CGT small business concessions continue to catch SMEs out

A lot has been written about the capital gains tax (CGT) small business concessions, not all of it complimentary. As I have said a number of times before, the concessions are valuable but are complex to understand and comply with.

A fundamental threshold is the necessity to meet what is known as the maximum net asset value test (MNAV) in order to qualify for the concessions. Under that test, the value of all the CGT assets of the taxpayer, entities “connected with” the taxpayer, the taxpayer’s “affiliates” and entities “connected with” the taxpayer’s affiliates must not exceed $6 million. Such assets would include a debt owed to the taxpayer.

A recent case before the Administrative Appeals Tribunal (AAT) highlighted the importance of passing that threshold test and what is required to do so. It is one of the most fundamental issues that a taxpayer will confront when seeking to obtain the benefit of the small business concessions.

The AAT confirmed the Tax Commissioner’s view that a taxpayer failed the MNAV for the purpose of qualifying for the CGT small business concession because of a $500,000 capital gain he made in relation to the sale of his finance broking business.

The taxpayer argued that a debt of $1.1 million owed to a related entity had a nil value and should not be taken into account for the purpose of the MNAV test as it was “statute-barred” from recovery. However, the AAT found otherwise on the basis that the debt had been legally acknowledged as recoverable and legally in existence at the relevant time.

The taxpayer was a beneficiary (and trustee) of a family trust that held units in a unit trust which operated a finance broking business. The business was sold in the 2008 income year for a capital gain of $500,000 to which the taxpayer was entitled.

The issue in this case was whether the capital gain could be reduced or disregarded under the tax law, if the taxpayer and his related entities satisfied the maximum net asset value test. In particular, just before the sale of the finance broking business, did the sum of the net value of the assets of the applicant and his related entities exceed $6 million?

The taxpayer argued that, in determining whether the MNAV test was satisfied, a loan of $1.1 million made to him by the family trust prior to 1998 had a nil value and was not to be taken into account as it was “statute-barred” from recovery. In particular, he claimed that the family trust could no longer sue for the debt because of the six-year statute of limitation – where it had not sought repayment of the debt because it may have been used to repay a debt of another entity in the group that had become insolvent.

However, the AAT found that the fact that the taxpayer signed the balance sheets of the family trust for the 2003 to 2008 income years (in his capacity as trustee) was sufficient acknowledgment in writing that the debt was still legally in existence as an asset of the family trust in the year in question and it had a market value equal to its face value in the balance sheet records. The inclusion of the $1.1 million debt meant the taxpayer failed the MNAV and therefore could not reduce his $500,000 capital gain under the small business concessions.

The AAT also noted that the trustee of a trust has the authority to sign off on such balance sheet records as an agent of the trust (which the AAT found was equivalent to the situation where directors of a company sign balance sheets of the company in pursuance of their duty as directors).

That the CGT small business concessions continue to catch out taxpayers, for varying reasons, is some cause for concern. While it may be true that ignorance of the law is no excuse, the complexity surrounding these concessions still confounds many. May be it’s time they were simplified. No doubt the government’s Tax White Paper reform process will look at them.

Terry Hayes is the editor-in-chief of tax news reporting at Thomson Reuters, a leading Australian provider of tax, accounting and legal information solutions.