Private ruling: Capital gains relief - small business concession
Date of advice: 17 May 2016
Published: June 2016
Ruling period: 29/01/2016 to 30/06/2016
Date scheme commenced: 29/01/2016

Ruling: Q1: Does the taxpayer satisfy the basic conditions necessary for capital gains tax concessions for small business and also the CGT retirement exemption? | A1: Yes. The basic conditions for capital gains tax concessions are set out in section 152-10 ITAA 1997. The taxpayer will meet the basic conditions in s152-10 ITAA 1997. Further, the conditions for the small business retirement exemption to apply are set out in subdivision 152-D ITAA 1997.

Relevant facts and circumstances: A taxpayer and another person incorporated a company and have been the sole directors for the life of the company. All the shares of the company are owned by the two directors and have been fully paid. The Directors of the company propose to obtain an independent assessment of the market value of the shares and propose to sell the shares to a family trust at the assessed market value. The Directors of the company will declare a dividend equal to the retained earnings the day prior to any share transfer.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 152-10 | Income Tax Assessment Act 1997 section 152-15 | Income Tax Assessment Act 1997 section 152-35 | Income Tax Assessment Act 1997 section 152-40

Reasons for decision: Summary: In order to be eligible for capital gains relief under Division 152 ITAA 1997, the taxpayer must first meet the basic conditions for relief set out in s152-10 ITAA 1997. The following conditions must be met: (a) A CGT event happens in relation to a CGT asset of yours in an income year (b) The event would (apart from this Division) have resulted in the gain (c) At least one of the following applies: (ii) you satisfy the maximum net asset value test (a) the CGT asset satisfies the active asset test Conditions (a) and (b) Without the operation of Division 152 ITAA 1997, CGT event A1 Disposal of a CGT asset , would occur when the shares are disposed of. A share is a CGT asset (s100-25(2) ITAA 1997). As the amount to be received is expected to be in excess of the cost base (s100-35 ITAA 1997), a capital gain would occur. Conditions (a) and (b) in section 152-10 ITAA 1997 will be satisfied. Condition (c) Maximum net asset value test The maximum net asset value test is set out in section 152-15 ITAA 1997. The maximum net asset value test is satisfied if the net value of the CGT assets of the taxpayer, entities connected with the taxpayer and the affiliates do not exceed $6m. The taxpayer has stated that the sum of the CGT assets of the taxpayer, entities connected with the taxpayer and affiliates does not exceed $6m. Condition (c) would be satisfied. Condition (d) Active asset test The CGT asset must satisfy the active asset test. The active asset test is set out in section152-35 ITAA 1997. Under section 152-35, a CGT asset satisfies the active asset test if the taxpayer owned the asset for 15 years or less and the asset was an active asset for a total of at least half the period between when the asset was acquired and the CGT event. The assets have been owned for less than 15 years. The assets have been used in the business for the entire period and would satisfy the conditions in subsection 152-35(1). An active asset is further defined in section 152-40(3) ITAA 1997. Under subsection 152-40(3) ITAA 1997, a share in a company that is an Australian resident at that time, where the total of the active assets, financial instruments and cash of the company is 80% or more of the market value of all the assets of the company, is an active asset. This requires us to look through the shares to the assets of the company in order to satisfy the 80% test. Under subparagraph152-40(3)(b)(iii), cash of the company can be included in the calculation of the 80% amount, if that cash is inherently connected with the business. An asset would be considered to be inherently connected where it is a permanent or characteristic attribute of the business. The cash is not held as a passive income earning asset in the business. Its purpose is to maintain a buffer to meet costs and maintain liquidity. It is used to meet the regular expenses of the business, including BAS and wages. It could therefore be considered to be inherently connected with the business and an active asset. Goodwill, as an intangible asset, can be classified as an active asset if it is inherently connected with a business that is carried on, according to paragraph 152-40(1)(b). Note 3 to subsection 152-40 states that, 'An example of an asset that is inherently connected with a business is goodwill or the benefit of a restrictive covenant'. The goodwill can be attributed to factors such as its past earnings and future profitability and quality of clients. The goodwill of the business, as calculated by the taxpayer, is an active asset for the purposes of the 80% test. The tax assets relate to the tax-effect accounting treatment of the provision raised for annual and sick leave for employees. This would be considered to be an intangible asset and must be inherently connected with the business carried on (paragraph 152-40(1)(b)). As the asset relates to provisions for employees, it could be considered to be inherently connected with the business and would therefore be an active asset. The trade receivables and property, plant and equipment are active assets as they are used in the course of carrying on the business. The shareholders' loan (loan to shareholders) was included as a non-current liability on the balance sheet due to the accounting software. It would normally be classified as an asset. It would not satisfy the definition of an active asset as it is not used or held ready for use in the course of carrying on a business that is carried on (paragraph 152-40(1)(a)). The taxpayer has passed the 80% test, meaning that the active asset test has been satisfied. Basic conditions for relief - section 152-10 As the basic conditions for relief have been met, the taxpayer will be eligible for the small business capital gains relief. CGT retirement option The small business retirement exemption is set out in subdivision 152-D ITAA 1997. A taxpayer may choose this exemption under section 152-305. Under this provision, an individual can choose to disregard all or part of a capital gain if the individual is under 55 before the choice is made and the amount is contributed to a complying superannuation fund or a retirement savings account. The amount contributed must be equal to the asset's CGT exempt amount. The CGT retirement exemption limit is set at $500,000 (section 152-320 ITAA 1997). The taxpayer is able to choose the small business retirement exemption as the amount will be under the $500,000 limit and is under 55 years of age. | Detailed Reasoning - Small business retirement exemption: The small business retirement exemption is set out in subdivision 152-D ITAA 1997. Under s152-305 ITAA 1997, an individual can choose to disregard all or part of a capital gain if: (a) the basic conditions in Subdivision 152-A are satisfied for the gain (b) the individual is under 55 before the choice is made and the amount equal to the asset's CGT exempt amount is contributed to a complying super fund, and (c) the contribution is made at the later of when the choice is made and when the proceeds were received The basic conditions of subdivision 152-A have been met, as set out above. The taxpayer will be under 55 before the written election is executed and will contribute an amount equal to the CGT exempt amount to a complying superannuation fund. The conditions in section 152-305 will be satisfied, meaning that the small business retirement exemption is available to the taxpayer.