1 Will Company A satisfy the basic conditions under section 152-10 of Income Tax Assessment Act 1997 (ITAA 1997) for small business relief upon the disposal of the commercial property (the Property)?
Yes Question 2 If the answer to Question 1 is yes, will Company A be eligible to disregard its capital gain upon the disposal of the Property by applying the small business 15-year exemption under section 152-110 of the ITAA 1997? Answer Yes This ruling applies for the following period : 30 June 2022 The scheme commences on: 1 July 2021
Company A was established for the purpose of acquiring commercial property to rent. Individual X and Individual Y have each owned one ordinary share in the Company A since its establishment. There have been no other shareholders in Company A. Company A purchased the Property holding it for more than twenty years before selling it for a gain. The Property was used solely by Company B in carrying on its business for more than 10 years (the relevant period). Apart from a short period of time at the beginning of the relevant period, Individual X and Individual Y each held less than 40% of the ordinary shares in Company B. At all times during the relevant period, Individual X and Individual Y together held 40% or more of the ordinary shares in Company B. Individual X and Individual Y were in a spousal relationship throughout the relevant period. All Company B ordinary shares on offer during the relevant period, had equal capital, dividend and voting rights. Varying numbers of E class shares were also on offer in Company B during the relevant period. E class share did not have voting rights. At the end of the relevant period, Individual X and Individual Y sold their shares in Company B.
Subsequent to the relevant period, the Property was rented by Company A to third parties with these rental arrangements managed by external property agents. The third-party rental use of the Property by Company A continued for several years until the 2021-22 financial year. The total ordinary income of Company A together with any connected entities and affiliates for the 2020-21 financial year was less than $2 million and will be below $2 million in the 2021-22 financial year. Company A has consistently reported profits on its company tax returns predominantly derived from its rental operations. The net value of the assets of Company A for the purpose of section 152-15 of the ITAA 1997 exceeds $6 million. At the time of the sale of the Property, both Individual X and Individual Y were over 55 years of age. Prior to the sale of the Property, Individual X and Individual Y contacted a financial planner for consideration of their investment options and retirement plan. In the lead up to the sale of the Property, the tenant of the Property gave formal notice that they would not be renewing the lease on the Property.
You have stated that initial enquiries into re-leasing the Property suggested that Company A would have needed to accept a reduction in the rental income and provide significant incentives in order to secure a new tenant. This would have resulted in a return on investment of well below expectation. You have stated that given that the income from the Property was a major contributor to Individual X's and Individual Y's retirement plans, they decided to sell the Property and look for a better investment strategy. You have stated that after considering their options, Individual X and Individual Y proceeded with the following: Sell the Property. ii. Have Individual Y retire from her employment position. iii. Contribute funds from the Property sale into superannuation to fund their retirement plans. iv. Wind up Company A in order to simplify their affairs, investing in real estate and/or shares in their individual names. You have stated that Individual Y has no intention of resuming any employment.
Income Tax Assessment Act 1997 Division 152 Income Tax Assessment Act 1997 Subdivision 152-A Income Tax Assessment Act 1997 Subdivision 152-B Income Tax Assessment Act 1997 subsection 108-5(1) Income Tax Assessment Act 1997 section 104-10 Income Tax Assessment Act 1997 section 152-10 Income Tax Assessment Act 1997 subsection 152-10(1AA) Income Tax Assessment Act 1997 section 152-35 Income Tax Assessment Act 1997 section 152-47 Income Tax Assessment Act 1997 subsection 152-40(1) Income Tax Assessment Act 1997 paragraph 152-40(4)(e) Income Tax Assessment Act 1997 subsection 152-40(4A) Income Tax Assessment Act 1997 section 152-55 Income Tax Assessment Act 1997 section 152-65 Income Tax Assessment Act 1997 section 152-70 Income Tax Assessment Act 1997 section 152-110 Income Tax Assessment Act
Question 1 Summary Company A satisfies the basic conditions for small business relief set out in section 152-10 of the ITAA 1997, in respect to the sale of the Property in the 2021-22 financial year. It carried on a business, meeting the aggregated turnover requirement to be regarded as a small business. The sale of the Property, a (capital gains tax) CGT event A1, would have resulted in a gain apart from Division 152. The Property was an active asset of Company A, having been used in the business of a connected entity for more than 7 ½ years during Company A's ownership period of more than 15 years. Detailed reasoning Capital gains made by eligible small businesses can be reduced or disregarded under Division 152 of the ITAA 1997. Basic Conditions For Company A to qualify for the small business CGT concessions in relation to the sale of the Property, the basic conditions as contained in Subdivision 152-A of the ITAA 1997 must be satisfied. The applicable basic conditions under section 152-10 of the ITAA 1997 that need to be satisfied in this case are: (a) A CGT event happens in relation to a CGT asset owned by Company A in an income year.
(b) The event would have resulted in a gain (apart from Division 152). (c) Company A was a CGT small business entity for the income year. (d) The Property was a CGT asset that satisfies the active asset test in section 152-35 of the ITAA 1997. The Property satisfies the definition of a CGT asset provided in subsection 108-5(1) of the ITAA 1997. CGT event A1 happened upon the sale of the Property (section 104-10 of the ITAA 1997). This event resulted in a capital gain for Company A but for the application of Division 152. Therefore, the first two basic conditions in section 152-10 of the ITAA 1997 are satisfied. CGT small business entity With reference to section 328-110 and subsection 152-10(1AA) of the ITAA 1997, Company A was a CGT small business entity for the 2021-22 financial year if: (a) It carried on a business in the 2021-22 financial year; and (b) The aggregated turnover of it together with its connected entities and affiliates was less than $2 million in either the 2020-21 financial year or 2021-22 financial year.
The aggregated turnover being the sum of the total ordinary income derived by the relevant entities (Company A and its connected entities and associates) in the income year, not including dealings between the relevant entities (section 328-115 of the ITAA 1997). Firstly, it is necessary to consider whether the activities of Company A in renting the Property amounted to carrying on a business in the 2021-22 financial year. Business as defined by subsection 995-1(1) of the ITAA 1997, includes 'any profession, trade, employment, vocation or calling', but excludes 'occupation as an employee'. Taxation Ruling TR 2019/1 Income Tax: when does a company carry on a business (TR 2019/1), discusses when a company is considered to be carrying on a business for certain income tax provisions including section 328-110 of the ITAA 1997. Paragraph 59 of TR 2019/1 provides that where a Company is established and maintained to make a profit for its shareholders and invests its assets in gainful activities that have both a purpose and prospect of profit, it will normally be carrying on a business. Application to Company A's circumstances
Applying the principles in TR 2019/1 to Company A's circumstances leads to a conclusion that Company A was carrying on a business in the 2021-22 financial year for the following reasons: • Company A was established and maintained for the purpose of profit. Company A's operations have regularly recorded profits as provided by their company tax return. • The scale and size of the rental returns as provided by their company tax return indicate a commercial concern. • Due the statutory imposed requirements, Company A conducts its operations and activities in a methodical and business-like manner. • The ongoing operation of Company A and management of the Property have been conducted with repetition and regularity in order to generate Company A's profits. Paragraphs 66 to 70 of TR 2019/1 provides an example of a business conducted by a property investment company which is similar to the circumstances of Company A.
On an analysis of the overall impression from Company A's activities, it is reasonable to conclude that for the purpose of section 328-110 of the ITAA 1997, Company A carried on a business in the 2021-22 financial year. The application provides that the total ordinary income of the business activity of Company A, together with any connected entities and affiliates was less than $2 million for both the 2020-21 and 2021-22 financial years. Therefor the aggregated turnover requirement under section 328-115 of the ITAA 1997 is satisfied. As Company A conducted a business and satisfied the aggregated turnover requirement, it is a small business entity under section 328-110 and subsection 152-10(1AA) of the ITAA 1997 in the 2021-22 financial year satisfying the third requirement of the basic conditions. Active asset test Section 152-35 of the ITAA 1997 provides the active asset test. 152-35(1) A *CGT asset satisfies the active asset test if: (a) you have owned the asset for 15 years or less and the asset was an *active asset of yours for a total of at least half of the period specified in subsection (2); or
(b) you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7 ½ years during the period specified in subsection (2). 152-35(2) The period: (a) begins when you *acquired the asset; and (b) ends at the earlier of: (i) the *CGT event; and (ii) if the relevant business ceased to be carried on in the 12 months before that time or any longer period that the Commissioner allows - the cessation of the business. Subsection 152-40(1) of the ITAA 1997 details that a CGT asset is an active asset of an entity at a time if it is used, or held ready for use, in the course of carrying on a business that is carried on by the entity, its affiliate, or another connected entity. However, an asset whose main use to derive rent is not and active asset (paragraph 152-40(4)(e) of the ITAA 1997), unless the rent was paid by a connected entity during that entities use of the asset (subsection 152-40(4A) of the ITAA 1997). Under subsection 328-125(1) of the ITAA 1997 an entity is connected with another entity if: (a) one entity controls the other entity or
(b) both entities are controlled by the same third entity. A company is controlled by an individual owner where the individual or the individual together with their affiliates carry between them the right to exercise a control percentage that is at least 40% of the voting power in the company (paragraph 328-125(2)(b) of the ITAA 1997) Under subsection 328-130(1) of the ITAA 1997, an individual or a company is an affiliate of yours if the individual or company acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with the you, in relation to the affairs of the business of the individual or company.
However, the meaning of affiliate can be extended for a spousal relationship. For the purposes of determining whether an individual's spouse is an affiliate for the purpose of Subdivision 152-A of the ITAA 1997, section 152-47 of the ITAA can be applied. This provision deems an affiliate relationship with an individual's spouse where an asset owned by one entity is used in the course of carrying on a business by another entity, and the business entity is not otherwise an affiliate of or connected with the asset owner (subsection 152-47(1) of the ITAA 1997). Application to Company A's circumstances The Property has not been an active asset of Company A during its recent use to derive third party rent due to the exception in paragraph 152-40(4)(e) of the ITAA 1997. However, the previous use of the Property during the relevant period it was used by Company B to carry on its business, may satisfy the active asset test, if, during this time, Company A was connected to Company B. Company A and Company B were not connected under paragraph 328-125(1)(a) of the ITAA 1997, as neither company controlled the other.
However, if during the relevant period, both entities were controlled by Individual X, or Individual Y, or both individuals together as affiliates, the two companies were connected under section 328-125(1) of the ITAA 1997. Individual X and Individual Y each have owned one ordinary share in Company A since establishment. There have been no other shareholders in Company A. Therefore, under paragraph 328-125(2)(b) of the ITAA 1997, both Individual X with Individual Y controlled Company A, as they each held more than 40% of Company A's voting power. Neither Individual X nor Individual Y always held sufficient shares in Company B during the relevant period to hold 40% or more of the voting rights required under paragraph 328-125(2)(b) of the ITAA 1997. They will need to rely on an affiliate relationship for their control interest held individually to be combined for the purpose of the company control test. The affiliate test under 328-130(1) of the ITAA 1997 is not satisfied in this case, as each individual is not acting in accordance with the other's wishes with respect to the other's business carried on in their individual capacity. That is, as sole trader.
Company B is not otherwise an affiliate of, or connected with Company A, for the purpose of Subdivision 152-A of the ITAA 1997. Therefore section 152-47 of the ITAA 1997 deems Individual X and Individual Y to be affiliates for the purposes of the active asset test. Due to this deemed affiliate relationship, both Individual X (together with their affiliate spouse) and Individual Y (together with their affiliate spouse) held 40% or more of the voting rights required under paragraph 328-125(2)(b) of the ITAA 1997 to control Company B during the relevant period. As both Company B and Company A were both controlled by Individual X (together with their affiliate spouse) and Individual Y (together with their affiliate spouse), they were connected under paragraph 328-125(1) of the ITAA 1997 during the relevant period. If follows that as the Property was used by Company A's connected entity Company B, it was an active asset of Company A during the relevant period under subsection 152-40(1) of the ITAA 1997.
Company A owned the Property for a period of more than 15 years. During this time the Property was used by the connected entity (Company B) in its business for a period of more than 7 ½ years, satisfying the active asset test in section 152-35 of the ITAA 1997. Question 2 Summary The requirements to allow Company A to apply the small business 15-year exemption to the sale of the Property are satisfied. These include the basic conditions as outline in question 1 of this ruling. It owned the Property for more than 15 years and had a significant individual for at least 15 years who was at least 55 years at the time the event happened. The sale of the Property happened in connection with a significant individual's retirement. Detailed reasoning Under Subdivision 152-B of the ITAA 1997, a CGT small business entity can disregard a capital gain arising from a CGT asset that it owned for more than 15 years if certain conditions are met. Section 152-110 of the ITAA 1997 provides a small business 15-year exemption for companies and trusts. Under this section, Company A can disregard the capital gain from the disposal of a CGT asset if:
(a) it satisfies the basic conditions in Subdivision 152-A of the ITAA 1997 for the small business CGT concessions, (b) it continuously owned the CGT asset for the 15-year period ending just before the CGT event happened, (c) it had a significant individual for a total of at least 15 years (even if the 15 years was not continuous and it was not always the same significant individual) during which time Company A owned the CGT asset; and (d) an individual who was a significant individual of Company A just before the CGT event was either: (i) at least 55 years old at that time and the event happened in connection with their retirement or (ii) permanently incapacitated at that time.
An individual is a significant individual in a company or trust if they have a small business participation in the company or trust of at least 20% (section 152-55 of the ITAA 1997). The small business participation percentage can be made up of direct and indirect percentages (section 152-65 of the ITAA 1997). Relevant to this case, an individual's direct small business participation in a company under section 152-70 of the ITAA 1997 is the smallest of: • the percentage of the voting power in the company that the entity is entitled to exercise (except for jointly held shares, • the percentage of any dividend payment that the entity is entitled to receive, • the percentage of any capital distribution that the entity is entitled to receive. In this case, Company A satisfies the basic conditions and has continuously owned the property for more than 15 years at the time just before the CGT event occurred. Individual Y was a significant individual of Company A for at least 15 years as they held more than 20% of the issued ordinary shares of Company A since establishment.
Individual Y was over 55 years of age at the time of the CGT event and the sale of the property is in connection with Individual Y's retirement. As such Company A satisfies the conditions under section 152-110 of the ITAA 1997 to apply the small business 15-year exemption to the sale of the Property.