A look at the small business entity capital gains tax exemptions

The Australian taxation regime provides contains several capital gains tax (CGT) exemptions for small business entities (SBEs). 

In 2019 the Board of Taxation completed a review of the small business tax concessions, including the four CGT small business concessions. In December of that year, the Board released its report. In that report the Board stated the following:

“The small business CGT concessions are, arguably, the most important in the small business concessionary regime as these provide significant benefits and are, accordingly highly valued by stakeholders. However, the generosity of the concessions is matched by equally complex legislation that leads to increased compliance costs and distortions in business decision making.”

In this article we take a look at requirements that a SBE must satisfy in order to access the CGT concessions, to cut through the complexity of these provisions.

What are the CGT concessions?

The Income Tax Assessment Act 1997 (Income Tax Act)allows qualifying “small business entities” to access four small business concessions on the making of a capital gain. These are: the 15-year retirement exemption, the 50% business reduction, the $500,000 lifetime retirement exemption, and the roll-over (replacement of business assets) relief.

The 15-year retirement exemption

This exemption allows for a total exemption if a qualifying SBE makes a capital gain on an “active” asset that it has owned for at least 15 years prior to disposing of the asset. The event giving rise to the capital gain must be connected to the relevant taxpayer either retiring at 55 years or older, or the taxpayer’s permanent incapacitation.

The 50% business reduction

The 50% business reduction provides for a 50% reduction to a capital gain if the necessary conditions are satisfied by the SBE. The 50% business reduction applies in addition to the general 50% discount, allowing for an effective discount on a capital gain of 75%.

The $500,000 lifetime retirement exemption

If the relevant conditions are met, this allows for an exemption on a capital gain of up to $500,000.

The roll-over (replacement of business assets) relief

This allows for deferral of a capital gain if a replacement asset is acquired by the SBE, subject to other conditions being met.

What are the requirements to access the concessions?

The Income Tax Act contains a number of complex gateway provisions that must be satisfied before a SBE can access the generous concessions.

Preliminarily, there are two preconditions that must be met. First, a “CGT event” must happen in relation to a “CGT asset”. These are both terms defined in the Income Tax Act. The Income Tax Act sets out more than 50 CGT events, with the most common being the disposal (i.e. sale) of a CGT asset. The definition of “CGT asset” casts such a wide net as to capture essentially all types of property, both tangible and intangible.

Provided these preconditions are met, attention must be turned to the gateway provisions concerning the tax profile of the taxpayer. The first of these gateways is the “CGT small business entity test”. This test has two parts:

1 – the taxpayer must have been carrying on a business; and

2 – the taxpayer must satisfy a $2 million aggregated turnover test.

If the taxpayer cannot satisfy this test, there is an alternative “maximum net asset value test”. This requires the taxpayer and its affiliates to have a pool of net assets that does not exceed $6m.

If the taxpayer satisfies either of these two tests, the next gateway to pass through is the active asset test. That is, the asset in question must be used or installed ready for use in the course of carrying on business.

The answer to whether an asset is an active asset will at times be simple. In other circumstances, it will require a thorough examination of the facts and circumstances of the taxpayer, the nature of the asset, and how the asset was deployed as part of the taxpayer’s business.

Provided a taxpayer meets these tests, they will be prima facie eligible to access the SBE CGT concessions, though further analysis will always be required to determine which of the concessions the taxpayer may claim. For example, if a CGT event is not connected to a taxpayer’s retirement or permanent incapacitation, they will not be able to access the 15-year retirement exemption.

Claiming a SBE concession

If you believe you are eligible to claim a SBE CGT concession, it is critical to first seek professional advice as to your circumstances. Given the nature of the concessions as being both generous and complicated, a taxpayer claiming any of the exemptions is at least somewhat likely to be subject to an audit down the track. If later determined by the Australian Taxation Office that you were ineligible to claim a concession, you may be subject to interest and penalties.

Obtaining professional written advice known as a “reasonably arguable position” (RAP) paper will help immunise you from these penalties if the ATO later assesses you on the basis of being ineligible for the SBE CGT concessions.

At PGG Legal we specialise in providing tax advice to a broad range of small businesses, and can assist you in navigating the complex gateway provisions of the small business concessions.

If you would like to discuss the issues discussed in this article, please get in contact with us.

Peter Gell

Peter was admitted as a solicitor in 1981 and holds qualifications in law and a Masters degree in taxation conferred by the University of NSW. Peter practises in taxation advisory, estate planning and wills, probate and commercial law.