When you sell a share in a company or an interest in a trust and aim to qualify for the small business CGT concessions, you need a CGT concessional stakeholder and possibly also a small business participation percentage of at least 90%.
The new rules that apply retrospectively from 2 February 2018 don’t change that. They just add more rules, but this basic rule stilll stands.
Small Business Participation Percentage
You sold a CGT asset. You passed the turnover test or the maximum net asset value test. And the CGT asset qualifies as an active asset. So you have pretty much ticked off all basic conditions for claiming the small business CGT concessions.
There is just one small fact that changes everything. The CGT asset you just sold is a parcel of shares or units. So s152- 10 (2) throws this at you:
s152-10 (2):…(d) just before the CGT event, either:
(i) you are a CGT concession stakeholder in the object entity; or
(ii) CGT concession stakeholders in the object entity together have a small business participation percentage in you of at least 90%.
There are two different scenarios – (i) and (ii).
The first scenario – described in (i) – is about an individual selling an interest in an object entity.
The second scenario – described in (ii) – is about a non-individual – as in a company or trust – selling an interest in another company or trust (the object entity).
And for either scenario individuals need to have a certain small business participation percentage.
# 1 Individual Selling
The first scenario in (i) is about an individual selling their interest in the object entity. It requires this individual to be a CGT concession stakeholder in the object entity. The object company or trust is the one they just sold.
s152-10 (2):…(d) just before the CGT event…(i) you are a CGT concession stakeholder in the object entity…
The legislator addresses this to ‘you’ as the individual who sold the interest. So this could be you, your client or a hypothetical taxpayer.
As long as ‘you’ hold at least 20% of the voting and distribution rights in the object company or trust, you are a CGT concession stakeholder. And hence pass this test.
Only an individual can be a CGT concession stakeholder so this first limb only applies when it is an individual who owns and then sells the interest. It doesn’t apply to a company or trust selling an interest they hold in another company or trust.
# 2 Non-Individual Selling
So what happens if it is a company or trust selling the interest in the object entity? If the individual used an interposed entity that actually owned the company or trust?
Concept
The small business CGT concessions are to support individual small business owners, not companies or trusts as such. But at the same time small business owners should be free to organise their affairs the way they see best. So if that means using companies or trusts, then they shouldn’t miss out for doing that.
So for this reason there is (ii). It allows small business owners to still claim the small business CGT concessions even if they use an interposed entity.
s152-10 (2):…(d) just before the CGT event…(ii) CGT concession stakeholders in the object entity together have a small business participation percentage in you of at least 90%.
So there is the ‘you’ again. But this time ‘you’ isn’t the CGT concession stakeholder. Instead ‘you’ is the interposed entity that actually sold the interest.
Tracing Back to Individuals
The rule in (ii) traces the object company or trust back to the individual CGT concession stakeholders. Since they are the ones the concessions are meant for. And it sets two conditions:
1) An individual needs to hold at least 20% in the object entity (any spouse > 0%) and hence be CGT concession stakeholders. So we need to trace their holdings through any interposed entities down to the actual object entity that got sold.
2) These individuals need to hold a small business participation percentage of at least 90% in the interposed entity that sold the interest.
So to work this one out you need to determine the small business participation percentage for two entities – the object entity and the interposed entity.
Example # 1
You are the beneficiary of a discretionary trust, receiving 50% of the trust’s distributions every year. This trust used to own and now sold all the shares in a company, the object company. And made a capital gain.
The trust would like to claim the small business CGT concession. But the trust isn’t a CGT concession stakeholder in the company – it can’t, only an individual can – and so doesn’t pass (i).
You are a CGT concession stakeholder in the object company. You could satisfy (i). But you are not the one who sold the shares and made the capital gain. You can’t claim a concession for a capital gain you didn’t make. So (i) doesn’t apply to you.
This is where (ii) kicks in. You are a CGT concession stakeholder in the company since your small business participation percentage in the object company is 50%. So you meet the first limb of (ii).
You receive 50% of the trust distributions. So your small business participation percentage in the trust is 50%. That’s not enough for the second limb of (ii), which requires 90%.
But you have a spouse. And this spouse receives the other 50% of the trust distribution every year. So your spouse is also a CGT concession stakeholder in the object company. And your spouse has a small business participation percentage of 50% in the trust.
So you are both CGT concession stakeholders in the object company (first limb in (i)) and together you have a small business participation percentage of at least 90% in the interposed trust (second limb in (ii)).
Example # 2
Two discretionary trusts (D1 and D2) hold the units of a unit trust (U). D1 sells their units and makes a capital gain. D1 claims the 50% CGT discount and would also like to claim the small business CGT concessions.
There is just one problem. D1 is not a CGT concession stakeholder in U1. D1 is a trust, not an individual and only an individual can be a CGT concession stakeholder. So it can’t pass s152-10 (2) (d) (i).
But what about s152-10 (2) (d) (ii)? It all depends on the distributions D1 makes in the year of the CGT event.
If 90% of D1’s distributions of income and capital went to one individual, that individual would hold a small business participation percentage in D1 of 90% and a small business participation percentage in U1 of 45% (90% x 50% = 45%). So D1 would pass both conditions in (ii).
If D1 distributes 90% to 2 individuals in equal shares, these two will hold 90% in D1 and 22.5% each in U1. So D1 would still pass both conditions and meet the basic conditions.
But if D1 distributes to 4 individuals in equal shares, each would hold 25% in D1, but only hold 12.5% in U1, not enough to be a CGT concession stakeholder in U1. So D1 could no longer pass (ii) and hence would fail the basic conditions.
Example # 3
Five discretionary trusts D1 to D5 have an equal interest in the object unit trust U1. Again D1 sells its units in U1. And again D1 distributes 90% to an individual. But this time D1 wouldn’t pass the second limb, since the individual would only have a small business participation percentage of 18% in the object trust U1 (90% x 20% = 18%).
Conclusion
So selling an interest in an object entity is a numbers’ game. It comes down to the small business participation percentage. They either pass the 20% and 90% thresholds or they don’t. There are other conditions to pass as well, but this is how you start. This is the concept.
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Small Business CGT Concessions
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