Staying active on CGT concessions

There are three basic conditions that must be satisfied before the four small business capital gains tax (CGT) concessions can be utilised:

(i) maximum net asset value test;

(ii) active asset test; and

(iii) significant individual test.

The maximum net asset value test does not always apply. For example, a small business entity (defined as an entity with an aggregated annual turnover of less than $2 million) does not have to satisfy the maximum net asset value test.

Similarly, the significant individual test only applies as a basic condition where the asset being disposed of is a share in a company or an interest in a trust.

However, the active asset test needs to be satisfied on all occasions where you are looking to utilise the small business CGT concessions. The active asset test, therefore, is the core test of the basic conditions, as the actual small business CGT concessions cannot be utilised for assets that are not active assets.

What is an active asset?

A CGT asset is an active asset if at that time:

(a) you own the asset (doesn’t matter whether it is tangible or intangible), and (i) you use it, or hold it ready for use, in the course of carrying on a business, or (ii) it is used, or held ready for use, in the course of carrying on a business by your affiliate, or by another entity that is connected with you; or

(b) if the asset is an intangible asset (eg, goodwill or the benefit of a restrictive covenant) — you own it and it is inherently connected with a business that you, your affiliate, or another entity that is connected with you carries on.

The term ‘you’ used throughout this article is used to refer to the taxpayer who has made the capital gain. For the purposes of the active asset test the term ‘affiliate’, if the taxpayer is an individual, also has its own meaning.

For the purposes of the active asset test, the following rules apply to a CGT asset that you own if you are an individual:

(a) the asset (whether it is tangible or intangible) is taken to be used, or held ready for use, in the course of carrying on a business by your affiliate if the asset is used, or held ready for use, in the course of carrying on a business by your spouse or child under 18 years of age; or

(b) if the asset is an intangible asset — the asset is taken to be inherently connected with a business that your affiliate carries on (eg, goodwill or the benefit of a restrictive covenant) if the asset is inherently connected with a business that your spouse or child under 18 years of age carries on.

Furthermore, for the purposes of determining whether an entity is connected with you for the active asset definition, a trustee of a discretionary trust may nominate not more than four beneficiaries as controllers of the trust for a tax year in which the trust did not make a distribution of income or capital, if the trust had a tax loss or no taxable income, for that tax year.

Such a nomination, which must be in writing and be signed by the trustee and each nominated beneficiary, has the same effect as if each nominated beneficiary controlled the trust for that tax year. This means each nominated beneficiary is connected with the trust for the purposes of the definition of an active asset.

There are a number of assets that are specifically excluded in the legislation from being an active asset. These are covered in the section titled, ‘What is not an active asset?’.

Satisfying the active asset test

Once you have determined whether or not the CGT asset that has been sold is an active asset, you also need to see whether the active asset test can be satisfied.

A CGT asset satisfies the active asset test if:

(a) you have owned the asset for 15 years or less and the asset was an active asset of yours for a total of at least half the period specified below, or

(b) you have owned the asset for more than 15 years and the asset was an active asset of yours for a total of at least 7.5 years during the period specified below.

The period referred to above:

(a) begins when you acquired the asset; and

(b) ends at the earlier of:

(i) the CGT event; and

(ii) if the relevant business ceased to be carried on in the 12 months before that time or any longer period that the Commissioner allows, the cessation of the business.

The rules described in this section regarding the active asset test have only applied from July 1, 2006. Prior to this date, an asset needed to be an active asset just before the CGT event. (See case study for a comparison of the benefits of the revised active asset test.)

When is a share or an interest in a trust an active asset?

A CGT asset is also an active asset at a given time, if at that time you own it and it is either a share in a company that is an Australian resident at that time or an interest in a trust that is a resident trust for CGT purposes for the tax year in which that time occurs, and the total of the following:

n the market value of the active assets of the company or trust; and

n the market value of any financial instruments of the company or trust that are inherently connected with a business that the company or trust carries on; and

n any cash of the company or trust that is inherently connected with such a business, is 80 per cent or more of the market value of all of the assets of the company or trust.

Effectively, this is a look-through provision that says that for a share in a company or an interest in a trust to be an active asset at least 80 per cent of the underlying assets of that company or trust need to be active assets.

A number of changes have been made that make the 80 per cent test easier to satisfy from July 1, 2006, and generally more user friendly.

Firstly, cash and other financial instruments that are inherently connected with the business are now counted towards this test. Previously, where a company or a trust held large amounts of cash from takings this may actually have prevented them from satisfying the 80 per cent test.

To ensure that the 80 per cent test does not need to be applied every day, a share or an interest in a trust (for the purposes of the 80 per cent test) is an active asset at a time (the later time) if:

l the share or trust interest was an active asset at an earlier time; and

l it is reasonable to conclude that the share or trust interest is still an active asset at a later time.

A share or an interest in a trust is still an active asset if it fails to meet the 80 per cent test at that time and the failure is of a temporary nature only.

What is not an active asset?

There are a number of assets that are specifically excluded from satisfying the active asset test.

The following CGT assets cannot be active assets:

n an asset whose main use in the course of carrying on a business (for you, an affiliate or another entity connected with you) is to derive interest, an annuity, rent, royalties or foreign exchange gains unless:

(i) the asset is an intangible asset and has been substantially developed, altered or improved by you so that its market value has been substantially enhanced; or

(ii) its main use to derive rent was only temporary.

n financial instruments (such as loans, debentures, bonds, promissory notes, futures contracts, forward contracts, currency swap contracts and a right or option in respect of a share, security, loan or contract);

n interests in an entity that is connected with you other than shares and interests that meet the definition of an active asset (that is, shares in a company that is an Australian resident or an interest in a trust that is a resident trust for CGT purposes and satisfies the 80 per cent test mentioned previously);

n shares in a company, other than:

(i) shares in a widely held company that meets the definition of an active asset (see the 80 per cent test) and are held by a CGT concession stakeholder of the company, and

(ii) shares in any other company that are covered by the active asset test (see the 80 per cent test).

n interests in a trust, other than:

(i) interests in a widely held trust that are covered by the active asset test (see the 80 per cent test) and are held by a CGT concession stakeholder of the trust; and

(ii) interests in any other trust that are covered by the active asset test (see the 80 per cent test).

Tax advice

All advice in relation to the small business CGT concessions needs to be confirmed by an accountant.

The accountant should be someone who has a good understanding of the various rules associated with the small business CGT concessions and, in particular, with the recent changes to the concessions.

There are also a number of ‘grey areas’ associated with the small business CGT concessions. In particular, the changes are relatively new, so there will be very few Australian Taxation Office (ATO) Tax Determinations and Interpretative Decisions that can be used as a reference in areas where the law is unclear.

In these situations, clients should be referred to an accountant. If the accountant can’t make a decision in relation to that matter, then the client, through their accountant, should apply to the ATO for a binding private tax ruling.

Robert Thomas is the national manager of technical, research, advice and paraplanning at AXA Australia .