Basic conditions for the small business CGT concessions

Basic conditions

The basic conditions are contained in subdivision 152-A - Income Tax Assessment Act 1997.

To qualify for the small business CGT concessions, you must satisfy several conditions that are common to all the concessions. These are called the 'basic conditions'.

Each concession also has further requirements that you must satisfy for the concession to apply (except for the small business 50% active asset reduction which applies if the basic conditions are satisfied).

Follow the steps below to determine if you satisfy the basic conditions:

Step 1

You must first satisfy one of the following:

• you are a small business entity
• you do not carry on business (other than as a partner) but your asset is used in a business carried on by a small business entity that is your affiliate or an entity connected with you (passively-held assets)
• you are a partner in a partnership that is a small business entity, and the CGT asset is
  • an interest in a partnership asset (partnership assets) or
  • an asset you own that is not an interest in a partnership asset (partner's assets)
   
• you satisfy the maximum net asset value test.

In the 2008-09 Budget the government announced that it will increase access to the small business CGT concessions with effect from the 2007-08 income year for:

• taxpayers who own a CGT asset used in the business of an affiliate or connected entity (passively-held assets), and
• partners who own a CGT asset used in the partnership business (partner's assets).

These changes became law in June 2009 and apply for 2007-08 and later income years. For a summary of these and other changes see Capital gains tax (CGT) concessions for small business - more changes for the 2007-09 years .

Step 2

The asset in question must satisfy the active asset test.

Step 3

This step is only applicable if the CGT asset is a share in a company or interest in a trust. Where this is the case one of these additional basic conditions must be satisfied just before the CGT event:

• the entity claiming the concession must be a CGT concession stakeholder in the company or trust, or
• CGT concession stakeholders in the company or trust together have a small business participation percentage in the interposed entity of at least 90% (the 90% test).

Small business entity

You will be a small business entity if you are an individual, partnership, company or trust that:

• is carrying on a business, and
• has an aggregated turnover of less than $2 million.

What is aggregated turnover?

Aggregated turnover is your annual turnover plus the annual turnovers of any business entities that are your affiliates or that are connected with you. There are aggregation rules help you determine if you need to include the annual turnover of another business entity (a relevant entity) when calculating your aggregated turnover. These rules aim to prevent businesses splitting their activities in order to inappropriately access the small business entity concessions.

A relevant entity is an entity that is your affiliate or is connected with you.

Working out if you are a small business entity

Depending on your circumstances there are three methods of working out if you are a small business entity in the current year.

Method 1 - Use your previous years aggregated turnover

If your aggregated turnover for the previous income year was less than $2 million, you will be a small business entity for the current year.

When you work out your aggregated turnover for the previous income year apply the current rules about aggregated turnover as if they were in force for the 2006-07 income year.

Method 2 - Estimate your current year aggregated turnover

If your estimated aggregated turnover for the current year is less than $2 million, you will be a small business entity for the current year. However, you can only estimate your turnover if your aggregated turnover for one of the two previous income years was less than $2 million.

About estimating your turnover

If you are estimating your turnover, you need to determine whether your aggregated turnover is more likely than not to be less than $2 million.

You must estimate your turnover based on the conditions you are aware of at the beginning of the income year or, if you are starting a business part way through the year, at the time that you start your business. Factors to consider when estimating your turnover include:

• your turnover in previous income years
• whether you plan to reduce or increase staff in the current year
• whether your business operating hours are increasing or decreasing
• whether previous extraordinary sales or product lines will be available in the current income year
• whether your business will face increased competition in the current income year, and
• whether your business activity will increase or decrease because of changing conditions.

When you work out your aggregated turnover for the previous income years, apply the current rules about aggregated turnover as if they were in force for those years. In the 2005-06 income year, if your aggregated turnover is $2 million or more you can use your simplified tax system (STS) group turnover figure instead if that would be less than $2 million.

Method 3 - Use your actual current year turnover

If your actual aggregated turnover is less than $2 million at the end of the income year, you will be a small business entity for that year.

You must use the same method, either prior year, estimated current year or actual current year, for calculating the annual turnover of your business and all your relevant entities.

How to work out your aggregated turnover

Step 1 - work out your annual turnover (for your previous or current year)

Your annual turnover includes all ordinary income earned in the ordinary course of business for the income year. Turnover refers to your gross income or proceeds, rather than your net profit.

If you operate multiple business activities, either as a sole trader or within the same business structure, you must include the income from all your activities when working out your annual turnover. For example, a sole trader operating a part time consultancy and a retail shop would include the income from both business activities when working out annual turnover.

Here are some examples of amounts included and not included in ordinary income:

Include these amounts	Do not include these amounts
sales of trading stock fees for services provided interest from business bank accounts amounts received to replace something that would have had the character of business income, for example, a payment for loss of earnings	GST you have charged on a transaction amounts borrowed for the business proceeds from the sale of business capital assets insurance proceeds for the loss or destruction of a business asset amounts received from repayments of farm management deposits

Special rules for calculating your annual turnover

Business operated for part of the year (starting or ceasing)

If you start or cease a business part way through an income year, you will need to work out your turnover using a reasonable estimate of what your turnover would have been if you had carried on the business for the entire income year. This rule applies for all three methods of working out whether you are a small business entity.

Retail fuel sales

You do not include retail fuel sales when calculating your turnover. This is a special rule because sales of retail fuel are characteristically high in sales volume with low profit margins.

Non-arm's length business transactions

Any income from transactions with an associate should be included in your turnover. If the dealing was not at arm's length (that is the goods or services were sold at a discounted price because of their association with you) you must use the market value of the goods or services when calculating your annual turnover.

However, you may take into account any discounts that would have been offered had the dealing been at arm's length.

Associate has the meaning given by section 318 of the Income Tax Assessment Act 1936. As an individual, your associates include but are not limited to:

• your relatives, such as your spouse or children
• a partnership that you are a partner in
• another partner in that partnership, and that partner's spouse and children
• a trustee of a trust that you, or your associate, are a beneficiary of, and
• a company that you, or your associate, control or influence.

There are similar rules to determine who is an associate of a company, partnership and trustee.

If the aggregation rules do not apply to you, your aggregated turnover will be the same as your annual turnover. You do not need to read any further. If you must consider the aggregation rules, or are not sure if they apply to you, go to step 2 below.

Step 2 - consider the aggregation rules

You must include the annual turnover of a relevant business entity with your annual turnover when working out your aggregated turnover.

A relevant business entity is a business entity that, at any time during the income year, is:

• connected with you, or
• is your affiliate.

If you have a relevant business entity, repeat step 1 for each relevant business entity to work out their annual turnover. You must use the same method for working out your annual turnover and the annual turnovers of all your relevant businesses entities.

Step 3 - work out your aggregated turnover

To work out your aggregated turnover, add the annual turnovers of relevant business entities to your annual turnover.

When working out your aggregated turnover, do not include income:

• from dealings between you and a relevant business entity
• from dealings between any of your relevant business entities, and
• of an entity when it was not your relevant business entity.

If your aggregated turnover is less than $2 million you are a small business entity for the current year.

If you are not a small business entity in an income year, you may still be able to access the capital gains tax concessions if you pass the $6 million maximum net asset value test.

Passively-held assets

This basic condition allows you to access the concessions for a CGT asset you own where you are not carrying on a business, but that CGT asset is used in the business of your affiliate or an entity connected with you. It can also apply where your asset is held ready for use in, or is inherently connected with, the business of your affiliate or entity connected with you.

The following conditions must be satisfied at a time in the income year:

• Your affiliate, or entity connected with you, is a small business entity for the income year (that is, the income year in which the CGT event happens to your CGT asset).
• You do not carry on a business in the income year other than in partnership.
• If you carry on a business in partnership, the CGT asset is not an interest in an asset of the partnership.
• Your affiliate or entity that is connected with you at a time in the income year is the same small business entity that carries on the business and uses the asset at that time and the asset is the same asset that also meets the active asset test at that time.

There is a special rule for calculating aggregated turnover where the basic condition for passively-held assets applies.

An entity that is your affiliate, or is connected with you, is deemed to be an affiliate of, or connected with (as the case may be), the small business entity that uses the asset. This rule only applies if the entity is not already an affiliate or connected with the small business entity. In calculating the aggregated turnover of the small business entity, the turnover of entities that are deemed to be affiliates or connected entities must be included. The calculation of aggregated turnover is otherwise the same.

There is a special affiliate rule for spouses and children under 18 that applies in these cases.

 

Partner in a partnership - using the small business entity test

The CGT rules operate on the basis that a partner in a partnership carries on the partnership business collectively with the other partners. However, a partner cannot be a small business entity. It is the partnership that must satisfy the small business entity test, that is the $2 million aggregated turnover test to qualify as a small business entity.

If the relevant conditions are met, a partner may be eligible for the small business CGT concessions using the turnover test for:

• their interest in a partnership asset, or
• an asset that is not a partnership asset that is used in the business of the partnership.

In both cases the partner is not required to be connected with the partnership.

The maximum net asset value test applies differently so that it is the individual partners in the partnership that determine their eligibility for the small business CGT concessions, and not the partnership.

Partnership assets

An asset is a partnership asset if the partners own the asset in accordance with their respective interests as specified in the partnership agreement.

Partners may be eligible for the concessions if:

• the asset is the partner's interest in a partnership asset, and
• that partnership is a small business entity.

Partner's assets

Partners may also be eligible for the concessions for a CGT asset the partner owns, (that is not their interest in a partnership asset), when the following conditions are satisfied at a time in the income year:

• they were a partner in a partnership in the income year in which the CGT event happens to the partner's CGT asset
• that partnership uses the asset in carrying on the partnership business and is a small business entity for that income year
• the only business the partner carries on is as a partner in a partnership.

There is a special rule for calculating aggregated turnover in cases where a partner's asset is being used in the business carried on by the partnership.

An entity that is an affiliate of, or connected with, the partner is deemed to be an affiliate of, or connected with (as the case may be), the partnership that uses the asset. This rule only applies if the entity is not already an affiliate or connected with the partnership.

In calculating the aggregated turnover of the partnership, the turnover of entities that are deemed to be affiliates or connected entities must be included. The calculation of aggregated turnover is otherwise the same.

There is another special rule for calculating aggregated turnover where the taxpayer is a partner in more than one partnership and the asset is used in more than one partnership business. It treats each partnership that the taxpayer is a partner in, and that uses the asset, as being connected with the partnership that is trying to work out if it is a small business entity (the test entity). When working out the aggregated turnover of the test partnership, the turnover of any other partnerships that are deemed to be connected must be included.

Businesses that are winding up

The basic conditions for passively-held assets and partner's assets require that:

• the asset is used in the business of your affiliate, connected entity or partnership, at a time in the income year that the CGT event happens; and
• that entity is a small business entity in the year the event happens.

If an entity is not using the asset in the business in the year the CGT event occurs, because the business the entity previously carried on is winding up, there is a special rule that applies provided the entity used the asset in the business in the year the business ceased.

This rule treats the entity as carrying on the business for a moment in time in the income year the CGT event happens and treats the asset as being used, held ready for use in, or inherently connected with, the business at that same moment in time in the CGT event year.

There is another rule that applies for all the basic conditions that use the turnover test. This rule allows an entity to work out if it is a small business entity in the CGT event year when the entity is winding up a business it previously carried on. The entity will be taken to be still carrying on the business if:

• it is winding up a business it previously carried on, and
• it was a small business entity in the income year the entity ceased business.

Maximum net asset value test

There is a limit of $6 million on the net value of the CGT assets that you and certain entities can own and still qualify for the small business CGT concessions. This $6 million limit is called the maximum net asset value test. It is not indexed for inflation.

You satisfy the maximum net asset value test if the total net value of CGT assets owned by certain entities does not exceed $6 million just before the CGT event that results in the capital gain for which the concessions are sought. You must include the net value of CGT assets owned by:

• you
• any entities connected with you, and
• any of your affiliates and entities connected with your affiliates (subject to the note below).

Only include the net value of assets of your affiliates, and entities connected with your affiliates, if the assets are used, or held ready for use, in a business carried on by you or an entity connected with you. Don't include an asset if it is used in the business of an entity that is connected with you only because of your affiliate.

Meaning of net value of CGT assets

The net value of the CGT assets of an entity is the amount (whether positive, negative or nil) worked out by taking the:

Sum of the market values of those assets less any liabilities of the entity that are related to those assets.

Partner in a partnership

If you are a partner in a partnership and the CGT event happens in relation to an asset of yours or a CGT asset of the partnership (for example, disposal of a partnership asset), the maximum net asset value test would include:

• all the assets of the partnership if you are connected with it, and you would exclude the value of your interest in the partnership, or
• only your interest in the partnership if you are not connected with it, you would not count the assets of the partnership as a whole.

Entities that hold shares or trust interests would calculate their maximum net asset value test in a similar way.

What assets are included in the net value of the CGT assets?

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

In the case of a dwelling, an individual only includes the current market value of a dwelling in their net assets to the extent that it is reasonable - having regard to the amount that the dwelling has been used to produce assessable income which gives rise to deductions for interest payments or would give rise to deductions for interest if interest had been paid.

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.

If the dwelling has had some income producing use, the percentage of income producing use is multiplied by the current market value to work out the value of the dwelling that should be included. This will take into account the length of time and percentage of income producing use of the dwelling.

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.

Liabilities included in the net value of the CGT assets

Liabilities to be included in determining the net value of the CGT assets include:

• legally enforceable debts due for payment
• presently existing obligations to pay either a certain sum or ascertainable sums, and
• the following provisions
  • provisions for annual leave
  • provisions for long service leave
  • provisions for unearned income, and
  • provisions for tax liabilities.
   

However, contingent liabilities are not included in the calculation. A contingent liability is a liability that will become due only on the occurrence of an event that may or may not happen.

Examples of amounts that are not included in 'liabilities' for the purposes of determining the 'net value of the CGT assets' of an entity include:

• provisions for possible obligations to pay damages in a pending lawsuit
• provisions for liabilities in respect of an earn-out contract
• provisions for the guarantee of a loan
• accounting liabilities arising as a result of receiving prepaid income
• expenses that are not yet due, and
• provisions in general for such things as quantity rebate.

Liabilities related to the assets

A liability must be related to the CGT assets of an entity to be taken into account in determining the net value of the CGT assets of the entity.

This includes liabilities directly related to particular assets that are themselves included in the calculation - for example, a loan to finance the purchase of business premises. It also includes liabilities not directly related to a particular asset but rather to the assets of the entity more generally - for example, a bank overdraft or other short-term financing facility that provides working capital for the operation of the business. Liabilities that are directly related to an asset that is excluded from the net asset calculation are, however, excluded. However, certain liabilities related to excluded interests in connected entities may be counted. See Some interests in connected entities.

Example

Cool Tool Pty Ltd is selling its business. The assets and liabilities of the company are as follows:

Assets

Plant and machinery	$1,500,000	-
Freehold premises	$3,500,000	$5,000,000

Liabilities

Mortgage (secured over the premises)	$2,000,000	-
Provision for leave of employees	$500,000	-
Unbilled expenses (business consultant)	$200,000	-
Provision for rebates	$200,000	-
Provision for possible damages payout	$100,000	$3,000,000
Net assets:	-	$2,000,000

The net value of the CGT assets of the company is calculated as follows:

Assets

Plant and machinery	$1,500,000	-
Freehold premises	$3,500,000	$5,000,000

Liabilities

Mortgage (secured over the premises)	$2,000,000	-
Provision for leave of employees	$500,000	$2,500,000
Net value of CGT assets:	-	$2,500,000

The following items are not taken into account in working out the net value of the CGT assets of Cool Tool Pty Ltd because they are contingent liabilities, future obligations or expectancies:

• provision for possible damages payout
• unbilled expenses (business consultant), and
• provision for rebates.

Assets not included

Some interests in connected entities

Shares, units or other interests (apart from debt) that you hold in an entity connected with you or your affiliate are excluded from the calculation of net value. This is because the net value of the CGT assets of the connected entity is already included in the test.

Liabilities relating to these excluded interests in connected entities are also excluded, because these liabilities are not related to an asset included in the net asset value calculation.

Changes resulting from the June 2009 amendments allow liabilities related to excluded interests in connected entities to be taken into account in working out the net asset value. The amendment applies to CGT events that happen on or after 23 June 2009.

Some non-business assets of affiliates or connected entities

Any assets of an affiliate or an entity connected with an affiliate are excluded unless they are used, or held ready for use, in a business carried on by you or by an entity connected with you (but not if the entity is connected with you only through your affiliate).

Assets solely for personal use, superannuation assets

If you are an individual, you should 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 affiliate
• your own home, to the extent that you use it for private purposes (also, if your only other use is some incidental income-producing use, exclude your home from the net asset value test)
• 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 your life.

Where an asset is disregarded, any related liability is also disregarded because these liabilities are not related to an asset included in the net asset value calculation.

Who an affiliate is

An affiliate is an individual or company that, in relation to their business affairs, acts or could reasonably be expected to act:

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

Trusts, partnerships and superannuation funds cannot be your affiliates. However a trust, partnership or superannuation fund may have an affiliate who is an individual or company.

However, a person is not your affiliate merely because of the nature of a business relationship you and the person share.

For instance, if you are a partner in a partnership, another partner is not your affiliate merely because you act, or could reasonably be expected to act in accordance with their directions or wishes in relation to the affairs of the partnership.

Similarly, companies and trusts are not affiliates of their directors and trustees respectively, and vice versa, merely because of the positions held.

Whether a person acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes, or in concert with the taxpayer is a question of fact dependent on all the circumstances of the particular case. No one factor will necessarily be determinative.

Relevant factors that may support a finding that a person acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes, or in concert with the taxpayer, include:

• the existence of a close family relationship between the parties
• the lack of any formal agreement or formal relationship between the parties dictating how the parties are to act in relation to each other
• the likelihood that the way the parties act, or could reasonably be expected to act, in relation to each other would be based on the relationship between the parties rather than on formal agreements or legal or fiduciary obligations, and
• the actions of the parties.

Generally, another business would not be acting in concert with you if they:

• have different employees
• have different business premises
• have separate bank accounts
• do not consult you on business matters, and
• conduct their business affairs independently in all regards.

In certain circumstances an individual or entity can be taken to be your affiliate. See Are spouses and children affiliates? and Passively-held assets and Partner's assets.

 

Are spouses and children affiliates?

Neither a spouse nor a child is automatically your affiliate. You must consider whether they are acting according to your directions or wishes, or in concert with you, in relation to their business affairs.

However, where you own an asset that your spouse or child uses in a business they carry on as an individual, they will be taken to be your affiliate for the purposes of the:

• active asset test
• $6 million maximum net asset value test, and
• $2 million aggregated turnover test.

By child, we mean your child less than 18 years of age.

Your spouse or child may also be taken to be your affiliate where:

• an asset is owned by you and that asset is used in a business carried on by an entity that your spouse (or child) owns or has an interest in, or
• an asset is owned by an entity that you own or have an interest in, and that asset is used in a business carried on by your spouse (or child), or an entity that your spouse or child has an interest in.

For example, your spouse is taken to be your affiliate if you own an asset that is used in the business of an entity your spouse owns. Similarly, your spouse is taken to be your affiliate if an entity you own leases an asset to an entity your spouse owns, and that entity uses the asset in business.

Your spouse or child is treated as your affiliate when working out whether the entity that owns the asset is an affiliate of or connected with the entity that uses the asset in their business. If, by treating your spouse or child as your affiliate the result is that the business entity is taken to be an affiliate of, or connected with, the entity that owns the asset, then the affiliate rule will also apply to treat the spouse or child as an affiliate of the individual for the purposes of the small business CGT concessions in relation to:

• all the basic conditions for eligibility, and
• calculating aggregated turnover and net asset value.

This rule only applies in relation to eligibility for the small business CGT concessions and not the other small business entity concessions.

If this second stage of the affiliate rule applies it will also apply for any gain that arises from any asset that either the asset owner or the business entity or the individual or their spouse or child owns. This affiliate rule works both ways so that the individual is also taken to be an affiliate of their spouse or child. However it only applies for as long as:

• the person is their spouse or the child is under 18 years, and
• any asset is being passively-held.

This affiliate rule for spouses and children also has application for the meaning of active asset.

This affiliate rule applies only if the business entity is not already an affiliate of, or connected with, the asset-owner.

The treatment of spouses and children as affiliates in certain circumstances changed as a result of the second round of changes for 2007-08 and later income years arising from the June 2009 amendments. If this would result in you being ineligible for the concessions there is a transitional rule.

Under the first round of changes in 2007 to the meaning of affiliate for 2007-08 and later income years, spouses and children were not automatically affiliates. However, an asset held by a spouse or child was treated as an asset held by an affiliate for the purpose of the active asset test only. This was to ensure that an asset did not lose active asset status as a result of the amendments.

The term 'small business CGT affiliate' applied for the 2006-07 and earlier years. There are differences in the meanings of affiliate and small business CGT affiliate. For 2006-07 and prior years spouses and children were automatically small business CGT affiliates.

Transitional rule

The transitional rule ensures you are not made ineligible for the concessions, for CGT events occurring prior to 19 March 2009, because of the June 2009 amendment to the affiliate rule and the retrospective application of that rule.

The affiliate rule that applied for spouses and children as a result of the June 2007 amendments only applied where the asset was held by an individual and was used in a business directly carried on by a spouse or child. It treated an asset used or held ready for use in or inherently connected with the business of a spouse or child as if it were used, held ready for use or inherently connected with a business carried on by your affiliate. This allowed your asset to be an active asset. However, this rule did not allow a CGT asset to be active where the taxpayer's spouse held an interest in an entity that used the CGT asset in its business or the asset was not owned by an individual.

The June 2009 amendment to the affiliate rule expands the definition of affiliate to include a spouse or child of an individual, where an asset is held by one entity but used in the business of another. That entity could be an individual or a non-individual.

The transitional rule will apply if:

• you would satisfy the basic conditions as they existed following the June 2007 amendments and
• you would not satisfy the basic conditions if the new rule about spouses and children applied to you following the June 2009 amendments.

If the transitional rule applies to you, then the following June 2009 amendments will only apply to CGT events that happen to your assets on or after 19 March 2009:

• the new basic conditions for passively-held assets and partner's assets, and
• the expanded definition of affiliate to include a spouse or child in passively-held asset cases.

If you are using the transitional rule, use the affiliate rule that applied following the June 2007 amendments for CGT events prior to 19 March 2009.

Are franchisees and franchisors affiliates?

Franchisees are not necessarily affiliates of the franchisor simply because of the franchise arrangement. Whether the franchisee acts in concert with the franchisor in respect of their franchise business depends on, among other things, the nature of the franchise agreement between them.

The affiliate relationship does not include the relationship between the 'controller' of an entity and the entity itself. The relationship in these situations is considered to be dictated more by obligations imposed by law, formal agreements and fiduciary obligations. Accordingly, companies, trusts and partnerships are not considered to be affiliates (and vice versa) of the various officers/persons/entities that are related to the company, trust or partnership in various capacities - for example, the trustees and beneficiaries of a trust, the directors and shareholders of a company and the partners in a partnership.

When an entity is 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.

In certain circumstances an entity can be taken to be connected with you. See Passively-held assets and Partner's assets.

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

An entity controls another entity if it, its 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, equity interests in the company that give at least 40% of the voting power in the company.

The way in which an entity can directly control a company has been expanded from 2007-08 by replacing the term shares with equity interests. The meaning of an equity interest includes, but is not limited to, a share in a company.

 

At least 40% but less than 50% control

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 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 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 (despite holding at least 40% interest in it), there must be a third entity that has a control percentage (including the interests of any affiliates) of at least 40% in the other entity.

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

Control by entity with influence over trustee

From the 2007-08 year an entity controls the discretionary trust if the trustee either acts, or might reasonably be expected to act, in accordance with the directions or wishes of the entity and/or the entity's affiliates.

All the circumstances of the case need to be considered in determining whether you satisfy this test. For example, the mere presence in the trust deed of a requirement that the trustee should have no regard to such directions or wishes would not be sufficient.

Some factors which might be considered include:

• the way in which the trustee has acted in the past
• the relationship between the entity and/or its affiliates and the trustee
• the amount of any property or services transferred to the trust by the entity and/or its affiliates, and
• any arrangement or understanding between the entity and any person who has benefited under the trust in the past.

This entity may control a discretionary trust in addition to any beneficiary with control as described below.

Control by beneficiary

The level of actual distributions made by a discretionary trust is used to determine who controls the trust. 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 affiliates 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 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.

Where a discretionary trust makes a contribution to a superannuation (or similar) fund for an employee who is also a beneficiary of the trust, this payment is not considered to be a distribution of income or capital of the trust. This is because the payment is made for the person in their capacity as employee and not in their capacity as beneficiary.

 

No distributions made

The trustee of a discretionary trust may nominate up to four beneficiaries as being controllers of the trust for an income year in which the trust had a tax loss or no taxable income and in 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.

Effect of nominating a beneficiary as controller of the trust

From the 2007-08 year a beneficiary nominated as controller of a trust is connected with the trust for the purposes of the active asset test only. Neither the beneficiary nor the trust need to include the CGT assets or turnover of the other in the calculation of the maximum net asset value test or aggregated turnover test.

For 2006-07 and prior years a nominated controller was connected with the trust for the purposes of the maximum net asset value test.

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).

Active asset test

The active asset test is satisfied if:

• you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the test period detailed below, or
• you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of least 7.5 years during the test period.

The test period:

• begins when you acquired the asset, and
• ends at the earlier of
  • the CGT event, and
  • if the business in question ceased in the 12 months before the CGT event (or such longer time as the Commissioner allows) - when the business ceased.
   

The periods in which the asset is an active asset do not need to be continuous. However, they must add up to the minimum periods specified above, depending on the total period of ownership.

The asset does not need to be an active asset just before the CGT event.

Cessation of a business

If the CGT event happens within 12 months after the business ceased, the test period can end when the business ceased.

This aspect of the active asset test allows some flexibility in the situation where a business is sold, or has otherwise ceased, and an asset previously used in the business is sold after that time. The asset only needs to be an active asset for half (to a maximum of 7.5 years) of the shorter test period during the total time the asset was owned.

If the CGT event happens more than 12 months after the business ceased, the test period ends either:

• when the CGT event happens, or
• when the business ceased if the Commissioner grants you an extension of time.

Extension of time requests are considered on the merits of each case.

For the purposes of the active asset test, the cessation of a business includes the sale of a business. That is, it is not limited to a business that ends in the sense that no-one continues to carry it on but also includes a business that has ceased to be carried on by an entity because the entity has sold that business.

Death and the active asset test

Where you are one of the following, you may be eligible for the concessions to the same extent that the deceased would have been just prior to their death:

• beneficiaries of deceased estates
• legal personal representatives (executors)
• surviving joint tenants
• trustees and beneficiaries of testamentary trusts (trusts created by a will).

You will be eligible for the concessions where the CGT event happens within two years of the individual's death. The active asset test applies to you for any capital gain made on a sale of the assets after the two-year time limit. This means that if you do not continue to carry on the deceased's business, or use the asset in another business, after the two-year time period, the active asset test may not be satisfied and the small business concessions may not be available.

The Commissioner can extend this two year period.

See Death and the small business CGT concessions.

Continuing time periods for active asset test for involuntary disposals

There are modified rules to determine if the active asset test is satisfied for CGT assets acquired or transferred under the rollover provisions relating to assets compulsorily acquired, lost or destroyed or to marriage breakdown (Subdivisions 124-B and 126-A of the ITAA 1997 respectively).

If you acquired a replacement asset to satisfy the rollover requirements for the compulsory acquisition, loss or destruction of a CGT asset, the replacement asset is treated as if:

• you acquired it when you acquired the original asset, and
• it was an active asset at all times when the original asset was an active asset.

If you have a CGT asset transferred to you because of a marriage breakdown, and the capital gain arising from that transfer was rolled over under the marriage breakdown rollover provisions, for purposes of the active asset test you can choose whether to:

• include the ownership and active asset periods of your former spouse, or
• commence the ownership and active asset periods from the time the asset was transferred to you.

If you choose to include your former spouse's ownership and active asset periods of the CGT asset, that asset is treated as if it had been:

• acquired by you when your former spouse acquired the asset, and
• an active asset of yours at all times when the asset was an active asset of your former spouse.

Modified active asset test for CGT event D1

A modified active asset test applies if you make a capital gain from CGT event D1 (about creating rights in another entity).

The active asset test requires you to own the CGT asset before the CGT event happens. However, under CGT event D1, the relevant CGT asset (the rights) are created in the other entity without you owning them so it would not be possible to satisfy the active asset test.

Accordingly, the test is modified to require the right you create that triggers the CGT event to be inherently connected with another CGT asset of yours that satisfies the active asset test.

Meaning of active asset

A CGT asset is an active asset if it is owned by you and is:

• used or held ready for use in a business carried on (whether alone or in partnership) by you, your affiliate, your spouse or child, or an entity connected with you, or
• an intangible asset that is inherently connected with a business carried on (whether alone or in partnership) by you, your affiliate, your spouse or child, or another entity that is connected with you, carries on, for example, goodwill.

Where you own an asset that your spouse or child uses in their business, they will be taken to be your affiliate for the purposes of the:

• active asset test
• $6 million maximum net asset value test, and
• $2 million aggregated turnover test.

Where we say 'child' we mean your child under 18 years.

Your spouse (or child) may also be taken to be your affiliate where:

• an asset is owned by you and that asset is used in a business carried on by an entity that your spouse (or child) owns or has an interest in, or
• an asset is owned by an entity that you own or have an interest in, and that asset is used in a business carried on by your spouse (or child), or an entity that your spouse or child has an interest in.

The rule is applied in two stages. The first stage treats an individual's spouse or child as their affiliate for the purposes of working out whether the entity that uses the CGT asset, or holds it ready for use in its business, is an affiliate of, or connected with, the entity that owns the CGT asset.

If by applying the first stage of the rule, the entity is taken to be an affiliate of, or connected with the entity that owns the asset - the asset is an active asset. The asset must still meet the active asset test.

The second stage of the rule treats the spouse or child as an affiliate for other purposes in the basic conditions. See Are spouses and children affiliates?

The treatment of spouses and children as affiliates in certain circumstances changed as a result of the second round of changes for 2007-08 and later income years arising from the June 2009 amendments. If this would result in you being ineligible for the concessions there is a transitional rule.

Under the first round of changes to the meaning of affiliate for 2007-08 arising from June 2007 amendments, a spouse or child was not automatically an affiliate. However, an asset used by a spouse or child in their business was treated as an asset used by an affiliate for the purpose of the active asset test. This was to ensure that an asset does not lose active asset status as a result of the June 2007 amendments.

For the 2006-07 and earlier years a 'small business CGT affiliate' included a spouse or child.

Businesses that are winding up

If you are accessing the concessions using the basic condition for passively-held assets or a partner's assets there is a special rule that affects the period of time that your asset is an active asset in the CGT event year. It applies in the income year the CGT event happens where:

• a business previously carried on by your affiliate, an entity connected with you or a partnership in which you are a partner, is being wound up and the asset is no longer being used in the business, and
• the asset was used, held ready for use in, or inherently connected with the business at a time in a previous income year when you ceased to carry on the business.

This rule treats the entity as carrying on the business for a moment in time in the income year the CGT event happens and treats the asset as being used, held ready for use in, or inherently connected with, the business at that same moment in time in the CGT event year. The asset must still pass the active asset test.

This rule is also required to enable you to meet the basic condition for passively-held assets and partner's assets.

When an asset is 'held ready for use'

For an asset to be held ready for use in the course of carrying on a business, it needs to be in a state of preparedness for use in the business and functionally operative. As such, premises still under construction or land, upon which it is intended to construct business premises, could not be said to be 'held ready for use' and would, therefore, not be active assets at that time.

Shares and trust interests may also be active assets

A CGT asset is also an active asset at a given time if you own it, and:

• it is either a share in a company that is an Australian resident at that time or an interest in a trust that is a resident trust for CGT purposes for the income year in which that time occurs, and
• the total of the following is 80% or more of the market value of all of the assets of the company or trust
  • the market values of the active assets of the company or trust, and
  • the market value of any financial instruments of the company or trust that are inherently connected with a business that the company or trust carries on, and
  • any cash of the company or trust that is inherently connected with such a business.
   
• Cash and financial instruments are not active assets, but they count towards the satisfaction of the 80% test provided they are inherently connected with the business.
• This means a share in a company or an interest in a trust is an active asset if the company or trust itself has active assets with a market value of at least 80% of the market value of all its assets. Including capital proceeds from any recent sale of active assets in the 80% test provides some flexibility where the total market value of the active assets of the company or trust temporarily drops below 80% between the time active assets are sold and new active assets acquired.
• The active asset test requires a CGT asset to have been an active asset for at least half of a particular period, as outlined earlier. For example, for a share in an Australian resident company to meet this requirement, the company must satisfy the 80% test for that same period.

The 80% test will be taken to have been met:

• where breaches of the threshold are only temporary in nature, and
• in circumstances where it is reasonable to conclude that the 80% threshold has been passed.

 

Interests in holding entities

An interest in an entity that itself holds interests in another entity that operates a business may be an active asset, depending on the successive application of the 80% test at each level.

Assets that cannot be active assets

The following CGT assets cannot be active assets (even if they are used, or held ready for use, in the course of carrying on a business):

• shares in companies or interests in trusts, other than those that satisfy the 80% test see Shares and trust interest may also be active assets
• financial instruments - such as bank accounts, loans, debentures, bonds, futures and other contracts and share options (unless they are inherently connected with a business, in which case they count towards the satisfaction of the 80% test)
• assets whose main use is to derive interest, an annuity, rent, royalties or foreign exchange gains (unless the main use for deriving rent was only temporary or the asset is an intangible asset that you have substantially developed or improved so that its market value has been substantially enhanced), and
• shares and trust interests in widely-held entities unless held by a CGT concession stakeholder in the widely-held entity.

Trade debtors are not considered to be financial instruments for the purposes of the active asset exclusions. Rather, they are a business facilitation mechanism that assists in the conduct of the business and are inherently connected with the business. Accordingly trade debtors can be included in the value of active assets when calculating the 80% test.Deriving rent

As already noted, an asset whose main use is to derive rent (unless that main use is only temporary) cannot be an active asset. This is the case even if the asset is used in the course of carrying on a business.

Whether an asset’s main use is to derive rent will depend on the particular circumstances of each case. The term ‘rent’ has been described as referring to the payments made by a tenant/lessee to a landlord/lessor for exclusive possession of the leased premises. As such, a key factor in determining whether an occupant of premises is a lessee paying rent is whether the occupier has a right to exclusive possession.

If, for example, premises are leased to a tenant under a lease agreement granting exclusive possession, the payments involved are likely to be rent and the premises are not an active asset. On the other hand, if the arrangement allows the person only to enter and use the premises for certain purposes and does not amount to a lease granting exclusive possession, the payments involved are not likely to be rent.

An asset that is leased to a connected entity or affiliate for use in its business may still be an active asset. It is the use of the asset in that entity’s business that will determine the active asset status of the asset.

The June 2009 amendments ensure all uses of an asset are considered in determining what the main use of the asset is and therefore whether it is an active asset. However, personal use of the asset by the asset owner, or by an individual who is their affiliate, is not considered in determining the main use of the asset.

The amendments apply to CGT events that happen on or after 23 June 2009.

 

Main use to derive rent – CGT events happening on or after 23 June 2009

The June 2009 amendments ensure that, when working out what the main use of the asset is, and therefore if it’s an active asset, all uses of the asset are considered. Previously only the use of the asset by an affiliate or connected entity was considered. Personal use by the asset holder or their affiliate is not considered.

The following is considered use of the asset to derive rent, where the rent is derived:

• from an entity that is not an affiliate or connected with the asset owner (third party), or
• by an entity that is an affiliate or connected with the asset owner (relevant entity).

The use of the asset to derive rent from a third party will be considered use to derive rent, even if that entity uses the asset in their business. This is because the use of the asset by the asset owner is to derive rent.

However, use of the asset by a relevant entity is treated as the use by the asset owner, even if the asset owner receives rent from the relevant entity for the use of that asset.

This means, if the relevant entity uses the asset:

• in its business, that use is treated as use by the asset owner to carry on business
• to derive interest, rent, royalties, or foreign exchange gains from an entity that is a third party, that use is treated as use by the asset owner to derive passive income.

 

Additional conditions if the CGT asset is a share or trust interest

If the CGT asset is a share in a company or an interest in a trust, one of these additional basic conditions must be satisfied just before the CGT event:

• the entity claiming the concession must be a CGT concession stakeholder in the company or trust, or
• CGT concession stakeholders in the company or trust together have a small business participation percentage in the interposed entity of at least 90% (the 90% test).

CGT concession stakeholder

An individual is a CGT concession stakeholder of a company or trust if they are a significant individual or the spouse of a significant individual where the spouse has a small business participation percentage in the company or trust at that time that is greater than zero.

This participation percentage can be held directly or indirectly through one or more interposed entities.

The percentages are worked out in the same way as for the significant individual test.

If a company or trust has claimed the small business 15-year exemption or the small business retirement exemption, a CGT concession stakeholder may receive an exempt amount from the company or trust if the conditions are satisfied.

Significant individual test

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%. The 20% can be made up of direct and indirect percentages.

A company or trust satisfies the significant individual test if it had at least one significant individual just before the CGT event. The small business 15-year exemption further requires a company or trust to have a significant individual for periods totalling at least 15 of the years of ownership of the CGT asset.

The significant individual test is not the same as the control tests used to determine if an entity is ‘connected with’ another entity for the purposes of the $6 million maximum net asset value test or the $2 million aggregated turnover test.

Total small business participation percentage

An entity’s small business participation percentage in another entity at a time is the percentage that is the sum of:

• the entity’s direct small business participation percentage in the other entity at that time, and
• the entity’s 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 percentage of:

• voting power that the entity is entitled to exercise
• any dividend payment that the entity is entitled to receive, or
• any capital distribution that the entity is entitled to receive.

As with the significant individual test, the participation percentage can be held directly or indirectly through one or more interposed entities.

If an entity has different participation percentages in a company, their participation percentage is the smaller or smallest percentage. The same applies for a trust.

All classes of shares (other than redeemable shares) are taken into account in determining an entity’s participation percentage in a company.

 

Trusts

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 percentage of:

• the income of the trust that the entity is beneficially entitled to receive, or
• the capital of the trust that the entity is beneficially entitled to receive.

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 percentage of:

• distributions of income that the entity is beneficially entitled to during the income year, or
• distributions of capital that the entity is beneficially entitled to during the income year.

If the trust did not make a distribution of income or capital during the income year it will not have a significant individual during that income year.

Indirect small business participation percentage

An entity’s indirect small business participation percentage in a company or trust is calculated by multiplying together the entity’s direct participation percentage in an interposed entity, and the interposed entity’s total participation percentage (both direct and indirect) in the company or trust.

The 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 satisfies the test if 90% of the participation percentages in that entity are held by CGT concession stakeholders of the company or trust in which the shares or interests are held.

 

Small business 15-year exemption

The rules covering the small business 15-year exemption are contained in Subdivision 152-B of the Income Tax Assessment Act 1997.

Interaction with other concessions

If you qualify for the small business 15-year exemption, you can entirely disregard the capital gain and do not need to apply any other concessions. Further, you do not have to apply capital losses against your capital gain before applying the 15-year exemption.

If the conditions are satisfied and you make a capital loss from the CGT event, you may use the capital loss to reduce other capital gains.

Conditions you must meet

You can disregard a capital gain from a CGT event happening to a CGT asset you have owned for at least 15 years if you:

• satisfy the basic conditions for the small business CGT concessions (the active asset test requires the asset to have been an active asset for at least 7.5 years of the whole period of ownership)
• continuously owned the CGT asset for the 15-year period ending just before the CGT event happened.

If you are an individual:

• you are at least 55 years old at the time of the CGT event and the event happens in connection with your retirement, or
• you were permanently incapacitated at the time of the CGT event, and
• if the CGT asset is a share in a company or an interest in a trust, that company or trust must have had a significant individual for periods totalling at least 15 years during the entire time you owned the share or interest – even if it was not the same significant individual during the whole period).

If you are a company or trust:

• you had a significant individual for a total of at least 15 years of the whole period of ownership (even if it was not the same significant individual during the whole period), and
• the individual who was a significant individual just before the CGT event was
  • at least 55 years old at that time and the event happened in connection with their retirement, or
  • permanently incapacitated at that time.
   

Death and the 15-year exemption

You may be eligible for the concessions if you make a capital gain on an asset within two years of a person’s death, if that asset is or was part of that individuals estate, and you are a:

• beneficiary of the deceased estate
• legal personal representatives (executor), or
• trustee or beneficiary of the testamentary trust
• (trusts created by a will).

You may also be eligible if you, together with the deceased, owned the asset as joint tenants.

You will be eligible for the 15-year exemption to the same extent that the deceased would have been just prior to their death, except that:

• the CGT event does not need to be in connection with the retirement of the deceased
• the deceased needs to have been 55 or older immediately before their death, rather than at the time of the CGT event.

The Commissioner can extend the two year period.

See ‘Basic conditions’ on page 11 and ‘Death and the small business CGT concessions’ on page 58.

Exception for discretionary trusts with tax losses

This exception applies only for the small business 15-year exemption and not for any of the other small business concessions. Further, there must still be a significant individual just before the CGT event, so this exception does not apply in the year the CGT event happens.

In a year that a discretionary trust has no taxable income (or a tax loss) and did not make a distribution of income or capital, it is treated as having met the significant individual requirement.

In connection with an individual’s retirement

Whether a CGT event happens in connection with an individual’s retirement depends on the particular circumstances of each case. There would need to be at least a significant reduction in the number of hours the individual works or a significant change in the nature of their present activities to be regarded as a retirement. However, it is not necessary for there to be a permanent and everlasting retirement from the workforce.

The following examples provide a guide as to the likely scope of the term.

 

A CGT event may be ‘in connection with your retirement’ even if it occurs at some time before retirement. Whether particular cases satisfy the conditions depends very much on the facts of each case.

Similarly, the words ‘in connection with’ can apply where the CGT event occurs sometime after retirement. Again, this type of case would depend on its own particular facts and cases would need to be considered on a case-by-case basis.

Permanent incapacity

Whether an individual is permanently incapacitated at the time of the CGT event depends on the particular circumstances of each case. Having regard to the meaning of the term permanent incapacity elsewhere within the retirement and superannuation law, an indicative description of the term is:

Ill health (whether physical or mental), where it is reasonable to consider that the person is unlikely, because of the ill-health, to engage again in gainful employment for which the person is reasonably qualified by education, training or experience. The incapacity does not necessarily need to be permanent in the sense of everlasting.

The following examples provide an indication of the meaning of the term for the purposes of the small business 15-year exemption.

 

 

Involuntary disposals

A requirement of the small business 15-year exemption is that you must have owned the CGT asset for one or more periods of time that total 15 years. However, there are modified rules to determine if this requirement is satisfied for CGT assets acquired or transferred under the rollover provisions relating to assets compulsorily acquired, lost or destroyed, or to marriage breakdown (Subdivisions 124-B and 126-A of the Income Tax Assessment Act 1997 respectively).

If you acquired a replacement asset to satisfy the rollover requirements in respect of the compulsory acquisition, loss or destruction of a CGT asset, the replacement asset is treated as if you acquired it when you acquired the original asset.

If you have a CGT asset transferred to you because of a marriage breakdown, and the capital gain arising from that transfer was rolled over under the marriage breakdown rollover provisions, for the purpose of determining whether the 15-year requirement has been satisfied you can choose to:

• include the ownership period of your former spouse, or
• commence the ownership period from the time the asset was transferred to you.

If you choose to include your former spouse’s ownership period of the CGT asset, that asset is treated as if you acquired it when your former spouse acquired the asset.

Separate interests in the same CGT asset

If you own separate interests in the same CGT asset and sell those interests together, the 15-year exemption applies only to interests in the asset that you have owned continuously for at least 15 years. The exemption does not apply to any interest you have owned for less than 15 years. This is because interests in an asset acquired at different times are separate CGT assets.