On 8 February 2018, Treasury put up, an exposure draft of the Treasury Laws Amendment (Measures # ??) Bill 2018, on its website. This Bill proposes amendments to to deal with ‘integrity’ concerns for the small business CGT concessions‘. The Draft is for consultation, and Treasury will take submissions, until 28 February 2018.
In the 2017-18 Budget, the Government announced that it would change and add to the conditions for these CGT concessions, so that a taxpayer will only be able to access them in respect of assets that are used in a small business, or which represent an ownership interest in the small business (sounds vague – read on).
It announced that these changes would be retrospectively enacted with effect from 1 July 2017.
A. The Small Business CGT concessions are in Div 152 of the ITAA97 and allow for:
- complete CGT exemption, if the asset is held for at least 15 years & the taxpayer or shareholder retires [subdivision 152-B];
- a 50% discount, or further discount, on remaining amount of the gain, to be assessed (viz: a 75% discount after the 50% general discount) [subdivision 152-C];
- exclude up to $500k, of the gain, from assessment, for amounts, contributed into a superannuation fund, on the retirement of the taxpayer or shareholder [subdivision 152-D]; and
- a replacement asset rollover, deferring CGT on any remaining gain [subdivision 152-E].
B. To access these concessions, there are some ‘basic conditions’ (in s152-10), which include:
- The taxpayer is either a ‘CGT small business’ (sub-$2m turnover) or it must pass the ‘maximum net assets value test’ (less than or equal to $6m) [s152-10(1)(c)(i)&(ii)]. Both the ‘small business’ turnover [s328-115(2)] and the $6m asset values [s152-15(1)], include that of entities ‘connected with’, or an ‘affiliate’ of, the taxpayer [see also s152-10(1A) for passively held assets].
- The relevant asset satisfies the ‘active asset test’ [s152-10(1)(d)], which involves it being ‘active’ for at least half of the period the taxpayer owns the asset [s152-35(1)(a)]. This in turn involves the asset being used in a business by the taxpayer, or an entity that is ‘connected with’ the taxpayer, or its ‘affiliate’ [s152-40(1)].
- If the asset is a share in a company or an interest in a trust (‘Object Company/Trust’) the taxpayer must [under s152-10(2)] be a ‘CGT concession stakeholder’ (at least a 20% interest [under s152-50/60]) and those ‘stakeholders’ must hold a ‘small business business participation interest’ of at least 90% [under s152-65/75].
C. Where shares in a company, or interests in a trust, are sold (or there is another CGT event), there will be three new conditions for the relief. They are as follows.
- the shares or interests in the object entity must satisfy a modified active asset test that looks through shares in companies and interests in trusts to the activities and assets of the underlying entities
- unless the taxpayer satisfies the maximum net asset value test, the relevant CGT small business entity must have carried on a business just prior to the CGT event;
- the object entity must carry on a business just prior to the CGT event and either:
- be a CGT small business entity (sub-$2m turnover); or
- satisfy the maximum net asset value test ($6m or less); and
These will all be effected by inserting a new s152-10(2), (2A) & (2B) into the ITAA97.
D. The draft EM makes various comments about these 3 classes of proposed changes.
- Modified active asset test: This to be effected by the replacement s152-10(2)(a) and new ss(2A). The EM explains this test at some length and has some helpful examples [paras 1.16 to 1.26]. This is a substantive change.
- Condition relating to taxpayer (shareholder etc.) [new s152-10(2)(b)]. Where the concession is to depend on the taxpayer being a ‘CGT small business entity’, then the requirement is that its business activities have to be ‘just prior’ to the relevant CGT event – eg. sale of the shares in that entity. There is no need to impose this ‘proximity’ test, when the concessions are claimed on satisfying the $6m net worth test, as it does not depend on carrying on business. [EM, paras 1.25 & 1.26]
- Condition relating to object entity [new s152-10(2)(c)&(d)]. The major change, here, is that the taxpayer can no longer sell the shares/units in an ‘object entity’ that simply leases or licences valuable valuable assets for a related business (if that does not amount to carrying on a business) [ss(2)(c)&(d)(i)&(ii)]. When working out if the object entity is a CGT small business entity, or satisfies the maximum net asset value test, the turnover or assets of entities that may control the object entity are disregarded. This ensures that the outcomes for taxpayers do not depend upon the income or assets of third parties [ss(2)(d)(iii)&(iv)].
EDITORIAL COMMENT – there is much to say about the new ‘object entity’ requirement.
- It is objectionable, as it is an incursion into long practised ‘asset protection’ strategies, without being justified by any identifiable mischief.
- It might have been satisfactory, to have required the object entity, to either satisfy the $6m net assets test (which it effectively had to, already), or be a ‘small business entity’ (including the requirement to carry on business, immediately before the relevant CGT event).
- But, requiring an object entity, to carry on business, would appear to preclude a related entity leasing, or licensing, the valuable assets, to a liability prone business, for rent, fees or royalties. It would seem to many, that this does not amount to ‘carrying on a business’.
- A shareholder/unitholder might be prepared to sell the shares in Business Co. and sell the actual (valuable) assets out of Property Co/Trust (to avoid this new problem). But that can make it difficult for the taxpayer, to access the untaxed profit, from Property Co/Trust, without further tax (effectively clawing back the concession – which was the problem that lead to all the concession provisions, that allow shares and units, to be sold, in the first place).
- These changes will be retrospectively enacted with insufficient detail, at the time they were announced, to now have retrospective effect (especially if the measure is objectionable in the way described here).
- Professor Bob Deutsch, writing as Senior Tax Council, for the Tax Institute, has identified this requirement as objectionable, for the same reasons (see the Institute’s weekly email publication, to members: The Vine, #5, 16 February 2018).
- The only ameliorating consideration could be the Commissioner’s recently expressed view that, for a company, the range of activities that constitute ‘carrying on a business’, is wider than for an individual, and will commonly include mere leasing of property to some-one else. This was in his draft ruling: TR 2017/D7, which was initially expressed to be for the purposes of the same test, which was relevant for the staged reduction in company tax, under s23AA of the Income Tax Rates Act 1986 (TT article1). Later, however, he issued a fresh draft, which was expressed to apply generally (TT article2). This ruling was always going to be a ‘two edged sword’.
I made submissions, to this effect, to Treasury, about the objectionable nature of the ‘object entity’ requirement.
[FJM; LTN 26, 8/2/18; Tax Month February 2018]
Study questions (answers below*)
- Does the draft bill seek to implement a measure announced in the 2017/18 budget, to deal with ‘integrity’ concerns relating to the ‘Small Business CGT concessions’ in Div 152 of the ITAA97?
- Are there 3 types of this CGT relief?
- Is one of the ‘basic conditions’, for this relief, that the taxpayer meet either a $2m business turnover test or $6m net assets test?
- Does this draft bill seek to add 3 more basic requirements, for the sale of all types of assets?
- Is one of the new tests, a modified ‘active assets test’ that looks through to the underlying assets?
- Does the ‘object entity’ amendment, require that entity to be either, a small business entity, or satisfy the $6m net assets test (in which case, it doesn’t have to carry on business – like in the new ‘taxpayer requirement’)?