Understanding Capital Gains Tax

Anyone running their own business will appreciate the build up of wealth within the business as it matures and succeeds. For some small business owners, this build up of wealth may be the only savings they have for retirement. David Maloney explains…

Results from a recent KPMG survey of family businesses indicate that 26% of business owners plan to retire in the next five years, 35% in five to ten years. The amount ultimately received from the sale of the business will depend on the amount a buyer is willing to pay for the business and the amount of tax the business owner will have to pay on the sale. This equation makes it fundamental that small business owners understand the impact of taxation rules as they impact on small business.

The Main Concessions

The small business capital gains tax (CGT) concessions are in addition to the general CGT discount of 50%. The four concessions available to small businesses are:

1. The 15-year exemption –

The capital gain realised on the sale is entirely tax-free. This is particularly relevant for businesses that were started post-September 1985, but more than 15 years ago. This concession must be applied first.

2. Small business 50% reduction –

Where the 15-year exemption does not apply, this concession allows the capital gain realised on the sale to be reduced by 50%. This concession, when grouped with the additional 50% CGT discount, can result in a favourable tax result.

3. Small business retirement exemption –

This concession allows the capital gain to be exempt from tax if the proceeds from the sale are used for retirement (depending on age).

4. Small business rollover –

The final concession allows business owners to defer any tax being paid by rolling over the proceeds from the sale of the business into the acquisition of another business. The tax is therefore not payable until the newly-acquired business is sold (which may be many years down the track).Who Qualifies?

Each of these concessions can be very favourable, depending on your personal circumstances, and each has detailed qualifying conditions and requirements that need to be worked through. In order to qualify for the concessions, the following must apply:

1. there needs to be an event that results in a capital gain;

2. the total value of the net assets of the business and assets of related entities and individuals cannot exceed $5m – the Government announced in the May 2006, Federal Budget, that this threshold will be increased to $6m from July 1, 2007; and

3. the assets or businesses being sold are active – that is, used in carrying on a business and can include intangible assets.

Small business owners often dismiss their eligibility to qualify for the concessions due to their assets exceeding the $5m level identified in the second point above. Importantly, this test does NOT include your home and your superannuation balance. The test is also a net asset test, and therefore, you can deduct any borrowings connected to the asset being sold against the final value.

2006 Budget Changes

In addition to the increase in the net asset threshold (as discussed above), changes proposed in the May 2006 Federal Budget will broaden the qualifying rules to allow businesses with a wide ownership base to qualify. Currently, in order to qualify for the small business concessions, it is necessary to identify the controlling individual (the one who has an ownership interest of at least 50%). The new rules propose a new ‘Significant Individual’ test, which only requires a 20% interest that can be satisfied directly or indirectly through interposed entities. Therefore, the lower threshold of 20% means that five shareholders could sell 100% of the shares in a company for $30m and still qualify for the concessions! The availability of the small business tax concessions can clearly make a significant difference to the after-tax amount received on the sale of a business.

David Maloney is a Director at Goldman Sachs JBWere specialising in strategic financial planning for small business owners. David.Maloney@nullgsjbw.com.

Stop Press

On November 13, 2006, the Treasurer announced that the Federal Government will introduce legislation to standardise the eligibility criteria for a number of small business tax concessions, including the CGT concession. As a result of the announcement, any business with annual turnover of less than $2 million will be able to access the small business CGT concessions. Those benefits will apply to businesses that meet the new small business definition or other existing eligibility criteria. The new measures will apply from July 1, 2007.