The small business capital gains tax (CGT) concessions are a set of tax provisions that allow eligible small business owners to pay less tax on capital gains they make on the sale of certain business assets. To be eligible for these concessions, a business must meet certain criteria, including having an aggregated annual turnover of less than $10 million and satisfying the “maximum net asset value test.” The concessions can provide significant tax savings for small business owners, but it is important to carefully consider the rules and seek professional advice to ensure that the concessions are applied correctly. Some tips for navigating the small business CGT concessions include keeping good records, obtaining a valuation of the assets being sold, and seeking professional tax advice.
Remember your spouse’s and children’s birthdays…and that they are no longer automatically your affiliates.
Determining whether a person is an “affiliate” is important in several contexts related to small business capital gains tax (CGT) concessions, including when applying the:
- Maximum net asset value test
- Small business test
- Active asset test
Since 1 July 2007, an individual or company is considered an affiliate if they act (or could reasonably be expected to act) in accordance with your directions or wishes, or in concert with you, in relation to the affairs of their business. It’s important to note that an individual or company can only be an affiliate if they are carrying on a business. Trusts and superannuation funds, however, cannot be affiliates. A person is more likely to be considered an affiliate if there is a close family relationship between them and a lack of formal agreement dictating how they should act. However, an individual or company is not considered an affiliate simply because of their business relationship. In The Taxpayer v FCT, the Administrative Appeals Tribunal rejected the argument that one of the directors of the taxpayer (and the son of the controller) was a small business affiliate of the company. The tribunal found that the son’s actions could be explained by their position as a director and employee of the taxpayer.
- Connected Entities
Consider whether the beneficiaries can sense a pattern.
Here are the key points to consider when determining whether an entity is connected with another entity in the context of small business CGT concessions:
- Connection depends on “control” – whether one entity controls the other, or both entities are controlled by a common third entity.
- A “control percentage” is generally 40% or more (subject to the Commissioner’s discretion when the percentage is between 40% and 50%).
- In the case of a discretionary trust, control can be established through influence over the trustee or through the “pattern of distributions” rule.
- Control can only be established in the year after a sufficient distribution (of 40% or more) is made – not in the year of the distribution.
- Once a beneficiary has received sufficient distribution, they will be connected to the trust for the next four years.
- If a discretionary trust does not make a distribution in an income year, the trustee may nominate up to four beneficiaries as controllers of the trust.
- A special rule exists to ensure that exempt entities or deductible gift recipients do not control the trust under the pattern of distributions control rule. (Contd.)
As mentioned above, an entity with significant influence over a trustee can be found to have control over the discretionary trust. An entity controls a discretionary trust (and is therefore connected to it), if the trustee of the trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of that entity and/or their affiliates. This definition shares similarities with but is broader than, the definition of affiliate discussed in tip 1.
Some factors that may be relevant in determining whether an entity has influence over the trustee of a discretionary trust include:
- The way in which the trustee has acted in the past
- The relationship between the entity and the trustee
- The amount of any property or services transferred to the trust by the entity
- Any arrangement or understanding between the entities and a person or persons who have benefited under the trust in the past
Previously, the Australian Taxation Office (ATO) took the view that the appointor of a discretionary trust (with the right to appoint and remove trustees) did not automatically control the trust under this particular test. However, this is no longer the case. The application of this control rule was considered in the case of Gutteridge v FCT, in which the question was whether the daughter of Mr Gutteridge controlled the trust under the influence test. While the daughter was the sole director and shareholder of the trustee, the evidence showed that she was simply a figurehead who rubber-stamped decisions made by her father. As a result, the Administrative Appeals Tribunal (AAT) held that the father, not the daughter, controlled the trust. This case illustrates that substance should be given precedence over form – even to the extent that a sole director and shareholder of a trustee cannot be said to automatically exert significant influence over that trustee. (Contd.)
- Significant Individuals
Trying for a better class of shareholders can lead to significant problems.
There are numerous aspects of the small business capital gains tax (CGT) concessions where it is important to have a “significant individual” and/or a “CGT concession stakeholder.” In general, a significant individual in a company or trust is someone who has a “small business participation percentage” of 20% or more. A CGT concession stakeholder is a significant individual or the spouse of a significant individual who has a small business participation percentage greater than zero. Therefore, understanding the concept of small business participation percentage is crucial. This percentage is the lowest percentage of the individual’s direct and indirect:
- Voting power in the company
- Entitlement to any dividend that the company may pay
- Entitlement to any distribution of capital that the company may make
If a company has different classes of shares and the discretion to pay a dividend to one class of shareholder to the exclusion of another, no shareholder can be said to have an entitlement to any dividend that the company may pay. This means that the company will not have a significant individual or a CGT concession stakeholder. While it may be beneficial to stream dividends to certain shareholders (e.g. those on lower income levels), creating different classes of shares should only be done with caution if it is anticipated that the small business CGT concessions will be accessed. At a minimum, the benefits should be weighed against the potential costs.
- 15-Year Exemption
Know when it is time to go.
Here are the key points to consider when determining whether an individual qualifies for the small business 15-year exemption:
- The individual must be 55 years or older when the CGT event occurs
- The CGT event must happen in relation to their retirement
- Retirement must involve at a minimum a significant reduction in the number of hours the individual works or a significant change in the nature of their activities
- If the individual agrees to stay on in the business for a transitional period after a sale, they should be careful to ensure that this does not jeopardize their access to the 15-year exemption. If the transitional period is less than six months, access to the exemption should not be at risk.