New Small Business CGT Concessions

New Small Business CGT Concessions.pdf (364.7k)

Capital gains tax ('CGT') was introduced into the Australian taxation system with effect from 20 September 1985. The original CGT provisions were contained in Part IIIA of the Income Tax Assessment Act 1936 (Cth) ('ITAA36').

From its inception, the CGT provisions contained an exemption for certain capital gains made by small business. Originally, this exemption was provided in the form of a reduction in the amount of the taxable capital gain arising from the disposal of the goodwill of a business.^[1] The small business CGT concessions in Division 152 were introduced into the CGT provisions within the Income Tax Assessment Act 1997 (Cth) ('ITAA97') with effect from 1 July 1997^[2].

The key features of the new law are:

• increasing access to the concessions by replacing the controlling individual (50% test) with the significant individual (20% test) This will allow up to eight taxpayers (five taxpayers or four taxpayers and their spouses) to benefit from the CGT concessions;

• changing the maximum net asset value test by allowing for:

1. provisions for annual, long service leave, unearned income, and tax liabilities, and

2. negative net asset value of connected entities,

to be taken into account for the purposes of the test;

• allowing taxpayers to roll over the whole or part of a capital gain;

• giving deceased estates access to the CGT concessions on assets disposed of within two years of death to the same extent that the taxpayer could have utilised those concessions before death;

• Where the CGT events happens to a share in a company or an interest in a trust, allowing for indirect ownership for the purposes of determining eligibility.

The table below, extracted from the Explanatory Memorandum^[4], highlights the changes in the law.

The small business CGT concessions are particularly relevant to the sale of a business, but it is important to remember that there are both income tax and CGT implications for the vendor^[5]. In particular:

• the sale of plant and equipment, trading stock and work in progress may give rise to income tax liability;
• the sale of goodwill, business premises and shares in a company may give rise to CGT liability; and
• the sale of intellectual property, motor vehicles and plant and equipment may give rise to both CGT and income tax liability.

Where the vendor generates an income tax liability, there are generally no income tax concessions available to reduce the amount of income tax payable^[6]. However, where a CGT liability arises, there are certain concessions that the vendor may apply to reduce or eliminate the CGT payable from the disposals. These CGT concessions include the Division 115 50% general discount and the Division 152 small business CGT concessions.

Each of these concessions are discussed in detail below.

Division 115 50% general discount

The Division 115 50% general discount allows eligible vendors to reduce the capital gain generated from the disposal of a CGT asset by up to 50%, provided that the relevant CGT asset has been held by the vendor for at least 12 months.

Vendors will be eligible to apply this discount if they are:

• an individual;
• a trust (provided an individual beneficiary is presently entitled to capital gain. Sections 115-20 and 115-25 of the ITAA 1997 provides that a trustee assessed pursuant to sections 98(3) and 99A of the ITAA 1936 is unable to use the discount); or
• a complying superannuation fund.

An individual or trust vendor will receive a 50% discount, while a complying superannuation fund vendor will receive a 33.3% discount. Companies, however, are not eligible for this discount.

Division 152 small business CGT concessions

There are four small business CGT concessions:

1. the 15-year exemption in Subdivision 152-B;

2. the 50% active asset concession under Subdivision 152-C;

3. the retirement concession under Subdivision 152-D; and

4. the rollover concession under Subdivision 152-E.

These concessions are available in addition to the Division 115 50% general discount.

The preconditions – Subdivision 152-A

In order to qualify for the small business concessions, the vendor must meet the following conditions:

a) a CGT event must happen in relation to the vendor's asset;

b) the vendor must generate a capital gain from the CGT event;

c) the vendor must satisfy the maximum net asset threshold test; and

d) the asset subject to the CGT event must be an active asset.

Under the old law where the CGT asset is a share in a company or an interest in a trust, the following additional conditions had to be met:

a) the company or trust must have a controlling individual just before the CGT event; and

b) the individual holding the share or interest seeking to apply the concession must be CGT concession stakeholder of the company or trust.

The new law modifies this requirement so that one of the following two requirements must be met just before the CGT event:

1. the entity making the gain is a CGT concession stakeholder in the company or the trust (there is no longer a requirement for a controlling individual); or

2. alternatively the 90% test is met. This test only applies if there is an interposed entity between the CGT concession stakeholder and the company or trust in which the shares or interests are held.

The 90% test

An interposed entity satisfies the 90% test if 90% of the participation percentages^[7] in the interposed entity are held by CGT concession stakeholders of the company or trust in which the shares or interests are held. As with the significant individual test (see below) the participation percentage can be held directly or indirectly through more than one interposed entity.

The small business concessions in Division 152 apply to all capital gains except for a capital gain from CGT event K7^[8]. Section 152-10(4) provides that the small business 15-year exemption in subdivision 152-B and the 50% active asset reduction in subdivision 152-C do not apply to CGT events J2, J5 and J6^[9]. The rollover concessions in subdivision 152-E will not apply to CGT events J5 and J6.

Maximum net asset threshold test

The vendor will satisfy the maximum net asset threshold test if the net value of assets held by the vendor, entities connected with the vendor and vendor's small business CGT affiliates do not exceed $5 million^[10] (see section 152-15). What constitutes a connected entity and a small business CGT affiliate are discussed below.

Net value of CGT assets

Section 152-20 defines the 'net value of the CGT assets' as the difference between the market value of those assets and the sum of the liabilities of the entity that relate to those assets.

In determining whether the vendor satisfies this test, certain assets are ignored. These include:

• personal use assets held by the vendor (e.g. a boat or caravan used for private purposes);
• the vendor's main residence;
• assets held in the vendor's superannuation fund;

· shares, units or other interests, apart from debt, in a connected entity of either the taxpayer or a small business CGT affiliate; and

· assets of a small business CGT affiliate that are not used or held for use in a business carried on by the taxpayer or a connected entity.

The net value of shares and units are excluded to avoid double counting.

Market value

The term 'market value' is not a defined term and in practice it is often difficult to ascertain the market value of assets. While the concept of market value for CGT purposes is not defined in the legislation, a common definition is the price that a 'willing but not anxious purchaser would pay to a willing but not anxious seller' (see Spencer v The Commonwealth (1907) 5 CLR 418). In Taxation Determination 10 the Commissioner states that where market value is required for CGT purposes, taxpayers can choose to either:

• obtain a valuation from a qualified valuer; or
• determine their own valuation based on objective and supportable data.

The phrase 'liabilities of the entity that are related to the assets' creates some difficulty in practice as it implies that there must be some nexus between the liability and the asset disposed. In many cases, certain liabilities of a business may not be referable to specific assets^[11].

Under the old law, amounts that are within the accounting meaning of the term 'liabilities' such as provisions for leave entitlements but not within its legal meaning, are therefore not within the scope of the term as used in subsection 152-20(1).

However, the new law provides that provision for annual leave, long service leave, unearned income and tax liabilities are included as 'liabilities' because although they 'are not present legal obligations, [they] are relevant to the value of the business, having regard to its commercial business valuation methods'^[12]. In the new law, subsection 152-20(1) has been repealed and replaced with a subsection that provides for the inclusion of these amounts when determining the maximum net asset value test. The new subsection 152-20(1) states that:

(1) the net value of CGT assets of an entity is the amount (whether positive, negative or nil) obtained by subtracting from the sum of the market values of those assets the sum of:
(a) the liabilities of the entity that are related to those assets; and

(b) the following provisions made by the entity:

(i) provisions for annual leave;

(ii) provisions for long service leave;

(iii) provisions for unearned income;

(iv) provisions for tax liabilities.

Main residence exemption

Under the old law there was a potential trap in the main residence exemption arising from the operation of section 152-20(2)(b)(ii) and section 118-190(1)(c). Where a residence was used partly for business purposes, the full value of the residence was taken into account for the purposes of the $5 million threshold test (which is proposed to be increased to $6 million from 1 July 2007). The value of any mortgage debt against the home could be applied to reduce it to the net value. The gains on the disposal of residences used partly for business purposes qualify for the small business concessions (provided the eligibility criteria are met).

However, the new law provides that the full value of the residence need not be included.^[13] A taxpayer's dwelling will now only be included in the test to the extent that it has had some income producing use. If the dwelling has had some income producing use, the percentage of that use is multiplied by the current market value to determine the value of the dwelling that will be included. The length of time the dwelling has been used to produce income will be taken into consideration.

Connected entity and small business CGT affiliates

There is a difference in the range of assets to be counted for a small business CGT affiliate and for a connected entity.

The assets of a small business CGT affiliate that are counted are those used in a business carried on by the taxpayer or the taxpayer's connected entity. Accordingly, other assets such as investment properties or a share portfolio of a small business CGT affiliate are ignored. Where these assets are owned by a connected entity they will be included. One hundred per cent of the net value of such connected entity assets must be included even though the interest of the taxpayer in the connected entity may be less than this amount.

Pursuant to section 152-15(b) of the old law where the vendor is a partner in a partnership and the CGT event happened in relation to an asset of the partnership, the net value of the assets of the partnership could not exceed $5 million. This additional test did not apply where only one partner disposed of an interest in the partnership. The Bill repeals this section and provides that in applying the maximum net asset value test in relation to partnership assets, a partner only includes or counts the partner's proportion of the assets not the partnership assets as a whole.

Small business CGT affiliate

A small business CGT affiliate of the vendor includes the vendor's spouse or child/children under the age of 18, or any other person who acts, or could reasonably be expected to act, in accordance with the vendor's directions or wishes^[15] (see section 152-25).

This could include any connected entities of the taxpayer, as the taxpayer has control of the entity and would presumably be reasonably expected to act in accordance with the taxpayer's wishes or directions.

A business partner is, however, not a small business CGT affiliate merely because the partner acts, or could reasonably be expected to act, in concert with the taxpayer in a particular business. This presumably recognises the reality that partners generally act in concert but are also at arm's length from each other, and also to avoid double counting as partnership assets will have been included already under section 152-15.

Consequently, the assets of another partner that are not part of the partnership property will not usually be included in determining the $5 million asset value ceiling.

Entity connected with the vendor

An entity will be connected with the vendor if the vendor controls that entity or if both the vendor and that entity are controlled by a second entity (see sec 152-30). Control is generally deemed to apply if 40% or more ownership rights are held.

In relation to companies and fixed trusts, control for these purposes is set at a beneficial ownership of rights at least 40% of the voting power in the company or the right to receive at least 40% of any distribution of income or capital of the trust. Where the taxpayer holds a greater than 40% but less than 50% interest, control would be assumed unless the Commissioner is satisfied or thinks it reasonable to assume that the entity is controlled by another entity (e.g. if another entity held a greater than 50% interest).

In relation to discretionary trusts, an entity controls the discretionary trust where:

• the entity is the trustee of the trust; or

• the entity has the power to determine the manner in which the trustee exercises the power to make any payment of the income or capital to or for the benefit of beneficiaries.^[16]

There are further rules relating to discretionary trusts in section 152-30(4) to (6C).

The indirect control rule in section 152-30(7) provides that an entity that directly controls a second entity as if it also controlled any other entity that is directly, or indirectly controlled by the second entity.

Active asset test

Section 152-40(1) defines an active asset as:

A CGT asset (whether tangible or intangible) is an active asset at a given time if, at that time, you own it and:

• use it or hold it ready for use in the course of carrying on a business; or

• it is used or held ready for use in the course of carrying on a business by:

— your small business CGT affiliate; or

— another entity that is connectedwith you [emphasis added].

· If the asset is an intangible asset, it is inherently connected to a

business carried by the taxpayer, their CGT small business affiliate or a connected entity.

An active asset is defined as an asset used, or held ready for use, by the entity or one of its affiliates in the course of carrying on a business. An intangible asset will fall within the definition of an active asset if it is inherently connected with the business. Previously, the assets must have been active just before the CGT event and must have been active for at least half of the period of ownership^[17]. Assets must still have been active for at least half of the period of ownership however, under the new law the assets need not be active at the time the CGT event occurred. This is achieved by repealing subsection 152-35(a)(i)^[18].

Passive investment assets are specifically excluded from the definition of an active asset by section 152-40.

It is common for assets to be held in a number of entities for asset protection purposes. One trust may hold the freehold from which the business operates and another trust may operate the business. Section 152-40(1)(c) recognises this and provides for the definition of 'active assets' to extend to assets used in carrying on a business but held by a small business CGT affiliate or a connected entity.

This definition is expanded by section 152-40(3) to include shares and units in entities provided that at least 80% of the market value of assets held by the entity are themselves active assets.

There is no minimum interest that must be held in such a company or trust by a taxpayer for the share or interest in a trust to be an active asset, but the controlling individual test must be satisfied with respect to the company or trust.

Under the old law shares in a company would constitute an active asset if:

• the market value of the company's active assets; and
• any cash proceeds from the sale by the company of any other active assets during the previous two years,

was 80% or more of the market value of all the company's assets (see section 152-40)(3)).

However, the Bill has repealed subparagraph 152-40(3)(b)(ii) and replaced it with new subparagraphs so that shares in a company will constitute an active asset if:

• the market value of the company's active assets; and
• the market value of any financial instruments of the company that are inherently connected with a business that the company carries on; and
• any cash of the company that is inherently connected with such business.

is 80% or more of the market value of all the assets of the company.

Section 152-40(4) provides for the exclusion of certain assets as active assets.

Controlling individual/ significant individual

The old law provided that a vendor company or trust would have a controlling individual if an individual has an interest in the company or trust which carries with it the rights to:

• exercise at least 50% of the voting power; and
• receive at least 50% of any dividends or capital distributions of the trust or company (see sec 152-55).

The new law replaces the controlling individual 50% test with the 'significant individual' 20% test for the 2006–2007 year and following years of income. An individual will be a significant individual if they have a small business participation percentage of at least 20%. The controlling individual test could only be satisfied directly, it is important to note that the significant individual test can be satisfied either directly or indirectly through one or more interposed entities.

An individual is a significant individual in a company or trust if they have a small business participation percentage in the company or trust of at least 20%. This can be made up of direct or indirect percentages. The participation percentage is the sum of the direct and indirect participation percentages.

The direct small business participation percentage

For a company the direct small business participation percentage is the smaller of:

• the percentage of the voting power in the company; or
• sthe percentage of any dividend that the company may pay; or
• the percentage of any distribution of capital that the company make

The following example from the Explanatory Memorandum highlights the importance of using the smallest percentage.

A trust with fixed entitlements to all the income and capital of the trust (such as a fixed trust or unit trust) is treated in a similar way to a company.

The rules in relation to a trust in which entities do not have fixed entitlements (e.g. a discretionary trust) to all the income and capital of the trust is treated differently. Where such a trust made a distribution of income or capital to an entity, the small business participation percentage is the percentage of the distributions of income and capital that the entity is beneficially entitled to for that year. Where the percentages of income and capital distributions are different the small business participation percentage is the smaller of the two. If the trust did not make a distribution of income and capital for a particular year it will not have a significant individual for that year.

The indirect small business participation percentage

An entity's small business participation percentage is calculated by multiplying together an entity's direct participation percentage in an interposed entity and that interposed entity's total participation percentage (direct and indirect) in the company or trust. An indirect interest can be held through one or more interposed entities.

The following example from the Explanatory Memorandum^[19] to the Bill explains the calculation and effect of the indirect small business participation percentage.

Case Study – Discretionary Trust Discretionary Trust owns 100% of the shares in Operating Company; therefore Discretionary Trust has a 100% direct interest (and no indirect interest) in Operating Company. Anna receives 80% of the distributions from Discretionary Trust; therefore she has a direct participation percentage of 80% in Discretionary Trust. To find Anna's participation percentage in Operating Company, multiply together Anna's direct participation percentage in Discretionary Trust and Discretionary Trust's total participation percentage in Operating Company. 80% × 100% = 80% Anna has an 80% participation percentage in Operating Company and is therefore a significant individual of Operating Company. Bill receives 15% of the distributions from Discretionary Trust; therefore he has a direct participation percentage of 15% in Discretionary Trust. To find Bill's participation percentage in Operating Company, multiply together Bill's direct participation percentage in Discretionary Trust and Discretionary Trust's total participation percentage in Operating Company. 15% × 100% = 15% Bill has a 15% participation percentage in Operating Company and is therefore not a significant individual of Operating Company. (As a spouse of a significant individual with a participation percentage greater than zero in the entity, Bill will be a CGT concession stakeholder. See paragraph 1.23.) Deborah receives 5% of the distributions from Discretionary Trust; therefore she has a direct participation percentage of 5% in Discretionary Trust. To find Deborah's participation percentage in Operating Company, multiply together Deborah's direct participation percentage in Discretionary Trust and Discretionary Trust's total participation percentage in Operating Company. 5% × 100% = 5% Deborah has a 5% participation percentage in Operating Company and is therefore not a significant individual of Operating Company. (Deborah is not a CGT concession stakeholder. See paragraph 1.23.) (See Example 1.2 in the Explanatory Memorandum to the Bill).

The concept of a significant individual and formerly a controlling individual is a key concept for the small business CGT concessions. It applies to determining whether:

• a company or trust satisfies the controlling individual/significant individual test;
• a company or trust is eligible for the 15 year small business concession; and
• a shareholder of a company or beneficiary of a trust is a CGT concession stakeholder.

A CGT concession stakeholder is relevant for the purposes of:

(a) the basic preconditions where the CGT asset is a share in a company or interest in a trust;

(b) the CGT small business 15-year concession for the operation of the flow through concession; and

(c) the CGT small business 15-year concession and the CGT small business retirement concession are applied to companies and trusts.

CGT concession stakeholder

Under the old law section 152-60 provided that a controlling individual of a company or trust was a CGT concession stakeholder. In addition, a spouse of a controlling individual was also a CGT concession stakeholder where:

• for a company, the spouse held shares in the company;
• for a fixed trust, the spouse had an entitlements to the income or capital of the trust; or
• for a non-fixed trust, the trust had made a distribution of income or capital during the relevant income year and the spouse was beneficially entitled to that distribution.

For a company or trust there could only be two CGT concession stakeholders: either two controllers or one controller and the spouse of a controller.

As the new changes the controlling individual test to a significant individual test, now there may be up to eight CGT concession stakeholders. The spouse of a significant individual must have some direct or indirect participation percentage in the company or trust and the participation percentages are worked out in the same way as for the significant individual test.

A significant individual must have a small business participation percentage of at least 20%. This means that a company or trust may have up to five significant individuals. If there are five significant individuals, a spouse of these significant individuals cannot be a CGT concession stakeholder as it is not possible in such circumstances for the spouse(s) to have any participation percentage in the company or trust. For one spouse to have a small business participation percentage, one of the five taxpayers must have a small business participation percentage of less than 20%. This would disqualify that taxpayer from being a significant individual. Under the new there may be up to five significant individuals or four significant individuals and their spouses (total eight) that can access the small business concessions.

The concept of a CGT concession stakeholder is particularly important in relation to the small business retirement exemption.

The Concessions

The 15-year exemption – Subdivision 152-B

This is the most valuable of the four small business CGT concessions. The 15-year retirement exemption allows the vendor to disregard a capital gain arising from a CGT event that happens to an active asset held by the vendor for at least 15 years. If the vendor is a company or trust and distributes this CGT-free amount to its CGT concession stakeholder, these distributions will also be exempt.

Prior to the Bill, to be eligible for this concession the vendor must have met the preconditions in Subdivision 152-A and satisfy the following:

• The vendor must continuously own the asset for at least 15 years leading up to the CGT event.
• If the vendor is an individual, he or she must be:

– over 55 and the CGT event occurs in connection with the vendor's retirement; or

– permanently incapacitated.

If the CGT asset is a share in a company or an interest in a trust prior to the introduction of the new Bill, the company or trust was required to have a controlling individual throughout the entire period of ownership. (The controlling individual does not have to be the same controlling individual during the whole period.)

However, the new Bill has altered this condition in several ways. Firstly, the controlling individual requirement has been replaced by the significant individual requirement. Secondly, although the company or trust must have a significant individual for periods totalling at least 15 years during which time the individual owned the shares or trust interests. The requirement that this period is continuous will no longer apply.

Companies and trusts: Flowthrough of concessions to CGT concession stakeholders

Prior to the new Bill, section 152-110 provided:

An entity that is a company or trust can disregard any capital gain arising from a CGT event if all of the following conditions are satisfied:

(a) the basic conditions in Subdivision 152-A are satisfied for the gain;

(b) the entity continuously owned the CGT asset for the 15-year period ending just before the CGT event;

(c) at all times during the whole period for which the entity owned the asset, the entity had a controlling individual (even if it was not the same controlling individual during the whole period);

(d) an individual who was a controlling individual of the company or trust just before the CGT event either:

(i) was 55 or over at that time and the event happened in connection with the individual's retirement; or

(ii) was permanently incapacitated at that time.

However, the new provisions will allow a company or trust to access the 15 year exemption on assets it owns, if it has a significant individual for at least 15 of the years it owned the assets. Again, this need not be the same individual for the 15 year period.

Case Study – Julie and Juice Company^[20]

Julie owned 10% of the shares in Juice Company for 18 years from 1987 to 2005. For 5 years (1987–1992) she owned another 10% and was a significant individual. For 10 years (1995–2005), another person (Edward) was a significant individual. From 1987to 2005 Juice Company has owned a factory.

The significant individual requirement is met for Julie's shares.

Juice Company will also satisfy the significant individual requirement in relation to the factory.

Where a company or trust disregards a capital gain that capital gain is described as the 'exempt amount' in section 152-125. Where a company or trust that has derived a gain that is exempted under the 15-year rules and that gain is paid out to the relevant individual(s) as an exempt amount, it must be paid so it reflects the stakeholder's control percentage. Under the old law this was referred to as the stakeholder participation percentage. Section 152-125 applies to distributions made by a company or trust within two years after the CGT event to an individual who was the CGT concession stakeholder of the company or trust at the time of the CGT event. The payment may be made directly or indirectly through an interposed entity. Further the new law provides that the two year time limit for the payment of the CGT exempt amount may be extended by the Commissioner.

The distribution is not taken into account in determining the taxable income of the company, the trust or the individual or any of the interposed entities.

The 50% 'active asset' concession – Subdivision 152-C

The 50% 'active asset' concession allows the vendor to reduce the capital gain generated from a CGT event by 50%. In order to qualify for this concession, the vendor need only meet the preconditions in Subdivision 152-A.

This concession can be used in addition to the Division 115 50% general discount. The effect of both these concessions means that the vendor effectively reduces his or her taxable capital gain to 25% of the original capital gain.

Pursuant to section 152-220 there is a choice as to whether or not this concession is applied. A company or unit trust may consider not using this concession^[21].

The small business retirement concession – Subdivision 152-D

This is the second most valuable small business concession as it allows the vendor to disregard the capital gain if the proceeds are used in connection with the vendor's retirement. Where the vendor qualifies for both the active asset concession and the retirement concession, the active asset exemption must be applied first if the choice is made to apply it.

Where the vendor is an individual

Where the vendor is an individual, he or she may apply this concession if the basic conditions in Subdivision 152-A are satisfied. Under the old law, if the vendor was under the age of 55 at the time of the CGT event, the capital gain had to be rolled over as an eligible terminating payment ('ETP'). Now, under section 152-305(1)(b) individuals aged under 55 must rollover each ETP and the individual's age is tested at the date of the choice made for the retirement exemption (generally on lodgment of the relevant tax return). Under the old law the age was tested just before the capital proceeds from the CGT event were received. Where the taxpayer chooses to rollover in this way, no tax is applicable, subject only to the $500,000 lifetime limit. To satisfy the rollover requirement, the individual must pay the amount into a complying superannuation fund no later than on the day the payment is received. Failure to immediately rollover the amount will mean that the retirement exemption is not available^[22].

Although Section 152-305(1)(b) allows the individual's age to be tested at a time after the capital proceeds are received, where the taxpayer is under the age of 55 at the test time the capital proceeds from the CGT event must be rolled over into a superannuation fund no late than on the day the payment was received. This may be much earlier than the date the choice is made to apply the retirement exemption.

The choice to use the retirement exemption is generally upon lodgement of the relevant tax return. The new law ensures that the amount is not required to be rolled over into a superannuation fund only because the person was less than 55 years old at the time capital proceeds were received.

Under section 152-310(1), the capital gain will be reduced by the CGT exempt amount. Prior to the introduction of the Bill for the exemption to apply, it was necessary for a taxpayer to receive actual capital proceeds consequently capital gains arising from the application of the market value substitution rule were excluded.

The new law provides that it is no longer necessary to receive actual capital proceeds in order to apply the retirement concession. Where a capital gain is made by gifting an active asset application of the market substitution rules, or a gain arises from a CGT event J2, J5 or J6, the retirement exemption may be applied.

Where the vendor is a company or trust

Under the new law a company or trust may apply this concession if:

• the basic conditions in Subdivision 152-A are satisfied;
• the vendor must make a payment to at least one of its CGT concession stakeholders (under the old law the vendor had to have a controlling individual) if the choice is made to apply the retirement concession in respect of a CGT event.;
• the vendor pays an ETP or a payment deemed to be in respect of the employment to each of its CGT concession stakeholders equal to the capital proceeds of the CGT event or if the CGT concession stakeholder is under the age of 55, the vendor rolls an amount equal to the ETP into a superannuation fund of each of the CGT concession stakeholders, noting that the Bill deems that 55 years of age is relevant when choosing to use this concession rather than the receipt of any payment.

A company or trust could only choose to disregard an amount where certain additional conditions are satisfied such as the requirement that the entity must have at least one controlling individual.

Where a company or trust received disposal proceeds from the sale of an active asset, it could elect to make an ETP in respect of its CGT concession stakeholder(s). A CGT concession stakeholder of a company or trust generally included a controlling individual and the controlling individual's spouse where the spouse also holds interests in the company or trust.

Termination of employment not required

Under the new law, payment of an amount exempted under the retirement exemption will be deemed to be either an ETP or to have been paid in respect of employment. Subsection 152-325(7) now states:

(7) This Act applies to a payment as if the payment:

(a) for a CGT concession stakeholder who is an employee of the company or trust – were made in consequence of the termination of employment of the stakeholder; or

(b) for another CGT concession stakeholder – were an eligible termination payment.

Under the old law a company or trust choosing this concession had to make an actual ETP in relation to each of its CGT concession stakeholders. This meant that for the payment to qualify as an ETP under the ETP provisions of the ITAA36, the payment had to be made in consequence of the termination of any employment of the stakeholder.

As 'employment' includes the holding of an office, this requirement was satisfied for a company if the CGT concession stakeholder retired or resigned either as an employee or as a director or secretary. If there is was no termination of any employment, the retirement exemption could not be applied.

For an individual choosing the small business retirement exemption, there was no requirement to terminate any activity or cease his or her business. This is because there is no requirement to make an actual ETP, rather the exempt amount is simply taken to be an ETP.

Lifetime limit

Advisors should note that the small business retirement concession has a lifetime limit of $500,000 in respect of any individual This means that the exempt amount for a particular individual must not exceed $500,000. This limit is reduced by any previous amounts exempted under this concession.

The $500,000 limit is a lifetime limit, but is calculated after the 50% active asset exemption and the Division 115 50% discount (where applicable) have been allowed. Accordingly, this means that a taxpayer can realise a $2 million capital gain without tax where Subdivision 152-D is satisfied.

The small business rollover concession – Subdivision 152-E

This concession allows the vendor to defer the making of a capital gain if the vendor acquires a replacement asset. The effect of the rollover is that the capital gain made by the vendor from the CGT event is ignored to the extent that it does not exceed the cost base of the replacement asset. The capital gain will instead be deferred to when a CGT event subsequently happens to the replacement asset.

The replacement asset conditions are presently contained in section 152-420 of the ITAA 1997, the Bill proposed that the replacement assets conditions will be contained as part of the J2 CGT event set out in section 104-185 of the ITAA 1997. A replacement asset may be an active replacement asset acquired by the taxpayer and/or fourth element expenditure^[24] on an existing CGT asset. The allowance for fourth element expenditure was introduced with the Bill. The expenditure on the replacement asset must be incurred one year before or up to two years after the last CGT event in the income year for which rollover relief was obtained. The replacement asset must be an active asset at the end of the replacement asset period (i.e. two years after the relevant CGT event for which rollover was obtained).

If a replacement asset is a share in a company or an interest in a trust, the taxpayer, or an entity connected with the taxpayer:

• must be a CGT concession stakeholder in the company or trust (or, prior to the Bill, the controlling individual of the company or trust just after acquiring the share or interest); or
• CGT concession stakeholders in the company or trust have a small business participation percentage of at least 90%.

Currently, an eligible small business entity cannot choose to rollover only part of an active asset gain against the acquisition of replacement active assets. The amendments made to Subdivision 152-E by the Bill will allow an eligible small business entity to rollover only part of the gain using a replacement active asset.

Where an individual who has chosen the small business rollover dies, section 152-425 effectively allows there to be a deemed continuity of the small business rollover, provided certain conditions are met.

CGT event J2

A CGT event J2 happens where there is a change in relation to a replacement asset of a kind that would give rise to CGT events J2 and J3 as currently enacted. (Note the Bill repeals CGT event J3.)

The Bill provides that a CGT event J2 happens where you hold a CGT asset as a replacement asset for the purposes of the small business concessions under Subdivision 152-E and a change happens to the asset after the end of the replacement asset period such that:

· the asset stops being an active asset); or

· the asset becomes your trading stock; or

· you make a testamentary gift of the asset under the Cultural Bequests Program; or

· you start to use the asset to solely produce exempt income or non-assessable non-exempt income.

In addition to the above where the asset is a share in a company or an interest in a trust the change is:

· A CGT event G3 or I1; or

· The taxpayer ceases to be a CGT concession stakeholder; or

· CGT Concession stakeholders in the company or trust cease to have a small business participation percentage of at least 90%.

The CGT event happens at the time there is a change in the status of the asset. The capital gain is equal to the capital gain that was disregarded for the asset under Subdivision 152-E.

CGT event J5

A CGT event J5 happens where a taxpayer chooses small business rollover under Subdivision 152-E and by the end of the replacement asset period (2 years after the CGT event subject to the rollover) the taxpayer fails to acquire a replacement asset or incur fourth element expenditure in relation to an existing asset.

CGT event J6

The CGT event J6 applies in circumstances where the taxpayer incurs expenditure on a replacement asset or fourth element expenditure on an existing asset by that expenditure is not sufficient to cover the disregarded capital gain under Subdivision 152-E.

No person should rely on the contents of this paper without first obtaining advice from a qualified professional person.

This paper is made available on the understanding that it is intended for general information purposes only and does not constitute advice relating to the readers specific circumstances. Further:

(1) the author(s) and/or Ambry Legal are not responsible for the results of any actions taken on the basis of information in this paper, nor for any error in or omission from this paper; and

(2) in preparing and/or presenting this paper the author, presenter and Ambry Legal are not providing legal or other professional advice.

Ambry Legal and the author(s) expressly disclaim all and any liability and responsibility to any person, whether a purchaser or reader of this paper or not, in respect of anything, and of the consequences of anything, done or omitted to be done by any such person in reliance, whether wholly or partially, upon the whole or any part of the contents of this paper.

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