Taxation Determination

TD 2007/14

Income tax: capital gains: small business concessions: what 'liabilities' are included in the calculation of the 'net value of the CGT assets' of an entity in the context of subsection 152-20(1) of the Income Tax Assessment Act 1997?

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Ruling

1. The term 'liabilities' in the context of subsection 152-20(1) of the Income Tax Assessment Act 1997^[1] has its ordinary meaning. 'Liabilities' extend to legally enforceable debts due for payment and to presently existing obligations to pay either a sum certain or ascertainable sums. It does not extend to contingent liabilities, future obligations or expectancies.

Example 1

2. Cool Tool Pty Ltd is selling its business. The assets and liabilities of the company are as follows:

3. The net value of the CGT assets of the company is calculated as follows:

4. The following items are not taken into account in working out the net value of the CGT assets of Cool Tool Pty Ltd because they are contingent liabilities, future obligations or expectancies:

•

provision for possible damages payout;

•

unbilled expenses (business consultant); and

•

provision for rebates.

(Note: Although the provision for leave of employees is not a liability, it is separately taken into account under paragraph 152-20(1)(b) to determine the net value of CGT assets.)

Example 2

5. Pretty in Pink Pty Ltd is selling its clothing business. The assets and liabilities of the company are as follows:

6. The fixtures and fittings may be depreciating assets and the gains from them may be treated as income rather than capital gains but they are still CGT assets. Hence, they are included in the calculation of the net value of CGT assets of Pretty in Pink Pty Ltd.

7. The bank overdraft is taken into account in working out the net value of the CGT assets of Pretty in Pink Pty Ltd because it is a general liability that relates to all the assets of the company.

Example 3

8. Cassandra operates a dancing school. Five years ago, Fancy Foot Pty Ltd, which is wholly owned by Cassandra, bought a dancing studio where she conducts the dancing school. Fancy Foot Pty Ltd has no other CGT assets. The studio has a current market value of $5 million with $0.5 million of the loan used to purchase the studio still outstanding.

9. Last year, Wanadance Pty Ltd, also wholly owned by Cassandra, bought a warehouse to store dancing costumes and stage materials. Wanadance Pty Ltd has no other CGT assets. The market value of the warehouse subsequently fell, and is now $2 million. $2.8 million of the loan to purchase the warehouse is still outstanding.

10. Cassandra has accepted a leading role in a Broadway show overseas. A contract has been entered into to sell both the studio and the warehouse.

11. Both Fancy Foot Pty Ltd and Wanadance Pty Ltd are connected with Cassandra for the purposes of small business concessions. Cassandra has no small business CGT affiliates. She has other CGT assets, which have a net value of $1 million.

12. The net value of Cassandra's CGT assets is calculated as follows:

13. Cassandra qualifies for the small business CGT concessions because she satisfies the $5 million maximum net asset value test. Note that the $0.8 million excess liability in respect of Wanadance Pty Ltd's CGT asset (the warehouse) can be offset against the value of Cassandra's assets or Fancy Foot Pty Ltd's CGT asset (the studio).

Date of effect

14. This Determination applies to years commencing both before and after its date of issue. However, it does not apply to taxpayers to the extent that it conflicts with the terms of a settlement of a dispute agreed to before the date of the determination (see paragraphs 75 and 76 of Taxation Ruling TR 2006/10).

Commissioner of Taxation
9 May 2007

Appendix 1 - Explanation

Explanation

15. One of the basic conditions that must be satisfied to qualify for the small business CGT concessions is the maximum net asset value test in section 152-15. Under this test, the net value of the CGT assets of the taxpayer and certain related entities must not exceed $5 million just before the relevant CGT event.

16. The 'net value of the CGT assets' of an entity is the amount (whether positive, negative or nil) obtained by subtracting from the sum of the market values of those assets the sum of:

•

the liabilities of the entity that are related to the assets; and

•

the following provisions made by the entity:

-

provisions for annual leave

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provisions for long service leave

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provisions for unearned income, and

-

provisions for tax liabilities (subsection 152-20(1)).

17. The term 'liabilities' is not defined for the purposes of the 'net value of the CGT assets' definition. Accordingly, it has its ordinary meaning reflecting the context in which it is used. The Macquarie Dictionary, revised 3rd edition, defines liability to mean: 'an obligation, especially for payment; debt or pecuniary obligation'.

18. In the context of subsection 152-20(1), 'liabilities' extend to legally enforceable debts due for payment and to presently existing obligations to pay either a sum certain or ascertainable sums. The term does not extend to contingent liabilities, future obligations or expectancies.

19. A 'contingent liability' is a liability which will become due only on the occurrence of an event that may or may not happen. An example is a possible obligation to pay damages in future if the judgment in a pending lawsuit is unfavourable.

20. Examples of amounts that are not included in 'liabilities' for the purposes of determining the 'net value of the CGT assets' of an entity include:

•

provisions for possible obligation to pay damages in a pending lawsuit;

•

provisions for liabilities in respect of an earn-out contract;

•

provisions for guarantee of a loan;

•

provisions for long service and annual leave entitlements;

•

provisions for income and other taxes prior to the liability arising;

•

accounting liabilities arising as a result of receiving prepaid income;

•

expenses that are not yet due; and

•

provisions in general for such things as quantity rebates and the like.

(Note: provisions for annual leave, provisions for long service leave, provisions for unearned income and provisions for tax liabilities are not within the meaning of the term 'liabilities' but are separately taken into account in determining the net value of the CGT assets of an entity.)

Liabilities that are related to the assets

21. The 'liabilities of the entity that are related to the assets' in subsection 152-20(1) include liabilities directly related to particular assets that are themselves included in the calculation, for example, a loan to finance the purchase of business premises.

22. The 'liabilities of the entity that are related to the assets' also include liabilities that, although not directly related to one particular asset, are related to the assets of the entity more generally, for example, a bank overdraft or other short term financing facility that provides working capital for the operation of the business.

23. [Omitted.]

Note

24. 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 Taxation Determination is part of the Commissioner's response to Recommendation 6.1 of the Board's report.

25. The Board's report also contains a number of legislative recommendations. Taxation Laws Amendment (2006 Measures No. 7) Act 2007, which received Royal Assent on 12 April 2007, gives effect to the Board's legislative recommendations accepted by Government. The changes apply to CGT events happening in the 2006-07 income year or later income years. There are two changes relevant to this Determination:

•

amended subsection 152-20(1) allows the possibility of a negative net value of the CGT assets of any entity to be calculated; and

•

new paragraph 152-20(1)(b) allows provisions for annual leave, provisions for long service leave, provisions for unearned income and provisions for tax liabilities to be taken into account in determining the net value of the CGT assets of an entity but does not affect the meaning of the term 'liabilities' as discussed in this Determination.

Appendix 2 - Alternative views

Alternative view: accounting meaning of 'liabilities'

26. An alternative view is that in the context of subsection 152-20(1), 'liabilities' has its accounting meaning.

27. The Commissioner considers the term 'liabilities' should not have its accounting meaning in the context of subsection 152-20(1) as, unlike the thin capitalisation provisions in Division 820, for example, where the term has its accounting meaning (see Taxation Ruling TR 2002/20), there are insufficient contextual factors for that interpretation.

Previously released in draft form as TD 2006/D27

References

ATO references:
NO 2006/8992

Related Rulings/Determinations:

TR 2002/20
TR 2006/10

Subject References:
basic conditions for relief
capital gains tax
CGT assets
CGT events
CGT small business relief
contingent liabilities
maximum net asset value test

Legislative References:
ITAA 1997 152-15
ITAA 1997 152-20(1)
ITAA 1997 152-20(1)(b)
ITAA 1997 Div 820
TAA 1953
Taxation Laws Amendment (2006 Measures No. 7) Act 2007

Other References:
The Macquarie Dictionary, 2001, rev. 3rd edn, The Macquarie Library Pty Ltd, NSW
Treasurer's Press Release No. 38 of 2006