Advanced guide to capital gains tax concessions for small business

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Chapter 3 - How do you apply losses, concessions and the discount?

Applying Capital Losses

If the small business 15-year exemption applies, you do not reduce the capital gain by any capital losses before you apply that concession.

In all other cases, you apply the CGT discount and the small business concessions to the capital gain after the capital gain has been reduced by any current and prior year capital losses.

If you have more than one capital gain, you can choose the order in which your capital gains are reduced by your capital losses.

Applying the discount and concessions

The small business 15-year exemption takes priority over the other small business concessions and the CGT discount. If the small business 15-year exemption applies, you entirely disregard the capital gain so there is no need to apply any further concessions.

If the 15-year exemption doesn't apply, you apply the CGT discount (if applicable) to the capital gain before applying the remaining small business concessions.

If you satisfy the conditions for more than one of the remaining small business concessions, you may apply each of those concessions to different parts of the capital gain.

After applying any capital losses, individuals and trusts eligible for both the CGT discount and the small business 50% active asset reduction can reduce a capital gain by 75% - that is, by 50% then 50% of the remainder.

The order in which you apply capital losses and the CGT concessions to capital gains is shown in the flowchart on page 7.

Example

• Ken is a small business operator who sells an active asset that he has owned for more than 12   months. He makes a capital gain of $20,000. Ken also has a separate capital loss of $4,000. Assuming he satisfies all the conditions for the CGT discount and the small business   50% active asset reduction, Ken calculates his net capital gain as follows:

Capital gain Capital loss Take the loss away from the gain.	$20,000   $4,000   $16,000
Apply   50% CGT discount.	$8,000   $8,000
Apply   50% small business active asset reduction Reduced capital gain	$4,000   $4,000

• Ken may be able to further reduce his $4,000 (reduced) capital gain by using the small business retirement exemption and small business rollover if he satisfies the conditions for those concessions.

The order in which to apply the discount and concessions

Depreciating assets

Special rules apply to depreciating assets. A depreciating asset is an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used. Examples of depreciating assets include the plant and equipment you use in your business.

Under the uniform capital allowances system that has applied since 1 July 2001, any gain or loss from a depreciating asset is included in your assessable income, or is deductible as a balancing adjustment, to the extent the asset was used for a taxable purpose - for example, to produce assessable income. The small business CGT concessions do not apply to gains you make on depreciating assets that are included in your income under the uniform capital allowances system.

You make a capital gain or capital loss from a depreciating asset to the extent you have used the depreciating asset for a non-taxable purpose - for example, for private purposes - CGT event K7. Any capital gain you make in this way does not qualify for the small business concessions because it reflects the non-business use of the asset.

However, as depreciating assets are still CGT assets, they must be included in the maximum net asset value test. A depreciating asset may also be an active asset and may be chosen as a replacement asset under the small business rollover.

Choosing Small Business Concessions

You must choose the 15-year exemption, the retirement exemption and the rollover for those concessions to apply. However, the 50% active asset reduction applies automatically if the basic conditions are satisfied and you have not specifically chosen that it not apply.

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

The way you prepare your income tax return is generally sufficient evidence of the choice you have made. However, the retirement exemption requires you to keep a written record of the amount you choose to disregard.

If you became eligible for the concessions as a result of the March 2012 amendments, you have until the later of:

• the day the entity lodges its income tax return for the income year in which the relevant CGT event happened, or
• 2 years after 30 March 2012 (the commencement date), or
• a later day allowed by the Commissioner.

The extension of time to make a choice applies where the entity's original assessment was made before the 30 March 2012.

If you became eligible for the concessions as a result of the June 2009 amendments, you have until the later of:

• the day the entity lodges its income tax return for the income year in which the relevant CGT event happened, or
• 12 months after the day on which these amendments receive Royal Assent, or
• a later day allowed by the Commissioner.

The extension of time to make a choice applies to CGT events happening before the 23 June 2009.

Distributions out of concession amounts: Tax Consequences

Where a company or trust chooses a concession and then distributes an amount out of the capital gain to a shareholder or beneficiary, there are varying tax consequences for the shareholder or beneficiary, depending on which concession the company or trust chooses. For some concessions the amounts received by the individuals are exempt, while for other concessions the amounts are not exempt.

15-year exemption

If a company or trust chooses the 15-year exemption and satisfies certain further conditions relating to the distribution of the exempt amount, the amount received by the shareholder or beneficiary is not included in their assessable income. For more information, see 'Consequences of applying the exemption' on page 43.

50% active asset reduction

The tax consequences for distributions made out of 50% active asset reduction amounts will depend on, among other things, the type of entity involved. A distribution by a fixed trust could give rise to a capital gain (after firstly reducing the cost base of the beneficiary's interest in the trust to nil). However, there are no such consequences for distributions by non-fixed trusts. For more information, see 'Fixed trust distributions and the 50% active asset reduction' on page 46.

A distribution by a company out of a 50% active asset reduction amount is likely to be assessable to the shareholder as an unfranked dividend.

Retirement exemption

If a company or trust chooses the retirement exemption and satisfies the requirements for the retirement exemption, the payment received by the shareholder or beneficiary is not included in their assessable income.

Rollover

If a company or trust chooses the rollover for a capital gain and then distributes an amount out of the gain to a shareholder or beneficiary, the distribution is not exempt - that is, the concession does not flow through to the individuals. The consequences of such distributions are similar to those noted above for the 50% active asset reduction.

Complying superannuation funds and the concessions

Concessions not available for complying superannuation funds

The small business concessions will not be available for any capital gain a complying superannuation fund makes on the sale of an asset used in a 'related' entity's business.

It may be common for a complying superannuation fund to own premises used in the business of a 'related' entity - for example, business real property. However, as the members or trustees of the fund (who typically also control the 'related' entity) do not control the fund in the manner required, the related entity is not a connected entity and, therefore, the business real property is not an active asset.

Interaction with superannuation

There is considerable interaction between the retirement exemption and superannuation.

Immediate payment to superannuation fund required

The retirement exemption requires amounts to be immediately contributed into a complying superannuation fund or a retirement savings account if the recipient is younger than 55 years old when they make a choice to use the retirement exemption. This is an important requirement - failure to immediately pay the amount to a superannuation (or similar) fund will mean the conditions are not satisfied and the retirement exemption will not be available. For more information see 'Small business retirement exemption' on page 47.

Payments for termination of employment

Where a company or trust makes use of the retirement exemption, the amounts may be paid to CGT concession stakeholders who are employees or non-employees. Such a payment made to a CGT concession stakeholder who is an employee is deemed to be in consequence of the termination of employment (for deemed dividend purposes).

However, it is not necessary for the person to actually terminate their employment if they choose the retirement exemption. There are no such implications for CGT concession stakeholders who are not employees. For more information see Deemed dividends on page 50.

Payments of amounts exempted under the retirement exemption to a CGT concession stakeholder who is an employee, are no longer deemed to be in respect of their termination of employment. This applies to payments made on or after 23 June 2009. Such payments also ceased to be treated as eligible termination payments from 2007-08.

For the 2006-07 and prior years such a payment was deemed to be an ETP made in consequence of the termination of employment of the CGT concession stakeholder. This applied regardless of whether the CGT concession stakeholder was actually an employee or not. However employees were not required to terminate their employment. The law has been amended to abolish RBLs and limit the significance of ETPs from the beginning of the 2007-08 income year.

Extensions of time

In some situations, you need to take action within a certain period of time to qualify for the concessions. A set period is usually prescribed. However, the law also provides the Commissioner with the discretion to allow you a longer period.

Examples include:

• Active asset test: relevant business ceased. Where your business has ceased, the active asset test requires the CGT event (for example, the sale of a former business asset) to happen within 12 months of the business ceasing
• Small business rollover: acquisition of replacement asset. Under the small business rollover, you must acquire a replacement asset or make a capital improvement to an existing asset within the period starting one year before and ending two years after the last CGT event happens in the year for which you choose the rollover.

However, in both these cases, the Commissioner has the discretion to allow a longer period.

In determining whether to allow a longer period, the Commissioner will consider a range of factors, such as:

• whether there is evidence of an acceptable explanation for the period of extension requested, and whether it would be fair and equitable in the circumstances to provide such an extension
• whether there is any prejudice to the Commissioner if the additional time is allowed (however, the mere absence of prejudice is not enough to justify the granting of an extension)
• whether there is any unsettling of people, other than the Commissioner, or of established practices
• the need to ensure fairness to people in like positions and the wider public interest
• whether there is any mischief involved
• the consequences of the decision.

ATO references:
NO NAT 3359