This article first appeared May 4, 2010.
Countless small business owners, depending upon their circumstances, may have some powerful reasons to feel relieved. The Government hasn’t picked up any of the Henry Tax Review’s proposals that could have effectively cutback on the best tax breaks of all for small business owners – the CGT small business concessions.
The concessions provide the potential to significantly reduce or even eliminate multi-million capital gains on the sale of their businesses.
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These may be particularly valuable for highly-success entrepreneurs who have built their businesses from scratch. Without the concessions, these entrepreneurs may otherwise face massive CGT bill when selling their businesses.
The Henry Review had recommended “rationalising and streamlining” of the small business CGT concessions by removing two of the most valuable concessions, including the full exemption from CGT on the sale of active business assets owned for 15 years. Further, the Henry Review proposed removing the exemption from CGT of assets acquired before the introduction of CGT.
And the review had recommended several improvements to other small business CGT concessions, which could be particularly rewarding to some business vendors, again depending on their circumstances.
It should be emphasised that there is widespread criticism among tax professionals about the sheer complexity of the existing small CGT concessions and the possible traps for business owners.
As all SME owners should know, the small business CGT concessions are broadly limited to businesses with an annual net turnover of less than $2 million or a maximum net asset value of $6 million.
Basically, an eligible small business is entitled to CGT exemptions, discounts or rollover relief on the sale of active business assets. The special small business CGT discount is in addition to the 50% general CGT discount applying to individuals, trusts and super funds.
“Active” business assets include goodwill, trademarks and business premises but do not extend to a business’s passive assets such as its investment portfolio.
Broadly, the net market value of the vendor’s business assets, personal bank accounts, personal investment portfolios and personal investment properties – as well as those of their business partners, spouses, children under 18 or any entities or people under their control – count towards the $6 million threshold.
Specialist tax consultant Gordon Cooper, principal of Cooper & Co in Sydney, gives a telling example of how a $2 million capital gain, for instance, can be received without paying any CGT – thanks to CGT concessions. First, the general CGT discount could reduce the taxable gain to $1 million, and then a series of small business CGT discounts and exemptions could eliminate the rest “in the appropriate circumstances”.
Cooper emphasises that the $2 million annual turnover provision provides an opening for an asset-rich, income-poor business worth tens of millions of dollars to become eligible for the small business CGT concessions.
Cooper’s latest book – Cooper & Evans on CGT, co-written with a professor of taxation at the Australian School of Taxation, Chris Evans, and published by Thomson Reuters – features the case study of a family farm operated on land revalued as residential. The farm has a market value of $20 million but its turnover of just $500,000 means it meets the small business test.
Cooper explains that under one of the CGT small business concessions, active assets owned by the vendor for at least 15 years are exempt from CGT – provided the vendor is at least 55 and the sale is “in connection with retirement”. Under this exemption, Cooper says the entire capital gain on the family farm, $19 million, would not be subject to CGT.
One of the most frustrating things for an SME owner is overshooting the $6 million asset threshold by even a few dollars. It can cost millions in lost CGT concessions.
Here are eight tips to consider for falling within the threshold – take special note of strategy eight regarding the anti-avoidance provisions:
1. Upgrade your family home: This is perhaps the most straightforward strategy to consider before selling your business. Your main residence is expressly excluded from the small business asset test. And one of the biggest advantages of spending more on your home is the property can later be sold free of CGT.
2. Buy a holiday home: Apart from having a place to get away from the city, an added incentive to buy a holiday cottage is that the property will not be countered towards the small-business asset test. This is because assets used solely for “personal use and enjoyment” are excluded from the test.
Cooper and Evans say in their book: “It can be argued that if a taxpayer allows family or friends to stay with them in a holiday cottage, this comes within the concept of the ‘personal use and enjoyment’ of the taxpayer.”
3. Help your children with the deposit on their first home: Gifts to your children over 18 do not count towards the small business asset test – provided these children are not connected with your business, says tax lawyer Robert Richards, principal of Robert Richards & Associates in Sydney.
4. Make a large super contribution: Like your home, super savings are expressly excluded from the small-business asset test. And many SME owners obviously want to sell their businesses on the eve of retirement when super may make most sense.
Interestingly, Gordon Cooper and Chris Evans point out in their book that a business property held in a self-managed super fund would not count towards the small-business asset test.
5. Buy a luxury car or boat: A luxury car or boat is not included in the asset test. But the car or boat should not be used for business purposes. Your purchase of a luxury item might not seem such an indulgence if it is saving you millions in CGT which may otherwise be payable if your SME exceeds $6 million in value.
6. Take a long-awaited overseas holiday: The cost of your holiday will not be included in the asset test. Richards asks: If the money spent on taking a holiday brings you under the asset test, why not take it? Or why not go sailing in your own yacht?
7. Watch out for cash traps: As mentioned, the asset test catches a range of assets – such as your private share portfolio – which many small business owners might regard as private. And the tax commissioner has issued a ruling that your cash holdings count towards the small-business asset test.
8. Keep an eye on the anti-avoidance provisions: Gordon Cooper warns that undertaking any action – such as those set out in the above strategies – with the dominant purpose of getting within the small business asset threshold could be caught by the Part IVA anti-avoidance provisions.
But, Cooper says, if you had been about to sell your business and thinking for some time about buying, say, a holiday unit on the Gold Coast, you may be better to buy it before selling your business.
Robert Richards says business owners should obviously remain aware of the anti-avoidance provisions when undertaking all tax-planning. But he does not believe Part IVA would cause a serious risk for most small business owners who spend a large amount of money before selling their businesses.