Consolidation: capital gains tax - CGT small business retirement exemption - controlling individual test

For the purpose of applying the small business retirement exemption, is the controlling individual condition in paragraph 152-305(2)(b) of the Income Tax Assessment Act 1997 (ITAA 1997) applied to the head company of a consolidated group rather than the subsidiary member of the group that actually sells an asset?

Yes. The effect of the single entity rule in subsection 701-1(1) of the ITAA 1997 is that the controlling individual condition in paragraph 152 305(2)(b) of the ITAA 1997 is applied to the head company of a consolidated group for the purposes of the small business retirement exemption.

All the shares in H Co are owned by an individual. H Co is the head company of a consolidated group consisting of H Co and Sub Co. Sub Co carries on a small business.

In the 2004 income year Sub Co sold an asset. For the purposes of working out H Co's liability to income tax for that income year, H Co is taken to have sold the asset and made a capital gain. H Co wishes to treat the capital gain as exempt under the small business retirement exemption in Subdivision 152 D of the ITAA 1997.

H Co satisfies all of the basic conditions in section 152-10 of the ITAA 1997.

Apart from the basic conditions in section 152-10 of the ITAA 1997, a company wishing to claim the small business retirement exemption (in this case the head company of the consolidated group) must satisfy the controlling individual test: paragraph 152-305(2)(b) of the ITAA 1997.

The controlling individual test is satisfied if the company had at least one controlling individual just before the CGT event: section 152-50 of the ITAA 1997. An individual is a controlling individual of a company if, at that time, the individual holds the legal and equitable interest in shares, other than redeemable shares, that carry the right to exercise at least 50% of the voting power in the company and receive at least 50% of any dividend or distribution of capital the company may pay: subsection 152-55(1) of the ITAA 1997.

If Sub Co were not a member of a consolidated group it would not qualify for the retirement exemption because it could not satisfy the controlling individual test (all the shares in Sub Co being owned by H Co).

An issue arises as to whether the single entity rule in subsection 701-1(1) of the ITAA 1997 affects the application of the controlling individual test for entities that are part of a consolidated group. Under the single entity rule, subsidiary members of a consolidated group are taken to be parts of the head company and not separate entities when working out the group's income tax liability or loss. This means that actions of subsidiaries are treated as actions of the head company for the purposes of working out the income tax liability or losses of a consolidated group.

Therefore, the controlling individual test must be applied to the group's head company with the result, in this case, that H Co satisfies the test in section 152-50 of the ITAA 1997 and will be able to claim the small business retirement exemption to the capital gain made on the disposal of the asset.

The result in this case, while different from that which would arise had Sub Co not been a member of a consolidated group, is consistent with the fundamental principles underpinning the consolidation regime.