One of the key basic conditions to access the small business CGT (SBCGT) concessions is that the relevant CGT asset subject to the particular CGT event (generally CGT event A1 on disposal) satisfies the active asset test.
What is the active asset test?
The active asset test requires that the relevant CGT asset was an active asset for:
- where it was held for up to 15 years – at least half the relevant period (generally, between acquisition and disposal); and
- where it was held for more than 15 years – at least 7.5 years.
What is an active asset?
A CGT asset is an active asset if:
- you own the asset, and it is used, or held ready for use, in carrying on business that carried on by:
- a connected entity (Connected Entity); or
- an affiliate (Affiliate); or
- if the asset is an intangible asset – you own it, and it is inherently connected with a business that is carried on (whether alone or in partnership) by:
- a Connected Entity; or
- an Affiliate.
The most common example of an intangible asset that is an active asset is goodwill.
Exceptions to active asset treatment
Notwithstanding the general definition of an active asset above, an asset whose main use is to derive interest, an annuity, rent, royalties or foreign exchange gains unless:
- the asset is an intangible asset and has been substantially developed, altered, or improved by you so that its market value has been substantially enhanced; or
- its main use for deriving rent was only temporary.
What constitutes main use is a question of fact and requires a comparison as between:
- the respective areas of use; and/or
- the respective level of income generated by the various activities (see Taxation Determination TD 2006/78).
Exception to the exception to active asset treatment
Notwithstanding the exception for assets whose main use is to derive rent, the ATO accepts that a CGT asset (i.e., real property) leased by a taxpayer to a Connected Entity for use in the Connected Entity’s business is an active asset (see Taxation Determination TD 2006/63).
For more information in this regard, see our article here.
Special rules for shares in a company or interests in a trust (including units)
Where the relevant CGT assets subject to the CGT event (e.g., CGT event A1 on disposal) are shares in a company or interests (including units) in a trust, special rules apply.
It is important to note that the relevant company or trust must be an Australian resident, that is:
- for companies – either:
- it is incorporated in Australia; or
- not being incorporated in Australia, both:
- carries on business in Australia; and
- has its central management and control (CMC) in Australia; or
- has its voting power controlled by Australian resident shareholders; and
- for trusts:
- other than unit trusts – either:
- any trustee is an Australian resident; or
- the CMC of the trust is in Australia; and
- for unit trusts – one of the requirements of Column 1 and one of the requirements in Column 2 of the table below are met:
|Column 1||Column 2|
|Any property of the trust is in Australia||The central management and control of the trust is in Australia|
|The trust carries on a business in Australia||Australian residents hold more than 50% of the beneficial interests in the income or property of the trust|
The general active asset test in relation to shares or interests in trusts requires that the total of the market values of the company or trust’s active assets, together with the market value of:
- financial instruments; and
inherently connected with the business must be 80% or more of the market value of all of its assets.
However, following recent legislative amendments aimed at preventing unintended access to the SBCGT regime, the general active asset test must be applied based on various complex assumptions in order to satisfy the basic conditions for SBCGT relief in this regard.
Eichmann – context at ten paces
In the recent case of Eichmann, the Full Court of the Federal Court (FFC) settled a matter centred on the scope and meaning of an active asset and, specifically, the phrase “in the course of carrying on a business” in paragraph 152-40(1)(a) of the Income Tax Assessment Act 1997 (ITAA 1997).
The history of the matter was such that:
- the taxpayer owned land adjacent to his main residence (Property);
- the taxpayer’s family trust (Trust) carried on a building, bricklaying, and paving business (Business);
- the Trust used the Property to store vehicles, tools, equipment, and materials and occasionally some preparatory work was also undertaken (although it did not formally lease the premises or pay rent);
- the taxpayer sought a Private Binding Ruling as to the availability of the SBCGT concessions on disposal of the Property (PBR);
- the Commissioner ruled that the SBCGT concessions were not available;
- the taxpayer sought review of the Commissioner’s decision under the PBR in the Administrative Appeals Tribunal (AAT);
- the AAT found that the PBR was incorrect (i.e., the taxpayer won);
- the Commissioner appealed the AAT decision to the Federal Court (FC);
- the FC upheld the appeal (i.e., the Commissioner won); and
- the taxpayer appealed the FC decision to the FFC.
As outlined above, at the centre of each battle was the scope and meaning of the phrase, “in the course of carrying on a business” in determining whether an asset was an active asset for SBCGT purposes and:
- the Commissioner took a strict, contextual approach to narrow the scope to assets used in core business activities only; however,
- the taxpayer sought a more purposive interpretation in seeking to expand the scope to assets used in the course of carrying on the Business more broadly.
That is, the Commissioner took a strict, contextual approach in seeking to deny the availability of SBCGT relief in relation to what was effectively a storage yard for the safe storage of plant, equipment, and materials used in the day-to-day operations of the Business.
The FFC highlighted that in the decision below (i.e., the FC decision), a distinction was drawn between the statutory use of the word “in” rather than the apparently broader phrase, “in relation to”.
The active asset test refers to the use of the asset “in” the course of carrying on a business and the Commissioner argued, citing case law in relation to different legislation in a different legislative context, that the use of the word, “in” rather than the broader phrase, “in relation to” justified a narrower construction.
The FC agreed with the Commissioner in this regard and held that the Property did not have ‘direct functional relevance’ to the carrying on of the normal day-to-day activities of the Business and, therefore, was not an active asset.
This would have resulted in some very strange outcomes, for example, if the Trust had paid the taxpayer rent for the lease of the Property, in our view there would be no doubt that such expenditure would have been tax-deductible to the Trust, notwithstanding that the positive limbs of section 8-1 of the ITAA 1997 refer to a loss or outgoing either:
- incurred “in” gaining or producing assessable income; or
- necessarily incurred “in” carrying on a business for the purpose of gaining or producing assessable income,
as opposed to the apparently broader phrase, “in relation to”.
On appeal, the FFC held:
- the SBCGT regime is beneficial in nature based on:
- the Explanatory Memorandum to the Bill which, when passed, introduced the legislation; and
- the legislative Guide to the relevant provisions;
- Based on the above, the SBCGT regime must be construed beneficially rather than restrictively;
- in construing paragraph 152-40(1)(a) of the ITAA 1997, three things are required:
- determine the use of a particular asset;
- determine the course of the carrying on of a business; and
- determine whether the asset was used in the course of carrying on that business,
with no narrow approach to be adopted in considering these issues;
- it is sufficient if the asset is used at some point in the course of the carrying on of an identified business, rejecting both:
- concepts such as the asset having to be used in the:
- ordinary course of a business; or
- day-to-day course of a business; and
- restrictive requirements such as the asset needing a direct or integral connection to the carrying on of a business;
- The Commissioner’s contextual interpretation as to the meaning of the word, “in” within the phrase, “in the course of carrying on a business” for the purposes of the active asset test relies on authorities dealing with different legislation in a different legislative context to that at hand; and
- Even if the FFC were to adopt the primary judges ‘direct functional relevance’ test (which the FFC rejected), the FFC’s view is such that the use of the Property clearly met that narrower test as it was used as a ‘secure and necessary place for the storage of plant and equipment of the business’, which bore a direct relationship to the activities of building, bricklaying, and paving.
Whether or not an asset is an active asset for SBCGT purposes is generally straightforward, however, it is important to turn your mind to the appropriate test and apply the law to the particular facts in each instance.
Eichmann confirmed that no narrow approach should be adopted in applying the active asset test.
For more information on the SBCGT concessions, please see our Explainer video here.
If you would like to discuss this issue, or any other eligibility issues surrounding the SBCGT concessions and how you, or your clients, can benefit from them, contact Mosaic Tax Legal at email@example.com or 1300 115 841.