This blog post seeks to outline some of the more typical circumstances where the small business Capital Gains Tax (CGT) concessions apply. So, if you are a small business entity (‘SBE’) and you’re not sure what these concessions mean, and where you can or can’t use them, we’re going to explain them in a practical sense, to give you an understanding of what may or may not apply in your situation.
There are four main small business CGT concessions:
- Small business 15-year exemption (Subdiv 152-B)
- Small business 50% reduction (Subdiv 152-C)
- Small business retirement exemption (Subdiv 152-D)
- Small business roll-over (Subdiv 152-E)
We also like to refer to a fifth pillar of the small business CGT concessions, known as the small business restructure rollover.
1. Small business 15-year exemption (Subdiv 152-B)
This concession, if applicable, is the most generous and powerful exemption. However, in the circumstances of many of our clients, it’s probably the hardest to meet because of the eligibility requirements. In order to be eligible you must have owned the active asset for 15 years or longer, you’re over the age of retirement (50 years or older), and retiring or permanently incapacitated.
This concession typically applies to clients of New Leaf that have mature businesses, are wealthy, and have accumulated active assets during the course of their business life cycle, or throughout the operating years of their business, and they’re considering retirement. They might own commercial premises or a parcel of land, and they’re wanting to sell the asset, in conjunction with retirement, after the age of 55 years, having owned the asset for a period of time exceeding 15 years.
“We do regularly get the circumstance with mature business owners that obviously have used profits from their trading businesses to buy assets that are associated with or accompany those businesses. So, they’re active assets. They’ve held them for a long period of time, usually have a lot of equity in them, and large capital gains. So, that’s the typical circumstance or scenario we see in applying the 15-year exemption,” Patrick McStay, New Leaf Advisory Director.
2. Small business 50% reduction (Subdiv 152-C)
The second CGT concession is the active asset reduction – the most common, the most prolific, and the handiest day to day concession that’s used amongst the New Leaf client base. Essentially, it allows small businesses to get an additional 50% off the capital gain upon disposal of an active asset. It might be a parcel of land that’s used in conjunction with an enterprise. It might be shares that are held in a trading business, or a partnership interest. It might be a partnership interest that you have in an asset that is used in connection with a small business. It’s very broad and we can’t cover all the applicable circumstances.
Basically, an active asset by definition is a capital asset that’s used in a trading business or enterprise. If you have an interest in the asset, then it’s highly likely that, pending meeting all the other eligibility conditions, you’ll get additional 50% off any derived capital gain applicable upon disposal of the asset.
“We apply this concession in the common circumstances where clients are looking to sell an interest in their business to another business partner, or clients are looking to restructure, and move ownership structures from say, an asset being held in their own name to a family trust, where they sell the shares at market value. The client will often receive the benefit of a capital gains tax 50% general discount. But then they also get the 50% active asset reduction, because the asset is associated with a small business entity. This is quite common, quite prolific, and I’d say is a month-to-month activity for us,” Patrick McStay.
3. Small business retirement exemption (Subdiv 152-D)
The third CGT concession is a small business retirement exemption. Similar but distinct from the first concession, the 15-year exemption. This concession allows taxpayers a lifetime limit of $500,000 if they dispose of an asset where a capital gain is exempt up to that limit of $500,000. If you’re under 55, then an applicable amount must be paid into a complying superannuation fund. But if you’re over 55, then you are able to keep the proceeds outside of superannuation and do whatever you want with them.
With the small business 15-year exemption, you basically have to retire, and you must have owned the asset for 15 years. With the small business retirement exemption, you don’t have to retire or have held the asset for 15 years.
If you’re over 55 and continue to work after disposing of an eligible asset, you won’t meet the small business 15 year exemption, because it requires you to retire. But the retirement exemption, which has a limit of $500,000, will enable you to utilise that exemption, and continue to work. If you’re under 55, you’re not eligible for the small business 15 year exemption, but you are eligible for the retirement exemption, providing you put the applicable proceeds from sale of the asset into super.
“We encounter the application of this concession when clients are under 55 and have generated a capital gain from an active asset, whether that’s the sale of a business, a sale of a property that’s being used in business, and there’s a material capital gain. Rather than paying tax, they would prefer to put an amount of money into their superannuation fund, up to $500,000 to mitigate the tax burden. They don’t lose the tax. They do lose the access to the funds until retirement, given it’s contributed into superannuation. There’s no tax paid in the superfund. So from there, they can invest that money in perpetuity and generate growth year on year in their superfund. It’s a very handy exemption for those that see the bigger picture, and are willing to forgo some of the proceeds of the sale of the asset to tip into their superannuation fund, and think a little bit more medium to long term,” Patrick McStay.
4. Small business roll-over (Subdiv 152-E)
The fourth major or common CGT concession is a small business rollover. This is generally applicable when you sell an asset and buy a replacement asset or improve an existing active asset.
This concession requires the replacement or improvement of existing active assets, with time frames around replacement. A typical example for us would be a client that’s acquired a small business premises, an office or factory for example, they move into it and they trade from it . It’s an active asset however they find at some point in their business life cycle, that the asset is no longer suitable for their needs. They’ve grown out of the space, whether it’s too many employees, or too much stock, etc. So, they need to move, crystallising the sale of an active the asset and resulting in the acquisition of a replacement asset.
The terms and conditions around what is considered a replacement asset, or an improvement to an existing asset are quite extensive in detail. Overall, it needs to be the same style of asset with the same purpose and intention and acquired within a specific period of time.
“You can’t just sell an asset, and then wait 10 years (for example) and buy another asset. There are time limits to acquire the replacement asset. However, as long as the eligibility criteria/conditions are met, you can defer the capital gain. Whilst you don’t pay any tax when you dispose of the asset in the first instance, you do pay the tax in the end. So, it is principally a tax deferral benefit. For example, if you sold your existing premises, and upgraded to a new one, and it met the conditions of the rollover, you would defer the tax burden of any capital gain at the time of the upgrade. However further along the line when you sold that premises, if you didn’t replace it again, or you ceased using it for business, then there would be a capital gain derived at that point in time,” Patrick McStay.
That’s the four main CGT concessions and typical scenarios we encounter here at New Leaf.
5. The fifth concession – the small business restructure rollover
The fifth concession, which is listed separately on the tax office website, and one that is not as commonly spoken about is the small business restructure rollover.
This concession can be helpful if your business has been poorly structured, or the structure you have is not appropriate or fit for purpose. The concession basically allows the tax consequence of a restructure to be eliminated or deferred, providing the eligibility criteria and conditions are met.
“We had two individual clients trading in a partnership structure. They utilised the small business restructure rollover to move their business into a company. It was a bit of a no-brainer. It offered them superior asset protection as well as a fixed tax rate. All their profit outside the business was being taxed year on year at the highest marginal tax rates. So, it saved them tax too. It was a significant improvement.
Other common examples we have dealt with are small business owners that requires flexibility in the distribution of profit. A rigid shareholding or ownership structure can be problematic for a company, in some instances. In these circumstances, we are able to restructure the company and roll it into a family trust. Whilst there needs to be no change of economic ownership, we are able to establish a much more flexible structure for distributing profits to the ultimate economic owners.” Patrick McStay.