1 Pursuant to section 328-125 of the Income Tax Assessment Act 1997 (ITAA 1997), was Trust Y connected with Trust N for the 20XX-XX income year for the purpose of subparagraph 152-10(1)(c)(iv) in respect of transferring your interests in the farmland (the "Land")?
1 No Question 2 Will the capital gains tax (CGT) small business relief basic conditions in subsection 152-10(1) of the ITAA 1997 be satisfied for the capital gain you will make from transferring your interests in the Land? Answer 2 Yes Question 3 Will you be eligible to disregard the capital gain you will make from transferring your interests in the Land under the CGT small business 15-year exemption in Subdivision 152-B of the ITAA 1997? Answer 3 Yes This ruling applies for the following period : Income tax year ending 30 June 20XX The scheme commenced on: DDMMYYYY
In YYYY, you began farming operations (the "Business") as a sole proprietor. A trust, Trust N, was established by Deed of Trust dated DDMMYYYY, which was amended by deed dated DDMMYYYY (together, the "Trust Deed). The Business was transferred to Trust N, and it has conducted the Business since that time. The Trustee for Trust N is Company S (the "N Trustee"). You and Individual A have been the directors of the N Trustee since the trust was established. The planned transfer of your interests in the farmland On DDMMYYYY, you acquired ownership interests in farmland (the "Land"), some jointly with Individual A: The Land has been used in the Business of Trust N since the acquisition date. In YYYY, you and Individual A began discussions with your family members, Individual B and Individual C, about the Business succession and your retirement. Your retirement plan involves transferring your interests in the Land to Individual B and Individual C. The date for the transfer has not yet been determined, but it is expected to happen by DDMMYYYY. Your retirement Since YYYY, you have been a full-time farmer, managing the farming operations.
In MMMYYYY, you handed over management of the farming operations to Individual B & Individual C and reduced the amount of time you were spending on the farm. You estimate that you now spend around two out of every five weeks on farm. You have reduced your physical work on the farm. Your work on the farm is dictated by the farm's needs and busy periods. Whilst you no longer manage the cattle trading, you are still involved in the cattle trading decisions to a small degree and you also undertake maintenance jobs on the Land like fencing, weed and pest control, and carry out repairs on plant and machinery. After transferring the Land, the N Trustee intends to cease carrying on the Business and to wind up the trust, and you and Individual A will permanently retire. Trust Y A new trust, Trust Y, was established on DDMMYYYY to undertake farming operations. The Trustee for Trust Y is Company T (the "Y Trustee"). Since establishment, the directors and equal shareholders of the Y Trustee and named beneficiaries of Trust Y have been Individual B and Individual C.
In MMMYYYY, Trust Y began purchasing and trading cattle and using the Land. Trust N also continued using the Land for the cattle it still holds. This arrangement will continue until Trust N has fully ceased trading. The Y Trustee made distributions of income of Trust Y for the 20XX-XX income years of at least 40% to Company U and Individual D. For the 20XX-XX income year, no beneficiary received distributions of at least 40% of Trust Y's income. In the 20XX-XX income year, Trust Y had no distributable income. Company U was incorporated on DDMMMYYYY and, since that time, has been wholly owned by the Y Trustee as trustee for Trust Y. Other facts relevant to the small business concessions You will not satisfy the maximum net asset value test in section 152-115 of the Income Tax Assessment Act 1997 (ITAA 1997) just before the CGT event. There were no individuals or companies that carried on business in the 20XX-XX income year that were influenced by the N Trustee (in that capacity), or acted in concert with Trust N, in that year.
There were no individuals or companies that carried on business in the 20XX-XX income year that were influenced by the Y Trustee (in that capacity), or acted in concert with Trust Y, in that year. You did not control any other entities in a way described in section 328-125 of the ITAA 1997 that carried on businesses in the 20XX-XX income year. Individual A did not control any other entities in a way described in section 328-125 of the ITAA 1997 that carried on businesses in the 20XX-XX income year. You will be over 55 years of age when the Land is transferred.
Income Tax Assessment Act 1997 Division 152 subsection 152-10(1) paragraph 152-10(1)(a) paragraph 152-10(1)(b) paragraph 152-10(1)(c) subparagraph 152-10(1)(c)(i) subparagraph 152-10(1)(c)(ii) subparagraph 152-10(1)(c)(iii) subparagraph 152-10(1)(c)(iv) paragraph 152-10(1)(d) section 152-15 section 152-35 subsection 152-35(1) paragraph 152-35(1)(b) subsection 152-35(2) subsection 152-40(1) section 152-55 section 152-65 subsection 152-70(1) subsection 152-70(4), subsection 152-70(5) and subsection 152-70(6) Subdivision 152-B section 152-105 paragraph 152-105(a) paragraph 152-105(b) paragraph 152-105(c) paragraph 152-105(d) subsection 328-110(1) section 328-115 subsection 328-115(3) section 328-120 section 328-125 subsection 328-125(1) paragraph 328-125(1)(b) subsection 328-125(2) subsection
In the following reasons for decision, all legislative references are to the Income Tax Assessment Act 1997 unless otherwise specified. Question 1 Detailed reasoning Whether Trust Y is connected with Trust N - How this is relevant to you. One of the basic conditions to be satisfied for you to be eligible to use the CGT small business concessions is that one of the subparagraphs in paragraph 152-10(1)(c) applies in your circumstances. Subparagraph 152-10(1)(c)(iv) is relevant in your circumstances as the Land was used by Trust N in its business (the "Business") and you will not satisfy the maximum net asset value test just before you transfer the Land. Together with paragraph 152-10(1A)(a), subparagraph 152-10(1)(c)(iv) requires that Trust N is a CGT small business entity for the income year in which you transfer the Land - as proposed, the 20XX-XX income year. Trust N will be a "CGT small business entity" for the 20XX-XX income year under subparagraph 328-110(1)(b)(i) as modified by subsection 152-10(1AA) (the "modified previous year test"), if: • it carries on the Business in the 20XX-XX income year; and
• also carried on a business in the 20XX-XX income year; and • its aggregated turnover for the 20XX-XX income year was less than $2 million. The "aggregated turnover" of Trust N for an income year includes, among other things, the annual turnovers for the income year of any entity that is connected with Trust N at any time during the relevant income year (paragraph 328-115(2)(b)). For the purpose of calculating the aggregated turnover of Trust N, the current question focuses on whether Trust Y was connected with Trust N during the 20XX-XX income year. Was Trust Y connected with Trust N at any time during the 20XX-XX income year? An entity is "connected with" another entity if: (a) either entity controls the other entity in a way described in section 328-125; or (b) both entities are controlled by the same third entity in a way described in section 328-125 (subsection 328-125(1)). Subsection 328-125(2) describes direct control of an entity that is not a discretionary trust for the purpose of the small business concessions, as follows: An entity (the first entity
) controls another entity if the first entity, its *affiliates, or the first entity together with its affiliates: (a) except if the other entity is a discretionary trust - own, or have the right to acquire the ownership of, interests in the other entity that carry between them the right to receive a percentage ... that is at least 40% of: (i) any distribution of income by the other entity; or (ii) if the other entity is a partnership - the net income of the partnership; or (iii) any distribution of capital by the other entity; or (b) if the other entity is a company - own, or have the right to acquire the ownership of, *equity interests in the company that carry between them the right to exercise, or control the exercise of, a percentage ... that is at least 40% of the voting power in the company. Subsections 328-125(3) and (4) describe the two ways you can determine direct control for an entity that is a discretionary trust, as follows: 328-125(3) An entity (the first entity
) controls a discretionary trust if a trustee of the trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the first entity, its *affiliates, or the first entity together with its affiliates. 328-125(4) An entity (the first entity ) controls a discretionary trust for an income year if, for any of the 4 income years before that year: (a) the trustee of the trust paid to, or applied for the benefit of: (i) the first entity; or (ii) any of the first entity's *affiliates; or (iii) the first entity and any of its affiliates; any of the income or capital of the trust; and (b) the percentage (the control percentage ) of the income or capital paid or applied is at least 40 % of the total amount of income or capital paid or applied by the trustee for that year. Subsection 328-125(7) describes indirect control of an entity, as follows: This section applies to an entity (the first entity ) that directly controls another entity (the second entity
) as if the first entity also controlled any other entity that is directly, or indirectly by any other application or applications of this section, controlled by the second entity. For example, Entity A indirectly controls Entity C if: • Entity A controls Entity B, and • Entity B controls Entity C. An individual or a company is your "affiliate" if the individual or company acts, or could reasonably be expected to act, in accordance with your directions or wishes, or in concert with you, in relation to the individual or company business affairs (subsection 328-130(1)). Only an individual or company can be an affiliate, and the individual or company must be carrying on a business. Further, the example in section 328-130 establishes that directors of the same company would not be affiliates of each other merely because they act, or could reasonably be expected to act, in accordance with the other directors' directions or wishes, or in concert, in relation to the affairs of the company. Who controlled Trust N for the 20XX-XX income year?
As each of you and Individual A held X% of the vested interests in Trust N, with those interests carrying rights to receive at least 40% of any income or capital distribution, you and Individual A each directly controlled Trust N pursuant to subsection 328-125(2) and Trust Y did not control Trust N. Did you, Individual A or Trust N control Trust Y for the 20XX-XX income year? As you and Individual A controlled Trust N and Trust N was not controlled by Trust Y, Trust Y will be connected with Trust N if: • Trust N controlled Trust Y, or • You or Individual A controlled both Trust N and Trust Y (ie. the same third entity). As Trust Y is a discretionary trust, subsection 328-125(3) and (4) are relevant. Applying subsection 328-125(3), Trust Y has a corporate trustee (the "Y Trustee") and, since incorporation, the directors of the Y Trustee have been Individual B and Individual C. During the 20XX-XX income year, the Y Trustee did not act in accordance with the directions or wishes of you, Individual A or the N Trustee.
Applying subsection 328-125(4), the relevant years are the four years before the 20XX-XX income year. However, given the date Trust Y was established, this only includes to the 20XX-XX and 20XX-XX income years. In the relevant years, the Y Trustee did not distribute any trust income to you, Individual A or Trust N. Further, as none of the beneficiaries that received distributions of the Trust Y's income carried on business, none of the beneficiaries were affiliates of you, Individual A or Trust N. As such, Trust Y was not directly controlled by you, Individual A or Trust N at any time during the 20XX-XX income year under either subsection 328-125(3) or (4).
Considering the application of subsection 328-125(7), Company U received X% of the income of Trust Y in the 20XX-XX income year, so it directly controlled Trust Y during that year pursuant to subsection 328-125(4). During that year, Company U was controlled by the Y Trustee as trustee for Trust Y pursuant to subsection 328-125(2). Neither the Y Trustee nor Trust Y were directly controlled by you, Individual A or Trust N at any time during the 20XX-XX income year under either subsection 328-125(2), (3) or (4). Therefore, neither Company U nor Trust Y were indirectly controlled by you, Individual A or Trust N. Conclusion During the 20XX-XX income year, applying section 328-125, it is considered that: • Only you and Individual A controlled Trust N • Neither you nor Individual A controlled Trust Y • Trust N did not control Trust Y, and • Trust Y did not control Trust N. Question 2 Detailed reasoning A capital gain you make may be reduced or disregarded under the CGT small business concessions in Division 152 (about CGT small business relief) if the following basic conditions are satisfied for the gain:
(a) a CGT event happens in relation to a CGT asset of yours in an income year (b) the event would (apart from this Division) have resulted in the gain (c) at least one of the following applies: (i) you are a CGT small business entity for the income year; (ii) you satisfy the maximum net asset value test in subsection 152-15; (iii) you are a partner in a partnership that is a CGT small business entity for the income year and the CGT asset is an interest in an asset of the partnership; or (iv) the conditions mentioned in subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year, and (d) the CGT asset satisfies the active asset test in subsection 152-35. Paragraph 152-10(1)(a) - will a CGT event happen in relation to a CGT asset of yours? CGT event A1 happens if you dispose of a CGT asset (subsection 104-10(1)). You "dispose of" a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law (subsection 104-10(2)). The time of the event is: (a) when you enter into the contract for the disposal; or
(b) if there is no contract - when the change of ownership occurs (subsection 104-10(3)). You will cease to own your interests in the Land when you transfer them to Individual B and Individual C. This will constitute a disposal for the purpose of section 104-10. CGT event A1 will happen when the contracts for the transfer are signed. This will satisfy the condition in paragraph 152-10(1)(a). Paragraph 152-10(1)(b) - will the CGT event result in a gain (apart from Division 152)? You make a capital gain from CGT event A1 if the capital proceeds from the disposal are more than the asset's cost base (subsection 104-10(4)). In relation to capital proceeds, the market value substitution rule in section 116-30 provides that: • if you don't receive any capital proceeds from the disposal, you are taken to have received the market value (at the time of the disposal) of the CGT asset (subsection 116-30(1)); and
• if you received capital proceeds that are more or less than the market value of the CGT asset, and you and the purchaser are not dealing with each other at arm's length, the capital proceeds are replaced with the market value of the CGT asset (subsection 116-30(2)). For the purpose of this ruling, it is accepted that you will make a capital gain from the disposal and the condition in paragraph 152-10(1)(b) will be satisfied. Paragraph 152-10(1)(d) - Will your interest in the Land satisfy the active asset test? A CGT asset satisfies the active asset test in subsection 152-35(1), if: (a) you 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 owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7½ years during the period specified in subsection (2). Relevantly, subsection 152-35(2) provides that the period begins when you acquired the asset; and ends at the time of the CGT event.
A CGT asset is an active asset at a time if, at that time, you own the asset (whether the asset is tangible or intangible) and it is used, or held ready for use, in the course of carrying on a business that is carried on (whether alone or in partnership) by: (i) you; or (ii) your affiliate; or (iii) another entity that is connected with you (subsection 152-40(1)(a)). Your interests in the Land have been used in the Business of Trust N since you acquired them, prior to MMMYYYY. As such, provided Trust N was connected with you for at least 7½ years since MMMYYYY, your interests in the Land will satisfy the active asset test. Was Trust N connected with you for at least 7½ years since MMMYYYY? Pursuant to subsection 328-125(1), Trust N will be "connected with" you if it was controlled by you at the relevant times. Direct and indirect control of different types of entities was explained in question 1, above, and applies equally for this purpose. From MMMYYYY until DDMMYYYY, you controlled Trust N pursuant to subsection 328-125(2) as you held vested interests in Trust N entitling you to at least 40% of the income and capital distributions of Trust N.
As you controlled Trust N since MMMYYYY: • Trust N was connected with you since that time, and • Your interests in the Land satisfy the active asset test pursuant to paragraph 152-35(1)(b). The condition in paragraph 152-10(1)(d) is satisfied for the capital gain you will make from transferring your interests in the Land in the 20XX-XX income year. Paragraph 152-10(1)(c) - one of the subparagraphs is satisfied for the gain Subparagraph 152-10(c)(iv) is relevant in your circumstances as you have determined that you will not satisfy the maximum net asset value test for the 20XX-XX income year; and you will not be carrying on a business (either as a sole proprietor or as a partner in a partnership) in the year. This subparagraph requires that the conditions in either subsection (1A) or (1B) are satisfied in relation to the CGT asset in the income year. Subsection (1A) is relevant in your circumstances. Subsection 152-10(1A) - Passively held assets used by affiliates or entities connected with you 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 *CGT 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 CGT 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. To clarify, paragraph 152-10(1A)(d) means that the entity that uses the CGT asset in its business for the purpose of the active asset test must be the same entity referred to in paragraph (a), that is: • your affiliate or is connected with you in the income year; and • is a CGT small business entity for the income year. As you will not be carrying on a business in the 20XX-XX income year, subparagraph 152-10(1A)(b) will be satisfied and subparagraph (1A)(c) will not apply.
As discussed above, Trust N used the Land in its Business for the purpose of the active asset test. Pursuant to the modified previous year test, as Trust N carried on the Business in both the 20XX-XX and 20XX-XX income years, provided its aggregated turnover for the 20XX-XX income year is less than $2 million, it will be a CGT small business entity for the 20XX-XX income year. Section 328-115 provides that an entity's "aggregated turnover" for an income year is the sum of: (a) your annual turnover for the income year; and (b) the annual turnover for the income year of any entity that is connected with you at any time during the income year; and (c) the annual turnover for the income year of any entity that is your affiliate at any time during the income year; excluding any amounts covered by subsection 328-115(3). An entity's "annual turnover" for an income year is the total ordinary income that the entity derives in the income year in the ordinary course of carrying on a business (section 328-120). In relation to the 20XX-XX income year: • the annual turnover of Trust N was $X;
• Trust N had no affiliates during the year as there were no other individuals or companies that carried on business that were influenced by the N Trustee, or that acted in concert with Trust N; and • there were no entities that carried on business that were connected with Trust N during the year. As such, the aggregated turnover of Trust N for the 20XX-XX income year was $X and, pursuant to the modified previous year test, Trust N will be a CGT small business entity for the 20XX-XX income year. The conditions in subsection 152-10(1A) will be satisfied in relation to the Land, so subparagraph 152-10(1)(iv) will apply and the basic condition in paragraph 152-10(1)(c) will be satisfied. Conclusion - Basic conditions The basic conditions in subsection 152-10(1) will be satisfied for the gain you will make from transferring your interests in the Land in the 20XX-XX income year. Question 3 Detailed reasoning Section 152-105 states an individual can disregard any capital gain arising from a CGT event if all of the following conditions are satisfied: (a) the basic conditions in Subdivision 152-A are satisfied for the gain;
(b) the entity continuously owned the CGT asset for the 15-year period ending just before the CGT event; (c) if the CGT asset is a share in a company or an interest in a trust ... (d) either: (i) you are 55 or over at that time of the CGT event and the event happened in connection with your retirement; or (ii) you are permanently incapacitated at the time of the CGT event. Paragraph 152-105(a) - the basic conditions As discussed in question 2, above, the basic conditions in Subdivision 152-A will be satisfied for the capital gain you will make from transferring your interests in the Land so paragraph 152-105(a) will be satisfied. Paragraph 152-105(b) - continuous ownership of your interests in the Land for 15-years Your interests in the Land were each acquired before MMMYYYY. As such, they have been continuously owned by you for the 15-year period that will end just before the CGT event and paragraph 152-105(b) is satisfied. Paragraph 152-105(c) - regarding shares in a company or interests in a trust
The CGT assets you are transferring are not shares in a company or interests in a trust, so paragraph 152-105(c) is not relevant in your circumstances. Paragraph 152-105(d) - 55 and in connection with retirement or permanent incapacity You will be over 55 at the time of the CGT event. As such, if transferring your interests in the Land is in connection with your retirement the condition in paragraph 152-105(d) will be satisfied. In connection with an individual's retirement Our website, ato.gov.au, provides the following guidance about whether an event happens in connection with an individual's retirement (see 'Small business 15-year exemption', use quick search code QC44192). The website explains: Whether a CGT event happens in connection with an individual's retirement depends on the circumstances of each case. There would need to be at least a significant reduction in the number of hours the individual works or a significant change in the nature of their present activities to be regarded as a retirement. However, it is not necessary for there to be a permanent and everlasting retirement from the workforce.
A CGT event may be in connection with retirement even if it occurs at some time before or after an individual's retirement. On the facts, it is considered that transferring your interests in the Land will be in connection with your retirement and that the condition in paragraph 152-105(d) will be satisfied. Conclusion - entitlement to the small business 15-year exemption As the conditions in section 152-105 will be satisfied in relation to transferring your interests in the Land in the 20XX-XX income year, you can disregard the capital gain that will arise from the transfer.