Things to consider when Capital Gains Tax applies
CLANCY looks at tax strategies for farms and small businesses in the second part of a two-article series. Last month he tackled income tax, this month he looks at capital gains tax.
THIS article is the second instalment looking at the criteria and advantages of small businesses utilising Capital Gains Tax (CGT) concessions. The first instalment focused on income tax benefits available and the criteria in order to be deemed a small business for income tax purposes, and this instalment will concentrate on the criteria and concessions available for small businesses specific to CGT.
With average age of farmers on the rise, and property prices at record highs, the need to consider capital gains is inevitable for succession planning or realising the assets held.
Firstly, before mentioning the CGT concessions available for small businesses, it is worth recognising the criteria to be considered a small business, noting these are different to those for income tax purposes discussed previously.
There are two eligibility criteria for the small business CGT concessions:
- Having an aggregate turnover of less than $2m; or
- Having net assets of no more than $6m.
From experience, passing the aggregate turnover test is more easily achieved than the net assets test. This is due to the fact that in the primary production industry, generating revenue of greater than $2m generally requires a property with a value greater than $6m.
So, focusing on the $2m turnover test, it is important to note that similar to the income tax criteria, it is the aggregate turnover, which includes all connected entities and affiliates.
If one, or both of these criteria are met, the asset must then pass the active asset test in order to apply the CGT concessions. There are numerous tests that can prove an asset was active.
Given article constraints, I have chosen not to discuss these further, as they can become complex. It is merely mentioned as a criterion that will require further consideration on a case by case basis if a capital event has occurred.
To meet the criteria for an entity to be classified a small business for CGT purposes, the following four concessions are available:
- 15-year exemption (not applicable to companies);
- 50 per cent active asset reduction;
- retirement exemption (not applicable to companies); and
- replacement asset rollover.
The 15-year exemption is applied first if you have owned the active asset for 15 years or more (of which the asset was active for at least 50 per cent of the time held), are older than 55 and are retiring, or are permanently incapacitated.
This makes the CGT exempt, which eliminates the need to pay any tax on the capital gain.
Before assessing the further small business CGT concessions it is important to be aware that the first reduction applicable to a capital gain is the 12 month 50 per cent reduction.
This reduces the capital gain by half and is applicable to any capital gain held longer than 12 months, regardless of whether they were a small business or not. It is worth noting that this reduction cannot be applied by a company.
If the 15-year exemption is not applicable and following the 12 month 50 per cent reduction, then there is a 50 per cent active asset reduction which can reduce further the capital gain by half. If the 12 month reduction is applied then the small business 50 per cent reduction will be applied to the reduced capital gain amount (See the scenario below for the application of this).
The retirement exemption allows up to $500,000 (lifetime limit) to be exempt, noting if you are under 55 and wish to apply for this concession, the amount you are claiming an exemption for must be deposited into a complying superannuation fund.
Finally, the rollover relief allows you to defer the remaining capital gain (after the other concessions have been applied) if you acquire a replacement asset within two years.
This concession will reduce the cost base in the replacement asset, so essentially the capital gain upon the sale of the replacement asset will be greater due to the decreased cost base. It should be noted that unlike the concessions above, this is a deferral mechanism and not an exemption.
Similar to most concessions provided by the government, there are, of course, conditions and clauses further to what has been discussed that need to be considered before definitively being able to apply each concession.
As a general note however, it is evident that the difference between being classified a small business or not can have a significant impact on the resulting tax bill associated with business transactions from day to day transactions through to the final sale of the business.
Here is an example to illustrate the difference between being deemed a small business or not. In this scenario let’s assume a cattle farmer purchased a property for $3m and has subsequently sold it some years later for $4m.
They then purchased a new property some months later.
(Deemed a Small Business)
(Not deemed a small business)
|Gross Capital Gain||1,000,000||1,000,000|
|Small Business Reduction||(250,000)|
|Net Capital Gain||NIL||500,000|
This table shows how the small business deduction and the rollover exemption can be applied to fully eliminate the $1m capital gain incurred upon the sale of the property, noting that the rollover exemption can only be applied if the farmer purchased another property. The $250,000 would reduce the cost base of the new property purchased.
As stated above, it should be noted that if a company incurs the capital gain it cannot apply the general 50 per cent discount, the 15-year exemption or the retirement exemption leaving only the active asset reduction and the rollover exemption.
A final comment to make is that there are complex rules where shares are being sold for determination if they are active assets and where a trust makes the capital gain and distributes this to a beneficiary.
Based on the complex rules regarding this area of CGT, we recommend you discuss your circumstances with your advisor prior to undertaking any transactions.
About the Author:
Clancy Cox is a fourth-generation cattle farmer from the Cox and Atkinson lineages. His great-grandfather Monty Atkinson was instrumental in developing the droughtmaster herd which is still incorporated in the family operation today. Clancy was born and raised on “Glensfield Station,” a cattle station 45km west of Mackay. The family operation runs 10,000 head of cattle for breeding and fattening across three properties.
Clancy has a unique understanding of the agribusiness sector, combining his involvement in the family operation with skills he has developed as a Senior Accountant at PVW Partners.
Clancy is passionate about growing regional Australia.
Information provided in the article is of a general nature and is intended for informative purposes only. It does not take into account personal financial circumstances. Tailored professional advice should be sought before acting on any of the information contained above.