By Harrison Dell, Director.
One area of significant interest for small business owners is the eligibility for Capital Gains Tax (CGT) concessions. These concessions can offer substantial tax relief, making them a critical factor in financial and tax planning for small businesses.
It is often said, if you apply these concessions and you still have a tax bill – go back and check again.
This article aims to explain the eligibility criteria for these concessions, the expanded testing and the concessions themselves.
Eligibility Conditions
To qualify for small business CGT concessions, businesses must first meet several basic conditions:
- Either of the following tests:
- Small Business Entity Test: The business must be a small business entity with an aggregated turnover of less than $2 million in the previous income year, or expected in the current income year.
- Maximum Net Asset Value Test: You have net assets of less than $6 million, excluding your home, superannuation and personal use assets.
- Asset Test: The CGT event must concern an asset used in the business. This asset can be either a tangible or intangible asset directly connected to the business operations.
- Active Asset Test: The asset in question must be an active asset, which means it must have been used or held ready for use in the course of conducting business.
- Ownership Period Test: There are specific timeframes during which the asset must have been held, typically a minimum period of 12 months, to be eligible for concessions.
Additional Conditions for Trusts and Companies
When a Capital Gains Tax (CGT) asset is a share in a company or an interest in a trust, there are specific additional conditions to be met for small business CGT concessions, aside from the basic eligibility requirements. These conditions are crucial for companies and trusts to navigate in order to benefit from these concessions.
1. Business Operation or Asset Value Test
The company or trust must satisfy one of the two below tests:
- Business Activity: The entity must have been actively running a business just before the CGT event and have turnover of less than $2 million.
- Net Asset Value Test: Alternatively, the entity must meet the maximum net asset value test.
This is in addition to either of those the Small Business Entity Test and the
2. Stakeholder and Participation Requirements
There are two main requirements:
- CGT Concession Stakeholder: Just before the CGT event, the individual must have been a CGT concession stakeholder in the company or trust.
- Participation Percentage: Alternatively, the CGT concession stakeholders in the company or trust must have a combined small business participation percentage of at least 90% (known as the 90% test).
3. Modified Connected Entity Rule
The company or trust needs to apply the modified connected entity rule to determine entities controlled by it. Under this rule, the company or trust must either be a small business entity for the income year or meet the maximum net asset value test itself ($6m net asset value).
4. Modified Active Asset Test
The shares or interest must meet a modified active asset test, which assesses whether the asset was actively used in the business.
Applying the Concessions
Beyond these primary conditions, other factors may also come into play, depending on the specific nature of the CGT event and the business:
- 15-year Exemption: If the business asset has been owned for over 15 years and the owner is retiring or permanently incapacitated, more significant concessions may apply.
- 50% Active Asset Reduction: A 50% reduction in the capital gain may be available if certain conditions are met, in addition to the basic requirements.
- Retirement Exemption: There are specific concessions available for those who are retiring, with caps on the benefits based on age and other factors.
- Rollover Relief: In some cases, if a business asset is replaced, the capital gain can be deferred or ‘rolled over’ into the new asset.
There are some additional conditions for some of the above. The 50% Active Asset Reduction, and Rollover Relief apply in almost all cases.
Example
Consider a small business, ‘Tech Innovations’, with an annual turnover of $1.8 million in 2022 year and $2.5m in the 2023 income year. It sells an intellectual property asset that was an active asset in the business for the whole period. The sale date is 30 June 2023.
In this scenario, ‘Tech Innovations’ meets the basic conditions for the small business CGT concessions due to its turnover and the nature of the asset. The turnover test is met as the turnover test allows for using either the previous income year (2022) or the current income year (2023).
Additional consideration would be needed to determine if they qualify for other concessions like the 15-year exemption or the retirement exemption.
Conclusion
Understanding and navigating the eligibility for small business CGT concessions can be complex. However, these concessions offer significant tax advantages for small businesses in Australia.
It’s strongly recommended for business owners to consult with a tax professional to fully understand their eligibility and to ensure they do not inadvertently trigger an ATO audit.
Disclaimer: This material is produced by Cadena Legal, a NSW-registered legal practice. It is intended to provide general information and opinions on legal topics, current at the time of first publication. The contents do not constitute legal advice and should not be relied upon as such. Contact us here for advice.
