Edited version of private advice

Authorisation Number: 1052242561297

Date of advice: 30 April 2024

Ruling

Subject: CGT - small business concessions

Question

Is the property an active asset in accordance with section 152-35 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following periods:

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

You are the trustee for the discretionary trust XYZ Trust. The trustee is Company A.

Company A's shares are held in equal shares by Individual X and Individual Y, who are husband and wife. They are also the directors of the company.

On behalf of the trust, you purchased commercial property in 20XX. The property has two commercial leases which have been in place since acquisition.

One is a formal lease to an unrelated third-party entity. The lease premises includes an exclusive use area of 5% of the property. There is also a common use licenced area representing approximately half of the property which allows the lessee to use the area for their operations.

The other is an informal lease to a related entity. The lessee has an exclusive use area of about 40% of the property and is subject to the same common use licenced area.

The related entity is Company B. The sole director and shareholder of Company B is Individual X. Company B operates a business on the property, and Individual X and Individual Y are employees of the business.

You receive rent from both entities.

During the years that the property has been owned, the gross income received from the business has always been significantly more than the rental income.

You are preparing to sell the property.

Relevant legislative provisions

Income Tax Assessment Act 1997 paragraph 152-10(1A)(a)

Income Tax Assessment Act 1997 section 152-35

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 328-125

Income Tax Assessment Act 1997 subsection 328-125(2)

Income Tax Assessment Act 1997 paragraph 328-125(2)(b)

Income Tax Assessment Act 1997 subsection 328-125(5)

Income Tax Assessment Act 1997 subsection 328-125(7)

Reasons for decision

Active asset test

The active asset test is set out in section 152-35 of the ITAA 1997. Where an asset is owned for less than 15 years, the test is satisfied if the asset was an active asset for a total of at least half of the time in the test period. The test period begins when the asset was acquired and ends at the CGT event. Under subsection 152-40(1) of the ITAA 1997, a CGT asset is an active asset if it is owned and used, or held ready for use, by you, your affiliate or another entity that is connected with you in the course of carrying on a business that is carried on, whether alone or in partnership.

The basic conditions for relief will be met if the CGT asset is passively held by an entity that is connected with you under paragraph 152-10(1A)(a) of the ITAA 1997. This means that you can access the small business concessions for a CGT asset you own where you are not carrying on a business, but the CGT asset is used in the business of your affiliate or an entity that is connected with you.

'Connected with'

The meaning of 'connected with an entity' is set out in section 328-125 of the ITAA 1997. An entity is connected with another entity if either entity controls the other, or both entities are controlled by the same third entity.

Under paragraph 328-125(2)(b) of the ITAA 1997, an entity (the first entity) controls a company if the first entity owns a percentage of at least 40% of the voting power in the company.

The conditions for whether an entity has direct control of a discretionary trust are contained in subsection 328-125(3) of the ITAA 1997. An entity (the first entity) controls a discretionary trust if a trustee acts, or could be reasonably expected to act, in accordance with the directions or wishes of the first entity.

The conditions for indirect control of an entity are under subsection 328-125(7) of the ITAA 1997. If an entity (the first entity) directly controls a second entity, and the second entity controls (whether directly or indirectly) a third entity, the first entity is also taken to control the third entity.

Main use

Paragraph 152-40(4)(e) of the ITAA 1997 provides that where the main use of an asset is to derive rent, it cannot be an active asset. Subsection 152-40(4A) of the ITAA 1997 provides other factors to account for when determining the main use of an asset. Any personal use or enjoyment of the asset is disregarded, and any use by your affiliate or an entity that is connected with you is treated as your use of the asset.

Factors to consider when determining the main use of an asset are set out in Taxation Determination TD 2006/78 Income tax: capital gains: are there any circumstances in which the premises used in a business of providing accommodation for reward may satisfy the active asset test in section 152-35 of the Income Tax Assessment Act 1997 notwithstanding the exclusion in paragraph 152-40(4)(e) of the Income Tax Assessment Act 1997 for assets whose main use is to derive rent? In example 5, for property that is mixed-use, consideration is given to:

1. the proportion by area of the land used for business purposes
2. the proportion of business income in comparison to the rent income

Application to your circumstance

Active asset test

You acquired the property in 20XX. The business has been operated during the entire period of ownership. The property will meet the active asset test as long as it has been an active asset for at least half of the time in the test period. The end of the test period will be when the property is disposed of.

'Connected with'

An entity is connected with another entity if both entities are controlled by the same third entity. This means that XYZ Trust, through trustee Company A will be connected with Company B if they are both controlled by the same entity.

Individual X is connected with Company B as they own a 100% percentage of the voting power in the company being sole director and shareholder. As this is more than the control percentage of 40%, Individual X is considered to be connected with Company B for the purposes of paragraph 328-125(2)(b) of the ITAA 1997.

Individual X is also connected with Company A under paragraph 328-125(2)(b) of the ITAA 1997 as they own a 50% percentage of the voting power in the company. As Company A is trustee for XYZ Trust, Individual X therefore has direct control the discretionary trust in accordance with subsection 328-125(3) of the ITAA 1997. This is because it can be reasonably expected that the trustee would act in accordance with Individual X's directions and wishes. Indirect control can also be established under subsection 328-125(7) of the ITAA 1997, as Individual X controls Company A, and Company A also controls XYZ Trust as the trustee of the discretionary trust.

Individual X controls both Company B and Company A and is directly connected with XYZ Trust. In applying subsection 328-125(2) of the ITAA 1997, XYZ Trust and Company B are therefore connected as they are both controlled by the same entity, being Individual X.

The property owned by XYZ Trust is used in the course of carrying on a business that is carried on by another entity that is connected with you, being Company B. The meaning of active asset under subparagraph 152-40(1)(a)(iii) is therefore met.

Main use

The property will be excluded from being an active asset if the main use is to derive rent. The business use of the land by Company B is taken to be your use of the land, as the company operating the business is connected with you. If the business use of the land by area or business income is a majority, then the main use of the land is not to derive rent.

Looking at the exclusive use areas only, majority of the land by area is exclusively used by the business. The income from the business has also been significantly more than the income derived from the leases. The property is therefore not excluded from being an active asset as the main use is not to derive rent.

We consider the property owned by you to be an active asset as it meets the active asset test and was used by the company entity connected with you in the course of carrying on a business.

For the purposes of this ruling, it is assumed that the facts of your situation as outlined above will not materially change during the ruling period and will continue until the date of settlement of the property.

The Commissioner has not considered your eligibility for the small business concessions in this ruling. You must satisfy the relevant requirements and conditions to claim the small business concessions.

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