Private ruling: Income tax: Capital gains tax: Small business relief
Date of advice: 12 October 2016
Published: December 2016
Ruling period: 1 July 20XX to 30 June 20YY
Date scheme commenced: 1 July 20XX

Ruling: Q1: Is the Property an active asset of the Unit Trust in accordance with section 152-40 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: Is Individual a significant individual of the Unit Trust as defined in section 152-55 of the ITAA 1997? | A2: No | Q3: Was the sale of the Property an event which happened in connection with the Individual's retirement for the purposes of paragraph 152-110(1)(d)(i) of the ITAA 1997? | A3: No Issue 2 | Q4: Is the distribution of the gain attributable to the sale of the Property made by the Unit Trust to the Super Fund non-arm's length income of the Super Fund as defined in subsection 295-550(5) of the ITAA 1997? | A4: No

Relevant facts and circumstances: 1. The Super Fund is a regulated complying self-managed superannuation fund. 2. There are only two members of the Super Fund including the Individual. 3. The Trustee of the Super Fund is the Company. 4. The Company is the trustee of the Unit Trust. 5. The Super Fund beneficially owns all the issued units in the Unit Trust. 6. The Individual and the other member of the Super Fund each hold 50% of the issued shares in the Company. 7. The Individual and the other member of the Super Fund are both directors of the Company. 8. The Property was acquired by the Unit Trust from parties, who were not related to the Individual or the other member of the Super Fund. 9. Businesses were operated by the Company at the Property during the entire ownership period by the Unit Trust. 10. The Property was purchased for use in the Businesses and was not a passive asset. 11. In 20YY the Unit Trust sold the Property to parties, who were not related to the Individual or the other member of the Super Fund. 12. Prior to its sale, the Property was first offered for sale by auction, it was passed in at that auction and the ultimate sale price was arrived at by negotiation. 13. The Company made a capital gain on the sale of the Property. 14. When the Property was sold the Individual was aged over 55. 15. Before 20XX the Individual was working more than 40 hours per week in the Businesses. 16. As a result of ill health the Individual was forced to substantially reduce the number of hours worked in the Businesses. 17. As of January 20YY the Individual was working less than 20 hours each week in the Businesses. 18. There is no legal binding lease agreement between the Unit Trust and the Company in relation to the Property. 19. The rent for the Property was determined by the Unit Trust and the Company based on an appraisal by them of comparable arm's length rent. 20. The rent for the Property was paid to the Unit Trust on a monthly basis by the Company. 21. Under the terms of the Super Fund beneficiaries are not limited to the members of the fund; rather beneficiaries include dependants (and pensioners) as defined in in the deed. 22. Dependants are defined in the deed of the Super Fund to include as beneficiaries: • the spouse, widow or widower of the member, • any child of the Member including any child of the member born after the death of the member; • any person who in the opinion of the Trustee is at the relevant time (or in the case of a deceased member, was at the time of death of that Member) wholly or partially dependent on the member for that person's maintenance and support or who has or had at the relevant time a legal right to maintenance and support from that member; and • any other person who is a dependant as defined by the law. 23. Under the terms of the deed of The Super Fund: • A beneficiary includes a member, dependant or pensioner, who is presently and absolutely entitled to the payment of a benefit, or has a contingent right or mere expectancy to receive a payment once a prescribed event occurs. • Benefit entitlement only happens upon the occurrence of a prescribed event causing the payment of a benefit to a beneficiary. • A benefit means any amount payable by the Trustee to a beneficiary including a retirement benefit, an early resignation benefit, a death benefit and a permanent disability Benefit. 24. The Unit Trust deed only provides for distributions to unit holders and allows the trustee to accumulate income of the trust. Issue 1 Question 1 Summary An active asset is a Capital Gains Tax (CGT) asset which is owned by you and is used or held ready for use in a business carried on by you, your affiliate or an entity connected with you. An affiliate is 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. Whether two entities are affiliates is a question of fact in the circumstances of each case. In your circumstances the Businesses were carried on by the Company which is also the trustee of the Unit Trust which beneficially owned the Property. The Property was purchased by the Unit Trust for use by the Businesses and was in fact used by the Businesses during the entire ownership period. While it is acknowledged that the rental terms were on an arms-length basis, it is accepted that the dealings between the Company and the Unit Trust involved at least an understanding between the parties as to a common purpose or object, meaning that the Company and the Inform Unit Trust were acting in concert with each other. As the Company was acting in concert with the Unit Trust in relation to the Property it is accepted based on your circumstances that the Company is an affiliate of the Unit Trust. As such, the Property will be an active asset of the Unit Trust because, based on the facts of your case, it is used or held ready for use in a business carried on by the Company which is an affiliate of the Unit Trust. Detailed reasoning All references are to the ITAA 1997 unless specified otherwise. The meaning of active asset is provided by subsection 152-40(1) as: A *CGT asset is an active asset at a time if, at that time: (a) you own the asset (whether the asset is tangible or intangible) and it is used, or held ready for use, in the course of carrying on a *business that is carried on (whether alone or in partnership) by: (i) you; or (ii) your *affiliate; or (iii) another entity that is *connected with you; …. Section 4-5 provides generally that the expression 'you', applies to entities generally (unless its application is expressly limited). Subsection 960-100(1) specifies the meaning of an entity, in the context of subsection 960-100(1) entity includes an individual, a body corporate, a trust and a superannuation fund. Additionally subsection 960-100(3) specifies that a legal person can have a number of different capacities and the person is taken to be a different entity for each capacity. In your case the Company serves in three capacities: • in its own capacity as a body corporate, • as the trustee of the Super Fund, and • as the trustee of the Unit Trust. Thus, for Taxation Law purposes there are three different entities, the Company, the Super Fund and the Unit Trust. In addition, the Individuals and the other member of the Super Fund will also be different entities. As The Property is beneficially owned by the Unit Trust and the Businesses are operated by the Company, the Property will be an active asset by virtue of paragraph 152-40(1)(a)(i). Affiliate The term 'affiliate' is defined in section 328-130 as follows: 328-130(1) An individual or a company is an affiliate of yours if the individual or company acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the affairs of the *business of the individual or company. 328-130(2) However, an individual or a company is not your affiliate merely because of the nature of the business relationship you and the individual or company share. In your case for paragraph 152-40(1)(a)(ii) to apply The Company, which operates The Businesses, would need to be an affiliate of the Unit Trust. The ATO guide Capital gains tax concessions for small business (ato.gov.au, QC 48078, Last modified: 26 May 2016) provides the following guidance on the meaning of affiliate: Whether a person acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes, or in concert with the taxpayer is a question of fact dependent on all the circumstances of the particular case. No single factor will necessarily determinative. Relevant factors that may support a finding that a person acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes, or in concert with the taxpayer, include: • the existence of a close family relationship between the parties • the lack of any formal agreement or formal relationship between the parties dictating how the parties are to act in relation to each other • the likelihood that the way the parties act, or could reasonably be expected to act, in relation to each other would be based on the relationship between the parties rather than on formal agreements or legal or fiduciary obligations • the actions of the parties. The meaning of the phrase 'to act in concert with' was considered in Stephens v. Commissioner of Taxation [2008] AATA 176 ( Stephens ): 44. The meaning of phrase to act in concert with has been subject to substantial judicial scrutiny. …. Barrett J in Bateman and Ors v Newhaven Park Stud Limited and Ors [2004] ACSR 597 canvassed a number of authorities dealing with the phrase acting in concert . Included among those cases was the decision of Owen J in Bank West Western Australia v Ocean Trawlers (1995) 13 WAR 407 which was referred to by Mr Nicholas. His Honour said, at 431 - 432: 'The meaning to be ascribed to the words used must be gleaned from the context to which they relate and from the scope and purpose of the instrument in which they appear. The phrase acting in concert connotes knowing conduct the result of communication between parties and not simultaneous actions occurring contemporaneously. . . . Acting in concert involves at least an understanding between the parties as to a common purpose or object: …' 45. Finkelstein J in Papua New Guinea Dockyard Ltd v Adams and Ors [2005] FCA 413; (2005) 215 ALR 742 summarised the cases discussing the meaning of acting in concert as collected by Barrett J in Bateman's case. He said, at 746: '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 …' In your circumstances: • The Individual and the other member of the Super Fund, as owners and directors of the Company, would be the ultimate controlling mind of the group comprising the Company, the Super Fund and the Unit Trust. • The Property was purchased by the Unit Trust for use by the Company in its Businesses and was used during the ownership period by the Company in its Businesses. • There was no formal lease agreement between the Unit Trust and the Company relating to the Property and the rent for the Property was determined based on an appraisal by the Unit Trust and the Company of comparable arm's length rent. To some extent the relationship between the Company, the Super Fund and the Unit Trust would be based on the formal obligations of the Super Fund to ensure compliance with its prudential obligations in relation to its investment in the Unit Trust. However it is considered that this formal relationship alone would not be sufficient to explain the dealings between the Company and the Unit Trust in relation to the Property. The Property was purchased by the Unit Trust for use by the Company in its Businesses and was used in this manner during the entire ownership period. In your circumstances where the Company and the Unit Trust share the same controlling minds and the Property was purchased for use by the Company in its businesses, it is accepted that the Company and the Unit Trust share a common purpose or object such that it could be said that they were acting in concert with each other with regards to the use of the Property. As such it is accepted that the Company is an affiliate of the Unit Trust. Connected with you The term 'connected with you' is defined in subsection 328-125(1) to mean: An entity is connected with another entity if: (a) either entity controls the other entity in a way described in this section; or (b) both entities are controlled in a way described in this section by the same third entity Section 328-125 also provides that an entity can either be directly or indirectly controlled by another entity. In the context of a trust (other than a discretionary trust) the meaning of direct control is provided in subsection 328-125(2): An entity (the first entity ) controls another entity if the first entity, its *affiliates, or the first entity together with its affiliates: (a) except if the other entity is a discretionary trust - own, or have the right to acquire the ownership of, interests in the other entity that carry between them the right to receive a percentage (the control percentage ) that is at least 40% of: (i) any distribution of income by the other entity; or (ii) if the other entity is a partnership - the net income of the partnership; or (iii) any distribution of capital by the other entity; or (b) …. Subsection 328-125(7) provides that: This section applies to an entity (the first entity ) that directly controls another entity (the second entity ) as if the first entity also controlled any other entity that is directly, or indirectly by any other application or applications of this section, controlled by the second entity. As the Businesses are operated by the Company, for paragraph 152-40(1)(a)(iii) to apply, the Company will need to be connected with the Unit Trust. In the present case, as the only unitholder (with associated rights to 100% of any income or capital distributed by the Unit Trust), the Super Fund directly controls the Unit Trust. Also because the Super Fund owns 100% of the units, no other entity will directly control the Unit Trust. Thus, any connection to the Unit Trust will need to be established indirectly through any connected entities of the Super Fund. Paragraph 2 of Taxation Determination TD 2006/68 Income tax: capital gains: small business concessions: can trustees or members of a complying superannuation fund 'control' the superannuation fund in the way described in section 328-125 of the Income Tax Assessment Act 1997?, states: The members of a complying superannuation fund do not beneficially own, or have the right to acquire beneficial ownership of, interests carrying the right to distributions of income or capital. Further, a complying superannuation fund does not distribute income or capital as such, but rather pays benefits in the form of pensions or lump sums on the occurrence of certain events, such as retirement, death while in employment or the attainment of a stated age. Additionally paragraph 10 of TD 2006/68 states: Neither the trustees nor the members of a complying superannuation fund beneficially own, or have the right to acquire beneficial ownership of, the required interests in the fund and therefore neither control the fund under paragraph 328-125(2)(a) of the ITAA 1997. The fund is not connected with the members or trustees under paragraph 328-125(1)(a) of the ITAA 1997. Applying the principles in TD 2006/68, as the Super Fund is a complying super fund, neither the Members of the Super Fund, nor the Company (as trustee of the Super Fund) control the Super Fund. Because the only means of connecting the Unit Trust to The Company is indirectly via the Super Fund and the Super Fund is not controlled by its members or its trustee, the Unit Trust is not connected with The Company. Conclusion - Active Asset Thus, while the Property is not used by the Unit Trust in a business carried on by the Unit Trust and the Unit Trust is not connected with the Company, the Property is an active asset of the Unit Trust because it is used in a business carried on by the Company which is an affiliate of the Unit Trust. Question 2 Summary The Super Fund has a direct small business participation percentage in the Unit Trust of 100%, because the Super Fund holds all the entitlements to income or capital distributions from the Unit Trust. As such, the only way the Individual can have a small business participation percentage in the Unit Trust is indirectly as a result of any entitlements the Individual may have to the income or capital of the Super Fund. Under the Terms of the Super Fund the Individual does not have an interest in the income or capital of the fund in the required sense. Rather the Individual may have an entitlement to a Benefit from the Super Fund upon the occurrence of a Prescribed Event. This entitlement to the payment of a benefit does not amount to an entitlement to the income or capital of the Super Fund. As such the Individual will not have a direct small business participation percentage in the Super Fund. Because the Individual does not have a direct small business participation percentage in the Super Fund they will not have an indirect participation percentage in the Unit Trust meaning they will not be a significant individual of the Unit Trust. Detailed reasoning An individual is a significant individual in a trust, in accordance with section 152-50, if they have a small business participation percentage (either directly or indirectly) in the trust of at least 20%. An entity's small business participation percentage in another entity, in accordance with section 152-62, at a time is the percentage that is the sum of: • the entity's direct small business participation percentage in the other entity at that time, and • the entity's indirect small business participation percentage in the other entity at that time. Indirect small business participation percentage An entity's indirect small business participation percentage in a trust is calculated (in accordance with section 152-75) by multiplying together the entity's direct participation percentage in an interposed entity, and the interposed entity's total participation percentage (both direct and indirect) in the trust. Direct small business participation percentage An entity's direct small business participation percentage in a trust, other than a discretionary trust, is determined by items 2 & 3 of the table in subsection 152-70(1). Where entities have entitlements to all the income and capital of the trust the small business participation percentage is (in accordance with item 2 of the table in subsection 152-70(1)) the smaller percentage of: • the percentage of any distribution of income that the trustee may make to which the entity would be beneficially entitled, or • the percentage of any distribution of capital that the trustee may make to which the entity would be beneficially entitled. Where entities do not have entitlement to all the income and capital of the trust the small business participation percentage is (in accordance with item 3 of the table in subsection 152-70(1)) the smaller percentage of: • distributions of income that the entity is beneficially entitled to during the during the income year, or • distributions of capital that the entity is beneficially entitled to during the income year. A complying superannuation fund will not be a discretionary trust because all provisions relating to the triggering of the payment of benefits from the complying superannuation fund are set out fully in the trust deed. As such the trustee of a complying superannuation fund has no discretions, outside of the provisions of the trust deed, to make beneficiaries entitled to income or capital of the trust estate. Thus, subsections 172-70 (4), (5) & (6), relating to discretionary trusts, will have no application in the case of a complying superannuation fund. Nature of the entitlement of a member of a complying superannuation fund in the income and capital of the fund The nature of a beneficiaries entitlement to the income and capital of a superannuation fund was considered by the Federal Court in Kafataris & Anor v. Deputy Commissioner of Taxation [2008] FCA 1454 ( Kafataris ). Lindgren J observed that the deed for the Helen Kafataris Superannuation Fund conferred upon the trustee the power to pay benefits to dependants, spouse and relatives of members of the superannuation fund, stating at paragraph 64 that: There is no ground for saying that once Helen's [superannuation] Fund was established, Helen [Kafataris] was absolutely entitled as against the Trustees to the half interest in the Property that she had owned prior to its establishment. Lindgren J concluded at paragraph 66 of Kafataris that: Helen [Kafataris] was not entitled to the half interest once it was subjected to the Trust. Her only entitlement was to require the Trustees to pay her money once the conditions of her entitlement [to a superannuation benefit] were satisfied. The view expressed in Kafataris is similar to that taken in paragraph 2 of TD 2006/68 that the members of a complying superannuation fund do not beneficially own, or have a right to acquire beneficial ownership of, interests carrying the right to distributions of income or capital. Rather, the member's entitlement is to the payment of a benefit from the Superannuation fund (in the form of a pension or lump sum) on the occurrence of certain events (such as retirement, death while in employment or the attainment of a stated age). Application to your circumstances As the Super Fund holds all the units issued by the Unit Trust, the Super Fund will have a direct small business participation percentage of 100% in the Unit Trust, because the Super Fund will be beneficially entitled to all the income and capital of the Unit Trust. Under the terms of the Super Fund, as with Kafataris , beneficiaries are not limited to the members of the fund; rather beneficiaries include dependants (and pensioners) as defined in in the deed. Dependants are defined in the deed of the Super Fund to include as beneficiaries: • the spouse, widow or widower of the member, • any child of the Member including any child of the member born after the death of the member; • any person who in the opinion of the Trustee is at the relevant time (or in the case of a deceased member, was at the time of death of that Member) wholly or partially dependent on the member for that person's maintenance and support or who has or had at the relevant time a legal right to maintenance and support from that member; and • any other person who is a dependant as defined by the law. Under the terms of the deed of The Super Fund: • A beneficiary includes a member, dependant or pensioner, who is presently and absolutely entitled to the payment of a benefit, or has a contingent right or mere expectancy to receive a payment once a prescribed event occurs. • Benefit entitlement only happens upon the occurrence of a prescribed event causing the payment of a benefit to a beneficiary. • A benefit means any amount payable by the Trustee to a beneficiary including a retirement benefit, an early resignation benefit, a death benefit and a permanent disability Benefit. Thus, under the terms of the Super Fund the Individual and the other member of the Super Fund as Members of the fund do not have a beneficial interest in the income or capital of the Super Fund. Furthermore once a prescribed event occurs which would entitle the Individual or the other member to a payment from the Super Fund, this payment in accordance with paragraph 2 of TD 2006/68 would be an entitlement to the payment of a benefit, not the income or capital of the Super Fund. As such neither the Individual nor the other member has a direct small business participation percentage in the Super Fund in accordance with section 152-70. Thus, for the Individual to be a significant individual of the Unit Trust they will need to have a direct small business participation percentage in the Super Fund of 20%, which (when multiplied by the 100% small business participation percentage held by the Super Fund in the Unit Trust) would give them an indirect small business participation percentage in the Unit Trust of 20%. As the Individual does not have a direct small business participation percentage in the Super Fund they will not have an indirect small business participation percentage in the Unit Trust. Which means the Individual will not be a significant individual of the Super Fund nor the Unit Trust in accordance with section 152-50. Question 3 Summary One of the conditions for a company or trust to satisfy the small business CGT 15 year exemption in section 152-110 is that at the time of the CGT event a significant individual of the company or trust must be over 55 and the event must happen in connection with that individual's retirement (an alternative condition is that the relevant significant individual was permanently incapacitated just before the CGT event). Because the Property is an asset of the Unit Trust, a wholly owned unit trust of the Super Fund, the Unit Trust does not have, as explained in question 2 above, a significant individual. Thus, it is not possible to identify a significant individual to which the CGT event relates which is in connection with that individual's retirement. Detailed reasoning Section 152-110 sets out the eligibility conditions for the small business CGT 15-year exemption applicable to companies and trusts. In order for a company or trust to disregard a capital gain under section 152-110 they must for the CGT event to be disregarded: • satisfy the basic conditions for small business CGT concessions for the gain, • continuously own the CGT asset for the 15-year period ending just before the CGT event, • have a significant individual for a total of at least 15 years of the whole period of ownership (even if it was not the same significant individual during the whole period), and • the significant individual who was the significant individual just before the CGT event was • at least 55 years old at that time and the event happened in connection with their retirement (paragraph 152-110(1)(d)(i)), or • was permanently incapacitated at that time. Paragraph 152-110(1)(d)(i) requires a significant individual (which at the time of the CGT event was 55 or over), to which the CGT event must happen in connection with that significant individual's retirement. In answering question 2 above, it was established that the Unit Trust does not have a significant individual. As the Unit trust does not have a significant individual there is no significant individual to which the sale of the Property relates. As the Individual is not a significant individual of the Unit Trust, they are not the significant individual to which Paragraph 152-110(1)(d)(i) is referring. Whether or not the sale of the Property is in connection with the Individual's retirement is of no significance in this context. While it may be that the Individual has dramatically reduced their working hours and may well have retired, it is not accepted that the sale of the Property was an event which happened in connection with their retirement in the required sense. Issue 2 Question 1 Summary As a unit trust it is accepted that distributions from the Unit Trust to the Super Fund will be trust distributions arising from a fixed entitlement in accordance with subsection 295-550(5). As the purchase and sale of the Property by the Unit Trust was between disinterested third parties, at market rates and the Super Fund, as the sole unit holder, is the only beneficiary of the Unit Trust, it is accepted that the distribution of the gain on the sale of the Property will not be non-arm's length income of the Super Fund. Detailed reasoning Division 295 provides for the taxation of complying superannuation funds, complying approved deposit funds and pooled superannuation trusts (Superannuation Entities). Under subdivision 295-H the taxable income of a Superannuation Entity is made up of two components: • a low tax component which is taxed at 15%, and • a non-arm's length component with is taxed at 45% (plus any relevant levy such as the 2% budget repair levy in the 20XX/YY and 20ZZ/AA tax years). Section 295-550 provides the meaning of non-arm's length income. Of relevance (in the case of income derived by a Superannuation Entity as a beneficiary of a trust through holding a fixed entitlement to income of the trust) subsection 295-550(5) provides that: Other income *derived by the entity as a beneficiary of a trust through holding a fixed entitlement to the income of the trust is non-arm's length income of the entity if: (a) the entity acquired the entitlement under a *scheme, or the income was derived under a scheme, the parties to which were not dealing with each other at *arm's length; and (b) the amount of the income is more than the amount that the entity might have been expected to derive if those parties had been dealing with each other at arm's length. Paragraph 102 of Taxation Ruling TR 2006/7 Income tax: special income derived by a complying superannuation fund, a complying approved deposit fund or a pooled superannuation trust in relation to the year of income , states that: A trust distribution to a complying superannuation fund, complying ADF or PST will fall within subsection [295-550(5) of the ITAA 1997] rather than subsection [295-550(4) of the ITAA 1997] if the entity's entitlement to the distribution does not depend upon the exercise of the trustee's or any other person's discretion. Under the Unit Trust deed, the Trustees must pay, apply or set aside the net income of the Trust Fund for the benefit of the unit holders for each accounting period until the Vesting Day. While the Unit Trust deed does permit the Trustee, to accumulate the income of the Trust Fund, a power in the trustee to accumulate income or capital of the trust will not of itself cause a beneficiary's interest in that income or capital (which is otherwise vested in interest) to be contingent. As such it is accepted that the distributions from the Unit Trust to the Super Fund will be trust distributions arising from a fixed entitlement to which subsection 295-550(5) will apply. In the present instance the Property was acquired by the Unit Trust at market value from disinterested third parties and sold by the trust to disinterested third parties at market value in 20YY. In these circumstances it is considered that the parties to the purchase and sale of the Property were dealing with the Unit Trust at arm's length. As the Super Fund is the only beneficiary of the Unit Trust, it is accepted that the distribution relating to the gain made on the Property from the Unit Trust to the Super Fund will not be non-arm's length income in accordance with subsection 295-550(5).