CGT Event J2-J5-J6

Given the relevance of the small business roll-over concession to CGT events J2, J5 and J6, it is worth exploring some of the basic features of the concession.

The roll-over concession is one of four forms of tax relief available under the CGT small business concessions contained in Division 152 of the Income Tax Assessment Act 1997 (the ITAA).

The small business roll-over concession provisions are principally contained in Subdivision 152-E of the ITAA.

Key features of the concession which can be observed when reading through Division 152 (generally) and Subdivision 152-E include the following:

• To be eligible for the concession the taxpayer must, at the relevant time, satisfy the ‘basic conditions’ for the small business CGT concessions. This includes any relevant additional basic conditions, for example, in relation to shares in a company or interests in a trust. Remembering of course that the small business CGT concessions are targeted at small businesses. The CGT concessions are not available in situations where a small business is not being carried on. For example, the CGT concessions are not available to an individual in respect of a property they have only ever used entirely for private purposes.
• The concession is designed to allow a taxpayer to defer any tax arising from the recognition of capital gains (capital gains tax) from a CGT event which happens in relation a CGT asset.
• The use of the concession is optional from asset to asset. The concession can be applied to multiple CGT assets (including perhaps to some but not others).
• The taxpayer can choose to apply the concession to only part of a capital gain.
• There is no cap on the value of capital gains which can be deferred.
• The concession provides a taxpayer with an automatic right of deferral for 2 years (the calculation of the 2 years period is set-out later in this article). This period is often referred to as the ‘replacement asset period’.
• The right to defer capital gains for 2 years is not contingent on the taxpayer acquiring a replacement asset or using that replacement asset (if acquired) as an active asset.
• The ability to defer capital gains tax can continue beyond 2 years provided the taxpayer does not act in a way that invokes the operation of CGT event J2, J5 or J6.
• The concession is potentially available in respect of CGT assets which form part of a deceased estate in the manner described in section 152-420 of the ITAA.
• The roll-over concession will only be available to be utilised in respect of the part of the capital gain (if any) that has not already been eliminated by other concessions. The small business roll-over concession is generally the last concession that will tend to be available to discount a capital gain made on a CGT asset. According to the ITAA, within an income year, capital gains are generally reduced by the following CGT-type concessions in the following order:
  • Available capital losses during the same income year.
  • Previously unapplied net capital losses.
  • The general CGT discount.
  • The small business 15-year exemption (part of the small business CGT concessions). Noting that if this concession applies, the capital gain will be disregarded entirely meaning the roll-over concession will not be relevant.
  • The small business 50% reduction (part of the small business CGT concessions).
  • The small business retirement exemption (part of the small business CGT concessions).
  • And finally, the small business roll-over concession.

Based on this ordering of CGT concessions, it is entirely possible that a capital gain on a business asset is entirely reduced before the roll-over is available to be used. Consider the example of a taxpayer that makes a $600,000 capital gain from the disposal of a CGT asset. The taxpayer has no other current year capital gains, a current year capital loss of $100,000, a previously unapplied net capital loss of $100,000. The taxpayer is also entitled to access the general CGT discount and the small business CGT concessions (but not the 15-year exemption). Here, the capital gain of $600,000 is reduced by $100,000 (to $500,000), then by another $100,000 (to $400,000), then by 50% (to $200,000), then by 50% (to $100,000). Then, reduced by another $100,000 under the retirement concession (to nil). As you can see, at the point where the taxpayer would consider applying the small business roll-over concession, there is no longer any capital gain which is available to be reduced referrable to the relevant CGT asset.

The concession will not be available (or relevant) in respect of a CGT asset that is subject to a capital loss.

There are several key terms which are used in Subdivision 152-E. These terms are helpful to define before we go any further.

Subdivision 152-E amount: this is the amount of any capital gain which is disregarded under the small business roll-over concession.

Replacement asset: this term is technically undefined in the ITAA but can be simplified as referring to a CGT asset that is acquired by a taxpayer to replace another CGT asset over which a CGT event has occurred (usually, CGT event A1 following disposal of that asset).

Replacement asset period: as set out in section 104-190 of the ITAA, this is essentially the period starting one year before the last CGT event in the income year for which the taxpayer obtains the roll-over and ending at the later of: (i) 2 years after that last CGT event; and (ii) In respect of a CGT asset which is disposed, 6 months after the latest time a possible financial benefit becomes or could become due under a look-through earnout right relating to the CGT asset. The replacement asset period is the time by which a taxpayer is permitted to defer capital gains. It also sets the time by which a taxpayer must take certain actions (e.g. acquire a replacement asset) in order to be eligible to continue to defer the relevant capital gain. The replacement asset period can be modified in certain circumstances. The ATO also has powers to extend the replacement asset period (at their discretion) where a taxpayer seeks an extension.

Fourth element expenditure: as set out in section 104-185 of the ITAA, this is essentially expenditure incurred in relation to a CGT asset that is included in the fourth element of the cost base of the asset. Section 110-25 of the ITAA provides that the fourth element of the cost base of an asset includes capital expenditure a taxpayer incurs with the purpose or the expected effect of increasing or preserving the asset’s value. It also includes capital expenditure that relates to installing or moving the asset. The expenditure can include the value of property given.

Per section 104-185 of the ITAA, CGT event J2 happens where:

• a taxpayer acquires a replacement asset or incurs fourth element expenditure in relation to a CGT asset (also the replacement asset), or both, by the end of the replacement asset period; and
• the replacement asset is an active asset at the end of the replacement asset period; and
• if the replacement asset is a share in a company or an interest in a trust, at the end of the replacement asset period, either: (i) the taxpayer, or an entity connected with the taxpayer, is a CGT concession stakeholder in the company or trust; or (ii) CGT concession stakeholders in the company or trust have a small business participation percentage in the taxpayer of at least 90%; and
• there is a ‘specified change’ after the end of the replacement asset period.

A ‘specified change’ referred to above includes where the asset ceases to be an active asset, or where the asset becomes trading stock, or where the asset starts being used to produce exempt income or non-assessable non-exempt income. In addition, for a share in a company or an interest in a trust, the specified change also includes a situation where CGT event G3 or I1 happens in relation to the CGT asset or where (c) (above) stops being satisfied.

Based on the above-described requirements, CGT event J2 tends to apply most commonly where a taxpayer acquires a replacement asset but where, at some point after 2 years following the CGT event which occurs to the original asset (i.e. after the expiry of the replacement asset period) the replacement asset is no longer used as an active asset in the business.

The time of CGT event J2 is when the relevant ‘change’ happens to the replacement asset. For example, at the time the replacement asset stops being an active asset.

Per section 104-197 of the ITAA, CGT event J5 happens where:

• a taxpayer has not acquired a replacement asset and has not incurred fourth element expenditure in relation to a CGT asset (also the replacement asset); or
• The replacement asset does not satisfy the ‘conditions’ in 104-197(2).

The ‘conditions’ referred to include:

• The replacement asset must be an active asset of the taxpayer; and
• If the replacement asset is a share in a company or an interest in a trust, either: (i) the taxpayer, or an entity connected with the taxpayer, must be a CGT concession stakeholder in the company or trust; or (ii) CGT concession stakeholders in the company or trust must have a small business participation percentage in the taxpayer of at least 90%.

The legislation provides a helpful example to demonstrate the meaning of the above condition regarding replacement assets that are shares in a company or an interest in a trust. That example is adapted below:

David owns 50% of the shares in ABC Pty Ltd and DEF Pty Ltd. He is therefore a CGT concession stakeholder in those two companies. The companies are connected with David because he has requisite levels of control over both of them.

ABC Pty Ltd owns land which it leases to David for use in a business. It sells the land at a profit and buys shares in DEF Pty Ltd.

Here, the ‘condition’ in relation to share in a company and interest in a trust is satisfied in respect of the shares. That is on the basis that David is both connected with ABC Pty Ltd and is a CGT concession stakeholder in DEF Pty Ltd.

Based on the above-described requirements, CGT event J5 tends to apply most commonly where a taxpayer does not acquire a replacement asset within the replacement asset period, or where the taxpayer acquires a replacement asset but where it is not used as an active asset.

The time of CGT event J5 is at the end of the replacement asset period.

Per section 104-198 of the ITAA, CGT event J6 happens where:

• by the end of the replacement asset period, the taxpayer has done either or both of: (i) acquired a replacement asset; or (ii) incurred fourth element expenditure in relation to a CGT asset (also the replacement asset); and
• at the end of the replacement asset period, the replacement asset is an active asset of the taxpayer; and
• if the replacement asset is a share in a company or an interest in a trust, at the end of the replacement asset period: (i) the taxpayer, or an entity connected with the taxpayer, is a CGT concession stakeholder in the company or trust; or (ii) CGT concession stakeholders in the company or trust have a small business participation percentage in the taxpayer of at least 90%; and
• The total amount of the following (in relation to each replacement asset that passes (b) and (c) above) is less than the amount of the capital gain that the taxpayer disregarded: (i) the first element of the cost base; (ii) the incidental costs the taxpayer incurred (including the value of property given), and (iii) the amount of fourth element expenditure incurred.

Based on the above-described requirements, CGT event J6 tends to apply most commonly where a taxpayer acquires a replacement asset within the replacement asset period which is an active asset, but where the relevant amount expended on that replacement asset is less than the capital gain that is disregarded under the roll-over concession. To illustrate, assume David sells a CGT asset for $1,000,000 and makes a capital gain of $500,000. That capital is reduced down to $100,000 (prior to using the roll-over concession) because of various preliminary CGT concessions which were available to be applied against the capital gain. David then sources a ‘cheap’ replacement asset which costs $80,000 (assume no other amounts expended). The asset is used in the business as an active asset. However, because the total amount incurred in relation to the replacement asset ($80,000) is less than the remaining capital gain to be disregarded under the roll-over concession (here, $100,000), CGT event J6 occurs and a capital gain of $20,000 is recognised.

The time of CGT event J6 is at the end of the replacement asset period.

CGT event J2

The calculation process depends firstly on whether there is a single replacement asset or multiple replacement assets (that satisfy the ‘active asset’ test and, if relevant, the test regarding shares in a company and interests in a trusts).

If there is a single replacement asset, the capital gain made by the taxpayer will be equal to the amount of the capital gain disregarded by use of the small business roll-over concession (i.e. the subdivision 152-E amount).

If there are multiple replacement assets and a specified change occurs for each replacement asset, the capital gain will also be the subdivision 152-E amount.

However, if there are multiple replacement assets and a specified change occurs for one or more of the replacement assets but not all of the replacement assets, then the capital gain is calculated as so much (if any) of the Subdivision 152-E amount as exceeds the sum of the below (in relation to which a specified change did not occur):

• The first element of the cost base of each of those replacement assets acquired.
• The incidental costs the taxpayer incurred to acquire each of those replacement assets.
• The fourth element expenditure incurred in relation to each of those replacement assets.

CGT event J5

The capital gain made by the taxpayer will be equal to the amount of the capital gain disregarded by use of the small business roll-over concession (i.e. the subdivision 152-E amount).

CGT event J6

The capital gain made by the taxpayer will be equal to the difference between: (a) the amount of the capital gain disregarded by use of the small business roll-over concession (i.e. the Subdivision 152-E amount); and (b) the amount incurred (i.e. the sum of the first element of the cost base and incidental costs and fourth element expenditure).

There are numerous quirks perhaps worth noting when it comes to the small business roll-over concession and CGT events J2, J5 and J6.

For instance, a capital gain can technically be rolled-over in respect of a CGT asset which has not actually been disposed of (provided a relevant CGT event occurs in respect of the asset). Obviously, unless the CGT asset is replaced or fourth element expenditure is incurred, the taxpayer is unlikely to be able to further defer capital gains beyond the replacement asset period.

Another quirk is that a CGT asset may be subject to more than one the J events over time. The most obvious example is CGT event J2 occurring after CGT event J6. This is because J6, if applicable, is triggered at the end of the replacement asset period and only brings to account the capital gains which relate to the amount by which the cost of the replacement asset (plus incidental costs and fourth element costs) is exceeded by the capital gain disregarded under the small business roll-over concession. If the replacement asset, for instance, subsequently stops being used as an active asset, CGT event J2 will occur to bring to account the capital gain on the original asset. However, the capital gain under CGT event J2 will be reduced by the capital gain previously brought to account under CGT event J6.

Another quirk is that a replacement asset can actually be acquired before a CGT event occurs to a CGT asset which is subject to the roll-over (but not earlier than 1-year before the last CGT event in the income year for which the taxpayer obtained the roll-over).

Another quirk is that it is possible to acquire another replacement asset (i.e. to replace the replacement asset) and further defer capital gains (subject to certain requirements).

Another quirk is that there is no specific requirement in the ITAA that the replacement asset performs the same function or is materially similar to the original asset which it is replacing. This gives taxpayer some degree of flexibility when it comes to the acquisition of a replacement asset.

While not specific to the small business roll-over concession and J2, J5 and J6, it is worth remembering that capital gains which are discounted within a company do not generally retain their tax-advantaged status when distributed to shareholders. That is a natural by-product of the Australian imputation system.

To give some illustration on the workings of CGT events J2, J5, and J6, let’s do a case study of David who operates a small business. On 1 March 2023, David acquired land which was an active asset in his business. On 1 February 2024, David sold the land and made a capital gain of $600,000 (the capital proceeds were $1,000,000 and the cost base was $400,000).

Let’s consider, in turn, the consequences under CGT events J2, J5 and J6 where David takes the following course of action after selling the land:

• Acquires another block of land on 1 March 2024. The land is purchased for a similar value of $1,000,000 and is used as an active asset in the business. On 1 March 2027, David sells the land – the J2 example.
• Rents a block of land instead of acquiring a replacement land – the J5 example.
• Acquires another block of land on 1 March 2024. The land is purchased for a significantly lesser value of $200,000 and is used as an active asset in the business. In relation to that land, there are $5,000 of incidental costs incurred and $15,000 of fourth element expenditure. On 1 March 2027, David stops using the land as an active asset in the business – the J5 and J2 example.

For the 2023/24 income year, David does not make any other capital gains or capital losses. However, he has a net unapplied capital loss from 2022/2023 income year of $50,000. He has held the asset for less than 12 months and is therefore ineligible for the general CGT discount. In the 2023/24 income year, he meets the basic conditions of eligibility for the small business CGT concessions. He is not eligible for the 15-year exemption, but is eligible for the small business 50% reduction and the small business retirement exemption (however, he does not want to use any of his retirement exemption lifetime cap and therefore elects not to use this concession).

David would like to defer capital gains, if possible.

CGT event J2

The capital gain of $600,000 from the sale of the land (from CGT event A1) can be discounted by David by firstly reducing it by the $20,000 net unapplied capital loss and then reducing the net amount by 50% under the small business 50% reduction. That leaves a capital gain of $290,000.

The capital gain is deferred automatically for two years (the replacement asset period) and then continues until the point where CGT event J2 (and/or J5 or J6, including subsequently) occurs to bring to account the relevant capital gains.

Here, CGT event J2 is triggered on 1 March 2027 when the replacement asset is subject to a change of the kind specified in section 104-185 (here, that change is David’s replacement asset no longer being an active asset).

The capital gain previously deferred under the small business roll-over concession is brought to account for David in the 2026/2027 income year.

The capital gain (as we are dealing with a single replacement asset) is equal to the amount disregarded by use of the roll-over concession. That is, $290,000. There may be discounting opportunities available in respect of that capital gain.

CGT event J5

As above, the capital gain of $600,000 can be discounted (up to nil) using the various available CGT concessions and the small business roll-over concession in Subdivision 152-E.

The capital gain can continue to be deferred beyond the replacement asset period unless CGT event J5 (and/or J2 or J6, including subsequently) occurs to bring to account the relevant capital gains.

Here, CGT event J5 is triggered at the end of the replacement asset period. That is because, as set-out in section 104-197, David does not acquire a replacement asset. (The same outcome would occur if the taxpayer had acquired replacement land where that land was not being used as an active asset by the end of the replacement asset period.)

The capital gain previously deferred under the small business roll-over concession is brought to account for David in the 2025/2026 income year.

The capital gain is equal to the amount disregarded by use of the small business roll-over concession. That is, $290,000. There may be discounting opportunities available in respect of that capital gain.

CGT event J6

As above, the capital gain of $600,000 can be discounted to nil using the various available CGT concessions and the small business roll-over concession in Subdivision 152-E.

The capital gain can continue to be deferred beyond the replacement asset period unless CGT event J6 (and/or J2 or J5, including subsequently) occurs to bring to account the relevant capital gains.

Here, CGT event J6 is triggered at the end of the replacement asset period. That is because, as set-out in section 104-198, David has acquired a replacement asset with an ‘amount incurred’ which is less than the capital gain that was disregarded under Subdivision 152-E. Here, the ‘amount incurred’ is $220,000. That is the sum of $200,000 (first element of the cost base), plus $5,000 (incidental costs incurred), plus $15,000 (amount of fourth element expenditure incurred). The capital gain disregarded under Subdivision 152-E was $290,000.

The CGT event J6 capital gain is therefore $70,000 ($290,000 – $220,000). That capital gain is brought to account in the 2025/2026 income year (i.e. at the end of the replacement asset period). There may be discounting opportunities available in respect of that capital gain.

Subsequently, CGT event J2 is triggered on 1 March 2027 when the active asset is subject to a change of the kind specified in section 104-185 (here, that occurs when David’s asset stops being an active asset in the business).

The capital gain previously deferred under the small business roll-over concession is brought to account for David in the 2026/2027 income year (less the capital gain previously brought to account under CGT event J6).

Therefore, the capital gain (as we are dealing with a single replacement asset) is $220,000. That is, the original $290,000 capital gain less $70,000 which was previously brought to account under CGT event J6. There may be discounting opportunities available in respect of that capital gain.