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By Mark Gleeson, Senior Technical Services Manager
For clients seeking to sell business assets and provide for retirement, the small business capital gains tax (CGT) concessions can provide one of the most significant planning opportunities under tax and superannuation law.
If you consider a client who disposes of non-business assets such as an investment property, shares or managed funds, the amount of capital gains tax payable can be substantial. In contrast, using the small business CGT concessions for eligible business assets can result in no tax payable on sizeable 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 contribution cap. The magnitude of the CGT cap contribution ($1.565m for FY2020/21) allows your clients to substantially boost their super upon selling business assets. In this article, we highlight some common oversights by advisers and outline some key unused opportunities when using the small business CGT concessions.
Many advisers overlook the small business CGT concessions because of its complexity and refer these matters to the client’s accountant. Although the accountant may be able to assist with the tax concessions, they may not be versed on superannuation, so may not understand the CGT cap contribution.
A practical solution is for you to engage with the accountant who can ensure that the eligibility criteria is satisfied and confirm availability for the CGT concessions. You can then provide guidance to the client on the superannuation aspects including contribution eligibility, the CGT cap contribution and transfer balance cap. By working together, you can ensure that the client is eligible for the concessions and can maximise both the tax and superannuation opportunities available.
Unlike the concessional contributions (CC) cap and non-concessional contribution (NCC) caps that have either decreased or struggled to increase over the years, the CGT cap continues to increase each year due to indexation. The graph below illustrates the unabated increases in the CGT cap (compared to other caps) and highlights the importance of the opportunity to build super using the small business concessions. You can use the CGT cap in combination with the CC cap and NCC caps.
Assumptions:– In some financial years, a higher CC cap applied based on age– The catch-up concessional contribution measure is not illustrated in the CC cap
Clients must satisfy the basic criteria to use the small business CGT concessions. Accordingly, all of the following tests must be satisfied:
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. We have a Strategy Guide (SG 71) to explain the eligibility criteria available on Fast Fact Finder under the “Tax” section by clicking on “Strategy guides”.
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. do not let the complexity dissuade you from the advice opportunity – embrace the challenge!
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.
Advisers must remember that their client must be age 55 or over and ensure the asset sale is in connection with their retirement (or under circumstances that they are permanently incapacitated). 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 retirement may be considered in connection with their retirement.
Demitri, 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% of the company shares for 20 years and plans to sell all the shares. Demitri’s 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 80% of the underlying assets of the company to be active assets (or cash/financial instruments inherently connected with carrying on a business).
Unfortunately, Demitri cannot use the 15 year exemption as he under age 55. He could consider the retirement exemption (discussed next) or he may wish to defer the asset sale until he turns age 55 and the disposal is in connection with his retirement.
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 CGT cap (2020/21) 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 and leads to mistakes by advisers. 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 lost opportunity to use the CGT cap should be considered if they do not wish to contribute. If the client misses the timeframe to make the contribution, the standard non-concessional contribution caps apply and the client cannot subsequently use the CGT cap for that asset.
Juliette, 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 Juliette 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 5 years to use this concession. She plans to sell the business property (deemed an active asset) and expects a $1m gross capital gain.
The first concession she applies is the 50% 12 month general discount for assets held personally. Accordingly, her assessable gain reduces $500,000. The next concession is the 50% active asset reduction. This concession applies unless Juliette chooses not to apply it. Juliette 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% active asset reduction. The table below outlines her options.
If we use option 1, Juliette is restricted to a CGT cap contribution of $250,000 and must use the standard NCC caps to place additional amounts into super. The advantage of option 1 is that Juliette has an additional $250,000 of retirement exemption to use on her next business pursuits.
Under option 2, Juliette 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. You should discuss the options with Juliette before any recommendations are made.
One of the key benefits of the 15 year exemption is the ability to contribute the proceeds to super using the CGT cap up to $1.565m (FY2020/21). In contrast, under the retirement exemption, the client is limited to $500,000 and the contribution amount must relate to the discounted capital gain, not the proceeds.
Milena, 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. Milena 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 $1.5m. Milena has a gross capital gain of $700,000 and a net capital gain of $350,000 after applying the 50% 12-month general discount. If Milena waits another two years, the value of her business could increase or decrease and she should consider the risk of market fluctuations over this period. The table below outlines the advantage of the 15 year exemption compared to the retirement exemption when using the CGT cap contribution.
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. Under option 1 (the retirement exemption), Milena can only boost her super by $350,000 using the CGT cap. In contrast, Milena can contribute the full amount of the proceeds ($1.5m) under option 2 using the 15 year exemption. The one year NCC cap of $100,000 is also available for her under either option. Furthermore, she may wish to consider personal deductible contributions to manage her tax position.
The key message is that the retirement exemption only permits a discounted capital gain up to $500,000 to be contributed, whereas, the 15 year exemption allows the entire proceeds (up to $1.565m for 2020/21) to be contributed. Under option 2, we must consider Melina’s transfer balance cap position before commencing an income stream.
Remember the work test from age 67
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.
Watch out for in-specie contributions
The strategy of making an in-specie contribution into super and simultaneously using the small business CGT concessions and CGT cap contribution has been called into question by recent ATO private binding rulings. These rulings are binding on the taxpayer who seeks the ruling and while they cannot be relied upon by anyone else, they give us insight into the ATO’s thinking on the relevant matter. Due to the uncertainty in this area, clients seeking to use the small business CGT concessions and the CGT cap contribution with in-specie contributions should seek tax advice or apply to the ATO for a private binding ruling beforehand.
Time the contributions to satisfy the cut-off times
As CGT cap contributions do not depend on total super balance at 30 June of the previous financial year, you may wish to consider making standard NCCs before using the CGT cap. Once the CGT cap contribution is made, the total super balance is likely to be higher at the next 30 June period, which could impact the ability to make NCCs in the next financial year.
Generally, the CGT cap contribution must be made before the later of:
Complete the CGT cap election form
To qualify as a CGT cap contribution, your client must provide a completed ‘Capital gains tax cap election’ form to the super fund before or at the time of making the contribution.
You should identify the small business CGT concessions as a significant planning opportunity for your clients who own a business and are seeking to sell in the future. The complexity of the concessions can deter advisers from assisting clients, so their needs remain unresolved.
A good approach is to work with your client’s accountant, who can confirm eligibility for the tax concessions, whilst you can plan the superannuation aspects of the strategy. The limited amounts of the CC and NCC caps highlight the considerable size of the CGT cap opportunity, currently $1.565m for FY2020/21.
Keep in mind the oversights mentioned above when applying the concessions and ensure you address all planning opportunities.
If you require more technical information, please refer to our Strategy Guide (SG 71) available on Fast Fact Finder. If you have a specific query about the small business CGT concessions, we can help. Please contact the Tech Connect team on 1300 650 414 or email@example.com
If you have any questions, or would like more information, please contact the IOOF TechConnect team on 1300 650 414.
DisclaimerThe information in this section of the website is intended for financial advisers only and is not to be distributed to clients. It has been prepared on behalf of Australian Executor Trustees Limited ABN 84 007 869 794 AFSL 240023, IOOF Investment Management Limited ABN 53 006 695 021 AFSL 230524, IOOF Investment Services Ltd ABN 80 007 350 405, AFSL 230703 and IOOF Ltd ABN 21 087 649 625 AFSL 230522 based on information that is believed to be accurate and reliable at the time of publication.