Private ruling: Capital gains tax and the small business concessions
Published: June 2014
Ruling period: Year ended 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q1: 1. Is Company A a small business entity for the purposes of section 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997)? Answer: Yes. 2. Does Property A satisfy the active asset test for the purposes of section 152-35 of the ITAA 1997? Answer: Yes. 3. Does Company A meet the requirements of paragraph 152-110(1)(d) of the ITAA 1997? Answer: Yes. 4. If the 15 year exemption in subdivision 152-B of the ITAA 1997 applies to the sale of Property A, will the Commissioner exercise his discretion contained in subsection 152-125(4) of the ITAA 1997 to extend the 2 year time limit that would ordinarily apply to payments from Company A to its CGT concession stakeholder? Answer: Yes.

Relevant facts and circumstances: Company A is an Australian private company incorporated approximately 20 years ago. Company A has 2 ordinary shares which were acquired by Individuals A and B (1 share each) on the date of incorporation. Individuals A and B have held the shares at all times and have equal voting, dividend and capital rights. Individuals A and B have been directors of Company A since incorporation and are both aged over 55 years. Company A acquired a property (Property A) more than 15 years ago. Company A has used Property A in its primary production business at all times since acquisition. In the relevant financial year, Company A executed a contract for the sale of the property. Settlement occurred in the relevant financial year and at the same time Company A sold the plant and equipment, crops and livestock used in the business. Company A made a capital gain on the disposal of the property. Under the sale agreement, Company A agreed to lend back to the purchaser a sum from the sale proceeds. The amount was withheld from the sale proceeds at settlement for these purposes. The loan is for a period of more than two years. Related entities: Family Trust A • Trustee - Corporate Trustee A • The trust owns all the issued units in a Unit Trust • Individuals A and B are directors of and own all the shares in Corporate Trustee A. • The trust does not carry on a business Unit Trust • The trust owns Property B on which a primary production business is conducted and owns plant and equipment used in the business. • The business itself is owned and operated by Company B. • The trust derives income in the form of rent for the use of both the property and equipment. • The trust has no other business income. Family Trust B: • Trustee - Corporate Trustee B • Trust owns all the issued shares in Company B • Individual A is the sole director of and owns all of the shares in Corporate Trustee B • The trust does not carry on a business. Company B • Conducts a primary production business on Property B. • Since the sale of Property A, Company B has also commenced a small livestock business. • Both businesses operate from Property B owned by the Unit Trust. Family Trust C: • Trustee - Corporate Trustee B • Trust owns Property C. • The premises are occupied by Company Z for use in its non-primary production business • The trust does not carry on a business. Company Z • Owned equally (50% each) by two trusts controlled by Individuals Y and Z. • The company commenced business approximately 10 year ago. • The premises from which the business operates is owned by Family Trust C and the company pays market value rent. Other relevant factors: • A family relationship exists between Individuals Y and Z (the controllers of Company Z) and Individuals A and B (the controllers of Company A) • There are no shared banking arrangements between the two companies. • There are no common directors or shareholders. • Company Z carries on a non-primary production business under the direction of Individuals Y and Z, whereas Company A carries on a primary production business under the direction of Individual A. There is little or no consultation between them regarding business matters. • There are no formal or informal obligations between the two companies regarding the purchase of goods. Company Z did make a single purchase of stock from Company A in the relevant financial year, representing 1% of total purchases made by Company Z in that year. • There are no common employees, resources, facilities or services between the companies. • Company Z has a borrowing from the Unit Trust (an entity controlled by Individual A). The current business is profitable and not reliant on any further funding. Rather, profits in recent years have been applied to reduce the debt owed. Individual X: • Individual X is the spouse of Individual Y and carries on a retail business. • The business is conducted from premises located on Property B owned by the Unit Trust. Other relevant factors: • There are no shared banking arrangements between Individual X and Company A. • There are no common employees. • Individual X carries on a non-primary production business, whereas Company A carries on a primary production business under the direction of Individual A. • There is no consultation between Individual X and Company A or Individuals A and B regarding business matters. • No working capital has been provided to Individual X by Company A, or Individuals A and B nor have they shared in any revenues or profits from the business. • No formal or informal obligations are present between Individual X and Company A regarding the purchase of goods. • Individual X purchased some products from Company B in the 20XX financial year. These purchases represented about 15% of the sales by Company B. These purchases were at market value. Individual A's retirement: • Individual A has had a long career and has worked in both Company A and Company B businesses. • Individuals A and B reside at Property B. Property A is close by. • Prior to the sale, Individual A travelled to Property A on average 2 to 3 times a week. Most of their time was spent working with the livestock while an employed farm manager and other employees spent most of their time with the cropping and general farm maintenance duties. • The balance of Individual A's working week was spent managing Company B's business. • Between Property A and Property B, it is estimated that Individual A would work on average 30 to 40 hours per week including travel time. • For the last full year complete prior to the sale, the turnover of these businesses were less than $2 million. After the sale of Property A, a much smaller livestock business was commenced by Company B on Property B. It is estimated that Individual A works now works on average 10 to 15 hours per week on the Company B business. Individual A has no intention to re-commence farming activities to the extent and scale of Property A. The reduction in Individual A's activities are permanent. They are over 55 years of age and their age and the poor health of Individual B was the key driver of the decision to sell Property A as part of a longer term retirement plan. Individual B was diagnosed with an illness several years ago. Individuals A and B plan to move to a new home soon, which is expected to further reduce time spent on the olive business.

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 152-40 | Income Tax Assessment Act 1997 - Section 152-47 | Income Tax Assessment Act 1997 - Section 152-78 | Income Tax Assessment Act 1997 - Sub division 328-C | Income Tax Assessment Act 1997 - Section 328-110 | Income Tax Assessment Act 1997 - Section 328-115 | Income Tax Assessment Act 1997 - Section 328-125

Reasons for decision: Summary: Under section 328-110, you are a small business entity for an income year if you carry on a business and your aggregated turnover for the previous year was less than $2 million. Under subsection 328-115(2) of the ITAA 1997, your aggregated turnover includes your annual turnover, the annual turnover of any relevant business entity connected with you at any time during the year, and the annual turnover of any entity that is an affiliate of yours during the income year. The meaning of a connected entity is defined under section 328-125 of the ITAA 1997 which states as follows: An entity is connected with another entity if: (a) either entity controls the other entity in the way described in this section; or (b) both entities are controlled in a way described in this section by the same third entity. | Detailed Reasoning - Direct control of a company: Paragraph 328-125(2)(b) of the ITAA 1997 provides that an entity controls a company if the entity, its affiliates, or the entity together with its affiliates beneficially own equity interests in the company that carry between them the right to exercise, or control the exercise of, a percentage (the control percentage) that is at least 40% of the voting power in the company. | Detailed Reasoning - Direct control or a discretionary trust: Subsection 328-125(3) of the ITAA 1997 provides that an entity controls a discretionary trust if a trustee acts, or could reasonably be expected to act, in accordance with the directions or wishes of the entity, its affiliates, or the entity together with its affiliates. In this case, Company A is connected with all of the related entities listed, except for Company Z, as all entities are considered to be controlled either directly or indirectly by Individual A. Of these entities, only the annual turnover of Company B will be included in your aggregated income as a relevant business entity. Affiliate Under section 328-130 of the ITAA 1997, 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. Trusts, partnerships and superannuation funds cannot be your affiliates. In this case, of the related entities listed, only Company B, Company Z and Individual X are able to be affiliates. 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. Generally, another business would not be acting in concert with you if they: • have different employees • have different business premises • have separate bank accounts • do not consult you on business matters • conduct their business affairs independently in all regards. There is nothing to suggest that Company B, Company Z or Individual X are affiliates of Company A. Based on the above discussion, your aggregated turnover for the 20XX financial year is less than $2 million. Therefore, Company A is a small business entity for the purposes of section 152-10 of the ITAA 1997. | Detailed Reasoning - Question 2: For a CGT asset of a business to be an active asset for the purposes of Division 152 of the ITAA 1997, it must firstly satisfy one of the 'positive tests' in subsection 152-40(1) of the ITAA 1997, and then also not be excluded by one of the exceptions in subsection 152-40(4) of the ITAA 1997. Under paragraph 152-40(1)(a) of the ITAA 1997 a CGT asset is an active asset (subject to the exclusions) if it is owned and used or held ready for use in the course of carrying on a business. In this case, Property A was owned and used in the course of carrying on a business and none of the exclusions in subsection 152-40(4) of the ITAA 1997 apply. | Detailed Reasoning - 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 begins when you acquired the asset, and 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. In this case, Property A has been owned for more than 15 years and it has been an active asset for the full ownership period. Therefore, Property A satisfies the active asset test for the purposes of section 152-35 of the ITAA 1997. | Detailed Reasoning - Question 3: You can disregard a capital gain from a CGT event happening to a CGT asset you have owned for at least 15 years if you: • satisfy the basic conditions for the small business CGT concessions • continuously owned the CGT asset for the 15 year period ending just before the CGT event happened; and if you are a company or trust: • you had a significant individual for a total of at least 15 years of the whole period of ownership, and • the individual who was a 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. | Detailed Reasoning - Significant individual: A company or trust satisfies the significant individual test if it had at least one significant individual just before the CGT event. 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. | Detailed Reasoning - Total small business participation percentage: An entity's small business participation percentage in another entity 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. | Detailed Reasoning - Companies: An entity's direct small business participation percentage in a company is the percentage of: • voting power that the entity is entitled to exercise • any dividend payment that the entity is entitled to receive, or • any capital distribution that the entity is entitled to receive. All classes of shares (other than redeemable shares) are taken into account in determining an entity's participation percentage in a company. In this case, Company A has two significant individuals in the two shareholders. Both have 50% of Company A shares and all shares have equal voting and income entitlements. The small business 15-year exemption further requires a company or trust to have a significant individual for periods totalling at least 15 of the years of ownership of the CGT asset. Both of Company A's significant individuals have held their shares for over 15 years and both are over 55 years of age. In order to satisfy the requirements for the 15 year exemption, the CGT event must have happened in connection with the retirement of the significant individual. 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. The sale of Property A will more than halve the number of hours Individual A works and would be considered a significant reduction. In this case, Company A satisfies the basic conditions for the small business CGT concessions and has owned the property for over 15 years. Company A has had two significant individuals for over 15 years and both significant individuals just before the CGT event were over 55 years of age and the event is happening in relation to the retirement of one significant individual. Therefore, Company A can disregard any capital gain from the sale of the property under the CGT small business 15 year exemption. | Detailed Reasoning - Question 4: The Commissioner may exercise his discretion under section 152-125(4) and allow further time to make payments to the concessional stakeholder. Factors to be considered include: • there should be evidence of an acceptable explanation for the period of time requested and it would be fair and equitable in the circumstances to provide such an extension; • account must be had to any prejudice to the Commissioner which may result from the additional time being allowed; • account must be had of any unsettling of people, other than the Commissioner, or of established practices; • there must be consideration of fairness between you and other people in like positions and the wider public interest; • whether there was any mischief involved; and • consideration of the consequences. Having considered the relevant facts, the Commissioner is able to apply his discretion under subsection 152-125(4) of the ITAA 1997 and allow an extension to the two year time limit to a period of three years and six months.