Small Business CGT Concessions Anti Avoidance Measures Bill Passes Parliament

We finally have some long-feared changes to the small business CGT concessions. These are in the Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018 and have now passed the Parliament.

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These changes propose to add additional basic conditions for these concessions to apply, but only where the CGT asset is share in a company or interest in a trust. If it is not a share or a unit there are no changes.

Remember that these amendments apply to CGT events that occur on or after 8 February 2018. The Government states that this “retrospective application is consistent with the Budget announcement by the Government on 9 May 2017 to ensure the small business CGT concessions are only available in relation to assets used in a small business and ownership interests in small businesses.”

The big change – looking through to the object entity

If I am selling shares or units, one of the questions I need to ask is if I am a small business entity or if I pass the maximum net assets test. But under the new rule I also have to ask if the object entity, being the entity that I own shares or units in, is a small business entity or passes the maximum net assets test.

Karen carries on a small consulting business as a sole trader. She is a CGT small business entity (according to the general rules) for the 2019-20 income year.

Karen also owns 30 per cent of the shares in Big Pty Ltd, a large private company with annual turnover in excess of $20 million in both the 2018-19 and 2019-20 income years. The net value of Big Pty Ltd’s CGT assets exceeds $100 million throughout this period.

On 1 October 2019, Karen sells her shares in Big Pty Ltd. She would not be eligible to access the Division 152 CGT concessions for any resulting capital gain.

Even if Karen satisfies the other basic conditions for relief, she cannot satisfy the new condition. Big Pty Ltd is not a CGT small business entity in the 2019-20 income year. It also does not satisfy the maximum net asset value test in relation to the capital gain, as its net assets exceed $6 million immediately prior to the CGT event happening (being in excess of $100 million for the entire income year).

If the object entity does not pass these tests, the small business CGT concessions do not apply to the sale of the shares or units in the object entity.

George carries on a small gardening business. George is a CGT small business entity for the 2019-20 income year.

George holds all of the units in G Trust, a trust that holds a number of investments in other entities but which does not carry on a business. The total value of the investments held by G Trust also means that it does not satisfy the maximum net asset value test.

On 17 February 2020, George sells the units it holds in G Trust. George is not eligible to access the Division 152 CGT concessions for any resulting capital gain.

Even if George satisfied the basic conditions for relief, he cannot satisfy the new condition as G Trust is not a CGT small business entity (as it does not carry on a business) and does not satisfy the maximum net asset value test.

When working out if the object entity is a CGT small business entity or satisfies the maximum net asset value test, the turnover or assets of entities that may control the object entity are disregarded. This ensures that the outcomes for taxpayers do not depend upon the income or assets of third parties.

Further, for these purposes (and only these purposes), an entity is treated as controlling another entity if it has an interest of 20 per cent or more, rather than 40 per cent or more. This means that more entities are considered to be ‘connected with’ one another for the purpose of this test and need to count the assets or turnover of the other entity towards their aggregate turnover or the total net value of their CGT assets.

Tien owns 20 per cent of the shares in Investment Co, a company that carries on an investment business. Investment Co is a CGT small business entity for the 2020-21 income year.

Investment Co holds 20 per cent of Van Co, a transport company. Van Co’s turnover and assets mean that it is not a CGT small business entity in the 2020-21 income year and does not satisfy the maximum net asset value test at any point during the income year.

On 15 May 2021, Tien sells his shares in Investment Co. He is not eligible to access the Division 152 CGT concessions for any resulting capital gain.

Even if Tien satisfies the other conditions, he cannot satisfy the new condition requiring the object entity be a CGT small business entity or satisfy the maximum net asset value test due to the modifications that apply when determining this matter for the purposes of this condition.

For the purposes of this condition, Investment Co is considered to be connected with Van Co, as Investment Co holds 20 per cent of Van Co’s shares. As a result, for this purpose, Investment Co’s turnover and assets include the turnover and assets of Van Co. As Van Co is not a CGT small business entity and does not satisfy the maximum net asset value test, Investment Co is also treated as not satisfying these requirements (despite its status under the general rules in the tax law).

A welcome change – retrospective small BUSINESS entities

Another change proposed in this Bill is the taxpayer must have carried on business just prior to the CGT event happening. This ensures that entities do not benefit from this concession where the relevant business activities are too remote to justify the entity receiving a concession for business activities.

However, this requirement does not apply to taxpayers that satisfy the maximum net asset value test in relation to the CGT event.

The technical change – modified active asset test for the sale of shares and units

There is an additional new condition that requires that, to pass the active asset test, for the lesser of seven and a half years or at least half the period a taxpayer has held the share or interest, at least 80 per cent of the sum of the:

  • total market value of the assets of the object entity (disregarding any shares in companies or interests in trusts); and
  • total market value of the assets of any entity (a later entity) in which the object entity had a small business participation percentage of greater than zero, multiplied by that percentage

must have related to assets that are:

  • active assets; or
  • cash or financial instruments that are inherently connected with a business carried on by the object entity or a later entity.

Further, if these assets are held by a later entity, being an entity that is owned by the object entity, the assets will only be active at a time if the later entity is an entity:

  • that is, at the relevant time, either:
    • a CGT small business entity; or
    • satisfies that maximum net asset value test in relation to the capital gain; and
  • in which the taxpayer has a small business participation percentage of at least 20 per cent or is a CGT concession stakeholder at the relevant time.

In determining if an entity is a CGT small business entity or satisfies the maximum net asset value test at a time, do not include the turnover or value of assets of entities that can control the object entity and control is an interest of 20% or more

What does this all mean??? In effect, when selling a share or a unit, the active asset test in is modified to adopt a look-through approach. Rather than treating shares or interests as active assets based on the activities of the underlying company, the modified test looks through such membership interests to include the proportionate amount of the value of the assets of other entities to which the interests relate.

And remember, it only includes a percentage of the later entity assets based on ownership. And remember, any asset of a later entity will not be an active asset if the later entity is not either a small business entity or passes the maximum net assets test AND the taxpayer has a 20% or greater ownership of.

But the best way to understand this is to look at an example or three…

Jesse carries on a small lapidary business as a sole trader. He is a CGT small business entity (according to the general rules) for the 2019-20 income year.

Jesse owns 50 per cent of the shares in A Co. A Co carries on a business providing cleaning services and is a CGT small business entity in the 2019-20 income year.

A Co also owns 10 per cent of B1 Pty Ltd and 15 per cent of B2 Pty Ltd. Both of these companies are also CGT small business entities in the 2019-20 income year. These companies are not affiliates of A Co.

There has been no significant change in the activities or holdings of A Co, B1 Pty Ltd or B2 Pty Ltd over the period Jesse has owned his shares.

On 9 November 2019, Jesse sells his interest in A Co.

In working out if this interest satisfies the modified active asset test, when working out the total value of the assets of A Co, Jesse must disregard the value of the shares A Co holds in B1 Pty Ltd and B2 Pty Ltd and include 10 per cent of the value of the assets of B1 Pty Ltd and 15 per cent of the value of the assets of B2 Pty Ltd.

Further, for this purpose none of the assets of B1 Pty Ltd and B2 Pty Ltd are active assets for A Co. Jesse’s small business participation percentage in B1 Pty Ltd is 5 per cent (i.e. his 50 per cent stake in A Co multiplied by A Co’s 10 per cent stake in B1 Pty Ltd). Similarly, his small business participation percentage in B2 Pty Ltd is 7.5 per cent (i.e. his 50 per cent stake in A Co multiplied by A Co’s 15 per cent stake in B2 Pty Ltd).

Still think this is hard… I do!

Charlotte owns 35 per cent of the shares in Colour Co. Colour Co carries on a business of wholesaling paint and related products and is a CGT small business entity (according to the general rules) in the 2019-20 income year.

Colour Co owns 20 per cent of the shares in three pigment suppliers Red Co, Green Co and Blue Co. Red Co and Blue Co are both CGT small business entities for the 2019-20 income year (and have been since Colour Co acquired its interest) according to the general rules. Green Co is not and has never been a CGT small business entity as it exceeds the turnover threshold.

On 3 March 2020, Charlotte sells her shares in Colour Co.

In working out if this interest satisfies the modified active asset test, when working out the total value of the assets of Colour Co, Charlotte must disregard the value of the shares Colour Co holds in Red Co, Blue Co and Green Co and include 20 per cent of the value of the assets of these companies.

Further, for the purposes of the modified active asset test, assets of later entities are only active if the entity is a CGT small business entity or satisfies the maximum net asset value test.

Green Co is not a CGT small business entity as its turnover is too high.

Additionally, Charlotte must treat Red Co, Blue Co and Green Co as being connected with Colour Co and with each other for the purposes of the test, because Colour Co holds 20 per cent of the shares of each entity.

Because they are treated as being connected with Green Co, Red Co and Blue Co are also treated as not being CGT small business entities for these purposes.

As a result, Charlotte is not able to treat the assets of Red Co, Blue Co or Green Co as active assets for the purposes of this test unless the entities satisfy the maximum net asset value test.

Still confused… so am I…

Arnold carries on a small marketing business as a sole trader. He is a CGT small business entity (according to the general rules) for the 2019-20 income year.

Arnold also owns 20 per cent of Channel Investments Trust, a trust that invests in a wide range of widely held trusts and companies.

Channel Investments Trust has assets with a total net market value of $2 million, of which $1.95 million consists of shares in companies and units in trusts. Channel Investments Trust has never had a small business participation percentage exceeding 10 per cent in any other entity.

On 20 April 2020, Arnold sells his interest in Channel Investments Trust. Arnold is not eligible to access the CGT concessions under Division 152 for any resulting capital gain.
While Arnold may satisfy the basic conditions for relief for the capital gain, he does not satisfy the new conditions.

The investment in Channel Investments Trust does not satisfy the modified active asset test as 97.5 per cent of its assets are shares and interests in trusts that are considered passive assets as its small business participation percentage in the relevant entities is less than 20 per cent.

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About Ken Mansell

As a stay at home Dad most of the week this is my way of pretending I am still the tax counsel of ASX and SEC listed companies, working at big 4 firms, working at the Federal Treasury, on the Henry Review and at Parliament House for the previous government.
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