CGT small business retirement exemption: whether amount paid is 'unreasonable'

Will any part of a payment of $500 000 made by the taxpayer, a private company, under section 152-325 of the Income Tax Assessment Act 1997 (ITAA 1997) be considered by the Commissioner to be unreasonable under subsection 109(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

No. The payment of $500 000 made by the taxpayer, a private company, under section 152-325 of the ITAA 1997 will not be considered by the Commissioner to be unreasonable, in any part, under subsection 109(1) of the ITAA 1936.

The taxpayer is a private company with only a single shareholder who was employed in the business operated by the company as the business manager.

After five years of working in and managing the business the shareholder/employee decided to retire, having reached retirement age.

The company then disposed of the business assets in order to provide a retirement benefit to the retiring shareholder/employee. The company made a capital gain on the disposal and chose to disregard $500 000 of the capital gain in accordance with section 152-315 of the ITAA 1997. The capital gains tax exempt amount for the assets under consideration is therefore $500 000.

The company immediately made a payment of $500 000 under section 152-325 of the ITAA 1997 to the shareholder/employee who retired.

The company chose the small business retirement exemption and satisfied the requirements of Subdivisions 152-A and 152-D of the ITAA 1997.

For a company to choose the small business retirement exemption in Subdivision 152-D of the ITAA 1997 it must, among other things, make an eligible termination payment (ETP) in accordance with section 152-325 of the ITAA 1997. This ETP must satisfy the definition of 'eligible termination payment' in subsection 27A(1) of the ITAA 1936. Under subparagraph (a)(v) of that definition an amount that is deemed to be a dividend is excluded from being an ETP. Thus any payment or part thereof considered to be unreasonable and deemed to be a dividend will not satisfy section 152-325 of the ITAA 1997 and the retirement exemption will not be available.

Taxation Ruling IT 2621 outlines the factors and circumstances the Commissioner will take into consideration when determining whether a payment is unreasonable under section 109 of the ITAA 1936. Paragraph 13 of IT 2621 states that when forming an opinion under section 109 of the ITAA 1936 the Commissioner must take all the circumstances of the case into account.

In Ferris v. Federal Commissioner of Taxation (1988) 20 FCR 202; (1988) 19 ATR 1705; 88 ATC 4755, it was held that the Commissioner had used the discretion under section 109 of the ITAA 1936 incorrectly because the decision as to what was reasonable was based solely on what was reasonable for superannuation purposes. It was emphasised that what is and what is not reasonable depends on the circumstances of the case and upon commercial practice.

On this basis it would be incorrect for the Commissioner to base his decision as to what is reasonable solely with reference to the CGT retirement exemption limit of $500 000.

In determining whether an amount paid under section 152-325 of the ITAA 1997, in order to comply with the requirements of the small business retirement exemption, is unreasonable under section 109 of the ITAA 1936 the Commissioner will take all the circumstances of the case into account.

When all the circumstances of the current case are considered, a payment of $500 000 would not be unreasonable for the purposes of section 109 of the ITAA 1936. In forming this opinion under section 109 of the ITAA 1936, in this case, the Commissioner has had particular regard to: • the purpose behind the payment • the length of service with and level of contribution to the business by the shareholder/employee • the election by the taxpayer to use the small business retirement exemption • the policy intention behind the exemption; and • the level of the CGT retirement exemption limit ($500 000).

As the taxpayer has worked in the business for several years and is intending to use the small business retirement exemption, the Commissioner does not consider the payment of $500 000 to be unreasonable.