Small business owners may be eligible for various concessional treatments for transactions that involve capital gains tax (CGT). These concessions can reduce, defer or at times even eliminate tax payable from capital gains. Applying these concessions can often trip up small business taxpayers.

The Tax Office recently reported that its compliance work had revealed some common mistakes occurring on a regular basis from small business owners when applying the relevant tests for eligibility to these CGT concessions.

There are four concessions that may be available to eliminate or reduce capital gains made by a small business in respect of eligible assets:

• The 15 year exemption: Where a retiring taxpayer has held an asset for at least 15 years
• The retirement exemption: Where capital proceeds are put towards retirement savings (there is no need to actually retire)
• The 50% active asset reduction: The capital gain may be discounted by 50% (not to be confused with the 50% general discount for assets held for at least 12 months by certain taxpayers), and
• The CGT rollover: A capital gain may be deferred if a replacement asset is acquired within a specified time frame.

The concessions are subject to a number of eligibility criteria and conditions; ask this office if you would like to know more about these concessions for small business.

In an effort to stem the tide of erroneous claims, the Tax Office issued a statement, directed to both small business entities and to their tax agents, about its areas of concern.

Maximum net asset value

The Tax Office said that one of the most common errors seems to surround the maximum net asset value test, which is one of the basic conditions that may need to be satisfied in order to gain access to the concessions in some circumstances.

Under this condition, just before the relevant CGT event happening, the total “net value” of CGT assets that the taxpayer and specified related entities own cannot be more than $6 million. (This is inclusive of the CGT asset subject to the CGT event.)

Broadly, the net value of the CGT assets of an entity is the total market value of its assets, less any liabilities relating to those assets. The net asset value of an entity is also reduced by any provisions for annual leave, long service leave, unearned income and tax liabilities.

As noted, the maximum net asset total not only includes the value of assets that are owned by the taxpayer conducting the business, but also assets of any “connected entities” and “affiliates” of the taxpayer (contact this office for an explanation of these terms). The Tax Office said that failing to identify “connected entities” and “affiliates” is one of the common mistakes, but other errors include:

• the valuation of assets at historical cost rather than market value just before the CGT event
• not including the CGT asset sold in the calculation, and
• not including relevant goodwill assets in the calculation.

The Tax Office added that where a market value is required, accepted valuation principles should be applied.

Use contract date, not settlement date

The Tax Office also found that business owners had incorrectly used the settlement date instead of the contract date when recording details of the CGT event. This can end up resulting in:

• the “active asset” test not being met (broadly, that the asset be “actively” used in the business for a certain period of time), or
• incorrectly applying the 15 year exemption when the asset had not been held for that time.

The Tax Office noted that a CGT event is generally deemed to occur at the time a contract is entered into, not at the settlement date.

Where contract and settlement dates cross over financial years, the capital gain or loss should be declared in the financial year in which the contract was signed.

Earn-out arrangements

The sale of a business often includes a clause that the seller will obtain further payments based on the business achieving certain future goals, otherwise referred to as earn-out rights. The Tax Office said that earn-out rights must be included in the capital proceeds when selling a CGT asset, and also when calculating the maximum net asset value.