When a client sells a business or assets used in the business, the small business capital gains tax (CGT) concessions provide significant planning opportunities.
If you consider a client who disposes of non-business assets, such as an investment property, shares or managed funds, the amount of CGT payable can be substantial. In contrast, using the small business CGT concessions for eligible business assets can result in no tax payable on sizeable capital gains. Contributions to super, within the small business CGT cap amount, relating to the disposal of small business assets are excluded from the non-concessional contributions (NCC) cap. The size of the CGT cap contribution ($1.565 million for FY2020/21) allows clients to substantially boost their super upon selling business assets.
In this article, we highlight four hurdles financial planners encounter and outline some key unused opportunities when using the small business CGT concessions.
Overlooking the concessions
Many planners overlook the small business CGT concessions because of their complexity and refer these matters to their client’s accountant. Although their accountant may be able to assist with the tax concessions, they may not be sufficiently versed on superannuation, so may not entirely understand the CGT cap contribution.
A practical solution is for planners to engage directly with a client’s accountant who can ensure that the eligibility criteria is satisfied and confirm availability for the CGT concessions. You can then provide guidance to clients on superannuation aspects, including contribution eligibility, the CGT cap contribution and transfer balance cap. By working together, you can ensure that your mutual client is eligible for the concessions and can maximise both the tax and superannuation opportunities available.
Often there is no inherent value in the business itself and accordingly, no assets to realise upon retirement. You should ensure clients review the value of their business. If your client has a low or nil value business, consider building retirement assets via additional contributions to super, for example, personal deductible contributions or salary sacrifice contributions.
Eligibility for the concessions
Clients must satisfy both of the following criteria to use the small business CGT concessions:
the turnover test (aggregate turnover of less than $2 million) or the maximum net asset value test (assets must not exceed the value of $6 million); and
the active asset test: the asset must be used or held ready for use for the purpose of running a business. Intangible assets, such as goodwill, can be considered as an active asset.
Additional conditions apply where the asset is a share in a company or interest in a trust.
Most of the concessions have additional conditions, for example, the 15-year exemption requires that the client is age 55 or over and the disposal is in connection with retirement.
The eligibility criteria can be complex, so you should work with your client’s accountant to confirm that the small business CGT concessions are available.
Common hurdle 1: Disregarding the 15-year exemption retirement rule
The first and most valuable small business CGT concession is the 15-year exemption. This concession allows a full CGT exemption on the gain and the opportunity to contribute the capital proceeds up to $1.565m (FY2020/21) into super. As the name suggests, the asset must be held for at least 15 years to qualify.
Financial planners must remember that their client must be age 55 or over and ensure the asset sale is in connection with their retirement (or they are permanently incapacitated at the time of the asset sale). Your client does not need to permanently retire, but there must be a significant reduction in working hours, or a significant change to the nature of work activities. An asset sold before or after the time of retirement may still be considered in connection with their retirement.
Case study 1:
Hans, age 54, operates a small business through his own company. He plans to retire and needs help with the small business CGT concessions. He has owned 100 per cent of the company shares for 20 years and plans to sell all the shares.
Hans’ accountant confirms that he satisfies the basic criteria for the small business concessions. As the assets being disposed are shares in the company, additional criteria applies, including a test that generally requires at least 80 per cent of the underlying assets of the company to be active assets (or cash/financial instruments inherently connected with carrying on a business).
Unfortunately, Hans cannot use the 15-year exemption as he is under age 55. He could consider the retirement exemption (discussed following) or he may wish to defer the asset sale until he turns age 55 and the disposal is in connection with his retirement.
Common hurdle 2: Retiring to use the retirement exemption and overlooking the 50 per cent active asset reduction opportunities
Another popular small business CGT concession is the retirement exemption. This concession allows an exemption from CGT up to $500,000 (lifetime limit) and the opportunity to contribute the discounted capital gain (not proceeds) into super using the CGT cap. A $500,000 lifetime limit applies to the retirement exemption and so the $1.565 million CGT cap (FY2020/21) cannot be fully utilised if the 15-year exemption is unavailable.
The title of the concession ‘retirement exemption’ is misleading and suggests a need to retire – this is not true. There is no need to retire to use the retirement exemption. The client does not need to reduce work hours or change duties (as required by the 15-year exemption). The retirement exemption requires that clients under age 55 must contribute the assessable gain (disregarded under the exemption) to super.
From age 55, the client is not compelled to contribute to super, but the opportunity to use the CGT cap should be considered, even if they are not required to access the concession. If the client misses the timeframe to make the contribution, the standard NCC cap applies and the client cannot subsequently use the CGT cap for that asset.
Case study 2:
Maureen, age 57, has been operating her business as a sole-trader for 10 years. She is keen to sell her business and pursue another business venture. Although Maureen satisfies the basic criteria to use the small business CGT concessions, she cannot use the 15-year rule and does not wish to wait another five years to sell her business to take advantage of this concession. She plans to sell the business property (which the accountant has deemed to be an active asset) and expects a $1 million gross capital gain.
The first concession Maureen must apply is the 50 per cent 12-month general discount for assets held personally. Accordingly, her assessable gain reduces to $500,000. The next concession is the 50 per cent active asset reduction. This concession applies unless Maureen chooses not to apply it. She can maximise the capital gain to which the retirement exemption is applied and allow a greater CGT cap contribution by choosing not to apply the 50 per cent active asset reduction. Table 1 outlines the options in this scenario.
Option 1: Applying the 50% active asset reduction
Option 2: Electing not to apply the 50% active asset reduction
Gross capital gain
Capital gain after applying the 50% general discount for assets held longer than 12 months (must be used)
Capital gain after applying the 50% active asset reduction
(active asset reduction not applied)
CGT cap contribution
If we use option 1, Maureen is restricted to a CGT cap contribution of $250,000 and must use the standard NCC cap to place additional amounts into super. The advantage of option 1 is that Maureen has an additional $250,000 of retirement exemption to use on her next business pursuits.
Under option 2, Maureen can contribute a significantly larger amount into super using the CGT contribution ($500,000 compared to $250,000) and does not need to consume as much of her NCC cap to contribute additional amounts. A disadvantage of option 2 is that her retirement exemption lifetime limit of $500,000 is fully utilised and cannot be used for her future business assets.
Maureen’s planner should discuss both options with her before any recommendations are made. To qualify as a CGT cap contribution, Maureen must provide a completed ‘Capital gains tax cap election’ form to the super fund before or at the time of making the contribution.
Common hurdle 3: Calculating CGT cap contributions for the retirement exemption based on the capital gain, not proceeds
One of the key benefits of the 15-year exemption is the ability to contribute the sale proceeds to super using the CGT cap up to $1.565 million (FY2020/21). In contrast, under the retirement exemption, a client is limited to $500,000 and the contribution amount must relate to the discounted capital gain, not the proceeds.
Case study 3:
Rose, age 68, has operated her business through her company for 13 years. She is considering retirement and selling her shares in the company to fund her retirement. Rose satisfies the work test and her current super balance is about $100,000. She is unsure if she should wait a couple of years until the 15-year exemption is available.
Let’s assume she acquired the shares for $800,000 and the market value is now $1.5 million. Rose has a gross capital gain of $700,000 and a net capital gain of $350,000 after applying the 50 per cent 12-month general discount. If Rose waits another two years to meet the 15-year exemption, the value of her business could increase or decrease, so she should consider the risk of market fluctuations over this period.
Table 2 outlines the advantage of the 15-year exemption compared to the retirement exemption when using the CGT cap contribution, based on the current value of her business.
Option 1: Retire now and use the retirement exemption
Option 2: Wait until the 15-year exemption is available
Gross capital gain
(assume no change in two years)
Capital gain after applying the 15-year exemption
Capital gain after applying the 50 per cent general discount for assets held longer than 12 months (must be used)
Capital gain after electing for the 50% active asset reduction to not apply
CGT cap contribution
(discounted capital gain)
Both options result in no amount of CGT payable. A gross capital gain of $700,000 has been reduced to nil by using the various CGT concessions. The one-year NCC cap of $100,000 is available for Rose under both options.
Under option 1 using the retirement exemption, Rose can boost her super by $350,000 using the CGT cap. In contrast, Rose can contribute the full amount of the proceeds ($1.5 million) under option 2 using the 15-year exemption.
Rose may wish to consider personal deductible contributions to further manage her tax position.
The key message is that option 1 – the retirement exemption – only permits a discounted capital gain up to $500,000 to be contributed. Option 2 – the 15-year exemption – allows the entire proceeds (up to $1.565 million for FY2020/21) to be contributed. Under option 2, we must consider Rose’s transfer balance cap position before commencing an income stream.
Common hurdle 4: Overlooking the super contribution rules
The CGT cap contribution is a contribution (not a rollover) and so your client must be eligible to contribute. From age 67, the work test (or work test exemption) must be satisfied. Clients are often operating their business and so the work test is likely to be satisfied, but sometimes problems can arise. For example, a client may dispose of business assets later in the financial year and receive proceeds early in the new financial year. In this case, the work test (or work test exemption) may not be satisfied and the CGT cap contribution cannot be made. Once a client turns age 75, the contribution must be made within 28 days after the end of the month in which they turn 75 years old.
Case study 4:
Julius, age 73, had owned his farm since 1983 and made no significant capital improvements (pre-CGT asset). Julius recently disposed of the farm and assuming that a capital gain was made, he could apply the 15-year exemption to disregard the capital gain.
Julius received $800,000 in proceeds from the sale of the farm and can satisfy the work test (at least 40 hours within 30 consecutive days), making him eligible to contribute to superannuation. Julius can make a CGT cap contribution of up to $800,000 (the proceeds of the sale).
We identify that the small business CGT concessions can provide significant planning opportunities for your clients who own a business and are seeking to sell their business in the future. The complexity of the concessions can sometimes deter financial planners from using this to assist their clients, so their needs remain unresolved.
We recommend working alongside your client’s accountant, who can confirm eligibility for the tax concessions, while you plan the superannuation aspects of the strategy, thereby providing the best possible outcome for your mutual client.
Mark Gleeson is Technical Services Manager at IOOF.
1. Which of the following is a requirement of the 15-year exemption?
The client must be under age 55 and the disposal is in connection with retirement.
The client must be under age 55 and contribute the amount to super.
The client must be age 55 or over and the disposal is in connection with retirement.
The client must be age 55 or over and contribute the amount to super.
2. Which of the following is a requirement of the retirement exemption?
If the client is under age 55, they must contribute the assessable amount to super.
If the client is age 55 or over, they must contribute the assessable amount to super.
If the client is under age 55, the disposal is in connection with retirement.
If the client is age 55 or over, the disposal is in connection with retirement.
3. Which statement is true regarding the 50 per cent general CGT discount and the 50 per cent active asset reduction?
The 50 per cent general discount is optional but the 50 per cent active asset reduction must be applied.
The 50 per cent general discount must be applied but the 50 per cent active asset reduction is optional.
Both the discounts must be applied.
Both the discounts are optional.
4. Kyle, age 52, satisfies the criteria for the small business CGT concessions. He disposes of a business asset with a gross capital gain (before applying any discounts) of $2.5 million. The asset has been held for at least 12 months. What is the maximum CGT cap contribution using the retirement exemption during FY 2020/21?
5. Carly, age 64, satisfies the criteria for the small business CGT concessions. She disposes of a business asset with a gross capital gain (before applying any discounts) of $2.5 million. The asset has been held for at least 12 months. What is the maximum CGT cap contribution using the 15-year exemption during FY 2020/21?