Details matter for the Small Business CGT 15-year exemption

As tax advisers, we have to pay attention to detail. Every word in a section has a purpose, and so we have to consider what that purpose is when giving advice.

A recent example of this related to the use of similar terms in the small business CGT concessions. The taxpayers were selling the business and retiring; they were over 55 and had owned and run the business in a trust for over 15 years. The question was about access to the small business 15-year exemption.

The phrases in the law that drew our attention were ‘CGT concession stakeholders’ who have ‘small business participation percentages’ in the basic rules, while the 15-year exemption refers to a ‘stakeholder’s participation percentage’, which sounds like a combination of the two. However, they are different phrases with different definitions. As it turns out, this can give an outcome which might differ from what was expected.

For trusts and companies who are choosing the 15-year exemption, the cap on the amount which can be paid to each CGT concession stakeholder and disregarded for tax purposes is based upon the individual’s small business participation percentage as determined under the basic rules. For a company, a shareholder’s small business participation percentage is the same as their stakeholder’s participation percentage, i.e. their percentage ownership interest. That shareholder can receive up to that percentage of the overall capital gain as non-assessable non-exempt (NANE) income under Subdivision 152-B. If the shareholder somehow receives more, then the additional amount is a dividend and is assessed via section 44, even though the underlying gain was NANE in the company itself. Unit trusts have a similar application, except any additional amount received would be dealt with under CGT event E4. So far, so good.

The unusual complication here though is that these rules work differently for non-fixed trusts.

To determine the cap of what can be paid as NANE to CGT concession stakeholders of a non-fixed trust, the cap is calculated as 100% divided by the number of CGT concession stakeholders. The unusual aspect here is that this ignores their actual small business participation percentage in the year (which is the percentage which is used to calculate their eligibility to the concessions in the first place). So as an example, if there are three siblings each to receive 1/3 of the gain and the trustee determines that for one sibling their gain is to be split between them and their spouse (say 20% to one and 13.33% to the other) then there are four CGT concession stakeholders. As 100 divided by four is 25, each of the four has a cap of 25% as to what can be paid to them under the 15-year exemption and be non-taxable as a result.

The outcome in the above example would be:

• Siblings #1 and #2 have a 25% cap but will receive 33.3% each, so part of their payment will be over the cap;
• Sibling #3 has a 25% cap and is receiving 20%, so there is no amount they receive in excess of their cap; and
• Sibling #3’s spouse has a 25% cap and is receiving 13.33%, so again there is no amount that they receive in excess of their cap.

The difference between the distributions an individual receives, and which determine whether they are a CGT concession stakeholder, can thus be different from the cap that the trust can pay them under the protection of the 15-year exemption.

The tax treatment of the ‘over cap’ amount which siblings #1 and #2 will receive is not something that is well understood. The only ATO document we could find was private ruling 1012763304218.

Our preliminary view of the outcome in the above example is as follows:

1. The excess distribution above the cap is still NANE for the trust;
2. It is an otherwise non-taxable distribution made by the trust to the relevant siblings;
3. Section 95 only brings in assessable income – so if the excess gain is still NANE then it does not seem to make the excess subject to tax;
4. Subdivision 115-C cannot include a share of the capital gain in the siblings’ assessable income as it has been disregarded by the trust; and
5. The fact that the excess is not an amount paid under the section 152-125 cap means that the excess may not qualify to be able to be contributed into super by the relevant siblings.

Whilst the only practical difference appears to be the inability to place the further 8.33% per sibling into super (assuming that they were considering that in any event), the consequences to their superannuation balances of exceeding the cap could be significant. This includes whether the fund can accept such a contribution, and whether any excess super contribution exposures arise.

We think we understand why the law is the way it is though. The relevant sections were changed in 2007 when the threshold for a significant individual was reduced from 50% to 20%.  Under the old rules it was set at a fixed 50% per individual when there were two, and a fixed 100% when there was only one, which made sense where you had a maximum of two people only. The updated law changed the calculation for non-fixed trusts to continue to split the cap equally between all CGT concession stakeholders of that trust. If only the change had been to use the beneficiary’s small business participation percentage the law would not only be simpler, it would also make more sense. In addition, it would achieve the policy objective of allowing individuals to place these types of capital gains into super to provide for themselves in retirement.

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