Contributed by Domenic Festa, Principal, Steps Law
Amendments to the small business CGT concessions (SBCC) were introduced into parliament in the Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018 (AITB: ¶114-080) on 28 March 2018. In an earlier article posted to this blog, More complexity for small business in CGT amendments, the application of the amendments was considered. In this article, current applications of SBCC that operate in a manner adverse to taxpayers and not in accordance with the policy of the legislation will be considered.
Application of SBCC adverse to taxpayers
The Bill is concerned to address a number of integrity issues, although they are not articulated in the explanatory memorandum.
There are two aspects in which the SBCC operates in a manner adverse to taxpayers — the application of the rule that excludes assets of affiliates or entities connected with affiliates, and the decision in Altnot which allows the ATO to manipulate the application of the Net Asset Value test by converting an affiliate into a controller.
Exclusion of assets of affiliates and entities connected with affiliates
The Net Asset Value test includes assets of the taxpayer, affiliates of the taxpayer, entities controlled by the taxpayer together with its affiliates, persons that control the taxpayer (controllers), and entities controlled by controllers together with their affiliates. The test is depicted in the following diagram:
It should be noted that the test includes assets of affiliates of the taxpayer, entities controlled by an affiliate of the taxpayer, and entities controlled by an affiliate of a controller.
Subsections (3) and (4) of s 152-20 of ITAA 1997 then exclude assets of affiliates and entities connected with affiliates that are not used in the business of the taxpayer or entities that are connected (but ignoring the interests of affiliates). The important point is the application of the exclusion to affiliates only applies to affiliates of the taxpayer, it does not apply to affiliates of a controller. Therefore, the assets of entities controlled by an affiliate of a controller (other controllees in the diagram above) are not eligible for the exclusion. This is an application that is against the policy of the legislation.
Decision in Altnot (2014 ATC ¶20-454)
The facts in this case were Altnot Pty Ltd sold a 50% interest in a business generating a capital gain. Mr Roberts held 50% of the shares in Altnot, the other 50% were held by an unrelated party. Taking into account the assets of Mr Roberts, Altnot satisfied the Net Asset Value test. On the other hand, Altnot would not satisfy the Net Asset Value test if the assets of a third party that was an affiliate of Mr Roberts were taken into account. Under the definitions, Mr Roberts and the third party were affiliates of each other.
The Net Asset Value test includes assets of the taxpayer, affiliates and connected entities, as described above.
The logical application of the test is for each person with an ownership interest in the taxpayer, determine whether that person together with his or her affiliates controls the taxpayer. In Altnot, Mr Roberts had an ownership interest but the third party had no ownership interest. On the logical application of the test, Mr Roberts is a controller and the third party is an affiliate of Mr Roberts.
However, the test of control is worded such that a person will control an entity if the person, the person’s affiliates, or the person together with its affiliates controls the entity. The ATO argued that the third party (that held no ownership interest) controlled the taxpayer because its affiliate (Mr Roberts) controlled the taxpayer. This was accepted upon appeal.
The effect of the decision is that where two persons are affiliates of each other, the ATO can manipulate the application of the Net Asset Value test by picking who is a controller and who is an affiliate. It is submitted that the policy of the legislation requires that in selecting who is a controller between a person and its affiliates, the person with the greatest ownership percentage is selected. Adopting this principle, in Altnot the controller is Mr Roberts (since he was the only person with an ownership percentage), and therefore the assets of the third party were not required to be taken into account.
This article identifies two areas in which the SBCC applies adverse to taxpayers and contrary to the policy behind the legislation. In the writer’s opinion, these areas require legislative change.