Private ruling: Small business entity concessions
Date of advice: 30 June 2020
Published: August 2020
Ruling period: Year ending 30 June 20YY
Date scheme commenced: 1 July 20YY

Ruling: Q1: Is the condition in subsection 152-10(1A)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) satisfied such that a connected entity of the taxpayer is a CGT small business entity in the income year ended 30 June 20YY? | A1: Yes. The condition in subsection 152-10(1A)(a) of the Income Tax Assessment Act 1997 (ITAA 1997) is satisfied such that a connected entity of the taxpayer is a CGT small business entity in the income year ended 30 June 20YY.

Relevant facts and circumstances: 1. The taxpayer is a discretionary trust ("Taxpayer"). 2. Historically, the Taxpayer conducted a primary production business on land located in Australia ("Subject Land"). 3. As part of a recent restructure of the Taxpayer's business activities, the Taxpayer ceased carrying on the primary production business. 4. From 1 July 20YY, the Taxpayer has made the Subject Land available to a related discretionary trust ("Operating Trust"). 5. The Operating Trust carries on a primary production business involving the sale of sheep, cattle and wool on the Subject Land ("Subject Business"). 6. On 30 December 20ZZ, in the midst of a severe Australian bushfire season, a bushfire in the region was sparked by dry lightning. 7. The bushfire impacted the Subject Land. 8. The bushfire burned significant areas of the Subject Land and destroyed kilometres of fencing. 9. The bushfire also resulted in the loss of cattle and sheep being livestock (and therefore trading stock) owned by the Operating Trust. 10. As a result of the bushfire and the consequential lack of dry feed and fencing used to contain livestock, the Operating Trust was forced to sell livestock in the year ending 30 June 20YY that would normally have been sold in the year ending 30 June 20XX. 11. The normal activities of the Subject Business involve the Operating Trust retaining livestock until such time as a commercial decision is made that they are suitable for sale. 12. The forced nature of the sales is demonstrated by the fact that the Operating Trust would ordinarily sell its livestock cattle at around XX months of age. Such cattle would each ordinarily weigh approximately XXXkg. 13. Due to sales being brought forward, the Operating Trust sold a number of cattle at a younger age and lower weight then they ordinarily would have been. A further number of cattle were sold to a feedlot (as opposed to the trust's usual abattoir customer), each at a lower weight then they would have ordinarily been sold at. 14. As a result of the livestock sales brought forward, $X,XXX (excluding GST and selling costs such as sales commission, insurance and levies) was derived as ordinary income for the year ended 30 June 20YY when such an amount or a similar would have normally been derived as ordinary income during the year ended 30 June 20XX on account of the livestock being sold in the latter income year. 15. At 1 July 20YY, the Taxpayer intends to dispose of the Subject Land and will crystallise a capital gain as a consequence. 16. For the year ended 30 June 20YY, The Taxpayer is connected with the Operating Trust for the purposes of section 328-125 of the ITAA 1997 and uses the Subject Land in the course of carrying on its business. 17. For the year ended 30 June 20YY, the aggregated turnover of the Operating Trust and relevant entities will be less than $2 million as per subsection 152-10(1AA) of the ITAA 1997, if the sales amount of $X,XXX is excluded from the annual turnover of the Operating Trust.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 152-10 | Income Tax Assessment Act 1997 subsection 152-10(1) | Income Tax Assessment Act 1997 subsection 152-10(1A) | Income Tax Assessment Act 1997 subsection 152-10(1AA) | Income Tax Assessment Act 1997 section 328-125

Reasons for decision: Summary: All legislative references are to the Income Tax Assessment Act 1997 ('ITAA 1997') unless otherwise stated. | Detailed Reasoning - Basic conditions for small business concessions: To qualify for any of the CGT small business concessions, an entity must satisfy several conditions that are common to all the concessions, known as the basic conditions. The basic conditions are contained in subdivision 152-A. According to subsection 152-10(1): A capital gain (except a capital gain from CGT event K7) you make may be reduced or disregarded under this Division if the following basic conditions are satisfied for the gain: (a) a CGT event happened in relation to a CGT asset of your in an income year; (b) the event would (apart from this Division) have resulted in the gain; (c) 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; (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; (iv) the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year; (d) the CGT asset satisfies the active asset test in section 152-35. | Detailed Reasoning - Basic condition 152-10(1)(c)(iv): Paragraph 152-10(1)(c) states that at least one of the requirements listed at subparagraphs (i) to (iv) must apply. For the purposes of this ruling we are considering subparagraph (iv): (iv) the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year; For 152-10(1)(c)(iv) to apply the conditions mentioned in subsection 152-10(1A) or (1B) must be satisfied in relation to the CGT asset in the income year. Subsection 152-10(1B) is not relevant in this case. Subsection 152-10(1A) is discussed below. Conditions in subsection 152-10(1A) The conditions in subsection 152-10(1A) are satisfied if: (a) your *affiliate, or an entity that is *connected with you, is a *CGT 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 CGT 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. This ruling focuses on the condition in subsection 152-10(1A)(a). | Detailed Reasoning - Paragraph 152-10(1A)(a): To satisfy the condition in subsection 152-10(1A)(a) it needs to be determined if an affiliate, or an entity that is connected with you is a CGT small business entity. This is considered below: Affiliate, or an entity that is connected Paragraph 152-10(1A)(a) requires us to determine whether the Taxpayer is connected with the Trust. The rules for determining whether an entity is 'connected with' another entity are contained in section 328-125. The Taxpayer has stated in their application that they are connected to the Operating Trust for the purposes of section 328-125. For the purposes of this ruling we are considering if the Operating Trust, a connected entity, is a CGT small business entity as per paragraph 152-10(1A)(a). | Detailed Reasoning - CGT small business entity: The term 'small business entity' is defined in section 328-110. It requires the entity to carry on a business and have aggregated turnover below $10 million. The definition of CGT small business entity is contained in subsection 152-10(1AA) and requires that the entity be a small business entity with aggregated turnover below $2 million. The definition of aggregate turnover is contained in subsection 328-155 as the sum of the relevant annual turnovers. The relevant annual turnovers are outlined in subsection 328-155 (2) and exclude any amounts covered by subsection 328-155 (3). Carrying on a Business It is accepted that the Operating Trust is carrying on a business for the purposes of section 328-110. Aggregate Turnover The aggregated turnover of the Operating Trust and relevant entities must be below $2 million as per subsection 152-10(1AA) to satisfy the definition of a CGT small business entity. For the year ended 30 June 20YY, the Taxpayer has confirmed that the aggregated turnover of the Operating Trust and relevant entities will be less than $2 million as per subsection 152-10(1AA), if the sales amount of $X,XXX is excluded from the annual turnover of the Operating Trust. Therefore, it must be considered if the amount of $X,XXX is to be included in the annual turnover of the Operating Trust for the year ended 30 June 20YY. Annual Turnover The meaning of 'annual turnover' is provided in section 328-120 of the ITAA 1997. Subsection 328-120(1) of the ITAA states: An entity's annual turnover for an income year is the total *ordinary income that the entity *derives in the income year in the ordinary course of carrying on a *business.' The term 'ordinary income' is defined in section 6-5 of the ITAA 1997 as income according to ordinary concepts. An entity's annual turnover therefore includes all income according to ordinary concepts derived in the ordinary course of carrying on a business. 'In the ordinary course of carrying on a business' is not defined in the ITAA 1997. The term therefore takes its ordinary meaning. In Doutch v FC of T [2016] FCAFC 166, which was an appeal against the decision of the AAT in respect of small business entity concessions, the Full Federal Court confirmed the following reasoning provided by the Tribunal: 70 The phrase "in the ordinary course of carrying on a business", as it appears in s 328-120(1) of the ITAA 1997, is not defined in the ITAA 1997 and it is necessary to construe those words. In engaging in the exercise of statutory construction, the Court is to consider the text of the statute in context. The High Court in Commissioner of Taxation v Consolidated Media Holdings Ltd (2012) 250 CLR 503 observed as follows at [39]: "This Court has stated on many occasions that the task of statutory construction must begin with a consideration of the [statutory] text" [ Alcan (NT) Alumina Pty Ltd v Commissioner of Territory Revenue [2009] HCA 41; (2009) 239 CLR 27 at 46 [47]]. So must the task of statutory construction end. The statutory text must be considered in its context. That context includes legislative history and extrinsic materials. Understanding context has utility if, and in so far as, it assists in fixing the meaning of the statutory text. Legislative history and extrinsic materials cannot displace the meaning of the statutory text. Nor is their examination an end in itself. 71 The extrinsic materials to which the High Court referred includes an explanatory memorandum. 72 The definition of "annual turnover" in s 328-120(1) of the ITAA 1997 was inserted into the ITAA 1997 by Tax Laws Amendment (Small Business) Act 2007 ( TLASBA 2007 ). The "Explanatory Memorandum" to the Tax Laws Amendment (Small Business) Bill 2007 ( EM ), which Bill was ultimately enacted as the TSLABA 2007, commencing from the 2008 income year, states: | Detailed Reasoning - What does 'in the ordinary course of carrying on a business' mean?: ........ 2.15 In general, income is derived in the ordinary course of carrying on a business if the income is of a kind that is regularly or customarily derived by the entity in the course of carrying on its business, arising out of no special circumstance or event. Similarly, the income is derived in the ordinary course of carrying on a business if the income although not regularly derived, is a direct result of the normal activities of the business . Thus, according to the EM, income is derived in the ordinary course of carrying on a business where: (a) the income is of a kind that is regularly or customarily derived by an entity in the course of carrying on its business, arising out of no special circumstance or unusual event; and (b) the income, although not regularly derived, is derived as a direct result of the normal activities of the business. Annual Turnover of the Operating Trust In this case, the business carried on by the Operating Trust is a primary production business involving the sale of sheep, cattle and wool. In respect to the sale of livestock, the normal activities of the Subject Business involve the Operating Trust retaining livestock until such time as a commercial decision is made that they are suitable for sale to an abattoir. Severe bushfires impacted large parts of Australia from late 20ZZ. On 30 December 20ZZ, bushfires destroyed 'significant areas' of the Subject Land. The fires effected X kilometres of fencing that would normally contain cattle. As a result of this fencing being destroyed the cattle could no longer be kept on the Subject Land. Due to the consequential lack of dry feed and destroyed fencing, the Operating Trust was forced to sell livestock in the year ending 30 June 20YY that would normally have been sold in the year ending 30 June 20XX. The forced nature of the sales is demonstrated by the fact that the Operating Trust sold their livestock cattle at a much earlier stage. It was customary, that the livestock would be sold at around XX months of age, ordinarily weighing approximately XXXkg. Instead as a result of the fires the cattle were sold at a younger age and lower weight then they would have ordinarily been sold at. A further number of cattle were sold to a feedlot (as opposed to the trust's usual abattoir customer), each weighing less than they ordinarily would have at the time of sale. As a result of the livestock sales brought forward, $X,XXX (excluding GST and selling costs such as sales commission, insurance and levies) was included as ordinary income derived for the year ended 30 June 20YY. This amount of income or similar would normally been derived as ordinary income during the year ended 30 June 20XX on account of the livestock being sold in the latter income year. In these circumstances, to determine whether this amount is included in the annual turnover of the entity, we need to consider if the income is of a kind that is regularly or customarily derived by an entity in the course of carrying on its business, arising out of no special circumstance or unusual event. Income from the disposal of livestock is of a kind that is customarily or regularly derived by a cattle farming business, however in this case the disposal of the livestock occurred primarily due to the severe bushfires. As discussed above, the Operating Trust would not have made the $X,XXX of livestock sales in the income year ending 30 June 20YY if the bushfires had not occurred. That is, the income from the disposal was the result of an unusual event or special circumstance. The sale of the livestock by the Operating Trust is not a disposal in the ordinary course of business and is instead a disposal of the assets of the business due to an unusual event or special circumstance. Further, the income from the livestock sales were not derived as a direct result of the normal activities of the business. The normal activities of the Operating Trust involve retaining livestock until such time as a commercial decision is made that they are suitable for sale to an abattoir. Due to the severe fires which effected the Subject Land, the Operating Trust was unable to retain the livestock until it was commercially suitable to sell them. The cattle were sold at a different age, weight and in some instances to a different end customer. Therefore, it cannot be said that, the income from the sale of cattle, in this case, is derived as a direct result of the normal activities of the business. As a result, the annual turnover of the Operating Trust for the purposes of section 328-120 of the ITAA 1997 does not include the $X,XXX of livestock sales that was derived as result of the bushfires. | Detailed Reasoning - CONCLUSION: The condition in subsection 152-10(1A)(a) is satisfied such that a connected entity of the taxpayer is a CGT small business entity in the income year ended 30 June 20YY. Provided that the aggregated turnover of the Operating Trust and relevant entities will be less than $2 million once the sales amount of $XXX is excluded from the annual turnover of the Operating Trust, the condition in subsection 152-10(1A)(a) is satisfied, as an entity connected with the taxpayer is a CGT small business entity in the income year ended 30 June 20YY.