+ CGT Issues on Sale of Business

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CGT Issues on Sale of Business

Amora Hotel Jamison, 11 Jamison Street, Sydney

30 November 2006

Prepared and presented by Leigh Adams

Principal,  Leigh Adams Lawyers

Capital Gains Tax and the Small Business Concession

There are four concessions that allow small businesses to reduce or eliminate any capital gains tax arising from the sale of a business. The concessions are:

1. the fifteen year exemption;
2. the fifty per cent active asset reduction;
3. the retirement exemption; and
4. the rollover.

Before a small business is entitled to any of the CGT small business concessions, it must satisfy a number of basic conditions. This paper will briefly describe those   basic conditions.

Basic Conditions for Relief

The basic conditions to be met are:

1. a CGT event happens in relation to an asset that the tax payer owns;
2. the event would otherwise have resulted in a capital gain;
3. the maximum net asset value test is satisfied; and
4. the asset is an active asset.

If the asset is a share in a company or an interest in a trust, then further provisions apply and they are discussed briefly at the end of this paper.

Maximum Net Asset Value Test

There is a $5 million limit on the net value of the assets of the tax   payer – s. 152 – 15 of the Income Tax Assessment Act 1997 (ITAA 1997). The net value of the assets of (i) the tax payer’s small business CGT affiliates (a term referred to below) and (ii) entities connected with them, also count toward the $5 million limit.

The maximum net asset value test applies just before the time of the CGT event. 

Small Business CGT Affiliates

Small business CGT affiliate means the tax payer’s spouse or child under 18 years or a person who acts or could reasonably be expected to act in accordance with the tax payer’s directions or wishes or in concert with the tax payer (s. 152 – 25 ITAA 1997).

However, a partner in a partnership in which the tax payer is a partner is not a small business CGT affiliate only because the partner acts in concert with the tax payer in relation to the affairs of the partnership.

Working out the net value

The net value of the assets is the amount by which the market value of those assets exceeds the liabilities relating to those assets – s. 152-20 ITAA 1997.

In addition, in the case of an individual, the net value does not include:

i)                assets being used solely for the personal use and enjoyment of the tax payer or for the small business CGT affiliate;

ii)              the ownership interest in a dwelling where the dwelling is used to produce assessable income to any extent but no interest deductions on related borrowings are allowable – in other words, the tax payer’s residence in his name;

iii)            a right to any allowance or capital amount payable out of a superannuation fund;

iv)             a right to any asset of a superannuation fund;

v)               a life insurance policy.

In addition, a third group of assets which are ignored when working out the net value of the assets of a small business CGT affiliate or connected entity, is assets that are not used or held ready for use in carrying on a business that the tax payer carries on.

Connected Entities

Entities are connected to one another if one controls the other or if they are both controlled by another entity – s. 152-30 ITAA 1997. Control is generally deemed to apply if 40 per cent or more of ownership rights are held. Control may be either direct or indirect.

The Active Asset Test

The issue of determining whether an asset is an active asset is to be considered just before exchange of contracts – s. 152-35 ITAA 1997. In addition, the asset must also have been an active asset for more than half the period of the tax payer’s ownership. An asset is an active asset if it is owned by the tax payer and used or held ready for use by the tax payer, or by a small business CGT affiliate or by a connected entity in the course of carrying on the business. An example is plant machinery or the factory of a manufacturing company. Alternatively, it can include an intangible asset inherently connected with the business such as goodwill or the benefit of a restrictive covenant – s. 152-40 ITAA 1997.

A share in a resident company is an active asset at a given time if the tax payer owns the share and the total of:

(i) the market value of the company’s active assets; and

(ii) any capital proceeds that the company received during the two years before that time from the disposal of any of its active assets, which the company holds in the form of cash or debt;

is 80 per cent or more of the market value of all the company’s assets.

Where the active asset is a share in a company or an interest in a trust

(i) Controlling individual test for companies and trusts

An additional basic requirement for a company or trust is that it must have at least one controlling individual just before the CGT event – s.152-50 ITAA 1997.

A controlling individual is one who has shares in the company (other than redeemable shares) that have rights to (i) at least 50 per cent of the voting power and (ii) at least 50 per cent of any dividends or capital distribution – s.152-55 ITAA 1997.

The controlling individual of a fixed trust is an individual who has entitlement to at least 50 per cent of the income and capital of the trust.

A tax payer is a controlling individual of a non-fixed trust if, during the income year in which the CGT event occurs, the trust made a distribution of income or capital or both and the individual was beneficially entitled to at least 50 per cent of the total distribution of income and of capital made by the trust during the income year.

There is a proposal before Parliament to reduce the applicable percentage for both companies and trusts to 20%, but this is not law at the time of writing.

(ii) CGT Concession Stakeholder

A controlling individual of a company or trust is a CGT concession stakeholder – s.152-60 ITAA 1997.

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