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 Income 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).

Unless the capital gain arises from CGT event J5 or 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.

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 individual's estate, and you are a:

• beneficiary of the deceased estate
• legal personal representative (executor), or
• trustee or beneficiary of the testamentary trust (trust 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 retirement 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 (RSA).

The Commissioner can extend the two-year period.

See Basic conditions for the small business CGT concessions 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 is more than one CGT concession stakeholder , 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, and
• 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).

You must make payments:

• if you choose the retirement exemption for a J2, J5 or J6 event, seven days after you choose to disregard the capital gain
• 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.

If a CGT concession stakeholder is under 55 years old just before a payment is made in relation to them, the company or trust must make the payment to the CGT concession stakeholder by contributing it to a complying superannuation fund or 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.

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

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 make a payment by the end of seven days after making the choice to a CGT concession stakeholder (if they are 55 years old or older) or into a complying superannuation fund or RSA (if the stakeholder is under 55 years old) will mean the conditions are not satisfied and the retirement exemption will not be available.

If the gain arises as a result of CGT events J5 or J6 happening (when the replacement asset conditions have not been 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

Where payments are made by a company or trust to a CGT concession stakeholder, 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.

Deemed dividends

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.

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
• 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.
• 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. Even though 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.

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 each spouse has a small business participation percentage greater than zero) the limit is effectively $4 million, that is, $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 not assessable income and is not 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 interposed 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

From 1 July 2007, if you are contributing a retirement exemption amount to a superannuation fund or RSA, the amount is generally a non-concessional contribution. To exclude the amount from your non-concessional contributions cap and have it count towards your superannuation CGT cap instead ($1.255m for 2012-13), you must notify the fund on Capital gains tax cap election (NAT 71161). You must complete this form by no later than the time you make the contribution.

ATO references:
NO NAT 3359