinary resolution, shall confer on him/her as many votes as shall constitute a majority and, in the case of a special resolution, shall confer on him/her as many votes as shall constitute a majority of three-fourths. · Share B in the capital of the company - at the death of shareholder Y, shall confer on the holder; the right to the whole management and control of the company, in the case of an ordinary resolution, as many votes as shall constitute a majority, in the case of a special resolution, shall confer on him/her as many votes as shall constitute a majority of three-fourths, and all the powers authorities rights privileges and discretions, whether general or special, exercisable by shareholder Y as governing director. The shares A and B, held by shareholder Y, provide for the effective control and governance of the company. The rights associated with the ordinary shares are not provided for in the articles of association, but include the following: · Voting - the right to attend and vote at all meetings of the company and on a show of hands or poll to one vote for every share held. · Dividend - the rights to participate in the dividends (if any) determined by the directors to be paid on that share. · Surplus Assets - in the winding up of the company to repayment of the paid issue price of such share and to participate in the division of surplus assets or profits of the company and in this regard to rank equally with all other shareholders so entitled. Shares A only retain the control and governance rights whilst held by shareholder Y and the rights associated with share B will survive shareholder Y. The share register of the company includes the following details: · shares A and B were acquired by shareholder Y over 40 years ago along with one ordinary share · approximately C ordinary shares were acquired by shareholder X over 40 years ago and these were transferred to shareholder Y on the death of shareholder X approximately 10 years ago. · D ordinary shares each were also issued to three shareholders Z after 1985. At the time of incorporation, the company purchased a commercial property. The commercial property was used as follows: · For over 15 years - the entire property was used as the retail business premises of shareholder Y, in partnership and as a sole trader. · For the remaining time, the property was predominately used of the leasing of commercial space to non-related entities. The company is considering selling the commercial property. The overall value of the company would be approximately less than $3 million. The net asset value of shareholder Y is less than $3.5 million.

Relevant legislative provisions: Income Tax Assessment Act 1997 - Division 149 | Income Tax Assessment Act 1997 - Section 149-15 | Income Tax Assessment Act 1997 - Section 149-30 | Income Tax Assessment Act 1997 - Section 149-35 | Income Tax Assessment Act 1997 - Division 152 | Income Tax Assessment Act 1997 - Section 152-10 | Income Tax Assessment Act 1997 - Section 152-55 | Income Tax Assessment Act 1997 - Section 152-65 | Income Tax Assessment Act 1997 - Section 152-70 | Income Tax Assessment Act 1997 - Section 328-125

Reasons for decision: Summary: A capital gain may be reduced or disregarded under Division 152 of the Income Tax Assessment Act 1997 (ITAA 1997) if the following basic conditions are satisfied for the gain: 1. a capital gains tax (CGT) event happens in relation to a CGT asset in an income year; 2. the event would have resulted in a gain; 3. at least one of the following applies: (i) you are a small business entity for the income year (ii) you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997 (iii) you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership or (iv) the conditions in subsection 152-10(1A) or (1B) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year. 4. The CGT asset satisfies the active asset test. | Detailed Reasoning - Conditions 1 & 2: In this case, when the company enters into a contract of sale for the commercial property, CGT event A1 will happened. However, generally when disposing of a pre CGT asset, any capital gain would have been disregarded; therefore, the event would not have resulted in a gain. Subsections 149-30(1) and 149-30(1A) of ITAA 1997 provide that an asset stops being a pre-CGT asset at the earliest time when majority underlying interests in the asset were not held by the ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985. This applies to the asset as if the entity had acquired the asset at the earliest date when majority underlying interest changed. Majority underlying interests is defined in subsection 149-15(1) of the ITAA 1997 as more than 50% of: (a) the beneficial interests that ultimate owners have (whether directly or indirectly) in the asset and (b) the beneficial interests that ultimate owners have (whether directly or indirectly) in any income that may be derived from the asset. Accordingly, ultimate owners who held majority underlying interests in an asset just before 20 September 1985 must retain such interests after that date, otherwise Division 149 of the ITAA 1997 will be triggered to convert the asset into a post-CGT asset. In these cases, the asset is deemed to have a new date of acquisition (the date the majority underlying interest changed). Section 149-35 of the ITAA 1997 provides that the deemed first element acquisition costs for the purposes of determining the cost base (and reduced cost base), will be the market value of the asset at the time of change. In this case, the company purchased the commercial property prior to 1985. The majority underlying interest in the asset was held by shareholder Y as majority shareholder immediately before 20 September 1985. After 1985, additional shares where issued to shareholders Z changing the majority underlying interest in the asset as a result. Division 149 of the ITAA 1997 was triggered, converting the asset into a post-CGT asset. The new date of acquisition is date the additional shares were issued and the cost base (and reduced cost base) will be the market value at that time. Therefore, the disposal of a post CGT asset would have resulted in a gain, satisfying condition 2. | Detailed Reasoning - Condition 3: Under paragraph 152-10(1)(c) of the ITAA 1997 you must satisfy one of the following: · you are a small business entity · you do not carry on business (other than as a partner) but your asset is used in a business carried on by a small business entity that is your affiliate or an entity connected with you (passively held assets) · you are a partner in a partnership that is a small business entity, and the CGT asset is · an interest in a partnership asset (partnership assets), or · an asset you own that is not an interest in a partnership asset (partner's assets) · you satisfy the maximum net asset value test. In this case, the company is not carrying on a business in the current financial year and the property has been a passively held asset for more than 20 years, being leased to non-related third parties. | Detailed Reasoning - Maximum net asset test: There is a limit of $6 million on the net value of the CGT assets that you and certain entities can own and still qualify for the small business CGT concessions. This $6 million limit is called the maximum net asset value test. It is not indexed for inflation. You satisfy the maximum net asset value test if the total net value of CGT assets owned by certain entities does not exceed $6 million just before the CGT event that results in the capital gain for which the concessions are sought. You must include the net value of CGT assets owned by: · you · any entities 'connected with' you, · any of your 'affiliates' and entities connected with your affiliates Under section 328-125 of the ITAA 1997, an entity is connected with another entity if: · either entity controls the other entity, or · both entities are controlled by the same third entity. Paragraph 328-125(2)(b) of the ITAA 1997 states that, in relation to a company, an entity controls a company if they have the right to exercise at least 40% of the voting power in the company. In this case, shareholder Y, as holder of shares A and B, has the right to exercise a majority of the votes. Therefore, shareholder Y controls the company and is 'connected with' the company for the purposes of maximum net assets test. There are no other entities identified as being either connected with or affiliates of the company. The company satisfies the maximum net asset test. | Detailed Reasoning - Condition 4: The asset in question must satisfy the active asset test. 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 by you, your affiliate or an entity connected with you. If you have owned the asset for more than 15 years, the active asset test is satisfied where the asset was an active asset of yours for a total of least 7.5 years during the test period. In this case, the company purchased the commercial property over 40 years ago and the property was solely used in to operate a retail business for more than 15 years. Shareholder Y, an entity connected with the company, had an ownership interest in the retail business, either as a sole trader or in partnership, for at least seven and a half years. As the property has been owned for more than 15 years and was used in the business activity of an entity connected with the company for more than 7.5 years, the property satisfies the active asset test. Therefore, the company satisfies the 'basic conditions' required to qualify for the small business CGT concessions. | Detailed Reasoning - Significant individual test: Under section 152-55 of the ITAA 1997, a company or trust satisfies the significant individual test if it had at least one significant individual just before the CGT event. 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%. The 20% can be made up of direct and indirect percentages. | Detailed Reasoning - Total small business participation percentage: Under section 152-65 of the ITAA 1997, an entity's small business participation percentage in another entity at a time is the percentage that is the sum of: · the entity's direct small business participation percentage in the other entity at that time, and · the entity's indirect small business participation percentage in the other entity at that time. | Detailed Reasoning - Direct small business participation percentage: What constitutes an entities direct small business participation percentage is included in section 152-70 of the ITAA 1997. For companies, an entity's direct small business participation percentage in a company is the percentage of: · voting power in the company · any dividend payment that the entity is entitled to receive, or · any capital distribution that the entity is entitled to receive. If an entity has different percentages in a company, their participation percentage is the smaller or smallest percentage. All classes of shares (other than redeemable shares) are taken into account in determining an entity's participation percentage in a company. In this case, there are four share holders in the company. The three shareholders Z hold around 30% of the total ordinary shares issued. However, the voting power attached to shares A and B held by shareholder Y would, in effect, reduce their voting power in the company to zero and as this is the lowest percentage, they would fail the significant individual test. Shareholder Y, as holder of less than 20% of the ordinary shares, is entitled to less than 20% of any dividend payment and as this is the lowest percentage, he/she would also fail the significant individual test. Based on the above, the company does not currently satisfy the significant individual test.

Please check this edited version to be sure that there are no details remaining that you think may allow you to be identified. If you have any concerns about this ruling you wish to discuss, you will find our contact details in the fact sheet. | 2. Does the company satisfy the significant individual test?