Private ruling: Capital gains tax and the small business concessions
Date of advice: 30 July 2015
Published: July 2015
Ruling period: Year ending 30 June 2016 | Year ending 30 June 2017
Date scheme commenced: 1 July 2015

Ruling: Questions and answers | 1. Will the sale of each of the subdivided blocks be treated as the disposal of a capital gains tax (CGT) asset under section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997)? | Yes. | 2. On the disposal of the lot containing the dwelling, will the main residence exemption under section 118-110 of the ITAA 1997 apply so that any capital gain is disregarded? | Yes. | 3. Can you apply the 50% CGT discount under section 115-25 of the ITAA 1997 to any capital gain made on the disposal of the non-main residence lots? | Yes. | 4. Will the disposal of the non-private use lots satisfy the active asset test under section 152-35 of the ITAA 1997? | Yes. | 5. On the disposal of the non-private use lots, will you satisfy the basic conditions for small business relief under section 152-10 of the ITAA 1997 and be able to consider your eligibility for the CGT concessions contained in Division 152 of the ITAA 1997? | Yes.

Relevant facts and circumstances: You and your spouse have operated a business as a partnership for many years. Over 10 years ago, you acquired a property that you thought was ideal for joint use as a main residence and base for the business. The property contained a dwelling (your residence), garage, swimming pool (near the dwelling), several sheds, various hardstand areas and a pond. The business has turned over around $X in recent years (with smaller turnover in earlier years) and is registered for GST. Large areas of the property were used in your business to take deliveries, store materials and prepare finished items for despatch. However, each area of the land was only used at certain times through the business process. The various sheds were used at all times for the storage of equipment and materials used in the business. You have used the dwelling on the property as your main residence for the entire period of your ownership and the only income generated from the property has related to the business. You now plan to subdivide the property into a number of lots for sale. Apart from the lot which contains the dwelling, all the lots will be sold as vacant land. You have gained development approval with the assistance of a surveyor and you will engage contractors to construct an access road and connect utilities to the front of each lot. During the subdivision process, you will undertake only the minimum required work to subdivide the lots. Your involvement will be of a decision making and project management capacity only, with the substantial work being outsourced to professional in the relevant fields. You have no previous experience in land developments or subdivision projects. You will cease your business and the GST registration will be cancelled. You satisfy the $6,000,000 maximum net asset value test for the purposes of the small business CGT concessions.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 Income Tax Assessment Act 1997 Section 6-10 | Income Tax Assessment Act 1997 Section 102-5 | Income Tax Assessment Act 1997 Section 102-20 | Income Tax Assessment Act 1997 Section 104-10 | Income Tax Assessment Act 1997 Section 112-25 | Income Tax Assessment Act 1997 Section 115-25 | Income Tax Assessment Act 1997 Section 118-110 | Income Tax Assessment Act 1997 Division 152 | Income Tax Assessment Act 1997 Section 152-10 | Income Tax Assessment Act 1997 Section 152-35 | Income Tax Assessment Act 1997 Section 152-40

Reasons for decision: Detailed Reasoning - Question 1 - Disposal of subdivided blocks: The assessable income of a resident taxpayer includes income according to ordinary concepts (ordinary income) and amounts that are not ordinary income but are included in assessable income by legislative provisions about assessable income (statutory income). Division 102 of the ITAA 1997 provides that your assessable income includes your net capital gain for the income year. You make a capital gain or capital loss as a result of a CGT event happening. Section 104-10 of the ITAA 1997 provides that CGT event A1 happens if you dispose of a CGT asset such as a dwelling or block of land. Section 15-15 of the ITAA 1997 specifies that your assessable income includes profit arising from the carrying on or carrying out of a profit-making undertaking or plan. However, this provision does not apply to a profit that is assessable as ordinary income under section 6-5 of the ITAA 1997 or which arises in respect of the sale of property acquired on or after 20 September 1985. The Commissioner's view on profits made from isolated transactions is contained in Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3). Isolated transactions in this context are those outside the ordinary course of business of a taxpayer carrying on a business and transactions entered into by non-business taxpayers. Paragraph 6 of TR 92/3 provides that a profit from an isolated transaction will generally be income when both the following elements are present: • your intention or purpose in entering into the transaction was to make a profit or gain, and • the transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction. Additionally, paragraph 42 of TR 92/3 states that if a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to commit the asset, either: • as the capital of a business or • into a profit-making undertaking with the characteristics of a business operation or commercial transaction, this activity constitutes the carrying on of a business, or a business operation or commercial transaction. The profit from such activity is income even though the taxpayer did not have the purpose of profit-making at the time of acquiring the asset. In contrast, paragraph 36 of TR 92/3 notes that the courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. Some of the factors to consider when looking at whether an isolated transaction amounts to a business operation or commercial transaction are listed at paragraph 13 of TR 92/3. They are: (a) the nature of the entity undertaking the operation or transaction; (b) the nature and scale of other activities undertaken by the taxpayer; (c) the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained; (d) the nature, scale and complexity of the operation or transaction; (e) the manner in which the operation or transaction was entered into or carried out; (f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction; (g) if the transaction involves the acquisition and disposal of property, the nature of that property; and (h) the timing of the transaction or the various steps in the transaction. In your case, you acquired a property over 10 years ago to use as your main residence and to carry on your business. Consequently, we do not consider that your main intention when originally purchasing the land was to make a profit or gain from the land itself. You have now decided to cease running your business and have decided to increase the value of the property by subdividing it. From the information provided, we consider that the proceeds of the subdivision will represent a mere realisation of a capital asset Therefore, the disposal of each of the subdivided blocks will be treated as the disposal of a CGT asset under section 104-10 of the ITAA 1997. | Detailed Reasoning - Question 2 - Main residence exemption: Section 118-110 of the ITAA 1997 provides that you can disregard a capital gain or capital loss made from a CGT event that happens to a dwelling that is your main residence. To qualify for the full exemption: • the dwelling must have been your main residence throughout your ownership period; • the interest must not have passed to you from a deceased estate; • the land the dwelling is situated on must be a maximum of 2 hectares in size; and • you must not have used the dwelling to produce assessable income. In your case, you acquired the property to use as your main residence and also to carry out your carpentry business. The dwelling has been your main residence throughout your ownership period and has not itself been used to generate income. Consequently, the sale of the lot containing the dwelling will satisfy the requirements of the main residence exemption and you will be able to disregard any capital gain you make on the sale. | Detailed Reasoning - Question 3 - CGT discount: Section 115-25 of the ITAA 1997 specifies that a discount capital gain is available in relation to a CGT event when the CGT asset was acquired by the entity making the gain at least 12 months before the CGT event. The amount of the discount percentage is 50%. Section 112-25 of the ITAA 1997 provides that a CGT event does not happen when a CGT asset is split into 2 or more assets. In the case of land, the subdivided blocks are treated as new separate assets and they are taken to have been acquired by the owner when the original land was acquired (Taxation Determination TD 97/3). Therefore, you are eligible for the 50% discount capital gain on the sale of the non-main residence lots. | Detailed Reasoning - Question 4 - Active asset test: Division 152 of the ITAA 1997 contains the provisions relating to capital gains tax relief for small business. Section 152-35 of the ITAA 1997 states that where you have owned a CGT asset for more than 15 years, the asset satisfies the active asset test if the asset was an active asset of yours for a total of at least 7 ½ years during the period between when you acquired the asset and the earlier of when the CGT event happens or the relevant business ceased. Section 152-40 of the ITAA 1997 states that a CGT asset that is a tangible CGT asset is an active asset if you own the asset and it is used, or held ready for use, in the course of carrying on a business that is carried on by you, your affiliate or another entity that is connected with you. All the subdivided lots were used in the business apart from the main residence lot and another private use lot. Consequently, we consider that the non-private use lots were active assets and the sale of the lots will satisfy the active asset test. | Detailed Reasoning - Question 5 - Basic small business concession conditions: Section 152-10 of the ITAA 1997 contains the basic conditions to be satisfied in order to access the small business concessions. These conditions are: (a) a CGT event happens in relation to a CGT asset in an income year (apart from CGT event D1); (b) the event would (apart from Division 152 of the ITAA 1997) 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 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; and (d) the CGT asset satisfies the active asset test. In your case, you satisfy all four basic conditions and are able to consider your eligibility for the small business CGT concessions contained in Division 152 of the ITAA 1997.