Private ruling: Capital gains tax-15 year exemption
Date of advice: 20 May 2016
Published: June 2016
Ruling period: Year ending 30 June 2016 | Year ending 30 June 2017 | Year ending 30 June 2018
Date scheme commenced: 1 July 2015

Ruling: Q1: Does the trust satisfy the basic conditions for the small business CGT concessions under section 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: Is the trust entitled to claim the 15 year exemption under section 152-110 of the ITAA 1997 for any capital gain arising from the sale of the property? | A2: Yes


Relevant legislative provisions: Income Tax Assessment Act 1997 Paragraph 108-5(1)(a) | Income Tax Assessment Act 1997 Section 152-10 | Income Tax Assessment Act 1997 Subsection 152-10(1A) | Income Tax Assessment Act 1997 Paragraph 152-10(1)(b). | Income Tax Assessment Act 1997 Paragraph 152-10(1)(d). | Income Tax Assessment Act 1997 Subsection 152-10(1B) | Income Tax Assessment Act 1997 Section 152-35. | Income Tax Assessment Act 1997 Paragraph 152-35(1)(a). | Income Tax Assessment Act 1997 Paragraph 152-35(1)(b). | Income Tax Assessment Act 1997 Subparagraph 152-40(1)(a)(ii). | Income Tax Assessment Act 1997 Subparagraph 152-40(1)(a)(iii). | Income Tax Assessment Act 1997 Section 152-55. | Income Tax Assessment Act 1997 Section 152-65. | Income Tax Assessment Act 1997 Section 152-70 | Income Tax Assessment Act 1997 Section 152-110 | Income Tax Assessment Act 1997 Subsection 152-70(1) | Income Tax Assessment Act 1997 Paragraph 152-70(5)(a) | Income Tax Assessment Act 1997 Paragraph 152-70(5)(b) | Income Tax Assessment Act 1997 Subsection 328-125(1) | Income Tax Assessment Act 1997 Subsection 328-125(3) | Income Tax Assessment Act 1997 Subsection 328-125(4) | Income Tax Assessment Act 1997 Section 328-130 | Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision: Detailed Reasoning - Small Business Concessions: Section 152-10 of the Income Tax Assessment Act 1997 (ITAA 1997) contains the basic conditions you must satisfy to be eligible for the small business capital gains tax (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 a 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 in section 152-15 of the ITAA 1997 (iii) you are a partner in a partnership that is a small business entity for the income year and the CGT asset is an asset of the partnership or (iv) the conditions in subsection 152-10(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. | Detailed Reasoning - Passively held assets - affiliates and entities connected with you: The conditions in subsection 152-10(1A) of the ITAA 1997 are satisfied in relation to the CGT asset in the income year if: (a) your affiliate, or an entity that is connected with you, is a small business entity for the income year; and (b) you do not carry on a business in the income year (other than in partnership); and (c) if you carry on a business in partnership - the CGT asset is not an interest in an asset of the partnership; and (d) in any case - the small business entity referred to in paragraph (a) is the entity that, at a time in the income year, carries on the business (as referred to in subparagraph 152-40 (1)(a)(ii) or (iii) or paragraph 152-40 (1)(b) in relation to the CGT asset. | Detailed Reasoning - Active asset test: The active asset test is contained in section 152-35 of the ITAA 1997. 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 at least 7.5 years during the test period. The test period is from when the asset is acquired until the CGT event. If the business ceases within the 12 months before the CGT event (or such longer time as the Commissioner allows) the relevant period is from acquisition until the business ceases. A CGT asset is an active asset if it is owned by you and is used or held ready for use in a business carried on (whether alone or in partnership) by you, your affiliate, your spouse or child, or an entity connected with you. | Detailed Reasoning - Connected entities: The term 'connected with' is defined in subsection 995-1(1) of the ITAA 1997 as: an entity is connected with you in the circumstances described in section 328-125. Subsection 328-125(1) of the ITAA 1997 states that 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. Direct control of a discretionary trust may be established via either of two paths: subsection 328-125(3) or subsection 328-125(4) of the ITAA 1997. Subsection 328-125(3) of the ITAA 1997 provides that an entity controls a discretionary trust if the trustee of that trust 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. Subsection 328-125(4) provides, in part, that an entity directly controls a discretionary trust for an income year if, for any of the preceding four income years, the discretionary trust distributed at least 40% of any income or capital paid for that year to either the entity, its affiliates, or to the entity together with any of its affiliates. | Detailed Reasoning - Affiliates: An affiliate is, according to section 328-130 of the ITAA 1997, an individual or a company who 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. The Advanced guide to capital gains tax concessions for small business (NAT 3359) confirms that an individual or a company can be an affiliate of a trust. However, this will only occur providing that the individual or company acts or could reasonably be expected to act in accordance with the directions or wishes of the trust, or in concert with the trust, in relation to the affairs of the individual's or company's business. | Detailed Reasoning - Application to the trust's circumstances: The trust intends selling the property giving rise to CGT event A1 and a gain on the sale. The company is the trustee for the trust. The property was used in the business of the company (which is a small business entity) for the entire period it was owned by the trust. Therefore, the conditions in subsection 152-10(1A) will be met if the company was either an entity connected with the trust or an affiliate of the trust. In this case, person A & B equally controlled the company as both are directors and equal shareholders. In addition they also have 100% control of the day to day running of the trust (subsection 328-125(3) of the ITAA 1997). Further, from the information provided, we also accept that company is an affiliate of the trust as the company acts in accordance with the directions of the trust and in concert with the trust. The last basic condition that must be met for the small business CGT concessions is the active asset test. As noted above the property was used in the business of the company for the entire period it was owned by the trust. Accordingly, the basic conditions for the small business CGT concessions have been satisfied. | Detailed Reasoning - 15-year exemption: Section 152-110 of the ITAA 1997 provides that a trust 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 (b) you continuously owned the CGT asset for the 15-year period ending just before the CGT event (c) you had a significant individual for a total of at least 15 years of the whole period of ownership (even if the 15 years was not continuous and it was not always the same significant individual), and (d) 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, or • permanently incapacitated at that time. Section 152-55 of the ITAA 1997 explains that an individual is a significant individual in a trust if the individual has a small business participation percentage in the trust of at least 20%. The 20% can be made up of direct and indirect percentages. A company or trust satisfies the significant individual test if it had at least one significant individual just before the CGT event. 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. Section 152-65 of the ITAA 1997 provides that an entity's small business participation percentage in another entity at a time is the percentage that is the sum of: (a) the entity's direct small business participation percentage in the other entity at that time; and (b) the entity's indirect small business participation percentage in the other entity at that time. Subsection 152-70(1) of the ITAA 1997 explains that an entity's direct small business participation percentage in a trust, where entities do not have entitlements to all the income and capital of the trust, and the trust makes a distribution of income or capital, is the percentage of: • distributions of income that the entity is beneficially entitled to during the income year, or • distributions of capital that the entity is beneficially entitled to during the income year. Ordinarily, if the trust does not make a distribution of income or capital during the income year it will not have a significant individual during that income year. However, section 152-70 of the ITAA 1997 allows an entity another method to work out their small business participation percentage in a discretionary trust if, in the CGT event year, the trustee of the trust: • did not make a distribution of income or capital during the income year, and • had no net income or had a tax loss for the income year. Then, the entity's direct small business participation percentage at the relevant time is worked out using the percentage of the distributions the entity was beneficially entitled to in the last income year before the CGT event year in which the trustee made a distribution (paragraph 152-70(5)(b)of the ITAA 1997). Importantly, a distribution by the trustee during the CGT event year of some or all of the capital gain made from the CGT event is a distribution for the purpose of assigning a small business participation percentage in that income year to the objects of the trust (paragraph 152-70(5)(a) of the ITAA 1997). Trust law would determine whether the distribution is a distribution of income or capital. In the trust's case, upon the sale of the property a distribution of a capital gain will be made in the CGT event year. The trust states that persons A & B will each receive an equal distribution of the capital gain from the sale of the property in the CGT event year. Therefore, each individual will be considered a significant individual of the trust for that year as they will both have a small business participation percentage in the trust of more than 20%. The trust did not distribute income in some financial years as the trust derived no assessable income. For the remaining years, up until the CGT event year, the trust made distributions of income to either person A or B or both. Accordingly, the trust had a significant individual for the years that distributions were made. Also, persons A & B will be deemed to be the significant individuals with the same small business participation percentage (as noted above) for the remaining financial years as in the CGT event year when they receive a distribution of the capital gain from the trust. Therefore, as the trust; • satisfies the basic conditions • has owned the asset for over 15 years • has had a significant individual for at least 15 years during the period of ownership, and • as the significant individuals are over 55 at the time of the event and will retire the trust meets all the necessary conditions to be eligible to disregard any capital gain made on disposal of the property under section 152-110 of the ITAA 1997.

Relevant facts: The trust was created over 20 years ago. | The trust is a discretionary trust. | Under the trust deed the specified beneficiaries of the trust are persons A & B. | The trustee of the trust is a company. | The directors and members of company are persons A & B | Distributions of income from the trust have always been distributed to persons A & B. | Persons A & B have had 100% control over the day to day running of the trust and the company. | The trust acquired a property (the property) with the intention of carrying on a farming business. | The farming business was operated by the company on the property. | The aggregated turnover of the company and the trust does not exceed $2 million in any financial year. There is no other business entity that is connected with, or an affiliate of, the company or trust. | The trust intends to sell the property as soon as a suitable purchaser can be found. | The sale of the property will result in a capital gain made by the trust. | The net capital gain made by the trust from the sale of the property will be distributed to persons A & B at 50% each. | Persons A & B are over 55 years of age. | When the property is sold, the farming business will cease and persons A & B intend to retire as they have no intention of pursuing any other business or employment arrangement. | In a number of financial years the trust made no distributions of income as the trust derived no assessable income. | A review of the trust returns over the period of ownership of the property shows that in the years that the trust had a net income, at least one beneficiary received 20% or more of the income of the trust. | In the current financial year the trust is expected to distribute all of its income to person B.