Real CGT relief for your business

Does your business operate with active or inactive assets? It can be an important tax distinction, and could free your company from unnecessary capital gains pain. By ROBERT RICHARDS

By Robert Richards

Does your business operate with active or inactive assets? It can be an important tax distinction, and could free your company from unnecessary capital gains pain.

The small business capital gains tax relief provisions (division 152 of the Income Tax Assessment Act 1997) are perhaps the most generous part of all tax law.

The combination of the 15-year exemption, a 50% additional general discount, a retirement concession, and a rollover, means the capital gains made on the sale of a small business (or of shares in a company carrying on a small business) might be totally exempt from CGT.

However, these concessions are not allowed unless some basic conditions are satisfied. From 1 July 2007 the taxpayer must satisfy either the “$6 million net asset test” or “the $2 million turnover test”. The first requires that the total net value of assets owned by the taxpayer and associated entities must not exceed $6 million (excluding personal assets such as the family home, life insurance and superannuation).

The alternative $2 million turnover test will be met where the aggregated turnover of the taxpayer and associates does not exceed $2 million. Also, the asset being sold must be an active asset, which broadly excludes assets that are not used in carrying on a business. There are additional tests where the asset sold is a share or an interest in a trust.

While it is possible to plan to ensure that a taxpayer’s business assets are within the $6 million net value limit, it is a question of fact whether an asset is active or not.

The general rule is that an asset is active if it is used in a business. If the asset is an intangible asset (such as goodwill) it has to be inherently connected with a business carried on by the taxpayer or an associate of the taxpayer. Passively held shares and real estate will not normally be active assets.

The decision in Carson and Anor v Federal Commissioner of Taxation (Administrative Appeals Tribunal, 26 February 2008) is an example of this. (This decision should also be seen as being relevant to the business real property provisions of the Superannuation Industry (Supervision) Act 1997.)

There, the taxpayers owned a holiday unit that was let on short-term leases (occasionally it was also used by them). The tribunal said that the taxpayers in leasing the unit were not carrying on a business.

It said: “Whether a business is being carried on is a question of fact and objective consideration of the extent of the applicants’ activities relating to the property. Here, they invested approximately $500,000 in one property, appointed a real estate agent to arrange rentals and minor repairs, spent one week every six months servicing the property and provided brochures relating to the property as required.

“These activities have all the hallmarks of maintaining and deriving income from an investment rather than the carrying on of a business,” the tribunal said. “The activities such as financing the property, dealing with the rating authorities and body corporate are no more than any investor in real estate would do. Equally, the maintenance of accounting and tax records are relevant to any income-producing investment.”

Accordingly the tribunal concluded: “The consequence of the foregoing is that the objection decision under review should be affirmed on the basis that the holiday unit was not an active asset as it was not used or held ready for use in the course of carrying on a business.”

This article first appeared in CPA Australia’s magazine, In the Black

Read more about capital gains tax