How do the small business CGT concessions in an asset sale actually work out? Let’s go through an example.
CGT Concessions in an Asset Sale
We started with a really complicated example. Numbers flying around left, right and centre. But then we stopped and realised that it is more important to understand the concept than adding up long lines of numbers.
So we toned it down. Rather than hitting you with all the numbers up front, we will drip feed them to you as we go and keep it simple.
Let’s say you started a company on 1 July 2005 and put all shares into a family trust who only distributes to you. You now sell all assets for $3m as of 30 June 2019. You wanted a share sale but the buyer insisted on an asset sale, so an asset sale it is.
Income Provisions
When you do an asset sale, not everything is CGT. Quite a few assets will fall under the income provisions. Trading stock, plant and equipment, patents and receivables, for example. These are taxed under Div 70 and 40 and specifically excluded from CGT under s118-25 and s118-24 ITAA97.
Other assets fall under the income provisions and are hence taken out of the CGT provisions through the general over-lap rule in s118-20.
Which is not great for you. You want assets to fall under the CGT provisions. The CGT provisions give you the 50% CGT discount (unless it is a company selling) and the small business CGT concessions. The income provisions give you nothing. So you would choose CGT over income any time unless you make a loss. But you don’t have a choice. It is what it is.
So here are your assets on revenue account:
Trading stock at cost $ 300,000 – MV $400,000
Plant & Equipment at written down value $200,000 – MV $100,000
Patents at cost $200,000 – MV $700,000 – earning a foreign royalty
Trade debtors at cost $ 200,000 – MV $ 100,000
So you make a profit of $400,000 and pay tax on this without any concessions or discounts.
CGT Provisions
So this leaves you with assets that fall under the CGT provisions. Examples are goodwill, land, trademarks. When a company started post CGT (20 September 1985), all company assets are post-CGT. A CGT event, usually CGT event A1, occurs resulting in a capital gain or loss. Goodwill is intrinsically derived and usually has no cost base.
You received $3m, of which $1.3m covered the market value of assets under income provisions. That leaves $1.7m for assets under the CGT provisions. Let’s say in your case these have a cost base of $0.7m, leaving you with a $1m capital gain.
Assets sitting in a company don’t get the 50% CGT discount when sold. That is one of severals disadvantage of operating out of a company.
The only chance you have to reduce a capital gain in a company is to qualify for the small business CGT concessions.
So over to Subdiv 152-A. You already got the CGT assets, the CGT event and the capital gain, so you just need to pass the turnover test or the maximum net asset value test as well as the active asset test.
Affiliates
You start with pegging out the area. Do you have any associates per s328-150? People you tell what to do in their business? Not in yours but in theirs?
Let’s assume that in your case there aren’t any.
Connected entities
Next come the connected entities. Anybody holding more than 40% in voting rights, rights to income or capital is a connected entity.
In your case the family trust holds 100% of the shares in your company and you receive all the distributions from the family trust. That makes you all connected – the company, the trust and you.
Small Business Entity Turnover Test
The threshold is $2m. One cent more in aggregated turnover and the company is out. Don’t forget to throw affiliates and connected entities into the pot.
In your case let’s assume the company’s turnover is already over $2m, so no need to even look at affiliates and connected entities. You are already out.
Maximum Net Asset Value Test
The threshold is $6m. Again you include affiliates and connected entities.
Remember to include all CGT assets, not just the ones falling under the CGT provisions. So you include trading stock, plant & equipment, receivables and so on, even though they fall under the income provisions.
Deduct all liabilities related to these assets. For example trade creditors, provision for employee entitlements, tax provisions and any bank loan to provide working capital, even the refinancing of such a bank loan per TD 2007/4 and Bell and FCT [2012] AATA45.
You exclude any shares in connected entities, since you already include the assets in those connected entities. You also exclude a private residence, any superannuation accounts and assets held for private use and enjoyment per s152-20 (2) (b). But you don’t exclude investment properties.
So in your case you exclude the shares in your company held by your family trust, since you already listed your company’s assets. You exclude your home, your SMSF and your beach house in Portsea. You deducted any related liabilities. And then passed the maximum net asset value test.
Unpaid Present Entitlements
Let’s do a quick detour to unpaid present entitlements (UPE). Whenever a trust is involved, you usually have one somewhere.
A UPE is a CGT asset. So you need to include it in any maximum net asset value calculation.
In layman’s terms think of a UPE as a liability on the trust side and a receivable on the beneficiary side. So when trust and beneficiary are both included in your MNAV calculation, the liability and receivable offset each other. When they are not, you recognise one side or the other. This is the essence of it.
TR 2015/4 explains all this in a more sophisticated (and confusing) way. It usually involves moving the UPE to a subtrust. But in the end it all comes down to offset or no offset.
Active Asset Test
The CGT assets the company is selling need to be active assets per 152-40 (1). So we are back to actual CGT assets. No more trading stock and the lot.
And it is back to just the CGT assets being sold,. No more affiliates and connected entities either.
Goodwill is inherently connected with a business per definition.
So in your case it is goodwill and a trademark which you use in your business. So your CGT assets pass the active asset test.
CGT concession stakeholder
The small business CGT concessions are to support small business owners. Not companies or trusts. So if it is a company or trust selling the asset, s152-20(2) wants to trace the company or trust back to the individuals. Only individuals as in natural living people can be CGT concession stakeholders.
So we need to look at you. You are the only one receiving distributions from the family trust. So you have a small business participation percentage in the family trust of 100%. The trust holds 100% of the shares, so you also have a small participation percentage in the company of 100%, because 100% x 100% is 100%.
This is the last hurdle of the basic conditions. Once you pass this one, and in your case you do, you have passed the basic conditions – in an asset sale. It is time to look at the actual concessions.
Specific conditions
The 15-year exemption in Subdiv 152-B is the most generous, but also the hardest to pass.
In your case the company is selling the assets, so the company must have had a significant individual for at least 15 years, which it didn’t. You started the company in 2005 and sold in 2018 – that’s less than 15 years. So the 15-year exemption in s152-B is out.
The 50% reduction in s152-C is the most straight forward of the four concessions. It has no further strings attached apart from meeting the basic conditions. It is not mandatory to apply the 50% reduction. You could skip it if you wanted to get as much as possible into super through the retirement exemption.
Let’s assume you are not interested in super so you apply this one, reducing your net capital gain to $500,000.
To qualify for the retirement exemption in s152-D you need a significant individual. There is a lifetime cap of $500,000. And if you are under 55, the exempt amount needs to go into super.
The exempt amount paid into super under this exemption doesn’t count towards the $100,000 NCC cap. So you can still make non-concessional contributions, even if you contributed more than $100,000 under this exemption.
And the exempt amount paid into super isn’t hit with 15% contribution tax. But for that it doesn’t go into your tax-free component either.
In your case you are the significant individual and 53. So you can only claim this concession, if you contribute the entire $500,000 into super. But let’s say you don’t want to put more into super. You need the money.
The roll-over exemption in s152-E will come in handy when you to start a new business. And it can buy you time – 2 years to be exact.
You are 53 and hence 2 years away from the age threshold around the retirement exemption. So you claim the rollover exemption to defer and wait two years, by which stage you are 55. You then trigger CGT event J5 resulting in a capital gain and claim the retirement exemption with no requirement to pay the cash into super.
Dividend and Distribution
The company sold the assets. So at the moment the $1m is still sitting in the company plus the $280,000 on the $400,000 profit less 30% tax.. How do we get it into your pockets without triggering tax on the capital gain?
The company pays a $1m unfranked dividend and a 30% franked dividend of $280,000 to the trust. The trust treats the $1m as a capital gain with the relevant Div 152 concessions attached. And then streams the capital gain and the franked dividends plus franking credits to you.
So this is a good outcome. You walk away with $1m in your pocket and no tax bill coming your way. You paid tax on the $400,000 profit from selling assets under the income provisions, but the capital gain is all yours.
If you had sold the shares in the company instead, things would have gotten more complicated. The new basic conditions for the sale of shares or unit would have kicked in. But since you ended up doing an asset sale, those new conditions didn’t touch you.
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