Maximum net asset value test

There is a limit of $5 million on the net value of the CGT assets that you and certain related entities can own and still qualify for the small business CGT concessions. This $5 million limit is called the maximum net asset value test. The $5 million limit is not indexed for inflation.

You satisfy the maximum net asset value test if the total net value of CGT assets owned by:

• you
• any entities connected with you, and
• any of your small business CGT affiliates or entities connected with your small business CGT affiliates (subject to the note below)

does not exceed $5 million just before the CGT event that results in the capital gain for which the concessions are sought.

The assets of your small business CGT affiliates, or entities connected with your small business CGT affiliates, are included in the maximum net asset value test only if those assets are used, or held ready for use, in a business carried on by you or by an entity connected with you (but not an entity connected with you only because of your small business CGT affiliate).

Additional test for partnerships

If you are a partner in a partnership and the CGT event happens in relation to a CGT asset of the partnership (for example, a partnership asset is disposed of), the net value of the CGT assets of the partnership also must not exceed $5 million.

This additional test does not apply if a partner in a partnership disposes of an interest in a partnership asset (and the other partners retain their interest in the partnership asset). This is because a partner's interest in a partnership asset is a CGT asset of the partner and not of the partnership.

Meaning of net value of CGT assets

The net value of the CGT assets of an entity is:

Sum of the market values of those assets

less

any liabilities of the entity that are related to those assets

Assets to be included in determining the net value of CGT assets are not restricted to business assets and include all CGT assets of the entity, unless the assets are specifically excluded (as noted below).

Although gains from depreciating assets may be treated as income rather than capital gains, depreciating assets are still CGT assets and are therefore included when calculating the net asset value.

Assets excluded from the net value of CGT assets

Some interests in connected entities

To avoid double counting when calculating the net value of your CGT assets, you disregard any shares, units or other interests (apart from debt) that you hold in an entity connected with you or your small business CGT affiliate. This is because the net value of the CGT assets of the connected entity is already included in the test.

Assets solely for personal use, superannuation assets

If you are an individual, also disregard the following assets when working out the net value of your CGT assets:

• assets being used solely for your personal use and enjoyment, or that of your small business CGT affiliate
• rights to amounts payable out of a superannuation fund or an approved deposit fund
• rights to an asset of a superannuation fund or an approved deposit fund, and
• insurance policies on the life of an individual.

Individual's own home if incidental income-producing use

If an individual's own home is not used solely for personal use and enjoyment only because of some incidental income-producing use, the home is also excluded from the maximum net asset value test.

However, if the individual had incurred interest on a loan taken out to purchase the home and would have been able to be deduct at least some of that interest from their assessable income, the total market value of their home is included in the maximum net asset value test, even if it is predominantly used for private purposes.

The individual would be entitled to deduct part of the interest on money they borrowed to buy the home if:

• part of the home is set aside exclusively as a place of business and is clearly identifiable as such, and
• that part of the home is not readily adaptable for private use, for example, a doctor's surgery located within a doctor's home.

This is a hypothetical interest deductibility test. If the individual did not actually incur any interest, the test looks at whether they would have been entitled to a deduction if they had taken out a loan to purchase their home.

Who is a small business CGT affiliate?

Your spouse, or child under 18 years, is a small business CGT affiliate of yours.

A person is also your small business CGT affiliate if they act, or could reasonably be expected to act:

• in accordance with your directions or wishes, or
• in concert with you.

However, if you are a partner in a partnership, another partner is not your small business CGT affiliate only because that partner acts, or could reasonably be expected to act, in concert with you in relation to the affairs of the partnership.

When is an entity connected with you?

An entity is connected with another entity if:

• either entity controls the other entity, or
• both entities are controlled by the same third entity.

Connected with - control of a partnership, company or trust (except a discretionary trust)

An entity controls another entity if it, its small business CGT affiliates, or all of them together:

• beneficially own/s or has/have the right to acquire beneficial ownership of, interests in the other entity that give the right to receive at least 40% (the control percentage) of any distribution of income or capital by the other entity, or
• if the other entity is a company, beneficially own/s, or has/have the right to acquire beneficial ownership of, shares in the company that give at least 40% of the voting power in the company.

 

Control where interest is at least 40% but less than 50%

If an entity's control percentage in another entity is at least 40% but less than 50%, the Commissioner may determine that the first entity does not control the other entity if he is satisfied that a third entity (not including any small business CGT affiliates of the first entity) controls the other entity.

For an entity to be controlled by a third entity, the third entity must also have a control percentage of at least 40% in the entity. That is, it must control the entity in the way described above. In working out the third entity's control percentage, the interests of any small business CGT affiliates of the third entity are taken into account.

In other words, for the Commissioner to be able to determine that an entity does not control another entity, there must be a third entity that has a control percentage (including the interests of any small business CGT affiliates) of at least 40% in the other entity.

If there was a third entity with a control percentage of at least 40% (that is, there were two shareholders with a control percentage of at least 40%) it would be necessary to consider additional factors to determine if the third entity controls it. Such additional factors could include who is responsible for the day-to-day and strategic running of the company.

Alternatively, it is possible that both of the entities with a control percentage of at least 40% may control the company if such responsibilities are shared.

Connected with - control of a discretionary trust

Proposed changes to the control test for discretionary trusts have now become law. They were previously announced by the government in Assistant Treasurer Media Release CO97/03 on 16 October 2003 and were introduced into Parliament in Tax Laws Amendment (2004 Measures No. 1) Bill 2004 on 19 February 2004. The new rules are set out below.

Subject to certain transitional rules, the changes apply to CGT events happening after 11.45 am, by legal time in the Australian Capital Territory, on 21 September 1999.

Control by trustee

An entity may control a discretionary trust if the entity, its small business CGT affiliates, or all of them together:

• is/are the trustee of the discretionary trust (other than the public trustee of a state or territory), or
• has/have the power to determine how the trustee makes distributions of income or capital to the beneficiaries of the trust.

However, this will be the case only if certain beneficiaries are not taken to control the trust.

If a beneficiary of a discretionary trust controls the trust and the beneficiary is not a small business CGT affiliate of the trustee, or of a person who has the power to determine how the trustee makes distributions, then the trustee or that other person will not also be taken to control the discretionary trust.

Control by beneficiary

The level of actual distributions made by a discretionary trust is used to determine who controls the trust. Subject to certain transitional arrangements, a beneficiary is taken to control a discretionary trust only if, for any of the four income years before the year for which relief is sought for a CGT event:

• the trustee paid to, or applied for the benefit of, the beneficiary and/or their small business CGT affiliates (for example, their spouse or child under the age of 18) any of the income or capital of the trust, and
• the amounts paid or applied were at least 40% (the control percentage) of the total amount of income or capital paid or applied for that income year (subject to the Commissioner's discretion where the control percentage is between 40% and 50%).

Exempt entities and deductible gift recipients are not treated as controlling a discretionary trust regardless of the percentage of distributions made to them.

To determine if a particular beneficiary controls a trust, amounts paid to or applied for the benefit of any of the beneficiary's small business CGT affiliates are also included when determining whether the beneficiary reaches the 40% threshold.

Distributions of income and capital made to the same beneficiary are considered separately (that is, not added together) to determine if the beneficiary reaches the 40% threshold.

Public entities can also be taken to control a discretionary trust if distributions to them meet the 40% control percentage. A public entity is a publicly traded company or unit trust, a mutual insurance company, a mutual affiliate company or a company in which all the shares are beneficially owned by one or more of those entities.

 

No distributions made because of tax loss

The trustee of a discretionary trust may nominate up to four beneficiaries as being controllers of the trust for an income year for which the trust had a tax loss and for which the trustee did not pay or apply any income or capital of the trust.

In such a case, the trust might not have had the funds to make a distribution, which would prevent it from being controlled in that year. The trustee may wish to make the nomination to ensure that a particular CGT asset is treated as an active asset for that year.

The nomination must be in writing and signed by the trustee and each nominated beneficiary.

Transitional rules

As noted earlier, there are certain transitional rules that may apply in relation to the changes (reflecting their retrospective nature).

1. Modification of the new control test for the 2001-02 and prior income years

The new control test for discretionary trusts is based on actual distributions made for any of the four income years before the year in which the small business CGT concessions are sought.

As a transitional rule (designed to reduce compliance costs), the control test is modified for CGT events happening in the 1999-2000, 2000-01 and 2001-02 income years. For these years, you have to take into account actual distributions made only in the particular year for which the small business concessions are sought. That is, you need to examine only the one year.

2. Choice for continued operation of former control test

The new control test applies to CGT events happening after 11.45am, by legal time in the Australian Capital Territory, on 21 September 1999. You can choose a further transitional rule to apply for CGT events that happen before the end of the 2003-04 income year.

In such a case, you can choose to apply the former control test for discretionary trusts (but do not need to take into account assets of potential beneficiaries that are exempt entities or deductible gift recipients). Under the former control test, all potential beneficiaries of a discretionary trust were taken to control the trust regardless of actual distributions (assuming they could potentially receive at least 40% of the total distributions of income or capital).

You must choose to apply the transitional rule by the latest of:

• the day you lodge your income tax return for the income year in which the CGT event happened
• 30 June 2005 (12 months after the date of royal assent), and
• a later day allowed by the Commissioner.

The way you prepare your income tax return is sufficient evidence of making the choice.

You might choose to apply the former control test to enable particular entities to be treated as connected entities so that an asset owned by one entity and used in another entity's business can be an active asset. In this case, the assets of all potential beneficiaries (except exempt entities and deductible gift recipients) must also be included in the trust's $5 million net asset test.

3. Extension of time to make choices

The small business CGT concessions require you to make choices. Generally, a choice available under the CGT law must be made by the day you lodge your income tax return for the income year in which the relevant CGT event happened, or within such further time as the Commissioner allows.

A transitional rule applies in relation to CGT events that happen before the date of Royal Assent (29 June 2004) for entities that become eligible to make a choice under the new rules in relation to those events.

In such a case, the transitional rule allows you to make a choice by the latest of:

• the day you lodge your income tax return for the income year in which the CGT event happened
• 30 June 2005 (12 months after the date of royal assent), and
• a later day allowed by the Commissioner.

4. Extension of time to acquire replacement assets

Under the small business rollover, you must generally acquire a replacement asset within the period starting one year before and ending two years after the relevant CGT event (or within such further period as the Commissioner allows). As well, the replacement asset must be an active asset when it is acquired, or by the end of two years after the CGT event.

A transitional rule applies in relation to CGT events that happen before the date of Royal Assent (29 June 2004) for entities that become eligible to make a choice under the new rules in relation to those events.

In such a case, the transitional rule extends the period for acquiring the replacement asset and the period within which the asset must be an active asset to the latest of:

• two years after the last CGT event happened in the income year for which the entity obtained the small business rollover
• 30 June 2005 (12 months after the date of royal assent), and
• a later day allowed by the Commissioner.

Connected with - indirect control of an entity

The control tests for the 'connected with' rules are designed to look through business structures that include interposed entities. If an entity (the first entity) directly controls a second entity, and the second entity controls (whether directly or indirectly) a third entity, the first entity is also taken to control the third entity.

In the above figure, the small business entity controls Companies A and B but not Company C.

Exception where interposed entity is a public entity

The indirect control test does not apply if an entity controls a public entity and that public entity controls a third entity, unless the first entity actually controls the third entity (for example, because it holds 50% of the voting shares of the third entity).