The 4 small business CGT concessions are a huge tax concession. They can save our clients a lot of tax, hence money. They can change a life.
The 4 Small Business CGT Concessions
Many small business owners sell their business to provide for their retirement. And the small business CGT concessions will determine what that retirement looks like.
Working this out is the last leg in a long journey. There is a lot of ground to cover beforehand. From the nature and amount of the capital gain over the 50% CGT discount to the basic conditions including the ones for selling an interest in an object company or trust.
If you have worked all this out, you are ready for this part. This is the fun part. This is where you get to count the dollars you can save your client.
4 Concessions
There are four CGT concessions in Div 152 of ITAA97. The small business
- 15-year exemption (Subdiv 152-B)
- 50% reduction (Subdiv 152-C)
- retirement concession (Subdiv 152-D)
- rollover relief (Subdiv 152-E)
They all rely on the same basic conditions. No matter which one you want to claim, you need to pass the same basic conditions.
But past these basic conditions, each of the four concessions is unique. With their own set of additional rules and requirements.
And how you combine these four is important as well. And might result in different tax outcomes.
To keep things simple let’s assume in the following it is just one individual selling a CGT asset and realising a capital gain.
Small Business 15-Year Exemption
The 15-year exemption lives in Subdivision 152-B. It is quite unique in that it exempts the entire capital gain without any cap. It takes priority over the other three exemptions. And it applies before any capital loss offset.
This is what s152-100 looks like if your CGT event doesn’t involve the sale of a share or trust interest:
If you are an individual, you can disregard any capital gain arising from a CGT event if ..you continuously owned the CGT asset for the 15-year period ending just before the CGT event…[and] …either: (i) you are 55 or over at the time of the CGT event and the event happens in connection with your retirement; or (ii) you are permanently incapacitated at the time of the CGT event.
Individual
“If you are an individual…” Think of sole traders or partners in a partnership – owned the asset for at least 15 years, at least 55 years old, ready to retire. Or permanently incapacitated.
There is one trap in this though. The CGT event aka sale must happen in connection with the individual’s retirement or permanent incapacitation. What is or isn’t “in connection with your retirement” is often a point of contention though.
Rollovers
Section 152-115 provides that certain rollovers will not interrupt the 15-year period. Examples are a marriage breakdown, compulsory acquisition, loss or destruction rollover. However, most CGT rollover events will break the 15-year ownership requirement. So check how your client acquired the asset.
In Connection With Your Retirement
Whether a CGT event happens in connection with an individual’s retirement or not is a contentious issue. It depends on each case, and hence there is no black and white answer but a lot of grey.
The ATO wants to see “at least a significant reduction in the number of hours the individual works or a significant change in the nature of their present activities to be regarded as a retirement. However, it isn’t necessary for there to be a permanent and everlasting retirement from the workforce.”
Example # 1 – Change to Few Hours
Nick (62) sells his small business. The new owner employs Nick for a few hours each week over two years. The sale of the business is in connection with Nick’s retirement.
Example # 2 – Change to Less Hours
Liam (65) runs two laundries. He sells one and reduces his working hours from 60 to 40 hours per week. There is no retirement.
Example # 3 – Spouse Retires
Bob (62) and Sally run two grocery stores. They sell one. Bob stops working and Sally continues running the second store. The sale is in connection with Bob’s retirement.
Example # 4 – Sale Before Retirement
Hannah (65) sells some business assets ahead of selling the business 6 months later. If the earlier CGT event was integral to Hannah’s plan to retire, the CGT event probably happens in connection with her retirement.
Example # 5 – Sale After Retirement
Peter (68) retires and his children take over the business. They sell some business assets 6 months later.
Here is the ATO on this one, “Several reasons may have prompted the sale of the assets. If there is no relevant connection with the small business operator’s retirement, the requirement would not be satisfied.
However, if it can be shown that the reason for the disposal of the assets is connected to retirement and the later sale is integral to the small business operator’s retirement plan, the sale may be accepted as happening in connection with retirement.”
Priority concession
The 15-year exemption is a priority concession. If the taxpayer qualifies for this one, it can’t apply the other concessions. But we haven’t seen a taxpayer yet, where this worked to their disadvantage.
This exemption means the entire capital gain is tax free. So you don’t need another concession. And you don’t even have to first apply any capital losses you might have. Why would anybody not choose this one?
While subdivision 152-B is a priority concession, the other concession are a matter of choice.
Method Statement
The 15-year exemption didn’t require you to first apply capital losses or the 50% CGT discount. So you didn’t have to run through the method statement in s102-5. But the other three concessions are not that generous. So you need to run through the method statement under s 102-5:
You offset current year capital losses and unapplied net capital losses against capital gains in the most beneficial order.
You then reduce any remaining capital gain by the CGT discount set out in Div 115 (generally 50%) if taxpayer is eligible.
And only then do you apply some or all of the other three small business concessions (Subdiv 152-C, 152-D and 152-E) against any remaining gain.
The Small Business 50% Reduction
The 50% reduction lives in Subdiv 152-C. And is an additional discount to the 50% CGT discount in Div 115.
50% CGT Discount
It starts with the 50% CGT discount in Div 115. Individuals and trusts can apply a 50% CGT discount under Div 115. Complying superannuation funds get a 33 1/3 % discount. Always provided that the asset has been held for 12 months.
50% Reduction
Subdivision 152-C provides a further 50% reduction for small business when they meet the basic conditions. This reduction applies to the reduced capital gain after the Div 115 discount.
The 50% reduction is a matter of choice. You can decline it. And go straight to the retirement exemption or rollover relief. And you can choose in which order these apply.
None of all this is relevant if the Subdiv 152-B exemption (15-year exemption) applies. In that case there is no longer a capital gain to worry about (s 152-215).
Small Business Retirement Exemption
This exemption lives in Subdiv 152-D. An entity may choose to disregard a capital gain from a small business CGT asset under the retirement concession. A lifetime limit of $500,000 applies to this concession.
You can skip the 50% reduction and just apply this concession. It is also possible to choose the small business rollover concession in conjunction with the retirement exemption.
If an individual chooses the small business retirement exemption, the part of the capital gain equal to the CGT to the exempt amount is disregarded – see s 152-310(1).
No Need To Retire
The taxpayer does not need to retire to access the concession. This concession is not about retirement. But to get more money into super when the taxpayer is under 55.
Contribution to Super
If an individual chooses the retirement exemption and is under 55 years of age just before making the choice, they must contribute an amount equal to the CGT exempt amount to a complying superannuation fund or RSA. The contribution is due at the time of making the choise or if it is later when receiving the capital proceeds.
Small Business Rollover Relief
The small business rollover relief in Subdiv 152-E allows a taxpayer to defer capital gains from small business assets for at least two years or beyond two years if they acquire a replacement active asset or incur capital expenditure on active assets.
A taxpayer can mix and match this relief with the retirement exemption. The relief is a matter of choice.
The rollover is available if the basic conditions for small business CGT relief are satisfied and a choice is made for rollover relief in respect of all part of a capital gain. If a choice is made, the amount of the capital gain chosen for rollover relief is disregarded (s 152-415).
Replacement Asset
Replacement active assets must be acquired or capital expenditure incurred in relation to an active asset which falls within the fourth element of the cost base, within the period commencing one year before and ending two years after the happening of the last CGT event in the income year for which small business rollover relief is claimed.
No Replacement Asset
If a replacement asset is not acquired, or the expenditure is not incurred within this period, or the asset that acquired within this period is not an active asset at the end of the two years mentioned (or later period allowed by the Commissioner), then CGT event J5 will happen at the end of that replacement asset period (which ends two years after the original CGT event) and a capital gain equal to the capital gain rolled over will be made in the income year in which that period ends (s 104-197).
CGT Event J6
If the amount of the capital gain rolled over exceeds the amount of the cost of acquisition (and incidental acquisition costs) of a replacement asset and the amount of any eligible fourth element expenditure, CGT event J6 will happen at the end of the replacement asset period mentioned and a capital gain equal to the excess will be made in the income year in which the period ends (s 152-198).
Capital Gains
To the extent the rolled over capital gain is not brought to account under CGT event J5 or J6, it will be crystallised and brought to tax after the end of the replacement asset period by the happening of CGT event J2 when a CGT event happens to the replacement asset or its status is changed in particular ways under s 104-185.
In addition, a separate capital gain in respect to the replacement asset may subsequently be realised when a CGT event happens to the replacement asset.
A capital gain made from the happening of CGT event J5 or J6 can only qualify for retirement relief. A capital gain made from the happening of CGT event J2 can qualify for retirement relief and/or rollover relief.
Section 152-305(4) overcomes a previous technical problem that there was no actual asset that could satisfy the basic condition in s 152-10 that a CGT event has happened to a CGT asset.
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