Extra conditions for the small business CGT concessions
If the capital gains tax (CGT) asset is a share in a company or interest in a trust, you must meet the following extra conditions, in addition to the basic eligibility conditions, to be eligible for the small business CGT concessions:
- You either:
- ran a business just before the CGT event
- meet the maximum net asset value test
- Just before the CGT event, either:
- you were a CGT concession stakeholder in the company or trust
- the CGT concession stakeholders in the company or trust had a total small business participation percentage of at least 90% (the 90% test)
- The company or trust, when applying the modified connected entity rule in determining entities controlled by it, must either:
- be a small business entity for the income year
- meet the maximum net asset value test.
- Your shares or interest must meet the modified active asset test.
Who is a CGT concession stakeholder
You are a CGT concession stakeholder of a company or trust if you are either:
- a significant individual
- the spouse of a significant individual and you have a small business participation percentage in the company or trust that is more than zero.
You can hold the small business participation percentage directly or indirectly through one or more interposed entities.
You work out the small business participation percentage in the same way as the significant individual test.
Significant individual test
You are a significant individual in a company or trust if you have a small business participation percentage in the company or trust of at least 20%. This 20% can be made up of direct and indirect percentages.
A company or trust meets the significant individual test if it had at least one significant individual just before the CGT event.
Small business participation percentage
An entity’s small business participation percentage in another entity's test time is the sum of the entity's:
- direct small business participation percentage in the other entity at that time
- indirect small business participation percentage in the other entity at that time.
Direct small business participation percentage
Companies
An entity’s direct small business participation percentage in a company is the smallest percentage out of:
- the percentage of the voting power in the company that the entity is entitled to exercise (except for jointly owned shares)
- the percentage of any dividend payment that the entity is entitled to receive
- the percentage of any capital distribution that the entity is entitled to receive.
The smallest percentage could be 0%. This could be if shares do not have voting rights or if the shares do not carry a right to capital distributions or dividends.
Take all classes of shares (other than redeemable shares) into account when determining an entity’s participation percentage.
Ignore the voting power calculation for jointly owned shares because neither owner individually controls the voting power.
Example: significant individual holding 2 classes of shares in a company
Brave Company has 2 different classes of shares, A and B, which have equal voting and distribution rights.
The directors of the company can decide to make a distribution of income or capital to either class of shares to the exclusion of the other class of shares.
Isaac holds 22% of each class of shares. This means he:
- will receive 22% of any distribution made by the company, regardless of how the directors exercise their discretion
- holds 22% of the voting power through each class of shares.
Isaac is a significant individual because his smallest small business participation percentage in the company is 22% (and it must be at least 20%).
End of exampleTrusts
An entity’s direct small business participation percentage in a trust, where entities have entitlements to all the income and capital of the trust, is the lower percentage of either the:
- income of the trust that the entity is beneficially entitled to
- capital of the trust that the entity is beneficially entitled to.
An entity’s direct small business participation percentage in a trust (where entities do not have entitlements to all the income and capital of the trust, and the trust makes a distribution of income or capital) is the lower percentage of either distributions of:
- income that the entity is beneficially entitled to during the income year
- capital that the entity is beneficially entitled to during the income year.
Discretionary trusts with tax losses or no net income
An entity can use another method to work out their small business participation percentage in a discretionary trust if, in the CGT event year, both:
- the trustee did not make a distribution of income or capital during the income year
- the trust had no net income or had a tax loss for the income year.
The entity's direct small business participation percentage at the relevant time is the percentage of the distributions the entity was beneficially entitled to in the last income year before the CGT event in which the trustee made a distribution.
An entity's small business participation percentage is zero if either the:
- trust had net income and did not have a tax loss, and the trustee decided not to distribute
- trustee has never made a distribution in the income years up to and including the CGT event year (including where the trust had no net income or had a tax loss in each of those income years).
Example: significant individuals of a discretionary trust with no distribution and tax loss
After a bad trading year, XYZ Trust:
- sells its shares in an operating company and makes a capital gain
- makes no distributions in the CGT event year
- has an overall tax loss.
In the year prior to the CGT event year, the trustee makes a distribution of income to the following beneficiaries as:
- 21% to Evangeline
- 23% to Dennis
- 25% to Katrin.
Evangeline, Dennis and Katrin all have a small business participation percentage in XYZ Trust of at least 20%. This makes them significant individuals and CGT stakeholders in XYZ Trust.
End of exampleIndirect small business participation percentage
An entity’s indirect small business participation percentage in a company or trust is the entity’s direct participation percentage in an interposed entity multiplied by the interposed entity’s total participation percentage (both direct and indirect) in the company or trust.
An indirect interest can be held through one or more interposed entities.
If a trust has a tax loss or no net income for the income year, a beneficiary of a discretionary trust may calculate their indirect small business participation percentage to be more than zero.
Example: calculating the participation percentage of a trust to determine significant individuals
ABC Trust owns 100% of the shares in Operating Co. Therefore, ABC Trust has a 100% direct interest (and no indirect interest) in Operating Co.
Jennifer, Bill and Nicky are the beneficiaries of ABC Trust.
Jennifer
Jennifer receives 80% of the distributions from ABC Trust. Therefore, she has a direct participation percentage of 80% in ABC Trust.
Jennifer’s participation percentage in Operating Co is calculated by multiplying Jennifer’s direct participation percentage in ABC Trust and ABC Trust’s total participation percentage in Operating Co:
- 80% × 100% = 80%
Jennifer has an 80% participation percentage in Operating Co, so she is a significant individual of Operating Co.
Bill
Jennifer's spouse, Bill, receives 15% of the distributions from ABC Trust. Therefore, he has a direct participation percentage of 15% in ABC Trust.
Bill’s participation percentage in Operating Co is calculated by multiplying his direct participation percentage in ABC Trust and ABC Trust’s total participation percentage in Operating Co:
- 15% × 100% = 15%
Bill has a 15% participation percentage in Operating Co, so he is not a significant individual of Operating Co.
However, as a spouse of a significant individual with a participation percentage greater than zero in the entity, Bill will be a CGT concession stakeholder.
Nicky
Nicky receives 5% of the distributions from ABC Trust. Therefore, she has a direct participation percentage of 5% in ABC Trust.
Nicky’s participation percentage in Operating Co is calculated by multiplying her direct participation percentage in ABC Trust and ABC Trust’s total participation percentage in Operating Co:
- 5% × 100% = 5%
Nicky has a 5% participation percentage in Operating Co, so she is not a significant individual of Operating Co. Nicky is not a CGT concession stakeholder.
End of exampleThe 90% test
The 90% test only applies if there is an interposed entity between the CGT concession stakeholders and the company or trust in which the shares or interests are held. The interposed entity is the entity accessing the concessions.
The test is met if CGT concession stakeholders in the company or trust in which the shares or interest are held have a total small business percentage in the entity claiming the concession of at least 90%.
Like the significant individual test, the participation percentage can be held directly or indirectly through multiple interposed entities.
Example: the 90% test for ABC Trust
Based on the above 'Example: calculating the participation percentage of a trust to determine significant individuals':
- Jennifer, a significant individual and CGT concession stakeholder of Operating Co, has an 80% small business participation percentage in ABC Trust
- Bill, a CGT concession stakeholder of Operating Co, has a 15% small business participation percentage in ABC Trust
- Nicky, who is not a CGT concession stakeholder of Operating Co, has a 5% small business participation percentage in ABC Trust.
At least 90% of the participation percentages in ABC Trust are held by CGT concession stakeholders of Operating Co (Jennifer and Bill). As a result, ABC Trust meets the ownership requirement if it sells its shares in Operating Co, and can access the concessions on those shares, provided the other conditions are met. ABC Trust is not a CGT concession stakeholder in Operating Co because it is not an individual.
End of exampleModified connected entity rule
The company or trust must be a small business entity or meet the maximum net asset value test using the modified connected entity rule. When applying each of these tests, the company or trust must include the annual turnovers and assets of its affiliates and entities controlled by it.
Under the modified connected entity rule, the company or trust controls another entity if it has a control percentage of at least 20% in the other entity.
Any Commissioner's determination that the entity does not control another entity (discretion about control between 40% and 50%) is disregarded for the modified connected entity rule.
Example: entity fails modified connected entity rule
Colour Co is a small business entity with an aggregated turnover of less than $2 million.
When applying the general connected entity rule, Red Co, Big Green Co and Blue Co would not be connected with Colour Co because Colour Co holds less than 40% of shares in each of them.
However, to determine if Colour Co is a small business entity or meets the maximum net asset value test to access the small business CGT concessions, we need to apply the modified connected entity rule. This is because the CGT asset is a share in a company.
Because Colour Co owns 20% of the shares in Red Co, Big Green Co and Blue Co, Colour Co controls them. Therefore, Colour Co must include the annual turnovers in its aggregated turnover and the net asset values in the maximum net asset value test.
Big Green Co has an annual turnover of $5 million (from dealings unrelated to Colour Co) and the net value of its assets is $20 million. This means Colour Co would not:
- be a small business entity with an aggregated turnover of less than $2 million
meet the maximum net asset value test as the total net value of the assets owned by Colour Co and entities controlled by it (Red Co, Big Green Co, Blue Co) exceeds $6 million.
End of example
Example: entity fails modified connected entity rule
Colour Co is a small business entity with an aggregated turnover of less than $2 million.
When applying the general connected entity rule, Red Co, Big Green Co and Blue Co would not be connected with Colour Co because Colour Co holds less than 40% of shares in each of them.
However, to determine if Colour Co is a small business entity or meets the maximum net asset value test to access the small business CGT concessions, we need to apply the modified connected entity rule. This is because the CGT asset is a share in a company.
Because Colour Co owns 20% of the shares in Red Co, Big Green Co and Blue Co, Colour Co controls them. Therefore, Colour Co must include the annual turnovers in its aggregated turnover and the net asset values in the maximum net asset value test.
Big Green Co has an annual turnover of $5 million (from dealings unrelated to Colour Co) and the net value of its assets is $20 million. This means Colour Co would not:
- be a small business entity with an aggregated turnover of less than $2 million
meet the maximum net asset value test as the total net value of the assets owned by Colour Co and entities controlled by it (Red Co, Big Green Co, Blue Co) exceeds $6 million.
End of exampleModified active asset test
In determining whether your share in a company or interest in a trust meets the modified active asset test, your share or interest must have been an active asset with some modifications to the 80% test.
Whilst the modified 80% test must be met for at least half of the asset ownership period, it does not need to be applied on a day-to-day basis.
When applying the modified 80% test, a share in a company or an interest in a trust will continue to be an active asset at a later time if it:
- was an active asset at an earlier time
- is reasonable to conclude that the share or interest is still an active asset at the later time.
A temporary breach of this requirement will not result in the test being failed.
Steps to work out if your share or interest meets the modified active asset test
Step 1: Work out the total market value of the entity
Work out the total market value of both:
- the assets of the company or trust
- the assets of a later entity in which the company or trust has a small business participation percentage, multiplied by that percentage.
Exclude the market value of shares or interests held, directly or indirectly, by the company or trust.
Step 2: Work out the total market value of active assets
Work out the total market value of both:
- the active assets of the company or trust
- the active assets of a later entity, multiplied by that percentage.
Assets of a later entity are only active assets if both:
- the later entity, when applying the modified connected entity rule, either
- is a small business entity
- meets the maximum net asset value test in relation to a notional capital gain; and
- you either
- have a small business participation percentage of at least 20% in the later entity
- are a CGT concession stakeholder of the later entity.
Step 3: Calculate the minimum 80% requirement
At least 80% of the step 1 amount must be made up of:
- active assets (the step 2 amount)
- cash or financial instruments that are inherently connected with a business run by the company or trust, or a later entity.
Any cash or financial instruments acquired or held by the company or trust only for the purpose of meeting the 80% requirement are disregarded.
Example: meets the modified active asset test
Karen is a sole trader and is a small business entity with an aggregated turnover of less than $2 million (applying the general connected entity rule) for the 2018–19 income year.
Karen owns 50% of the shares in Consulting Co, which is a small business entity with an aggregated turnover of less than $2 million (applying the modified connected entity rule) for the 2018–19 income year.
The total market value of Consulting Co's assets (excluding the value of shares in Big Co and Media Co) is $1 million, of which $980,000 is the value of its active assets.
Consulting Co also owns 1,000 shares of the 10 million shares in Big Co. Consulting Co's small business participation percentage in Big Co is 0.01%. The total market value of Big Co's assets is $100 million.
Consulting Co also owns 50% of Media Co, which is a small business entity with an aggregated turnover of less than $2 million. The total market value of Media Co's assets is $1.2 million, of which $1 million is the value of its active assets.
There are no significant amount of cash and financial instruments inherently connected to the business of Consulting Co and Media Co.
There has been no significant change in the activities or holdings of Consulting Co, Big Co and Media Co over the period Karen has owned the shares.
On 20 April 2019, Karen sells her shares in Consulting Co.
The shares need to meet the modified active asset test for Karen to access the small business CGT concessions.
Step 1: Work out the total market value of the entity
The total market value of the assets in Consulting Co and other entities that Consulting Co has a small business participation percentage in (Big Co and Media Co) is $1.61 million. This is the sum of:
- $1 million (Consulting Co's assets)
- $100 million (the value of Big Co's assets) × 0.01% (Consulting Co's participation percentage in it) = $10,000
- $1.2 million (the value of Media Co's assets) × 50% (Consulting Co's participation percentage in it) = $600,000
Step 2: Work out the total market value of active assets
The market value of Consulting Co's active assets is $980,000.
An asset of Media Co can only be an active asset for Consulting Co if Karen is a CGT concession stakeholder of Media Co.
Karen's small business participation percentage is 25% in Media Co, calculated as 50% (Karen's small business participation percentage in Consulting Co) × 50% (Consulting Co's participation percentage in Media Co).
As Karen's small business participation percentage in Media Co is at least 20%, the market value of Media Co's active assets ($500,000) is included. This is calculated as $1 million (Media Co's active assets) × 50% (Consulting Co's participation percentage in Media Co).
Big Co's assets are not included as Karen is not a CGT concession stakeholder of Big Co.
$980,000 (market value of Consulting Co's active assets) + $500,000 (market value of Media Co's active assets) = $1.48 million.
Step 3: Calculate the minimum 80% requirement
Karen's shares meet the modified active asset test because:
- $1.48 million (the step 2 amount) ÷ $1.61 million (the Step 1 amount) = 92%
there have been no significant changes to the activities or holdings of the relevant entities during the ownership period.
End of exampleCapital gains made before 8 February 2018
If you made a capital gain relating to shares in a company or an interest in a trust before 8 February 2018, there are fewer conditions you need to meet to be eligible.
You must meet the basic CGT concessions eligibility conditions and just before the CGT event you must either:
- be a CGT concession stakeholder in the company or trust
- meet the 90% test.