Advanced guide to capital gains tax concessions for small business

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Chapter 7 - Small Business Retirement Exemption

The rules covering the small business retirement exemption are contained in Subdivision   152-D of the Incom e Tax Assessment Act   1997 .

You may choose to disregard all or part of a capital gain under the small business retirement exemption if you satisfy certain conditions. If you are an individual who chooses the retirement exemption, you do not need to terminate any activity or cease business. This concession allows you to provide for your retirement. If you are a CGT concession stakeholder and receive payments under the retirement exemption, you are not required to terminate your employment with the company or trust.

Interaction with other concessions

You may choose to apply the small business retirement exemption (if you are not eligible for the   15-year exemption):

• 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 capital losses have been applied
  
   
• instead of the small business   50% active asset reduction, that is, to the capital gain that remains after you have applied any CGT discount and capital losses (this choice might allow a company or trust to make larger tax-free payments under the small business retirement exemption)
  
   
• where there has been a change in status of a CGT asset that was a replacement or capital improved asset in a rollover under subdivision   152-E (CGT event J2)
  
   
• where a change happens in circumstances where a share in a company or an interest in a trust was a replacement asset in a rollover under subdivision   152-E (CGT event J2)
  
   
• where you chose the rollover under subdivision   152-E and by the end of the relevant period you had not acquired a replacement asset, or made any capital improvements (CGT event J5), or
  
   
• where you chose the rollover under subdivision   152-E and by the end of the relevant period the amount you incurred on a replacement asset was less than the amount chosen for the rollover (CGT event J6).

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

Conditions you must meet

Individual

If you are an individual, you can choose to disregard all or part of a capital gain if:

• you satisfy the basic conditions
  
   
• you keep a written record of the amount you chose to disregard (the CGT exempt amount), and
  
   
• if you are under 55   years old just before you choose to use the retirement exemption, you make a personal contribution equal to the exempt amount to a complying superannuation fund or retirement savings account (RSA).

You must make the contribution:

• when you made the choice to use the retirement exemption, or when you received the proceeds (whichever is later), or
• when you made the choice to use the retirement exemption if the relevant event is CGT event J2, J5 or J6.

If you are 55   years old or older when you make the choice to access the retirement exemption, there is no requirement to pay any amount to a complying superannuation fund or RSA even though you may have been under 55   years old when you received the capital proceeds.

If you choose the retirement exemption after you have received the capital proceeds (for example, when you lodge your income tax return) you are not required to make the contribution until you make the choice. Accordingly, you may use the capital proceeds for other purposes before making the choice. However, once you make the choice you must immediately make a contribution of an amount equal to the exempt amount if you were under 55   years old just before you made the choice.

To satisfy this requirement, you must pay the amount into a complying superannuation fund or RSA by the relevant date. This is an important requirement. Failure to immediately contribute the amount will mean the conditions are not satisfied and the retirement exemption will not be available.

This requirement applies to payments made as a consequence of choices made, and capital proceeds received, after 30   June 2007. Payments made on or before 30   June 2007 were required to be rolled over.

For the 2006-07 income year the amount disregarded under the retirement exemption was taken to be an ETP. However ETPs have now been abolished since 1   July 2007.

If the gain arises as a result of CGT   events J5 or J6 happening (about the replacement asset conditions not being met for the small business rollover concession) you can choose the retirement exemption for those gains without having to satisfy the basic conditions again. This is because you would have already satisfied the basic conditions at the time you chose the rollover.

If you receive the capital proceeds in instalments the above requirements about making a contribution apply to each instalment (up to the asset's CGT exempt amount).

Death and the retirement 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 there is no requirement for the deceased to contribute an amount to a complying superannuation fund or a retirement savings account.

The Commissioner can extend the two year period.

See Basic conditions and Death and the small business CGT concessions .

Company or trust

If you are a company or trust, other than a public entity, you can also choose to disregard all or part of a capital gain where you meet all the following conditions:

• you satisfy the basic conditions
• you satisfy the significant individual test
• you keep a written record of the amount you choose to disregard (the exempt amount) and, if there are more than one CGT concession stakeholders , each stakeholder's percentage of the exempt amount (one may be nil but together they must add up to   100%)
• you make a payment to at least one of your CGT concession stakeholders worked out by reference to each individual's percentage of the exempt amount
• the payment is equal to the exempt amount or the amount of capital proceeds, whichever is less
• where you receive the capital proceeds in instalments, you make a payment to a CGT concession stakeholder for each instalment in succession (up to the asset's CGT exempt amount).

If a CGT concession stakeholder is under 55   years old just before receiving a payment, an amount equal to that payment must be immediately paid to a complying superannuation fund or retirement savings account (RSA) on their behalf. The company or trust must notify the trustee of the fund or the RSA at the time of the contribution that the contribution is being made in accordance with the requirements of the retirement exemption.

If the stakeholder was 55   years old or older there is no requirement to make this contribution.

You must make payments:

• seven days after you choose to disregard the capital gain if you choose the retirement exemption for a J2, J5 or J6 event, or
• in any other case, by the later of
  • seven days after you choose to disregard the capital gain, and
  • seven days after you receive the capital proceeds from the CGT   event.

Therefore, if you choose the retirement exemption after you have received the capital proceeds (for example, when you lodge your tax return) there is no requirement to make any payment until you have made the choice. Accordingly, you may use the capital proceeds for other purposes before choosing. However, once you choose, you must make the payment by the end of seven days after making the choice.

This is an important requirement. Failure to immediately make a payment into a complying superannuation fund or RSA will mean the conditions are not satisfied and the retirement exemption will not be available. Generally, to satisfy the requirement, the funds need to be transferred direct from the payer of the payment to the nominated fund. A transfer of the funds direct to a stakeholder before being transferred to the nominated fund will only be accepted as satisfying the requirement in certain circumstances.

The requirement to make a payment to a complying fund or RSA applies to payments made to a qualifying fund after 30   June 2007. Payments made on or before 30   June 2007 were required to be rolled over.

For the 2006-07 income year the amount disregarded under the retirement exemption was taken to be an ETP. However ETPs have now been abolished since 1   July 2007.

If the gain arises as a result of CGT   events J5 or J6 happening (about the replacement asset conditions not being met for the small business rollover concession) you can choose the retirement exemption for those gains without having to satisfy the basic conditions again. This is because you would have already satisfied the basic conditions at the time you chose the rollover.

The requirement for companies and trusts to make a payment to at least one CGT concession stakeholder was modified by the June 2009 amendments. These entities can now make a retirement exemption payment directly, or indirectly, through one or more interposed entities to a CGT concession stakeholder. The amendments ensure there is no tax impact on the interposed entity that receives and passes on the payments. The amendments apply to payments made on or after 23   June 2009.

Termination of employment not required

Payments made by a company or trust to an employee of an amount exempted under the retirement exemption are deemed to be payments in respect of the termination of employment of the employee. There is no need for an actual termination of employment.

Where such payments are made by a company or trust to a CGT concession stakeholder who is not an employee, the stakeholder is not required to cease any activity or office holding. Also see Deemed dividends .

For an individual choosing the retirement exemption, there is no requirement to terminate any activity or cease their business.

Payments made on or after 23   June 2009 to a CGT concession stakeholder who is an employee, to satisfy the retirement exemption requirements, are no longer deemed to be in consequence of termination of employment. Also see Deemed dividends . Such payments also ceased to be treated as eligible termination payments from 2007-08.

Deemed dividends

Where a payment is made by a company or trust under the retirement exemption to a CGT concession stakeholder who is an employee of that entity, the payment is deemed (for the purposes of section   10 9 of the Income Tax Assessment Act   1936 ) to have been made in consequence of the termination of employment of the stakeholder.

If the payment from a private company to the employee CGT concession stakeholder is excessive (after considering all the circumstances), section   109 of the Income Tax Assessment Act   1936 deems the excessive remuneration to be a dividend.

Consideration of what is unreasonable or excessive is not restricted to the retirement exemption limit of $500,000. Any opinion formed should also have regard to the length of service and level of contribution to the business by the CGT concession stakeholder or employee.

There are no such implications for payments made to CGT concession stakeholders who are not employees of the company or trust.

Payments made on or after 23   June 2009 to a CGT concession stakeholder who is an employee, to satisfy the retirement exemption requirements, are no longer deemed to be in consequence of termination of employment for the purposes of section   109 of the ITAA   1936 (about excessive payments to shareholders, directors and associates being deemed to be dividends). Division   7A of the ITAA   1936 also no longer applies to treat such payments made by a company or trust as dividends Such payments also ceased to be treated as eligible termination payments from 2007-08 onwards. Payments made on or after 23   June 2009 to satisfy the retirement exemption requirements are not treated as a dividend nor a frankable distribution provided: you are a company making a payment to a CGT concession stakeholder or an interposed entity , or you are an interposed entity receiving a payment and passing that payment on. See Interposed entities receiving or making payments on or after 23   June 2009 .

Capital proceeds received in instalments

If a company or trust receives the capital proceeds from a CGT event in instalments and chooses the retirement exemption, it must make a payment to at least one of its concession stakeholders on receipt of each instalment, up to the CGT exempt amount. As mentioned earlier, the payment must be made by the later of seven days after the choice is made or seven days after an instalment of the capital proceeds is received.

In this situation, the total amount of each instalment must be paid until the total of the payments equals the capital gain being disregarded. In other words, the requirement to make a payment must be satisfied to the greatest extent possible out of the initial instalments rather than in some other way, such as an apportionment across all the instalments received.

If an individual receives capital proceeds in instalments, each instalment is treated as a separate payment. This means that each instalment is looked at separately and in succession in applying the exemption up to the individual's CGT exempt amount.

Receiving actual capital proceeds not required

It is not essential to receive actual capital proceeds from the CGT event to be able to choose the retirement exemption. The retirement exemption is available where a capital gain is made when an active asset is gifted and the market value substitution rule has applied, or where CGT event J2, J5 or J6 happens.

Example

• In December 2006, Harry retires from farming and transfers the farm (which he acquired in 1996) to his son for no consideration. The market value of the farm was $1   million so the market value substitution rule applies to deem the capital proceeds to equal the market value of the farm. As the cost base of the farm was $600,000, Harry made a capital gain of $400,000 (assuming the other retirement exemption conditions are satisfied.
• Harry reduces his capital gain by the   50% CGT discount to $200,000 and then further by the   50% active asset reduction to $100,000. Notwithstanding that he did not receive any capital proceeds, Harry may choose the retirement exemption for the full amount of the remaining $100,000 capital gain (assuming the other retirement exemption conditions are satisfied).

In order to access the exemption on a gain made by a company or trust for which there are no actual proceeds, the company or trust must make a payment of the disregarded capital gain to at least one of its CGT concession stakeholders.

In 2005-06 and earlier years, the taxpayer needed to have received actual capital proceeds from the CGT   event to qualify for the retirement exemption. If the market value substitution rule applied to increase the capital proceeds taken to be received, the retirement exemption was available only to the extent of the actual capital proceeds received. Also where a taxpayer made a capital gain from CGT event J2 or J3 in the 2005-06 or prior year, following an earlier small business rollover, they can disregard the capital gain under the retirement exemption only if the original capital gain involved actual capital proceeds.

CGT retirement exemption limit

The amount of the capital gain that you choose to disregard (that is, the CGT exempt amount) must not exceed your 'CGT retirement exemption limit' or, in the case of a company or trust, the CGT retirement exemption limit of each CGT concession stakeholder receiving a payment.

An individual's lifetime CGT retirement exemption limit is $500,000, reduced by any previous CGT exempt amounts the individual has disregarded under the retirement exemption. This includes amounts disregarded under former (repealed) retirement exemption provisions. For a company or trust with eight CGT concession stakeholders (four significant individuals and their four spouses where the spouse has a business participation percentage greater than zero), the limit is effectively $4   million ($500,000 for each stakeholder).

A company or trust may determine the percentage of the exempt amount attributable to each stakeholder, having regard to each stakeholder's retirement exemption limit (or remaining limit).

Example

• Daryl and his wife Mary each own   50% of the shares in a company and are both significant individuals of the company. The company makes a capital gain and specifies Daryl's percentage of the exempt amount to be   90% (which means that the percentage specified for Mary must be 10%). Daryl's retirement exemption limit is $500,000.
• To determine whether his exemption limit is exceeded, Daryl would take   90% of the exempt amount, add that to amounts previously specified and see whether the total exceeds $500,000.

Consequences of choosing the exemption

If you choose this exemption, you disregard the amount of the capital gain you have chosen as the CGT exempt amount.

The amount of any capital gain that exceeds the CGT exempt amount does not qualify for this exemption.

Payments made to CGT concession stakeholder

If you are a CGT concession stakeholder, a payment you receive from a company or trust to satisfy the retirement exemption requirements is exempt from income tax. This has implications for any tax losses from prior years (not capital losses) you are entitled to claim as a deduction. A tax loss must first be offset against net exempt income.

If you are a company or trust making the payment, it is not able to be deducted from your assessable income.

Interposed entities receiving or making payments on or after 23 June 2009

If you are a company or trust receiving a payment (whether directly or indirectly through one or more interposed entities) that another company or trust made to satisfy the retirement exemption requirements and you are passing that payment on to a CGT concession stakeholder or another interposed entity:

• the payment you receive is not included in your assessable income and is not exempt income, and
• the payment you make is not deductible from your assessable income.

Amounts which are not assessable income and not exempt income have no implications for tax losses of previous years.

A payment you make to satisfy the retirement exemption requirements is not treated as a dividend nor a frankable distribution provided:

• you are an interposed entity receiving a payment and passing that payment on, or
• you are a company making a payment to
  • a CGT concession stakeholder, or
  • an inter p os ed entity.

This is the case despite section   109 of the ITAA   1936 which can treat excessive payments to shareholders, directors and associates as dividends. Therefore section   109 no longer has any application to these payments.

Division   7A of the ITAA   1936 also no longer applies to treat such payments made by a company or trust as dividends.

For payments made prior to 23   June 2009 the company or trust is required to make the payment directly to the CGT concession stakeholder.

Superannuation consequences

The Superannuation Legislation Amendment (Simplification) Act   2007 has abolished ETPs and RBLs from 1   July 2007.

For the 2006-07 and earlier years, exempt amounts that were taken to be ETPs (for small business individuals) or paid as ETPs (for companies and trusts) were not subject to tax in the hands of the individual, unless they exceeded the recipient's reasonable benefit limit (RBL).

There is no need to report a payment or contribution made under the retirement exemption from the 2007-08 year.

ATO references:
NO NAT 3359