House of Representatives

Tax Laws Amendment (2006 Measures No. 7) Bill 2006

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello MP)

Chapter 1 Small business CGT provisions

Outline of chapter

1.1 Schedule 1 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997), the Income Tax Assessment Act 1936 (ITAA 1936) and the Income Tax (Transitional Provisions) Act 1997 to reduce the compliance costs for small business and increase the availability of the small business capital gains tax (CGT) concessions.

1.2 These amendments also replace the controlling individual 50 per cent test with a significant individual 20 per cent test that can be satisfied either directly or indirectly through one or more interposed entities.

Context of amendments

1.3 Four small business CGT concessions are available for eligible small businesses:

the 15-year exemption;
the retirement exemption;
the active assets 50 per cent reduction; and
the small business roll-over.

1.4 The small business CGT concessions in their present form have applied since 21 September 1999. The concessions were introduced to further encourage investment in small business and assist small business taxpayers to provide for their retirement.

1.5 These amendments are in response to the recommendations made by the Board of Taxation in October 2005 ( Post-implementation review of the quality and effectiveness of the small business capital gains tax concessions ).

Summary of new law

1.6 A number of changes have been made to the small business CGT concessions to reduce the compliance costs for small business and increase the availability of the concessions.

1.7 The amendments will improve the operation of the small business CGT concessions by making changes to the maximum net asset value test, the active asset test, the 15-year exemption, the retirement exemption, the small business roll-over and how the concessions apply to partners in a partnership and deceased estates.

1.8 The controlling individual 50 per cent test is replaced by the new significant individual 20 per cent test. The test can be satisfied directly or indirectly through one or more interposed entities.

1.9 The significant individual 20 per cent test enables up to eight taxpayers to benefit from the full range of concessions (five taxpayers, or four taxpayers and their spouses) instead of the current limit of two controlling individuals or one controlling individual and their spouse.

1.10 Allowing the requirement to be satisfied either directly or indirectly, rather than just through direct interests as at present, has the additional advantage of assessing the real economic interests in the business.

Comparison of key features of new law and current law

New law Current law
Controlling / significant individual test
Significant individual 20 per cent test that can be satisfied either directly or indirectly through one or more interposed entities. Controlling individual 50 per cent test that could only be satisfied directly.
Maximum net asset value test
The maximum net asset value test takes into account a negative net asset value of a connected entity in looking at the net assets of an entity. The maximum net asset value test did not allow the possibility of a negative net asset value for an entity.
The maximum net asset value test takes into account the assets and related liabilities of an entity and provisions for annual leave, long-service leave, unearned income and tax liabilities. The maximum net asset value test only took into account the assets and related liabilities of an entity.
The maximum net asset value test in relation to a partnership only applies to the individual partners in a partnership. The maximum net asset value test in relation to a partnership applied to a partnership as a whole.
The assets of an individual, for the purposes of the maximum net asset value test, include only the proportion of a dwelling that was used for income producing purposes. The assets of an individual, for the purposes of the maximum net asset value test, include the entire value of a dwelling that had an income producing use.
Active asset test

Active asset test requires the asset to be active for the lesser of 71/2 years or half of the period of ownership.

The asset does not need to be an active asset just before the CGT event.

Active asset test required the asset to be active for the lesser of half the period of ownership or 71/2 of the last 15 years. It also required the asset to be active just before the CGT event.
An 80 per cent look through test is applied to the active assets of the company or trust to determine whether shares in a company or interests in a trust qualify as active assets. Cash and financial instruments inherently connected with the business are counted towards the 80 per cent requirement. Certain cash and financial instruments inherently connected with the business were not counted towards the 80 per cent requirement.
The 80 per cent look through test does not need to be tested in circumstances where it is reasonable to conclude that the 80 per cent test has been passed. Theoretically, the 80 per cent look through test needed to be monitored on a continuous basis.
The 80 per cent look through test is not failed because of a breach of the threshold that is only temporary in nature. The 80 per cent look through test could be failed for a temporary breach - this could result in a capital gain being realised.
Additional requirement for shares or trust interests

In addition to the existing test, an alternative to the direct ownership requirement is introduced.

The alternative requirement is the 90 per cent test. An entity satisfies the test if there are CGT concession stakeholders in the object company or trust, and the CGT concession stakeholders have a small business participation percentage in the entity disposing of the shares or interests, of at least 90 per cent.

The entity that owns the shares or trust interests must be a CGT concession stakeholder in the company or trust (the object company or trust).
15-year exemption
The 15-year exemption requires a significant individual of a company or trust only for any period or periods totalling 15 years during the period of ownership. The 15-year exemption required a controlling individual of a company or trust for the entire period of ownership.
Retirement exemption
A payment of an amount exempted under the retirement exemption will be either deemed to be an eligible termination payment or to have been paid in respect of employment. A payment of an amount exempted under the retirement exemption was required to be an eligible termination payment.

The retirement exemption also applies to gifts of property.

As there are no capital proceeds from the event the market value substitution rule applies to determine the amount of deemed capital proceeds.

The retirement exemption did not apply to gifting of property.
Small business roll-over
A taxpayer can choose to roll-over all or part of a capital gain. A taxpayer could only choose to roll-over all of a capital gain.
Replacement assets can be newly acquired assets or improvements to assets that the taxpayer already owns. A replacement asset could only be a newly acquired asset.

A taxpayer can choose to roll-over a capital gain before acquiring a replacement asset or making a capital improvement (a replacement asset).

CGT event J5 will happen if no replacement assets are held at the end of two years.

CGT event J6 will happen if insufficient replacement assets are held at the end of two years.

A taxpayer would have to return a capital gain if they had not yet acquired a replacement asset, and could seek an amended assessment following acquisition of a replacement asset.
Deceased estates
The legal personal representative of the deceased or a beneficiary of the deceased's estate can access the concessions to the same extent that the deceased could have used them just prior to death, on assets disposed of within two years of death. No equivalent.

Detailed explanation of new law

Significant individual test

1.11 An individual is a significant individual in a company or trust if they have a small business participation percentage in the company or trust of at least 20 per cent. [ Schedule 1, item 39, section 152-55 ]

1.12 The 20 per cent can be made up of direct and indirect percentages. [ Schedule 1, item 39, section 152-65 ]

1.13 An entity's direct small business participation percentage in a company is the percentage of:

voting power that the entity is entitled to exercise;
any dividend payment that the entity is entitled to receive; and
any capital distribution that the entity is entitled to receive.

[ Schedule 1, item 39, subsection 152-70(1 ), item 1 in the table ]

1.14 For a trust, where entities have entitlements to all the income and capital of the trust, an entity's direct small business participation percentage is the percentage of the income and capital of the trust that the entity is beneficially entitled to receive. [ Schedule 1, item 39, subsection 152-70(1 ), item 2 in the table ]

1.15 An entity's direct small business participation percentage in a trust, where entities do not have entitlements to all the income and capital of the trusts, if the trust made a distribution of income or capital, is the percentage of distributions of income and capital that the entity is beneficially entitled to during the income year. If the trust did not make a distribution of income or capital during the income year it will not have a significant individual during that income year. [ Schedule 1, item 39, subsection 152-70(1 ), item 3 in the table ]

1.16 If an entity has different percentages in a company, their participation percentage is the smaller or smallest percentage. The same applies for a trust. [ Schedule 1, item 39, subsection 152-70(1 )]

Example 1.1 Peter has shares that entitle him to 30 per cent of any dividends and capital distributions of Coffee Co. The shares do not carry any voting rights.Peter's direct small business participation percentage in Coffee Co is zero per cent

1.17 An entity's indirect small business participation percentage in a company or trust is calculated by multiplying together the entity's direct participation percentage in an interposed entity, and the interposed entity's total participation percentage (both direct and indirect) in the company or trust. [ Schedule 1, item 39, section 152-75 ]

Example 1.2 Discretionary Trust owns 100 per cent of the shares in Operating Company; therefore Discretionary Trust has a 100 per cent direct interest (and no indirect interest) in Operating Company.

Diagram:  Example 1.2

Anna receives 80 per cent of the distributions from Discretionary Trust; therefore she has a direct participation percentage of 80 per cent in Discretionary Trust.To find Anna's participation percentage in Operating Company, multiply together Anna's direct participation percentage in Discretionary Trust and Discretionary Trust's total participation percentage in Operating Company.

80% x 100% = 80%

Anna has an 80 per cent participation percentage in Operating Company and is therefore a significant individual of Operating Company.Bill receives 15 per cent of the distributions from Discretionary Trust; therefore he has a direct participation percentage of 15 per cent in Discretionary Trust.To find Bill's participation percentage in Operating Company, multiply together Bill's direct participation percentage in Discretionary Trust and Discretionary Trust's total participation percentage in Operating Company.

15% x 100% = 15%

Bill has a 15 per cent participation percentage in Operating Company and is therefore not a significant individual of Operating Company. (As a spouse of a significant individual with a participation percentage greater than zero in the entity, Bill will be a CGT concession stakeholder. See paragraph 1.23.)Deborah receives 5 per cent of the distributions from Discretionary Trust; therefore she has a direct participation percentage of 5 per cent in Discretionary Trust.To find Deborah's participation percentage in Operating Company, multiply together Deborah's direct participation percentage in Discretionary Trust and Discretionary Trust's total participation percentage in Operating Company.

5% x 100% = 5%

Deborah has a 5 per cent participation percentage in Operating Company and is therefore not a significant individual of Operating Company. (Deborah is not a CGT concession stakeholder. See paragraph 1.23.)

1.18 An indirect interest can be held through one or more interposed entities.

Example 1.3

Diagram:  Example 1.3

Melissa's total small business participation percentage in Company C is the sum of her direct and indirect participation percentages (section 152-65). Direct small business participation percentage in Company C Melissa has a direct participation percentage in Company C of 10 per cent (section 152-70). Indirect small business participation percentage in Company C Because there are two interposed entities between Melissa and Company C, she will need to calculate the indirect small business participation percentage in respect of each interposed entity on the following basis. First application : Melissa as the holding entity; Company A as the intermediate entity; and Company C as the test entity; and Second application : Melissa as the holding entity; Company B as the intermediate entity; and Company C as the test entity (subsection-152-75(2)).The indirect percentages Melissa has in Company C via Company A will need to be added to her indirect percentage in Company C via Company B to work out her total indirect percentage. First application - Melissa's indirect percentage in Company C via interposed entity Company A Melissa (holding entity) has a direct percentage in Company A (intermediate entity) of 50 per cent. This percentage is multiplied by the sum of Company A's direct and indirect percentage in Company C (test entity).Company A has a direct percentage in Company C of zero per cent.Company A has an indirect percentage in Company C of 20 per cent.See below for how Company A's indirect percentage is worked out.Therefore Melissa's indirect percentage in Company C via interposed entity Company A is:

50% x [0% + 20%] = 10 %

Alternatively this can be expressed as Melissa's direct percentage in Company A multiplied by the sum of Company A's direct percentage and indirect percentage in Company C.Working out Company A's indirect percentage in Company CTo work out Company A's 20 per cent indirect percentage in Company C, we treat Company A as the holding entity, and Company B as the intermediate entity (subparagraph 152-75(1)(b)(ii)).Company A's indirect small business participation percentage in Company C via interposed entity Company B is calculated as follows.Company A (as holding entity) has a direct percentage of 50 per cent in Company B (the intermediate entity).Company B (as intermediate entity) has a direct small business participation percentage in Company C of 40 per cent and a zero indirect percentage.Therefore, Company A's indirect percentage in Company C is:

50% x [40% + 0%] = 20%

Alternatively this can be expressed as Company A's direct percentage in Company B multiplied by the sum of Company B's direct percentage and indirect percentage in Company C. Second application - Melissa's indirect percentage in Company C via interposed entity Company B Melissa (holding entity) has a direct percentage in Company B (intermediate entity) of 20 per cent. This amount is multiplied by the sum of Company B's direct and indirect percentage in Company C (test entity).Company B has a direct percentage in Company C of 40 per cent.Company B has an indirect percentage in Company C of zero per cent.Therefore Melissa's indirect interest in Company C via interposed entity Company B is:

20% x [40% + 0%] = 8%

This is Melissa's direct percentage in Company B multiplied by the sum of Company B's direct percentage and indirect percentage in Company C.Melissa's indirect small business participation percentage in Company CMelissa's indirect small business participation percentage in Company C is 18 per cent. This is the sum of her indirect percentages in Company C via Company A and Company B.Melissa's total small business participation percentage in Company CMelissa's total small business participation percentage is the sum of her direct 10 per cent and indirect 18 per cent small business participation percentages in Company C (section 152-65).As Melissa has a total small business participation percentage of 28 per cent she is a significant individual (section 152-55).

1.19 The small business concessions are intended for active participants in a small business, and the significant individual test represents a readily verifiable proxy for active participation. This reflects the fact that there is typically minimal separation between significant underlying ownership and management in small businesses. Put more simply, those who own a small business tend to run the business.

1.20 This amendment is in addition to those recommended by the Board of Taxation.

1.21 A number of amendments are made to reflect the replacement of the controlling individual test with the significant individual test. [ Schedule 1, items 18, 38 to 40, 43 to 45, 48 and 53, paragraph 152-5(c ), sections 152-50 and 152-100, paragraph 152-110(1)(d ), section 152-115, note to section 152-120, paragraph 152-305(2)(b ) and the example in subsection 152-315(5 )]

1.22 A number of amendments are made to reflect the possibility of having more than two CGT concession stakeholders because of the change to the significant individual test. [ Schedule 1, items 45, 52 and 54, paragraph 152-125(2)(b ), subsections 152-315(5 ) and 320(2 )]

CGT concession stakeholder

1.23 A person is a CGT concession stakeholder of a company or trust if they are a significant individual or the spouse of a significant individual with some participation percentage in the company or trust. This participation percentage can be held directly or indirectly through one or more interposed entities. The percentages are worked out in the same way as for the significant individual test. [ Schedule 1, item 39, section 152-60 ]

Maximum net asset value test

1.24 The maximum net asset value test allows the net asset value of an entity to be reduced by provisions for annual leave, long service leave, unearned income and tax liabilities. These amounts are not included as liabilities because they are not present legal obligations, but are relevant to the value of the business, having regard to commercial business valuation methods. This amendment addresses Recommendation 6.3 of the Board of Taxation report. [ Schedule 1, item 23, paragraph 152-20(1)(b )]

Example 1.4 Hanna has CGT assets with a value of $7.2 million, liabilities relating to the assets of $1.1 million and has made provisions for $100,000 of annual leave for her employees, $20,000 for unearned income and $50,000 for tax liabilities for the financial year. Hanna has a net asset value of $5.93 million.

1.25 The maximum net asset value test takes into account the net assets of a taxpayer, as well as the net assets of connected entities and small business affiliates (subject to certain exclusions). The net assets calculation allows an entity to have a negative net asset value, and for that to be taken into account in determining if another entity satisfies the test. This amendment addresses Recommendation 6.2 of the Board of Taxation report. [ Schedule 1, item 23, subsection 152-20(1 )]

Example 1.5 Ice Cream Co has CGT assets with a value of $2 million and liabilities relating to those assets of $3 million. Ice Cream Co has a net asset value of negative $1 million.From Example 1.4, Hanna owns 70 per cent of the shares of Ice Cream Co and Ice Cream Co is a connected entity. Net asset value includes the value of connected entities, therefore Ice Cream Co's net asset value is included in Hanna's net asset value. Hanna's net asset value is reduced by $1 million to $4.93 million.

1.26 The maximum net asset value test, when applied in relation to partnership assets, only counts the assets of each relevant partner and not the assets of the partnership as a whole. This is achieved by repealing subsection 152-15(2). This amendment addresses Recommendation 6.8 of the Board of Taxation report. [ Schedule 1, item 22, section 152-15 ]

Example 1.6 Dan is a partner in an accounting firm. The firm has net assets of $10 million and Dan has a 20 per cent stake in the partnership. The partnership sells the building from which it operates. In applying the net asset test, Dan only includes $2 million in net assets in relation to his interest in the partnership.

1.27 A person is not automatically another person's small business CGT affiliate because of a business relationship. For example, co-directors, co-trustees or partners are not necessarily affiliates. Nor are directors automatically affiliates of the company, nor the company an affiliate of them. This amendment addresses Recommendations 6.6 and 6.7 of the Board of Taxation report. [ Schedule 1, item 28, subsection 152-25(2 )]

Example 1.7 Tom and Bob are both directors of Import Company. They do not have any relationship outside the company. Tom and Bob will not be small business CGT affiliates because of their co-directorship of Import Company. Example 1.8 Chris and Melanie are both trustees of the Export Trust which runs a family business. They are not necessarily small business CGT affiliates because they are trustees of the same trust. However, it is necessary to apply the test of whether one of them acts, or could be expected to act, in concert with the other.

1.28 An individual only includes in their net assets the current market value of a dwelling to the extent that it is reasonable, having regard to the amount that the dwelling has been used to produce assessable income which gives rise to deductions for interest payments. This amendment addresses Recommendation 6.9 of the Board of Taxation report. [ Schedule 1, item 26, subsection 152-20(2A )]

1.29 If the dwelling has never had any income producing use, the value is not included at all. [ Schedule 1, item 25, subparagraph 152-20(2)(b)(ii )]

1.30 If the dwelling has had some income producing use, the percentage of income producing use is multiplied by the current market value to work out the value of the dwelling that should be included. This will take into account the length of time and percentage of income producing use of the dwelling.

Example 1.9 Ben owns a house that has a market value of $750,000 just before applying the net assets test. Ben owned the house for 12 years - for the first three years, 20 per cent of it was used for producing assessable income, for the following two years it was used 40 per cent for producing assessable income, for two years it was used solely as a main residence and for the last five years it was used 10 per cent for producing assessable income.Ben's dwelling has had 15.8 per cent income producing use (3/12 x 20%) + (2/12 x 40%) + (2/12 x 0%) + (5/12 x 10%).Ben will include $118,750 in his net asset test ($750,000 x 15.8%).Ben has a liability of $500,000 attached to the house. Therefore 15.8 per cent ($79,166) of the liability is also included in the net asset test.

1.31 The rules in the net asset test for dwellings also apply to land that would be included for the purpose of the main residence exemption under section 118-120. This exemption allows up to two hectares of land that is adjacent to the dwelling, to the extent that the land is used primarily for private or domestic purposes. This amendment is in addition to those recommended by the Board of Taxation. [ Schedule 1, item 25, subparagraph 152-20(2)(b)(ii )]

1.32 When working out whether or not a taxpayer exceeds the $5 million net asset value test, the taxpayer takes into account assets of an entity connected with them that are used in the entity's business. However, the taxpayer does not take into account such assets if the entity is connected with the taxpayer just because another entity is the taxpayer's small business CGT affiliate. This amendment does not change the law; it rewrites the provisions to make them clearer. This amendment addresses Recommendation 6.10 of the Board of Taxation report. [ Schedule 1, item 27, subsections 152-20(3 ) and ( 4 )]

Active asset test

1.33 An asset that was owned for less than 15 years will satisfy the active asset test provided that it was active for periods totalling half the relevant period. The relevant period is from when the asset is acquired until the CGT event. If the business ceases within the 12 months before the CGT event (or such longer time as the Commissioner of Taxation (Commissioner) allows) the relevant period is from acquisition until the business ceases. [ Schedule 1, item 31, subsections 152-35(1 ) and ( 2 )]

1.34 The asset no longer has to be active just before the CGT event. This is achieved by repealing subparagraph 152-35(a)(i). [ Schedule 1, item 31, section 152-35 ]

Example 1.10 Jodie ran a florist business from a shop that she has owned for eight years. She ran the business for five years, and then leased it to an unrelated party for three years before selling. The shop satisfies the active asset test because it was actively used in Jodie's business for more than half the period of ownership - even though the property was not used in the business just before it was disposed of.

1.35 If an asset is owned for more than 15 years, it need only be active for periods totalling at least 71/2 years during the relevant period. [ Schedule 1, item 31, subsections 152-35(1 ) and ( 2 )]

Example 1.11 Alice ran a farming business on a property that she has owned for 17 years. She ran the farm for three years, and then leased it to an unrelated party for five years. She then ran the farm for another five years before retiring and leasing the farm for another four years before selling it. The farm satisfies the active asset test because it was actively used in Alice's farming business for at least 71/2 years - even though the period was not continuous and the property was not used in the business just before it was disposed of.

1.36 This amendment addresses Recommendation 7.1 of the Board of Taxation report, with minor modifications that favour the taxpayer.

1.37 There are alternative requirements that can be met for an asset to be an active asset. An asset is active if it is used, or held ready for use, in carrying on a business by the taxpayer, the taxpayer's small business CGT affiliate or a connected entity - this can apply to both tangible and intangible assets. [ Schedule 1, item 32, paragraph 152-40(1)(a )]

1.38 An intangible asset is also active if the taxpayer owns it and it is inherently connected with a business that the taxpayer, a small business CGT affiliate, or another connected entity, carries on. This is an alternative test for intangible assets, because it will be difficult for some intangible assets to meet the requirement that it is used, or held ready for use, in carrying on a business - for example, goodwill is not 'used' in a business, but is inherently connected with it. This amendment addresses Recommendation 7.4 of the Board of Taxation report. [ Schedule 1, item 32, paragraph 152-40(1)(b )]

1.39 To find out whether a share in a company or an interest in a trust is an active asset, it is necessary to 'look through' the company or trust and establish whether 80 per cent of the company or trust's assets are active. Cash and financial instruments are not active assets, but they count towards the satisfaction of the 80 per cent test provided that they are inherently connected with the business. This amendment addresses Recommendation 7.5 of the Board of Taxation report. [ Schedule 1, item 33, subparagraphs 152-40(3)(b)(ii ) and ( iii )]

1.40 Existing subparagraph 152-40(3)(b)(ii), which allows capital proceeds held to acquire new active assets to count towards satisfaction of the 80 per cent test, is no longer necessary because the new inclusions for cash and financial instruments covers such capital proceeds.

1.41 Applying the 80 per cent test on a continuous basis can impose an onerous compliance requirement on small business. Taxpayers are not required to continually apply the 80 per cent test if the test has been passed at some stage and there is no reason to think that the test will be failed at the later time. An example of when it will be reasonable to think that the share or trust interest is still an active asset is when there have been no significant changes to the assets or liabilities of the company or trust. This amendment addresses Recommendation 7.6 of the Board of Taxation report. [ Schedule 1, item 35, subsection 152-40(3A )]

1.42 If there have been significant changes and the 80 per cent test is reapplied and is not met, the share or trust interest will still be an active asset provided that the failure of the test is only temporary. This amendment addresses Recommendation 7.6 of the Board of Taxation report. [ Schedule 1, item 35, paragraph 152-40(3B )]

Example 1.12 John sells an active asset, meets the basic conditions and makes a capital gain of $500,000. He acquires shares in Fruit and Veg Co, which runs his family business, as replacement assets. The shares in Fruit and Veg Co meet the 80 per cent test and thus are active assets. Some time later, Fruit and Veg Co borrows money to pay a dividend, and fails the 80 per cent test. Two weeks later the dividend is paid and the shares pass the 80 per cent test again. For the two weeks, the shares are treated as active assets even though they do not pass the 80 per cent test. Example 1.13 Georgina buys shares in a company that buys a property in order to start a farm. The property makes up 50 per cent of the asset value of the company. For the first year that she owns the shares, the company does not actively use the property. After that time, the company starts the farming business. The property is not active for the first year therefore the company does not pass the 80 per cent test. The shares are not treated as active because the company failed the 80 per cent test for an extended period of time (not just a temporary failure).

1.43 Shares in widely held companies cannot be active assets, even if they pass the 80 per cent test, unless they are held by a CGT concession stakeholder of the company. The same rule applies to trusts that are similar to widely held companies. This amendment addresses Recommendation 7.7 of the Board of Taxation report. [ Schedule 1, item 36, subparagraphs 152-40(4)(b)(i ) and ( c)(i )]

1.44 Trusts that are similar to widely held companies are trusts that are listed on an approved stock exchange, or the trust has more than 50 members (other than a discretionary trust). However, there are exceptions for trusts with 20 members or less, that between them, either:

hold at least 75 per cent of the value of the membership interests in the trust;
are capable of controlling at least 75 per cent of the trust voting interests; or
received at least 75 per cent of the distributions made by the trustee during the year.

[ Schedule 1, item 37, subsection 152-40(5 )]

1.45 When an asset is owned by a discretionary trust but is used in carrying on a business by another entity, that other entity must be connected with the discretionary trust in order for the asset to satisfy the active asset test. The other entity would be connected with the discretionary trust if, for example, it controlled the discretionary trust.

1.46 An entity is treated as controlling a discretionary trust in any income year if, for any of the four preceding income years, the entity and/or its affiliates received at least 40 per cent of any income or capital distributed by the trustee. This does not change the law; it clarifies that the test can be applied to any income year, rather than just the current one. This amendment is in addition to those recommended by the Board of Taxation. [ Schedule 1, item 29, subsection 152-30(5 )]

1.47 The trustee of a discretionary trust can nominate up to four beneficiaries as controllers of the trust for an income year where the trust had no taxable income or a tax loss. This amendment is in addition to those recommended by the Board of Taxation. [ Schedule 1, item 30, subsection 152-30(6A )]

Additional requirement for shares in companies and interests in trusts

1.48 In addition to the other basic requirements, if the CGT event happens to a share in a company or an interest in a trust, one of two additional basic conditions must be satisfied just before the CGT event.

1.49 The first requirement is that the entity making the capital gain on the shares or trust interests is a CGT concession stakeholder in the company or trust. This test already exists under existing paragraph 152-10(2)(b). [ Schedule 1, item 20, paragraph 152-10(2)(a )]

1.50 The alternative requirement is the 90 per cent test. This test only applies if there is an interposed entity between the CGT concession stakeholder and the company or trust in which the shares or interests are held. The interposed entity satisfies the test if 90 per cent of the participation percentages in that entity are held by CGT concession stakeholders of the company or trust in which the shares or interests are held. [ Schedule 1, item 20, paragraph 152-10(2)(b )]

Example 1.14 From Example 1.2:

Diagram:  Example 1.2

Anna, a significant individual and a CGT concession stakeholder of Operating Company, has an 80 per cent small business participation percentage in Discretionary Trust.Bill, a CGT concession stakeholder of Operating Company, has a 15 per cent small business participation percentage in Discretionary Trust.Deborah, who is not a CGT concession stakeholder of Operating Company, has a 5 per cent small business participation percentage in Discretionary Trust.At least 90 per cent of the participation percentages in the Discretionary Trust are held by CGT concession stakeholders of Operating Company. Therefore Discretionary Trust satisfies the ownership requirement if it sells its shares in Operating Company and can access the concessions on those shares, provided that the other conditions are met

1.51 As with the significant individual test, the participation percentage can be held directly or indirectly through multiple interposed entities.

Example 1.15

Diagram:  Example 1.15

The discretionary trust sells the units in the Unit Trust.Catherine, a significant individual and a CGT concession stakeholder of Unit Trust, has a 72 per cent participation percentage in Discretionary Trust.If the other interests in Discretionary Trust are held by people who are not CGT concession stakeholders, Discretionary Trust will not satisfy the ownership requirement and will not be able to access the concessions.

1.52 The existing requirement in paragraph 152-10(2)(a) that the company or trust have a controlling individual is removed because the company or trust will always have a controlling individual (now significant individual) if the other additional conditions are met.

1.53 These amendments are in addition to those recommended by the Board of Taxation. [ Schedule 1, item 20, section 152-10 ]

15-year exemption

1.54 For an individual to access the 15-year exemption on shares in companies or interests in trusts, one condition is that the company or trust must have had a significant individual for periods totalling at least 15 years during which the individual owned the shares or trust interests. It does not need to be the same significant individual at all times. This amendment addresses Recommendation 10.2 of the Board of Taxation report, with minor modifications that favour the taxpayer. [ Schedule 1, item 41, paragraph 152-105(c )]

Example 1.16 Julie owned 10 per cent of the shares in Juice Company for 18 years from 1987 to 2005. For five years (1987 to 1992) she owned another 10 per cent and was a significant individual. For a different 10 years (1995-2005), another person (Edward) was a significant individual. The significant individual requirement is met for Julie's shares.

1.55 For a company or trust to access the 15-year exemption on assets it owns, there must have been a significant individual for at least 15 of the years they owned the asset. This amendment addresses Recommendation 10.2 of the Board of Taxation report, with minor modifications that favour the taxpayer. [ Schedule 1, item 42, paragraph 152-110(1)(c )]

Example 1.17 From Example 1.16, Juice Company had a factory for the last 18 years. Julie was a significant individual for five years and Edward was a significant individual for 10 years. Juice Company will satisfy the significant individual requirement in relation to the factory.

1.56 In a year that a discretionary trust has no taxable income, or a tax loss, and did not make a distribution of income or capital it is treated as having met the significant individual requirement. [ Schedule 1, item 45, section 152-120 ]

1.57 When the company or trust is eligible for the 15-year exemption, payments that relate to that exempt amount are disregarded in the hands of the CGT concession stakeholder that ultimately receives the amount, and any interposed entity that facilitates the payment of the amount. This applies to the extent that the payments are equal to or less than the stakeholders participation percentage (this was previously called the stakeholders control percentage). [ Schedule 1, item 45, subsection 152-125(2 )]

1.58 The stakeholder's participation percentage for a company or a trust is the person's small business participation percentage. However, the stakeholder's participation percentage for a trust, where entities do not have entitlements to all the income and capital of the trust, is 100 per cent divided by the number of CGT concession stakeholders. [ Schedule 1, item 45, paragraphs 152-125(2)(a ) and ( b )]

1.59 A payment that is disregarded under the 15-year exemption will have no other tax consequences - it will not constitute a dividend and will not be a frankable distribution. This amendment addresses Recommendation 10.3 of the Board of Taxation report. [ Schedule 1, items 45 and 58, subsection 152-125(3 ), paragraph 202-45(j )]

1.60 The payment will not cause CGT event G1 (capital payments for shares where the payment is not assessable) to happen. This amendment is in addition to those recommended by the Board of Taxation. [ Schedule 1, item 11, paragraph 104-135(1A)(c )]

1.61 A payment relates to the exempt amount to the extent that it represents a distribution of the capital gain. It is not intended that other payments, such as salary, fringe benefits, repayments of loans, dividends or eligible termination payments, should have different consequences for CGT concession stakeholders than they otherwise would. This amendment addresses Recommendation 10.3 of the Board of Taxation report. [ Schedule 1, item 45, paragraph 152-125(1)(b )]

1.62 There is a requirement that the company or trust make the payments relating to the exempt amount within two years of the CGT event. To take into account actual taxpayer circumstances and commercial practices, the Commissioner has a discretion to extend this time limit. This amendment addresses Recommendation 10.4 of the Board of Taxation report. [ Schedule 1, item 45, subsection 152-125(4 )]

Retirement exemption

1.63 Payments made by a company or trust to an employee of an amount exempted under the retirement exemption are deemed to be payments in respect of the termination of employment of the employee. There is no need for an actual termination of employment. [ Schedule 1, item 55, paragraph 152-325(7)(a )]

1.64 If the payment is made by a private company to a shareholder, the payment can constitute excessive remuneration under section 109 of the ITAA 1936.

1.65 Payments made by a company or trust to a non-employee of an amount exempted under the retirement exemption are deemed to be an eligible termination payment. [ Schedule 1, item 55, paragraph 152-325(7)(b )]

1.66 This amendment addresses Recommendation 12.1 of the Board of Taxation report.

1.67 One requirement of the retirement exemption is that, if the person is less than 55 years old, a payment of the amount exempted must be made to a superannuation fund. For an individual making the gain, the relevant time at which the person must be 55 or over is the time that the choice is made, rather than at the time that capital proceeds are received. This ensures that the amount is not required to be rolled over into a superannuation fund because the person was less than 55 at the time capital proceeds were received, but 55 or over by the time the choice to use the retirement exemption is made (generally on lodgement of the relevant income tax return). This amendment addresses Recommendation 12.2 of the Board of Taxation report. [ Schedule 1, item 47, paragraph 152-305(1)(b )]

Example 1.18 Jamie sells his factory, satisfies the basic conditions and makes a capital gain of $400,000. Jamie is aged 54 when he receives capital proceeds from the sale. He had not decided what to do with the money at that time. Jamie turns 55 years of age, and decides when lodging his income tax return, that he wants to use the retirement exemption - he is not required to pay the money into a superannuation fund because he was aged 55 just before he made the choice.

1.68 If an individual receives capital proceeds in instalments, each instalment is treated as a separate payment. This means that each instalment is looked at separately and in succession in applying the exemption up to the individual's CGT exempt amount. [ Schedule 1, items 49 and 55, subsections 152-310(3 ) and 325(2 )]

1.69 In order to access the retirement exemption on a capital gain made by a company or trust, the company or trust must make a payment of the amount to at least one of its CGT concession stakeholders. [ Schedule 1, item 55, subsection 152-325(1 )]

1.70 If the company or trust receives more than one amount of capital proceeds, the first instalment needs to be fully paid out where the amount of that instalment is less than the CGT exempt amount. Subsequent instalments must be compared with the CGT exempt amount, as reduced by any earlier payments made from previous instalments. [ Schedule 1, items 49 and 55, subsections 152-310(3 ) and 325(2 )]

1.71 It is not necessary to receive actual capital proceeds in order to access the retirement exemption - the retirement exemption is available where a capital gain is made when an active asset is gifted and the market value substitution rule has applied or where CGT event J2, J5 or J6 happens. This is achieved by repealing subsections 152-310(3) and 325(4). [ Schedule 1, item 17, subsection 116-30(1 )]

1.72 Therefore if the individual disposing of the asset is aged 55 or over, they can use the retirement exemption if they meet the basic conditions. If they are less than 55, they can access the retirement exemption provided that they meet the basic conditions and pay an amount equal to the disregarded capital gain into a superannuation fund. In order to access the exemption on a gain made by a company or trust for which there are no actual proceeds, the company or trust must make a payment of the disregarded capital gain to at least one of its CGT concession stakeholders. This amendment is in addition to those recommended by the Board of Taxation.

Example 1.19 Amber, a farmer aged 52, decided that she wanted to give her farm to her son Frank. She made a capital gain of $150,000 on the gift of the asset to Frank. Provided that Amber meets the basic conditions, she can put $150,000 into a superannuation fund and use the retirement exemption to disregard the capital gain. (If Amber was 55 or over she would not need to pay the amount into a superannuation fund to gain access to the retirement exemption.) Example 1.20 In 1999, Amanda sold the shop where she operated her hairdressing business in order to move to larger premises, and disregarded the capital gain of $250,000 under the small business roll-over. She purchased new premises as a replacement asset. In 2005, Amanda ceased operating the hairdressing business; the premises stopped being an active asset and CGT event J2 happened. There are no capital proceeds from this event; however Amanda, aged 45, can access the retirement exemption on the capital gain, provided that she makes a payment equal to the amount of the capital gain into a superannuation fund. (If Amanda was 55 or over, it would not be necessary to make a payment into a superannuation fund.)

Small business roll-over

1.73 The small business roll-over is available for capital gains from a CGT event if the basic conditions for relief are met. A replacement asset need not be acquired, or expenditure does not need to be incurred to improve an asset, before choosing the roll-over. This amendment and the inclusion of CGT events J5 and J6 (see below) address Recommendation 13.5 of the Board of Taxation report. [ Schedule 1, item 57, section 152-410 ]

1.74 If a taxpayer chooses the roll-over, they can disregard all or part of the gain. This amendment addresses Recommendation 13.3 of the Board of Taxation report. [ Schedule 1, item 57, section 152-415 ]

1.75 Certain CGT events will happen if, by the end of two years after the capital gain was made, there are no replacement assets; if sufficient expenditure on replacement assets is not incurred; or if the assets do not meet certain criteria. A CGT event can happen after that period if there were replacement assets at the end of the period and a change happens in respect of the replacement asset after the end of the period.

1.76 Replacement assets can be newly acquired or improvements to an asset a taxpayer already owns. This amendment addresses Recommendation 13.4 of the Board of Taxation report. [ Schedule 1, items 12 and 13, paragraphs 104-185(1)(a ), 197(1)(a ) and 198(1)(a )]

CGT event J5

1.77 CGT event J5 will happen two years after the last CGT event in the year in which the roll-over is chosen if there are no replacement assets. [ Schedule 1, item 13, paragraph 104-197(1)(a ) and subsection 104-197(3 )]

1.78 CGT event J5 will also happen if a replacement asset does not meet certain conditions. It must be active at the end of that period. [ Schedule 1, item 13, paragraph 104-197(2)(a )]

1.79 Also, if the asset is a share in a company or an interest in a trust, the asset must be owned by either:

a CGT concession stakeholder of the company or trust [ Schedule 1, item 13, subparagraph 104-197(2)(b)(i )];
an entity connected with a CGT concession stakeholder [ Schedule 1, item 13, subparagraph 104-197(2)(b)(i )]; or
a company or trust that meets the 90 per cent test (see paragraph 1.50) [ Schedule 1, item 13, subparagraph 104-197(2)(b)(ii )],

at the end of that period.

1.80 The first two dot points previously required a controlling individual rather than a CGT concession stakeholder. This amendment addresses Recommendation 13.7 of the Board of Taxation report.

1.81 The capital gain is the amount of the previous capital gain that was rolled over. [ Schedule 1, item 13, subsection 104-197(4 )]

Example 1.21 In 2004, Jennifer makes a capital gain of $80,000 on an active asset and meets the maximum net asset value test. Jennifer disregards the whole capital gain under the small business roll-over.In 2006, Jennifer does not have any replacement assets by the end of the two-year period. CGT event J5 happens and Jennifer makes a capital gain of $80,000. Example 1.22 In 2004, Anthony makes a capital gain of $50,000 on an active asset and meets the maximum net asset value test. Anthony disregards the whole capital gain under the small business roll-over.In 2005, Anthony spends $50,000 on improving an asset. However, the asset is not active at the end of two years from the CGT event.In 2006, Anthony does not have any other replacement assets. CGT event J5 happens and Anthony makes a capital gain of $50,000.

1.82 The Commissioner can extend the two-year time limit for CGT event J5. This amendment addresses Recommendation 13.1 of the Board of Taxation report. [ Schedule 1, items 12 and 13, section 104-190, subsection 104-197(5 )]

CGT event J6

1.83 CGT event J6 will happen two years after the last CGT event in the year the roll-over is chosen if there has been insufficient expenditure on the replacement asset or assets that met certain conditions (eg, the replacement asset is the taxpayer's active asset at the end of the two year period). [ Schedule 1, item 13, subsection 104-198(2 )]

1.84 Expenditure is insufficient if the relevant expenditure is less than the amount of the capital gain that is rolled over. The relevant expenditure is made up of:

the costs that would be included in the first element of cost base of a replacement asset;
the incidental costs of acquisition of a replacement asset; and
the costs that would be included in the fourth element of cost base of a replacement asset,

where the replacement asset met the required conditions. [ Schedule 1, item 13, paragraph 104-198(1)(d ]

1.85 The capital gain is the difference between the original capital gain that was rolled over and the amount of expenditure incurred. [ Schedule 1, item 13, subsection 104-198(3 )]

Example 1.23 In 2004, Abby makes a capital gain of $700,000 on an active asset and meets the maximum net asset value test. Abby chooses to disregard the whole capital gain.In 2005, Abby purchased new business premises for $300,000 and spent $150,000 on improving some other assets. The replacement assets meet all of the relevant conditions.However, the amount of expenditure on the replacement assets is only $450,000. The capital gain that was rolled over was $700,000.In 2006, two years after the original CGT event, CGT event J6 happens because there has been insufficient expenditure and Abby makes a capital gain of $250,000. The roll-over of $450,000 of the original capital gain continues.

1.86 The Commissioner can extend the two-year time limit for CGT event J6. This amendment addresses Recommendation 13.1 of the Board of Taxation report. [ Schedule 1, items 12 and 13, section 104-190 and subsection 104-198(4 )]

CGT event J2

1.87 CGT event J2 can happen when a person has chosen the small business roll-over and has acquired replacement assets that meet the following tests:

the asset is acquired or improved in the period starting one year before and ending two years after the last CGT event in the year of income in which the roll-over is chosen [ Schedule 1, item 12, paragraph 104-185(1)(a )];
the asset is active at the end of that same period [ Schedule 1, item 12, paragraph 104-185(1)(b )]; and
the owner of the asset is one of the following:

a CGT concession stakeholder of the company or trust [ Schedule 1, item 12, subparagraph 104-185(1)(c)(i )];
an entity connected with a CGT concession stakeholder [ Schedule 1, item 12, subparagraph 104-185(1)(c)(i )]; or
a company or trust that meets the 90 per cent test (see paragraph 1.50) [ Schedule 1, item 12, subparagraph 104-185(1)(c)(ii )].

1.88 CGT event J2 happens when there is a change in relation to a replacement asset of the kind that previously caused CGT event J2 or former CGT event J3 to happen. [ Schedule 1, item 12, subsections 104-185(2 ) and ( 3 )]

1.89 Because of the need to integrate the replacement asset conditions previously in Subdivision 152-E into the CGT events, and to ensure that the events interact appropriately, CGT events J2 and J3 are integrated into a single CGT event. Section 104-190 (CGT event J3) is repealed. [ Schedule 1, item 12, section 104-185 ]

1.90 CGT event J2 can only happen after the end of the replacement asset period. [ Schedule 1, item 12, paragraph 104-185(1)(d )]

1.91 CGT event J2 will not happen to shares and trust interests when the owner of the share or trust interest stops being:

a CGT concession stakeholder of the company or trust;
an entity connected with a CGT concession stakeholder; or
a company or trust that meets the 90 per cent test (see paragraph 1.50),

provided that the owner continues to be one of those things listed.

[ Schedule 1, item 12, paragraphs 104-185(1)(c ) and ( 3)(b )]

Example 1.24 Company A acquires shares in Company B as a replacement asset. Company A is connected to Megan who is a CGT concession stakeholder in Company B.Megan sells her shares in Company B and is no longer a CGT concession stakeholder in Company B.However, Company A is 100 per cent owned by Beth, who is a CGT concession stakeholder in Company B. Company A is connected with Beth and is 90 per cent owned be CGT concession stakeholders of Company B.CGT event J2 does not happen when Megan sells her shares.

1.92 If there was only one replacement asset, or if a change happens to all of the replacement assets, the capital gain is the amount that was originally rolled over. [ Schedule 1, item 12, paragraphs 104-185(5)(a ) and ( b )]

1.93 If there was more than one replacement asset and a change happens to less than all of the assets, the capital gain is the difference between the amount that was originally rolled over and the relevant expenditure on the remaining replacement assets that satisfied relevant conditions. [ Schedule 1, item 12, paragraph 104-185(5)(c )]

1.94 If CGT event J6 had previously happened in relation to the roll-over, the capital gain is the same as calculated above, less the capital gain previously made under CGT event J6. [ Schedule 1, item 12, subsection 104-185(6 )]

1.95 If CGT event J2 had previously happened in relation to the roll-over, the capital gain is the same as calculated above, less the capital gain previously made under CGT event J2. [ Schedule 1, item 12, subsection 104-185(7 )]

1.96 If CGT events J6 and J2 have both previously happened in relation to the roll-over, the capital gain is the same as calculated above, less the capital gains previously made under CGT events J6 and J2. [ Schedule 1, item 12, subsection 104-185(7 )]

Example 1.25 From Example 1.23, Abby's new business premises ceased being active after five years. CGT event J2 will happen raising a capital gain of $300,000.$700,000 (the original capital gain rolled over); less$250,000 (the capital gain previously made under CGT event J6); less$150,000 (the relevant expenditure on the remaining active replacement assets).The roll-over of $150,000 of the original capital gain (which equates to the amount spent on improving the other assets, which are the only replacement assets that remain active) continues.After another two years, the improved assets cease being active, CGT event J2 will happen again raising a capital gain of $150,000.$700,000 (the original amount rolled over); less$250,000 (the gain previously made under CGT event J6); less$300,000 (the gain previously made under CGT event J2); less$0 (the relevant expenditure on the remaining replacement assets that satisfy the relevant conditions).

1.97 In order to ensure that the small business roll-over works appropriately for the time before these amendments apply, a transitional provision provides that a taxpayer would not have to return a capital gain in the year of disposal:

It also ensures that the taxpayer (if they did not subsequently acquire a replacement asset) is not precluded from accessing the retirement exemption on the capital gain (ie, if a replacement asset was not acquired, it would be as though the roll-over never happened).
It allows for the amendment of assessments if:

a replacement asset was never acquired and the retirement exemption did not reduce the capital gain to nil; or
a capital gain was returned in the year of disposal, and the time in which the taxpayer could acquire a replacement asset has not expired.

[ Schedule 1, item 67, Division 152 of the Income Tax ( Transitional Provisions ) Act 1997 ]

Deceased estates

1.98 When an individual dies, their legal personal representative or beneficiary can access the concessions - to the extent that the deceased would have been able to access them just before they died - if a CGT event happens to the assets in the hands of the legal personal representative or beneficiary within two years of the death of the individual. This amendment addresses Recommendation 13.8 of the Board of Taxation report. [ Schedule 1, item 39, subsections 152-80(1 ) and ( 2 )]

1.99 The Commissioner can extend the two year period. [ Schedule 1, item 39, subsection 152-80(3 )]

1.100 If the deceased met the basic conditions just before death the active asset 50 per cent reduction, the small business roll-over, and / or the retirement exemption can be accessed. [ Schedule 1, item 39, paragraph 152-80(1)(c )]

1.101 For the retirement exemption, there is no need for the amount to be paid into a superannuation fund, even if the deceased was less than 55 years of age just before their death. This reflects the likely outcome if the deceased had disposed of the asset before death and paid the amount into a superannuation fund. The amount would be released to beneficiaries after death. [ Schedule 1, item 39, paragraph 152-80(2)(b )]

1.102 In order to access the 15-year exemption, the deceased would have to have met the additional requirements in section 152-105 just before death. However, the requirement that the CGT event happens in relation to the retirement of the individual does not need to be met. [ Schedule 1, item 39, paragraph 152-80(2)(a )]

Application and transitional provisions

1.103 These amendments apply to CGT events happening in the 2006-07 and later income years.

1.104 This means that some of the new tests will apply to time periods before the 2006-07 income year if the relevant CGT event happens after that time. For example, if a CGT event happens after the application of these amendments, a company or trust that wants to access the 15-year exemption will only need to have had a significant individual in earlier years, not a controlling individual. Also, the amendments described in paragraph 1.97 will apply to CGT events that happened in the 2005-06 income year or an earlier income year.

Consequential amendments

1.105 A number of amendments are made to allow capital gains to be rolled over against expenditure on capital improvements as well as acquisitions of replacement assets. [ Schedule 1, items 9, 12 and 56, sections 104-5, 104-185, 104-190, 152-400 ]

1.106 A number of amendments are made to reflect the removal of the requirement that payments be eligible termination payments in order to access the retirement exemption. [ Schedule 1, items 1, 2, 46 and 51, paragraph 27A(1)(jaa ) and subsection 140M(6 ) of the ITAA 1936, note to section 152-220, subsection 152-310(5 )]

1.107 A number of amendments are made to reflect the inclusion of CGT events J5 and J6. [ Schedule 1, item 3 subsection 102-5(1 ), items 6 and 7, paragraphs 103-25(3)(b ) and ( c ), item 10, section 104-5, item 19, section 152-5, item 21 and subsection 152-10(4 )

1.108 A number of amendments are made to reflect the removal of CGT event J3. [ Schedule 1, item 4, subsection 102-25(2 ), item 5, subsection 102-25(2A ), item 8, section 104-5, item 16, paragraph 115-25(3)(hb ), item 15, section 112-115, item 19, section 152-5, item 21, subsection 152-10(4 )]

1.109 Some definitions are added to and removed from the Dictionary. [ Schedule 1, items 59 to 64, subsection 995-1(1 )]

REGULATION IMPACT STATEMENT - for the significant individual test

Policy objective

1.110 The controlling individual test in the small business CGT concessions can be onerous to satisfy for some small businesses (eg, if a business has three equal owners, there is no controlling individual), and can exclude businesses that would be able to access the concessions, but for the structure of that business (eg, if the business is run by an individual with a 100 per cent stake but through a tiered ownership structure, there may be no controlling individual).

1.111 The objective is to make the controlling individual test less onerous so that the small business CGT concessions can be accessed by a broader range of small business taxpayers.

Implementation options

Option 1: replacing the current controlling individual test with a (new) significant individual test (direct ownership only, as at present)

1.112 This option is to replace the current controlling individual (50 per cent) test with a significant individual test, with a reduced percentage interest of:

a) 33? per cent (this option would enable up to four taxpayers to benefit from the full range of concessions (three taxpayers, or two taxpayers and their spouses));
b) 25 per cent (this option would enable up to six taxpayers to benefit from the full range of concessions (four taxpayers, or three taxpayers and their spouses), providing other requirements are satisfied);
c) 20 per cent (this option would enable up to eight taxpayers to benefit from the full range of concessions (five taxpayers, or four taxpayers and their spouses), providing other requirements are satisfied); or
d) 10 per cent (this option would enable up to 18 taxpayers to benefit from the full range of concessions (10 taxpayers, or nine taxpayers and their spouses), providing other requirements are satisfied).

Option 2: replacing the current controlling individual test with a (new) significant stake test (direct or indirect ownership)

1.113 Same as above (Options (a) to (d)) except that the test would also allow the relevant percentage of ownership to be satisfied either directly or indirectly through one or more interposed entities, rather than just through direct ownership as under the controlling individual test.

Option 3: combining the interests of close family members

1.114 Another option is to allow the existing controlling individual test to be satisfied by combining the interests of close family members.

Assessment of impacts of each implementation option

Impact group identification

1.115 The taxpayers who are affected are small business taxpayers who carry on a business via a company or trust who cannot currently access the small business CGT concessions, and the spouses of small business taxpayers who would qualify as CGT concession stakeholders will be affected.

1.116 Given the difficulty in determining the ownership structure of trusts and companies, it is not possible to accurately estimate the number of small businesses likely to be affected.

Analysis of the costs and benefits associated with each implementation option

Option 1

1.117 Amending the percentage requirements would enable some small businesses run through a company or trust to access the concessions even if they do not currently have a controlling individual. The number of stakeholders that a business could have and still access the concessions is included in the information on Option 1.

Government revenue ($ million)

2006-07 2007-08 2008-09 2009-10
Option 1a 0 -11 -12 -12
Option 1b 0 -15 -16 -17
Option 1c 0 -16 -17 -18
Option 1d 0 -18 -19 -20

Negative figures indicate a cost to revenue

Option 2

1.118 Amending the percentage requirements would enable some small businesses run through a company or trust to access the concessions even if they do not currently have a controlling individual. The number of stakeholders that a business could have and still access the concessions is included in the information in Option 1.

1.119 In addition, allowing the significant individual test to be satisfied either directly or indirectly through one or more interposed entities (rather than just through direct ownership as at present) would have the advantage of assessing the real economic interest that individuals have in a small business, rather than just their direct interest.

1.120 Currently, some small businesses are excluded from the concessions because of a tiered ownership structure. For example, a business structure that has an individual with a 100 per cent stake in a discretionary trust which has a 100 per cent stake in a unit trust or company, does not have a controlling individual. Under Option 2, the individual's 100 per cent stake in the unit trust or company, held indirectly through the discretionary trust, would be taken into account.

Government revenue ($ million)

2006-07 2007-08 2008-09 2009-10
Option 2a 0 -22* -23* -24*
Option 2b 0 -30* -32* -33*
Option 2c 0 -32* -34* -35*
Option 2d 0 -36* -38* -40*

* The nature of this measure is such that a reliable estimate cannot be provided. Where a value is followed by *, the estimate is considered indicative of the order of magnitude only.

Negative figures indicate a cost to revenue.

Option 3

1.121 Allowing the controlling individual test to be satisfied by combining the interests of close family members would have the effect of allowing more small business taxpayers to access the small business CGT concessions; however a number of complications would arise.

It would be necessary to determine what would constitute family interests for the purpose of the test, for example, spouses, children, only dependent children, siblings or more extended family.
It would also be necessary to determine which family member would be the controlling individual on the basis of the aggregated family interest. This would be especially difficult (and likely to give rise to dispute) if they have equal interests.
Some structures could be inappropriately excluded, for example if a non-family group jointly owned a company (or if the parents and children grouping was used, three or more siblings or more removed family members), the company would not have a controlling individual, but if they were two parents and a child, it would.

Government revenue ($ million)

2006-07 2007-08 2008-09 2009-10
Option 3 0 -15* -16* -17*

* The nature of this measure is such that a reliable estimate cannot be provided. Where a value is followed by *, the estimate is considered indicative of the order of magnitude only.

Negative figures indicate a cost to revenue.

Compliance costs for all options

1.122 Small businesses that will be affected would already be required to keep records of CGT assets, acquisition date, etc, for tax purposes, and having access to the concessions is likely to have little impact on these requirements. Gaining access to the 15-year and the retirement exemptions will mean that exempt capital gains will not need to be reported in a business or individual tax return, which is expected to reduce compliance costs for small businesses.

Administrative costs for all options

1.123 The Australian Taxation Office (ATO) has advised that there is minimal administrative impact for any of the options and no need for further resources.

Consultation

1.124 This proposal arose out of the Board of Taxation's post implementation review of the small business CGT concessions. A number of submissions made to the Board of Taxation highlighted that the availability of the small business CGT concessions differs significantly depending on the structure of the business.

1.125 Several of the submissions recommended a 'family-based' controlling individual test, rather than the current treatment which looks at the interests of each individual separately. There were also suggestions that the test should be satisfied either directly or indirectly through one or more interposed entities, rather than just through direct ownership as at present.

1.126 Draft legislation was made available to tax and industry body representatives. Consultation participants provided substantial feedback on the whole draft, and in particular on how the measurement of indirect interests could be achieved.

Conclusion and recommended option

1.127 Option 2c (replacing the controlling individual test with a significant individual test with a requirement of a 20 per cent interest and allowing the requirement to be satisfied either directly or indirectly) is preferred.

1.128 The 20 per cent requirement allows additional small business taxpayers to access the concessions, while allowing indirect as well as direct interests has the additional advantage of assessing the real economic interests in the business.

1.129 The small business concessions are intended for active participants in a small business, and the significant individual test represents a readily verifiable proxy for active participation. This reflects the fact that there is typically minimal separation of significant underlying ownership from management in small businesses. Put more simply, those who own a small business tend to run the business.

1.130 The Treasury and ATO will monitor this taxation measure, as part of the whole taxation system, on an ongoing basis.


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