Private ruling: Capital Gains Tax - Small Business Exemption
Date of advice: 24 November 2016
Published: February 2017
Ruling period: 30 June 20YY. | 30 June 20ZZ.
Date scheme commenced: 1 July 20XX.

Ruling: Q1: Will the property be an active asset under section 152-40 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Are you able to disregard any capital gain made on the disposal of your X% interest in the property that you acquired many years ago under the CGT small business 15 year exemption? | A2: No. | Q3: Will the Commissioner exercise his discretion under subsection 152-80(3) of the ITAA 1997 and extend the time period for the application of the small business 15 year exemption for your X% ownership interest in the property that you acquired on the date of death of your spouse? | A3: No.

Relevant facts and circumstances: The property is located in Australia (the property). You and your spouse bought the property sometime after 20 September 1985. The size of the property is more than 16 hectares (approx. XX acres). The vast majority of the property is vacant land, roughly XX hectares. You have said that in one year you tried to crop this area, however it was unsuccessful and you made no money from this cropping attempt. When asked how you managed the grass on this area of land over the years (because you have stated that you had no livestock and did not use the land for agistment), you have said that when your spouse was alive they used to mow the grass. You have said that the grass was not turned into hay, but rather you just cut it. You now get a person to cut the grass for you, free of charge. The land area that contains the X houses and the shed is approximately X acres (X hectares). The shed is located on the property boundary. One house is your main residence. This dwelling was built more than 25 years ago and has been your main residence since that time. The other house was built more than 15 years ago and has been described as X units of accommodation that is the main residence of your adult children. Your adult children live in this house rent free. You carried on a small business partnership until about 20 years ago and then you transferred the business to private company. You and your late spouse were both directors and shareholders of the company. The company still operates as a business. The company was a small business entity in the year ended 30 June 20YY. Expected aggregated turnover in the year ended 30 June 20ZZ will be below $2million dollars. You remain a director and shareholder the company. The property has not been used by any other business. You have said that business insurance at the property is not necessary as stock deliveries are made to the relevant work sites. The company has domestic building insurance and the registered address is listed as the property. The company has Home Warranty Insurance approval and the registered address is listed as the property. The shed dimensions according to the building approval issued by the relevant shire more than 25 years ago have been provided. Its estimated cost to build at that time was a few thousand dollars. The shed contained shelves around half of it for storage and there were X rooms, an office, telephone line and fax machine. When your main residence was built about 25 years ago, the home office was moved to a room in your main residence. The company does not pay you any rent for any use of the shed. The shed is used as a storage facility in the following ways: ● Store tools; ● Plant and equipment and ● Motor vehicles. There are X containers outside the shed containing material supplies. Only a small portion of the property was used in the running of your business. The vast majority of the property was not used for business purposes at all. You have provided a photo of the dining room table in your main residence and describe this as a conference table. You have also provided photos of the home office in your main residence. The home office inside your main residence contains the following equipment: a) Telephone lines; b) Desktop computer; c) Laptop computers; d) Commercial photocopy machines e) Filing cabinets. The property address has been used as the postal address for: ● Accounts payable by the company in relation to the purchase of various supplies. (The delivery of the supplies on the invoices provided is to the actual off site location and not to the property address.); ● Work permits for customers; ● Motor vehicle registration papers; ● Home Warranty Insurance and Domestic Building Insurance documents. You have said that the home office is manned by X staff on a full time basis, 9am to 5pm Monday to Friday. You are both paid as employees. The property does not have any signage to identify it as a place of business. The website for the company lists the property address as the Operations Office and another address as an additional office. The additional office is a room operating out of a real estate firm as an agency, this office opened recently. The following motor vehicles are registered by the company and you have said that these vehicles were used mostly for business. Vehicle Driver/s Overnight parking Utility tradesman Not at the property Wagon you Parked at the property Sedan tradesman Parked at the property Utility various Parked at the property The vast majority of the property does not produce any sort of income, let alone business income. The majority of your business activities were conducted off site. This is evidenced by the invoices issued for various supplies where the delivery address for the goods is to the relevant worksite. In a private ruling application lodged with the Australian Taxation Office (ATO) on behalf of you and your late spouse sometime in 20XX you said that you were considering selling the property to a property developer and retaining X hectares of land as a part of your main residence. In a private ruling application lodged with the ATO for you sometime in 20WW, you again stated that you were considering selling the property to a property developer and retaining X hectares of land as a part of your main residence. In both these private ruling applications you stated as a fact that the property was an active asset. This active asset aspect of those private ruling applications was not examined at that time. This statement was accepted on face value as correct. You do not own any other adjacent land to the property. Your spouse's date of death was sometime in 20UU. Your solicitor has not applied for probate. Your spouse's half share of the property has passed to you at their date of death because you had joint tenancy of the property with them. You have received verbal offers for the sale of the property; the offers did not proceed further when the vendor discovered that the Precinct Structure Plan (PSP) had not been completed. Earlier this year there had been no offers to buy the property for a lower price without the PSP. A PSP has been described as a master plan which shows the location of future land uses, such as residential, schools, shops, open space and community facilities. Your property is included in the proposed PSP. Sometime in 20VV, you as a landowner were sent a letter from a project management company (X) providing an update on land re-zoning issues and progress. X advised that they would be writing a submission to have your property area included in the draft re-zoning submissions. In 20TT, the Minister for Planning approved a larger area to be in the initial stages of land sub-division re-zoning. Your property is located in this area. A short time later in 20TT X notified you that your area was included in the initial stages of re-zoning and requested that landowners sign a form confirming their individual support of the process. The letter advised that another company (Y) and X had paid all production costs and consultancy fees associated with the submissions. Later in 20TT, Y also confirmed that your property was included in the expanded re-zoning area. Later in 20TT X wrote to you as a landowner of the property inviting you to engage them (X) to provide project management services to introduce and negotiate with purchasers of your property on your behalf. The agreement discussed that any offer to purchase would include a non-refundable option fee. On achieving a sale X would charge you a total management fee of X% plus GST of the sale price, this fee was based on X% for management and submissions for the land re-zoning process plus X% for management of the sale. As a result of this invitation you signed with X, the details of which are described below at dot point. Later in 20TT you and your late spouse appointed X to act on your behalf in negotiating the terms of sale for your property for a period of three months. In this agreement with X you agreed to accept a sale price for your property in a certain range per acre, with a deposit of a certain percentage and sale period/terms of three to four years. In 20UU a document from X advised you as a landowner that you had been included in a petition along with other landowners in the area lobbying various authorities and the Council to recognise the development potential in your area and commit to the preparation and approval of a PSP so that the general development layout for the area could be determined. In 20WW X wrote to you confirming their services to manage the sale of your property exclusively for a X month period. The letter advised buyer interest in a certain price range was achievable. In 20XX X wrote to you confirming the extension of their services to manage exclusively the sale of your property until the end of 20XX. Later in 20XX X advised you that they had recently introduced your property area development to a large property developer. The document included details of a meeting with Council to advise and update on the PSP. Council advised that once they received an initial payment from a developer to fund the PSP that the PSP would commence. The Council anticipated that once the funding was received that the PSP would be completed in about a 24-30 month period. Later in 20XX the large property developer wrote to X confirming interest in purchasing properties including yours. Later in 20XX X wrote to you and advised of delays in the PSP process commencing and in relation to marketing advised you to formally cancel the sale authority with a certain real estate, so that X could market to other agents for prospective buyers. You signed a letter authorising the cancellation of the sale authority with the real estate agent. Later in 20XX in a letter addressed to you from the Council, you were advised that the pre-planning work of the PSP had commenced, however it had been put on hold due to significant delays with third party funding. The letter stated that there had been a re-commencement of background reports such as transport assessment, Aboriginal cultural heritage assessment, drainage assessment and an economic assessment. The letter stated that a preliminary plan will be prepared by mid-20YY. After this report there would be land owner consultation, and review of all the documents by relevant government agencies and community. It is later, after this process is completed that the PSP document will be prepared. The current status of the PSP is that a developer has paid a certain amount to Council for the PSP to be completed but it has not commenced. You will not undertake any sub-division of the property yourself. You will sell the property as one lot. A few months ago you had thought that you would agree or accept to sell the property for a certain sale price. The property has been listed for sale with real estate. The property was first listed publicly for sale sometime in 20TT. The property was marketed as follows: ● Prime Position - about XX hectares (approx. XX acres) in the initial stages of re-zoning for land sub-division; ● The site represents an excellent development opportunity and land banking opportunity; ● The property is well-placed to provide its future owner with a variety of opportunities to develop this substantial site; Key Features: ● Potential yield circa over XXX residential allotments STCA; ● Suitable for residential land development; ● Property is located within the initial land sub-division re-zoning; ● It is a short drive from a Shopping Centre; ● Located in close proximity to all of the local suburb's amenities; ● A train station is nearby; ● Close to a freeway with direct access to the City; ● Within close proximity to the proposed new town centre and new residential estates; ● The block of land comes with an additional X separate houses; ● The precinct structure plan suggests these sites will suit residential lots (STPA) in the near future; ● It is commuter distance to a city and airport; ● At a close proximity to a well known shopping centre strip and within the radius are primary and secondary schools, parks, recreation facilities and local amenities; ● This site represents an unparalleled opportunity to secure a unique development site in one of the fastest growth corridors; ● The vendors are considering reasonable offers with negotiable settlement terms. Recently you signed a Heads of Contract agreement for the sale of the property for a purchase price of a certain amount plus GST if applicable between yourself as Vendor and the purchaser and/or Nominee. Even more recently you signed a Contract of Sale for the sale of the property for a purchase price of a certain amount between you as vendor and X other people and/or Nominee. The payment for the sale of the property is as follows: Price Certain amount Deposit a percentage paid in accordance with a Special Condition Balance Balance payable at settlement. In regard to the deposit, the purchaser will pay the deposit as follows: A small amount upon execution of Heads of Contract (this has been paid and is held in trust by your agent) About ¼ of the deposit amount upon 30 days expiration of the due diligence period, (the due diligence is 60 days from the date of the sale contract); ● ¼ of the deposit amount to be paid 12 months from the date of the sale contract; ● ¼ of the deposit amount to be paid 24 months from the date of the sale contract; ● ¼ of the deposit amount to be paid 36 months from the date of the sale contract. Settlement will be by 48 months from the date of the sale contract unless the parties agree to settle earlier. You will not be entering into a property development agreement with the purchaser to develop or subdivide the property. The sale is for an outright sale in one lot.

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 | Income Tax Assessment Act 1997 , Section 152-80 | Income Tax Assessment Act 1997 , subsection 152-80(3) | Income Tax Assessment Act 1997 , Section 152-105 | Income Tax Assessment Act 1997, Section 328-110 | Income Tax Assessment Act 1997 , Section 328-130

Reasons for decision: Summary: The property is not an active asset for CGT purposes. | Detailed Reasoning - Basic Conditions: To qualify for the small business CGT concessions in Division 152 of the ITAA, you must satisfy several conditions that are common to all the concessions. These are called the basic conditions and are as follows: The basic conditions, contained in section 152-10 of the ITAA 1997, are as follows: ● A CGT event happens in relation to a CGT asset of yours in an income year, ● The event would have resulted in a gain, ● The CGT asset satisfies the active asset test in section 152-35 of the ITAA 1997, and ● At least one of the following applies; ● you are a small business entity for the income year, ● you satisfy the maximum net asset value test in section 152-15 of the ITAA 1997, ● 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, or ● you do not carry on a business, but your CGT asset is used in a business carried on by a small business entity that is your affiliate or an entity connected with you. | Detailed Reasoning - Passively-held assets: The conditions in subsection 152-10(1A) 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 - Application to your situation: In your case a CGT event happened when you signed the contract of sale for the property and the event will result in a gain. You hold your interest in the asset (the property) passively. This does not preclude you from accessing the small business CGT concessions where the asset (the property) is used in the business of your CGT affiliate that is a small business entity for the relevant income year and the property is held to be an active asset. These tests are considered below. | Detailed Reasoning - CGT affiliate: It is accepted that the company is your affiliate as defined in section 328-30 for the ITAA 1997. | Detailed Reasoning - Active Asset: For the sale of the property to qualify for any of the small business CGT concessions, the CGT asset must also satisfy the active asset test in section 152-35 of the ITAA 1997. In this case, the active asset test is satisfied if: ● You have owned the property for more than 15 years and the asset was an active asset of yours for at least 7.5 years during the test period. The test period: ● begins when you acquired the asset; ● ends at the earlier of: ● the CGT event, and ● when the business ceased, if the business in question ceased in the 12 months before the CGT event (or such longer time as the Commissioner allows). The meaning of an active asset is given in subsection 152-40 (1) of the ITAA 1997. Paragraph 152-40(1) (a) states that a CGT asset is an active asset at a given time if at that time, you own it and: ● use it in the course of carrying on a business, or ● hold it ready for use in the course of carrying on a business by: i. you; or ii. your affiliate; or iii. another entity that is connected with you Accordingly, for the land in this case to be considered an active asset it must satisfy one of the above conditions. | Detailed Reasoning - Application to your situation: The central issue to be determined in this case is whether the property was being used, or held ready for use, in the course of carrying on your business. The property was used, as a matter of fact, as a venue for storing tools and equipment as well as providing a storage space for vehicles and some left over supplies. Your main residence on the property also has a home office and the property address is used for service of notices for the business. The dominant use of the property has been its use as a main residence for you and your late spouse and your X adult children and their families. It has been a lifestyle property. | Detailed Reasoning - Was the land being used?: The term use is not explained in either the legislation or the Explanatory Memorandum to the New Tax System (Capital Gains Tax) Bill 1999 which introduced Division 152 into the ITAA 1997. The Shorter Oxford English Dictionary uses an expression make use of a thing, especially for a particular end or purpose to express the ordinary meaning of the word use. The ordinary English meaning of the term would cover the storage of some tools, equipment and motor vehicles in the shed on the property. This was a physical use of the property that was connected with the conduct of the business. However, this does not mean that the use to which the property was being put was contemplated by subsection 152-40(1) of the ITAA 1997 because the use may not have had the required connection with your business. | Detailed Reasoning - The relevant connection: Paragraph 152-40(1) (a) of the ITAA 1997 requires an asset to be used in the course of carrying on a business. This requirement does not require exclusive use of the asset for business purposes but a use that is sufficient to establish the required connection between the asset and the operations of the business. The degree of connection required is expressed by the words in the course of , which connotes the idea that the use of the asset is an integral part of the process by which the business is carried on. In your case, you acquired the property sometime after 20 September 1985. The purpose of you keeping the property and dwellings for the significant period was to provide a home to you and your late spouse and your X adult children. It is acknowledged that during your period of ownership your business and company also used the property to store some tools, plant and equipment relevant for the business and storing some materials ad hoc. It is also accepted that the main residence has a designated home office. The question now is whether storing materials, some tools, equipment and motor vehicles in the shed and on the property; and having a home office in the main residence was integral to the process by which the business was conducted. If it was, the use of the property in such circumstances constitutes a use as contemplated by paragraph 152-40(1) (a) of the ITAA 1997 and the property would qualify as an active asset. | Detailed Reasoning - Conclusion: The property was not an active asset of yours or the company. The reasons are: ● The shed and the property with a land size of over 16 hectares (15 hectares of vacant land) was used in a manner that was incidental to the conduct of the business. The actual business activities were carried on off site at various sites. This is also evidenced by the tax invoices that you have provided that show the delivery address for goods as the relevant off site location. You have also said that business insurance is not required for the property because all goods were/are directed to the various work sites. It seems that only left over materials are predominantly stored at the property. The property was not used in the course of carrying on the business as required by paragraph 152-40(1)(a) of the ITAA 1997. ● Conducting a home office from the main residence does not change the character of the main residence from exactly that - a main residence. There is no signage or other features that would identify the property as a place of business. The business use is minor and incidental and does not change the character of this property from a lifestyle property (a home for you and your late spouse and your X adult children and their families). The home office and the use of the dining room as a conference table occasionally does not change the property (that includes XX hectares of vacant unused land) to an active asset. ● In addition the following factors do not support that the asset (the property) was being 'used' or being 'held ready for use' : ● the asset is not, with reference to its character specifically unique to, or traditionally used solely by that particular business type in its activities (e.g. as would a concrete truck be by a concrete supply business); ● the asset is quite significantly costly and its cost is not directly related to the previous business partnership or in the business of the affiliated company. The shed was built for an estimated low cost (a few thousand dollars) and you have sold the property for more than a few million. ● The property has been used for purposes totally unrelated to business, i.e. personal. For these reasons the property cannot be readily accepted as an active asset on the basis that is was ' used' or is 'held ready for use'. ● The degree of connection required by paragraph 152-40(1)(a) ITAA 1997 is expressed by the words 'in the course of' which mean 'integral to the process by which the business was carried on' . The relevant question, in this case, is whether storing some left over materials, tools, plant and equipment; and X motor vehicles in the shed or on the property and having a home office was integral to the process by which the business was conducted? The answer is that the activity was not integral to the process by which the business was conducted, but was instead merely incidental or not sufficient to change the character of the asset to an active asset. The active asset meaning and incidental use is further explained in Karapanagiotidis and Anor v FC of T 2007 ATC 2746 , in that case it was found that vacant land used passively to store old records in containers on the property could not be regarded as using the land in the course of carrying on a business. This was seen as passive use and not active use. The use of your shed and the home office in relation to all of the property's uses is considered at the passive end of the passive to active scale spectrum. The main purpose of the property was to provide a home for you and your late spouse and adult children. ● The shed on the property was merely a convenient place to: ● Store tools; ● Plant and equipment; ● Some motor vehicles. ● The home office is a room in the main residence. ● The table that you identify as the conference table is a dining room table. ● The X containers outside the shed was a convenient place to store material supplies on a small scale. ● Only a very small portion of the property (the shed and home office in your main residence) was used in the running of your business. The vast majority was not used for business purposes at all. We consider the fact that you used a small portion of the property to park your motor vehicles and store some tools and equipment to have been a convenient option for you, rather than an essential activity in the running of your business. The work vehicle Utility driven by the registered tradesman is not parked at the property overnight as they reside elsewhere. A home office in your main residence does not change the character of the main residence to that of an active asset let alone the entire property (including XX hectares of vacant land) to that of an active asset. ● No other business activities were conducted on the property and all the essential activities were conducted elsewhere off site as relevant. The business income was derived off site at various off site locations. The delivery address for the purchase of supplies is recorded on the invoices as the actual off site work location where the business activities took place and not the address of your property. You have also said that business insurance was not required for the property because stock deliveries where to the relevant work sites. All the profit generating work was undertaken away from the property. The property was not used in generating income. ● When looking at the property as a whole, it cannot be said that the property (over XX hectares and including XX hectares of vacant land) is being ' used' in the course of carrying on a business. The use of the land in the business in terms of area and time is considered minimal. ● Also relevant in assessing the character of the asset is how you have marketed and sold the property. It was never advertised as a business for sale or of land unique to your business type. The property has been a main residence and a passive investment in vacant land and sold as such to property developers. ● The intention of the small business concessions was not designed to exempt a property that is predominantly vacant land by virtue of the main residence having a home office and a shed located on it for the storage ad hoc of various left over materials, tools, some motor vehicles that would have a component of private use, some trailers and equipment. ● The requisite degree of connection has not been established. An incidental connection between the business and the asset is insufficient to establish that it was used or held ready for use in the course of carrying on the business. | Summary: You are unable to disregard any capital gain made on the disposal of your XX% interest in the property that you acquired just after 20 September 1985 under the CGT small business 15 year exemption because the property is not considered an active asset. | Detailed Reasoning - Detailed Reasoning: Subsection 152-10(1) of the ITAA 1997 provides the basic conditions that must be satisfied in order to apply any of the small business CGT concessions. One of the conditions outlined in paragraph 152-10(1)(d) of the ITAA 1997 is that the CGT asset (the property) must satisfy the active asset test (section 152-35 of the ITAA 1997). In your circumstances the property is not considered an active asset (section 152-40 of the ITAA 1997). Refer to detailed reasoning at Question 1. | Summary: The Commissioner will not exercise his discretion under subsection 152-80(3) of the ITAA 1997 to extend the time limit in relation to the ownership interest that you have inherited from your late spouse because the property is not considered an active asset. | Detailed Reasoning - Detailed reasoning: Section 152-80 of the ITAA 1997 potentially extends the availability of the small business CGT concessions to an asset held by a legal personal representative, beneficiary or surviving joint tenant. This section applies if a CGT event happens within 2 years of the individual's death (subsection 152-80(1)(d) of the ITAA 1997). Subsection 152-80(3) of the ITAA 1997 gives the Commissioner the discretion to extend this time limit. Paragraph 152-80(1)(c) of the ITAA 1997 states that that section only applies in the situation where, if the CGT event had happened immediately before the individual's death, then the deceased would have been entitled to reduce or disregard a capital gain under that Division. Subsection 152-10(1) of the ITAA 1997 provides the basic conditions that must be satisfied in order to apply any of the small business CGT concessions. One of the conditions outlined in Subsection 152-10(1)(d) of the ITAA 1997 is that the CGT asset (the property) must satisfy the active asset test (section 152-35 of the ITAA 1997). In your circumstances the deceased (your late spouse) would not have been able to apply the small business CGT concessions if they had disposed of the asset just prior to their death because the property is not considered an active asset. Because the property is not considered an active asset, then Section 152-80 of the ITAA 1997 cannot apply. As the requirements of section 152-80 are not met, the Commissioner is not able to exercise the discretion contained within subsection 152-80(3) of the ITAA 1997.