Private ruling: CGT-small business concessions-deceased’s estate
Date of advice: 3 May 2018
Published: July 2018
Ruling period: Year ending 30 June 2017
Date scheme commenced: 1 July 2016

Ruling: Q2: Will the sale by the executor of the estate of P of the X% interests in lots d, e and f to the beneficiary of the estate of P be exempt from CGT under section 152-80 of the Income Tax Assessment Act (ITAA) 1997? | A1: No, only X% of the interest will be exempt from CGT. The remaining X% interest in lots d, e and f will not meet the requirements of section 152-80 of the ITAA 1997 and will therefore not be exempt from CGT.

Relevant facts and circumstances: Q and P purchased a property after 20 September 1985 (property W). Q and P used the property for the purposes of carrying on a farming business. Q and P lived away from the property. The property consisted of X lots. R, the child of P and Q is over 50 years of age. R assisted P and Q in operating the farming business. R entered into a share farming arrangement with P and Q which allowed R to derive income from the property and in return R provided labour and expertise, which allowed P and Q to derive an annual income of around $XX,XXX. This share farming arrangement was not subject to any formal agreement and continued up until a formal lease was entered into. As part of this share farming arrangement, Q worked in conjunction with R in operating the farming business. Q passed away in 20XX and Q’s half interest as joint tenant in the property passed to P. P continued to carrying on the farming business with the assistance of R for some time. R entered into a lease with P to rent the property. In return for the use of the property, R paid annual rent to P. In 20XX P relocated and lived in a nursing home. P passed away in 20XX. For the purposes of this ruling, R is referred throughout this ruling as either R or beneficiary 1 (beneficiary 1). R’s siblings who are beneficiaries of P’s estate are referred to as beneficiaries (beneficiaries). The beneficiaries entered into an agreement with beneficiary 1, which entitled beneficiary 1 to a 100% ownership interest in lots a,b and c, which beneficiary 1 inherited from the executor of the Estate of P. These lots were valued at $XXX,XXX. The agreement provided that the X% interest that each of R’s siblings held in lots d,e and f would be purchased by beneficiary 1 making a payment of $XXX,XXX to the executor of P’s estate in 20XX. Beneficiary 1 would retain X% of the inherited interest in lots d, e and f. The agreement valued the lots forming part of property as being around $X,XXX,XXX. P was over 55 years of age at the date of P’s passing. You have confirmed that the activities conducted by R are considered a small business entity, as R is operating a farming business and the turnover of the business is less than $2,000,000.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 128-20 | Income Tax Assessment Act 1997 Subsection 128-50 | Income Tax Assessment Act 1997 Section 152-10 | Income Tax Assessment Act 1997 Subsection 152-80

Reasons for decision: Summary: Any capital gain the Trustee of P’s Estate makes when lots a, b and c and the X% interest in lots d, e and f passes to R as beneficiary of P’s estate is disregarded. | Detailed Reasoning - Joint interests: Under section 128-50(2) of the ITAA 1997, a surviving joint tenant is taken to have acquired the deceased joint tenant’s interest in the asset at the date of the deceased’s death. | Detailed Reasoning - Asset passing from the legal personal representative or trustee of an estate to the beneficiary: Any capital gain or capital loss made by the legal personal representative (LPR) or trustee on the transfer or ‘passing’ of an asset of the deceased to a beneficiary in the estate is disregarded in accordance with section 128-15(3) of the ITAA 1997. Section 128-20(1) provides that an asset is taken to have ‘passed’ to the a beneficiary when the beneficiary becomes the owner of the asset in any of the following circumstances: ● Under a will or will varied by a court order: ● By operation of an intestacy law; ● By appropriation to a beneficiary; ● Under a deed of arrangement; or ● By absolute entitlement. An asset will pass to a beneficiary of an estate under a ‘deed of arrangement’. This is provided: ● The beneficiary entered into the deed to settle a claim to participate in the distribution of the estate; and ● Any consideration given by the beneficiary for the asset consists only of the variation or waiver of a claim to one or more other CGT assets that form part of the estate. Section 128-20(2) provides specifically that an asset will not pass to a beneficiary if the beneficiary acquires it from the LPR under a power of sale. Instead, CGT event A1 will apply to the disposal of the asset by the LPR. | Detailed Reasoning - Application to your circumstances: P and Q acquired the property as joint tenants. In 19XX, Q’s joint interest in the property passed to P at the date of Q’s passing. P became the sole owner of the property, and held 2 separate CGT interests. P held half of P’s interest in the property acquired in 19XX. P’s second interest was Q’s joint interest that passed to P as a tenant in common at the date of Q’s passing. By will, P bequeathed P’s interest, consisting of a property W and other farming land and cash to P’s children in equal shares. Beneficiary 1 and the other beneficiaries entered into an agreement which allowed property W and the other farms to be distributed in accordance with the will. This agreement provided that beneficiary would inherit lots a, b and c and a X% in lots d, e and f. As lots a, b and c and X% in lots d, e and f passed to beneficiary 1 as a beneficiary under a deed of arrangement, any capital gain is disregarded. | Summary: The X% interests that each of R’s siblings held in lots d, e and f are subject to a power of sale by the executor and do not pass to a beneficiary in accordance with section 128-15(3) of the ITAA 1997. Any capital gain on the sale of the C% interest in lots d, e and f acquired by P’s estate, representing the joint interests P originally acquired 19XX will be able to be disregarded under section 152-80 of the ITAA 1997. The X% interest in each of the lots d, e and f representing the joint interest P acquired from Q at the date Q passed away does not satisfy the active asset test and cannot be exempt from CGT under section 152-80 ITAA 1997. | Detailed Reasoning - Small Business Concessions: The trustee of a deceased’s estate is eligible to apply the CGT small business concessions to the same extent that the deceased would have been able to just prior to their passing. | Detailed Reasoning - Basic conditions: To qualify for the small business CGT concessions, you must satisfy several conditions that are common to all the concessions. These are called the basic conditions. A capital gain you make may be reduced or disregarded if the following basic conditions are satisfied: 1. A CGT event happens in relation to a CGT asset of yours in an income year; 2. The event would (apart from this division) have resulted in the gain; 3. At least one of the following applies: ● you are a small business entity (SBE) for the income year; or ● you satisfy the maximum net asset value test; ● you are a partner in a partnership that is a SBE for the income year and the capital gains tax (CGT) asset is an interest in an asset of the partnership; or ● the conditions mentioned in subsection 152-10(1A) or (1B) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year that the CGT event occurs 4. You satisfy the active asset test. The active asset test is satisfied if: ● You have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the test period detailed below, or ● You have owned the asset for more than 15 years and the asset was an active asset of yours for a total of least 7.5 years during the test period. The test period: 1. begins when you acquired the asset, and 2. ends at the earlier of ● the CGT event, and ● when the business ceased, if the business in question ceased in the 12 months before the CGT event (under subparagraph 152-35(2)(b)(ii) of the ITAA 1997 the Commissioner can allow a longer period than 12 months). In the case of an asset held for longer than 15 years, section 152-35 of the ITAA 1997 requires the asset to be held or used in the course of carrying on a business by you, your affiliate or another entity connected with you for a period of at least 7 1/2 years. | Detailed Reasoning - 15 year small business exemption: Section 152-110 of the ITAA 1997 provides that an individual can disregard any capital gain made on the disposal of an asset if all of the following conditions are satisfied: (a) You satisfy the basic conditions; and (b) You continuously own the CGT asset for the 15 year period ending just before the CGT event; and (c) The individual was either: i. 55 years of age or over at the time of the CGT event and the CGT event giving rise to the capital gain happened in connection with the individual’s retirement; or ii. The individual was permanently incapacitated at the time of the CGT event. | Detailed Reasoning - Passively held assets: This passively held asset condition allows you to access the concessions for a CGT asset you own where you are not carrying on a business, but that CGT asset is used in the business of your affiliate or an entity connected with you (subsection 152-10(1A) of the ITAA 1997). The following conditions must be satisfied: ● Your affiliate, or entity connected with you, is a small business entity for the income year, that is the income year in which the CGT event happens to your CGT asset ● You do not carry on a business in the income year other than in partnership ● If you carry on a business in partnership, the CGT asset is not an interest in an asset of the partnership ● Your affiliate or entity that is connected with you at a time in the income year is the same small business entity that carries on the business and uses the asset at that time and the asset is the same asset that also meets the active asset test at that time. | Detailed Reasoning - Affiliate: Subsection 328-130(1) of the ITAA 1997 defines the meaning of an affiliate as an individual or company that, in relation to their business affairs, acts or could reasonably be expected to act in accordance with your directions or wishes, or in concert with you. Trusts, partnerships and superannuation funds cannot be your affiliates. However a trust, partnership or superannuation fund may have an affiliate who is an individual or company. Subsection 328-130(2) of the ITAA 1997 specifically provides that an individual or company is not your affiliate merely because of the nature of the business relationship you and the individual or company share. A note under subsection 328-130(2) of the ITAA 1997 states that for the small business relief purposes, a spouse or a child under 18 years may also be an affiliate under section 152-47. The explanatory memorandum to the relevant amending Bill states: “2.36 The following factors may have a bearing on whether an individual or company is an affiliate of an entity to the extent that they show that two or more entities are acting in concert: ● family or close personal relationships; ● financial relationships or dependencies; ● relationships created through links such as common directors, partners, or shareholders; ● the degree to which the entities consult with each other on business matters; or ● whether one of the entities is under a formal or informal obligation to purchase goods or services or conduct aspects of their business with the other entity”. Former subsection 152-25(1) ITAA 97 was not limited to the conduct of the small business CGT affiliate in the use of the CGT asset. Rather, the section was couched in broad terms, and included the relationship between the parties in the conduct of the affiliate’s business generally. Justice Finkelstein in Papua New Guinea Dockyard Ltd v Adams and Ors (2005) FCA 413 provides the following meaning of acting in concert: “These cases show that a person, A, will be acting in concert with another person, B, if A engages in conduct (act or omission) in consequence of an agreement or understanding between A and B and the conduct is in pursuance of an objective or purpose which is common to both. It is not as is sometimes suggested necessary to show that the common objective or purpose has some pejorative element [such as] to circumvent the letter, or perhaps even the spirit, of some other statutory obligation or requirement …” For an entity to act “in accordance with” the instructions or wishes of another entity, there must be a causal connection between the instruction or wish of the other entity and the act taken by the first entity. | Detailed Reasoning - An entity is connected with another entity: Subsection 328-125(1) of the ITAA 1997 states that an entity is connected with another entity if either entity controls the other entity, or both entities are controlled by the same third entity. Generally speaking an entity controls another entity if it owns interests in the other entity that give the right to receive at least 40% of any distribution of income, the control percentage. | Detailed Reasoning - Application to your circumstances: The X% interests that each of R’s siblings held in lots d, e and f are subject to a power of sale by the executor and do not pass to a beneficiary in accordance with section 128-15(3) of the ITAA 1997. Therefore, any CGT cannot be disregarded on the transfer of these interests. The siblings X% interest in lots d, e and f consists of 2 separate CGT interests: 1. X% interest in each lot acquired by P’s Estate, representing the joint interest P originally acquired in 19XX. 2. X% interest in each lot acquired by P’s Estate, representing the joint interest P acquired from Q at the date Q passed away. Section 152-80 of the ITAA 1997 allows either the legal personal representative of an estate or the beneficiary to apply the small business CGT concessions in respect of the sale of the deceased’s asset in certain circumstances. Specifically, the following conditions must be met: ● A CGT asset forms part of the estate of the deceased individual; ● the asset devolves to the legal personal representative, passes to a beneficiary, devolves to a trustee of a trust established by a will or is acquired by a surviving joint tenant ● the deceased would have been able to apply the small business concessions themselves if they had disposed of the asset immediately prior to their death, and ● a CGT event happens within 2 years of the deceased’s death unless the Commissioner extends the time period in accordance with subsection 152-80(3) of the ITAA 1997. The conditions within section 152-80 of the ITAA 1997 must be applied to each of the two separate CGT interests held by the siblings (R’s interest is excluded): a. The X% interest in each lot acquired by P’s estate, representing the joint interests P originally acquired 19XX. You satisfy all 4 conditions under section 152-80 of the ITAA 1997: ● The CGT asset being property W forms part of the estate of P; and ● The CGT asset devolves to the Trustee of the estate of P before it is sold by the trustee to a beneficiary of the estate. ● You and your affiliate (being R) carried on a business of farming and used the CGT assets as part of the farming business for more than 7.5 years and will satisfy the active asset test. ● The sale of the deceased’s CGT asset occurs within 2 years of the deceased’s passing. Therefore, any Capital gain on the sale of the X% interest in lots d, e and f acquired by P’s estate, representing the joint interests P originally acquired 19XX will be able to satisfy the 15 year small business concessions. As the interest was held for more than 15 years and P was over 55 years of age, P would have been entitled to access the small business concessions immediately before P’s passing. b. The X% interest in each lot acquired by P’s estate, representing the joint interest P acquired from Q at the date Q passed away This interest was owned by P’s estate from the date P acquired it from Q in 20XX until P passed away in 20XX. The interest was owned by the Estate of P for a total of XXX days. In relation to this X% interest, the deceased would not have met the small business concessions as P would not have been able to satisfy the active asset test. This is because the CGT asset (X% of interest in lots d, e and f acquired from Q in 20XX) was used passively in a business carried on by the deceased’s affiliate for less than half the time the deceased owned the asset. The X% interest was acquired by P in 20XX and passively used by R from 20XX to 20XX, as part of a share farming arrangement with the asset owner. During this time P controlled the farming activities that could be carried out on at property W and directed that a share of the income from the farming operations being paid to the asset owner. More than half the days during which this interest was owned (XXX/XXX total ownership days), it was leased by R. During this time, R was not considered an affiliate of or connected with the asset owner as: ● R was not connected to the taxpayer as R does not own any interest in property W and was therefore not entitled to receive at least 40% of any distribution of income. ● In carrying on the business of farming at property W during the period of the lease arrangement commencing until P’s passing, R wasn’t an affiliate of P as he didn’t act in accordance with P’s directions or wishes or in concert with P. P was not entitled to any income under the lease arrangement and there were no conditions within the lease which controlled, restricted or indicated a common purpose between P and R in the conduct of R’s farming business. At the commencement of the lease period, P had relocated to a nursing home. There was no evidence of any wishes being expressed by P in relation to the conduct of R’s business and no evidence of R acting upon any such wishes. Therefore, the X% interest in lots d, e and f held by P’s Estate that represents the joint interest P acquired from P’s spouse does not satisfy the active asset test and cannot be exempt from CGT under the small business concessions.

Question 1: Will any capital gain or loss be disregarded, when lots a, b and c and the 1/5 interest in lots d, e and f forming part of property W, pass from the estate of P to beneficiary 1?