Division 152 – Small business concessions

Division 152 – Small business concessions

Division 152 of the ITAA 1997 brings together all of small business capital gains tax relief’s into one area with a common set of eligibility criteria.

The importance of structuring ownership of assets to qualify for these concessions can not be over-emphasised given that with the division 115 concession it is possible to pay no tax on a qualifying capital gain.

What are the concessions?

There are potentially four small business CGT concessions that may be able to be claimed.

The concessions may allow a taxpayer to receive the entire capital gain tax free.

The concessions are: 15 year concession; 50% reduction; retirement exemption; rollover relief.

The ability of a taxpayer to claim one or more of the small business CGT concessions depends on whether the taxpayer can satisfy all of the eligibility criteria.

What are the eligibility criteria?

The criteria are:

(a) A CGT event happens to a CGT asset of the taxpayer;

(b) The event would have resulted in a capital gain for the taxpayer;

(c) The taxpayer:

(i) Is a small business entity; or

(ii) Satisfies the maximum net asset value test; or

(iii) Is a partner in a partnership that is a small business entity and the CGT asset is an interest in an asset of the partnership; or

(iv) Does not carry on a business and owns a CGT asset that is used in the business of its affiliate or an entity connected with the taxpayer that is a small business entity; or

(v) Is a partner in a partnership that is a small business entity and does not otherwise carry on business and own a CGT asset (which is not a partnership asset) that is used in the business of the partnership.

(d) The CGT asset satisfies the active asset test.

If the capital gain is made in respect of a share in a company or an interest in a trust, then one of the following additional conditions must be satisfied just before the CGT event:

(e) The taxpayer is a CGT concession stakeholder; or

(f) The taxpayer is an entity in which CGT concession stakeholders have a small business participation percentage of at least 90%.

What is a small business entity?

A small business entity is defined in s 328-110 of the ITAA 1997. A taxpayer is a small business entity if the taxpayer carries on a business and satisfies the $2 million aggregated turnover test.

‘Business’ is defined broadly in s 995.1 to include 'any profession, trade, employment, vocation or calling, but does not include occupation as an employee'. ‘Carrying on’ is not defined in the tax law, and so therefore takes its ordinary meaning. However, provisions deem the business to still being carried on if the taxpayer is winding up the business or has stopped carrying on the business in that income year.

A person who is a partner in a partnership in an income year is not, in his or her capacity as a partner, a small business entity for the income year. A partner in a partnership business cannot be regarded as a small business entity. Partners must use the specific eligibility criteria relating to partnerships.

There are three ways an entity can satisfy the $2 million aggregated turnover test, being where the aggregated turnover:

(i) For the previous income year was less than $2 million; or

(ii) For the current income year, worked out as at the first day of the income year, is likely to be less than $2 million; or

(iii) For the current income year, worked out as at the end of the current income year, is actually less than $2 million.

What is aggregated turnover?

Aggregated turnover is defined in s 328-115 of the ITAA 1997. An entity’s aggregated turnover is the sum of the following:

(a) The total ordinary income that the entity derives in the income year in the ordinary course of carrying on business ('annual turnover');

(b) The annual turnover of other entities connected with the entity at any time during the income year; and

(c) The annual turnover of any affiliate of the entity at any time during the income year.

Aggregated turnover does not include amounts derived from dealings between the taxpayer and their connected entities and affiliates.
Ordinary income means income accordingly to ordinary (common law) concepts and excludes statutory income, including capital gains.

What is meant by a reference to 'likely' to be less than $2 million?

A reference to 'likely' means that, on the balance of probabilities, it is more likely than not that the entity’s aggregated turnover will be under $2 million.

Whether for the current income year, the aggregated turnover is likely to be less than $2 million is an objective test. Some factors to consider include:

• The entity’s aggregated turnover in previous income years;
• Exceptional sales or particular product lines last year that will not occur this year;
• Whether the entity is likely to have reduced staff this year;
• Whether the operating hours of the business will decrease;
• Whether any aspect of the location of the business, or its industry, indicates a declining turnover (e.g., if a drought is declared in an area, or if prices in the industry decline); or
• Whether the business will face increased competition.

Source: paragraph 1.28 of the explanatory memorandum to the Tax Laws Amendment (Small Business) Bill 2007.
If the aggregated turnover in each of the previous two income years (worked out as at the end of those years) was greater than $2 million, the entity cannot rely on the likely test: subsection 328-110(3).

What about an entity which starts carrying on a business part way through an income year?

Although the aggregated turnover for the purpose of the 'likely to be less than $2 million' test is worked out as at the first day of the current income year, if the entity starts to carry on a business part way through an income year, then the aggregated turnover is worked out as at the day that the entity starts to carry on the business: subsection 328-110(2). However, for the purpose of the test, the entity will need to calculate what their turnover would have been had the entity carried on the business for the entire income year.

How do you pass the maximum net asset value test?

A taxpayer satisfies the maximum net asset value test after 1 July 2007 if, just before the time of the CGT event (being the time of exchange of contract), the sum of the following amounts does not exceed $6,000,000:

(a) The net value of CGT assets of the taxpayer;

(b) The net value of CGT assets of any entities connected with the taxpayer; and

(c) The net value of the CGT assets of any affiliates of the taxpayer or entities connected with any affiliate of the taxpayer.

How is the active asset test passed?

A CGT asset satisfies the active asset test if the asset is an active asset of the taxpayer. The asset will be an active asset if it satisfies the definition in s 152-35 of the ITAA 1997. A CGT asset satisfies the active asset test if:

(a) The taxpayer owned the asset for 15 years or less and the asset was an active asset for at least half of the period; or

(b) The taxpayer owned the asset for more than 15 years and the asset was an active asset for a total of 7½ years or more during the period.

The period begins when the taxpayer acquired the asset and ends at the earlier of the CGT event or, if the relevant business ceased to be carried on in the 12 months before that time, the cessation of the business.

Section 152-35 of the ITAA 1997 does not require that the asset be an active asset just before the CGT event. Accordingly, passive assets may qualify depending on their history of use.

Example You acquire a building in 2000 from which you carry on your business. The building is used in the business until 2006 when the growth of your business means you need to move the business to larger leased premises. You rent your building for another 4 years before selling it. Even though the building has been leased passively for 4 years before it is sold, the building still qualifies as an active asset.

What is an active asset?

The meaning of active asset is defined in s 152-40 of the ITAA 1997. At any given time, an asset is an active asset if the taxpayer owns it, and:

(a) The asset (whether the asset is tangible or intangible) is used, or held ready for use, in the course of carrying on a business that is carried on (whether alone or in partnership) by:

(i) The taxpayer; or

(ii) The taxpayer’s affiliate; or

(iii) Another entity that is connected with the taxpayer; or

(b) If the asset is an intangible asset – the asset is inherently connected with a business that is carried on (whether alone or in partnership) by the taxpayer, the taxpayer’s affiliate, or another entity that is connected with the taxpayer;

(c) Is a share in a company that is an Australian resident, or an interest in a trust that is an Australian resident and the total of the market values of the active assets of the company or trust, and the market value of any financial instruments and any cash of the company or trust that are inherently connected with a business it carries on, is 80% or more of the market value of all of the assets of the company or trust.

Financial instruments and any cash of the company or trust are not active assets, but they count towards satisfaction of the 80% test provided they are inherently connected with a business it carries on.
There is no need to apply the 80% test continually – provided the test has been passed at a previous time and it is reasonable to conclude the share or interest will be active at the later time: subs 152-40(3A). Further, failing to meet the 80% test for a temporary time will no longer result in the asset failing the test: subs 152-40(3B).

What happens if you pass the eligibility criteria?

Once the minefield of all of the conditions and definitions are satisfied, then you can start looking at what concessions you can claim. The concessions available under division 152 are:

(a) The small business 15-year exemption (subdivision 152-B);

(b) Small business 50% reduction (subdivision 152-C);

(c) Small business retirement exemption (subdivision 152-D); and

(d) Small business roll-over relief (subdivision 152-E).

What is the small business 15-year exemption?

Under the 15-year exemption, if an asset is held for 15 years, then no capital gains tax is payable on the disposal of the asset subject to the additional conditions in subdivision 152-B.

What are the additional criteria that must be passed?

You can claim the 15-year concession if in addition to the basic conditions outlined above you:

(a) Have continuously owned the asset for the 15-year period ending just before the CGT Event happened; and

(b) Are an individual who is at least 55 years old at the time of the CGT event and the event happens in connection with your retirement; or permanently incapacitated at the time of the CGT event;

(c) Are an individual and the CGT asset is a share in a company or an interest in a trust and that company or trust had a significant individual for a total of at least 15 years (even if the 15 years was not continuous and it was not always the same significant individual) during which you owned the CGT asset; and

(d) Are a company or trust and had a significant individual for a total of at least 15 years (even if the 15 years was not continuous and it was not always the same significant individual) during which you owned the CGT asset and the individual who was a significant individual just before the CGT event was at least 55 years old at the time of the CGT event and the event happens in connection with your retirement; or permanently incapacitated at the time of the CGT event.

When is the CGT event in connection with retirement?

Examples A small business operator, aged over 55, sells his business. Under the terms of the sale, he agrees to be employed by the new owner for a few hours each week for two years. The sale of the business would be in connection with the small business operator’s retirement. He has permanently or indefinitely ceased being self-employed and has commenced gainful employment on a much reduced scale with another party, although still performing similar activities. A small business operator and spouse are both pharmacists, are both aged over 55 and carry on business through two pharmacies. They sell one (and make a capital gain) and, accordingly, reduce their working hours from 60 hours a week each to 45 and 35 hours a week respectively. So there has been some change to their present activities in terms of hours worked and location. But there has not been a significant reduction in the number of hours or a significant change in the nature of their activities and therefore there has been no ‘retirement’. If, on the other hand, one spouse reduced their hours to nil and stopped working, there would be a significant reduction in the number of hours (that is, to nil) that spouse was engaged in the business activities. The sale would be in connection with the retirement of that spouse. A small business operator, aged over 55, sells some business assets as part of a wind down in business activity ahead of selling the business. Within six months she sells the business and ends her present activities. If it can be shown that the earlier CGT event was integral to the business operator’s plan to cease her activities and retire, the CGT event may be accepted as happening in connection with retirement. A small business operator ‘retires’ and his children take over the running of the business. Within six months, some business assets are sold and a capital gain is made. Several reasons may have prompted the sale of the assets. If there is no relevant connection with the small business operator’s business, the requirement would not be satisfied. If it can be shown that the reason for disposing 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. Source: ATO Advanced Guide to the CGT concessions for small business.

What is the small business 50% reduction?

The small business 50% reduction (subdivision 152-C) results in 50% of the capital gain being disregarded. This concession, together with the Division 115 50% discount capital gain, results in 75% of the capital gain being received tax free.

Do you have to claim this concession?

No. This concession applies automatically unless you choose not to apply it.

You may choose not to apply it where you want to claim a larger amount under the retirement exemption. This may be particularly relevant where the capital gain is made by a company.

Is this concession real for companies?

Not really. Whilst the company gets to treat half of the proceeds from the sale of an asset as an exempt amount, it is then very difficult to pass the amount to the shareholders of the company without further tax consequences.

The amount can be paid out as a dividend prior to the liquidation of the company but because the amount was not taxed there will be no franking credits to attach to the dividend. Consequently the shareholder receives an unfranked dividend and pays tax at full marginal rates effectively losing the benefit of the concession.

On liquidation of the company the ATO accept that the payment of the exempt amount is not a dividend but capital proceeds for the cancellation of shares in the company. This provides a better tax outcome but still part of the concession will be clawed back.

What is the small business retirement exemption?

The small business retirement exemption (subdivision 152-D) allows a taxpayer to take an amount, up to a lifetime limit of $500,000, as a retirement payment. Where such a payment is made the amount of the capital gain is reduced by the retirement payment.

Is the $500,000 threshold indexed?

No.

What conditions must be satisfied to claim the retirement exemption?

In addition to the basic conditions, if the taxpayer is a company then the retirement payment must be made in respect of the CGT concession stakeholders of the company. Further, where the CGT concession stakeholders are under the age of 55 then the retirement payment must be made to a complying superannuation fund.

Is there a downside to using the retirement exemption?

No longer. Care was required in utilising the small business retirement exemption because the amount paid under the concession did count towards the reasonable benefit limit (RBL) of the CGT concession stakeholder. However, the amendments to superannuation from 1 July 2007 abolish RBLs and render this qualification unnecessary.

The RBL of a person determined how much superannuation they can receive which was taxed on a concessional basis. Accordingly, a person who has large amounts in superannuation prior to using the small business retirement exemption may have needed careful superannuation planning to ensure that the amounts from the fund could be withdrawn so that the benefits fell within the person’s RBL. RBLs were abolished from 1 July 2007

There are now no limits on the amount that can be taken out of superannuation on a tax concessional basis. The new regime limits the amount that can be placed into superannuation.

Do you need to retire?

No. The exemption can be claimed by anyone provided the proceeds of sale are put towards your retirement. That is why the exempt amount must be paid to a complying superannuation fund when the significant individual is under the age of 55.

Whilst you do not need to retire where the capital gain is made by a company or trust before 1 July 2006 the ATO requires the significant individual to terminate employment with the company or trust. This termination of employment is required because the legislation talks about an actual eligible termination payment being made. The legislation from 1 July 2006 removes this termination of employment requirement. The concession after 1 July 2006 can be claimed even if the significant individual remains employed.

Example As ‘employment’ includes the holding of an office, this part of the requirement is satisfied (for a company) if the stakeholder resigns/retires in a bona fide manner either as an employee or as a director. If there is no termination of any employment, the retirement exemption cannot be chosen. Source: ATO Advanced Guide to the CGT concessions for small business.

When must you pay the amount to superannuation?

You must choose for the retirement exemption to apply. If you are under 55 you must rollover the exempt amount in accordance with meaning of ‘rollover’ in the ETP provisions. That is immediately. The commissioner provides a concession whereby he will accept the ‘immediate’ requirement is satisfied where the payment is made within 7 days.

You are not however required to make the choice to use the retirement exemption until the later of:

• Receipt of the capital proceeds; or
• The date of lodgement of your tax return.

Consequently if you get your proceeds before the date of lodgement of your tax return you can use the funds for other purposes until such time as you choose to claim the retirement exemption.

What is the small business roll-over relief?

The small business rollover in subdivision 152-E allows a capital gain to be disregarded to the extent that the taxpayer buys a new active asset within a replacement asset period.

Is it an exemption from tax?

No. Unlike all of the above concessions, which are exemptions from tax, the small business roll-over is a mere deferral of tax. This subdivision allows the taxpayer to acquire another active asset and tax will not be payable on the disposal of the first active asset until the disposal of the later asset. This is achieved by the cost base in the new active asset being reduced by the amount of the capital gain being rolled over.

The deferral however allows for an automatic 2 year deferral of the time to pay the tax if the concession is chosen. The deferral may be longer if a replacement asset is acquired.

What criteria must be satisfied?

Pursuant to the s 152-410 of the ITAA 1997, a taxpayer can choose the rollover if the basic conditions are satisfied. You can choose the roll-over even if you have not acquired a replacement asset or incurred fourth element expenditure, but:

• CGT event J5 happens if, by the end of the replacement asset period, you do not acquire the asset or incur the fourth element expenditure; and
• CGT event J6 happens if, by the end of the replacement asset period, the cost of the replacement asset or the amount of fourth element expenditure incurred (or both) is less than the amount of the capital gain that you disregarded.

The ‘replacement asset period’ is the period starting one year before and ending 2 years after the last CGT event in the income year for which the taxpayer obtains the roll-over: paragraph 104-185(1)(a).

Example Jordan owns 50% of the shares in company A and company B. He is therefore a significant individual of both companies. The companies are connected with Jordan because he controls both of them. Company A owns land which it leases to Jordan for use in a business. It sells the land at a profit and buys shares in company B as replacement assets. All of company B's assets are active assets. The replacement asset test is satisfied because the shares are active assets and Jordan is connected with company A and is a significant individual of company B. Source: ATO Advanced Guide to the CGT concessions for small business.

When does the deferral come to an end?

The deferral comes to an end at the earlier of:

• The replacement asset being sold; or
• The replacement asset ceasing to be an active asset; or
• Where the replacement asset is a share or interest - the taxpayer or an entity connected with the taxpayer ceases to be a significant individual of that company or trust.

In such circumstances a special CGT event J2 or J3 applies. The taxpayer cannot reduce the capital gain under those events by attempting to use the general 50% discount or the small business 50% reduction.

Example Peter disposes of an active asset for $10,000, making a capital gain of $2,000. He buys two replacement assets (not being depreciating assets) for $5,000 each and chooses the small business rollover. $1,000 of the capital gain is disregarded for each replacement asset. Assume that one of the replacement assets are later sold for $7,500, resulting in Peter making a capital gain of $2,500. He will also make a capital gain of $1,000 as the sale of the replacement asset results in that asset no longer being an active asset. The $1,000 capital gain represents the capital gain made on the disposal of the active asset that was rolled over in respect of this replacement asset. Peter’s capital gain of $1,000 made from the crystallising of the deferred capital gain (CGT event J2) may be eligible for further rollover relief or the retirement exemption. The capital gain of $2,500 made from the disposal of the replacement asset (CGT event A1) may be eligible for any of the concessions if the relevant conditions are satisfied. Source: ATO Advanced Guide to the CGT concessions for small business.