Making CGT concession claims? Tread carefully

I have written regularly about the value of the small business capital gains tax (CGT) concessions. They can save much in tax.

But they are not simple to understand for the SME owner or operator. SMEs need an accountant or adviser to explain and apply the details of the concessions to their particular situation.

Not surprisingly, mistakes can be made, and the tax office has recently flagged some of the more common mistakes it has found in tax returns. These errors provide a useful roadmap for SMEs for traps to be wary of.

Maximum net asset value test

The tax office says the most common mistake is businesses not meeting one of the basic conditions for the CGT concessions – that is, the maximum net asset value test.

To pass this test, the total net value of CGT assets just before the CGT event (for example, the sale of an asset) that results in the capital gain an SME may claim the concessions for, must not exceed a specified amount ($6 million for 2007-08) for all of the following:

• The business that had the CGT event.
• Any connected entities.
• Any small business CGT affiliates.
  Generally, an affiliate would be an individual or company that acts in accordance with the wishes of the SME in relation to its business affairs.

Common mistakes in applying the maximum net asset value test include:

• Incorrectly valuing assets – the tax office says businesses often use the historical value or cost of the asset for the test, rather than the asset’s market value. The tax office has found that assets most likely to be undervalued are properties and shares.
• Not preparing financial statements for all connected entities just before the CGT event.
• Not including CGT assets sold or the goodwill of the business – the test includes all CGT assets.
• Not including the net value of the CGT assets of connected entities and small business CGT affiliates.

A connected entity is an entity in which the business (and any affiliates) have beneficial interests of 40% or more. An SME may be connected to a discretionary trust, for example, if:

• It received a distribution of income or capital from the trust in any of the four previous income years.
• This income or capital is equal to at least 40% of the total income or capital the trust distributed.

The tax office says it has also found that businesses often exclude CGT assets that were not used in the business. Businesses are reminded that they:

• Can only exclude these assets where they are owned by their CGT affiliates.
• Cannot exclude any CGT assets owned by a connected entity.

Other mistakes

Some more common mistakes include:

• Not passing the active asset test because CGT assets have not been active for long enough to qualify as active assets. An active asset is generally one that is used in the business. The law requires that the asset must have been an “active asset” for at least half the period of its ownership, or at least seven and a half years where the asset was owned by the business for more than 15 years.
• Not meeting the conditions for the 15-year exemption because they have not owned CGT assets for 15 years.
• Not grossing-up net gains if they are the beneficiaries of a trust.
• Choosing a CGT asset purchased more than two years after the last CGT event (which happened in the income year of the roll-over) as a replacement asset.
• Using a settlement date as the date of the CGT event instead of the contract date.

Get good advice

It is a well-worn cliché, but there really is no substitute for getting good professional advice concerning tax matters. The CGT small business concessions are no exception.

Terry Hayes is the senior tax writer at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions.