Advanced guide to capital gains tax concessions for small business

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Chapter 8 - Small Business Rollover

The rules covering the small business rollover are contained in Subdivision   152-E of the Income Tax Asse ssment Act   1997 . The small business rollover allows you to defer all or part of a capital gain made from a CGT event happening to an active asset.

Interaction with other concessions

You may choose to apply the small business rollover to as much of the capital gain as you decide:

• after the small business   50% active asset reduction, that is, to the remaining   50% (or if the CGT discount has also applied, the remaining   25%) of the capital gain after you have applied capital losses, or
  
   
• instead of the small business   50% active asset reduction, that is, to the capital gain remaining after you have applied any capital losses and CGT discount. Making this choice might ultimately allow a company or trust to make larger tax-free payment under the small business retirement exemption if they choose the retirement exemption after the deferred capital gain has crystallised, for example, when the replacement asset is later sold.

You may instead choose the small business retirement exemption if its conditions are satisfied or you may choose both concessions for different parts of the remaining capital gain.

Basic conditions

To qualify for the small business rollover you need to satisfy the basic conditions that apply to all the CGT small business concessions. There are rollover conditions that must also be met.

Consequences of choosing the rollover

If you choose the rollover, all or part of the capital gain will not be included in your assessable income until a change in circumstances happens, for example you don't meet the rollover conditions within the specified time period. One of the rollover conditions is that you must acquire a replacement asset or incur capital expenditure on improving an existing asset.

If your use of the replacement or improved asset changes (for example, you no longer use it in the business or you sell it) this is a change in circumstances.

When a change in circumstances happens the deferred capital gain will crystallise, that is, all or part of the capital gain previously deferred will become assessable.

You can choose to apply certain concessions to this gain. If there is any amount of the capital gain left after applying all the concessions you choose, this amount will be included in your assessable income.

Cost base of replacement asset There is no reduction in the cost base of the replacement asset when the capital gain is rolled over.

Example

• Karen had a capital gain of $100,000. It has been reduced to $25,000 under the CGT discount and   50% active asset reduction. She chose to rollover part of the remaining gain into an asset she has owned for eight months. The total of the first and second elements of the cost base of the replacement asset is $20,000. Karen can disregard $20,000 under the rollover leaving a final capital gain of $5,000.

Rollover conditions

There are rollover conditions that must be satisfied by the end of the replacement asset period. This period starts one year before and ends two years after the last CGT event that occurs in the income year for which you choose the roll over.

If the rollover conditions are not met within the replacement asset period the gain will become assessable.

You satisfy the rollover conditions where you meet all the following conditions:

• you acquire one or more CGT assets as replacement assets or make a capital improvement to one or more existing assets, or both, within the replacement asset period
  
   
• the replacement asset, or the asset to which the capital improvement was made is an active asset at the end of the replacement asset period (a depreciating asset such as plant can be a replacement asset)
  
   
• if the replacement asset is a share in a company or an interest in a trust, at the end of the replacement asset period:
  • you, or an entity connected with you, are a CGT concession stakeholder in the company or trust, or
    
     
  • CGT concession stakeholders in the company or trust have a small business participation percentage in the interposed entity of at least 90%
    
     
• the capital gain that is being rolled over is not more than the sum of the following
  • the amount paid to acquire the replacement asset (that is, the first element of the cost base of the replacement asset)
    
     
  • any incidental costs incurred in acquiring that asset, which can include giving property (that is, the second element of the cost base of the replacement asset), and
    
     
  • the amount expended on capital improvements to one or more assets that were acquired or already owned (that is, fourth element expenditure).

As the share or interest also needs to be an active asset, the company or trust must satisfy the 80% test . That is, the market value of the active assets and certain financial instruments of the company or trust must be   80% or more of the total of the market value of all the assets of the company or trust.

You can choose to obtain a rollover even if you have not yet acquired a replacement asset or incurred expenditure on a capital improvement to an existing asset. The Commissioner has the discretion to allow a longer replacement asset period by granting you an extension of time .

Example

• Jordan owns   50% of the shares in Company A and Company   B. He is, therefore, a CGT concession stakeholder in both companies. The companies are connected with Jordan because he controls both of them.
• Company A owns land which it leases to Jordan for use in a business. It sells the land at a profit and buys shares in Company   B as replacement assets. All of Company   B's assets are active assets.
• The replacement asset test is satisfied because the shares are active assets and Jordan is connected with Company   A and is a CGT concession stakeholder in Company   B.

When the gain crystallises

Failure to acquire a replacement asset and make a capital improvement after a rollover (CGT event J5)

CGT event J5 happens if you choose to obtain a rollover, and by the end of the replacement asset period:

• you have not acquired a replacement asset, and have not made a capital improvement to an existing asset
  
   
• the replacement or capital improved asset is not your active asset (for example you have sold it, it has become your trading stock or it is no longer used in the business), or
  
   
• where the replacement asset is a share in a company or an interest in a trust
  
   
  • the share or trust interest fails the   80% test (unless the failure is only of a temporary nature)
    
     
  • you, or an entity connected with you, are not a CGT concession stakeholder in the company or trust, or
    
     
  • CGT concession stakeholders in the company or trust do not have a small business participation percentage in the interposed entity of at least   90%.

Consequences of CGT event J5

When CGT event J5 happens, you make a capital gain equal to the amount of the capital gain previously disregarded under the small business rollover.

The time of the event is at the end of the replacement asset period.

The Commissioner may extend the replacement asset period.

A capital gain from CGT event J5 may be eligible for the retirement exemption if you meet the relevant conditions. You don't need to meet the basic conditions again but you must meet the retirement exemption conditions. However you cannot apply the   50% discount, small business   50% active asset reduction or the 15   year exemption to reduce this gain.

Example

• In September 2006, Luke makes a capital gain of $80,000 on an active asset and meets the maximum net asset value test. Luke disregards the whole capital gain under the small business rollover.
• In September 2008, Luke does not have any replacement or capital improved assets by the end of the two-year period. CGT event J5 happens and Luke makes a capital gain of $80,000 in September 2008.

A transitional provision provides that where you chose a rollover in the 2005-06 or earlier year, and did not subsequently acquire a replacement asset, you may access the retirement exemption on a capital gain. That is, if you did not acquire a replacement asset, it would be as though you never chose the rollover and the capital gain was not disregarded.

CGT event J6

CGT event J6 happens if:

• you choose to obtain a rollover, and
• by the end of the replacement asset period you satisfy all of the rollover conditions except one, namely the amount you choose to rollover is equal to or greater than the sum of the following amounts
  • the amount paid to acquire the replacement asset (that is, the first element of the cost base of the replacement asset)
    
     
  • any incidental costs incurred in acquiring that asset, which can include giving property (that is, the second element of the cost base of the replacement asset), and
    
     
  • the amount expended on capital improvements to one or more assets that were acquired or already owned (that is, fourth element expenditure).

Consequences of CGT event J6

When CGT event J6 happens, you make a capital gain equal to the difference between:

• the amount of the capital gain disregarded under the small business rollover, and
• the amount incurred on the replacement asset or capital improvements.

The time of the event is at the end of the replacement asset period.

The Commissioner may extend the replacement asset period.

When CGT event J6 occurs, you may be eligible for the retirement exemption, provided you meet the relevant conditions for that exemption. You don't need to meet the basic conditions again. However you cannot apply the   50% discount, small business   50% active asset reduction or the 15   year exemption to reduce this gain.

Example

• In October 2006, Nicky makes a capital gain of $700,000 on an active asset and meets the maximum net asset value test. Nicky chooses to disregard the whole capital gain.
• In November 2007, Nicky purchases new business premises for $300,000 and spends $150,000 on improving some other assets. The replacement and capital improved assets meet all of the relevant conditions.
• However, the amount of expenditure on the replacement and capital improved assets is only $450,000. The capital gain that was rolled over was $700,000.
• In October 2008, two years after the original CGT   event, CGT event J6 happens because there has been insufficient expenditure and Nicky makes a capital gain of $250,000. The rollover of $450,000 of the original capital gain continues.

A transitional provision applies where you chose the rollover in the 2005-06 or earlier income year and acquired a replacement asset but the expenditure incurred on that asset was less than the amount you chose to disregard under the rollover. The amount of the original capital gain that is able to be disregarded is limited to the total of the first and second elements of the cost base of the replacement asset.

CGT event J2

A CGT event (CGT event J2) happens if, after the end of the replacement asset period, there is a change in the status of a replacement or capital improved asset you chose for the small business rollover.

Examples of CGT event J2 include:

• the replacement or capital improved asset stops being your active asset, for example, you dispose of the asset or you stop using it or holding it ready for use in your business
  
   
• the replacement or capital improved asset becomes your trading stock, or
  
   
• you start to use the replacement or capital improved asset solely to produce exempt income
  
   
• where the replacement asset is a share in a company or an interest in a trust
  • the share or interest stops being an active asset, that is, the share or trust interest fails the   80% test (and the failure is more than just temporary in nature), or
    
     
  • a liquidator or administrator of the company declares the shares worthless (CGT event G3), or
    
     
  • you, or an entity connected with you, cease to be a CGT concession stakeholder in the company or trust (or that entity is no longer connected with you), or
    
     
  • CGT concession stakeholders in the company or trust cease to have a small business participation percentage in the interposed entity of at least   90%.

Consequences of CGT event J2

When CGT event J2 happens to your replacement or capital improved asset, you make a capital gain equal to the gain previously disregarded under the small business rollover.

If there was more than one replacement or capital improved asset and a change happens to only some of the assets, the capital gain is the difference between the amount that was originally rolled over and the relevant expenditure on the remaining replacement or improved assets that satisfied the relevant conditions.

The time of the event is when the change happens.

A capital gain from CGT event J2 may qualify for:

• further rollover, if you acquire another replacement asset, or
• the retirement exemption.

This is provided you meet the relevant conditions for the rollover or exemption. You cannot apply the CGT discount, the   15-year exemption or the small business   50% active asset reduction to reduce this capital gain.

If you dispose of a replacement or capital improved asset, another CGT event (CGT event A1) happens in addition to CGT event J2. Any capital gain you make from CGT event A1 on the disposal of the replacement or capital improved asset may qualify for any of the small business CGT concessions if the relevant conditions are satisfied.

Example

• Peter disposes of an active asset for $10,000, making a capital gain of $2,000. He buys two replacement assets (not being depreciating assets) for $5,000 each and chooses the small business rollover.
• $1,000 of the capital gain is disregarded for each replacement asset.
• Peter later sells one of the replacement assets for $7,500, so Peter makes a capital gain of $2,500.
• He also makes a capital gain of $1,000 as the sale of the replacement asset results in that asset no longer being an active asset. The $1,000 capital gain represents the capital gain made on the disposal of the active asset that was rolled over in respect of this replacement asset.
• Peter's capital gain of $1,000 made from the crystallising of the deferred capital gain (CGT event J2) may be eligible for further rollover relief or the retirement exemption. The capital gain of $2,500 made from the disposal of the replacement asset (CGT event A1), may be eligible for any of the concessions if the relevant conditions are satisfied.

If CGT event J6 had previously happened in relation to the rollover, the capital gain is the same as calculated above, less the capital gain previously made under CGT event J6.

If CGT event J2 has previously happened in relation to the rollover, the capital gain is the same as calculated above, less the capital gain previously made under CGT event J2.

ATO references:
NO NAT 3359