Small Business CGT Concessions: Small Business Entity Test – Part 1

In this post we’ll start to cover how a taxpayer can satisfy the small business entity test. This test was introduced for CGT events happening from the 1 July 2007 onwards as an alternative to the maximum net asset value test. It is a lot easier to apply and therefore taxpayers would normally look to this first before the net asset test.

To be a ‘small business entity’ the taxpayer must carry on a business and satisfy the $2m aggregated turnover test.

Carrying on a business

Whether or not a business is being carried on will normally be quite obvious and I don’t intend to talk about it here at great length (though it could make an interesting post for another time). However, if you are unsure whether or not a business is carried on I would suggest looking at the table at paragraph 18 in Tax Ruling TR 97/11 as a starting point.

It is quite common (at least amongst my clients) for one entity to own most of the assets while another entity (an affiliate or connected entity) runs the business. In the past this caused problems but under the current rules the small business entity test will still be satisfied where:

  • The entity that carries on the business is a small business entity and is connected to or is an affiliate of the taxpayer (i.e. the asset holding entity)
  • The taxpayer does not carry on a business itself (other than in partnership) and
  • The asset is used in the business carried on by the taxpayer’s affiliate or connected entity

 $2m aggregated turnover test

This test looks at whether the taxpayer, together with any connected entities and affiliates (a detailed explanation of what these terms mean will come in my next post) had, or is expected to have, a turnover of $2m or less. The test can be satisfied by looking at:

  • Actual turnover in the prior income year
  • Actual turnover in the current income year (i.e the year in which the CGT event happened) or
  • Estimated turnover in the current income year (obviously determined before the year is over).

Only one of these three needs to be satisfied.

 Turnover

Turnover is the GST-exclusive amount of income derived in the ordinary course of business, excluding from dealings with connected entities and affiliates (to avoid double-counting). It would typically include sales and interest from business bank accounts but wouldn’t include capital gains, dividends and passive rental income.

Some other points to note;

The method of determining turnover you choose must be used for all other connected entities and affiliates. You can’t choose a different method for each entity.

If using the estimated turnover method (i.e. at the start of the income year it appears likely that the aggregated turnover will be less than $2m) the onus is on the taxpayer to prove that the estimate is sound. The Explanatory Memorandum lists factors to consider when making this estimate.

The taxpayer cannot use the estimated turnover test if they carried on a business in the previous two income years and in both those years turnover exceeded $2m.

If the business was carried on for only part of the income year the taxpayer should use a reasonable estimate of what the turnover would have been if it were carried on for the entire year.

In my next post I’ll go into some detail about the aggregated part of the aggregated turnover test. That is, what are connected entities, what are affiliates, what gets included and what gets excluded.

 Image

My favourite type of turnover – an apple turnover

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