If you run a small business, you may be able to reduce your capital gains tax (CGT) liabilities and make additional contributions to your SMSF. But what is the criteria for this and how does it work?
Small businesses, and even some medium businesses, are able to access additional tax and super relief not available to other business operators or individuals generally. Tax advantages include the potential reduction or elimination of CGT liabilities, while the super opportunity is the ability to have additional contributions made in excess of the standard non-concessional cap.
An understanding of these opportunities is critical, not only at the time assets may be sold, but when setting up a business to ensure maximum flexibility in the longer term.
Who can qualify?
The eligibility for these concessions is driven under tax law definition of small business taxpayers.
While there are a number of criteria that need to be satisfied, and expert advice should be sought by anyone wanting to access these concessions, the starting point is to meet the definition of a ‘small business taxpayer’. There are two ways this can be satisfied:
- The relevant taxpayer (for example, is the business run through a company or as a sole trader?) has net assets not exceeding $6 million or
- The aggregated turnover (think simply as gross income) for the business this year or last year is (or was) less than $2 million.
It is this second definition around turnover that may actually result in some medium-size businesses qualifying (perhaps in only certain years) as a ‘small business’.
What are the CGT benefits?
Where a taxpayer qualifies as a small business and sells an ‘active asset’ during the year, there are opportunities to reduce the amount of CGT that may be payable, perhaps to as low as nil. An active asset is one that is used in the course of carrying on the business but, among other things, the main purpose of which is not to derive a rental stream.
A classic example of an asset that may qualify for some small businesses is a commercial property. If the business owns the property where it conducts its business, the CGT concessions may be available on the sale of that property. But if the property is leased to a third party, it will not qualify.
In terms of the actual concessions, if the asset has been held for more than 15 years, the entire capital gain is exempt. If it is held for less than 15 years, the gain can be halved, reduced by up to $500,000 or deferred to future years.
What are the super benefits?
If the eligibility for small business concessions is available, certain amounts may be able to be moved into the taxpayer’s superannuation fund. Instead of counting towards the annual non-concessional cap (currently $180,000), they could be counted towards a lifetime CGT cap (currently $1.395 million and rising to $1.415 million from 1 July 2016).
Where the asset was owned for more than 15 years, in addition to the elimination of capital gains tax mentioned earlier, the proceeds of sale (not just the eliminated capital gain amount) may be eligible to be rolled into super up to that CGT cap. Where owned for less than 15 years, any amount of the capital gain reduced under the $500,000 lifetime limit can be rolled to super (and in certain circumstances is actually required to be rolled over).
How might it work?
For many people, consideration of these options arises when the person is looking to wind up their business and sell their assets. However, it is also important to think if someone should consider these options at earlier opportunities, particularly when many get concerned about whether changes can be made in forthcoming federal budgets.
As an example, consider the following scenario:
Joe, aged 58, owns an auto repair business and meets the definition of a small business taxpayer. He has run the business for the last 35 years. One of the assets of the business is the garage from which the business is run. He acquired the garage in 1998 for $350,000. Today, that commercial property is valued at $1,000,000, a $650,000 unrealised.
While Joe isn’t thinking about retiring any time soon, he is concerned about ensuring he is preparing for his retirement and boosting his super given, like many small business owners, he has tended to redirect the majority of profits back into his business. Joe happens to have an SMSF with $300,000 cash currently in the fund.
One option available to Joe is to transfer ownership of the property to his SMSF, which would realise the gain. However, given the value of the property, he can’t do this as an in-specie contribution as it would exceed the non-concessional cap.
In order to overcome this, an option for Joe (if he is able to secure the funding) is for his SMSF to borrow $700,000 and combine this with the existing $300,000 to acquire the property at market value for $1,000,000. This triggers the $650,000 capital gain, but it is eliminated as he has owned the property for more than 15 years. Joe is then able to roll the $1,000,000 of sale proceeds into the fund under superannuation concessions and have it count to the CGT cap. With the $1,000,000 of cash just received, the fund could repay the loan, and now owns a property worth $1,000,000 as well as having $300,000 of cash that can be used for investment diversification.
The rules are complex
While the above example might sound straightforward, the rules around tax and super are quite complicated and timing is the key. If things are not done in the right order, and the correct processes are not followed, the available exemptions and concessions may be lost, resulting in the worst possible outcome. For these reasons, expert tax and super advice is essential when looking at the availability of these concessions.
Bryan Ashenden, senior manager, advice strategies and knowledge, BT Financial Group
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