Advanced guide to capital gains tax concessions for small business

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Chapter 6 - Small Business 50% Active Asset Reduction

The rules covering the small business 50% active asset reduction are contained in Subdivision 152-C of the Income Tax Assessment Act 1997 .

Interaction with other concessions

If you do not qualify for the small business 15-year exemption, the small business 50% active asset reduction may apply to reduce the capital gain.

Unlike the other small business concessions, the small business 50% active asset reduction applies automatically if the basic conditions are satisfied, unless you choose for it not to apply.

For example, you might prefer for it not to apply, and instead choose the small business retirement exemption or the small business rollover. Making this choice allows you to achieve the best result for your circumstances, for example, a company or trust may make larger tax-free payments under the small business retirement exemption.

Otherwise, the small business retirement exemption or the small business rollover (or both) may apply to the capital gain that remains after applying the small business 50% active asset reduction.

Conditions you must meet

To apply the small business 50% active asset reduction, you need to satisfy only the basic conditions . There are no further requirements.

Consequences of applying the reduction

If you satisfy the basic conditions, the capital gain that remains after applying any current year capital losses and any unapplied prior year net capital losses, and the CGT discount (if applicable), is reduced by 50%.

This means that if you are an individual or a trust and you have applied the CGT discount and the small business 50% active asset reduction, the capital gain (after being reduced by any capital losses applied against it) is effectively reduced by 75% (that is, 50% then 50% of the remainder).

Example

• Lana operates a small manufacturing business and disposes of a CGT asset she has owned for three years and used as an active asset of the business. She makes a capital gain of $17,000 from the CGT event and qualifies for the CGT discount and for the small business 50% active asset reduction. Lana also has a capital loss in the income year of $3,000 from the sale of another asset. She calculates her net capital gain for the year as follows:
• Offset capital losses against the capital gain:

• $17,000 - $3,000 = $14,000

• Apply the CGT discount:

• $14,000 - (50% x $14,000) = $7,000

• Apply the small business 50% active asset reduction:

• $7,000 - (50% x $7,000) = $3,500

• Her net capital gain for the year is $3,500, assuming the small business retirement exemption and the small business rollover do not apply. If Lana chooses the rollover or the retirement exemption, some or all of the remaining capital gain would be disregarded.

Rules for beneficiaries of trusts

The rules for beneficiaries of trusts are contained in Subdivision  115-C of the Income Tax Assessment Act 1997 , which was amended by Taxation Laws Amendment (2011 Measures No.5) Act 2011 applicable to the 2010-11 and later income years.

If a trust makes a capital gain, its net capital gain for the income year is generally calculated in the same way as for other entities, by reducing any capital gains firstly by any capital losses and then by any relevant concessions.

The net capital gain is included in the net income of the trust. A beneficiary who is 'specifically entitled' to a capital gain will generally be assessed on that gain, regardless of whether the benefit they receive or are expected to receive is income or capital of the trust.

Capital gains to which no beneficiary is specifically entitled will be allocated proportionately to beneficiaries based on their present entitlement to income of the trust estate (excluding capital gains and franked distributions to which any entity is specifically entitled). This is called the adjusted Division 6 percentage.

There are special rules that enable concessions obtained by a trust to be passed on to the beneficiaries of the trust who are entitled to a share of the trust's net capital gain.

A beneficiary must 'gross up' their share of any capital gain received from a trust by:

• multiplying that amount by two, if the trust has applied either the CGT discount or the small business 50% active asset reduction, or
• multiplying that amount by four, if the trust has applied both the CGT discount and the small business 50% active asset reduction.

The beneficiary's share of the trust capital gains (grossed up if required) is then taken into account in the method statement for calculating the beneficiary's net capital gain to be included in their assessable income by:

• the trust capital gains being firstly reduced by any capital losses of the beneficiary, and
• any trust capital gain remaining is then reduced by the CGT discount (unless the beneficiary is a company, see below) and the small business 50% active asset reduction, if the trust's capital gain was reduced by these two concessions to arrive at the beneficiary's net capital gain.

A corporate beneficiary of a trust must gross up (as above) their share of any net capital gains received from a trust that have been reduced (by the trust) by the CGT discount. They are not entitled to reduce this grossed-up amount by the CGT discount because companies are ineligible for the CGT discount.

Following legislative amendments made in 2011, beneficiaries no longer need to have an amount of assessable income included under section 97, 98 or 100 of the ITAA 1936 to be treated as having an extra capital gain. The grossed-up capital gain is no longer added to the beneficiary's share of the trust's net capital gain because this is no longer included in their share of the net income of the trust. Accordingly, the beneficiary no longer needs a deduction for that part of their share of the net income of the trust that is attributable to the trust's net capital gain.

Example

• A unit trust makes a capital gain of $100,000 when it disposes of an active asset. The trust has no capital losses. If all the conditions for the CGT discount and the small business 50% active asset reduction are satisfied, the trust's net capital gain is $25,000 (no other concessions apply).
• Assume there is one individual beneficiary presently entitled to the net income of the trust. The beneficiary also has a separate capital loss of $10,000.
• The beneficiary works out their net capital gain as follows:
• Share of trust net capital gain: $25,000
• Gross up this amount by multiplying by 4:

• $25,000 x 4 = $100,000

• Deduct capital losses: $10,000

• $100,000 - $10,000 = $90,000

• Apply 50% CGT discount:

• $90,000 x 50% = $45,000

• Apply 50% reduction:

• $45,000 x 50% = $22,500

• Net capital gain: $22,500

Fixed trust distributions and 50% active asset reduction

If a beneficiary's interest in a trust is fixed (for example, an interest in a unit trust) there are rules to deal with the situation where the trust distributes to the beneficiary an amount of capital gain that was excluded from the trust's net income because it claimed the small business 50% active asset reduction.

The distribution of the small business 50% active asset reduction amount is a non-assessable amount under CGT event E4 in section 104-70 of the Income Tax Assessment Act 1997 (ITAA 1997).

The payment of the amount will firstly reduce the cost base of the beneficiary's interest in the trust. If the cost base is reduced to nil, a capital gain may arise in respect of the beneficiary's interest in the trust. This capital gain may qualify for the CGT discount (after applying any capital losses) if the interest in the trust has been owned by the beneficiary for at least 12 months.

If a beneficiary's interest in a trust is not fixed (for example, the trust is a discretionary trust) there are no CGT consequences for the beneficiary.

ATO references:
NO NAT 3359