Income tax: capital gains: small business concessions: must a taxpayer receive actual capital proceeds from a CGT event to qualify for the small business retirement exemption under Subdivision 152-D of the Income Tax Assessment Act 1997 ?

Yes. A taxpayer must receive actual capital proceeds from a CGT event to qualify for the retirement exemption under Subdivision 152-D of the Income Tax Assessment Act 1997 (ITAA 1997). If the market value substitution rule in section 116-30 of the ITAA 1997 has applied to increase the capital proceeds taken to be received, the retirement exemption is available only to the extent of the actual capital proceeds received by the taxpayer.

A taxpayer who makes a capital gain from CGT event J2 or J3, in section 104-185 or 104-190 of the ITAA 1997, respectively, following an earlier small business rollover, can disregard the capital gain under the small business retirement exemption if they qualify for the retirement exemption.

If the original CGT event did not involve actual capital proceeds such that the retirement exemption was not available, the capital gain under CGT event J2 or J3 remains ineligible for the exemption.

Charlie transfers his farm to his son for no consideration. The market value of the farm is more than the cost base of the farm.

CGT event A1 happens. As Charlie did not receive any capital proceeds for the farm, the market value substitution rule applies to treat the capital proceeds to be an amount equal to the market value of the farm. Charlie makes a capital gain from the CGT event but no part of the gain is eligible for the small business retirement exemption because Charlie did not receive any actual capital proceeds.

The capital gain may be eligible for the CGT discount, the 50% active asset reduction or the small business rollover.

Following on from the facts in Example 1, six months later, Charlie buys a replacement farm closer to the town and chooses the small business roll-over to defer the capital gain from the transfer of his original farm. Two years later he decides to retire and sells the replacement farm to a third party for an amount equal to the cost base of the farm. Charlie now wants to choose the small business retirement exemption.

CGT event J2 happens when Charlie sells the replacement farm and realises the deferred capital gain from the original farm. This capital gain remains ineligible for the small business retirement exemption because the original CGT event, that is the sale of the original farm, did not involve actual capital proceeds.

When the final Determination is issued, it is proposed to apply both before and after its date of issue. However, the Determination will not apply to taxpayers to the extent that it conflicts with the terms of settlement of a dispute agreed to before the date of issue of the Determination.

A taxpayer can choose to disregard an amount of a capital gain if the taxpayer satisfies the conditions for the small business retirement exemption in sections 152-305 and 152-315 of the ITAA 1997. Additional conditions in section 152-325 of the ITAA 1997 apply to a company or a trust.

The amount of the capital gain that can be disregarded is limited to the actual capital proceeds received from the CGT event. In working out the capital proceeds received for the purposes of the small business retirement exemption, the market value substitution rule in section 116-30 of the ITAA 1997 is not taken into account (subsections 152-310(3) and 152-325(4) of the ITAA 1997). The exempt amount is limited to the actual capital proceeds received and the life time CGT retirement exemption limit of $500,000 (subsection 152-315(2) and section 152-320 of the ITAA 1997).

A taxpayer who has chosen a small business rollover and realises the previously rolled over capital gain under CGT event J2 or J3 can disregard the capital gain under the small business retirement exemption if they qualify for the exemption.

CGT event J2 happens when a replacement CGT asset changes status (section 104-185 of the ITAA 1997). For example, CGT event J2 happens if the replacement asset is sold, stops being used or held ready for use in the business, starts being trading stock or starts being used to produce exempt income.

CGT event J3 happens, in relation to a replacement CGT asset that is a share in a company or an interest in a trust, when there is a change in circumstances (section 104-190 of the ITAA 1997). For example, CGT event J3 happens if the share or interest ceases to be an active asset or the taxpayer stops being a controlling individual of the company or trust.

There are no capital proceeds from CGT event J2 or J3. In determining whether the small business retirement exemption can apply, the taxpayer should take into account the capital proceeds received for the original CGT event.

If the original CGT event did not involve actual capital proceeds such that the retirement exemption was not available, the capital gain under CGT event J2 or J3 remains ineligible for the exemption.

As noted in the Treasurer's Press Release No. 38 of 2006 (9 May 2006), the Board of Taxation's report on its Post-Implementation Review of the small business CGT concessions contains a number of administrative recommendations. This Draft Taxation Determination is part of the Commissioner's response to Recommendation 12.4 of the Board's report. The Board's report also contains a number of legislative recommendations. This Draft Taxation Determination may be affected by the legislative change relating to Recommendation 12.5 of the Board's report.

We invite you to comment on this draft Taxation Determination. Please forward your comments to the contact officer by the due date. (Note: The Tax Office prepares a compendium of comments for the consideration of the relevant Rulings Panel. The Tax Office may use a sanitised version (names and identifying information removed) of the compendium in providing its responses to persons providing comments. Please advise if you do not want your comments included in a sanitised compendium.) Due date: 11 August 2006 Contact officer details have been removed following publication of the final ruling.