Private ruling: Application of the small business capital gains concessions
Published: October 2014
Ruling period: 1 July 2012 to 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q2: Can you disregard any capital gain arising from the sale of The Goodwill under section 152-110 of the ITAA 1997? Answer Yes

Relevant facts and circumstances: 1. You are a company which was incorporated over 15 years ago. 2. You only have two ordinary shares issued. 3. In excess of 15 years ago each of your directors (Your Directors) acquired one ordinary share in you. 4. In excess of 15 years ago you commenced a business (Your Business). 5. Your Directors were employed by you as joint managing directors and each played an active role in managing the affairs of Your Business. 6. In the relevant income year, you executed a contract (The Purchase Agreement) to sell part of Your Business. 7. The Purchase Agreement provided that a component of the sale price included The Goodwill. 8. You have told us that: • Immediately prior to the execution of the Purchase Agreement, the sum of the net value of your CGT assets and Your Directors was less than $6 million. • You realised a capital gain on the sale of The Goodwill. • Prior to the sale of part of Your Business one of Your Directors (The Retiring Director) worked full time in Your Business, working an approximate average of 50 hours per week, often working on weekends. • Immediately following the sale of part of Your Business the hours worked by The Retiring Director reduced significantly. The work undertaken by The Retiring Director was mainly concerned with administrative matters related to the sale of part of Your Business. • Since the sale of part of Your Business The Retiring Director performed work for you from time to time to ensure that established administrative processes remained in place following the sale of part of Your Business and to attend to matters arising out of efforts to find a buyer for the remaining part of Your Business. The Retiring Director continued to perform work of this nature from time to time as required. Since the beginning of the 20XX calendar year The Retiring Director has generally worked no more than 16 hours per week. • The Retiring Director's wages from you for the income year ended 30 June 20XX were significantly less than the previous income year. • The Retiring Director has not drawn any wages from you for the income year ending 30 June 20YY. • At the time of the sale of The Goodwill the Retiring Director was over 55 years of age. • When the remaining part of Your Business is sold both Your Directors will retire from work entirely. • There are no other entities, apart from your Directors, that are connected with you. • You have no affiliates.

Relevant legislative provisions: Income Tax Assessment Act 1997 , section 104-10 | Income Tax Assessment Act 1997 , Division 152 | Income Tax Assessment Act 1997 , Subdivision 152-A | Income Tax Assessment Act 1997 , subsection 152-10(1) | Income Tax Assessment Act 1997 , section 152-15 | Income Tax Assessment Act 1997 , section 152-40 | Income Tax Assessment Act 1997 , subsection 152-40(1) | Income Tax Assessment Act 1997 , section 152-55 | Income Tax Assessment Act 1997 , section 152-65 | Income Tax Assessment Act 1997 , subsection 152-70(1) | Income Tax Assessment Act 1997 , section 152-75 | Income Tax Assessment Act 1997 , section 152-110 | Income Tax Assessment Act 1997 , subsection 152-110(1)

Reasons for decision: Summary: A capital gains tax (CGT) event may be 'in connection with your retirement' if: • there is a significant reduction in the number of hours you work, or • a significant change in the nature of your present activities. If the CGT event occurs at some time before retirement it may be in connection with your retirement providing it is integral to your plan to cease activities and retire. Based on what you have told us, after the sale of part of Your Business: • There was a significant reduction in the number of hours worked by the Retiring Director and a significant change to their duties. • While the sale of part of your Business occurred at a time prior to the Retiring Director's retirement from work completely their duties post the sale were consistent with their plan to retire and the Retiring Director has subsequently ceased being paid by you. It is accepted, based on what you have said that the sale of The Goodwill happened in connection with the Retiring Director's retirement. | Detailed Reasoning - Detailed reasoning: One of the conditions for a company to access the small business 15-year exemption in section 152-110 of the ITAA 1997 is that the CGT event to be disregarded must happen in connection with the retirement of an individual who is a significant individual of the company just before the CGT event occurred. Relevantly subsection 152-110(1)(d) of the ITAA 1997 states: an individual who was a significant individual of the company …. just before the CGT event either: (i) was 55 or over at that time and the event happened in connection with the individual's retirement ; or (ii) was permanently incapacitated at that time. | Detailed Reasoning - [Emphasis Added]: The phrase 'in connection with the individual's retirement' is not a defined term. Page 38 of the Advanced Guide to capital gains tax concessions for small business 2013-14 (NAT 3359-06.2014) states that: Whether a CGT event happens in connection with an individual's retirement depends on the particular circumstances of each case. There would need to be at least a significant reduction in the number of hours the individual works or a significant change in the nature of their present activities to be regarded as a retirement. However, it is not necessary for there to be a permanent and everlasting retirement from the workforce. Page 38 of NAT 3359 then goes on to provide the following example: A small business operator and spouse are both pharmacists, are both over 55 years old and carry on business through two pharmacies. They sell one (and make a capital gain) and, accordingly, reduce their working hours from 60 hours a week each to 45 and 35 hours a week respectively. There has been some change to their present activities in terms of hours worked and location - but there has not been a significant reduction in the number of hours or a significant change in the nature of their activities; therefore, there has been no 'retirement'. If, on the other hand, one spouse reduced their hours to nil (stopped working), there would be a significant reduction in the number of hours that spouse was engaged in the business activities. Therefore the sale would be in connection with the retirement of that spouse. Based on what you have told us your circumstances are analogous to the second paragraph of the above example, in particular: • On the sale of the Goodwill there was a reduction of the Retiring Director's working hours. • The work undertaken by the Retiring Director in the immediate period post the sale of part of Your Business was significantly different to their duties prior to the sale and was related to tidying up the affairs of your Business to facilitate the sale. • By the income year ended 30 June 20YY the Retiring Director ceased to be paid by you altogether. You have also told us that it is the intention of both your Directors to retire once the remainder of your Business is sold. The above analysis demonstrates that post the sale of part of your Business there has been a significant reduction in the number of hours worked by the Retiring Director and a significant change in the nature of their activities. A CGT event may be 'in connection with your retirement' even if it occurs at some time before retirement. Page 38 of NAT 3359 provides the following example: A small business operator, over 55 years old, sells some business assets as part of a wind-down in business activity ahead of selling the business. Within six months, she sells the business and ends her present activities. If it can be shown that the earlier CGT event was integral to the business operator's plan to cease her activities and retire, the CGT event may be accepted as happening in connection with retirement. Based on what you have told us the work activities undertaken by the Retiring Director post the sale of part of your Business are consistent with the wind-down of the your Business operations and integral to the Retiring Director's plan to retire. It is accepted, based on what you have said that the sale of The Goodwill is in connection with the retirement of the Retiring Director. | Summary: Based on what you have told us, you can disregard any capital gain associated with the disposal of The Goodwill under section 152-110 of the ITAA 1997 because at the time of the disposal: • You met the basic conditions for accessing the small business CGT concessions because: • a CGT event happened in relation to The Goodwill, which is a CGT asset of yours, • this event would (apart from Division 152 of the ITAA 1997) have resulted in a capital gain for you, • The Goodwill was an active asset, and • the maximum net asset value test, as it applies to you, was satisfied. • You continuously owned The Goodwill for the 15-year period ending just before its sale. • You had a significant individual for a total of at least 15 years during the period which you owned The Goodwill, and • at the time of the disposal of The Goodwill the Retiring Director was over 55, a significant individual and the sale of The Goodwill was in connection with their retirement. | Detailed Reasoning - Detailed reasoning: Relevantly, subsection 152-110(1) of the ITAA 1997 permits a company disregard a capital gain arising from a CGT event if: (a) the basic conditions for the small business CGT concessions (in Subdivision 152-A of the ITAA 1997) are satisfied for the gain, (b) the company continuously owned the CGT asset for the 15-year period ending just before the CGT event, (c) the company had a significant individual (as defined in the ITAA 1997) for a total of at least 15 years during which the company owned the CGT asset, and (d) an individual who was a significant individual of the company just before the CGT event either: (i) was 55 or over at that time and the event happened in connection with the individual's retirement, or (ii) was permanently incapacitated at that time. | Detailed Reasoning - Basic conditions: Subsection 152-10(1) of the ITAA 1997, which contains the basic conditions, provides that: 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 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; (ii) you satisfy the maximum net asset value test (see section 152-15); (iii) you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an interest in 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 | Detailed Reasoning - A CGT Event that would have resulted in a gain: According to section 104-10 of the ITAA 1997 CGT event A1 happens when you enter into a contract for the disposal of a CGT asset. In the relevant income year, you entered into a contract for the sale of The Goodwill, the Business Purchase Agreement. This disposal means that CGT event A1 happened in the relevant income year relating to your CGT asset The Goodwill and, apart from Division 152 of the ITAA 1997, this would amount to a capital gain in the relevant income year for you. | Detailed Reasoning - Maximum net asset test: You satisfy the maximum net asset value test set out in section 152-15 of the ITAA 1997 if the total net value of the CGT assets owned by you, any entities connected with you and any affiliates (and entities connected with your affiliates), is less than $6 million, just before the CGT event you wish to disregard occurred. Your Directors each own one of the two ordinary shares issued by you as such, they each control 50% of the voting power and have the right receive 50% of any distribution of income or capital. As such, in accordance with section 328-125 of the ITAA 1997, Your Directors both directly control you and are connected with you. You have told us that: • there are no other entities connected with you, • you have no affiliates, and • the sum of the net values of CGT assets held by you and Your Directors, immediately before the sale of The Goodwill is less than $6,000,000. Based on this it is accepted that at the time of the disposal of The Goodwill you met the maximum net asset test. | Detailed Reasoning - Active asset test: In accordance with subsection 152-40(1) of the ITAA 1997, an intangible CGT asset is an active asset if it is owned by you and is inherently connected with a business carried on by you. Note 3 found in subsection 152-40(1) of the ITAA 1997 provides goodwill as an example of an asset that is inherently connected with a business. It is accepted that The Goodwill is inherently connected with the part of your Business you disposed of and as such The Goodwill is an active asset. | Detailed Reasoning - Conclusion basic conditions: Based on what you have told us the sale of The Goodwill satisfies the basic conditions in Subdivision 152-A of the ITAA 1997. | Detailed Reasoning - Continuously owned the CGT asset for a 15-year period: To satisfy this condition you must have continuously owned the CGT asset for the 15-year period ending just before the CGT event. You have told us that you commenced carrying on Your Business in excess of 15 years before you disposed of part of Your Business. As such it is accepted that you held The Goodwill for a continuous period of over 15 years just before the CGT event. | Detailed Reasoning - Had a significant individual for at least 15-years during ownership period: In accordance with section 152-55 of the ITAA 1997 an individual is a significant individual in a company if they have a 'small business participation percentage' in the company of at least 20%. 'Small business participation percentage' takes its meaning from section 152-65 of the ITAA 1997, as the sum of the 'direct small business participation percentage' and the 'indirect small business participation percentage'. Relevantly, the 'direct small business participation percentage' in the context of an individual holding an interest in a company, is defined by item 1 of the table in subsection 152-70(1) of the ITAA 1997 as the percentage of: • voting power that the individual is entitled to exercise in the company • any dividend payment that the individual is entitled to receive from the company, or • any capital distribution that the individual is entitled to receive from the company. If the above definitions provide different percentages, the smallest percentage will be the 'direct small business participation percentage' of the individual in the company. In this instance as the shares in you are held directly by individuals it is not necessary to consider the application of the 'indirect small business participation percentage' defined in section 152-75 of the ITAA 1997. There are only two ordinary shares issued by you. Your Directors each own one ordinary share meaning they both have a 'direct small business participation percentage' of 50% in you. Following this through Your Directors, each have a 'small business participation percentage' of 50% meaning they are both your significant individuals. As Your Directors shareholding in you has not changed since they acquired their shares more than 15 years ago, they have both been significant individuals of you for a period which is at least 15-years during the ownership period of The Goodwill. Based on what you have told us, it is accepted that you have had a significant individual for at least 15-years during the ownership period of The Goodwill. | Detailed Reasoning - At the time of the CGT event the significant individual was over 55 and the CGT event was in connection with their retirement: You have told us that the Retiring Director, who was a significant individual of you at the time of the disposal of The Goodwill, was aged over 55 years when the sale of part of Your Business occurred in the relevant financial year. As already explained in answering question 1 above, it has been established that the disposal of The Goodwill is in connection with The Retiring Director's retirement. As such, based on what you have told us, it is accepted that at the time of the CGT event (the disposal of The Goodwill) you had a significant individual, the Retiring Director, who was over 55 and the disposal of The Goodwill was in connection with their retirement. | Detailed Reasoning - Conclusion: Based on what you have told us, all the conditions contained in section 152-110 of the ITAA 1997 are satisfied relating to the disposal of The Goodwill by you in the relevant financial year. Meaning you can disregard any capital gain arising from the sale of The Goodwill under section 152-110 of the ITAA 1997.

Did the sale of the goodwill associated with your business (The Goodwill) happen in connection with the retirement of your director (The Retiring Director) within the meaning of paragraph 152-110(1)(d)(i) of the Income Tax Assessment Act 1997 (ITAA 1997)?