Australia: Three tips for trusts and Small Business CGT Concessions (SBCGTC)

Last Updated: 27 July 2015

Small Business CGT Concessions

The ATO touts that 75% of Small Business CGT Concession ("SBCGTC") claims contain errors – a disturbingly high statistic. This statistic not only emphasises the need for advisers to take particular care when working through the provisions, but also forces us to question where the risks lie.

Some of the more complex mechanics of the SBCGTC can be found when working with discretionary trust taxpayers. In light of this, we have identified three important considerations that should be front of mind when dealing with trusts.

1. Verify the trust is "connected with" a small business entity

Consider the following structure:

three tips for trusts structure 1

If the land held in the trust is sold, you must focus on the trust as the relevant taxpayer for the purposes of the SBCGTC.

Firstly, as the trust does not carry on a business, it cannot be a "small business entity". You must therefore consider the SBCGTC from the perspective of the alternative $6M MNAV Test.

Secondly, you must carefully consider whether the land is in fact an "active asset" for the purposes of s152-40 ITAA 1997. In this particular scenario, you will need to ensure that the trust is "connected with" the Trading Company.

There are several ways that the trust and the Trading Company might be connected with each other, including:

  • The trust has distributed more than 40% of any distributions of income and capital in the last four years to the Trading Company; or
  • The trust and the Trading Company are both controlled by a third party (e.g. an individual).

Another example is identified in point three below – the "de facto" control test.

In any situation, your assessment must be guided by the facts.

2. Ensure the CGT Concession Stakeholders meet the Small Business Participation Percentage requirements

If your client utilises the structure in the diagram below, the trust will be the relevant taxpayer if the shares are sold.

three tips for trusts structure 2

In this instance, there are at least two critical aspects to consider:

  1. Are the shares "active assets"?

Shares in a company will be active if 80% of the assets of the company are "active" (by reference to market value). Therefore, you need to carefully assess each asset of the company in order to determine whether the shares themselves are active.

  1. Who will be the CGT Concession Stakeholders in the year that the shares are sold, and how much income and capital will they receive from the trust in that year?

If the CGT assets being sold are shares in a company then one of the following additional basic conditions must be passed:

  1. The taxpayer is a CGT Concession Stakeholder in the company; or
  2. The CGT Concession Stakeholders in the company together have a Small Business Participation Percentage in the trust of at least 90%.

A trust can never be a CGT Concession Stakeholder because it is not an individual, so basic condition (i) above is not applicable.

In order to satisfy the above basic condition (ii), the CGT Concession Stakeholders must together directly or indirectly receive at least 90% of the distributions of income and capital in the year that the CGT event occurs. If they don't meet these Small Business Participation Percentage requirements, the basic condition is failed and your client is ineligible.

The very real danger arises in situations where the trust resolutions prepared after the CGT event are focused on tax planning outcomes rather than ensuring that the CGT Concession Stakeholders reach the required percentages.

You may inadvertently disentitle your client to relief under the SBCGTC altogether if you aren't paying attention!

3. Be careful of the "de facto control" test

When considering which entities are "connected with" a discretionary trust taxpayer, it is always critical to review the distributions of income and capital throughout the last four tax years. This might often be considered the "primary test". However, many practitioners fail to also consider the additional "de facto control" test that is contained in s328-125(3) ITAA 1997.

Under this test, an entity will be deemed to control a discretionary trust (and therefore be connected with it) if a trustee of the trust acts, or could reasonably be expected to act, in accordance with their directions or wishes, or in concert with the directions or wishes, of that entity's affiliate.

Unlike the primary test discussed above, which focuses on who has received income or capital, this test is more interested in the dynamics of practical or de facto control within the business structure. For example, consider a family group where a particular individual may not have any legal ownership but tends to influence business decisions and exercise apparent control.

In some cases, the connection of a de facto controller to the trust taxpayer may significantly broaden the entities to which the $6M MNAV test applies. In fact, this connection may very well be the difference between whether your client exceeds the $6M threshold or not.

You will need to conduct a thorough factual assessment in all cases to determine where control resides to ensure that the connected entities are correctly ascertained.

Risks for you and your clients

Given the error rate in SBCGTC claims, the Commissioner will make an effort to review every claim that is made. This means there is even more pressure to get it right!

In the event that the Commissioner rejects your client's SBCGTC claim and issues an Amended Notice of Assessment, your client won't simply be required to pay the tax that they otherwise would have paid. In almost all circumstances the Commissioner will apply a penalty, which will vary in magnitude depending on the apparent diligence of the taxpayer in ascertaining their taxation liabilities. In cases of recklessness or intentional disregard, the penalties applied will represent 50% or 75% of the shortfall respectively. This could mean penalties stretching into the millions of dollars – a catastrophic outcome for your client!

What should you do?

Seeking the assistance of a SBCGTC expert shifts your risk and provides your client with clear evidence that they have taken reasonable steps to determine their eligibility.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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