Small business owners selling their active business assets may be eligible for one or more small business capital gains tax (CGT) concessions. They may then contribute certain proceeds into superannuation up to a lifetime CGT cap (currently $1.48 million) instead of regular contributions caps.
The following amounts can be contributed to superannuation under the lifetime CGT cap:
- Proceeds from the disposal of an asset that qualifies for the 15-year exemption;
- Proceeds from the disposal of an asset that would have otherwise qualified for the 15-year exemption, but:
- The asset was a pre-CGT asset
- There was no capital gain on the disposal, or
- The asset was sold within the 15-year timeframe due to permanent incapacity; and
- Capital gain exempted by the small business retirement exemption.
Small business owners need to meet a number of basic conditions to qualify for the small business CGT concessions. Additional conditions must then be met to qualify for specific concessions including the 15-year exemption and small business retirement exemption. Clients should always confirm their eligibility for any small business CGT concessions with their tax adviser.
This article looks at tips and traps to assist clients who are looking to make use of the lifetime CGT cap in the most efficient way.
Tip 1: Elect not to claim active asset reduction
Where an eligible business owner cannot qualify for the 15-year exemption, they may instead qualify for:
- The active asset reduction exemption (reduces assessable gain by 50%); or
- The retirement exemption (exempts up to $500,000 of otherwise assessable gain).
However, capital gains exempted using the active asset reduction are not able to be contributed to superannuation under the lifetime CGT cap. Therefore, maximising the capital gains exempted under the retirement exemption may result in a higher amount being contributed under the lifetime CGT cap.
To achieve this result, clients can elect not to apply the active asset reduction (as it is voluntary) where the overall assessable gain will be less than $500,000.
Haley (age 58) is selling a business property owned for 11 years for $1.5 million. She meets the basic conditions to qualify for small business CGT relief and the property satisfies the active asset test. There is a gross unrealised capital gain of $800,000 on the property, reduced to $400,000 after applying the general 50 per cent CGT discount (as the property has been owned for more than 12 months).
Haley can apply the active asset reduction, reducing the assessable gain by 50 per cent to $200,000, and then apply the retirement exemption to exempt the remaining $200,000 of assessable gain. However, she can then only contribute $200,000 to super (amount of capital gain exempted under the retirement exemption) and have it count towards the lifetime CGT cap.
Alternatively, Haley can elect not to apply the active asset reduction. She can then apply the retirement exemption to exempt $400,000 of assessable gain, and contribute $400,000 to superannuation, having it count towards the lifetime CGT cap.
Tip 2: Using the indexed cost base method for CGT discount
Where an eligible client sells an asset that has been owned for more than 12 months, the general CGT discount applies. Unlike the active asset reduction (see above tip), the general CGT discount applies automatically.
This generally means that where a client who doesn’t qualify for the 15-year exemption disposes of an asset, any capital gain is reduced by 50 per cent, which may reduce the amount that can be exempt under the retirement exemption and minimise the amount that can be contributed to super under the lifetime CGT cap.
However, where a client disposes of an asset that was originally acquired prior to 21 September 1999, they have the option to:
- Apply the 50 per cent general discount (default); or
- Apply the indexed cost base method.
In most cases, the indexed cost base method will provide a worse outcome in terms of minimising assessable capital gain, but this in turn may allow a client to maximise the amount of gain that can be exempt under the retirement exemption. This also maximises the amount that can be contributed to superannuation under the lifetime CGT cap.
Allan (age 50) meets the basic conditions for small business CGT relief. He is selling a business property owned since September 1998 for $1.1 million, which was originally purchased for $600,000. He wants to minimise CGT, and maximise his contribution to super under the lifetime CGT cap (as he’s already fully using his other contributions caps).
By default, Allan’s gross capital gain is reduced from $500,000 to $250,000 under the general 50 per cent CGT discount. The remaining gain is then exempt under the small business retirement exemption, and Allan can contribute $250,000 and have it count towards the lifetime CGT cap.
However, as the asset was originally purchased prior to 21 September 1999, Allan could instead elect to use the indexed cost base method. Under this approach, the cost base of $600,000 is indexed only slightly to $610,667. As Allan has elected to use the indexed cost base, the 50 per cent general CGT discount does not apply, and the remaining capital gain is $489,333. He can then exempt this amount under the retirement exemption and contribute it to super under the lifetime CGT cap.
Using the indexed cost base method has allowed Allan to increase his overall super contribution by $239,333.
Tip 3: Streaming retirement exemption to stakeholders
When a company or trust is disposing of an eligible asset and wishes to claim the small business retirement exemption, it must distribute 100 per cent of the exempt amount to its CGT concession stakeholders.
However, this distribution does not have to be made in proportion to each stakeholder’s small business participation in the company or trust. This means that where stakeholders of such a company or trust are members of a couple, they can effectively ‘stream’ the exempt gain in a way that will allow them (under the lifetime CGT cap) to optimise their superannuation balances.
For example, streaming an exempt gain to one member of a couple may allow contributions to super that:
- Equalise superannuation balances to ensure both members of the couple are able to transfer all of their superannuation to retirement phase income streams under the transfer balance cap rules;
- Keep one member of the couple’s total superannuation balance under a key threshold (e.g. under $1.6 million to allow them to make non-concessional contributions in the next financial year).
Gavin and Stacey (both age 50) have a self-managed superannuation fund (SMSF) – Gavin’s balance is $1.25 million and Stacey’s balance is $750,000. They wish to continue maximising their contributions to super in the coming years.
Gavin and Stacey are also CGT concession stakeholders in XYZ Co (Gavin has small business participation of 90 per cent and Stacey has small business participation of 10 per cent). On 1 April 2019, XYZ Co sells an active asset with a $500,000 capital gain and claims the small business retirement exemption. XYZ Co therefore needs to distribute 100 per cent of the $500,000 exempt amount to its CGT concession stakeholders, and as they are under age 55 must contribute the exempt amounts on their behalf to superannuation (they will count towards Gavin and Stacey’s respective lifetime CGT caps).
If XYZ Co makes distributions (via contributions to super) on 1 June 2019 in line with Gavin and Stacey’s small business participation, $450,000 would be contributed for Gavin and $50,000 for Stacey. Their superannuation balances would then increase to $1.7 million and $800,000 respectively.
This strategy means that Gavin’s total superannuation balance at 30 June 2019 is now more than $1.6 million, which will prevent him from making further non-concessional contributions in 2019-20 (and likely in all future financial years). His super balance when he retires in the future is also likely to be well over the $1.6 million transfer balance cap resulting in retirement savings that cannot be transferred into retirement phase income streams.
If XYZ Co instead distributes the entire $500,000 exempt amount (via super contribution) to Stacey on 1 June 2019, their superannuation balances would instead be $1.25 million each.
This alternative strategy means that Gavin and Stacey’s total superannuation balances at 30 June 2019 are both equal and under $1.4 million. This allows both Gavin and Stacey to make non-concessional contributions of $300,000 in 2019-20 under the bring-forward rule. As their super balances are now equal, in the future they will be able to make best use of their two $1.6 million transfer balance caps, maximising the overall amount of their retirement savings they can transfer into retirement phase income streams.
Note: To ensure that streaming of gains in this way is possible between members of a couple, it is important to ensure that both are CGT concession stakeholders in the company or trust. While one member of the couple must be a significant individual (at least 20 per cent small business participation), the other member of the couple (as the spouse of a significant individual) must have small business participation of greater than nil.
Tip 4: Sell business but keep properties
Where a client sells their business (including goodwill, property and other business assets), and does not qualify for the 15-year exemption, there may be a benefit in continuing to hold some assets until the point where they will qualify for the 15-year exemption, rather than selling all assets at the time the client sells their business.
This may be appropriate, for example in the case of a commercial property, where:
- The ownership period is reasonably close to 15 years;
- The active asset test will still be satisfied;
- The client will meet the Net Asset Value Test (less than $6 million) at the time of the property sale; and
- The client will be 55 or over when the property is sold and the sale will occur in connection with the client’s retirement.
Chris (age 56) started a business 13 years ago. Since then he has owned two assets:
- Business goodwill (current value: $1 million, cost base: Nil); and
- Commercial property (current value: $2 million, cost base: $400,000).
Chris meets the basic conditions for small business CGT relief and now plans to sell his business, although he is willing to continue working for the new owner for a number of years. He also wishes to maximise his contributions to super under the lifetime CGT cap.
If Chris disposes of both assets now, his CGT position and super contributions are as follows:
- CGT on business goodwill: Gross capital gain reduced to $250,000 due to both general CGT discount and active asset reduction. Retirement exemption used to exempt remaining $250,000; and
- CGT on commercial property: Gross capital gain reduced to $400,000 due to both general CGT discount and active asset reduction. Retirement exemption used to exempt $250,000 of gain (as Chris only has $500,000 lifetime retirement exemption limit). Remaining gain of $150,000 assessable to Chris.
- Super contributions under the lifetime CGT cap limited to $500,000 (equal to total gain exempt under retirement exemption).
If Chris disposes of the goodwill now, but instead keeps the property for a further two years and continues working for the new owner during that time before retiring, his CGT position and super contributions are as follows:
- CGT on business goodwill: Gross capital gain reduced to $500,000 due to general CGT discount (elect not to apply active asset reduction). Retirement exemption used to exempt remaining $500,000;
- CGT on commercial property (in two years’ time): Entire gain disregarded under 15-year exemption; and
- Super contributions eligible to count towards lifetime CGT cap include exempt gain from goodwill and all proceeds from commercial property. However, contributions limited to lifetime CGT cap itself (assume $1.48 million 2018-19 cap for simplicity).
By delaying the disposal of his property for two years, Chris is able to contribute almost an extra $1 million to super, while disregarding an extra $150,000 in otherwise assessable capital gain.
Trap: Timing CGT contributions to avoid reducing non-concessional cap
Since 1 July 2017, a client’s total superannuation balance (just prior to the start of a financial year) has impacted their eligibility for a range of caps and concessions. For example, where a client’s total superannuation balance just prior to the start of a year is $1.6 million or more, their non-concessional cap for the financial year reduces to nil.
A client’s total superannuation balance does not impact their ability to take advantage of the lifetime CGT cap. However, once a lifetime CGT cap contribution is made, it counts towards the client’s total superannuation balance. This could reduce their non-concessional cap in future financial years (including to nil).
Where a client wishes to make both lifetime CGT cap contributions and non-concessional contributions, it is important to ensure for total superannuation balance purposes, that their CGT cap contribution is made in the same, or later, financial year as their non-concessional contributions.
Alice (age 63) disposes of a property on 1 November 2018 for $2 million that qualifies for the 15-year exemption. Alice had previously made a non-concessional contribution of $540,000 in 2016-17 under the bring-forward rule (meaning her existing bring-forward period will end on 1 July 2019), and her current super balance is $1 million.
Upon receiving the proceeds from the sale of her property on 15 December 2018, Alice immediately contributes $1.48 million to super and elects to count it towards her lifetime CGT cap. However, at 30 June 2019, Alice’s total superannuation balance is clearly in excess of $1.6 million. She can therefore not make any further non-concessional contributions in 2019-20 (or likely any future financial years).
Alice could instead wait until 1 July 2019 to make her CGT cap contribution, which, assuming AWOTE of 3 per cent would have increased to $1.525 million by that time. Her total superannuation balance at 30 June 2019 would then still be around $1 million and not include this contribution, allowing Alice to make a further non-concessional contribution of $300,000 using the bring forward rule.
By delaying her CGT cap contribution, Alice is able to increase her total super contribution by $345,000.
Tim Sanderson is the senior technical manager for Colonial First State FirstTech.