CGT concession pitfalls for retiring business owners

There are pitfalls in selling a business and moving to retirement, as Graeme Colley writes.

It was former Prime Minister Malcolm Fraser who famously (or infamously) said that life wasn’t meant to be easy.

Well, when it comes to small business owners attempting to maximise the capital gains tax (CGT) concessions, those words are prophetic.

The sad reality is that some business owners who are nearing retirement fail to understand the complexity surrounding the eligibility criteria for these CGT concessions and end up paying a high price. Indeed, in the case I am about to cite, a very high price.

But first things first; these concessions are generous, and if properly utilised are an important tool for business owners planning to retire.

They can be used to transfer business property into self-managed super funds (SMSFs) tax free, and can also allow small business owners to make tax-free contributions to their SMSF when they sell business assets. 

That’s the good news.

Where business owners slip up is by failing to appreciate that the provisions in Division 152 of the Income Tax Assessment Act 1997 (especially the eligibility criteria for the concessions) are complex, and that the conditions that need to be satisfied to secure the CGT small business concessions must be met just before the relevant CGT event occurs – usually just before the sale or disposal of the relevant asset.

Among these conditions are the small business entity test, the maximum net asset value test, the significant individual test, and the active asset test.

A case in point

To illustrate how it can all go pear-shaped, a recent Administrative Appeals Tribunal (AAT) case (Confidential and Commissioner of Taxation [2013] AATA 76) highlighted the adverse outcome for a small business owner where poor timing when selling an asset increased the taxable income by more than $700,000.

Timing was everything in this case. The taxpayer was selling his share in a business entered into a Heads of Agreement for sale on 7 August 2008, and the final contract of sale for the business was executed just over four months later on 19 December 2008. 

The taxpayer used the CGT discount and small business concessions to reduce the $704,129 capital gain made from the business sale to zero.

However, the ATO amended the taxpayer’s 2008-09 tax return to include the $704,129 capital gain in the taxpayer’s assessable income on the basis that the taxpayer did not qualify for the CGT small business concessions.

The Commissioner of Taxation contended that the taxpayer did not satisfy the conditions to access the small business concessions at the time of the CGT event, which the Commissioner viewed as being when the Heads of Agreement was finalised, and the AAT upheld the Commissioner’s decision. Why?

The AAT contended that the CGT event happened at the time the Heads of Agreement was executed because of the following:

• The terms left little scope for doubt that the parties agreed to the sale and purchase of the business;
• It included a schedule detailing the terms and conditions of the sale; and
• It expressly stated that the parties agreed to be bound by the terms of the document.

There are two obvious lessons here for small business owners about to sell up and enter retirement.

First, the importance of being fully across all the details of a taxpayer’s arrangements when dealing with the CGT small business concessions – even those that might be taken for granted, such as the date of a sale.

As I noted, the difference of four months in the sale of the small business made a significant difference to the taxpayer’s final tax outcome. 

Second, there is the need to get professional advice. Advisers can help clients qualify for the CGT concessions by:

• Checking and structuring their clients’ affairs to make sure they are eligible for the CGT small business concessions; and
• Seeking legal advice to make sure that Heads of Agreement do not form a binding contract for sale.

Graeme Colley is the director of education professional standards at the SMSF Professionals’ Association of Australia (SPAA).