Tue 05 2018

Failing to see the forest from the trees – changes to small business CGT Concessions

As part of its 2017-18 Budget, on 9 May 2017, the Government announced proposed amendments which would limit the application of the small business CGT concessions (SBCGT Concessions).

In our previous article, we discussed the exposure draft legislation and explanatory (Exposure Draft) released on 8 February 2018.

On 28 March 2018, the Government introduced into Parliament the Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018 (Bill). The Bill contains the first iteration of the proposed amendments to the SBCGT Concessions.

In the Government’s words, the amendments are intended to ‘improve the integrity of the tax system’. However, the breadth of the changes proposed raise a question as to whether the Bill will result in an integrity improvement or a broader shift away from the policy intentions which have underpinned the SBCGT Concessions since their introduction in 1999.

Changes to the concessions

The two key differences between the Exposure Draft and the Bill are as follows:

  • the removal of the proposed requirement that the Object Entity must carry on a business at the relevant time and
  • changes to a proposed exclusion regarding when cash and financial instruments would be regarded as active assets.

Under the Bill, the existing basic conditions for relief set out in subsection 152-10(1) of the ITAA 1997 will remain unchanged. However, for capital gains relating to shares in a company or interests in a trust, the Bill proposes significant amendments.

The table below provides a comparison between the current SBCGT rules and the changes proposed in the Bill.

Current SBCGT Rules Proposed new SBCGT Rules
The current SBCGT Concession rules apply the following additional basic conditions for capital gains relating to shares in a company or interests in a trust:

  • if the relevant taxpayer is an individual, either the taxpayer or their spouse must be a ‘CGT concession stakeholder’ in the Object Entity or
  • if the relevant taxpayer is a company or trust, CGT concession stakeholders in the Object Entity must together hold (directly or indirectly) at least 90% of the interests in the taxpayer.
The Bill proposes that additional basic conditions will apply for capital gains relating to shares in a company or interests in a trust (Object Entity) as follows:

  • either the taxpayer must be a CGT concession stakeholder in the Object Entity, or CGT concession stakeholders in the Object Entity must hold at least 90% of the interests in the taxpayer
  • unless the taxpayer satisfies the maximum net asset value test (MNAVT), the taxpayer must have carried on a business just prior to the CGT event
  • the Object Entity must either be a CGT small business entity for the income year or satisfy the MNAVT and
  • the shares or interests in the Object Entity must satisfy a modified active asset test.

 

While the measures in the Bill are an improvement to those announced in the Exposure Draft, some major issues still remain.

For example, the requirement for the Object Entity to meet the MNAVT or small business entity test will exclude taxpayers who are presumably outside the integrity concern. Further, under the shield of its original announcement on 9 May 2017, the Government has retained a retrospective application date of 1 July 2017.

History and policy

There are some broader underlying policy issues which the Bill raises.

The Government made a promise in its Budget announcement that the SBCGT Concessions would continue to be available to small business taxpayers, and stated in the Explanatory Memorandum to the Bill that the proposed changes are intended to ‘improve the integrity of the tax system’.

However, a question arises as to whether the Bill will result in an integrity improvement or a broader shift away from the policy intentions which have underpinned the SBCGT Concessions since their introduction in 1999.

The SBCGT Concessions found in Division 152 of the ITAA97 were introduced under the New Business Tax System (Capital Gains Tax) Act 1999. At that time, there was no requirement to test whether an Object Entity satisfied a maximum net asset value or a CGT small business entity test. Moreover, the concessions did not contain or refer to a separate concept of a ‘CGT small business entity’ – the relevant requirement was simply that the relevant taxpayer needed to satisfy a $5 million maximum net asset value test.

In fact, it was not until the enactment of Tax Laws Amendment (Small Business) Act 2007 that the concept of a ‘CGT small business entity’ was introduced directly into Division 152. However, this introduction was not intended as a restriction on the application of the SBCGT Concessions, but rather an extension of their availability.

That is, after the enactment of Tax Laws Amendment (Small Business) Act 2007 a taxpayer who failed the MNAVT could still access the SBCGT Concessions if it was a ‘small business entity’ – ie if it carried on a business and satisfied an aggregated turnover test of $2 million. This Act also increased the MNAVT from $5 million to $6 million.

Fast-forward to the 2017-18 Budget, where the Government stated that:

However, some taxpayers are able to access these concessions for assets which are unrelated to their small business, for instance through arranging their affairs so that their ownership interests in larger businesses do not count towards the tests for determining eligibility for the concessions.

The small business CGT concessions will continue to be available to small business taxpayers with aggregated turnover of less than $2 million or business assets less than $6 million

Through this announcement and the introduction of the Bill, the Government has seemingly shifted the focus further towards the concept of a CGT small business entity. In doing so, it has also proposed a shift from testing the taxpayer only (ie the entity disposing of an asset, share or interest) to a twofold approach which also tests an Object Entity. This is seemingly on the basis of a policy intention that an Object Entity must itself be a CGT small business entity in order for the SBCGT Concession to apply.

This requirement was neither contemplated by the Government when introducing Division 152 in the New Business Tax System (Capital Gains Tax) Act 1999, nor in making the amendments under the Tax Laws Amendment (Small Business) Act 2007 which introduced the concept of a ‘small business entity’. Put simply, under the guise of an integrity improvement the Government is proposing a significant change to the SBCGT Concessions.

It is also interesting to note that while the Government has focused on improving integrity measures in relation to the SBCGT Concessions, it hasn’t addressed the apparent complexity inherent in the rules which many in the industry have lamented for some time. Finally, one could question whether the Government appreciates that the measuring stick for a small business may change over 17 years; given that the MNAVT has only increased by $1 million in that amount of time.

This article was published by Thomson Reuters in Weekly Tax Bulletin.

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Michael’s practice focuses on tax disputes, capital gains tax, business sales and acquisitions and restructuring...

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Adam is an experienced tax lawyer, and advises clients on a range of matters including tax planning and structuring, Division 7A, the small business CGT concessions, corporate restructuring, professional firm structures, trust taxation, the taxation of settlements and cryptocurrency taxation.

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