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CAPITAL GAINS TAX (CGT) CONCESSIONS FOR SMALL BUSINESS – TIPS TO OVERCOME COMMON MISTAKES

INTRODUCTION

Various CGT concessions are available to reduce the impact of capital gains tax when small businesses dispose of CGT assets such as their business or a business asset.

The most common CGT assets are:

  • Land and buildings
  • Shares in a company
  • Units in a unit trust.

Less common CGT assets include:

  • Contractual rights
  • Options
  • Foreign currency
  • Leases
  • Licences
  • Goodwill.

KEY POINTS

The maximum net asset value test

A common mistake taxpayers make is not meeting one of the basic conditions for entitlement to these concessions – the maximum net asset value test.

From the 2007-08 income year, to pass this test, the total net value of CGT assets just before the CGT event must not exceed $6 million. The net value of CGT assets must be included for all of the following:

  • The entity that had the CGT event – that is the test entity
  • Any entities connected with the test entity
  • Any entities that are affiliates of the test entity
  • Entities connected with the affiliates.

This does not include and asset already counted for entities that are connected with the test entity.

For your clients to pass the maximum net asset value test you need to:

  • Correctly value assets, including property, shares and, goodwill
  • Use the asset’s market value, not the historical value or cost of the asset
  • The test includes all assets held by your client, including the asset that was sold and any goodwill of the business
  • Correctly identify entities that are affiliates of your client, or are connected with your client or client’s affiliates (relevant entities)
  • Include in the test all assets of relevant entities, regardless of whether they are used or not in your client’s business. However, do not include shares, units or other interests (apart from debt) held in any entities connected with your client or client’s affiliates because the net value of the CGT assets of connected entities has already been included
  • Include in the test any assets held by our client’s affiliates or entities connected with the affiliates, used or held ready for use in your client’s business, or in the business of their connected entity. However, do not include an asset if it is used in the business of an entity that is connected with your client only through your client’s affiliate
  • Use the market value of the assets held by an affiliate of your client or by an entity connected with your client or client’s affiliates, just before the CGT event occurred.

Your client can only exclude assets that are both of the following:

  • Owned by their affiliates or entities connected with their affiliates
  • Not used or held ready for use in their business or the business of a connected entity.

The small business entity test

This test is another basic condition taxpayers must satisfy in order to qualify for the small business CGT concessions. One of the key elements of this test is to work out if the taxpayer is classified as a small business entity for the current year using the aggregated turnover test of less than $2 million.

Using your client’s aggregated turnover, you can work out if your business client is a small business entity for the current income year using one of the following three methods:

  • Use their aggregated turnover for the previous income year
  • Estimate their aggregated turnover for the current income year worked out as at the
  • Beginning of the income year
  • Time your client starts their business, if your client is staring a business part way through the year
  • Use their actual aggregated turnover for the current income year as at the end of the current year.

Active asset test

Taxpayers often fail to satisfy this test by miscalculating the periods in which the asset was an active asset. When considering this test, remember:

  • The asset sold must be an active asset for a certain period of ownership – in most cases, this is half the period of ownership
  • There are strict rules around whether company shares and units in trust are active assets – often taxpayers fail to correctly calculate the 80% test or provide insufficient information to confirm the test is met for the required time period
  • Most CGT assets used mainly to derive rent are specifically excluded from being active assets
  • Properties rented to third parties that are not an affiliate of or connected with that property owner should not be classified as active assets.

Earn-out arrangements

Often, the sale of a business includes a clause for further payments to be made in respect of future earnings. The market value of rights to further payments (referred to as earn-out rights) must be included in the capital proceeds of the CGT event A1.

  • For more information about the CGT consequences of these types of arrangements, refer to Draft Taxation Ruling TR 2007/D10.

Settlement date versus contract date

You should apply any CGT concessions applicable at the time the contract was signed, not at the settlement date.

For disposals of assets (CGT event A1), the CGT event occurs when the disposal contract is signed.

Where the settlement date is in a different financial year to the date the contract was signed, declare the capital gains in the financial year when the contract was signed.

Applying capital losses

You must apply capital losses in the correct order, except where the 15-year exemption applies. Where the 15-year exemption does not apply, you should:

  1. Work out the capital gain for the year
  2. Deduct the capital losses you are bringing forward form the current year and any previous years if applicable
  3. Apply the CGT discount if applicable
  4. Apply the concessions, apart from the small business 15-year exemption.

If the small business 15-year exemption applies, do not reduce the capital gain by any capital losses before you apply that concession.

In all other cases, apply the CGT discount and the small business concessions to the capital gain after you have reduced it by any current and earlier year capital losses.

If your client has more than one capital gain, you can choose the order in which you reduce capital gains by capital losses.

WHAT YOU NEED TO DO

Ensure that they keep records:

  • Of everything that may be relevant to working out whether they have made a capital gain or loss from a CGT event
  • For at least five years after you sell or otherwise dispose of an asset, unless you keep an asset register.

If they have applied a net capital loss, you should generally keep records of the CGT event that resulted in the loss for four years from the income year when the net capital loss is fully applied.

MORE INFORMATION

For more information, refer to:

  • Capital gains tax (CGT) concessions for small business – overview
  • Guide to capital gains tax concessions for small business 2008-09
  • Advanced guide to capital gains tax concessions for small business 2008-09.

To access these publications, visit our website at ww.ato.gov.au and select: Business – Tax topics A-Z – A-C – Capital gains tax (CGT) – Small business concessions.

Source: Tax Practitioner Seminar – June 2010

 
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CAPITAL GAINS TAX (CGT) CONCESSIONS FOR SMALL BUSINESS – TIPS TO OVERCOME COMMON MISTAKES
  25 January 2011
Always tricky.

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