A recent decision handed down by the Full Federal Court (Commissioner of Taxation v Byrne Hotels Qld Pty Ltd  FCAFC 127) has given much needed guidance to the application of the small business CGT concessions. This decision has clarified that liabilities arising from transaction costs incurred prior to a sale (e.g. agents fee or legal costs) can be taken into consideration when calculating the maximum net asset value test ("MNAV").
Small business CGT concessions
The concessions operate to provide taxation relief to small business owners by reducing or deferring the taxable capital gain that can arise when a business is sold. The four small business CGT concessions are:
- Small business 15-year exemption
- Small business 50% active assets reduction
- Small business retirement exemption
- Small business roll-over
Under these provision owners are able to apply multiple concessions until the capital gain is reduced to its maximum extent. Therefore with effective planning and structuring owners stand to benefit from substantial reductions in their tax bill on an eventual exit.
To benefit under the small business CGT concessions a small business owner must first satisfy the basic conditions along with the additional conditions that may apply to each of the individual concessions themselves. The maximum net asset value ("MNAV") test is the main basic qualifying condition that must be satisfied. The test is satisfied if "just before" the CGT event, the total of net value of CGT assets of a business and its related entities is less than $6 million.
The MNAV requires that a snapshot be taken of a business' net asset value immediately prior to the CGT event. The net asset value calculation must take into account the business' (and related entities') relevant assets and liabilities to determine if the $6 million threshold is breached.
In the case discussed below, the issue to be considered by the court was whether certain costs (that were directly related to the asset sale) were actually liabilities of the business immediately before the CGT event. This classification was crucial as it ultimately determined whether the taxpayer satisfied the MNAV test and could obtain the benefit of the small business CGT concessions.
On 24 October 2003, Byrne Hotels ("Byrne") entered into a contract to sell a business which it operated, and at around the same time a related entity of Byrne contracted to sell the land on which Byrne operated the business. The resulting capital gain to Byrne was $4,125,955 which it did not disclose in its 2004 income tax return on the basis that it satisfied the MNAV test (and applied the small business CGT concessions), claiming that its net asset value "just before" the execution of the contracts was below $5 million (the applicable limit for the income year in question).
Following a review by the Commissioner Byrne was issued an amended assessment in respect of the capital gain on the disposal on the basis that Byrne did not satisfy the MNAV test. Specifically, the Commissioner disputed whether certain costs associated with the sale, being solicitor's fees and real estate agent's commissions, were liabilities to be taken into account "just before" the CGT event. The AAT (the "Tribunal") initially found in favour of Byrne, however, the Commissioner appealed to the Federal Court.
In its interpretation of the MNAV test, the Full Federal court regarded the "just before time," to mean the time at which the snapshot of Byrne's circumstances are to be considered, being the point in time "immediately prior to the execution of the first sale contract."
Their Honours unanimously agreed with the tribunal and held that those legal fees that were payable "just before" the CGT event could be classified as liabilities for the purposes of the MNAV test. Even though there was no obligation on Byrne to pay for the work at the relevant time, the invoices were issued on a periodic basis and were payable within 7 days, and it was clear that the solicitor's were being paid for work completed in stages. Therefore, in the eyes of the Full Federal Court only those costs relating to work done prior to the "just before" time could actually be considered as liabilities for the purposes of the MNAV test. This had the result of excluding any and all legal costs for work that was performed by the solicitors immediately after the transaction – notwithstanding the work performed was a direct result of the transaction.
Real estate agent's commission
The majority found that real estate agent's commission also constituted a liability for the purposes of the MNAV test. In determining the whether the commission could be classified as a liability, Greenwood J discussed the notion of a contingent liability. His Honour's view, also supported by Dowsett J, was that the commission should be classified as a liability, albeit contingent, as the legal obligation to pay these fees had arisen before the execution of the contracts for sale. This was because the real estate agent had already performed the bulk of its work for which it was to be paid, such as finding a buyer, prior to the "just before" time. The only task that remained was for Byrne and the purchaser to execute the contracts of sale. Greenwood J also held that a contingent liability is one which can be taken into account in determining the net value of CGT assets for the purpose of the MNAV test.
Implications of the decision
Despite the fact that the small business CGT concession are for the exclusive use and application to "small business" disposal, these rule represent one of the more complex areas of tax law. As such, this decision is welcomed as it provides much needed judicial guidance to the application of the small business rules.
Business owners that are considering selling their business should consider what transaction related costs might arise from a sale as these costs might prove the difference between paying no tax and several millions of dollars in tax. Equally, those that have sold their business and have not be able to pass the MNAV test should now take this opportunity to consider what transaction costs could have been taken into account in working out the relevant net asset values.
If you have any questions in relation to the above or wish to discuss the small business CGT concessions, please contact your Moore Stephens Relationship Partner.
This publication is issued by Moore Stephens Australia Pty Limited ACN 062 181 846 (Moore Stephens Australia) exclusively for the general information of clients and staff of Moore Stephens Australia and the clients and staff of all affiliated independent accounting firms (and their related service entities) licensed to operate under the name Moore Stephens within Australia (Australian Member). The material contained in this publication is in the nature of general comment and information only and is not advice. The material should not be relied upon. Moore Stephens Australia, any Australian Member, any related entity of those persons, or any of their officers employees or representatives, will not be liable for any loss or damage arising out of or in connection with the material contained in this publication. Copyright © 2011 Moore Stephens Australia Pty Limited. All rights reserved.