Private ruling: CGT - small business concessions
Date of advice: 4 October 2022
Published: December 2022
Ruling period: Income year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Will the water entitlements held by A Trustee, that were subject to the compulsory cancellation and replacement of new water allocation licences as a result of the introduction of the Water Management Act 2000 (NSW) (Water Act), be taken to have been held continuously by the A Trustee for more than 15 years for the purposes of paragraph 152-110(1)(b) of Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes - to the extent the A Trustee held the replacement licences for 15 years. The calculation of the 15 year period of continuous ownership of the water entitlements held by the A Trustee, that were subject to the compulsory cancellation and replacement with new water allocation licences as a result of the introduction of the Water Act commences from when the new water licences or entitlements were issued for the purposes of paragraph 152-110(1)(b) of ITAA 1997. | Q2: Will the transfer of the properties and water entitlements by the A Trustee be in connection with the retirement of the Individual for the purposes of paragraph 152-110(1)(d) of the ITAA 1997? | A2: Yes. | Q3: Will the transfer of the properties by B Trustee be in connection with the retirement of the Individual for the purposes of paragraph 152-110(1)(d) of the ITAA 1997? | A3: Yes.

Relevant facts and circumstances: The A Trust The A Trust was established on XX/XX/XXXX. AB Pty Limited continues to be the trustee of the A Trust (A Trustee). The Individual remained as a beneficiary of the A Trust. A Trustee conducts a business operation. The assets of the A Trustee The assets are real property and water entitlements. The issue dates of the various water allocation licences in their current form vary. Many of the underlying water entitlements were originally granted to the A Trustee earlier than the listed issue date above; however several of the original licences that these entitlements were attached to were cancelled and replaced with new licences as a result of the introduction of the Water Act. The regulation of water entitlements in New South Wales changed as a result of the introduction of the Water Act. As a result of this change, many older water licences were cancelled and replaced with new water licences issued in accordance with the Water Act. The majority of replacement asset licences that were issued as a result of this change were issued around the period 20XX - 20XX. At the time of these changes: a. The A Trust held water rights that arose from common law as a result of the ownership of the underlying land (i.e. groundwater entitlements). b. The A Trust had also received statutory water entitlements (being riparian rights to access water from a river system). As a result of the changes brought about under the Water Act, certain water allocation licences associated with a number of these entitlements were cancelled, and new water allocation licences were issued in accordance with the new act. As a result, there are certain water allocation licences that have been in existence for less than 15 years as at the date of the CGT event, that relate to water entitlements that have been held by the A Trustee for more than 15 years. The cancellation and issuing of the new water allocation licences did not in itself result in any additional water entitlements being granted to the A Trust. Any capital gain arising from the cancellation of the old water allocation licences and issuing of new licences would have been disregarded under the CGT rollover relief available under either Subdivisions 124-C or SD 124-R of the ITAA 1997. The transfers The water entitlements and land are transferred to other entities. The land is transferred to other entities. B Trust The B Trust was established on XX/XX/XXXX. The trustee for the B Trust is B Trustee. Individual has remained as a beneficiary of the B Trust. The assets of the B Trustee Land assets The transfer Under the contract the land is disposed of. The Individual The Individual does not conduct any business activities in their own name (either alone or in partnership). The Individual has remained solely responsible for the business operations of the A Trust. The Individual is 55 years of age or older. Other information The conditions in subsection 152-110(1)(a) and (c) of the ITAA 1997 are satisfied in respect of the transfer of properties and water entitlements from A Trustee to the new trusts. The conditions in subsection 152-110(1)(a) and (c) of the ITAA 1997 are satisfied in respect of the transfer of properties from B Trustee to the new trusts. the Individual is a 'significant individual', as defined in section 152-55 of the ITAA 1997, of the A Trust and B Trust just before the transfer of the relevant CGT assets.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 104-25(1) | Income Tax Assessment Act 1997 subsection 108-5(1) | Income Tax Assessment Act 1997 Subdivision 124-C | Income Tax Assessment Act 1997 section 124-70(2) | Income Tax Assessment Act 1997 subsection 124-140(1) | Income Tax Assessment Act 1997 subsection 124-140(3) | Income Tax Assessment Act 1997 Subdivision 126-A | Income Tax Assessment Act 1997 Subdivision 152-A | Income Tax Assessment Act 1997 Subdivision 152-B | Income Tax Assessment Act 1997 paragraph 152-110(1) | Income Tax Assessment Act 1997 paragraph 152-110(1)(b) | Income Tax Assessment Act 1997 paragraph 152-110(1)(d)(i) | Income Tax Assessment Act 1997 section 152-115 | Income Tax Assessment Act 1997 Subdivision 328-G

Reasons for decision: Summary: The 15 year period for the purposes of paragraph 152-110(1)(b) of the ITAA 1997 will be calculated from when the replacement water licence is first owned by the A Trustee. Where the original licence was cancelled, any period of ownership of that original licence will not form part of the 15 year period. | Detailed Reasoning - Detailed reasoning: For the purposes of determining whether an entity continuously owned the *CGT asset for the 15-year period ending just before the CGT event as set out in paragraph 152-110(1)(b) of the ITAA 1997, the commencement of that 15-year period begins when the CGT asset commences to be owned by the entity. Section 152-115 of the ITA 1997 provides certain instances for continuation of the period that an asset is owned for the 15 year period where there is an involuntary disposal of a relevant asset. They are: • Assets compulsorily acquired, lost or destroyed - where a replacement CGT asset has been acquired to satisfy the requirements in subsection 124-70(2) or subsection 124-75(2) of the ITAA 1997 for a rollover under Subdivision 125-B of the ITAA 1997. • Assets replaced during the Financial Services Reform (FSR) transition same owner roll-overs or new owners roll-overs - where automatic roll-over applies under Subdivision 124-O of the ITAA 1997 during the FSR transitional period. • Marriage or relationship breakdowns - where the entity is the transferee of a CGT asset as a result of a marriage or relationship breakdown roll-over under Subdivision 126-A of the ITAA 1997. • The small business restructure rollover in Subdivision 328-G of the ITAA 1997 applied to the asset. | Detailed Reasoning - Nature of the water entitlements: A CGT asset is defined in subsection 108-5(1) of the ITAA 1997 as: • any kind of property; or • a legal or equitable right that is not property. The original entitlements under the former legislation entitled their owners to take water subject to the specifications applicable to the licence. They are statutory rights and, therefore, they are CGT assets within the definition of a CGT asset under subsection 108-5(1) of the ITAA 1997. Each relevant water access licence or entitlement is a statutory right and is also a CGT asset within the terms of the definition in subsection 108-5(1) of the ITAA 1997. The effect of Schedule 10 of the Water Act is that each relevant pre-existing licence or entitlement was cancelled. CGT event C2 (subsection 104-25(1) of the ITAA 1997) happened on the ending of each entitlement. The pre-existing water access licences or entitlements are replaced with access licences or entitlements on substantially similar terms as were authorised by the original licences or entitlements. Each relevant water access licence or entitlement is a statutory right and is also a CGT asset within the terms of the definition in subsection 108-5(1) of the ITAA 1997. | Detailed Reasoning - Rollover relief: Each relevant licence or entitlement under the Water Act is a statutory licence for the purposes of subsection 124-140(3) of the ITAA 1997. Section 104-25 of the ITAA 1997 provides that CGT event C2 happens if a CGT asset you own ends in one of a number of ways, including its cancellation or expiry. Where the new water licence or entitlement issued under the Water Act authorises substantially similar activity as that authorised by the original and ownership of each expired or cancelled relevant licence or entitlement CGT rollover relief is provided by Subdivision 124-C of the ITAA 1997. The pre-existing water licences or entitlements that expired or were cancelled and replaced with new licences or entitlements (with respect to each expired or cancelled licence or entitlement) satisfies paragraph 124-140(1) of the ITAA 1997. However, the CGT roll-over in Subdivision 124-C of the ITAA 1997 is not a rollover listed in section 152-115 of the ITAA 1997. Therefore, irrespective of whether the particular water access licence had its origins in a common law right to water or a previous statutory right to water issued under the Water Act, section 152-115 of the ITAA 1997 does not apply to allow a period before the new replacement water licences were issued to be included for the purposes of calculating whether the A Trustee had continuously owned the *CGT asset, the new licence, for the 15-year period ending just before the CGT event. Consequently, the 15 year period for the purposes of paragraph 152-110(1)(b) of the ITAA 1997 will be calculated from when the replacement water licence is first owned by the A Trustee. Where the original licence was cancelled, any period of ownership of that original licence will not form part of the 15 year period. | Detailed Reasoning - Detailed reasoning: Subdivision 152-B of the ITAA 1997 allows a CGT small business entity to disregard a capital gain arising from a CGT asset that it has owned for at least 15 years if certain conditions are met. Relevantly, for a trust, subsection 152-110(1) of the ITAA 1997 provides: An entity that is a ... trust can disregard any *capital gain arising from a *CGT event if all of the following conditions are satisfied: ... (d) an individual who was a significant individual of the ... trust just before the CGT event either: (i) was 55 or over at that time and the event happened in connection with their retirement or ... | Detailed Reasoning - In connection with retirement: This phrase 'in connection with their retirement' has no statutory definition. The provisions relating to the small business 15-year exemption do not define what is meant by the phrase 'in connection with their retirement', nor does it give any indication of the degree of retirement for the purposes of this concession. Whether a CGT event happens in connection with an individual's retirement depends on the particular circumstances of each case. The Explanatory Memorandum (EM) to the New Business Tax System (Capital Gains Tax) Bill 1999 makes the following comments about the requirement to be permanently incapacitated or retiring as one of the conditions for the concession: | Detailed Reasoning - Requirement to be permanently incapacitated or retiring: 1.68 One of the requirements of this concession for an individual small business taxpayer is that they must be either permanently incapacitated at the time of the CGT event, or at least 55 years old and using the capital proceeds for their retirement. The legislation does not provide a specific definition of the word 'retirement' for the purpose of subparagraph 152-110(1)(d)(i) of the ITAA 1997. Consequently, it takes its ordinary meaning. The Macquarie Dictionary (online version, downloaded 7 August 2019) defines 'retirement' to mean 'removal or retiring from service, office, or business, especially in reaching the end of one's working life'. The phrase 'in connection with' has been judicially considered in numerous cases. In Collector of Customs v Pozzolanic Enterprises Pty Ltd (1993) 43 FCR 280 ( Pozzolanic ), it was stated by the Full Court of the Federal Court that: The words 'connected with' are capable of describing a spectrum of relationships ranging from the direct and immediate to the tenuous and remote. As Sheppard and Burchett JJ observed in Australian National Railways Commission v Collector of Customs (SA ) [(1985) 69 ALR 367 at 377-378; 8 FCR 264, at 265] the meaning of the word 'connection' is wide and imprecise, one of its common meanings being 'relation between things one of which is bound up with, or involved in, another': Shorter Oxford English Dictionary . (at 288) Given the potential width of the words 'in connection with', the question remains in a particular case what kind of relationship will suffice to establish the connection contemplated by the statute. This in turn will require a value judgment about the range of the statute: see e.g. Pozzolanic at 289 and Taciak v Commissioner of Australian Federal Police (1995) 59 FCR 285 at 295. Wilcox J of the Federal Court considered the meaning of the phrase 'in connection with the retirement' in Claremont Petroleum NL v Cummings (1992)110 ALR 239 (Claremont). The case concerned the application of provisions within the Queensland Companies Code and in particular, whether payments made were in connection with the retirement of certain individuals. Wilcox J made the following observations on the phrase 'in connection with: The phrase "in connection with" is one of wide import, as I had occasion to observe in a different context in Our Town FM Pty Ltd v Australian Broadcasting Tribunal (1987) 16 FCR 465 at p479-80; 77 ALR 577at p591-2: The words 'in connexion with'...do not necessarily require a causal relationship between the two things: see Commissioner for Superannuation v Miller (1985) 8 FCR 153 at 154, 160, 163;63 ALR 237 at 238, 244, 247. They may be used to describe a relationship with a contemplated future event: see Koppen v Commissioner for Community Relations (1986) 11 FCR 360 at 364, Johnson v Johnson [1952] P 47 at 50-1. In the latter case the United Kingdom Court of Appeal applied a decision of the British Columbia Court of Appeal, Re Nanaimo Community Hotel Ltd [1945] 3 DLR 225, in which the question was whether a particular court, which was given 'jurisdiction to hear and determine all questions that may arise in connection with any assessment made under this Act', had jurisdiction to deal with a matter which preceded the issue of an assessment. The trial judge held that it did, that the phrase 'in connection with' covered matters leading up to, or which might lead up to an assessment. He said...: 'One of the very generally accepted meanings of "connection" is "relation between things one of which is bound up with or involved in another"; or, again "having to do with". The words include matters occurring prior to as well as subsequent to or consequent upon so long as they are related to the principal thing. The phrase "having to do with" perhaps gives as good a suggestion of the meaning as could be had.' Having regard to the context of subparagraph 152-110(1)(d)(i) of the ITAA 1997, the Commissioner considers that it would be reasonable to adopt the meaning given to the phrase 'in connection with' in Claremont such that it is not necessary for there to be a permanent and everlasting retirement from the workforce; however, there would need to be at least a significant reduction in the number of hours worked or a significant change in the nature of the activities to be regarded as a retirement for the purposes of paragraph 152-110(1)(d)(i) of the ITAA 1997. Similarly, the words 'in connection with' can apply where the CGT event occurs sometime after retirement. Again, this would depend on the particular facts, and would need to be considered on a case-by-case basis. Relevantly, in this case: • The basic conditions for relief in Subdivision 152-A of the ITAA 1997 are satisfied. • Individual is a 'significant individual' of the A Trust and B Trust. just before the transfer of the relevant CGT assets. The Individual has been working for twenty to thirty hours per week for the A Trust, performing duties in relation to the business operations of the A Trust, and will retire from this work. As such, the Commissioner is satisfied that in these circumstances the sale of the CGT assets by A Trust and B Trust is in connection with the Individual's retirement for the purpose of subparagraph 152-110(1)(d)(i) of the ITAA 1997.

Reasons for decision: These reasons for decision accompany the Notice of private ruling for A Trust and the B Trust. | This is to explain how we reached our decision. This is not part of the private ruling.