Private ruling: Active asset test
Date of advice: 5 May 2017
Published: September 2017
Ruling period: Year ended 30 June 2016 | Year ending 30 June 2017
Date scheme commenced: 1 July 2015

Ruling: Q1: Does the Trust satisfy the basic conditions necessary to be eligible for the capital gains tax (CGT) concessions for small business? | A1: No. | Q2: Is the Trust eligible to choose the retirement exemption in relation to the sale of the commercial property? | A2: No.


Relevant legislative provisions: Income Tax Assessment Act 1997 Subsection 152-10(1) | Income Tax Assessment Act 1997 Section 152-35 | Income Tax Assessment Act 1997 Section 152-40 | Income Tax Assessment Act 1997 Section 328-125 | Income Tax Assessment Act 1997 Section 328-130

Reasons for decision: Detailed Reasoning - Basic Conditions for the Small Business CGT 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. The property has been sold which means that the Trust has disposed of its interest in the property. This is a CGT event for which a capital gain has been made. You have advised that the total net value of all the CGT assets of the Trust, its connected entities and its affiliates does not exceed $6,000,000 and consequently the maximum net asset value test is met. Therefore, the only remaining basic condition that requires consideration is the active asset test. | 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 (subsection 152-40(1) of the ITAA 1997). However, assets whose main use is to derive rent cannot be active assets, even if they are used in the course of carrying on a business (paragraph 152-40(4)(e) of the ITAA 1997). The circumstances concerning the use of the property changed over time so it is necessary to look at each of these time periods. | Detailed Reasoning - XXXX - XXXX: During this period the property was used by the company in its business. Consequently the Trust's 10% interest in the property will only be an active asset if the company is the trust's affiliate or an entity connected with it. Affiliate 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. Subsection 328-130(2) of the ITAA 1997 states: an individual or company is not your affiliate merely because of the nature of a business relationship you and the individual or company share. Example: A partner in a partnership would not be an affiliate or another partner merely because the first partner acts, or could reasonably be expected to act, in accordance with the directions or wishes of the second partner, or in concert with the second partner, in relation to the affairs of the partnership. Directors of the same company, or the company and a director of a company, would be in a similar position. The Advanced guide to capital gains tax concessions for small business (NAT 3359) (the Guide) confirms that an individual or a company can be an affiliate of a trust. However, it states that companies and trusts are not affiliates of their directors and trustees respectively and vice versa, merely because of the positions held. The Guide provides a number of relevant factors that may support a finding that an individual or company is an affiliate of a taxpayer: ● 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, and ● the actions of the parties. The Trustees of the Trust are Z and Y. During the period XXXX - XXXX, Z was a co-director of the company along with two other unrelated individuals. The three individuals collectively ran the company's business. Although Z was a director of the company, it could not be expected that the company would act in accordance with the directions or wishes of the Trust in relation to the company's business affairs, given that Z never owned a majority shareholding and two unrelated individuals were co-directors with Z. For example, it would not be expected that the other two co-directors would agree for the company to act in a way that was in the interests of the Trust if it was not also in the best interests of the company. Therefore, the company was not an affiliate of the Trust. It is also noted that the partnership could not be an affiliate of the Trust. Connected entity Under section 328-125 of the ITAA 1997 an entity is connected with another entity if: ● either entity controls the other entity, or ● both entities are controlled by the same third entity An entity controls a company if the entity, its affiliates or the entity together with its affiliates, owns or has the right to acquire ownership of, equity interests in the company that give at least 40% of the voting power in the company (subsection 328-125(2) of the ITAA 1997). An entity controls a discretionary trust if a trustee of the trust acts, or reasonably expected to act, in accordance with the directions or wishes of the entity or the entity's affiliates, or both the entity and its affiliates. An entity also controls a discretionary trust for an income year if, for any of the four prior income years: ● The trustee paid to, or applied for the benefit of, the entity or its affiliates, or both the entity and any of its affiliates, any of the income or capital of the trust and ● The amounts paid or applied were at least 40% (the control percentage) of the total amount of income or capital paid or applied for that income year. The Trust did not have at least 40% of the voting power in the company so did not control the company. The company did not control the Trust as the trustees of the Trust would not be expected to act in accordance with the directions or wishes of the company (unless it was also in the best interests of the trust) and there is no indication that the trust ever paid the company 40% of the income or capital of the trust in any year. As neither entity controls the other and it is not considered that both entities are controlled by a common third entity, the Trust and the company are not connected entities under section 328-125 of the ITAA 1997. As the company was not the Trust's affiliate or an entity connected with it, the trust's 10% interest in the property was not an active asset during the period XXXX - XXXX. | Detailed Reasoning - XXXX - XXXX: During this period part of the property was used by Z as a sole trader in their business (X out of XXX square metres (X%) for their office plus use of shared facilities) while the rest of the property continued to be used by the company in its business. It is not considered that the area of the property used by Z can all be 'allocated' to the 10% interest in the property owned by the Trust. That is, the trust has a 10% interest in the entire property which means it has a 10% interest in the area that was used as Z's office. Although the area used by Z was less than 10%, it is not considered to have been wholly owned by the Trust. In other words, only approximately X% of the Trust's interest in the property was used by Z in carrying on Z's business. The vast majority of the trust's interest in the property was used by the company in carrying out its business. As discussed previously, the company was not the Trust's affiliate or an entity connected with it. Therefore, the trust's 10% interest in the property was not an active asset during the period XXXX - XXXX. | Detailed Reasoning - XXXX - XXXX: The property was only used by the company during this period so as the company is not the Trust's affiliate or an entity connected with it, the trust's 10% interest in the property was not an active asset during this period. | Detailed Reasoning - Conclusion: The Trust's 10% interest in the property is not considered to have been an active asset for any of the trust's ownership period. Consequently the active asset test is not met and the trust is not eligible for the small business CGT concessions, including the small business retirement exemption.

Relevant facts: A commercial property (the property) was acquired by the partnership. | The Trust has a 10% interest in the partnership. | The Trust is a family discretionary trust. | The trustees of the Trust are Z and Y (spouses). | The partnership rented this property to the company which carried on a business on the property. | Z was a director and shareholder of the company from XXXX to XXXX. | From XXXX, Z ceased their involvement with the company and instead became a sole trader. Z retained use of their office (X square metres out of the total floor area of the property of XXX square metres) until they retired in XXXX. | While operating as a sole trader Z also used the shared facilities area (kitchen, bathroom, etc) and the shared administrative staff. | The partners sold the property with the sale contact entered into in XXXX.