House of Representatives

New Business Tax System (Capital Gains Tax) Bill 1999

Explanatory Memorandum

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

Chapter 1 - Small business relief

Outline of Chapter

1.1 Schedule 1 to this Bill amends the ITAA 1997 to streamline and simplify the current small business CGT concessions and to provide further concessions in relation to retirement from carrying on business by disregarding certain capital gains made by small business entities from the disposal of active assets.

Context of Reform

1.2 These amendments to the ITAA 1997 will significantly improve the way in which CGT concessions are delivered to small business entities by:

·
increasing the range of CGT concessions available;
·
rationalising and improving the current law; and
·
providing greater flexibility in accessing the various CGT concessions.

1.3 The interaction between the current roll-over relief, retirement exemption and goodwill exemption provisions is unnecessarily complex and, as a consequence, the law does not operate effectively. These amendments will allow small businesses to benefit successively from all of the CGT concessions for any single eligible capital gain. This will reduce unnecessary compliance costs for small business entities in determining which concession provides the most benefit.

1.4 These amendments give effect to Treasurer's Press Release No.58 of 21 September 1999 (Attachments E and F) and recommendations 17.5 and 17.6 of the ATax System Redesigned.

Summary of new law

1.5 The new law:

·
disregards a capital gain made by a small business entity from a CGT event that happens to an active asset that has been continuously owned by the taxpayer for at least 15 years, and the disposal is related to a person retiring or becoming permanently incapacitated;
·
replaces the current 50% goodwill exemption that applies to business entities with net assets of under $2.3 million with a 50% active asset exemption for all businesses with net assets of $5 million or less; and
·
replaces the existing small business retirement exemption and roll-over relief with more streamlined rules.

1.6 The new law will also reduce compliance costs by rationalising and standardising the eligibility criteria for small business CGT concessions.

Comparison of key features of new law and current law

New Law Current Law

Key features
The conditions for obtaining the small business CGT concessions are standard for all of the concessions, with minor modifications for specific measures.
Each concession can apply successively to each small business capital gain, if the particular conditions for the concession are satisfied.

Key features
The conditions for small business CGT concessions vary in the current law.
Only one concession can apply to each small business capital gain.

Small business 50% active asset reduction
The goodwill exemption has been replaced with a broader exemption for half of the capital gain on the disposal of all active assets of the business.

Goodwill exemption
A small business operator disposing of post-CGT goodwill qualifies for an exemption for half of the capital gain. This exemption does not apply to created assets such as restrictive covenants, which relate to and protect goodwill, that may arise out of the goodwill disposal.

Small business retirement exemption
The existing law has been replaced with streamlined provisions that allow better access to the concession.

Small business retirement exemption
There are a number of unintended results from applying the current law. The rules are complex, and difficult to apply.

Small business roll-over relief
The existing law has been replaced with streamlined provisions that allow better access to the concession.

Small business roll-over relief
There are a number of unintended results from applying the current law. The rules are complex, and difficult to apply.

Small business 15-year exemption
This is a new exemption for capital gains arising from the disposal of assets held for at least 15 years by a small business entity and the disposal is related to a person retiring, or becoming permanently incapacitated.

Detailed explanation of new law

What are the small business CGT concessions?

1.7 There are 4 small business CGT concessions. These are:

·
the small business 15-year exemption;
·
the small business 50% active asset reduction;
·
the small business retirement exemption; and
·
the small business roll-over relief.

[Item 1, Division 152]

1.8 A small business entity may also be able to apply the CGT discount [F1] to the capital gain before claiming any of the small business CGT concessions.

What are the basic conditions that must be satisfied to qualify for the small business CGT concessions?

1.9 If a CGT event happens to an asset owned by a small business entity and the CGT event results in the entity making a capital gain, the entity can apply the small business CGT concessions if it satisfies:

·
the maximum net asset value test [F2] ; and
·
the active asset test [F3] .

[Item 1, subsection 152-10(1)]

1.10 If the CGT asset is a share in a company or an interest in a trust:

·
the company or trust must have a controlling individual [F4] ; and
·
the asset must be owned by a 'CGT concession stakeholder' [F5] of that company or trust.

Item 1, subsection 152-10(2)

The maximum net asset value test

1.11 A small business entity satisfies the maximum net asset value test if the total net value of CGT assets owned by:

·
the small business entity;
·
an entity that is the taxpayer's 'small business CGT affiliate' [F6] ; and
·
an entity 'connected with' [F7] the small business entity or a small business affiliate,

does not exceed $5 million just before the CGT event happens to a CGT asset of the small business entity. [Item 1, section 152-15]

1.12 The purpose of the maximum net asset value test is to treat the small business and all of its related entities as a single economic unit. That unit's CGT assets must not exceed the $5 million net asset threshold just before the CGT event happens. If the unit's net assets exceed $5 million, the unit is not a small business and is not eligible for the small business CGT concessions.

1.13 To avoid double counting in calculating the net asset value for a small business entity, shares, units or other interests (apart from debt) held in an entity connected with the small business are disregarded in working out whether the entity satisfies the maximum net asset value test. [Item 1, paragraph 152-20(2)(a)]

1.14 Assets of a private or personal nature are also not included in the maximum net asset value test for a small business entity that is not a company or trust. The type of assets that are excluded are those that are:

·
solely for the personal use and enjoyment of the individual or a small business CGT affiliate;
·
rights to capital amounts payable out of a superannuation fund or an approved deposit fund;
·
rights to an asset of a superannuation fund or an approved deposit fund; and
·
life insurance policies.

[Item 1, paragraph 152-20(2)(b)]

1.15 The assets of a small business CGT affiliate are not included in the maximum net asset value test if those assets are not used, or held ready for use, in a business carried on by the small business entity, either alone or together with others, or in a business carried on by an entity connected with the small business entity, either alone or together with others. [Item 1, section 152-20(3)]

1.16 In considering whether a dwelling is used solely for personal use and enjoyment, the rule is relaxed if the dwelling is used incidentally for non-private purposes. It is inappropriate to include the dwelling in the maximum net asset value test merely because of that incidental usage. However, if the taxpayer had incurred interest on purchasing that dwelling and some or all of that interest would be deducted from their assessable income, that dwelling is included in the maximum net asset value test, even if its predominant use is for private purposes. [Item 1, subparagraph 152-20(2)(b)(ii)]

Who is a small business CGT affiliate?

1.17 A taxpayer's spouse, or child under 18 years is a small business CGT affiliate . A taxpayer's small business CGT affiliate may also be an entity that:

·
acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes; or
·
acts, or could be reasonably be expected to act, in concert with the taxpayer.

[Item 1, subsection 152-25(1)]

1.18 A partner in a partnership in which the taxpayer is also a partner is not a small business CGT affiliate of the taxpayer merely because the partner acts, or could reasonably be expected to act, in concert with the taxpayer. [Item 1, subsection 152-25(2)]

When is an entity connected with a small business entity?

Connected with control of a company or trust

1.19 A company or trust is connected with a small business entity if:

·
the small business entity controls the company or trust;
·
the company or trust controls the small business entity; or
·
both the company or trust and the small business entity are controlled by a third entity.

[Item 1, subsection 152-30(1)]

1.20 An entity will be connected with another entity if the first entity or its small business CGT affiliate, or the entity and the affiliate:

·
beneficially own, or have the right to acquire beneficial ownership of, interests in another entity that give the right to receive at least 40% (the control percentage) of any distribution of income or capital by the other entity; or
·
if the other entity is a company beneficially own, or have the right to acquire beneficial ownership of, shares in the company that give at least 40% (the control percentage) voting power in the company.

[Item 1, paragraphs 152-30(2)(a) and (b)]

1.21 Where an entity's control percentage in another entity is at least 40% but less than 50%, the Commissioner can ignore the interest or shares of that entity in the other entity if the first entity can satisfy the Commissioner that a third entity actually controls the other entity. [Item 1, subsection 152-30(3)]

Connected with control of a discretionary trust

1.22 There are special rules for identifying control of a discretionary trust for the purposes of the 'connected with' test. The small business entity controls a discretionary trust if the entity or its small business CGT affiliate or both:

·
are trustees of the discretionary trust (other than a Public Trustee of a State or Territory); or
·
have the power to determine how the trustee makes any payments of income or capital.

[Item 1, paragraph 152-30(2)(c)]

1.23 A beneficiary is taken to have an interest in any distribution of income or capital of the discretionary trust, up to the maximum percentage of the income or capital that the trustee could distribute to that beneficiary.

[Item 1, subsection 152-30(5)]

Example 1.1 A discretionary trust deed has the effect that a beneficiary may receive up to 100% of the income or capital of the trust. That beneficiary is taken to have a 100% interest in the discretionary trust for the purpose of the net assets test, with the result that the beneficiary is treated as 'connected with' the trust. The assets of the beneficiary will be included in the net assets test for the trust.

1.24 An entity will not be connected with a discretionary trust if all of the following conditions are met:

·
the discretionary trust is the entity making the capital gain;
·
there is another entity that is the trustee or has the power to determine how the trustee decides to make any payments of income or capital to beneficiaries of the trust; and
·
the beneficiary is not a small business CGT affiliate of the trustee of the trust or of an entity that has the power to determine how the trustee decides to make any payments of income or capital of the trust.

[Item 1, subsection 152-30(4)]

1.25 It is common for trust deeds of discretionary trusts to prescribe as beneficiaries any public entity in which a beneficiary of the trust has an interest. For example, if a beneficiary holds an interest in a listed public company, that company is treated as a potential beneficiary of that discretionary trust. As a result, in working out whether the discretionary trust satisfies the 'maximum net asset value test', it is possible that all of the assets of the listed public company would inappropriately be taken into account. To avoid this result, a beneficiary of a discretionary trust that is a company, trust or mutual insurance organisation whose shares or units are publicly traded (a public entity ) is not treated as connected with the trust. [Item 1, subsection 152-30(6)]

Connected with indirect control of an entity

1.26 The control tests for the 'connected with' rules are designed to look through business structures that include interposed entities. However, only controlled entities are taken into account in tracing interests. The indirect control rule has been adopted to avoid complex tracing requirements for a small business entity. If an entity (the first entity) directly controls a second entity, and the second entity controls (whether directly or indirectly) a third entity, the first entity is also taken to control the third entity. [Item 1, subsection 152-30(7)]

Example 1.2

Example 1.2 - Connected with  indirect control of an entity

The small business entity controls companies A and B but not C.

1.27 The indirect control test in subsection 152-30(7) does not apply if a small business entity controls a public entity and that public entity controls a third entity, unless the small business entity actually controls the third entity (e.g. because it holds 50% of the voting shares of the third entity). [Item 1, subsection 152-30(8)]

Example 1.3 If an entity (E1) controls a public entity (E2) that in turn controls another entity (E3), E1 will not be deemed to control E3 merely because it controls E2. However, E1 will control E3 if, for example, E1 beneficially owns shares that carry a right to 50% of the voting rights in E3.

Who is a CGT concession stakeholder?

1.28 An individual is a CGT concession stakeholder of a company or trust if the individual is:

·
a 'controlling individual' of that company or trust; or
·
a controlling individual's spouse who holds legal and equitable interests in the company, or is beneficially entitled to the income or capital of the trust, or may be entitled to receive any of the income or capital of the trust.

[Item 1, section 152-60]

What is the active asset test?

1.29 A CGT asset is an active asset if it is owned by a small business entity and it is:

·
used or held ready for use by the small business entity, a small business CGT affiliate, or an entity connected with the small business entity, in the course of carrying on a business; or
·
an intangible asset that is connected with a business carried on by the small business entity.

[Item 1, subsection 152-40(1)]

1.30 To satisfy the active asset test, the CGT asset must have been an active asset of the small business entity seeking the concession just before the earlier of:

·
the CGT event; and
·
if the small business ceases and the CGT event happens within 12 months (or any longer period that the Commissioner allows) of the business ceasing when the small business ceased, and
for at least half of the period beginning at the later of:
·
acquisition of the CGT asset; and
·
15 years before the CGT event

and ending at the time of the CGT event or the small business ceasing. [Item 1, section 152-35]

1.31 A share in a company or an interest in a trust may also be an active asset if:

·
the company or trust is an Australian resident; and
·
the total of the market values of the active assets of the company or trust is 80% or more of the total of the market values of all of the assets of the company or trust for at least half of the time the small business entity owns the share or interest.

[Item 1, paragraphs 152-40(3)(a) and (b)(i)]

1.32 Cash or a debt asset of a company or trust that is attributable to the sale proceeds of an active asset are not included for the purposes of the 80% active asset test if that cash or debt asset is held for less than 2 years from the time of the CGT event that generated the relevant sales proceeds. The cash or debt asset must have been held with a view to acquiring active assets. [Item 1, subparagraph 152-40(3)(b)(ii)]

Certain assets cannot be active assets

1.33 The definition of active asset specifically excludes those assets that are held to produce passive investment income. Examples of such assets are loans, debentures, bonds and assets whose main use is to derive interest and rental income. [Item 1, subsection 152-40(4)]

What is the controlling individual test?

1.34 A company or trust will satisfy the controlling individual test if there is at least one controlling individual of the company or trust just before the CGT event happens to the active asset. [Item 1, section 152-50]

1.35 An individual is a controlling individual of a company if the individual holds legal and equitable interests in shares (apart from redeemable shares) that carry between them:

·
the right to exercise at least 50% of the voting power in the company; and
·
the right to receive at least 50% of any distribution of income and capital that the company may make.

[Item 1, subsection 152-55(1)]

1.36 An individual is a controlling individual of a trust if the individual is beneficially entitled to at least 50% of the income and capital of the trust. [Item 1, subsection 152-55(2)]

1.37 An individual is a controlling individual of a discretionary trust if:

·
the trust made a distribution of income or capital or both during the year of income; and
·
the individual was beneficially entitled to at least 50% of the total of the distributions of income and the total of the distributions of capital made by the trust in that year.

[Item 1, subsection 152-55(3)]

1.38 This controlling individual test is modified for the small business 15-year exemption. [Item 1, section 152-120]

How does the CGT discount interact with the small business CGT concessions?

1.39 The assessable income of a small business entity, like any other taxpayer, includes any net capital gains the entity has made during the income year. A small business entity applies the method statement in section 102-5 of the ITAA 1997 to work out their net capital gain (if any) for an income year. This method statement incorporates the effect of the small business CGT concessions introduced by this Bill. [Item 7, subsection 102-5(1)]

1.40 A capital gain is disregarded if a small business entity qualifies for the small business 15-year exemption, and the method statement in subsection 102-5(1) does not apply to that gain. [Item 7, subsection 102-5(1)]

1.41 If the small business 15-year exemption does not apply to a capital gain made by a small business entity, step 1 and step 2 of the method statement in subsection 102-5(1) apply to that capital gain. These steps require the taxpayer to apply any current year capital losses and any unapplied net capital losses against any capital gains the taxpayer has made during the current year. [Item 7, subsection 102-5(1)]

1.42 Any capital gains that remain after the small business entity has applied:

·
the small business 15-year exemption;
·
current year capital losses; and
·
prior year unapplied net capital losses,

are subject to step 3 in the method statement in subsection 102-5(1). This step reduces any remaining discount capital gains by the taxpayer's discount percentage as set out in Division 115 of the ITAA 1997 [F8] . [Item 7, subsection 102-5(1)]

1.43 If a small business entity has any capital gains remaining after having applied:

·
the small business 15-year exemption; and
·
step 1 and step 2 (about applying capital losses) and step 3 (about applying any CGT discount) of the method statement in subsection 102-5(1).

Step 4 requires the taxpayer to consider whether they qualify for any of the small business CGT concessions in Division 152 of the ITAA 1997.

1.44 These small business CGT concessions are:

·
the small business 50% active asset reduction;
·
the small business retirement exemption; and
·
the small business roll-over.

[Item 7, section 102-5]

1.45 The small business CGT concessions can apply to both 'discount capital gains' [F9] and other capital gains. The method statement in section 102-5 requires the small business entity to apply the CGT discount to any discount capital gains before applying the small business CGT concessions (except for the small business 15-year exemption). After applying the concessions, any amount of capital gain remaining is the net capital gain for the income year. [Item 7, section 102-5]

Example 1.4 Fred is a small business operator who decides to sell an active asset of the business that he has owned for more than 12 months. The CGT event happens in November 1999, and Fred qualifies for both the CGT discount and the small business 50% active asset exemption in respect of the capital gain of $20,000. Fred also has a capital loss of $3,000 from another CGT event in the income year. Fred calculates his net capital gain for the year as follows:

$20,000 - $3,000 = $17,000 (under step 1 of the method statement in section 102-5)
$17,000 - (50% x $17,000) = $8,500 (under step 3 of the method statement in section 102-5)
$8,500 - (50% x $8,500) = $4,250 (under step 4 of the method statement in section 102-5)
Fred's net capital gain for the year is $4,250. This amount could also qualify for further relief under the small business retirement exemption or small business roll-over relief.

Capital gains, trusts and the small business CGT concessions

1.46 Capital gains made by trusts are eligible for the full range of CGT concessions available for capital gains. However, a beneficiary of a trust may not be eligible for all of the CGT concessions. For example, a trust may apply the CGT discount to a capital gain, but a company is ineligible for this discount. Rules are required to ensure that a beneficiary who is presently entitled to a share of the net income of a trust that is attributable to a discounted capital gain made by the trust is able to:

·
treat that part of the net income of the trust as a capital gain of the beneficiary;
·
apply any capital losses appropriately; and
·
claim any relevant CGT discount.

[Item 42, Subdivision 115-C]

1.47 Similar rules are required for certain trustee assessments. This result is achieved by effectively excluding the capital gain amount from the share of the net income to which a beneficiary is presently entitled, treating this amount as capital gains made by the beneficiary and applying the CGT discount to the capital gains as if the gains were made directly by the beneficiary. [Item 42, section 115-215]

Assessing presently entitled beneficiaries

1.48 If a beneficiary is presently entitled to a share of the net income of the trust (the trust amount ) that is attributable to a discounted capital gain or a capital gain which has been reduced because of the application of the small business 50% active asset reduction by the trustee, the beneficiary must treat that amount as a capital gain, and increase that amount before applying the method statement in subsection 102-5(1).

1.49 The amount by which the capital gain is to be increased depends on the trust's treatment of the original gain.

1.50 If a beneficiary is presently entitled to a share of the net income of the trust that is attributable to a capital gain which has not been reduced by the CGT discount or the small business 50% active asset reduction, no increase is required to the capital gain. [Item 42, paragraph 115-215(3)(a)]

1.51 If a beneficiary is presently entitled to a share of the net income of the trust that is attributable to a capital gain that has been reduced by 50% under either the CGT discount or the small business 50% active asset reduction but not both, the beneficiary must double the capital gain amount. [Item 42, paragraph 115-215(3)(b)]

1.52 If a beneficiary is presently entitled to a share of the net income of the trust that is attributable to a capital gain that has been reduced by 50% under both the CGT discount and the small business 50% active asset reduction, the beneficiary is to multiply the capital gain amount of the distribution by 4. [Item 42, paragraph 115-215(3)(c)]

1.53 After multiplying the capital gain amount of the distribution, the beneficiary applies the method statement in subsection 102-5(1) to the increased amount of capital gain. [Item 42, subsection 115-215(4)]

1.54 The trust amount applicable to either the discounted capital gain or the small business 50% active asset reduction or both can be deducted from the beneficiary's assessable income. [Item 42, subsection 115-215(6)]

Example 1.5 Martin is a beneficiary in the Shadows Unit Trust. He receives a distribution of $2,000 from the trust. This distribution includes $250 of net income remaining after a $1,000 capital gain made by the trustee was reduced by the CGT discount and the small business 50% active asset reduction.Martin must work out his net capital gain for the year of income. He reduces his assessable income by $250. As the trustee claimed both the CGT discount and small business 50% active asset reduction, Martin must multiply the $250 by 4. This results in a capital gain of $1,000 with which Martin calculates his net capital gain for the year of income.If Martin also had a capital loss of $100 from the sale of shares in the income year he would calculate his net capital gain, using the steps in subsection 102-5(1), as follows:

Step 1: $1,000 - $100 = $900
Step 2: $900 - nil = $900
Step 3: $900 - (50% $900) = $450
Step 4: $450 - (50% $450) = $225
Martin's net capital gain is $225. Martin must also include the net trust amount of $1,750.

Trustee assessments

1.55 Special rules apply for assessing trustees under subsection 98(3) and section 99A of the ITAA 1936.

1.56 Trustee assessments made under subsection 98(3) of the ITAA 1936 are based on net income of a trust to which a non-resident company beneficiary is presently entitled. To the extent this net income includes a capital gain to which the CGT discount has been applied, that amount is doubled. [Item 42, section 115-220]

1.57 Capital gains included in that part of the net income of a trust that is assessed under section 99A of the ITAA 1936 are ineligible for the CGT discount and the small business active asset reduction. To the extent this net income includes a capital gain to which:

·
either the CGT discount or the small business 50% active asset reduction has applied, that amount is doubled; or
·
both the CGT discount and the small business 50% active asset reduction, that amount is multiplied by 4.

[Item 42, section 115-225]

Small business 15-year exemption

1.58 A capital gain made by a small business entity from a CGT asset it has owned for at least 15 years will be disregarded if the small business entity:

·
satisfies the basic conditions for the small business CGT concessions in Subdivision 152-A, with a modified active asset test [F10] ;
·
continuously owned the CGT asset for at least 15 years just before the CGT event;
·
is an individual, and is either 55 years old or more and retires, or is permanently incapacitated; and
·
is a company or trust, and had a controlling individual for the entire time it owned the CGT asset, and that controlling individual is either 55 years old or more and retires, or is permanently incapacitated.

[Item 1, sections 152-105 and 152-110]

1.59 If the conditions in 1.58 are satisfied and a capital loss is made from the CGT event, the capital loss may be used to reduce other capital gains.

1.60 The active asset test normally requires the CGT asset to be active for at least half of the period of ownership. This rule is modified for the small business 15-year exemption. The CGT asset needs to have been an active asset for at least half of the 15 year period ending at the time of the CGT event or when the business ceased. [Item 1, subparagraph 152-35(b)(ii)]

Example 1.6 Ruth and Geoff are partners in a partnership that conducts a farming business on land they purchased in 1986, and have owned continuously since that time. The net value of the CGT assets of the partnership is less than $5 million. Ruth and Geoff wish to retire as they are both over 60 years of age. As they have no children, they decide to sell the farming business, and do so in 2002, for a total capital gain of $100,000. Both Ruth and Geoff qualify for the small business 15-year exemption in relation to the capital gain.

Distributions of the small business 15-year exemption amount

1.61 A capital gain made by a company or trust that qualifies for the small business 15-year exemption and is disregarded for the company or trust may be distributed to a CGT concession stakeholder of the company or trust as an exempt amount if certain conditions are satisfied. These conditions are:

·
the company or trust must make the payment within 2 years of the CGT event that resulted in the capital gain;
·
the payment must be made to a person who was a CGT concession stakeholder of the company or trust just before the CGT event; and
·
the payment must not exceed an amount determined by multiplying the CGT concession stakeholder's control percentage by the exempt capital gain.

[Item 1, section 152-125]

1.62 The exempt amount is calculated as a percentage (the stakeholder's control percentage) of the total capital gain disregarded for the company or trust under the small business 15-year exemption. The stakeholder's control percentage is:

·
for a company the percentage of the legal and equitable interests in shares in the company that satisfy the controlling individual test;
·
for a trust in which entities have entitlements to all of the income and capital of the trust, the percentage of the capital of the trust to which the beneficiary is entitled; or
·
for any other trust 100% if there is one CGT concession stakeholder or 50% each if there are 2 CGT concession stakeholders.

[Item 1, paragraphs 152-125(3)(a) and (b)]

Example 1.7 Joe is a controlling individual of Company X, owning 60% of the shares in the company. Joe's wife, Anne, owns the remaining 40% of the shares in the company. The company makes a capital gain of $10,000 and is able to disregard that capital gain under the small business 15-year exemption as both Joe and Anne are planning to retire. Six months after the CGT event, the company distributes the amount of the exempt capital gain to the shareholders. As CGT concession stakeholders, Joe and Anne both qualify for the small business 15-year distribution exemption. The amount that is exempt is calculated as follows:For Joe: 60% of $10,000 = $6,000For Anne: 40% of $10,000 = $4,000If it is decided to distribute $8,000 each to Joe and Anne, they can exclude from their assessable incomes for the income year an amount of $6,000 and $4,000 respectively.

Example 1.8 The M family discretionary trust has as its beneficiaries the members of the M family and 2 employees of the family business carried on by the trustee of the trust. Mrs M and Mr M are the controlling individuals of the discretionary trust, and are therefore CGT concession stakeholders. Their 3 children are treated as small business affiliates. The trustee of the trust sells a CGT asset of the business and makes a capital gain of $50,000 that qualifies for the small business 15-year exemption, as Mr M plans to retire from the family business. The trustee distributes that amount equally to Mrs M and Mr M and to the 3children.As CGT concession stakeholders, Mrs M and Mr M are each able to treat the distribution of $10,000 as an exempt amount. Their 3 children must include the distribution in their assessable incomes for the year.

Involuntary disposals

1.63 A requirement of the small business 15-year exemption is that the CGT asset must have been continuously owned for at least 15 years and must satisfy the modified active asset test. However, CGT assets acquired under roll-over relief in terms of Subdivision 124-B (assets compulsorily acquired, lost or destroyed) or Subdivision 126-A (marriage breakdown) will receive special treatment in determining whether the small business 15 year test and the active asset test have been satisfied. [Item 1, section 152-45]

1.64 For the purposes of the 15-year exemption, the replacement asset will be treated as if it had been:

·
acquired when the original asset was acquired; and
·
used in the same way as the original asset was used from the time the original asset was acquired.

[Item 1, subsection 152-115(1)]

1.65 A small business individual who has a CGT asset transferred to them because of a marriage breakdown, and the capital gain arising from that transfer was rolled over under Subdivision 126-A, will be able to choose whether:

·
to include the ownership and active asset periods of their former spouse; or
·
to commence the ownership and active asset periods from the time the asset was transferred to them.

1.66 If a small business individual chooses to include their former spouse's ownership and active asset periods of the CGT asset, that asset will be treated as if the entity:

·
had always owned the CGT asset; and
·
used it in the same manner as the person's former spouse used it.

[Item 1, subsection 152-115(2)]

Example 1.9 Cameron and Therese were married. During the 10 years they were married, Cameron owned a farm on which he operated a dairy business. Since their divorce Therese has owned the farm and operated the dairy business for the past 5 years. Therese is able to sell the farm and obtain the 15-year exemption if she chooses to adopt Cameron's ownership and active asset periods.

Impact on superannuation benefits

1.67 Many small business entities provide for their retirement by selling their business assets. This concession will allow individuals operating small businesses to dispose of their eligible active assets and retire without affecting their superannuation reasonable benefit limit. [Item1, subsection 152-110(2)]

Requirement to be permanently incapacitated or retiring

1.68 One of the requirements of this concession for an individual small business taxpayer is that they must be either permanently incapacitated at the time of the CGT event, or at least 55 years old and using the capital proceeds for their retirement.

Small business 50% active asset reduction

1.69 A small business entity that makes a capital gain that does not qualify for the small business 15-year exemption will be directed by the method statement in section 102-5 of Division 152 after the calculation of their discounted and non-discounted capital gain amounts.

1.70 If the remaining capital gains, both discounted and non-discounted, satisfy the basic conditions of the small business concessions in Subdivision 152-A they can be reduced by 50%. That is, an individual who makes a capital gain that satisfies the basic conditions may reduce the capital gain amount remaining after capital losses and net capital losses have been applied by 75%. [Item 1, section 152-205]

1.71 After applying the small business 50% reduction, the remaining capital gain may also qualify for the small business retirement exemption, or the small business roll-over relief or for both. If it qualifies for both the taxpayer can choose the order in which those concessions are to be applied. [Item 1, section 152-210]

Example 1.10 Mary operates a small manufacturing business and disposes of a CGT asset that she has owned for 3 years, and has used as an active asset of the business. Mary makes a capital gain of $17,000 from the CGT event, and qualifies for the CGT discount and for the small business 50% reduction. Mary also has a capital loss in the income year of $3,000 from the sale of another asset. Mary calculates her net capital gain for the year as follows:

$17,000 - $3,000 = $14,000 (under step 1 of the method statement in section 102-5)
$14,000 - (50% x $14,000) = $7,000 (under step 3 of the method statement in section 102-5)
$7,000 - (50% x $7,000) = $3,500 (under step 4 of the method statement in section 102-5)
Her net capital gain for the year is $3,500.

Small business retirement exemption

1.72 The new small business retirement exemption provisions are largely the same as the small business retirement exemption provisions in Subdivision 118-F of the ITAA 1997. The changes reflect the standardised and rationalised basic conditions for all of the small business CGT concessions.

1.73 In qualifying situations, a capital gain made by an individual, company or trust from a CGT event happening to an active asset is disregarded. [Item 1, Subdivision 152-D]

Choosing the exemption

1.74 A small business individual can choose to disregard a capital gain if the basic conditions in Subdivision 152-A are satisfied. If an individual who is under 55 years of age receives an ETP up to the amount of the excluded gain, the ETP must be rolled over. [Item 1, subsection 152-305(1)]

1.75 For a company or trust, the exemption is also available if the above conditions are satisfied, the entity has a controlling individual, and the CGT concession stakeholders are paid their proportion of the capital proceeds as an ETP by the later of:

·
7 days after the choice is made by the company or trust to disregard the capital gain; or
·
7 days after an amount of capital proceeds is received by the CGT concession stakeholder.

[Item 1, subsection 152-305(2) and section 152-325]

Choosing the amount to disregard

1.76 The capital gain that the taxpayer can choose to treat as exempt is a CGT exempt amount . That amount must not exceed the retirement exemption limit of the individual receiving the ETP. [Item 1, section 152-315]

Consequences of the exemption

1.77 The amount of the capital gain equal to the small business entity's CGT exempt amount is disregarded and the amount is to be paid in form of an ETP. Any capital gain made that exceeds the CGT exempt amount does not qualify for this exemption. [Item 1, section 152-310]

CGT retirement exemption limit

1.78 An individual's CGT retirement exemption limit is $500,000 reduced by any previous exemptions the individual has received under these rules or the earlier rules [F11] . [Item 1, section 152-320]

Superannuation reasonable benefit limit consequences

1.79 The ETP amounts will be assessed against the individual's RBL. Any amounts received in excess of their RBL will be taxed at the top marginal rate of tax.

Small business roll-over relief

1.80 The new small business roll-over provisions are largely the same as the small business roll-over in Division 123 of the ITAA 1997. The changes reflect the standardised and rationalised basic conditions for all of the small business CGT concessions. To qualify for the roll-over a small business entity must satisfy all of the basic conditions in Subdivision 152-A. [Item 1, paragraph 152-410(a)]

1.81 The small business entity must also satisfy additional conditions to obtain the roll-over relief. These conditions are:

·
the small business entity must acquire a replacement asset within one year before and 2 years after a CGT event happens to the active asset for which a roll-over is sought; and
·
the replacement asset must satisfy the conditions in section 152-475.

[Item 1, paragraphs 152-410(b) and (c)]

1.82 If these conditions are satisfied, the capital gain can be rolled over to the extent it does not exceed:

·
the acquisition consideration of the replacement asset (i.e. the first element of the cost base of the replacement asset); and
·
any incidental costs associated with that acquisition (i.e. the second element of the cost base of the replacement asset).

[Item 1, section 152-415]

What is a replacement asset?

1.83 A replacement asset is an active asset, as defined in section 152-45, acquired by the small business entity to replace an active asset (the original asset) to which a CGT event has happened. The replacement asset must be an active asset acquired within the period of one year before and 2 years after the CGT event happened to the original asset. The Commissioner may allow further time. [Item 1, subsections 152-420(1), (3) and(4)]

1.84 If the replacement asset is a share in a company or an interest in a trust, the small business entity or an entity connected with that small business entity must be a controlling individual of that company or trust while they own the share or interest. [Item 1, subsection 152-420(5)]

What happens if an individual dies and that person obtained a small business roll-over for a gain made on an active asset they owned?

1.85 If:

·
a person dies after they have acquired a replacement asset under the small business roll-over;
·
that asset forms part of the person's deceased estate; and
·
that asset passes to the legal personal representative of the deceased person,

the legal personal representative is treated, for the purposes of this roll-over, as if they had undertaken any actions taken by the person before they passed away. [Item 1, section 152-425]

1.86 However, this rule does not apply if the person before they died had done anything that would have triggered CGT events J2 or J3 [F12] . [Item1, subsection 152-425(1)]

1.87 The same concept applies to a beneficiary of a deceased estate where the replacement asset passes to the beneficiary. [Item 1, subsection 152-425(2)]

Can a capital gain that has been rolled over be rolled over again when CGT events J2 or J3 crystallise that gain?

1.88 If a rolled over capital gain is crystallised because the replacement asset:

·
loses its status (CGT event J2); or
·
if it is a share or interest in a trust, the company or trust ceases to satisfy the controlling individual test or the 80% active asset test (CGT event J3),

the capital gain may be eligible for further roll-over relief under Subdivision 152-E.

1.89 If a CGT event happens to a replacement asset that results in a taxpayer making a capital gain, that capital gain can be rolled over under the small business roll-over relief. Any capital gain made on a CGT event happening to the replacement asset that has been crystallised by either CGT event J2 or J3 may also be rolled over.

Example 1.11 Peter disposes of an active asset for $10,000, making a capital gain of $2,000. He buys 2 replacement assets for $5,000 each and obtains a roll-over under Subdivision 152-E.$1,000 of the capital gain is disregarded for each replacement asset.One of the replacement assets is later sold for $7,500 (CGT event A1) resulting in Peter making a capital gain of $2,500.He will also make a capital gain of $1,000 as the sale of the replacement asset has triggered CGT event J2. The $1,000 capital gain represents the capital gain made on the disposal of the active asset that was rolled over in respect of this replacement asset under Subdivision 152-E.Both capital gains ($2,500 made under CGT event A1 and $1,000 made under CGT event J2) may be eligible for further roll-over relief under Subdivision 152-E.

Application and transitional provisions

1.90 These amendments, including the consequential amendments, apply to assessments for the income year including 21 September 1999 and later years for CGT events happening at or after 11.45 am AEST on 21September 1999. [Item 61]

1.91 Taxpayers who have claimed the small business retirement exemption in income years before 1999-2000 have reduced their retirement exemption limit under the provisions in force at the time of the CGT disposal or event. A transitional measure will ensure that this reduction in the retirement exemption limit is also relevant for the new provisions. [Item 62]

Consequential amendments

1.92 Consequential amendments to a number of provisions in Parts 3-1 and 3-3 of the ITAA 1997 are being made to reflect the repeal of the small business roll-over relief in Division 123 and the small business retirement exemption in Division 118-F, and their replacement with Subdivisions 152-D and 152-E. [Items 8, 12, 13, 15 to 20, 22 to 25, 27, 29 to 32, 34, 36 to 38, 40 to 41, 43 to 48 and 50 to 53]

1.93 Consequential amendments are also being made to the ITAA 1936 to reflect these changes. [Items 54 to 60]

1.94 Certain other amendments are being made to reflect the effect of streamlining the basic conditions for the small business CGT concessions. [Items 9, 10, 11, 14, 21, 26, 28, 33, 35, 39 and 49]

1.95 The interaction between the CGT discount provisions and the small business CGT concessions have also led to certain changes to Subdivision 115-C, the method statement in section 102-5, and to the guide material in Division100. [Items 2 to 7 and 42]

1.96 Other consequential amendments are required to the cost base adjustment provisions in section 104-70 of the ITAA 1997 because of these changes to the small business CGT concessions. These amendments will be made in conjunction with other proposed changes arising from the Review.


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