Advanced guide to capital gains tax concessions for small business

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Chapter 5 - 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:

 

• when the CGT   event happened
  • you were permanently incapacitated, or
  • you were 55   years old or older   and the event happened in connection with your retirement, 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 and Death and the small business CGT concessions .

Example

• Ruth and Geoff are partners in a partnership that conducts a farming business on land they purchased in 1990 and have owned continuously since that time. The net value of their CGT assets for the purpose of the maximum net asset value test is less than $6   million.
• Ruth and Geoff are both over 60   years old and wish to retire. As they have no children, they decide to sell the major asset of the farming business (the land). They sell the land in December 2010, for a total capital gain of $100,000. Both Ruth and Geoff qualify for the small business   15-year exemption in relation to the capital gain.

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.

Example

• A small business operator, over 55   years old, sells his business. Under the terms of the sale, he agrees to be employed by the new owner for a few hours each week for two years. The sale of the business would be in connection with the small business operator's retirement. He has permanently or indefinitely ceased being self-employed and has commenced gainful employment on a much reduced scale with another party, although still performing similar activities.

Example

• A small business operator and spouse are both pharmacists, are both over 55   years old and carry on business through two pharmacies. They sell one (and make a capital gain) and, accordingly, reduce their working hours from 60   hours a week each to 45   and 35   hours a week respectively. There has been some change to their present activities in terms of hours worked and location. But there has not been a significant reduction in the number of hours or a significant change in the nature of their activities and, therefore, there has been no 'retirement'.
• If, on the other hand, one spouse reduced their hours to nil (stopped working), there would be a significant reduction in the number of hours that spouse was engaged in the business activities. The sale would, therefore, be in connection with the retirement of that spouse.

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.

Example

• A small business operator, over 55   years old, sells some business assets as part of a wind-down in business activity ahead of selling the business. Within six months, she sells the business and ends her present activities. If it can be shown that the earlier CGT event was integral to the business operator's plan to cease her activities and retire, the CGT event may be accepted as happening in connection with retirement.

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.

Example

• A small business operator 'retires' and his children take over the running of the business. Within six months, they sell some business assets and make a capital gain. Several reasons may have prompted the sale of the assets. If there is no relevant connection with the small business operator's business, the requirement would not be satisfied. However, if it can be shown that the reason for the disposal of the assets is connected to retirement and the later sale is integral to the small business operator's retirement plan, the sale may be accepted as happening in connection with retirement.

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.

Example

• Jack had been carrying on business for many years. Unfortunately, he developed severe health problems that continued to deteriorate to the point where he was incapable of operating the business and, as a result, he sold the business.
• At the time he sold the business, Jack's doctor provided a written statement that Jack suffered ill health to the extent that he was unlikely to be able to engage again in gainful employment for which he was reasonably qualified. Jack was under 55   years old when he sold the business.
• Having regard to all the circumstances, Jack would be considered to be permanently incapacitated at the time the business was sold. He may, therefore, qualify for the small business   15-year exemption if he satisfies the other conditions.

Example

• Fred had been carrying on a landscape gardening business for over 20   years. One day, Fred fell out of a tree and badly broke both arms and a leg. He was essentially confined to bed in hospital for several weeks and then at home for several more weeks. The doctor said his recovery would take quite some time. Fred then underwent extensive physiotherapy for several months and it was nearly a year before he regained full use of his arms and legs and was able to undertake normal activities again.
• During this time, as Fred could not operate the business effectively, he sold the business. Fred was under 55   years old at the time of the sale.
• Although Fred suffered a serious injury which required an extensive period of rehabilitation, he was always expected to regain his physical capabilities. Therefore, having regard to all the circumstances, it could not be said Fred was permanently incapacitated at the time he sold the business. The   15-year exemption would not be available in this case.

Example

• Reg had been carrying on business for many years. Suddenly, he suffered a severe stroke which left him paralysed down one side of his body and confined to a wheelchair. Because of the extent of the damage, the doctors thought it was unlikely that Reg would regain much movement in his affected limbs.
• As Reg was incapable of operating the business, he sold the business. Reg was under 55   years old at the time of the sale.
• Notwithstanding the bleak outlook, Reg and his family were determined that he recover and accordingly Reg underwent an extensive program of physiotherapy and exercises over an extended period. Remarkably, after 18 months, Reg had surpassed all expectations and had regained most bodily movements.
• Notwithstanding Reg's remarkable recovery, at the time he sold the business the prevailing medical opinion was that he was unlikely to be able to engage again in gainful employment for which he was reasonably qualified. Having regard to all the circumstances, Reg would be considered to be permanently incapacitated at the time the business was sold. He may, therefore, qualify for the small business   15-year exemption if he satisfies the other conditions.

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.

Example

• Cameron and Therese were married for 10 years, during which time Cameron owned a farm on which he operated a dairy business. Since their divorce, Therese has owned the farm (it was transferred to her in circumstances under which Cameron obtained a rollover under the marriage breakdown rollover provisions) and operated the dairy business for the past five years.
• Therese can sell the farm and obtain the   15-year exemption (if she is 55   years old or older and sells the farm to retire or is incapacitated) if she chooses to adopt Cameron's ownership and active asset periods.

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.

Example

• On 1   December 1992, Janet purchased a   40% interest in a 400-hectare parcel of grazing land. On 1   December 1997, she purchased the remaining   60% interest in the land. On 15   December 2010 (Janet's 60th birthday), she sold the land and retired.
• While Janet owned the   40% interest she purchased in 1992 for at least 15   years, she owned the   60% interest she purchased in 1997 for just over 13   years. The two interests are separate CGT assets and, accordingly, the capital gain made on the sale of the   60% interest is not eligible for the   15-year exemption (it may be eligible for other CGT concessions).

Consequences of applying the exemption

Distributions of the exemption amount

If a capital gain made by a company or trust is disregarded under the small business   15-year exemption, or would have been except that the capital gain was disregarded anyway because the relevant CGT asset was acquired before 20   September 1985, any distributions made by the company or trust of that exempt amount to a CGT concession stakeholder is:

• not included in the assessable income of the CGT concession stakeholder, and
• not deductible to the company or trust if certain conditions are satisfied.

The conditions are:

• the company or trust must make a payment within two years after the CGT event that resulted in the capital gain or, in appropriate circumstances, such further time as allowed by the Commissioner
• the payment must be made to an individual who was a CGT concession stakeholder of the company or trust just before the CGT   event, and
• the total payments made to each CGT concession stakeholder must not exceed an amount determined by multiplying the CGT concession stakeholder's control percentage by the exempt amount.

The CGT concession stakeholder's participation percentage is:

• for a company or a trust (where entities have entitlements to all the income or capital of the trust), the stakeholder's small business participation percentage in the company or trust just before the CGT   event, and
• for a trust (where entities do not have entitlements to all the income or capital of the trust), the amount (expressed as a percentage) worked out using the formula:

100                                                                                                   (number of CGT concession stakeholders of the trust just before the CGT   event)

Example

• Joe is a significant individual of Company X, owning   60% of the shares in the company. Joe's wife Anne owns the remaining   40% of shares in the company. The company makes a capital gain of $10,000, which it can disregard under the small business   15-year exemption as Joe is 56 and both Joe and Anne are planning to retire.
• Six months after the CGT   event, the company distributes the amount of the exempt capital gain to the shareholders. As CGT concession stakeholders, Joe and Anne both qualify for the small business   15-year distribution exemption. The amount that is exempt is calculated as follows:

For Joe: For Anne:

60% of $10,000 = $6,000 40% of $10,000 = $4,000

• If it is decided to distribute $8,000 each to Joe and Anne, they can exclude from their assessable incomes for the income year an amount of $6,000 and $4,000 respectively. The balance is likely to be assessable as a dividend.

Example

• The beneficiaries of the M family discretionary trust are the members of the M family and two employees of the family business carried on by the trustee of the trust. Mrs   M and Mr   M are the significant individuals of the discretionary trust and are, therefore, CGT concession stakeholders. The trustee of the trust sells a CGT asset of the business and makes a capital gain of $50,000. The gain qualifies for the small business   15-year exemption as Mr   M is 58 years old and plans to retire from the family business. In the next income year the trustee distributes that amount equally to Mrs   M and Mr   M and to the three children.
• As CGT concession stakeholders, Mrs M and Mr M and their three children are each able to treat the distribution of $10,000 as an exempt amount.

Impact on superannuation

A distribution of an exempt amount under the small business   15-year exemption has no superannuation implications, unlike the retirement exemption which interacts significantly with superannuation.

ATO references:
NO NAT 3359