This article is a brief overview of the small business capital gains tax (CGT) concessions. The small business CGT concessions can significantly reduce and sometimes eliminate tax payable on the sale of a small business. The concessions are therefore extremely important when tax planning for small businesses. This article is a brief overview only – it focuses on the most common and important issues and is not to be relied on without seeking expert advice. It is essential that you obtain expert advice if you intend to obtain the benefit of any of the small business CGT concessions.
To qualify for the small business CGT concessions, you must satisfy several conditions that are common to all the concessions. These are called the ‘basic conditions’. The basic conditions are outlined in section 152-5 Income Tax Assessment Act 1997 (ITAA 1997).
Each concession also has further requirements that you must satisfy for the concession to apply, except for the small business 50% active asset reduction, which applies if the basic conditions are satisfied.
IN THIS ARTICLE
Small business 50% active asset reduction
Small business 15-year exemption
Small business retirement exemption
Small business rollover
Definition of terms
The basic condition for small business CGT concessions are:
- You must be a small business entity
- You must satisfy the maximum net asset value test
- The asset in question must satisfy the active asset test
If the CGT asset is a share in a company or an interest in a trust, one of these additional basic conditions must be satisfied just before the CGT event:
- the entity claiming the concession must be a CGT concession stakeholder in the company or trust, or
- CGT concession stakeholders in the company or trust together have a small business participation percentage in the entity claiming the concession of at least 90%.
MAXIMUM NET ASSET VALUE TEST
To pass this test, the total net value of CGT assets must not exceed $6 million for the following entities:
- entities connected with you
- your affiliates, or entities connected with your affiliates
When calculating net asset values, include only those assets that are used, or held ready for use, in a business of yours, or an entity connected with you. Don’t include assets of your affiliate, or an entity connected with your affiliate, unless they are in your business or the business of an entity connected with you. The net value of the CGT assets of an entity is the total market value of its assets, less any liabilities relating to those assets.
Small business 50% active asset reduction
Unlike the other small business concessions, the small business 50% active asset reduction applies automatically if the basic conditions are satisfied, unless you choose for it not to apply. For example, you might prefer for it not to apply, and instead, choose the small business retirement exemption or the small business rollover. Making this choice allows you to achieve the best result for your circumstances, for example, a company or trust may make larger tax-free payments under the small business retirement exemption.
Otherwise, the small business retirement exemption or the small business rollover (or both) may apply to the capital gain that remains after applying the small business 50% active asset reduction.
If you satisfy the basic conditions, the capital gain that remains after applying any current year capital losses and any unapplied prior year net capital losses, and the CGT discount (if applicable), is reduced by 50%.
This means that if you are an individual or a trust and you have applied the CGT discount and the small business 50% active asset reduction, the capital gain (after being reduced by any capital losses applied against it) is effectively reduced by 75% (that is, 50% then 50% of the remainder).
Small Business 15-year exemption
If you qualify for the small business 15-year exemption, you can entirely disregard the capital gain and do not need to apply any other concessions. This exemption is the most valuable of the small business CGT concessions.
You can disregard a capital gain from a CGT event happening to a CGT asset you have owned for at least 15 years if you:
- satisfy the basic conditions for the small business CGT concessions
- continuously owned the CGT asset for the 15 years ending just before the CGT event happened.
If you are an individual:
- when the CGT event happened
- you were permanently incapacitated, or
- you were 55 years old, or older, and the event happened in connection with your retirement, and
- if the CGT asset is a share in a company or an interest in a trust, that company or trust must have had a significant individual for periods totalling at least 15 years during the entire time you owned the share or interest, even if it was not the same significant individual during the whole period.
If you are a company or trust:
- you had a significant individual for a total of at least 15 years of the whole period of ownership (even if it was not the same significant individual during the whole period), and
- the individual who was signed just before the CGT event was
- at least 55 years old at that time and the event happened in connection with their retirement, or
- was permanently incapacitated at that time.
Small Business Retirement exemption
You may choose to disregard all or part of a capital gain under the small business retirement exemption if you satisfy certain conditions. If you are an individual who chooses the retirement exemption, you do not need to terminate any activity or cease business. This concession allows you to provide for your retirement. If you are a CGT concession stakeholder and receive payments under the retirement exemption, you are not required to terminate your employment with the company or trust.
CGT retirement exemption limit
The amount of the capital gain that you choose to disregard (that is, the CGT exempt amount) must not exceed your ‘CGT retirement exemption limit’ or, in the case of a company or trust, the CGT retirement exemption limit of each CGT concession stakeholder receiving a payment.
An individual’s lifetime CGT retirement exemption limit is $500,000, reduced by any previous CGT exempt amounts the individual has disregarded under the retirement exemption. This includes amounts disregarded under former (repealed) retirement exemption provisions. For a company or trust with eight CGT concession stakeholders (four significant individuals and their four spouses, where each spouse has a small business participation percentage greater than zero) the limit is effectively $4 million, that is, $500,000 for each stakeholder.
A company or trust may determine the percentage of the exempt amount attributable to each stakeholder, having regard to each stakeholder’s retirement exemption limit (or remaining limit).
Consequences of choosing the retirement exemption
If you choose this exemption, you disregard the amount of the capital gain you have chosen as the CGT exempt amount. The amount of any capital gain that exceeds the CGT exempt amount does not qualify for this exemption.
If you are a CGT concession stakeholder, a payment you receive from a company or trust to satisfy the retirement exemption requirements is not assessable income and is not exempt income. If you are a company or trust making the payment, it is not able to be deducted from your assessable income.
If you are a company or trust receiving a payment (whether directly or indirectly through one or more interposed entities) that another company or trust made to satisfy the retirement exemption requirements, and you are passing that payment on to a CGT concession stakeholder or another interposed entity:
- the payment you receive is not included in your assessable income and is not exempt income, and
- the payment you make is not deductible from your assessable income.
Amounts that are not assessable income and not exempt income have no implications for tax losses of previous years.
A payment you make to satisfy the retirement exemption requirements is not treated as a dividend nor a frankable distribution provided:
- you are an interposed entity receiving payment and passing that payment on, or
- you are a company making a payment to
- a CGT concession stakeholder, or
- an interposed entity.
This is the case despite section 109 of the ITAA 1936 which can treat excessive payments to shareholders, directors and associates as dividends. Therefore, section 109 has no application to these payments.
Division 7A of the ITAA 1936 also does not apply to treat such payments made by a company or trust as dividends.
Small business rollover
The small business rollover allows you to defer all or part of a capital gain made from a CGT event happening to an active asset. You may choose to apply the small business rollover to as much of the capital gain as you decide:
- after the small business 50% active asset reduction, that is, to the remaining 50% (or if the CGT discount has also applied, the remaining 25%) of the capital gain after you have applied capital losses, or
- instead of the small business 50% active asset reduction, that is, to the capital gain remaining after you have applied any capital losses and CGT discount. Making this choice might ultimately allow a company or trust to make a larger tax-free payment under the small business retirement exemption if they choose the retirement exemption after the deferred capital gain has crystallised, for example, when the replacement asset is later sold.
You may instead choose the small business retirement exemption if its conditions are satisfied, or you may choose both concessions for different parts of the remaining capital gain.
If you choose the rollover, the capital gain will not be included in your assessable income.
Further CGT events happen if you previously chose the rollover and certain conditions are not met by the end of the replacement asset period. This period starts one year before and ends two years after the last CGT event that occurs in the income year for which you choose the rollover.
A capital gain will arise if:
- you do not acquire one or more CGT assets as replacement assets or make a capital improvement to one or more existing assets, or both, within the replacement asset period (CGT event J5)
- the replacement asset you acquired, or the asset to which you made the capital improvement is not an active asset at the end of the replacement asset period (a depreciating asset such as a plant can be a replacement asset) (CGT event J5)
- if the replacement asset is a share in a company or an interest in a trust, at the end of the replacement asset period
- you, or an entity connected with you, are not a CGT concession stakeholder in the company or trust, or
- CGT concession stakeholders in the company or trust do not have a small business participation percentage in you of at least 90% (CGT event J5)
- the capital gain previously disregarded under the rollover is, at the end of the replacement asset period, more than the sum of the following
- the amount paid to acquire the replacement asset (that is, the first element of the cost base of the replacement asset)
- any incidental costs incurred in acquiring that asset, which can include giving property (that is, the second element of the cost base of the replacement asset), and
- the amount expended on capital improvements to one or more assets that were acquired or already owned (that is, fourth element expenditure) (CGT event J6).
For a share in a company or interest in a trust to be an active asset, the company or trust must satisfy the 80% test, that is, the market value of the active assets and certain financial instruments of the company or trust must be 80% or more of the total of the market value of all the assets of the company or trust.
DEFINITIONS OF IMPORTANT TERMS
A Capital Gains Tax (CGT) asset is an active asset if you own it and :
- you use it or hold it ready for use in the course of carrying on a business (whether alone or in partnership)
- it is an intangible asset (for example, goodwill) inherently connected with a business you carry on (whether alone or in partnership).
A CGT asset is also an active asset if you own it and it is used or held ready for use in the course of carrying on a business, or it is an intangible asset inherently connected with a business carried on, (whether alone or in partnership) by any of the following:
- your affiliate
- your spouse or child under 18 years
- an entity connected with you.
However, certain CGT assets cannot be active assets, even if they are used or held ready for use in the course of carrying on a business, for example, assets whose main use is to derive rent (unless the asset was rented to an affiliate or connected entity for use in their business). Generally, a rental property will not be an active asset.
An affiliate is an individual or company that, in relation to their business affairs, acts or could reasonably be expected to act:
- per your directions or wishes, or
- in concert with you.
Trusts, partnerships and superannuation funds cannot be your affiliates. However, a trust, partnership or superannuation fund may have an affiliate who is an individual or company.
However, a person is not your affiliate merely because of the nature of a business relationship you and the person share. For example, if you are a partner in a partnership, another partner is not your affiliate merely because they act, or could reasonably be expected to act, under your directions or wishes concerning the affairs of the partnership.
Similarly, companies and trusts are not affiliates of their directors and trustees respectively, and vice versa, merely because of the positions held.
Whether a person acts, or could reasonably be expected to act, following the taxpayer’s directions or wishes, or in concert with the taxpayer, is a question of fact dependent on all the circumstances of the particular case. No single factor will necessarily be determinative.
Relevant factors that may support a finding that a person acts, or could reasonably be expected to act, in accordance with the taxpayer’s directions or wishes, or concert with the taxpayer, include:
- the existence of a close family relationship between the parties
- the lack of any formal agreement or formal relationship between the parties dictating how the parties are to act in relation to each other
- the likelihood that the way the parties act, or could reasonably be expected to act, in relation to each other would be based on the relationship between the parties rather than on formal agreements or legal or fiduciary obligations
- the actions of the parties.
Generally, another business would not be acting in concert with you if they:
- have different employees
- have different business premises
- have separate bank accounts
- do not consult you on business matters
- conduct their business affairs independently in all regards
CGT concession stakeholder
Share or interest owned by individual
You are a CGT concession stakeholder if:
- you are an individual that holds interests, either directly or indirectly, in the company or trust that carries entitlements to at least 20% of the
- dividends, capital distributions or voting power (except for jointly owned shares) if the asset is a share in a company
- distributions of income or capital if the asset is an interest in a trust, or
- you are the spouse of an individual who holds at least 20% of the interests and you also hold a percentage of shares or trust interests – your percentage can be less than 20% but must be greater than zero.
Share or interest owned by company or trust
If the share or interest is held by a non-individual, the 90% test must be met just before the CGT event. This test will be met if the CGT concession stakeholders in the entity in which the shares or interests are held, between them (either directly or indirectly) hold 90% of the shares or interests in the company or trust that made the capital gain.
CONNECTED WITH YOU
An entity is connected with another entity if:
- either entity controls the other entity, or
- both entities are controlled by the same third entity.
SMALL BUSINESS ENTITY
The definition of a small business entity for tax purposes is essentially a taxpayer which has less than $2 million aggregated turnover. Aggregated turnover is your annual turnover plus the annual turnovers of any business entities that are your affiliates or that are connected with you.
This article is for general information only. It does not make recommendations nor does it provide advice to address your personal circumstances. To make an informed decision, always contact a registered tax professional.