The small business Capital Gains Tax (CGT) concessions can provide a substantial tax relief on the sale of a business. Unfortunately, it can be a complex area to apply in practice with quite a few traps for the unwary.
The starting point is to work out if you pass the basic tests which are:
Step 1
- You must meet one of the following:
- You are a small business entity with an “aggregated turnover” of less than $2 million; or
- You satisfy the maximum net asset test where you and any “connected entities” or “affiliates” of yours have combined net CGT assets of less than $6 million at the time of the CGT event
Step 2
- The asset being sold satisfies the “active asset test”. Broadly and active asset is one that used in carrying on a business. Selling a rental property or shares in a listed company will not qualify.
Step 3
- If the asset being sold is a share in a company or interest in a trust, there are further tests that need to be met.
Assuming you meet the basic tests above, there are four possible concessions that may apply.
- The 15-year exemption which provides an exemption from CGT for active assets owned for 15 years and you are aged 55 or older (This exemption takes priority over the others if it applies).
- The Small business 50% active asset reduction which reduces the capital gain by 50%. This exemption applies automatically if the basic conditions are met. In the case of a sale by a company you may choose not to apply this to avoid leaving untaxed profits in the company.
- The Small business retirement exemption which exempts the capital gain up to a lifetime limit of $500,000 for each of the “CGT concession stakeholders”; and
- The Small business rollover which allows you to defer all or part of a capital gain if you buy a replacement active asset.
Common issues we see when applying the concessions
- Both the turnover test and the maximum net asset tests in Step 1 above require you to count not just your turnover and assets, but all of the entities that you are connected with or affiliated with. Working out who is connected or affiliated can be a complex exercise.
- For example, you hold 50% of the shares in company A and 50% of the shares in company B. When working out your aggregated turnover, you must combine the turnover of both companies. Similarly, you must combine the net assets of both companies under the net asset test.
- Under the net asset test, some assets are not counted. For example, your main residence (provided it has not been used to derive assessable income), amounts in super and personal use assets such as holiday homes that are not rented, boats and cars.
- The concessions only exempt capital gains. If you are selling trading stock or depreciating assets, profits on the sale of these assets are not included in the concessions.
- If the assets are held in a company or trust, there needs to be a “CGT concession stakeholder”. A CGT concession stakeholder is an individual or their spouse with a participation percentage of at least 20%. In some cases this may not be possible where there are different classes of shares held in a company, or distributions made by a trust are not made to the relevant individual.
- Sometimes business assets such as the warehouse or office building are held in a separate entity from the main trading entity for asset protection purposes. Some care is necessary to ensure that the two entities are connected to ensure this asset meets the test of an active asset and not one the is passively earning rent.
- The value of your assets for the purpose of the net asset test is the market value on the date of the CGT event, this includes any goodwill component that is part of the sale price. Liabilities can be deducted from these assets, but they must relate to the assets.
Planning
If you are thinking of selling your business in the next 5 years, we recommend you consider your eligibility for the small business CGT concessions now rather just prior to selling. Key areas that need to be addressed include:
- What is your aggregated turnover likely to be in the year of the sale? Are you growing or winding down?
- What assets need to be counted in the $6 million net asset test?
- Which of your entities will need to be counted in these tests?
- How long will the business assets have been held when you sell is it likely to be more than 15 years?
- How old will you and your spouse be when the business sells. Will you be 55 years old or more?
- What will you be selling – the assets of the business or the shares in the entity that carries on the business?
- Are there differing share classes in your company structure?
- How have trust distributions been made in the past and who will receive any trust distributions in the year of sale?
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Want to know if you qualify for small business Capital Gains Tax concessions? Talk to an expert today.