As announced in A New Tax System, the Government has decided to extend the capital gains tax (CGT) small business rollover relief and retirement exemption initiatives to include situations where land and buildings integral to the business are owned by an entity (for example, a trust, company or individual) other than the entity operating the business. Land and buildings include fixtures.
The new provisions will apply where the persons owning and controlling the land and buildings are substantially identical to those controlling the operating entity.
The Government has decided to introduce this new measure because it accepts that, for genuine commercial reasons, small businesses may operate through a structure that includes a non-operating entity which holds some of the business assets. In such cases, even though in substance assets are used actively in a business, they may be held by an entity which is not conducting the business. This means that capital gains arising from their sale might not be eligible for either the rollover relief or the retirement exemption benefits - because the assets are passive assets of the non-operating entity.
The new measures are to operate for all disposals of land and buildings after today. All of the other conditions for the CGT rollover relief and retirement exemption provisions will continue to apply.
The broad design details as to how these new measures are to operate are set out below.
CGT rollover relief
CGT rollover relief is available for an entity operating a small business that sells an active asset and then re-invests the proceeds in other active assets.
- Active assets are those owned by an entity and used directly by the entity to produce business income.
- Capital gains made upon the disposal by the entity of land and buildings used directly by it in the business generally qualifies for rollover relief.
A controlling individual of a company or unit trust may also qualify for small business rollover relief in certain circumstances where they dispose of their shares or units.
How the new measure will operate
Where land and buildings are held by an entity that is separate from the operating entity, CGT rollover relief will now be available if:
- the land and buildings would have qualified as active assets if they had been owned by the operating entity rather than through the non-operating entity; and
- the non-operating and the operating entity are connected associates. Entities are connected associates if they and any associate (as defined in section 160ZZPM of the Income Tax Assessment Act 1936) have a common controller or interlocking control exists (applying the control tests contained in section 160ZZPN of the Income Tax Assessment Act 1936).
Example 1: rollover relief available
Beefsteak Pty Ltd (Beefsteak) owns the land and associated buildings used by the Feedlot Trading Company Pty Ltd (Feedlot) in carrying on a feedlot business. Feedlot leases the land and buildings from Beefsteak. Mr Baron beneficially owns all of the shares in Feedlot, and he and his wife and two children are equal shareholders of Beefsteak. Mr Baron wishes to sell the assets of the business and to invest the proceeds into another type of business.
Under the existing law, the capital gain from the disposal of the land and buildings held in Beefsteak and used by Feedlot is not eligible for rollover relief as the land and buildings are not active assets of Beefsteak.
Under the proposed amendments, and viewing the business as a whole, the land and buildings will be treated as active assets, and Beefsteak and Feedlot will be connected associates, because they are both controlled by Mr Baron. The capital gain from the disposal of the land and buildings will therefore qualify for rollover relief.
CGT RETIREMENT EXEMPTION
A capital gain arising from the disposal of an active asset of a business qualifies for a CGT exemption where the proceeds are used for retirement.
How the new measure will operate
Specifically, small business people who satisfy the existing eligibility requirements will also be able to claim a CGT retirement exemption on the sale of land and buildings owned by an entity other than the operating entity of the business if:
- the land and buildings would have qualified as active assets if they had been held directly by the operating entity rather than by the non-operating entity; and
- the exemption is claimed by or on behalf of a person who, under the existing definition, is a controlling individual of both the operating entity of the business and the entity which owns the land and buildings. The controlling individual need only be an employee of the operating entity to be eligible for the exemption.
Example 2: retirement exemption available
The Breakfast Family Trust (Breakfast) owns the land and associated buildings used by the Cornflake Canning Company Pty Ltd (Cornflake) in carrying on a cornflake canning business. Cornflake leases the land and buildings from Breakfast. Ms Cornfast owns all of the shares in Cornflake, and she is the controller of Breakfast (based on a pattern of distributions test which indicates that her interest in the trust exceeds 50%). Cornflake employs all of the family members. Ms Cornfast wishes to sell all of the assets of the business and retire.
Under the existing law, the capital gain from the disposal of the land and buildings held in the trust and used by Cornflake is not eligible for retirement exemption as the land and buildings are not active assets of the trust.
Under the proposed amendments, and viewing the business as a whole, the land and buildings will be treated as active assets, as Breakfast and Cornflake are both controlled by Ms Cornfast. The capital gain from the disposal of the land and buildings will qualify for the retirement exemption.