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Self Managed Super Fund (SMSF) Article
Small Business CGT Exemptions - Part 1
By Tony Negline.
This article may be out of date.
30th August 2006
Small business owners have traditionally saved for retirement by investing in their businesses. They frequently leave profits in a business or take reduced salaries so the enterprise can expand.
As part of its 1996 election campaign, the then federal Opposition went to that election with a policy of providing capital gains tax (CGT) concessions.
The policy was legislated in 1997. The most recent changes were announced in the May budget and the latest amendments began on July 1. However, legislation implementing them has not yet passed.
Small business CGT exemptions are a powerful way to improve the benefits of investing in a small business.
Confusion about the rules often occurs due to the varied ways business can be conducted.
There are four common ways small businesses can be structured:
- Self-employed with some assets owned personally. Often some assets are owned by a trust - unit, discretionary or super fund - or a company
- Partnership, again with most assets owned personally. And a trust - unit, discretionary or super fund - or a company may also be involved
- Trust operation - the business is through a trust, typically a discretionary trust assets may be owned by that trust, by individuals, or by other trusts
- Company operation - assets may be owned by the company or related trusts or by individuals themselves.
The question that has to be answered is how small business CGT concessions are used in relation to all these structures.
A key question is: what is actually being sold?
For example, is an actual asset - for example, a business premises - being sold or the entity which owns the asset being sold? It has become increasingly common for the actual assets to be sold.
However, some decide to purchase the operating entity, though this has litigation risks.
There are four small business CGT concessions:
- A 15-year exemption
- The 50 per cent active asset reduction
- Retirement exemption
- Replacement asset concession.
There are common qualifying rules and then each concession has its own eligibility requirements.
The 15-year exemption takes priority. This allows a business asset owned for 15 years or more to be sold CGT free. The exemption applies before you deduct capital losses and before applying other concessions (such as the normal 50 per cent discount).
Further, you apply it before taking into account losses or general CGT discounts (note that the 50 per cent discount is only for non-super trusts and individuals). You cannot use the 15-year concession if an asset has been depreciated.
The 15-year exemption can only be used when a shareholder is retiring or permanently incapacitated and the money is paid out as cash. Assuming a recipient would prefer to put these proceeds into super, big problems can arise if the contribution is more than the new limit on undeducted contributions ($150,000 a year or $450,000 in advance).
Once you have used the 15-year exemption you must use all available capital losses, before applying CGT discounts and other small business concessions.
The remaining small business CGT concessions can be used in whatever order produces the desired result.
For example, the retirement concession allows a person to roll money into super, but a problem is some trust deeds cannot accept this rollover.
The following rules must be satisfied before small business CGT concessions can be applied:
- An asset has been sold or is no longer used in a business
- The "maximum net asset value" is satisfied
- The asset is an "active asset"
- If the asset is a share in a company or interest in a trust, then the company or trust must satisfy the "controlling individual" test and the entity claiming the concession is a "CGT concession stakeholder".
Each of these terms has specific definitions and it is important to understand the fine detail of what is required.
Recently, the ATO released some information detailing common problems people have in claiming concessions:
- Many taxpayers enter transactions before seeking advice on the tax consequences, and then have to manipulate their business affairs to minimise a capital gain or obtain a concession
- Some small businesses confuse the CGT record-keeping requirements with general record-keeping requirements. This mistake may leave these taxpayers unable to substantiate their capital gain, cost base or capital-loss claim
- Incorrect calculations for the small business concession net asset value test are often caused by taxpayers using historical cost instead of market value just before disposal
- Eligibility requirements for small business concessions (especially the retirement exemption and the active asset reduction concession) are not understood.
The best approach is to get advice well before acting.
This email is general in nature only and does not constitute or convey specific or professional advice. Legislation changes may occur quickly. Formal advice should be sought before acting in any of the areas discussed. Be aware that the information in these articles may become innaccurate with time. Responsibility is disclaimed for any inaccuracies, errors or omissions. Particular investments are neither invited nor recommended and hence this publication is not "financial product advice" as defined in Section 766B of the above legislation. All expressions of opinion by contributors are published on the basis that they are not to be regarded as expressing the official opinion of any other person or entity unless expressly stated. No responsibility for the accuracy of the opinions or information contained in the contributor's articles is accepted by any other person or entity. Copyright: This publication is copyright. If you wish to reproduce this article you require a license, which can be purchased here, to do so.