Advanced guide to capital gains tax concessions for small business

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Chapter 4 - Basic Conditions for the Small Business CGT Concessions

This document has been archived. It is current only to 30 June 2014.

The basic conditions are contained in subdivision 152-A - Income Tax Assessment Act 1997 .

To qualify for the small business CGT concessions, you must satisfy several conditions that are common to all the concessions. These are called the 'basic conditions'.

Each concession also has further requirements that you must satisfy for the concession to apply, except for the small business 50% active asset reduction, which applies if the basic conditions are satisfied.

Follow the steps below to determine whether you satisfy the basic conditions:

Step 1

You must first satisfy one of the following:

  • you are a small business entity
  • you do not carry on business (other than as a partner) but your CGT asset is used in a business carried on by a small business entity that is your affiliate or an entity connected with you ( passively-held assets )
  • you are a partner in a partnership that is a small business entity, and the CGT asset is
    • an interest in a partnership asset ( partnership assets ) or
    • an asset you own that is not an interest in a partnership asset ( partner's assets ) which is used in the business of the partnership
  • you satisfy the maximum net asset value test .

Step 2

The asset in question must satisfy the active asset test .

Step 3

This step is only applicable if the CGT asset is a share in a company or interest in a trust. Where this is the case, one of these additional basic conditions must be satisfied just before the CGT event:

  • the entity claiming the concession must be a CGT concession stakeholder in the company or trust, or
  • CGT concession stakeholders in the company or trust together have a small business participation percentage in the entity claiming the concession of at least 90% ( the 90% test ).

Small business entity

You will be a small business entity if you are an individual, partnership, company or trust that:

  • is carrying on a business , and
  • has an aggregated turnover of less than $2 million.

What is aggregated turnover?

Aggregated turnover is your annual turnover plus the annual turnovers of any business entities that are your affiliates or that are connected with you. The aggregation rules help you determine whether you need to include the annual turnover of another business entity (a relevant entity) when calculating your aggregated turnover. These rules aim to prevent businesses splitting their activities in order to inappropriately access the small business entity concessions.

A relevant entity is an entity that is your affiliate or is connected with you.

Working out whether you are a small business entity

Depending on your circumstances, you can use one of the following three methods to work out whether you are a small business entity in the current year:

Method 1 - Use your previous years aggregated turnover

If your aggregated turnover for the previous income year was less than $2 million, you will be a small business entity for the current year.

Method 2 - Estimate your current year aggregated turnover

If your estimated aggregated turnover for the current year is less than $2 million, you will be a small business entity for the current year. However, you can estimate your turnover only if your aggregated turnover for one of the two previous income years was less than $2 million.

About estimating your turnover

If you are estimating your turnover, you need to determine whether your aggregated turnover is more likely than not to be less than $2 million.

You must estimate your turnover based on the conditions that you are aware of at the beginning of the income year or, if you are starting a business part way through the year, at the time that you start your business. Factors to consider when estimating your turnover include:

  • your turnover in previous income years
  • whether you plan to reduce or increase staff in the current year
  • whether your business operating hours are increasing or decreasing
  • whether previous extraordinary sales or product lines will be available in the current income year
  • whether your business will face increased competition in the current income year
  • whether your business activity will increase or decrease because of changing conditions.

Method 3 - Use your actual current year turnover

If your actual aggregated turnover is less than $2 million at the end of the income year, you will be a small business entity for that year.

You must use the same method (either prior year; estimated current year; or actual current year) for calculating the annual turnover of your business and all your relevant entities.

How to calculate your aggregated turnover

Step 1 - work out your annual turnover (for your previous or current year)

 

Your annual turnover includes all ordinary income earned in the ordinary course of business for the income year, for example, turnover is your gross income or proceeds, rather than your net profit.

If you operate multiple business activities, either as a sole trader or within the same business structure, you must include the income from all your activities when working out your annual turnover, for example, a sole trader operating a part time consultancy and a retail shop would include the income from both business activities when working out annual turnover.

Here are some examples of amounts included and not included in ordinary income.

Include these amounts:

  • sales of trading stock
  • fees for services provided
  • interest from business bank accounts
  • amounts received to replace something that would have had the character of business income, for example, a payment for loss of earnings.

Do not include these amounts:

  • GST you have charged on a transaction
  • amounts borrowed for the business
  • proceeds from the sale of business capital assets
  • insurance proceeds for the loss or destruction of a business asset
  • amounts received from repayments of farm management deposits.
Special rules for calculating annual turnover

Business operated for part of the year

If you start or cease a business part way through an income year, you will need to work out your turnover using a reasonable estimate of what your turnover would have been if you had carried on the business for the entire income year. This rule applies for all three methods of working out whether you are a small business entity.

Retail fuel sales

Do not include retail fuel sales when calculating your turnover. This is a special rule because sales of retail fuel are characteristically high in sales volume with low profit margins.

Non-arm's length business transactions

Any income from transactions with an associate should be included in your turnover. If the dealing was not at arm's length (that is, the goods or services were sold at a discounted price because of their association with you) you must use the market value of the goods or services when calculating your annual turnover.

However, you may take into account any discounts that would have been offered had the dealing been at arm's length.

Associate has the meaning given by section 318 of the Income Tax Assessment Act 1936 . As an individual, your associates include, but are not limited, to:

  • your relatives, such as your spouse or children
  • a partnership that you are a partner in
  • another partner in that partnership, and that partner's spouse and children
  • a trustee of a trust that you, or your associate, are a beneficiary of
  • a company that you, or your associate, control or influence.

There are similar rules to determine who is an associate of a company, partnership and trustee.

If the aggregation rules do not apply to you, your aggregated turnover will be the same as your annual turnover. You do not need to read any further.

However, if you must consider the aggregation rules, or are not sure whether they apply to you, go to step 2 below.

Step 2 - consider the aggregation rules

You must include the annual turnover of a relevant business entity with your annual turnover when working out your aggregated turnover.

A relevant business entity is a business entity that, at any time during the income year, is:

If you have a relevant business entity, repeat step 1 for each relevant business entity to work out their annual turnover. You must use the same method for working out your annual turnover and the annual turnovers of all your relevant businesses entities.

Step 3 - work out your aggregated turnover

To work out your aggregated turnover, add the annual turnovers of relevant business entities to your annual turnover.

When working out your aggregated turnover, do not include income:

  • from dealings between you and a relevant business entity
  • from dealings between any of your relevant business entities
  • of an entity when it was not your relevant business entity.

If your aggregated turnover is less than $2 million, you are a small business entity for the current year.

If you are not a small business entity in an income year, you may still be able to access the capital gains tax concessions if you pass the $6 million maximum net asset value test .

Passively-held assets

This basic condition allows you to access the concessions for a CGT asset you own where you are not carrying on a business, but that CGT asset is used in the business of your affiliate or an entity connected with you. The basic condition can also apply where your asset is held ready for use in , or is inherently connected with, the business of your affiliate or entity connected with you.

The following conditions must be satisfied in the income year:

  • your affiliate, or entity connected with you, is a small business entity for the income year, that is, the income year in which the CGT event happens to your CGT asset
  • you do not carry on a business in the income year other than in partnership
  • if you carry on a business in partnership, the CGT asset is not an interest in an asset of the partnership
  • your affiliate or entity that is connected with you at a time in the income year is the same small business entity that carries on the business and uses the asset at that time, and the asset is the same asset that also meets the active asset test at that time.

There is a special rule for calculating aggregated turnover where the basic condition for passively-held assets applies.

An entity that is your affiliate, or is connected with you, is deemed to be an affiliate of, or connected with (as the case may be) the small business entity that uses the asset. This rule only applies if the entity is not already an affiliate or connected with the small business entity. In calculating the aggregated turnover of the small business entity, the turnover of entities that are deemed to be affiliates or connected entities must be included. The calculation of aggregated turnover is otherwise the same.

A special affiliate rule for spouses and children under 18 applies in these cases.

Example

  • Peter owns land that he leases to a company he wholly owns, Foxxy Farm Pty Ltd, which uses the land in its farming business. Peter does not carry on a business himself.
  • Peter would be able to access the small business CGT concessions via the small business entity turnover test, depending on the aggregated turnover of Foxxy Farm Pty Ltd.

Example

  • Assume the same facts as for the example above, except that Peter has an affiliate, Mike, who carries on a separate business. Mike acts in accordance with Peter's wishes in running his business. The special rule for calculating aggregated turnover will apply to treat Mike as Foxxy Farm's affiliate also. When working out Foxxy Farm's aggregated turnover, Mike's turnover will need to be includ ed.

Partner in a partnership: using the small business entity test

The CGT rules operate on the basis that a partner in a partnership carries on the partnership business collectively with the other partners. However, a partner cannot be a small business entity. It is the partnership that must satisfy the small business entity test (that is, the $2 million aggregated turnover test) to qualify as a small business entity.

If the relevant conditions are met, a partner may be eligible for the small business CGT concessions using the turnover test for:

  • their interest in a partnership asset, or
  • an asset that is not a partnership asset that is used in the business of the partnership.

In both cases the partner is not required to be connected with the partnership.

The maximum net asset value test applies differently so that it is the individual partners in the partnership that determine their eligibility for the small business CGT concessions, and not the partnership.

Partnership assets

An asset is a partnership asset if the partners own the asset in accordance with their respective interests as specified in the partnership agreement.

Partners may be eligible for the concessions if:

  • the asset is the partner's interest in a partnership asset, and
  • that partnership is a small business entity.

Partner's assets

Partners may also be eligible for the concessions for a CGT asset the partner owns (that is not their interest in a partnership asset) when the following conditions are satisfied in the income year:

  • they were a partner in a partnership in the income year in which the CGT event happens to the partner's CGT asset
  • that partnership uses the asset at a time in the income year, in carrying on the partnership business and is a small business entity for that income year
  • the only business the partner carries on is as a partner in a partnership.

There is a special rule for calculating aggregated turnover in cases where a partner's asset is being used in the business carried on by the partnership.

An entity that is an affiliate of, or connected with, the partner is deemed to be an affiliate of, or connected with (as the case may be) the partnership that uses the asset. This rule only applies if the entity is not already an affiliate or connected with the partnership.

In calculating the aggregated turnover of the partnership, the turnover of entities that are deemed to be affiliates or connected entities must be included. The calculation of aggregated turnover is otherwise the same.

There is another special rule for calculating aggregated turnover where the taxpayer is a partner in more than one partnership and the asset is used in more than one partnership business. It treats each partnership that the taxpayer is a partner in, and that uses the asset, as being connected with the partnership that is trying to work out whether it is a small business entity (the test entity). When working out the aggregated turnover of the test partnership, the turnover of any other partnerships that are deemed to be connected must be included.

Example

  • Beau and Irene each own 50% of a supermarket building, which is used in the business of a partnership carried on by Beau, Jack, Casey and Irene. Beau, Jack, Casey and Irene each have a 25% interest in the partnership, which trades under the name 'Auzzie Supermarket'.

  • Beau and Irene may be able to access the small business CGT concessions in relation to their respective shares of the building via the small business entity turnover test, depending on the aggregated turnover of the partnership calculated respectively for Beau and Irene. The aggregated turnover of Auzzie Supermarket must be calculated separately for Beau and Irene, taking into account any entities that are affiliates of, or connected with, each of them respectively.

Businesses that are winding up

The basic conditions for passively-held assets and partner's assets require that:

  • the asset is used in the business of your affiliate, connected entity or partnership, at a time in the income year that the CGT event happens, and
  • that entity is a small business entity in the year the event happens.

If an entity is not using the asset in the business in the year the CGT event occurs because the business the entity previously carried on is winding up, there is a special rule that applies provided the entity used the asset in the business in the year the business ceased.

This rule treats the entity as carrying on the business for a moment in time in the income year the CGT event happens and treats the asset as being used, held ready for use in, or inherently connected with, the business at that same moment in time in the CGT event year.

There is another rule that applies for all the basic conditions that use the turnover test; this rule allows an entity to work out whether it is a small business entity in the CGT event year when the entity is winding up a business it previously carried on. The entity will be taken to be still carrying on the business if:

  • it is winding up a business it previously carried on, and
  • it was a small business entity in the income year the entity ceased business.

Maximum net asset value test

There is a limit of $6 million on the net value of the CGT assets that you and certain entities can own and still qualify for the small business CGT concessions. This $6 million limit is called the maximum net asset value test. It is not indexed for inflation.

You satisfy the maximum net asset value test if the total net value of CGT assets owned by certain entities does not exceed $6 million just before the CGT event that results in the capital gain for which the concessions are sought. You must include the net value of CGT assets owned by:

  • you
  • any entities ' connected with ' you,
  • any of your ' affiliates ' and entities connected with your affiliates (subject to the note below).

Include the net value of assets of your affiliates, and entities connected with your affiliates, only if the assets are used, or held ready for use, in a business carried on by you or an entity connected with you.

Don't include an asset if it is used in the business of an entity that is connected with you only because of your affiliate.

Example

  • Colin operates a newsagency business as a sole trader. Simon carries on his own florist business, which is unrelated to the newsagency business. Simon owns the land and building from which the newsagency is conducted and leases it to Colin. Simon also owns 100% of the shares in Simco Pty Ltd, which carries on another separate business. Simon is connected with Simco Pty Ltd because he controls the company. Simon regularly consults Colin for advice in his business affairs and acts according to Colin's wishes - therefore, Simon is Colin's affiliate.
  • To determine whether he satisfies the maximum net asset value test, Colin includes the market value of the land and building owned by Simon (because it is used in his newsagency business) but does not include Simon's other assets used in his florist business (because they are not used in the newsagency business). Nor does Colin include Simco's assets, because those assets are not used in his business and Simco Pty Ltd is only connected because of his affiliate, Simon.

Meaning of net value of CGT assets

The net value of the CGT assets of an entity is the amount (whether positive, negative or nil) worked out by taking the sum of the market values of those assets less any liabilities of the entity that are related to those assets and provisions made for:

  • annual leave
  • long service leave
  • unearned income
  • tax liabilities.
Partner in a partnership

If you are a partner in a partnership and the CGT event happens in relation to an asset of yours or a CGT asset of the partnership (for example, disposal of a partnership asset) the maximum net asset value test would include:

  • all the assets of the partnership if you are connected with it, and you would exclude the value of your interest in the partnership, or
  • only your interest in the partnership if you are not connected with it, and you would not count the assets of the partnership as a whole.

Entities that hold shares or trust interests would calculate their maximum net asset value test in a similar way.

Assets included in the net value of CGT assets

Assets to be included in determining the net value of the CGT assets are not restricted to business assets. They include all CGT assets of the entity, unless the assets are specifically excluded (see Assets not included ).

In the case of a dwelling that is an individual's main residence, the individual only includes the current market value of the dwelling in their net assets 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, or would give rise to deductions for interest if interest had been paid.

The individual would be entitled to deduct part of the interest on money they borrowed to buy the home if:

  • part of the home is set aside exclusively as a place of business and is clearly identifiable as such, and
  • that part of the home is not readily adaptable for private use, for example, a doctor's surgery located within a doctor's home.

This is a hypothetical interest deductibility test. If the individual did not actually incur any interest, the test looks at whether they would have been entitled to a deduction if they had taken out a loan to purchase their home.

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

  • 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% of it was used for producing assessable income; for the following two years, it was used 40% 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% for producing assessable income.
  • Ben's dwelling has had 15.8% 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 assets ($750,000 x 15.8%).
  • Ben has a liability of $500,000 attached to the house, therefore 15.8% ($79,166) of the liability is also included in the calculation of the net assets.
  • Although gains from depreciating assets may be treated as income rather than capital gains, depreciating assets are still CGT assets and are included when calculating the net asset value.
Liabilities included in the net value of CGT assets

Liabilities to be included in determining the net value of the CGT assets include:

  • legally enforceable debts due for payment
  • presently existing legal or equitable obligations to pay either a certain sum or ascertainable sums

However future obligations, expectancies and liabilities that are uncertain as both a theoretical and a practical matter are not included in the calculation. See Taxation Determination TD 2007/14 for more information.

Examples of amounts that are not included in 'liabilities' for the purposes of determining the 'net value of the CGT assets' of an entity include:

  • provisions for possible obligations to pay damages in a pending lawsuit
  • provisions for liabilities in respect of an earn-out contract
  • provisions for the guarantee of a loan
  • accounting liabilities arising as a result of receiving prepaid income
  • provisions in general, for such things as quantity rebate.
Liabilities related to assets

A liability must be related to the CGT assets of an entity to be taken into account in determining the net value of the CGT assets of the entity.

This includes liabilities directly related to particular assets that are themselves included in the calculation, for example, a loan to finance the purchase of business premises. It also includes liabilities not directly related to a particular asset but rather to the assets of the entity more generally - for example, a bank overdraft or other short-term financing facility that provides working capital for the operation of the business. However, liabilities that are directly related to an asset that is excluded from the net asset calculation cannot be included - but certain liabilities related to excluded interests in connected entities may be counted. See Some interests in connected entities .

Example

Cool Tool Pty Ltd is selling its business. The assets and liabilities of the company are as follows:

Assets:

$

$

Plant and machinery

1,500,000

 

Freehold premises

3,500,000

5,000,000

Liabilities:

Mortgage (secured over the premises)

2,000,000

 

Provision for leave of employees

500,000

 

Provision for rebates

200,000

 

Provision for possible damages payout

100,000

2,800,000

Net assets:

 

2,200,000

The net value of the CGT assets of the company is calculated as follows:

Assets:

$

$

Plant and machinery

1,500,000

 

Freehold premises

3,500,000

5,000,000

Liabilities:

 

 

Mortgage (secured over the premises)

2,000,000

 

Provision for leave of employees

500,000

2,500,000

Net value of CGT assets:

 

2,500,000

The following items are not taken into account in working out the net value of the CGT assets of Cool Tool Pty Ltd because they are future obligations, expectancies or liabilities that are uncertain as both a theoretical and practical matter:

  • provision for possible damages payout
  • provision for rebates.

Assets not included

Some interests in connected entities

When calculating net value, you should exclude the shares, units and other interests (apart from debt) that you hold in an entity connected with you or your affiliate. This is because the net value of the CGT assets of the connected entity is already included in the test.

However, include any liabilities relating to these excluded interests in connected entities.

Non-business assets of affiliates or connected entities

Include the net value of assets of your affiliates, and entities connected with your affiliates, only if the assets are used, or held ready for use, in a business carried on by you or an entity connected with you. However, don't include an asset of your affiliate or an entity connected with your affiliate if it is used, or held ready for use, in the business of an entity that is connected with you only because of your affiliate.

Personal use and superannuation assets

If you are an individual, you should also disregard the following assets when working out the net value of your CGT assets:

  • assets being used solely for your personal use and enjoyment, or that of your affiliate
  • your own home, to the extent that you use it for private purposes (also, if your only other use is some incidental income-producing use, exclude your home from the net asset value test)
  • rights to 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
  • insurance policies on your life.

Where an asset is disregarded, any related liability is also disregarded because these liabilities are not related to an asset included in the net asset value calculation.

Who is an affiliate?

An affiliate is an individual or company that, in relation to their business affairs, acts or could reasonably be expected to act:

  • in accordance with your directions or wishes, or
  • in concert with you.

Trusts, partnerships and superannuation funds cannot be your affiliates. However, a trust, partnership or superannuation fund may have an affiliate who is an individual or company.

However, a person is not your affiliate merely because of the nature of a business relationship you and the person share.

For example, if you are a partner in a partnership, another partner is not your affiliate merely because they act, or could reasonably be expected to act, in accordance with your directions or wishes in relation to the affairs of the partnership.

Similarly, companies and trusts are not affiliates of their directors and trustees respectively, and vice versa, merely because of the positions held.

Whether a person acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes, or in concert with the taxpayer, is a question of fact dependent on all the circumstances of the particular case. No single factor will necessarily be determinative.

Relevant factors that may support a finding that a person acts, or could reasonably be expected to act, in accordance with the taxpayer's directions or wishes, or in concert with the taxpayer, include:

  • the existence of a close family relationship between the parties
  • the lack of any formal agreement or formal relationship between the parties dictating how the parties are to act in relation to each other
  • the likelihood that the way the parties act, or could reasonably be expected to act, in relation to each other would be based on the relationship between the parties rather than on formal agreements or legal or fiduciary obligations
  • the actions of the parties.

Generally, another business would not be acting in concert with you if they:

  • have different employees
  • have different business premises
  • have separate bank accounts
  • do not consult you on business matters
  • conduct their business affairs independently in all regards.

In certain circumstances, an individual or entity can be taken to be your affiliate. See Are spouses and children affiliates? and Passively-held assets and Partner's assets .

Example: Affiliates

  • Bob and Shirley are married. Bob has an events management business with an annual turnover of $1.7 million, and Shirley owns a consultancy business with an annual turnover of $1.8 million.
  • Bob acts in accordance with Shirley's wishes because he values her consultancy and business expertise. As a result, Bob is Shirley's affiliate because he acts in accordance with her directions and wishes in relation to his business. Shirley will need to count Bob's turnover in working out her aggregated turnover.
  • However, Shirley is not Bob's affiliate, because she does not act in accordance with his wishes or in concert with him in relation to her own business.

Example: Not affiliates

  • Matt and Sandy are married and share in the running of their household. Matt owns a cleaning business with an annual turnover of $1.7 million, and Sandy has a bakery with an annual turnover of $1.8 million.
  • They have nothing to do with each other's businesses. They have:
    • separate bank accounts for their businesses
    • different business locations
    • their own employees.
  • Neither Matt nor Sandy controls the management of the other's business.
  • Even though Matt and Sandy are married, neither is an affiliate of the other because they:
    • do not act in concert with each other in respect of their businesses, and
    • neither acts according to the directions or wishes of the other.
  • As a result, neither Matt nor Sandy has to include the annual turnover of the other's business in calculating the aggregated turnover of their own business.

Are spouses and children affiliates?

Neither a spouse nor a child is automatically your affiliate. You must consider whether they are acting according to your directions or wishes, or in concert with you, in relation to their business affairs.

However, where you own an asset that your spouse or child uses in a business they carry on as an individual, they will be taken to be your affiliate for the purposes of the:

  • active asset test
  • $6 million maximum net asset value test, and
  • $2 million aggregated turnover test.

By child, we mean your child less than 18 years of age.

Your spouse or child may also be taken to be your affiliate where:

  • an asset is owned by you and that asset is used in a business carried on by an entity that your spouse (or child) owns or has an interest in, or
  • an asset is owned by an entity that you own or have an interest in, and that asset is used in a business carried on by your spouse (or child), or an entity that your spouse or child has an interest in.

Example: Spouse

  • Sue's spouse is taken to be her affiliate if she owns an asset that is used in the business of an entity her spouse owns. Similarly, Sue's spouse is taken to be her affiliate if an entity she owns leases an asset to an entity her spouse owns, and that entity uses the asset in business.

Your spouse or child is treated as your affiliate when working out whether the entity that owns the asset is an affiliate of, or connected with, the entity that uses the asset in their business. If by treating your spouse or child as your affiliate the result is that the business entity is taken to be an affiliate of, or connected with, the entity that owns the asset, then the affiliate rule will also apply to treat the spouse or child as an affiliate of the individual for the purposes of the small business CGT concessions in relation to:

  • all the basic conditions for eligibility, and
  • calculating aggregated turnover and net asset value.

This rule only applies in relation to eligibility for the small business CGT concessions, and not the other small business entity concessions.

If this second stage of the affiliate rule applies, it will also apply for any gain that arises from any asset that either the asset owner or the business entity, or the individual or their spouse or child, owns. This affiliate rule works both ways, so that the individual is also taken to be an affiliate of their spouse or child. However, it only applies for as long as:

  • the person is their spouse or the child is under 18 years, and
  • any asset is being passively held.

This affiliate rule for spouses and children also has application for the meaning of active asset .

This affiliate rule applies only if the business entity is not already an affiliate of, or connected with, the asset-owner.

Example: Passively-held assets

  • Philip owns 100% of Horse Farm Pty Ltd, which owns land. Horse Farm Pty Ltd does not carry on a business. However, Philip's spouse, Crystal, owns Pig Farm Pty Ltd, which uses the Horse Farm land to carry on a business. In addition, Philip owns 30% of another entity, Carrot Pty Ltd, and Crystal owns 70% of Carrot Pty Ltd.

  • The amendments treat Crystal as Philip's affiliate in determining whether Pig Farm Pty Ltd (the entity that uses the land in its business) is connected with Horse Farm Pty Ltd (the entity that owns the land). The new affiliate rule applies because one entity (Horse Farm) owns a CGT asset that another entity (Pig Farm) uses in its business.
  • Pig Farm Pty Ltd is connected with Horse Farm Pty Ltd because Philip controls Horse Farm and Philip, together with his affiliate, Crystal, control Pig Farm. Horse Farm and Pig Farm are both controlled by the same third entity, Philip.
  • This makes the land that Horse Farm Pty Ltd owns an active asset. The land would also have to meet the requirements of the active asset test.
  • Therefore, Horse Farm Pty Ltd could access the small business CGT concessions if its maximum net asset value is not more than $6 million. Horse Farm could also access the concessions if Pig Farm's aggregated turnover is less than $2 million.
  • Because Crystal is treated as Philip's affiliate in determining whether Pig Farm is an affiliate of, or connected with, Horse Farm, Crystal is also treated as Philip's affiliate for testing whether Carrot Pty Ltd is connected with Horse Farm. Carrot is connected with Horse Farm because Philip controls Horse Farm and Philip, together with his affiliate, Crystal, control Carrot Pty Ltd.
  • In seeking access to the small business CGT concessions via the maximum net asset value test, Horse Farm Pty Ltd would need to include the net assets of its affiliates and entities connected with it (Pig Farm Pty Ltd and Carrot Pty Ltd).
  • In seeking access to the small business CGT concessions via the small business entity turnover test, Pig Farm's aggregated turnover would include the annual turnovers of its affiliates and entities connected with it (Carrot Pty Ltd if it carries on business and has turnover). Horse Farm Pty Ltd must not be carrying on business to qualify under this basic condition.
Are franchisees and franchisors affiliates?

Franchisees are not necessarily affiliates of the franchisor simply because of the franchise arrangement. Whether the franchisee acts in concert with the franchisor in respect of their franchise business depends on, among other things, the nature of the franchise agreement between them.

The affiliate relationship does not include the relationship between the 'controller' of an entity and the entity itself. The relationship in these situations is considered to be dictated more by obligations imposed by law, formal agreements and fiduciary obligations. Accordingly, companies, trusts and partnerships are not considered to be affiliates (and vice versa) of the various officers, persons and entities that are related to the company, trust or partnership in various capacities - for example, the trustees and beneficiaries of a trust, the directors and shareholders of a company, and the partners in a partnership.

When an entity is connected with you

An entity is connected with another entity if:

  • either entity controls the other entity, or
  • both entities are controlled by the same third entity.

In certain circumstances, an entity can be taken to be connected with you. See Passively-held assets and Partner's assets .

Connected with: control of a partnership, company or trust (except a discretionary trust)

An entity controls another entity if it or its affiliate (or all of them together):

  • owns, or has the right to acquire ownership of, interests in the other 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 partnership, the net income of the partnership or
  • if the other entity is a company, owns, or has the right to acquire ownership of, equity interests in the company that give at least 40% of the voting power in the company.

The meaning of an equity interest includes, but is not limited to, a share in a company.

Example

  • Olivia and Jill conduct a professional practice in partnership. As they each have a 50% interest in the partnership, they each control the partnership. Therefore, the partnership is connected with each partner, and Olivia and Jill are each connected with the partnership.

Example

  • Joseph is a sole trader. He also owns shares in a company that carry 50% of the voting power in the company. The net value of his CGT assets (apart from the shares in the company) is $3 million. In determining whether he satisfies the maximum net asset value test, Joseph must take into account the net value of his CGT assets ($3 million) and the net value of the company's CGT assets because the company is connected with him. He does not include the market value of his shares in the company in the net value of his CGT assets because this amount is already reflected in the net value of the company's CGT assets.
Between 40% and 50% control

If an entity's control percentage in another entity is at least 40% but less than 50%, the Commissioner may determine that the first entity does not control the other entity if he is satisfied that a third entity (not including any affiliates of the first entity) controls the other entity.

Whether or not the third entity has a control percentage of at least 40% may assist in determining whether the third entity controls the other entity, but it is not decisive. For example, the third entity may control a discretionary trust because the trustee acts, or could reasonably be expected to act, in accordance with the directions or wishes of the third entity even if the third entity's control percentage is zero. In working out the third entity's control percentage, the interests of any affiliates of the third entity are taken into account.

Alternatively, it is possible that both of the entities with a control percentage of at least 40%, or both an entity with a control percentage of at least 40% and an entity that controls the other entity in another way, may control the other entity if responsibilities are shared.

Example

  • Lachlan owns 48% of the shares in Ayoubi Art Supplies. He plays no part in the day-to-day or strategic decision making of the business. Daniel owns 42% of the shares in the company. The remaining 10% of shares are beneficially owned by a third shareholder who does not take part in the management of the business. All shares carry the same voting rights and Daniel makes all day-to-day and strategic decisions for the company. Even though Lachlan owns 48% of the shares in Ayoubi Art Supplies, he would not be taken to control the company if the Commissioner was satisfied that the company is controlled by Daniel.

Connected with: control of a discretionary trust

Control by entity with influence over trustee

From the 2007-08 year, an entity controls the discretionary trust if the trustee either acts, or might reasonably be expected to act, in accordance with the directions or wishes of the entity/or the entity's affiliates, or both the entity and its affiliates.

All the circumstances of the case need to be considered in determining whether you satisfy this test, for example, the mere presence in the trust deed of a requirement that the trustee should have no regard to such directions or wishes would not be sufficient.

Some factors which might be considered include:

  • the way in which the trustee has acted in the past
  • the relationship between the trustee and the entity or its affiliates, and the relationship the trustee has with both the entity and its affiliates
  • the amount of any property or services transferred to the trust by the entity or its affiliates, or by both the entity and its affiliates
  • any arrangement or understanding between the entity and any person who has benefited under the trust in the past.

This entity may control a discretionary trust in addition to any beneficiary with control as described below.

Control by beneficiary

The level of actual distributions made by a discretionary trust is used to determine who controls the trust. A beneficiary is taken to control a discretionary trust only if, for any of the four income years before the year for which relief is sought for a CGT event:

  • the trustee paid to, or applied for the benefit of, the beneficiary or their affiliates, or both the beneficiary and any of its affiliates, any of the income or capital of the trust, and
  • the amounts paid or applied were at least 40% (the control percentage) of the total amount of income or capital paid or applied for that income year (subject to the Commissioner's discretion where the control percentage is between 40% and 50%).

Exempt entities and deductible gift recipients are not treated as controlling a discretionary trust, regardless of the percentage of distributions made to them.

To determine whether a particular beneficiary controls a trust, amounts paid to or applied for the benefit of any of the beneficiary's affiliates are also included when determining whether the beneficiary reaches the 40% threshold.

Distributions of income and capital made to the same beneficiary are considered separately (that is, not added together) to determine if the beneficiary reaches the 40% threshold.

Public entities can also be taken to control a discretionary trust if distributions to them meet the 40% control percentage. A public entity is a publicly traded company or unit trust, a mutual insurance company, a mutual affiliate company or a company in which all the shares are beneficially owned by one or more of those entities.

Where a discretionary trust makes a contribution to a superannuation (or similar) fund for an employee who is also a beneficiary of the trust, this payment is not considered to be a distribution of income or capital of the trust. This is because the payment is made for the person in their capacity as employee and not in their capacity as beneficiary.

Example

  • The XY discretionary trust sold a business asset during the year ended 30 June 2014 and made a capital gain. The trust made the following percentage distributions of income and capital for the previous year (there were no distributions of any kind for any of the earlier years, nor did the trust have a tax loss in any previous year):
2012-13 distributions
incomecapital

Mr X

50%

-

Mrs X

50%

-

Mr Y

-

30%

Mrs Y

-

70%

As Mr and Mrs X each received at least 40% of the total distributions of income from the trust, they each control the trust. As Mrs Y received at least 40% of the total distributions of capital from the trust, she also controls the trust. However, as Mr Y received less than 40% (and Mrs Y is not his affiliate) he does not control the trust.

Example

  • The Z discretionary trust sold a business asset during the year ended 30 June 2014 and made a capital gain. None of the Z family members are affiliates of each other. The trust made percentage distributions of income for the previous four years as follows (there were no distributions of capital and no tax losses for any year):

 

2009-10

2010-11

2011-12

2012-13

Mrs Z

100%

-

25%

20%

Mr Z

-

-

25%

-

Child 1 (under 18)

-

25%

25%

40%

Child 2 (under 18)

-

25%

25%

40%

Exempt entity

-

50%

-

-

  • All four prior years need to be examined to identify everyone who controls the trust.

Year

Person or people controlling the trust

2009-10

Mrs Z controls the trust, as she received at least 40% of distributions.

2010-11

No one controls the trust in this year, because none of the individual Z family members received at least 40% of the distributio ns. Although the exempt entity received at least 40% of the total distributions, it is not taken to control the trust.

2011-12

Again, no one controls the trust in this year.

2012-13

As the children each received at least 40% of the total distributions, they are taken to control the trust.

Accordingly, Mrs Z and each child control the trust.

Nominating a beneficiary as controller of the trust

The trustee of a discretionary trust may nominate up to four beneficiaries as being controllers of the trust for an income year in which the trust had a tax loss or no net income and in which the trustee did not make a distribution of income or capital of the trust.

In such a case, the trust might not have had the funds to make a distribution, which would prevent it from being controlled in that year. The trustee may wish to make the nomination to ensure that a particular CGT asset is treated as an active asset for that year.

The nomination must be in writing and signed by the trustee and each nominated beneficiary.

A nominated beneficiary is connected with the trust (and the trust is connected with the nominated beneficiary) for the purposes of the maximum net asset value test, the aggregated turnover test and the active asset test.

Connected with: indirect control of an entity

The control tests for the 'connected with' rules are designed to look through business structures that include interposed entities. 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.

In the above figure, the small business entity controls companies A and B but not company C.

Exception where interposed entity is a public entity

The indirect control test does not apply if an entity controls a public entity and that public entity controls a third entity, unless the first entity actually controls the third entity, for example, because it holds 50% of the voting shares of the third entity.

Example

  • 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.

Active asset test

The active asset test is satisfied if:

  • you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half of the test period detailed below, or
  • you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of least 7.5 years during the test period.

The test period:

  • begins when you acquired the asset, and
  • ends at the earlier of
    • the CGT event, and
    • when the business ceased, if the business in question ceased in the 12 months before the CGT event (or such longer time as the Commissioner allows).

The periods in which the asset is an active asset do not need to be continuous. However, they must add up to the minimum periods specified above, depending on the total period of ownership.

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

Example

  • Jodie ran a florist business from a shop 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.

Land subdivision and active asset test

If land, part of which is used in the business of the taxpayer and part of which is vacant, is subdivided, the new subdivided blocks created out of the vacant part of the land will not satisfy the active asset test when they are sold.

Example

  • Tom acquired 10 hectares of land as a single parcel in 1988. There are three distinct areas of the land which have different uses. Approximately 20% of the land is used in his business and 20% of the land is used for domestic purposes and contains Tom's main residence. The remaining 60% (rear of property) is vacant. The vacant part of the property has not been used or held ready for use for any purpose. Tom will subdivide the land into residential blocks. The subdivided blocks will not be trading stock because Tom is not carrying on a business of land development. After the subdivision is completed, Tom will sell all of the new subdivided blocks including those created out of the vacant part of the land.
  • Land is a CGT asset. Tom owns the land and used it in his business. Although only 20% of the land area has been used in the business, it is considered the conditions of an active asset are satisfied.
  • When the land is subdivided, the original land parcel is split into subdivided blocks which are separate new assets. When a CGT asset is split into two or more assets and you are the beneficial owner of the original asset and each new asset, the split is not a CGT event. You work out the cost base and reduced cost base of each new asset using the method statement set out for split, changed or merged assets.
  • The new subdivided blocks are taken to have been acquired by Tom when that original parcel was acquired. The disposal of a subdivided block is treated as the disposal of an asset in its own right, and not as a disposal of part of an asset (the original land parcel).
  • The subdivided blocks that are created out of the vacant part of the land are new assets that have never been used or held ready for use in any business. Therefore, they are not active assets.
  • The main residence exemption will apply to the dwelling including up to two hectares of land adjacent to the dwelling, provided the main residence provisions are satisfied.
  • The new subdivided blocks created out of the part of the land on which Tom carried on the business will satisfy the active asset test when they are sold as they were owned for more than 15 years and were active assets for at least 7 1/2 years.

Cessation of a business

If the CGT event happens within 12 months after the business ceased, the test period can end when the business ceased.

This aspect of the active asset test allows some flexibility in the situation where a business is sold, or has otherwise ceased, and an asset previously used in the business is sold after that time. The asset only needs to be an active asset for half (to a maximum of 7.5 years) of the shorter test period during the total time the asset was owned.

If the CGT event happens more than 12 months after the business ceased, the test period ends either:

  • when the CGT event happens, or
  • when the business ceased, if the Commissioner grants you an extension of time.

Extension of time requests are considered on the merits of each case.For the purposes of the active asset test , the cessation of a business includes the sale of a business, that is, it is not limited to a business that ends in the sense that no-one continues to carry it on, but also includes a business that has ceased to be carried on by an entity because the entity has sold that business.

Example

Laura purchased business premises in February 2003 and immediately started to carry on her business from the premises. Her business expanded and she moved to larger premises across the street in April 2006. She entered into a contract to sell the original premises in July 2006. The premises were an active asset for at least half the period beginning in February 2003 and ending just before the CGT event in July 2006 and accordingly the active asset test is satisfied.

Death and the active asset test

Where you are one of the following you may be eligible for the concessions to the same extent that the deceased would have been just prior to their death:

  • a beneficiary of a deceased estate
  • a legal personal representative (executor)
  • a surviving joint tenant
  • a trustee or beneficiary of a testamentary trust (trust created by a will).

You will be eligible for the concessions where the CGT event happens within two years of the individual's death. The active asset test applies to you for any capital gain made on a sale of the assets after the two-year time limit. This means that if you do not conti nue to carry on the deceased's business, or use the asset in another business, after the two-year time period, the active asset test may not be satisfied and the small business concessions may not be available.

The Commissioner can extend this two-year period.

See Death and the small business CGT concessions .

Continuing time periods for active asset test for involuntary disposals

There are modified rules to determine if the active asset test is satisfied for CGT assets acquired or transferred under the rollover provisions relating to assets compulsorily acquired, lost or destroyed, or to marriage breakdown (Subdivisions 124-B and 126-A of the ITAA 1997 respectively).

If you acquired a replacement asset to satisfy the rollover requirements for the compulsory acquisition, loss or destruction of a CGT asset, the replacement asset is treated as if:

  • you acquired it when you acquired the original asset, and
  • it was an active asset at all times when the original asset was an active asset.

If you have a CGT asset transferred to you because of a marriage breakdown, and the capital gain arising from that transfer was rolled over under the marriage breakdown rollover provisions, for purposes of the active asset test you can choose whether to:

  • include the ownership and active asset periods of your former spouse, or
  • commence the ownership and active asset periods from the time the asset was transferred to you.

If you choose to include your former spouse's ownership and active asset periods of the CGT asset, that asset is treated as if it had been:

  • acquired by you when your former spouse acquired the asset, and
  • was an active asset of yours at all times when the asset was an active asset of your former spouse.

Modified active asset test for CGT event D1

A modified active asset test applies if you make a capital gain from CGT event D1 (about creating rights in another entity).

The active asset test requires you to own the CGT asset before the CGT event happens. However, under CGT event D1, the relevant CGT asset (the rights) are created in the other entity without you owning them, so it would not be possible to satisfy the active asset test.

Accordingly, the test is modified to require the right you create that triggers the CGT event to be inherently connected with another CGT asset of yours that satisfies the active asset test.

Meaning of active asset

A CGT asset is an active asset if it is owned by you and is:

  • used or held ready for use in a business carried on (whether alone or in partnership) by you, your affiliate, your spouse or child, or an entity connected with you, or
  • an intangible asset, for example goodwill, that is inherently connected with a business carried on (whether alone or in partnership) by you, your affiliate, your spouse or child, or another entity that is connected with you.

Where you own an asset that your spouse or child uses in their business, they will be taken to be your affiliate for the purposes of the:

  • active asset test
  • $6 million maximum net asset value test, and
  • $2 million aggregated turnover test.

Where we say 'child', we mean your child under 18 years old.

Your spouse (or child) may also be taken to be your affiliate where:

  • an asset is owned by you and that asset is used in a business carried on by an entity that your spouse (or child) owns or has an interest in, or
  • an asset is owned by an entity that you own or have an interest in, and that asset is used in a business carried on by your spouse (or child), or an entity that your spouse or child has an interest in.

The rule is applied in two stages. The first stage treats an individual's spouse or child as their affiliate for the purposes of working out whether the entity that uses the CGT asset, or holds it ready for use in its business, is an affiliate of, or connected with, the entity that owns the CGT asset.

If by applying the first stage of the rule the entity is taken to be an affiliate of, or connected with, the entity that owns the asset, then the asset is an active asset. The asset must still meet the active asset test.

The second stage of the rule treats the spouse or child as an affiliate for other purposes in the basic conditions. See Are spouses and children affiliates ?

Businesses that are winding up

If you are accessing the concessions using the basic condition for passively-held assets or a partner's assets, there is a special rule that affects the period of time that your asset is an active asset in the CGT event year. It applies in the income year the CGT event happens where:

  • a business previously carried on by your affiliate, an entity connected with you or a partnership in which you are a partner, is being wound up and the asset is no longer being used in the business, and
  • the asset was used, held ready for use in, or inherently connected with the business at a time in a previous income year when you ceased to carry on the business.

This rule treats the entity as carrying on the business for a moment in time in the income year the CGT event happens and treats the asset as being used, held ready for use in, or inherently connected with, the business at that same moment in time in the CGT event year. The asset must still pass the active asset test.

This rule is also required to enable you to meet the basic condition for passively- held assets and partner's assets.

When an asset is 'held ready for use'

For an asset to be held ready for use in the course of carrying on a business, it needs to be in a state of preparedness for use in the business and functionally operative. As such, premises still under construction, or land upon which it is intended to construct business premises, could not be said to be 'held ready for use' and would, therefore, not be active assets at that time.

Example

  • Margaret carried on business at various customer on-site locations. She acquired some land with the intention of constructing premises in which to carry on her business. Soon after Margaret acquired the land she was approached by another party that was keen to acquire the land. Margaret sold the land and made a capital gain. She was only part way through the construction of the premises at that time.
  • In this situation, the land was not held ready for use by Margaret in the course of carrying on her business at any time. It was not in a state of preparedness from which Margaret could carry on her business. Accordingly, the land was not an active asset at any time.

When shares and trust interests are active assets

A CGT asset is also an active asset at a given time if you own it and:

  • it is either a share in a company that is an Australian resident at that time or an interest in a trust that is a resident trust for CGT purposes for the income year in which that time occurs, and
  • the total of the following is 80% or more of the market value of all of the assets of the company or trust
    • the market values of the active assets of the company or trust, and
    • the market value of any financial instruments of the company or trust that are inherently connected with a business that the company or trust carries on, and
    • any cash of the company or trust that is inherently connected with such a business.

This means a share in a company or an interest in a trust is an active asset if the company or trust itself has active assets (and inherently connected financial instruments and cash) with a market value of at least 80% of the market value of all its assets.

Cash and financial instruments are not active assets, but they count towards the satisfaction of the 80% test provided they are inherently connected with the business.

Inherent connection

Inherent connection necessarily requires something more than just some form of connection between the financial instrument and the business. A thing might be regarded as inherently connected to a business when it is a permanent or characteristic attribute of the business - for example, goodwill, or trade debtors. Where a business is holding excess funds arising from a temporary spike in trading activity or the sale of a business asset, the excess funds might also reasonably be regarded as inherently connected with the business. A financial instrument must be inherently connected with a business that the owner of the financial instrument carries on, rather than any business a related entity carries on.

Example

  • Archimedes Pty Ltd carries on a manufacturing business. It lends $300,000 to a related company, Galileo Pty Ltd, to acquire various assets to be used in the businesses of both companies. However, a loan a company makes to a related entity to fund the acquisition of assets is not considered to be a permanent or characteristic attribute of the business the company carries on. As such, loans made between members of a corporate group as part of the overall financing of the group are not considered to be inherently connected with the business the lender carries on. Accordingly, the loan by Archimedes Pty Ltd to Galileo Pty Ltd is not included in the numerator (but is still included in the denominator) of the 80% test calculation in determining whether the shares in Archimedes Pty Ltd are active assets.

The active asset test requires a CGT asset to have been an active asset for at least half of a particular period, as outlined earlier, for example, for a share in an Australian resident company to meet this requirement, the company must satisfy the 80% test for that same period.

The 80% test will be taken to have been met:

  • where breaches of the threshold are only temporary in nature, and
  • in circumstances where it is reasonable to conclude that the 80% threshold has been passed.

Example

  • John sells an active asset that meets the basic conditions and makes a capital gain of $500,000. He acquired shares in Fruit and Veg Co, which runs his family business, as replacement assets. The shares in Fruit and Veg Co meet the 80% test and, as a result, they are active assets.
  • Some time later, Fruit and Veg Co borrows money to pay a dividend, and fails the 80% test. Two weeks later the dividend is paid and the shares pass the 80% test again. For the two weeks, the shares are treated as active assets even though they do not pass the 80% test.

Example

  • Jack and Jill are the only shareholders of Hill Water Supplies Pty Ltd, an Australian resident company that carries on a water supply business. The market values of the company's CGT assets are as follows:

    Business premises

    $    400,000

    Goodwill

    $    100,000

    Trading stock

    $    100,000

    Plant and equipment

    $    300,000

    Rental property (not an active asset)

    $    100,000

    Total

    $ 1,000,000

  • The total market value of the company's active assets is $900,000, which is more than 80% of the total market value of all the company's assets. Therefore, Jack and Jill's shares in the company are active assets.
  • The company sells its water filtration plant (for its market value of $200,000) and then immediately contracts to purchase new plant, which is delivered and installed two months later. The funds from the sale are held in the company's bank account before being used to pay for the new plant.
  • In this situation, although the market value of the company's active assets has dropped below the 80% mark, the company's bank account holding the $200,000 is a financial instrument inherently connected with the company's business and is therefore included in the calculation. This means the 80% test remains satisfied.
  • Although gains from depreciating assets may be treated as income rather than capital gains, depreciating assets, such as plant, are still CGT assets and may, therefore, be active assets and included in the 80% test.

Interests in holding entities

An interest in an entity that itself holds interests in another entity that operates a business may be an active asset, depending on the successive application of the 80% test at each level.

Example

  • Ben owns 100% of the shares in Holding Co, which, in turn, owns 100% of the shares in Operating Co (both are resident companies). The only assets of Holding Co are the shares in Operating Co, and all of Operating Co's assets are active assets.
  • As Operating Co satisfies the 80% test, the shares owned by Holding Co in Operating Co are active assets. As those shares are the only assets owned by Holding Co, then Holding Co also satisfies the 80% test. As a result, the shares owned by Ben in Holding Co are also active assets.
  • If Ben sold the shares in Holding Co, all the small business concessions may potentially apply to any gains made.
  • If Holding Co sold its shares in Operating Co, the small business concessions may apply because Ben is a CGT concessional stakeholder in Operating Co as well as having a small business participation percentage in Holding Co of at least 90%.
  • If Operating Co sold its active assets, Operating Co may be entitled to the small business concessions because Ben is a significant individual and CGT concessional stakeholder in Operating Co as a result of his direct and indirect small business participation percentage. For more information, see the significant individual test .

Assets that cannot be active assets

The following CGT assets cannot be active assets (even if they are used, or held ready for use, in the course of carrying on a business):

  • shares in companies or interests in trusts, other than those that satisfy the 80% test; see When shares and trust interests are active assets
  • financial instruments, such as bank accounts, loans, debentures, bonds, futures and other contracts and share options (Note: if a financial instrument is inherently connected with the business, it can nevertheless count towards the satisfaction of the 80% test)
  • assets whose main use is to derive interest, an annuity, rent, royalties or foreign exchange gains (unless the main use for deriving rent was only temporary or the asset is an intangible asset that you have substantially developed or improved so that its market value has been substantially enhanced)
  • shares and trust interests in widely-held entities, unless held by a CGT concession stakeholder in the widely-held entity.

Trade debtors are not considered to be financial instruments for the purposes of the active asset exclusions. Rather, they are a business facilitation mechanism that assists in the conduct of the business and are inherently connected with the business. Accordingly, trade debtors can be included in the value of active assets when calculating the 80% test.

Main use to deriving rent

As already noted, an asset whose main use is to derive rent (unless that main use is only temporary) cannot be an active asset. This is the case even if the asset is used in the course of carrying on a business.

Whether an asset's main use is to derive rent will depend on the particular circumstances of each case. The term 'rent' has been described as referring to the payments made by a tenant or lessee to a landlord or lessor for exclusive possession of the leased premises. As such, a key factor in determining whether an occupant of premises is a lessee paying rent is whether the occupier has a right to exclusive possession.

If, for example, premises are leased to a tenant under a lease agreement granting exclusive possession, the payments involved are likely to be rent and the premises are not an active asset. On the other hand, if the arrangement allows the person only to enter and use the premises for certain purposes and does not amount to a lease granting exclusive possession, the payments involved are not likely to be rent.

An asset that is leased to a connected entity or affiliate for use in its business may still be an active asset. It is the use of the asset in that entity's business that will determine the active asset status of the asset.

All uses of an asset are considered in determining what the main use of the asset is and, therefore, whether it is an active asset. However, personal use of the asset by the asset owner, or by an individual who is their affiliate, is not considered in determining the main use of the asset.

Example

  • Rachael owns five investment properties which she rents to tenants under lease agreements that grant exclusive possession. The lease terms vary from six months to two years. The properties are not active assets because they are mainly (only) used by Rachael to derive rent. It is irrelevant whether Rachael's activities constitute a business.

Example

  • Michael owns a motel (land and buildings) which he uses to carry on a motel business. The motel provides room cleaning, breakfast, in-house movies, laundry and other services as part of the business. Guests staying in the motel do not receive exclusive possession, but simply have a right to occupy a room on certain conditions. The usual length of stay by guests is between one and seven nights. The motel would be an active asset because its main use is not to derive rent.

The following is considered use of the asset to derive rent, where the rent is derived:

  • from an entity that is not an affiliate or connected with the asset owner (third party), or
  • by an entity that is an affiliate or connected with the asset owner (relevant entity).

The use of the asset to derive rent from a third party will be considered use to derive rent, even if that entity uses the asset in their business. This is because the use of the asset by the asset owner is to derive rent.

However, use of the asset by a relevant entity is treated as the use by the asset owner, even if the asset owner receives rent from the relevant entity for the use of that asset.

This means, if the relevant entity uses the asset:

  • in its business, that use is treated as use by the asset owner to carry on business
  • to derive interest, rent, royalties, or foreign exchange gains from an entity that is a third party, that use is treated as use by the asset owner to derive passive income.

Example

  • Kiki owns a property and rents out 90% of the floor area to Lost Dog Pty Ltd that is neither her affiliate nor connected with her (that is, a non-related third party). Kiki earns 90% of the revenue derived from owning the property from renting it to Lost Dog Pty Ltd.
  • Beaglehole Pty Ltd, which carries on a dog-grooming business, uses the remaining 10% of the floor area of the property as its business premises and pays Kiki rent for using it - this rent forms 10% of the revenue Kiki earns from owning the property. As Kiki owns 60% of Beaglehole Pty Ltd, Beaglehole is connected with Kiki.
  • Beaglehole Pty Ltd's use of that 10% of the property is treated as Kiki's use because Beaglehole Pty Ltd is connected with Kiki. Because Beaglehole uses that part of the property as its business premises, Kiki is treated as using that part as business premises. This means that the rent Beaglehole Pty Ltd pays to Kiki is not treated as rent for the purposes of determining Kiki's main use of the property.
  • However, Kiki's main use of the property is to derive rent, because 90% of the revenue she derives from the property is rent received from Lost Dog Pty Ltd, a non-related third party.
  • Kiki's property is not an active asset in these circumstances.

Example

  • Neil owns a property that is used as follows:
    • 60% of the floor area is rented to an affiliate, Andrea
    • 15% of the floor area is used in Neil's business
    • 25% remaining is used for his own personal use.
  • Because personal use of an asset by the owner or an affiliate of the owner is ignored in determining its main use, the proportions of 60% and 15% have to be adjusted to represent a proportion of the whole use of the asset excluding the personal use.
  • This adjustment is made by multiplying the 60% and 15% each by 100/75 [that is, 100/(60 + 15)].
  • Following the adjustments, Neil:
    • rents 80% (that is, 60% x 100/75) of the non-personal use floor area of the property to Andrea
    • uses 20% (that is, 15% x 100/75) of the non-personal use floor area in his business.
  • Andrea uses 50% of the 80% space rented to her in her business and rents the remaining 50% of the space to an entity that is neither Neil's affiliate nor connected with Neil (non-related third party). Andrea earns 50% of the revenue she derives from the property from her on-renting to the non-related third party.
  • Andrea's business use of the property is treated as Neil's use because she is his affiliate. Therefore, Neil is treated as:
    • renting 50% of 80% of the property to a non-related third party
    • using 50% of 80% in a business carried on by Neil.
  • The main use of the property is not to derive interest, an annuity, rent, royalties or foreign exchange gains. This is because:
    • 40% (that is, 80% x 50%) is treated as being used to derive rent from the non-related third party, and
    • the remaining 60% is either
    • actually used in Neil's business (20%), or
    • is treated as being used in a business carried by Neil (40%).
  • Neil's property is an active asset in these circumstances. Neil's asset would still have to satisfy the active asset test over the period that he has owned the asset.

Extra conditions if the CGT asset is a share or trust interest

If the CGT asset is a share in a company or an interest in a trust, one of these additional basic conditions must be satisfied just before the CGT event:

  • the entity claiming the concession must be a CGT concession stakeholder in the company or trust, or
  • CGT concession stakeholders in the company or trust together have a small business participation percentage in the entity claiming the concession of at least 90% ( the 90% test ).

CGT concession stakeholder

An individual is a CGT concession stakeholder of a company or trust if they are a significant individual or the spouse of a significant individual where the spouse has a small business participation percentage in the company or trust at that time that is greater than zero.

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 .

Example

  • There are 100 issued shares in Company X, all with equal voting, dividend and distribution rights. Joe owns 99 shares and his wife, Anne, owns one share. Joe is a significant individual in the company. Anne is Joe's spouse and, because she owns a share in the company, she has a small business participation percentage in the company greater than zero. Therefore, they are both CGT concession stakeholders. Anne and Joe may be entitled to the small business concessions when they sell their shares.

If a company or trust has claimed the small business 15-year exemption or the small business retirement exemption , a CGT concession stakeholder may receive an exempt amount from the company or trust if the conditions are satisfied.

Significant individual test

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% - this 20% can be made up of direct and indirect percentages.

A company or trust satisfies the significant individual test if it had at least one significant individual just before the CGT event. The small business 15-year exemption further requires a company or trust to have a significant individual for periods totalling at least 15 of the years of ownership of the CGT asset.

The significant individual test is not the same as the control tests used to determine if an entity is 'connected with' another entity for the purposes of the $6 million maximum net asset value test or the $2 million aggregated turnover test.

Total small business participation percentage

An entity's small business participation percentage in another entity at a time is the percentage that is the sum of:

  • the entity's direct small business participation percentage in the other entity at that time, and
  • the entity's indirect small business participation percentage in the other entity at that time.

Direct small business participation percentage

Companies

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

  • voting power that the entity is entitled to exercise (except for jointly owned shares) or
  • any dividend payment that the entity is entitled to receive, or
  • any capital distribution that the entity is entitled to receive, or

if they are different, the smallest of the three percentages above.

All classes of shares (other than redeemable shares) are taken into account in determining an entity's participation percentage in a company.

Example

  • Joe owns shares that entitle him to 30% of any dividends and capital distributions of Company X. The shares do not carry any voting rights.
  • Joe's direct small business participation percentage in Company X is 0%.

Example

  • A company has two different classes of shares, A and B, which have equal voting and distribution rights. Isaac holds 20% of the shares of each class. The directors can decide to make a distribution of income or capital to either class of shares to the exclusion of the other class of shares.
  • In this situation, the company does have a significant individual. Isaac holds 20% of the voting power and, regardless of how the directors' discretion is exercised, Isaac will always receive 20% of any distribution made by the company.
  • However, if Isaac only held the class A shares and no class B shares, he would not be a significant individual. His right to receive the distribution is only notional, and dependent on how the directors exercise their discretion to make distributions.
Jointly owned shares

The voting power calculation is ignored where the shares are jointly owned, as neither owner would individually control the voting power on the jointly owned shares.

Trusts

An entity's direct small business participation percentage in a trust, where entities have entitlements to all the income and capital of the trust, is the lower percentage of either :

  • the income of the trust that the entity is beneficially entitled to, or
  • the capital of the trust that the entity is beneficially entitled to.

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 trust, and the trust makes a distribution of income or capital) is the percentage of:

  • distributions of income that the entity is beneficially entitled to during the income year, or
  • distributions of capital that the entity is beneficially entitled to during the income year, or

if two different percentages apply, then the smaller of the two.

Discretionary trusts with tax losses or no net income

An entity can use another method to work out their small business participation percentage in a discretionary trust if, in the CGT event year, the trustee of the trust:

  • did not make a distribution of income or capital during the income year, and
  • had no net income or had a tax loss for income year.

The entity's direct small business participation percentage at the relevant time is worked out using the percentage of the distributions the entity was beneficially entitled to in the last income year before the CGT event year in which the trustee made a distribution.

An entity's small business participation percentage is zero if:

  • the trust had net income and did not have a tax loss, and the trustee decided not to distribute, or
  • the trustee has never made a distribution in the income years up to and including the CGT event year (including where the trust had no net income or had a tax loss in each of those income years).

Example

  • XYZ trust is a trust where entities do not have entitlements to all of the income and capital of the trust. The objects of the trust are Evan, Mario, Denise and Katrina.
  • After a bad trading year XYZ trust sells an asset and makes a capital gain. The trustee wants to exempt the capital gain under the small business 15 year exemption. One of the requirements is that the trust must have a significant individual (not necessarily the same individual) for at least 15 years.
  • XYZ trust has a tax loss and has made no distributions in the CGT event year. The trustee made a distribution of income in the year prior to the CGT event year, and in all the previous years except the income year 14 years before the CGT event year. The distributions made in that immediate prior year can be used to work out the small business participation percentages of Evan, Mario, Denise and Katrina for the CGT event year, and for the earlier year that the trustee was not able to make any distributions because the trust had no net income. These amendments allow the XYZ trust to satisfy the significant individual requirement, and if the other conditions are met, the trustee can disregard the capital gain under the small business 15 year exemption.

Indirect small business participation percentage

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.

Example

  • ABC Trust owns 100% of the shares in Operating Co, therefore, ABC Trust has a 100% direct interest (and no indirect interest) in Operating Co.

  • Jennifer receives 80% of the distributions from ABC Trust, therefore, she has a direct participation percentage of 80% in ABC Trust.
  • To find Jennifer's participation percentage in Operating Co, multiply Jennifer's direct participation percentage in ABC Trust and ABC Trust's total participation percentage in Operating Co.
  • 80% x 100% = 80%
  • Jennifer has an 80% participation percentage in Operating Co, so she is a significant individual of Operating Co.
  • Bill received 15% of the distributions from ABC Trust, therefore, he has a direct participation percentage of 15% in ABC Trust.
  • To find Bill's participation percentage in Operating Co, multiply Bill's direct participation percentage in ABC Trust and ABC Trust's total participation percentage in Operating Co.
  • 15% x 100% = 15%
  • Bill has a 15% participation percentage in Operating Co, so he is not a significant individual of Operating Co.
  • (As a spouse of a significant individual with a participation percentage greater than zero in the entity, Bill will be a CGT concession stakeholder).
  • Nicky receives 5% of the distributions from ABC Trust, therefore, she has a direct participation percentage of 5% in ABC Trust.
  • To find Nicky's participation percentage in Operating Co, multiply Nicky's direct participation percentage in ABC Trust and ABC Trust's total participation percentage in Operating Co.
  • 5% x 100% = 5%
  • Nicky has a 5% participation percentage in Operating Co, so she is not a significant individual of Operating Co (Nicky is not a CGT concession stakeholder).

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

An object of a discretionary trust (where entities do not have entitlements to all of the income and capital of the trust) may calculate their indirect small business participation percentage to be more than zero, where the trust had a tax loss or no net income for the income year. See Discretionary trusts with tax losses or no net income .

The 90% test

The 90% test only applies if there is an interposed entity between the CGT concession stakeholders and the company or trust in which the shares or interests are held.

The interposed entity satisfies the test if small business participation percentages in that entity totalling at least 90% are held by CGT concession stakeholders of the company or trust in which the shares or interests are held.

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

Example

  • The discretionary trust sells the units in Unit Trust.
  • Catherine, a significant individual and a CGT concession stakeholder of Unit Trust, has a 72% participation percentage in Discretionary Trust.
  • 80% x 90% = 72%
  • 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.

Example

  • Jennifer, a significant individual and CGT concession stakeholder of Operating Co, has an 80% small business participation percentage in ABC Trust
  • Bill, a CGT concession stakeholder of Operating Co, has a 15% small business participation percentage in ABC Trust
  • Nicky, who is not a CGT concession stakeholder of Operating Co, has a 5% small business participation percentage in ABC Trust.

At least 90% of the participation percentages in ABC Trust are held by CGT concession stakeholders of Operating Co. As a result, ABC Trust satisfies the ownership requirement if it sells its shares in Operating Co, and can access the concessions on those shares, provided the other conditions are met.

ATO references:
NO NAT 3359

Advanced guide to capital gains tax concessions for small business
  Date: Version:
  1 July 2010 Original document
  1 July 2011 Updated document
  1 July 2012 Updated document
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