The capital gains tax concessions available to small business owners are generous but they can be complex. The small business capital gains tax (CGT) cap is a lifetime indexed amount which is available to eligible businesses which dispose of a qualifying business asset. For the 2014-15 financial year this limit is $1.355 million.
The CGT cap can include any of the following:
- the capital proceeds from the disposal of business assets that qualify for the 15-year CGT exemption;
- up to $500,000 of capital gains that are disregarded under the CGT retirement exemption;
- capital proceeds from the disposal of business assets that would have qualified for the 15-year CGT exemption if not for the fact that:
– the disposal of the asset resulted in no capital gain;
– the asset was a pre-CGT asset; or
– the asset was disposed of before the required 15-year holding period due to the permanent incapacity of the person making the contribution.
Basic conditions for to qualify for these concessions
To be eligible for these concessions when you dispose of an active asset, at least one of the following needs to apply:
- the business has a turnover of less than $2 million in aggregate; or
- the asset was used in a closely connected small business; or
- the maximum $6 million net asset value test is satisfied.
Where the asset is a share in a company or interest in a trust, one of the following two additional conditions must be met:
- the entity claiming the concession must be a CGT concession stakeholder, or
- the CGT concession stakeholders in the company or trust must together have a small business participation percentage of at least 90% in the entity claiming the concession.
What concessions are available?
Business owners may qualify for one or more the following four concessions:
- CGT 15-year asset exemption;
- CGT 50% active asset reduction;
- CGT retirement exemption; and
- CGT rollover.
Are you a small business entity?
The first step in the process to work out whether you are a small business entity for the purposes of the Act. A small business is an individuals, partnership, company or trust that carries on a business and has an aggregated turnover of less than $2 million.
Aggregated turnover is based on your annual turnover plus that of any businesses that are connected with you (relevant entities).
There are three ways to satisfy the $2 million aggregated turnover requirement:
- Use the previous year’s turnover. If your aggregated turnover for the previous income year was less than $2 million, you are a small business entity.
- Use an estimate of current year turnover. If you estimate that your aggregated turnover for the current year is likely to be less than $2 million, you are a small business entity as long as your aggregated turnover for the two previous income years was not more than $2 million.
- Use actual current year turnover. If you cannot use the first two methods, you will need to wait until the end of the income year to calculate your aggregated turnover.
Working out whether you have ‘relevant entities’
The second step is to determine whether there are any ‘relevant entities.’ An individual or entity will be deemed as your affiliate if they could reasonably be expected to act in accordance with your wishes in relation to the business. For example, where a spouse owns an asset (e.g. a property) that is used in the business, they will be taken to be an affiliate.
Relevant entities will be considered in determining:
- the $2 million aggregated turnover test
- the $6 million maximum net asset value test, and
- the active asset test.
The $6 million maximum net asset value test
To pass this test, the total net value of the business owner’s CGT assets must not exceed $6 million. To determine the total net value of CGT assets, you must add together the value of net assets for the following entities:
- entities connected with you,
- your affiliates, and
- entities connected with your affiliates.
While this appears to cast a very wide net, the net value of assets of your affiliates and connected entities is only done if the assets are used, or held ready for use, in a business carried on by you or an entity connected with you.
This test needs to be applied just before the CGT event that results in the capital gain.
The net value of the CGT assets is the total market value of its assets less any liabilities relating to those assets. This value can be positive, negative or nil. The $6 million limit is not indexed for inflation.
Under the maximum net asset value test, you can reduce the net value of your CGT assets by provisions for annual leave, long service leave, unearned income and tax liabilities.
Companies and trusts
Where the business asset is held by a company or trust the CGT cap can still apply as long as the payment is made by the business entity to what is referred to as a CGT concession stakeholder.
An individual is a CGT concession stakeholder if:
- they are a significant individual (i.e. have a participation percentage of at least 20%); or
- are the spouse of a significant individual and have a business participation percentage of greater than zero.
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:
- you must be a CGT concession stakeholder in the company or trust
- the entity that owns the share or interest must satisfy the 90% test.
In working out whether you are a small business entity, you need to consider whether you have any affiliates (relevant entities).
The CGT rules operate on the basis that a partner in a partnership carries on the partnership business collectively with the other partners. A partner cannot be a small business entity – it is the partnership that must meet the turnover test to qualify as a small business entity.
If the relevant conditions are met, a partner may be eligible for the small business CGT concessions using the turnover test for either of the following:
- their interest in a partnership asset
- an asset that is not a partnership asset that is used in the business of the partnership.
In either case, the partner does not have to be connected with the partnership.
The maximum net asset value test applies differently. For this test, you use the individual partners in the partnership, not the partnership itself, to work out whether they are eligible for the small business CGT concessions.
A partner may also be eligible for the concessions for a CGT asset they own that is not a partnership asset. They may be eligible if the following conditions are met in the income year in which the CGT event happens to their CGT asset:
- they are a partner in a partnership
- the partnership uses the asset in carrying on the partnership business
- the partnership is a small business entity
- the only business the partner carries on is as a partner in a partnership.
There is a special rule for working out aggregated turnover where your asset is used in the business carried on by the partnership. This rule says an entity that is your affiliate or is connected with you is an affiliate of, or is connected with, the partnership that uses your asset. This rule only applies if the entity is not already an affiliate of, or connected with, the partnership.
In working out the aggregated turnover of the partnership, the turnover of entities that are deemed to be affiliates or connected entities must be included. Otherwise, working out the aggregated turnover is the same.
There is another special rule for working out aggregated turnover where:
- you are a partner in more than one partnership, and
- the asset is used in more than one partnership’s business.
Each of these partnerships are treated as being connected with the partnership that is trying to work out if it is a small business entity (the test entity). When working out the aggregated turnover of the test partnership, you must include the turnover of any of these other partnerships.
Assets that are not included
The following assets are not included when working out the net value of your CGT assets:
- shares, units or other interests (apart from debt) held in any entities connected with you or your affiliates (because you have already included the net value of connected entities’ CGT assets)
- any assets of an affiliate or an entity connected with an affiliate unless they are used, or held ready for use, in a business you carry on or an entity connected with you carries on
- if you are an individual
- assets that are solely for your personal use (or for your affiliates’ personal use) or superannuation assets;
- your own home, provided the home has never had any income producing use. If you have used part of the home to produce assessable income, you must make a reasonable apportionment having regard to the length of time and the percentage of income producing use. You multiply the percentage of private use by the current market value and do not include this amount.
Even though gains from depreciating assets may be treated as income (rather than a capital gain), depreciating assets are CGT assets and you must consider them for the maximum net asset value test.
The active asset test
For this test, the CGT asset must be an active asset for at least:
- 7.5 years if you have owned it for more than 15 years, or
- half of the test period if you have owned it for 15 years or less.
The asset does not need to be an active asset just before the CGT event.
The test period begins when you acquire the asset and ends at the earlier of:
- the time of the CGT event
- when the business stopped (if that happened within 12 months of the event or within a longer timeframe allowed by the Commissioner).
There are modified rules for CGT assets you acquired or transferred under the rollover provisions for assets:
- compulsorily acquired
- lost or destroyed
- relating to a marriage breakdown.
A CGT asset is an active asset if you own it and:
- you use it or hold 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).
It is still an active asset if you own it and it is used or held ready for use in the course of carrying on a business (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.
Shares and interests in trusts
In some circumstances, a share in a company or an interest in a trust can also be an active asset.
If the CGT asset is a share in a company or an interest in a trust, you must meet one of these additional basic conditions just before the CGT event:
- you must be a CGT concession stakeholder in the company or trust, or
- you must pass the 90% test.
CGT concession stakeholder
An individual is a CGT concession stakeholder of a company or trust if they are:
- a significant individual, or
- the spouse of a significant individual where the spouse has a small business participation percentage in the company or trust greater than zero (see the Significant individual test).
This participation percentage can be held directly or indirectly through one or more interposed entities. You work out the percentages in the same way as for the significant individual test.
Significant individual test
An individual is a significant individual in a company or trust if they have a small business participation percentage in the company or trust of at least 20%. The 20% can be made up of direct and indirect percentages.
An entity’s direct small business participation percentage in a company is the percentage of:
- voting power that the entity is entitled to exercise (except for jointly owned shares)
- any dividend payment it is entitled to receive
- any capital distribution it is entitled to receive.
The voting power calculation is ignored where the shares are jointly owned, as neither owner would individually control the voting power on the jointly owned shares.
If an entity has different percentages in a company, their participation percentage is the smaller or smallest percentage. The same applies for a trust.
This test only applies if there is an interposed entity between the CGT concession stakeholders and the company or trust in which the shares or interests are held.
The interposed entity satisfies the test if small business participation percentages in that entity totaling at least 90% are held by CGT concessions stakeholders of the company or trust in which the shares or interests are held.
As with the significant individual test, the participation percentage can be held directly or indirectly through multiple interposed entities.
Death and the small business CGT concessions
If you are one of the following you may be eligible for the concessions to the same extent that the deceased would have been just before their death:
- a beneficiary of a deceased estate
- a legal personal representative of the deceased (executor)
- a surviving joint tenant
- a trustee or beneficiary of a testamentary trust (a trust that is created by the will of the deceased).
You will be eligible for the concessions where the CGT event happens within two years of the individual’s death. Some of the conditions within each concession are modified in these cases. We may extend this two-year period.
You can apply as many concessions as you are entitled to until the capital gain is reduced to nil. This choice allows you to achieve the best tax result for your circumstances.
If you are aged 55 or older and retiring or are permanently incapacitated, and your business has owned an asset for at least 15 years, you won’t pay CGT when you sell the asset.
If you’ve owned an asset to conduct your business (an ‘active asset’) you’ll only pay tax on 50% of the capital gain when you sell the asset.
There is CGT exemption on the sale of a business asset, up to a lifetime limit of $500,000. If you are under 55, money from the sale of the asset must be paid into a complying superannuation fund or a retirement savings account.
If you sell a small business asset and buy a replacement asset or improve an existing one, you can defer your capital gain until a later year.
Get professional advice
Applying the small business CGT concessions can be complicated and it is essential to obtain professional tax, legal and financial advice before making any final decisions. This article is for general information purposes only.