Contributed by John Storey, Rajan Verma and Andrew Henshaw, Directors, Velocity Legal
Treasury has recently released draft legislation that significantly restricts the availability of the small business CGT concessions. The changes, labelled “integrity measures”, implement an announcement in the 2017/18 Budget.
However, the changes go much further than the Budget night announcement and will significantly restrict the availability of the small business CGT concessions (the “SB concessions”) where shares or units are being sold. Worse still, the changes are proposed to take effect, retrospectively, from 1 July 2017, which means that some taxpayers may already be affected.
Refer to CCH Books’ Small Business Tax Concessions Guide – 5th Edition for more guidance and insights.
On Budget night, 9 May 2017, the government announced an integrity measure to ensure that the SB concessions were appropriately targeted. In particular:
“The Government will amend the small business capital gains tax (CGT) concessions to ensure that the concessions can only be accessed in relation to assets used in a small business or ownership interests in a small business.”
This announcement was thought to be targeting situations where a taxpayer could access the SB concessions for the sale of a stake in a company or unit trust, by qualifying as a CGT small business entity for an unrelated business venture. The changes were stated to take effect from 1 July 2017.
On 8 February 2018, seven months after the changes were proposed to take effect, Treasury released exposure draft legislation for consultation (Treasury Laws Amendment (Measures for a later sitting) Bill 2018: improving the small business CGT concessions).
The changes go much further than the Budget night announcement and introduce four new criteria to be satisfied in order to access the SB concessions on the sale of shares or units.
New requirements for share or unit sales
The draft legislation repeals s 152-10(2) of the Income Tax Assessment Act 1997 (the ITAA 1997). In substitution, it inserts a new s 152-10(2). The conditions of the new subsection are:
- a stricter active asset test
- if a taxpayer relies on the CGT small business entity test to qualify for the SB concessions, they must be carrying on a business just before the relevant CGT event
- the company or trust in which the shares or units are being sold (the object entity) must be carrying on a business just before the CGT event, and
- the object entity must itself either satisfy the CGT small business entity test or a modified $6m maximum net asset value test.
We explore each of the new requirements in more detail below.
(1) Active asset test
Under the active asset test (s 152-35), the CGT asset must be active for at least half the CGT assets period of ownership. For example, if a CGT asset was purchased on 1 January 2012 and sold on 1 January 2018, it must be active for at least three years.
Shares or units will only be considered to be active assets if the assets of the object entity are predominately active assets themselves. In particular, the market value of the following assets must be at least 80% of the market value of all assets:
- active assets
- financial instruments that are inherently connected, and
The draft legislation requires that an additional active asset test must be satisfied (new s 152-10(2)(a)), based on the following assumptions:
- all financial instruments are excluded unless those instruments are held as trading stock, or as part of certain financial services businesses
- all cash is excluded unless that cash is held by the company or trust as trading stock
- all shares and units held by the object entity are excluded. Instead, a look-through approach will be taken with the underlying assets of the later company or trust.
The changes listed above go well beyond the 9 May 2017 Budget announcement. While these additional requirements may be reasonable from a policy perspective, the fact that they were previously unannounced is of concern. Even more disconcerting is the fact that the changes will have retrospective application to periods prior to 1 July 2017, by virtue of the application of the modified active asset test (which looks back at the history of ownership of the relevant shares or units).
(2) SBE must be carrying on a business
A taxpayer can qualify for the SB concessions if they satisfy either the CGT small business entity test (requires turnover of under $2m) or the maximum net asset value test (requires business assets of under $6m).
A taxpayer will be a CGT small business entity if they carry on a business at any point of time in a particular income year. The draft legislation requires that if a taxpayer qualifies for the SB concessions only because they are a CGT small business entity, they must also be carrying on a business just before the relevant CGT event.
This change is sensible and was anticipated by the Budget announcement. Practically, it means that a taxpayer cannot use the SB concessions to shield a capital gain on shares or units by becoming a CGT small business entity (ie by starting a new, unrelated business) later in that income year.
(3) Object entity must be carrying on a business
The draft legislation introduces a completely new requirement that the object entity must be carrying on a business just before the CGT event. Previously, it was sufficient that the active asset test was met.
This particular requirement is also beyond the scope of the Budget announcement. Moreover, it will effectively disqualify taxpayers from claiming the SB concessions in the following situations:
- where the object entity has ceased to carry on a business, but still owns business assets (eg land) which it is now seeking to sell
- where a business is structured with the business owned and operated by one entity and the property from which that business is conducted is owned by another entity (this type of structure is common for asset protection reasons). In that scenario, the sale of the shares or units in the property owning entity could never be eligible for the SB concessions.
(4) Object entity; CGT small business entity; modified $6m asset test
This fourth requirement introduced by the draft legislation is also a completely new requirement. The object entity must either qualify as a CGT small business entity or satisfy a modified $6m net asset value test (MNAV test). Previously, only the taxpayer making the capital gain needed to meet this requirement.
The modified MNAV test aggregates the assets of the object entity’s affiliates and any entities in which the object entity has a greater than 20% controlling interest. Thus, it does not aggregate other commonly-controlled entities like the standard MNAV test does. However, the threshold for inclusion in the MNAV test is much lower with 20% controlling interests being included in the calculation versus the usual 40% threshold under the normal MNAV test.
This change is not an integrity measure. It is a change in law. Under the current rules, three equal shareholders in a company worth $9m could each potentially qualify for the SB concessions, as each shareholder holds shares worth $3m. This new requirement will mean that those shareholders can no longer claim the SB concessions. In contrast, partners in a partnership worth $9m can still each potentially qualify for the SB concessions.
ATO administrative treatment
The ATO will accept tax returns as lodged during the period up until the proposed law change is passed by parliament. Past year assessments will not be reviewed until the outcome of the proposed amendment is known.
Unfortunately, the proposed law goes far beyond the 9 May 2017 Budget announcement and many aspects are a change in law, rather than integrity measures.
Even more unfortunate is the retrospective application of these proposed changes, which are stated to apply from 1 July 2017. This could have dramatic consequences for taxpayers who, relying on the current law, may have claimed the SB concessions when in fact they are not eligible. Further, some taxpayers may have claimed the retirement exemption under Subdiv 152-D of ITAA 1997 and contributed money into super, only to find those contributions being invalidated by the proposed changes.
Consultation on the proposed law is open until 28 February 2018. Velocity Legal intend to liaise with Treasury and we encourage others to do so. In the meantime, taxpayers who have sold shares or units on or after 1 July 2017 and intend to claim the SB concessions should review their situation.