Small business CGT concessions – Connected entities

It’s been a while since my last post because, well let’s face it – there are more enjoyable ways to spend your free time than writing about tax. However, this week I had the opportunity to advise two separate clients on the small business CGT concessions and figured I would take it as a sign that I should finally continue my series on small business CGT concessions. Today’s post will be about connected entities.

When applying the aggregated turnover test (and similarly when applying the maximum net asset value test as we shall see in a future blog post) a connected entity’s turnover is taken into account. That is, when determining if aggregated turnover of a taxpayer is $2m or less, it is necessary to count the turnover of its connected entities. To do this it will obviously be necessary to first identity which entities are connected.

One entity is connected with another entity if either entity controls the other entity or both entities are controlled by the same third entity.  When thinking about connected entities key number to remember is 40% because control will generally occur if the control percentage is 40% or more. However, the Commissioner does have the power to determine that control does not exist if the percentage is between 40 and 50% (say because another entity owns 50-60%). Remember also that control can be direct or indirect such as where an entity directly controls a second entity and this second entity directly controls a third.

There are different rules for establishing control for different types of entities so I will consider each separately;

Companies

A shareholder will have a 40% control percentage where, together with its affiliates (more on that in my next post) it beneficially owns shares that have the right to at least 40% of any dividends paid, any distributions of capital or voting power.

Unit Trusts

A unit holder will have a 40% control percentage where, together with its affiliates it beneficially owns units that have the right to at least 40% of any distributions of income or distributions of capital. Unlike companies there is no equivalent voting power test.

Discretionary Trusts

There are two ways an entity can control a discretionary trust.

The first way is by influencing  a trustee – where the trustee acts, or could reasonably be expected to act, in accordance with the directions or wishes of the entity, its affiliates or the entity acting together with its affiliates (deep breath). Some of the factors to consider when determining this include

How the trustee has acted in the past

The relationship between the entity and trustee

The amount of any property or services transferred to the trust by the entity  and

Any arrangement or understanding between the entity and any person who has benefited under the trust in the past

This test seems to have some strange consequences. On a strict reading, this rule seems to suggest that a sole director of a corporate trustee would be connected but not an individual acting in their own right as trustee. If the corporate trustee has two directors and decisions are made by them jointly neither one of them will control the trustee.  Finally, according to the Commissioner, an appointor will control a discretionary trust, even if it has no day-to-day involvement.

The other way to determine control of a discretionary trust is to look at the pattern of distributions in the previous four income years (excluding the current year in question).  A beneficiary controls a discretionary trust in an income year if at least 40% of the trust’s income or capital is paid/applied for the benefit of it and/or its affiliates.

Some things to note include;

According to new rules which apply to CGT events on or after 27 June 2011, if a trust is unable to establish a beneficiary-controller because it is unable make a distribution, the trustee may nominate up to 4 beneficiaries as controllers. This would occur where the trust had a tax loss or no net income and the trustee did not make a distribution of income or capital for that year.

It is income or capital but these are considered separately. If a beneficiary receives 35% of each they will not control the trust but a beneficiary who receives 40% of one and 0% of the other will.

Exempt entities and deductible gift recipients (e.g. charities) cannot be treated as controlling, regardless of the percentage of distributions made to them.

Partnerships

Even though a partnership is not a separate legal entity, it can be a connected entity. A partner  will be connected with a partnership if he/she/it is entitled to receive at least 40% of the income or net income of the partnership or at least 40% of distributions of capital

Hybrid Trusts

These would probably be considered under the discretionary trust rules.

Superfund

Although a super fund is a type of trust, the Commissioner’s view is that it will not be connected with any of its members or trustee. This opens up opportunities to reduce your net assets by contributing funds or assets into a super fund. Of course the contribution rules will need to be considered before doing this.

 

In my next post I’ll write about affiliates.

Cheers,

Simon

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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

Small Business CGT Concessions – Intro to the Basic Conditions

In order to access any of the concessions, the taxpayer must first satisfy the basic conditions set out in Subdivision 152-A. Some conditions require further tests to be passed but all, at a minimum, require these basic conditions to be met;

  1. A CGT event must happen in relation to a CGT event (except K7) of the taxpayer and this CGT event must result in a capital gain (so is not relevant to assets acquired before 20 September 1985).
  1. The  taxpayer satisfies at least one of the following;
  1. The taxpayer is a ‘small business entity’
  2. The taxpayer satisfies the ‘maximum net asset value test’
  3. The taxpayer is a partner in a partnership that is a small business entity and the CGT asset is an interest in an asset of the partnership or
  4.  The conditions in s 152-10(1A) or (1B) are met. I’ll explain these later.
  5. If the CGT asset is a share in a company or an interest in a trust then further conditions to do with ‘CGT concession stakeholders’ are met.

In my next post we’ll start to get stuck in to the details, first looking at how a taxpayer can be a ‘small business entity’. Spoiler alert – it’s all about having turnover of less than $2m but as you’d expect there’s a bit more too it than that.

Cheers,

Simon

Small Business CGT Concessions – Introduction

Size does matter.

At least it does when it comes to the Small Business CGT Concessions. These concessions, contained in Division 152 of the 1997 Act, can be extremely generous for those businesses who meet the requirements. They can;

In the case of the 15 year exemption – cause the capital gain to be reduced to nil, i.e. completely disregarded

In the case of the small business 50% reduction – reduce the gain by 50% (on top of the 50% general CGT discount, if applicable)

In the case of the retirement exemption – allow up to $500,000 of the gain to be disregarded and

In the case of the roll-over – defer all or part of the gain.

Furthermore, these concessions can be used in conjunction with each other. That is, they can be cumulative.

There is therefore a great benefit to access these concessions, if you can. Unfortunately the rules are complex and can be overwhelming, even to professional accountants. It doesn’t help that there were changes to the rules in 2006, 2007, 2009 and 2011 (the joys of being a tax accountant!). I hope to show that if you go through the requirements slowly and methodically, they aren’t so difficult.

The purpose of this series of articles (this is far too big a topic to cover in just one or two posts) is to explain how your business (or your client’s business) can qualify for the concessions and what it is you get if you do qualify. I hope you read and enjoy them and ask any questions that you have.

Cheers,

Simon