Private ruling: Small business CGT concessions
Date of advice: 27 July 2016
Published: September 2016
Ruling period: The period over which the ruling is sought is from 1 July 2015 to 30 June 2016.
Date scheme commenced: 1 July 2015

Ruling: Q1: Is the cash held by the Company for the income year ended 30 June 2016 inherently connected with its business for the purposes of subsection 152-40(3) of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: If the answer to Question 1 above is no. What amount of the cash would be considered inherently connected with its business for the purposes of subsection 152-40(3) of the ITAA 1997? | A2: N/A

Relevant facts and circumstances: The Company is a proprietary company incorporated in Australia. The Company has operated a contracting business since incorporation. Two individuals each own 3 ordinary shares in the Company. The industry that the Company operates in is cyclical in nature and contract driven. Business performance is reliant on obtaining the next contract and its terms. Due to the uncertainty of the business environment the Company operates in, it has a prudent approach to profit retention. At inception the directors agreed for the company to retain profits generated by the company to: • reduce the need for future borrowings or at least keep to a minimum and • ensure adequate funds were available to service the growth of the business and cater for the cyclical nature of the industry. The retained earnings have accumulated over the life of profitable business operations and have always been available for use of the business exclusively. The funds provide security for the business during tough economic times and ensure survival through the depressed climate that is affecting the local industry. Company funds are held in three at call bank accounts for future use of the Company's business operations. Transactions flowing through the Company's bank accounts are all business related and include: • Payments for creditors, salaries and contractors. • Superannuation, Payroll and Tax Office liability payments. • Operating costs including fuel, rent and insurances. • Debtor payments received. The funds are not maintained for deriving interest but allow the Company to tender on large projects providing financial capacity to cover costs relating to: • Requirements for bank guarantees to be held for construction and warranty periods without establishing an overdraft facility. • Managing supply of materials and to cover costs while waiting for contract payments to be received. • Increased Employee wages and entitlements to service contracts. • Managing a sufficient float for the operations of the business while waiting for receipt of customer payments. Cash flow management is critical for the company due to the nature of the business involving large contracts. The revenue is volatile and the fluctuations are cyclical, but dependent on the vagaries of a contracting business in the industry. The business is also exposed to large outlays for the supply of materials when required up front. The funds are solely generated from the business activities of the company with no funds added from any shareholders or others.

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

Reasons for decision: Summary: Subsection 152-10(1) of the (ITAA 1997) contains the basic conditions you must satisfy to be eligible for the small business CGT concessions. These conditions are: (a) a CGT event happens in relation to a CGT asset in an income year. (b) the event would 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; (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) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year. (d) the CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997. Subsection 152-35(1) of the ITAA 1997 states that a CGT asset satisfies the active asset test if: (a) 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 period of ownership, or (b) you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7 and a half years. Section 152-40 of the ITAA 1997 details the meaning of active assets. For a share to be an active asset it must satisfy the conditions in subsection 152-40(3) of the ITAA 1997. Paragraph 152-40(1)(b) of the ITAA 1997 requires an intangible asset, such as a share in a company, to be inherently connected with a business to be an active asset. In accordance with subsection 152-40(3) of the ITAA 1997, a share will be inherently connected if the company is an Australian resident and the 80% test in paragraph 152-40(3)(b) of the ITAA 1997 is passed. The 80% test specifies that if one of the assets of the business is cash, the cash must be inherently connected with the business to count towards satisfying the 80% or more of the total value of assets of the company. The term 'inherently connected' is not defined in the ITAA 1936 or the ITAA 1997. Therefore the term takes on its ordinary meaning. The Macquarie dictionary defines the term as Inherently: is 'existing in something as a permanent inseparable element, quality Or attribute Connected: to bind or fasten together, join or unite, link. to establish communication between, (something followed by with) to put in communication (something followed by with) to associate or attach: the pleasure connected with music. (something followed by with) to associate mentally to become connected; join or unite (something followed by with) (of trains, buses etc) to run so as to make connections baseball, tennis etc, colloquial to hit the ball, especially with force. In this case, the Company has cash held in 3 at call bank accounts. Applying the definitions of inherently and connected to 'inherently connected' with the business for Division 152 of the ITAA 1997, it means that the cash held in the at call bank accounts is available for use in the business. ATO Interpretative Decision ATO ID 2003/714 confirms the above meaning by stating that if the money in the bank account is held in trust for a client, it is not inherently connected with the business, as the business does not have an equitable interest in the cash. You have provided evidence that the three at call bank accounts are financial instruments of the company and that the funds held in these bank accounts have been exclusively used for the running of the business. Therefore, it is clear that the funds are not available to or held for any other entity and the business has an equitable interest in the cash. Hence the cash is inherently connected with the business. These bank accounts will therefore be active assets, and all the cash held by the Company in these accounts will be included in the numerator in the 80% test calculation in paragraph 152-40(3)(b) of the ITAA 1997 for the purpose of determining whether the Company's shares satisfy the active asset test in section 152-35 of the ITAA 1997.