Changes made to the CGT small business concessions through the measures contained in Treasury Laws Amendment (Tax Integrity and Other Measures) Bill 2018 represent a marked departure from the previous rules for determining if a capital gain from shares or trust interests qualified for the concessions.
These changes generally accord with the aim of preventing the concessions being available for “large businesses” to which the shares or trust interests may, direct or indirectly, “relate”.
The MNAV and SBE threshold test
Under the previous rules, the taxpayer who owns the CGT asset (be it shares, a trust interest or any other CGT asset) will first need to satisfy either the $6 million maximum net asset value (MNAV) test or the $2 million small business entity (SBE) test as a threshold requirement.
However under the new (or “modified”) MNAV and SBE tests for shares or trust interests, it will be the “object entity” in which these shares or trust interests are held that will need to meet either of these tests – including any “affiliates” (as currently defined) of that object entity.
Furthermore, for these purposes, the object entity will include “other entities” in which the object entity has a “controlling” interest of 20% or more (and not the 40% controlling interest as in the current “connected entities” test).
In short, the “object entity” in which the shares or trust interests are held must itself satisfy the SBE test or the MNAV test, together with “other entities”.
Note however that the turnover and market value of assets of entities that themselves “control” the object entity (in terms of the new 20% controlling interest rule) are not included in these “modified” MNAV and SBE tests.
A key (and presumably intended) consequence of this change is that a taxpayer cannot qualify for the concessions for a capital gain made on shares or trust interests where a taxpayer breaches the MNAV test, but otherwise qualifies for the concessions by virtue of being an SBE in an unrelated business activity.
The “80% active asset” test
At the same time, the new rules change the existing “80% active asset” test so that it will now only include as “active assets” those assets of relevant entities that themselves pass the SBE test or the MNAV test.
Under the previous rules, only the active assets of the “object entity” in which the shares or trust interest were held were taken into account, regardless of the size of the business it carried on (that is, regardless of whether it passed the SBE or the MNAV test or not – but provided, of course, that the taxpayer who owned the shares or trust interests passed the MNAV or SBE test).
Note that this included the case where shares or trust units were held in an interposed entity which in turn (directly or indirectly) held shares or trust interest in the entity carrying on the business (see TD 2006/65).
Under the new rules, a “look through” approach is taken, whereby the underlying assets owned by the “object entity” and other entities are taken into account to determine if the “80% active asset” test is passed. (But, in accordance with this “look through” approach, this will exclude shares or trust interests owned by the object entity in “other entities” and likewise, share or trust interest owned by other entities.)
Specifically, this approach involves determining the market value of all the assets of the object entity and “other entities” (which, for these purposes, include any entity in which the object entity has an interest in of greater than zero). However the market value of the assets of the “other entity” will only include the proportion of the object entity’s interests in the other entity.
It will then be necessary to determine which of these assets of the object entity and other entities are “active assets” (in terms of the existing definition) — but, subject to the crucial proviso that the assets of any “other entity” will only qualify as active assets if it satisfies the SBE or MNAV test in its own right.
Finally, it will then be a matter (as is currently the case) of determining whether the market value of these “active assets” is greater than 80% of the market value of total assets in question.
Importantly, a 20% interest “CGT concession stakeholder” test must also be met both for individual taxpayers and for company or trust taxpayers in order for the assets of an “other entity” to be considered “active assets”. This is determined by way of multiplying the taxpayer’s direct interest in the object entity and the object entity’s interest in the other entity (as per the current “small business participation percentage” rules).
Note that the amendments will apply to CGT events occurring from 8 February 2018 (instead of the proposed “retrospective” starting date of 1 July 2017).
More information and essential details on this legislation can be found in the October issue of The Taxpayer magazine. Tax & Super Australia members receive this magazine as a member benefit.