Interaction between the Small Business CGT Concessions and Look-Through Earnout Arrangements
This article explains the interaction between the Small Business CGT Concessions and look-through earnout arrangements.
Particularly, what a look-through earnout arrangement is, some general consequences for the selling taxpayer, and the modifications to the Small Business CGT Concessions.
What a look-through earnout arrangement is
A look-through earnout arrangement involves a right for which the following 8 conditions are met:
The right is a right to future financial benefits, which is anything of economic value and includes property and services, that are not reasonably ascertainable at the time the right is created;
The right is created under an arrangement that involves the disposal of a CGT asset;
The disposal causes CGT event A1 to happen which is about disposals of CGT assets;
Just before the CGT event, the CGT asset was an active asset;
All of the financial benefits that can be provided under the right are to be provided over a period ending no later than 5 years after the end of the income year in which the CGT event happens, and there are integrity provisions to prevent that 5-year period from being extended;
Those financial benefits are contingent on the economic performance of either the CGT asset or a business for which it is reasonably expected that the CGT asset will be an active asset for the period to which those financial benefits relate;
The value of those financial benefits reasonably relates to that economic performance; and
The parties to the arrangement deal with each other at arm’s length in making the arrangement.
A look-through earnout right is also a right to receive future financial benefits that are certain and are for ending another look-through earnout right that satisfies the requirements above.
Some general consequences for the selling taxpayer are:
Capital gains or losses on the creation of the look-through earnout right under CGT event D1, which is about creating contractual or other rights, are disregarded;
Capital proceeds from the disposal of the CGT asset excludes the value of the look-through earnout right, and instead, the capital proceeds are increased or reduced by any financial benefit that are received or provided under the look-through earnout right;
Any choice that is made under the capital gains tax provisions can be remade so long as the taxpayer provides or receives a financial benefit under a look-through earnout right and the taxpayer remakes the choice at or before the time they are required to lodge their income tax return for the tax year in which the financial benefit was provided or received;
A portion of any capital loss that the taxpayer might otherwise make from the disposal of a CGT asset is temporarily disregarded if the capital loss could be reduced by the taxpayer receiving financial benefits under a look-though earnout right relating to the CGT asset and the disposal;
When a financial benefit is subsequently received the taxpayer ceases to disregard a portion of the capital loss related to the amount of that financial benefit, and the taxpayer’s capital proceeds are increased which causes a reduction in the amount of the capital loss.
Modifications to the Small Business CGT Concessions
In broad terms, the look-through earnout right provisions impact the Small Business CGT Concessions for the selling taxpayer by:
Giving the taxpayer the choice to work out the net value of the CGT asset being disposed of for the Maximum Net Asset Value Test including either the market value of the look-through earnout right or the actual capital proceeds subsequently received in respect of the right;
Extending the time for a company or trust to make its required payment to an individual under the small business 15-year exemption;
Extending the time of the replacement asset period for a suitable replacement asset to be acquired under the small business roll-over;
Extending the time for an individual to make its required payment to a superannuation fund under the small business retirement exemption;
Extending the time for a company or trust to make its required payment to an individual or superannuation fund under the small business retirement exemption;
Extending the time for an individual to make superannuation contributions as CGT cap amounts in respect of payments from a company or trust under the small business 15-year exemption; and
Increasing a superannuation fund’s ability to accept contributions relating to look-through earnout rights.
Disclaimer – The above is intended as commentary and general information only. It should not be relied upon as taxation advice. Formal taxation advice should be sought for particular transactions or on matters of interest arising from the above.
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