Private ruling: Income Tax: Small business entity
Date of advice: 14 February 2017
Published: July 2017
Ruling period: Year ended 30 June 201Y
Date scheme commenced: During the income year ended 30 June 201Y.

Ruling: Q1: Is the taxpayer (Company A) a 'small business entity' as defined in Subdivision 328-C of the Income Tax Assessment Act 1997 (ITAA 1997) for the income year ended 30 June 201Y and for the purposes of subparagraph 152-10(1)(c)(i) of the ITAA 1997? | A1: Yes

Relevant facts and circumstances: Company A owned and operated a medical centre business (Medical Practice). Trust A provided certain administrative services for Company A as well as the services of subcontracted medical practitioners whose services were used in carrying on the Medical Practice. Trust B supplied the administrative personnel who performed the administrative services supplied by Trust A to the Medical Practice. Company A, Trust A and Trust B are members of a GST Group for GST reporting purposes. The Medical Practice was sold by Company A under a contract during the 201Y financial year. For the 201Y and prior income years, Company A controlled and was 'connected with' both Trust A and Trust B pursuant to section 328-125 of the ITAA 1997. At no time during the 201X and 201Y income years was Company A 'connected with' or an 'affiliate' of any other entity with an 'annual turnover' for that income year, including any of the subcontracted medical practitioners. Company A's ordinary income (and therefore its turnover) has, since the commencement of the Medical Practice, included the medical fees generated by: ● the two principals/directors of the business; and ● the subcontracted medical practitioners (approximately less than 10) engaged by Trust A. The inclusion of the medical fees generated by the subcontracted medical practitioners in Company A's ordinary income is explained “as a matter of convenience and accounting practice” and understood to be “standard medical industry practice”. More than 70% of the medical fees generated by the subcontracted medical practitioners for the 201X income year was included in Company A's total income. Trust A's ordinary income (and therefore its turnover) has, since the commencement of the Medical Practice, included: ● a management fee it charged to the subcontracted medical practitioners (as per the Consultancy Agreement referred to below); and ● a service fee (an administration fee) it charged to Company A for the provision of administration services. Trust A's total turnover for the 201X income year was comprised of approximately 60% for the management fee and approximately 40% for the service fee. Trust B's ordinary income (and therefore its turnover) has, since the commencement of the Medical Practice, included a service fee it charged to Trust A for the provision of labour hire services. Trust B's total turnover for the 201X income year comprised almost entirely of the service fee. The Consultancy Agreement between Trust A and each subcontracted medical practitioner provides for the following terms and conditions: ● the subcontracted medical practitioner is an independent medical service provider with a separate Australian Business Number (ABN), and not an employee of Trust A; ● the subcontracted medical practitioner will send a fortnightly account to Trust A for payment of services rendered retrospectively; ● 100% of the medical fees generated by the subcontracted medical practitioner is payable to the medical practitioner; ● the subcontracted medical practitioner is required to pay Trust A 37.5% of their medical fees for management fees; and ● taxation, superannuation and workers compensation insurance cover will be the sole responsibility of the subcontracted medical practitioner. The tax invoices issued to patients who see each subcontracted medical practitioner contained the subcontracted medical practitioners' name, the details of their practising entity and the ABN for the practising entity. The invoices also included Trust A's bank account details solely for the purposes of collecting the medical fees generated by the subcontracted medical practitioners, which is part of the management services provided by Trust A to each subcontracted medical practitioner. Assumption Each subcontracted medial practitioner included 100% of the medical fees they generated as assessable income pursuant to Division 6 of the ITAA 1997.

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 6 | Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 subsection 6-5(2) | Income Tax Assessment Act 1997 subsection 6-5(4) | Income Tax Assessment Act 1997 Division 152 | Income Tax Assessment Act 1997 section 152-10 | Income Tax Assessment Act 1997 subparagraph 152-10(1)(c)(i) | Income Tax Assessment Act 1997 section 152-35 | Income Tax Assessment Act 1997 Subdivision 328-C | Income Tax Assessment Act 1997 section 328-110 | Income Tax Assessment Act 1997 subparagraph 328-110(1)(b)(i) | Income Tax Assessment Act 1997 subparagraph 328-110(1)(b)(ii) | Income Tax Assessment Act 1997 subsection 328-110(2) | Income Tax Assessment Act 1997 subsection 328-110(3) | Income Tax Assessment Act 1997 subsection 328-110(4) | Income Tax Assessment Act 1997 section 328-115 | Income Tax Assessment Act 1997 subsection 328-115(1) | Income Tax Assessment Act 1997 subsection 328-115(2) | Income Tax Assessment Act 1997 subsection 328-115(3) | Income Tax Assessment Act 1997 paragraph 328-115(3)(a) | Income Tax Assessment Act 1997 paragraph 328-115(3)(b) | Income Tax Assessment Act 1997 section 328-120 | Income Tax Assessment Act 1997 subsection 328-120(1) | Income Tax Assessment Act 1997 subsection 328-125 | Income Tax Assessment Act 1997 section 328-130

Reasons for decision: Summary: Company A was a small business entity for the 201Y income year as it satisfies the $2 million aggregated turnover test under Subdivision 328-C of the ITAA 1997. As a result, and for the purposes of determining whether a capital gain made by Company A on the sale of the Medical Practice may be reduced or disregarded under Division 152 of the ITAA 1997, subparagraph 152-10(1)(c)(i) of the ITAA 1997 will apply to Company A. | Detailed Reasoning - Detailed reasoning: Section 152-10 of the ITAA 1997 contains the basic conditions you must satisfy to be eligible for the small business capital gains tax (CGT) concessions. These conditions are: (a) a CGT event happens in relation to a CGT asset of yours 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; … (d) the CGT asset satisfies the active asset test (see section 152-35). Section 328-110 of the ITAA 1997 defines 'small business entity'. To qualify as a small business entity for an income year, you must carry on a business in that year and satisfy the $2 million aggregated turnover test. There are several ways you may satisfy the $2 million aggregated turnover test. These are: ● subparagraph 328-110(1)(b)(i) of the ITAA 1997 - you carried on a business in the previous year and the aggregated turnover for the previous year was less than $2 million; ● subparagraph 328-110(1)(b)(ii) and subsection 328-110(2) of the ITAA 1997 - your aggregated turnover for the current year, worked out as at the first day of the current year, is likely to be less than $2 million. However, subsection 328-110(3) of the ITAA 1997 provides an exception to this in that you cannot qualify as a small business entity under this provision if you carried on a business in each of the two previous income years and your aggregated turnover in each of those years was $2 million or more; ● subsection 328-110(4) of the ITAA 1997 - your aggregated turnover for the current year, worked out as at the end of the current year, is less than $2 million. 'Aggregated turnover' is defined by section 328-115 of the ITAA 1997. Your aggregated turnover for an income year is the sum of the relevant annual turnovers (excluding certain amounts as provided for in subsection 328-115(3) of the ITAA 1997). The relevant annual turnovers as per subsection 328-115(2) of the ITAA 1997 are: (a) your annual turnover for the income year; and (b) the annual turnover for the income year of any entity (a relevant entity ) that is connected with you at any time during the year; and (c) the annual turnover for the income year of any entity (a relevant entity ) that is an affiliate of yours at any time during the income year. Subsection 328-115(3) of the ITAA 1997 states that your aggregated turnover for an income year does not include the following amounts: (a) amounts derived in the income year by you or a relevant entity from dealings between you and the relevant entity while the relevant entity is connected with you or is your affiliate; (b) amounts derived in the income year by a relevant entity from dealings between the relevant entity and another relevant entity while each relevant entity is connected with you or is your affiliate. (c) … Broadly, your 'annual turnover' for an income year is the total ordinary income derived by you in the income year in the ordinary course of carrying on a business (subsection 328-120(1) of the ITAA 1997). Consequently, it is necessary to consider what constitutes ordinary income so that annual turnover for the relevant income year can be established. The legislation does not provide guidance on the meaning of 'ordinary income' however, guidance as to its meaning can be found in case law. For instance, in Scott v. Commissioner of Taxation (NSW) (1935) 35 SR (NSW) 215, Jordan CJ held that the meaning of 'income' was to be determined according to 'ordinary concept and usages' at 219 as follows: The word “income” is not a term of art, and what forms of receipts are comprehended within it, and what principles are to be applied to ascertain how much of those receipts ought to be treated as income, must be determined in accordance with the ordinary concepts and usages of mankind, except in so far as the statute states or indicates an intention that receipts which are not income in ordinary parlance are to be treated as income, or that special rules are to be applied for arriving at the taxable amount of such receipts: A.-G. for British Columbia v. Ostrum ([1904] AC 144 at 147); Lambe v. Inland Revenue Commissioners ([1934] 1 KB 178 at 182-3). Income according to ordinary concepts, referred to as ordinary income, is included in your assessable income under section 6-5 of the ITAA 1997. An Australia resident's assessable income includes ordinary income derived directly or indirectly from all sources (subsection 6-5(2) of the ITAA 1997). In working out whether an amount if ordinary income has been derived by you and (if so) when, subsection 6-5(4) of the ITAA 1997 provides that the amount of ordinary income is taken to have been received as soon as it is applied or dealt with in any way on your behalf or as you direct. | Detailed Reasoning - Medical fees generated by the subcontracted medical practitioners: The medical fees generated by the subcontracted medical practitioners are not considered to be income of Company A or Trust A according to ordinary concepts as: ● they were not amounts received by Company A at any point in time, nor were they applied or dealt with in any way on Company A's behalf or as it directed, i.e. they were not amounts derived by Company A pursuant to subsection 6-5(4) of the ITAA 1997; ● they were amounts which were only received by Trust A (pursuant to the Consultancy Agreement) on behalf of the subcontracted medical practitioners, such that Trust A did not have an equitable or beneficial interest in the amounts at any point in time; ● they were amounts fully payable to, and therefore applied by Trust A on behalf of, the subcontracted medical practitioners pursuant to the Consultancy Agreement, i.e. they were amounts derived by the subcontracted medical practitioners pursuant to subsection 6-5(4) of the ITAA 1997; and ● the subcontracted medical practitioners were not employed by Trust A, such that the amounts were generated for their own account. As the medical fees generated by the subcontracted medical practitioners during the 201X income year were not ordinary income of Company A or either of the entities connected with Company A, they should not be included in the calculation of their annual turnover for that year, and should not be included in determining Company A's aggregated turnover under subsection 328-115(1) of the ITAA 1997. | Detailed Reasoning - Service fees: The service fees derived by Trust A and Trust B during the 201X income year constitute ordinary income derived in the ordinary course of carrying on their respective businesses, and therefore amounts of annual turnover pursuant to subsection 328-120(1) of the ITAA 1997. Whilst an amount of annual turnover of an entity that is connected with you at any time during the income year is generally included in your aggregated turnover for that year, the service fees of derived by Trust A and Trust B respectively are excluded from being included in the calculation of Company A's aggregated turnover for the 201X income year pursuant to the operation of subsection 328-115(3) of the ITAA 1997 as: ● the service fee derived by Trust A was from dealings between it and Company A while Trust A was connected with Company A (paragraph 328-115(3)(a)); and ● the service fee derived by Trust B was from dealings between it and Trust A while both trusts were connected with Company A (paragraph 328-115(3)(b)). | Detailed Reasoning - Conclusion: On the basis of the above, your aggregated turnover for the 201X income year was less than $2 million. Therefore you satisfy subparagraph 328-110(1)(b)(i) of the ITAA 1997 and consequently constitute a small business entity for the 201Y income year.