Private ruling: CGT - small business concessions - 15 year exemption - pre and post CGT assets - company
Date of advice: 8 October 2018
Published: November 2018
Ruling period: 1 July 2017 to 30 June 2018 | 1 July 2018 to 30 June 2019
Date scheme commenced: 1 July 2017

Ruling: Q1: Will you be entitled to apply the 15 year exemption under section 152-105 of the Income Tax Assessment Act 1997 (ITAA 1997) to the capital gain made on the sale of the property left to you and your relative as tenants in common in equal shares in remainder? | A1: No | Q2: Will you be entitled to apply the small business 50% reduction under subdivision 152-C, the retirement exemption under subdivision 152-D and the rollover concession under subdivision 152-E of the ITAA 1997 to the capital gain made on the sale of the property left to you and your relative as tenants in common in equal shares in remainder? | A2: Yes Issue 2 | Q3: Will a final distribution by the Liquidator be considered a capital payment for cancellation of shares in the company when the company is wound up? | A3: Yes | Q4: Will you be entitled to apply the 15 year exemption to a distribution by the Liquidator in received in connection with the cancellation of your shares in the company when the company is wound up? | A4: No | Q5: Will the market value of your relative’s life interest in the shares in the company when they surrenders that life interest form part of the cost base of your remainder interest? | A5: Yes

Relevant facts and circumstances: Your Relative One (the Deceased) purchased property one located at a place. Your Relative Two and the Deceased carried on a farming business in partnership until a date in 197X, when the operation moved to a company structure. The Deceased passed away on a date in 199X. Your Relative Two inherited property one as life tenant. You and your Relative Three inherited Property One as tenants in common in equal shares in remainder. You entered into a contract for the sale of Property One on a date 201X for $X,XXX,000. The sale settled on a date in 201X. You made a capital gain on the sale of property one. Company The Company was incorporated on a date in 197X. In 197X the Company purchased Property Two The Company used Property One in conjunction with Property Two to conduct its primary production business. Relative Two, You and Relative Three continued the farming operation through the Company structure after the deceased passed away. Relative Two, You and Relative Three are all Directors of the Company. On their passing, the Deceased left all of their shares in the Company to Relative Two as life tenant and You and Relative Three as tenants in common in equal shares in remainder. On a date in 199X, in their capacity as executor of the estate of the Deceased, Relative Two transferred legal ownership of the Class A shares and Class C shares to theirself as life tenant, and You and Relative Three as tenants in common in equal shares in remainder. Shareholding in the Company following that transmission and to present are as follows: Owner Shares Votes % of Votes % of Capital entitlement Pre/Post Relative Two as life tenant, You and Relative Three in equal shares in remainder 100 Class A shares 100 votes 65.79% 40% Post Relative Two as life tenant, You and Relative Three in equal shares in remainder 50 Class C shares 1 vote 0.66% 20% Post Relative Two 50 Class B shares 50 votes 32.89% 20% Pre Relative Two 50 Class D shares 1 vote 0.66% 20% Post Article 6 states that the Directors may declare dividends to: ● one or more class of shares to the exclusion of other classes. ● at different rates on different classes of shares respectively. ● on any particular share or shares to the exclusion of other shares The Company is a small business entity for the purposes of the capital gains tax (CGT) small business concessions (SBC). The Company is your affiliate for the purposes of the CGT SBC. More than 80% of the Company’s assets relate to the small business. Sale of Property Two The Company entered into a contract for the sale of Property Two for $X,XXX,000 on a date in 201X. The sale settled on a date in 201X. The Company made a gain on the sale of the property. The company accounted for the gain in a separate capital reserve account. Company to be wound up The Company will be wound up in the 201Y income year. Relative Two will surrender their life interest in the shares prior to the company being wound up. All shares in the Company will be cancelled when the Company is wound up. Remaining capital reserves will be distributed to shareholders. Plans to retire You are under 55 years of age and wish to retire from farming due to financial pressures and health issues.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 152-10 | Income Tax Assessment Act 1997 section 152-35 | Income Tax Assessment Act 1997 section 152-110 | Income Tax Assessment Act 1997 section 152-105 | Income Tax Assessment Act 1997 section 152-125 | Income Tax Assessment Act 1997 section 104-25 | Income Tax Assessment Act 1997 section 149-15 | Income Tax Assessment Act 1997 section 149-30 | Income Tax Assessment Act 1936 section 47(1)

Reasons for decision: Summary: You meet the Small Business Concessions (SBC) basic conditions in regards to the sale of Property One. You held your ownership interest in the asset for more than 15 years. Property One was an active asset for more than 71/2 years of your ownership interest. However you are under 55 years of age. You are unable to apply the 15 year exemption to any gain on the sale of Property One for CGT purposes. You are eligible to apply the 50% small business discount and the retirement exemption to any gain on the sale of Property One. | Detailed Reasoning - Detailed reasoning: 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 basic conditions are satisfied. In your case, the basic conditions you need to satisfy are: (a) a CGT event happens in relation to a CGT asset of yours; (b) the event would have resulted in the gain; (c) the small business entity that is your affiliate is the entity that carries on the business (d) the CGT asset satisfies the active asset test. Active asset test Where you have owned an asset for 15 years or longer, the asset must have been an active asset of yours for a total period of at least 7.5 years in the period from when you acquired it, until the earlier of when the CGT event occurred or when the relevant business ceased, if it ceased to be carried on in the 12 months before the CGT event occurred (or longer period allowed by the Commissioner). Definition of active asset You must also meet any additional conditions which apply to the particular concession you wish to apply to the gain. 15 year exemption ● An individual may disregard any capital gain arising from a CGT event under the 15 year exemption where: ● all of the basic conditions are met; and ● you continuously owned the relevant CGT asset for the 15 year period ending just before the CGT event; ● If the relevant asset is a share in a company or trust, the company or trust had a significant individual for a total of at least 15 years (even if the 15 years was not continuous and it was not always the same significant individual); and ● you are either over 55 at the time of the CGT event or permanently disabled. Other SBC concessions If you satisfy the SBC basic conditions, but are unable to apply the 15 year exemption under subdivision 152-B, you will be able to apply the SBC 50% reduction under Subdivision 152-C, the small business retirement exemption under subdivision 152-D and the small business rollover under subdivision 152-E. You can choose whether or not to apply these concessions, and the order in which you apply them. | Detailed Reasoning - Application to your circumstances: You have disposed of your interests in Property One in the 201Y income year and have made a capital gain on the disposal. You acquired your ownership interest in the property when the Deceased passed away in 199X. The property has been used by your affiliate, the Company in the operation of the primary production business from that date until present. Therefore, Property One has been an active asset of yours for longer than the 7.5 years required by the active asset test, and all of the basic conditions for small business CGT relief have been satisfied. You have continuously held an ownership interest in Property One for over 15 years. However, you are under the age of 55 years, and are not permanently disabled. Consequently you are not eligible to apply the 15 year exemption to your gain on the sale of Property One. Because you meet the basic conditions, you are eligible to apply the other SBC concessions to your gain. You may reduce the gain by 50% using the SBC 50% reduction. You may apply the retirement exemption by contributing all or part of the reduced assessable gain to superannuation, up to the CGT retirement lifetime exemption limit of $500,000. And you may apply the small business rollover to all or part of the gain, giving you two years to acquire a replacement asset. If you fail to acquire a replacement asset by the end of two years, the gain will be subject to taxation as a J5 event. You may be eligible to apply the retirement exemption to the gain at this point. | Summary: A liquidator’s distribution of capital from the Company will be considered to be proceeds on the disposal of your interest in the Company shares. You will not be entitled to apply the 15 year exemption to any capital gain which arises as a result of the cancellation of your interests the shares in the Company as you do not meet the additional SBC basic conditions for shares in a company. | Detailed Reasoning - Detailed reasoning: CGT event C2 Taxation Determination TD 2001/27 (TD 2001/27) considers how Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997) treat: ● a final liquidation distribution, including where all or part of it is deemed by subsection 47(1) of the Income Tax Assessment Act 1936 (ITAA 1936) to be a dividend; and ● an interim liquidation distribution to the extent it is not deemed to be a dividend by subsection 47(1) Paragraph 1 of TD 2001/27 states that the full amount of a final distribution made by a liquidator on the winding-up of a company constitutes capital proceeds from the ending of the shareholder's shares in the company for the purposes of capital gains or capital losses made on the happening of CGT event C2 (about cancellation, surrender and similar endings) in section 104-25 of the ITAA 1997. Basic conditions The basic conditions in section 152-10 of the ITAA 1997 must be met in order to apply the CGT SBC to a gain which arises in relation to the cancellation of your shares in the company. In order to meet the basic conditions, the relevant asset must be an active asset of the business. A CGT asset is an active asset (subject to exclusions) if it is owned and used, or held ready for use, in the course of carrying on a business by you or your small business CGT affiliate or another entity that is connected with you. An active asset may be a tangible asset or an intangible asset. The following assets cannot be active assets (subsection 152-40(4) of the ITAA 1997): a) interests in a connected entity (other than those satisfying the 80% test) b) shares in companies and interests in trusts (other than those satisfying the 80% test) Shares Shares are not active assets unless they satisfy the 80% test in subsection 152-40(3) of the ITAA 1997. A ‘share’ is an active asset if; the company is an Australian resident and at least 80% of the market value of the company’s assets are active assets. The ATO Website Small Business CGT Concessions (QC 22165) states that cash and financial instruments are not active assets, but they count towards the satisfaction of the 80% test provided they are inherently connected with the business. Subsection 152-10(2) applies an additional basic condition where the CGT asset is a share in a company. You are either required to be a CGT concession stakeholder in the company, or CGT concession stakeholders jointly hold a small business participation percentage of greater than 90%. Inherent connection A thing might be regarded as inherently connected to a business when it is a permanent or characteristic attribute of the business – for example goodwill, or trade debtors. Where a business is holding excess funds arising from a temporary spike in trading activity or the sale of a business asset, the excess funds might also reasonably be regarded as inherently connected with the business. 15 year exemption Where the relevant CGT asset is a share in a company, section 152-105 of the ITAA 1997 imposes the additional requirement that the company had a significant individual for a total of at least 15 years (even if the 15 years was not continuous and it was not always the same significant individual) for the application of the 15 year exemption. Significant individual 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. Direct small business participation percentage An entity’s direct small business participation percentage in a company is the percentage of: ● voting power that the entity is entitled to exercise or ● any dividend payment that the entity is entitled to receive, or ● any capital distribution that the entity is entitled to receive, or ● if they are different, the smallest of the three percentages above. Jointly owned shares The voting power calculation is ignored where the shares are jointly owned, as neither owner would individually control the voting power on the jointly owned shares. | Detailed Reasoning - Application to your circumstances: Basic conditions In your case, you own interests in the shares of a company which is being wound up. When the Company ceases to exist, CGT event C2 will happen to your shares. You will receive a capital distribution from the Liquidator in relation to pre-CGT land which has been sold by the Company. The distribution is deemed to be attributed to the cancellation of your shares, and will be proceeds of CGT event C2. The Company is a small business entity for the purposes of the small business CGT concessions. The Company is also your affiliate. You acquired your ownership interest in the Class A and Class C shares when the Deceased passed away in 1999. You have owned your interests in the Class A and Class C shares for approximately XX years. The interests in the A and C class shares that you own are post CGT assets. You expect to make a capital gain on the receipt of the distribution. Therefore, you have satisfied the requirements to have owned the asset for more than the required 15 years. Small business participation percentage Your direct small business percentage is the smallest of: your voting percentage; your right to income from the shares; and your right to capital from the shares. For the purpose of this calculation you disregard voting percentage on jointly held shares. Your interest in the shares is only a remainder interest while Relative Two retains their life interest. Relative Two holds 100% of the right to income distributions from the company. Your right to income, and therefore your small business participation percentage, will be zero. With a zero small business participation percentage, you cannot be a significant individual for SBC purposes or a CGT concession stakeholder in the company. Accordingly, you are not able to disregard any payments from the company under section 152-125 of the ITAA 1997. Relative Two holds a small business participation percentage in the company of less than 90%. There are no other small business participation percentage holders. As you are not a CGT concession stakeholder, and the combined small business participation percentage of CGT concession stakeholders is less than 90%, you do not meet the additional basic conditions for the SBC. Accordingly, you will not be able to apply the SBC to any gain you make on the C2 event on the liquidation of the company and the disposal of your interest in the shares. | Detailed Reasoning - Question 3: Relative Two will surrender their life interests in the A and C class shares. At the time they surrender these interests, a CGT event A1 will occur. As this is not an arms-length transaction, the market value substitution rule will operate to deem Relative Two to have received as proceeds the market value of these interests. When the life interest is cancelled, it ceases to exist. You do not acquire additional interests in the shares at this point. The remainder interest will be enlarged to include all the income and voting interests in the shares that you hold jointly with Relative Three. The market value substitution rule will also work to deem the market value of Relative Two’s life interests to form part of your cost base of your interest in the shares when you perform your CGT calculation on the C2 event on the cancellation of the shares. Because you do not acquire additional interests in the shares in the surrender of the life interests, you will have held the shares for longer than 12 months, and be eligible to apply the general 50% CGT discount to any gain on disposal.