How can Small Businesses reduce Capital Gains Tax?

Dated: July 2006

If you are selling small business assets there are a number of options for reducing or actually eliminating the capital gains tax consequences providing certain conditions are met. We would advise anyone considering the sale of assets to contact us before taking any action so that structures can be put in place to minimise the impact of tax on the sale.

The following is a summary of the concessions available to small businesses. The information provided is general in nature and does not provide all the relevant detail for determining access to the concessions. Please seek professional advice in determining the availability of the concessions for your personal circumstances.

The following four CGT concessions are available only for small business:

1. The small business 15-year exemption provides a total exemption for a capital gain on a CGT asset if you have continuously owned the asset for at least 15 years and the relevant individual is 55 or over and retiring, or is permanently incapacitated.
2. The small business 50% active asset reduction provides a 50% reduction of a capital gain.
3. The small business retirement exemption provides an exemption for capital gains up to a lifetime limit of $500,000. If the recipient is under 55, the amount must be paid into a superannuation (or similar) fund.
4. The small business rollover provides a deferral of a capital gain if a replacement asset is acquired. However, you may make a capital gain equal to the deferred gain if the replacement asset is disposed of or its use changes in particular ways. In this case the deferred capital gain is in addition to any capital gain made on disposal of the replacement asset.

Note that:

• More than one of the four concessions may apply to the same capital gain if the conditions for each are satisfied
• They may apply in addition to the CGT discount if it also applies
• If the small business 15-year exemption applies, you can disregard the entire capital gain and therefore don’t need to apply any further concessions
• With the exception of the small business 15-year exemption, you apply the small business concessions after reducing any capital gains by all available capital losses, and
• If you have more than one capital gain, you can choose the order in which to reduce capital gains by capital loss

So what is a “Small Business”?

To qualify for any of the small business CGT concessions, you must first satisfy several basic conditions. These conditions are in the form of three tests, namely:

(a) The maximum net asset value test
(b) The active asset test, and
(c) The controlling individual test. This test applies only where the CGT asset is a share in a company or interest in a trust, and the individual claiming the concession is a CGT concession stakeholder in the company or trust.

(a) Maximum net asset value test

Broadly, to pass this test, you and your related entities must not own assets with a total net value of more than $5 million just before the CGT event that results in the capital gain. 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. The $5 million limit isn’t indexed for inflation.

The following assets aren’t included when calculating the net value of your CGT assets:

• If you are an individual, assets that are solely for your personal use (or the personal use of your CGT affiliates) or superannuation assets, and
• If you are an individual, your own home, provided that you wouldn’t be entitled to a tax deduction for interest if you had taken out a loan to purchase it. If you are entitled to a deduction, the total market value of your home is included in the maximum net asset value test, even if you use it mainly for private purposes.

(b) The active asset test

This test requires the CGT asset to be an active asset at a particular time and for half a particular period. Broadly, if you have not ceased your business and you have owned the asset for less than 15 years, the CGT asset must be an active asset:

• Just before the CGT event, and
• For at least half of the period of ownership.

If the asset has been owned for more than 15 years, it needs to be an active asset for at least half of the 15-year period ending at the time of the CGT event (or when your business ceased, if earlier).

A CGT asset is an active asset if it is owned by you and is:

• Used or held ready for use by you, a small business CGT affiliate, or an entity connected with you, in the course of carrying on a business, or
• An intangible asset inherently connected with a business you carry on, for example, goodwill.

In some circumstances, a share in a company or an interest in a trust can also be an active asset. However, certain CGT assets can’t be active assets, even if they are used or held ready for use in the course of carrying on a business, for example, financial instruments such as loans, bonds, share options and assets whose main use is to derive rent.

(c) The controlling individual/CGT concession stakeholder test

This test is a basic condition only if the asset from which the capital gain was made is a share in a company or an interest in a trust. (However, some of the concessions have further controlling individual requirements.)

A company or trust satisfies the controlling individual test if it had at least one controlling individual just before the CGT event.

An individual is a controlling individual of a company if the individual holds interests in shares (apart from redeemable shares) that carry between them:

• The right to exercise at least 50% of the voting power in the company, and
• The right to receive at least 50% of any distribution of income and capital that the company may make.

If a company has no individual shareholders it will not have a controlling individual.

If you have any queries in relation to the Small Business CGT concessions please contact your Patison Partners advisor for more information.