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 detailed below .

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: $20,000
• Capital loss: $4,000
• Take the loss away from the gain

• $20,000 - $4,000 = $16,000

• Apply 50% CGT discount

• $16,000 x 50% = $8,000

• Apply 50% small business active asset reduction

• $8,000 x 50% = $4,000

• Reduced capital gain = $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.

Order in which to apply the discount and concessions

Note that you make a capital gain from a depreciating asset only to the extent that you have used the depreciating asset for a non-taxable purpose.

Step 1 : Determine whether you satisfy the basic conditions for the small business CGT concessions.

If so, go to step 2.

If not, go to step 3.

Step 2 : Determine whether you qualify for the small business 15-year exemption (not relevant to capital gains from depreciating assets).

If yes, disregard the entire capital gain. You don't need to apply any of the other CGT concessions.

Step 3 : Offset any capital losses against the capital gain.

Step 4 : Determine whether you are eligible for the CGT discount.

If so, reduce the remaining capital gain.

Go to step 5.

Step 5 : Determine whether the capital gain is from a depreciating asset and used at least partly for a non-taxable purpose.

If so, you are not eligible for any other concessions and can't reduce your capital gain any further.

If not, go to step 6.

Step 6 : Determine whether you qualify for the small business 50% active asset reduction (if you answered yes at step 1 you will qualify). If so, reduce the remaining capital gain.

You can choose not to apply the 50% active asset reduction and go straight to the small business retirement exemption or rollover in step 7.

Step 7 : Determine whether you qualify for the small business retirement exemption or rollover. If so, reduce the remaining capital gain.

Amount remaining equals the net capital gain to be included in your assessable income for the year.

Keep the necessary CGT records.

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 you lodge your income tax return for the income year in which the relevant CGT event happened, or
• 22 March 2014 (2 years after the commencement date ), or
• a later date allowed by the Commissioner.

The extension of time to make a choice applies where your original assessment was made before 22 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 you lodge your income tax return for the income year in which the relevant CGT event happened, or
• 23 June 2010 (12 months after the commencement date ), or
• a later date allowed by the Commissioner.

The extension of time to make a choice applies to CGT events happening before 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 .

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 .

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 (RSA) 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 complying superannuation fund or RSA will mean the conditions are not satisfied and the retirement exemption will not be available.

For more information, see Small business retirement exemption .

Extensions of time

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

Examples include:

• Where your business has ceased, the active asset test period for a CGT event (for example, the sale of a former business asset) ends when the business ceased if that occurred in the 12 months before the CGT event.
• If you previously chose the small business rollover and you don't acquire a replacement asset or make a capital improvement to an existing asset within the prescribed period, then a further CGT event happens. The prescribed period starts one year before and ends 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