Michelle Bromley CFP®, Director – Strategy & Advice
Introduction
Navigating the complexities of taxation is a crucial aspect of running a small business in Australia. When a profit is realised from selling business assets, Capital Gains Tax (CGT) is applied. However, the Australian tax system offers relief for small business owners through Small Business CGT Concessions, designed to ease the financial impact when selling assets or exiting a small business.
This article aims to demystify the various CGT concessions available, explain the eligibility criteria, and provide practical insights on how to leverage these benefits.
Tax Relief Available
Capital Gains Tax (CGT) is the tax you pay on the profit (or "capital gain") made from the sale of certain assets, such as property, shares, or business assets. In Australia, CGT is not a separate tax but part of your overall income tax, with the capital gain added to your taxable income in the financial year the asset is sold. However, you only pay CGT on the net capital gain, which is the sale price minus the cost of acquiring and maintaining the asset.
Some tax relief is available to reduce capital gains tax (CGT) through the general CGT discount, which automatically applies to individuals, trusts, and complying superannuation funds that hold an asset for more than 12 months. For individuals and trusts, this discount reduces the taxable capital gain by 50%, while superannuation funds receive a 33.33% discount. However, companies are not eligible for this discount, so it's important to consider the structure of your business when tax planning.
Importantly, there are four exemptions available, particularly for small business owners, each offering a unique benefit depending on the business owner’s circumstances:
- 15-Year Exemption
The 15-year exemption allows business owners to disregard the entire capital gain if they have owned the asset for at least 15 years and are 55 years or older and retiring or permanently incapacitated. This exemption provides full CGT relief, making it particularly valuable for business owners looking to exit the business and fund their retirement. - 50% Active Asset Reduction
Under the 50% active asset reduction, eligible small business owners can reduce their capital gain by 50%. This concession applies to assets that qualify as "active", meaning they have been used or held ready for use while running a business. - Retirement Exemption
The retirement exemption provides business owners with the ability to disregard capital gains of up to $500,000 over their lifetime. While the name suggests this is only for retirement, it is available to anyone selling a business asset, provided they contribute the exempt amount to their superannuation fund if they are under 55 years old. - Small Business Rollover
The small business rollover allows business owners to defer capital gains by reinvesting the proceeds of the sale into a new business asset. This deferral can extend up to two years, or longer if a replacement asset is acquired within that period.
This combination of discounts allows for significant tax relief and is a key strategy in minimising the CGT impact on the sale of business assets.
Eligibility Criteria
To access the Concessions, small business owners must meet specific eligibility criteria set by the Australian Tax Office (ATO):
- Aggregated Turnover Threshold: To qualify as a small business for CGT purposes, your business (and any affiliated businesses) must have an aggregated annual turnover of less than $2 million.
- Active Asset Test: The asset being sold must have been actively used or held ready for use in the business for at least half of the ownership period.
- Maximum Net Asset Value Test: If your business does not meet the turnover test, it can still qualify under the maximum net asset value test. To pass this test, the combined net assets of your business and related entities must not exceed $6 million.
- Additional Requirements for Specific Exemptions: Some exemptions have additional conditions. For example, to access the 15-year exemption, the owner must be 55 years of age or older, and the asset must have been held for at least 15 years. For the retirement exemption, the business owner can contribute the exempt amount directly into superannuation up to a lifetime cap of $500,000. There are strict timeframes for making superannuation contributions under these two exemptions and for lodging appropriate paperwork with your superannuation fund.
Once the basic conditions are met, it's important to understand how the exemptions can be strategically applied to maximise tax savings.
Strategic Application
Maximising the benefits of small business CGT exemptions requires a thoughtful and strategic approach. Small business owners can apply as many of the exemptions as they are eligible for, ensuring that each capital gain is reduced to zero if possible. The key is to follow the correct order of application to make the most of the available relief.
First, consider the 15-year exemption. If applicable, this disregards the entire capital gain and no further exemptions need to be applied. The entire proceeds, up to the Lifetime CGT Cap election amount (currently $1.78 million), can be contributed to your superannuation and not counted under the non-concessional contributions cap. However, the contribution must be made before the later of (1) the day you lodge your tax return or (2) 30 days after receipt of proceeds. A Lifetime CGT Cap election form must be provided to your super fund on or before the day you make the contribution.
If the 15-year exemption does not apply, the next step is to offset the capital gain against any current or prior year capital losses. For multiple capital gains, you can choose the order in which your capital gains are offset to maximise the benefit.
Once you have established the net capital gain you apply the general capital gains discount to reduce the remaining capital gain by 50% for individuals or Trusts.
After the general discount is applied, the 50% active asset reduction is then automatically applied, unless you elect not to use it.
Finally, any remaining capital gain can be deferred using the small business roll-over exemption or reduced by the $500,000 small business retirement exemption, depending on which suits your circumstances.
A super contribution under the $500,000 retirement exemption must be made by the later of (1) the day you choose to apply the retirement exemption i.e. the day you lodge your tax return or (2) 30 days after proceeds are received if you are over age 55 (different timing applies to those under age 55 or where a company or trust is claiming the exemption). A Lifetime CGT Cap election form must be provided to your super fund on or before the day you make the contribution.
This structured approach ensures you make the most of the available CGT relief to minimise your tax liability.
Common Pitfalls
While the small business CGT exemptions offer significant tax-saving opportunities, it’s important to navigate them carefully to avoid common mistakes that could lead to missed benefits. Engaging a qualified tax professional can help you:
- Clarify your status as an eligible ‘small business’.
- Identify whether you have a tax event relating to an ‘active asset’.
- Structure the timing of your asset sales to maximise your eligibility.
- Choose the appropriate exemptions and order of application.
- Ensure your choices are declared in your tax return for the applicable financial year.
- Ensure any superannuation contributions to be made under the 15-year or retirement exemptions are made within required timeframes and a Lifetime CGT Election form is lodged with your super fund; and
- Avoid costly mistakes.
Conclusion
The small business capital gains tax (CGT) exemptions provide a powerful set of tools to reduce or eliminate the tax burden when selling a business asset. By understanding the eligibility criteria, how the various concessions interact, and the importance of proper timing and record-keeping, small business owners can significantly reduce their capital gains liability. However, navigating these exemptions can be complex, and making the wrong choices can result in lost benefits or costly errors.
If you’re planning to sell a business asset or want to better understand how these CGT exemptions apply to your situation, it’s essential to seek expert advice as there are slightly different requirements for businesses owned within a company or trust structure. Reach out to our team to ensure you maximise the benefit of available concessions.
Contact one of our Wealth Advisers at clientservices@primefinancial.com.au for tailored financial solutions, utilising our strategic knowledge and investment acumen to help you and your family with long-term financial aspirations.
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