Small business 15 year exemption – look out for payment issues

by | Jul 18, 2017

The small business 15 year exemption is the best of the small business CGT concessions, allowing the entire capital gain on the disposal of a CGT asset to be disregarded.

Leaving aside any financial benefits relating to earnouts, when the capital gain occurs at a company or trust level, there is a requirement for the CGT exempt amount to be paid to each CGT concession stakeholder (up to each stakeholder’s participation percentage) within two years of the CGT event for that amount to remain exempt.

Better still is that each CGT concession stakeholder’s participation percentage of the capital proceeds (and not just of the CGT exempt amount) from the CGT event may able to be contributed to each CGT concession stakeholder’s complying superannuation fund up to their CGT cap amount ($1,445,000 for the 2017-18 income year) and not be counted as a non-concessional contribution if it made within 30 days of the payment.

However, advisers need to be aware that the payment of the excess of the capital proceeds over the CGT exempt amount may have tax consequences for the entities/individuals receiving those amounts.

Where the CGT asset has no cost base (e.g. goodwill), the capital proceeds will equal the gross capital gain and so the whole of any payment made to each CGT concession stakeholder (up to the amount based upon their participation percentage) will remain exempt.

However, it is when the CGT asset has a cost base that issues arise. The payment of this part of the amount may appear to be a return of capital but is not necessarily treated as such.

In the case of a company making the payment(s), the excess of the capital proceeds over the CGT exempt amount will likely be treated as a dividend. Tax will need to be paid and this may potentially reduce the amount of the proceeds available to a taxpayer to contribute to each CGT concession stakeholder’s superannuation fund.

Where a unit trust is making the payment(s), the excess of the capital proceeds over the CGT exempt amount will likely be treated as a non-assessable part under CGT event E4. This will be applied against the unit holder’s cost base in the units and to the extent there is any excess proceeds there will be an assessable capital gain.

When a discretionary trust is making the payment(s), the excess of the capital proceeds over the CGT exempt amount will often have no further income tax consequences.

As an example, assume that a unit trust realises a capital gain of $1,000,000 on the disposal of a CGT asset (capital proceeds of $1,300,000 less cost base of $300,000) that the gain is entirely disregarded under the small business 15 year exemption.

If there are two discretionary trust unit holders (each with a 50% interest) who, in turn, distribute all of their income and capital to a single individual beneficiary, each CGT concession stakeholder’s participation percentage of the CGT exempt amount could be disregarded when received by each discretionary trust (i.e. 100% × 50% × $1,000,000 = $500,000) and also by the CGT concession stakeholder if received within two years of the CGT event. However, the payment of the CGT concession stakeholder’s participation percentage of the capital proceeds (i.e. 100% × 50% × $1,300,000 = $650,000) to each discretionary trust will give rise to CGT event E4 issues in each discretionary trust as those trusts will receive payment of an amount (a non-assessable part) in excess of what they are assessed on.

The $500,000 CGT exempt component of the payment is excluded from the non-assessable part, leaving a non-assessable part of $150,000. If the cost base of the units held by each discretionary trust was $120,000, the $150,000 payment in excess of the CGT exempt amount (i.e. non-assessable part) to each discretionary trust will reduce the cost base of the units to $0, and the $30,000 excess will be an assessable capital gain under CGT event E4. This assessable amount will then flow through to the CGT concession stakeholder and potentially reduce the amount they can contribute as a CGT cap amount to their superannuation fund.

Any later winding up of the unit trust and return of capital may also give rise to a separate capital gain.

The above demonstrates another highly technical interaction between the small business CGT concessions and contributions to CGT concession stakeholders’ superannuation funds similar to the difficulties with in specie contributions.

Keep your eye out!

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