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When an accountant comes to us for assistance with their client’s small business CGT concession eligibility, we first try to understand the reasons for any of their concerns over eligibility and more often than not we discover that what they think the problem is, and what the problem actually is, are quite different. Of course, this has nothing to do with the adequacy of the accountant, and instead reflects our focused expertise on the small business CGT concessions.
Over time, we have come to find there are common mistakes or oversights, accountants make when establishing eligibility of their client for the small business CGT concessions; that not only could prevent their clients accessing the concessions, but that could also find themselves in legal trouble.
Here are three common small business CGT concessions mistakes made by accountants:
Missing connected entities and affiliates
When an accountant is doing a basic eligibility requirements test, two of the main questions are, ‘Do they satisfy the Maximum Net Asset Value Test’ or ‘Do they satisfy the CGT Small Business Entity Test’?
In very broad terms, the Maximum Net Asset Value Test requires the value of certain assets to be $6m or less. The CGT Small Business Entity Test requires that your turnover is less than $2m.
So, a client could have a $1.9m turnover, with a $75m net worth, and still be eligible for the concessions because they satisfy one of these two requirements.
The problem with these tests, however, is that it’s not just the taxpayer’s asset value or turnover that is important, it’s also the entities connected with them and their affiliates. They have to identify which entities are connected entities, and which entities are affiliates, and then work out if they satisfy the test. A lot of accountants miss this vital step which, if omitted, could significantly impact their client’s eligibility for the small business CGT concessions and could create a legal problem later.
To further explain: An individual taxpayer owns 100% of the shares in a company and is selling those shares for $5m, and that individual is also the beneficiary of a trust and receives some trust distributions each year. That trust is a separate entity that they control and is worth $4m. When an accountant looks at the Maximum Net Asset Value Test, it’s important they look at the individual client, the value of the company they’re selling that’s connected with them as well as the trust. Putting aside any other assets or liabilities of the individual, the company and trust have a combined value of $9m. In the absence of any additional information, the Maximum Net Asset Value Test should be failed.
Incorrectly applying the Active Asset Test
Concerning shares in a company or units in a unit trust, there is a further issue. Let’s focus on shares in a company. The shares have to satisfy the Active Asset Test that shows that throughout ownership the shares have been active assets for at least 50% of the ownership time (or at least for 7.5 years).
As long as the company has at least 80% of its underlying assets as active assets, then the shares in that company can be considered active assets at that time. So, to satisfy the Active Asset Test, the client needs to show that for at least half of the ownership time, up to 7.5 years, 80% of the company’s underlying assets have been active assets.
As an example of shares that are not active assets; shares in a private company that carries on business would not be an active asset if the company’s market value comprises more than 20% in loans to shareholders (being inactive assets) as a result of profits being lent to the shareholders instead of being paid out as dividends. The company could have business assets worth $7m and loans made to shareholders of $3m (total market value of $10m). The balance sheet of the company would indicate that the company has more than 20% of the value of the company in shareholder loan receivables, making the shares in the company an inactive asset at that time.
The problem? There needs to be a closer look at the year on year mix of underlying assets. Just because the shares aren’t active assets at the time of sale because of the shareholder loans doesn’t mean that the shares weren’t previously active assets. And the Active Asset Test doesn’t require the shares to be active assets at the time of sale, but rather for at least half of the ownership time, up to 7.5 years. It’s easy to quickly and incorrectly assume that a client has failed the Active Asset Test based solely on recent balance sheets.
Forgetting that some intellectual property is not taxed under the CGT regime
Intellectual property has a great value and is worth considering. If a client has sold an underlying business, the accountant might look at the concessions on an asset by asset basis, but may overlook that intellectual property is a separate asset to goodwill. The problem with this is that not all intellectual property is subject to tax under the CGT regime, and therefore not all intellectual property benefits from the small business CGT concessions. Examples of intellectual property that is not subject to tax under the CGT regime, and therefore not able to benefit from the small business CGT concessions, include depreciating assets (such as patents, registered designs and copyright), know-how (such as trade secrets and confidential information) and trading stock that comprises intellectual property.
That said, intellectual property not subject to tax under the CGT regime can be an active asset, and so if the shares in the company are sold instead of the underlying business assets, the capital gain on the sale of the shares (which incorporates the underlying value of the intellectual property) could still benefit from the small business CGT concessions.
Of course, many other requirements and considerations are vital to both giving your client the best outcome, and ensuring that you, the accountant, have covered all of your bases. It’s our priority to ensure that our expertise in small business CGT concessions is available to accountants and business owners to achieve the best possible outcome.