By Helen Ozolins.

After a long wait – more than nine months – we have details of the Australian government’s thinking when it comes to changes to capital gains tax (CGT) concessions that tighten rules for small businesses. But the delay, the changes themselves, and plans to make them apply from 1 July 2017 could have unexpected consequences for taxpayers who thought they had already met their obligations.

Legislation by retrospective press release not appropriate

The government announced in the federal budget on 9 May 2017 that it would amend small business CGT concessions with effect from 1 July 2017 “to ensure that the concessions can only be accessed in relation to assets used in a small business or ownership interests in a small business”. 

However, details in the form of draft legislation were not released until 8 February 2018, with an extremely short consultation period. Later – on 28 March 2018 – legislation was introduced to Parliament. “The proposed legislation contains changes that have taken our members by surprise and could adversely affect business transactions that have occurred since 1 July 2017,” says Susan Franks, Senior Tax Advocate, Leadership and Advocacy, at Chartered Accountants Australia and New Zealand. A submission by CA ANZ to Treasury in February this year also argues that the changes should not be retrospective, and should apply only from the date of release of the draft legislation. 

A number of the changes were unexpected and will result in some transactions that were entered into since 1 July 2017, changing from being eligible for the CGT concessions to being ineligible.

There could be particularly adverse consequences for taxpayers who have deposited proceeds from the sale of entities into superannuation funds. Such proceeds now risk being classified as non-concessional contributions and “could result in the imposition of a 47% tax on any excess contributions”, says Franks. 

The draft legislation contains changes that have taken our members by surprise and adversely affect business transactions that have occurred since 1 July 2017

Aggregation test changed

The budget announcement said the small business CGT concessions would be changed to ensure they only applied to small businesses. Treasury is of the view that this made it clear that an interest in an entity worth more than $6 million would not qualify for the small business CGT concessions.  

However, the submission by CA ANZ argues that the draft legislation also changes the mechanics of how you determine that an entity is a small business – by reducing the equity threshold for aggregating entities to 20% from 40%. This change adversely affects a number of transactions that have occurred since 1 July 2017.  

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“In these circumstances, taxpayers who have in good faith sold, or entered into agreements to sell, interests in entities on the basis that they qualified for the concessions but will not now do so should not be adversely impacted,” the submission says. The proposed legislation maintains the position outlined in the draft legislation – that is, it reduces the aggregation threshold to 20% from 40%.  

Active assets

The draft legislation proposed changing the treatment of financial instruments (and cash) to make it harder for an entity to satisfy the 80% active assets test and access small business CGT concessions. The CA ANZ submission argued that this policy reversal was contentious and gave examples of how the change in policy could generate adverse policy outcomes. The legislation now before Parliament no longer contains these changes – thus the treatment of financial instruments now remains largely unchanged.  

However, there is now a specific anti-avoidance provision that needs to be considered. This will deny a taxpayer the ability to count a financial asset as an active asset if it was acquired for a purpose that included assisting an entity to pass the active asset test.  

The need to carry on a business

For the sale of an interest in an entity to qualify for the CGT concessions, the draft legislation requires the entity to be carrying on a business just before the disposal. This may cause problems where: 

• a unit trust or company holds valuable assets that are leased to a commonly owned entity 
• a company is liquidated (generally the gain is triggered upon the deregistration date). 

Overall, the way an entity is carrying on a business has caused controversy in relation to the lower small business tax rate. While the Australian Taxation Office (ATO) has issued guidance in relation to companies, this does not extend to trusts where different considerations may apply.

Measures are too complex

The CA ANZ submission describes the measures contained in the exposure draft as extraordinarily complex. “These provisions are difficult for tax agents to navigate, let alone a segment of the taxpayer community for whom tax compliance burdens are already relatively high,” says Franks.  

The small business CGT concessions need to be reviewed holistically from a policy perspective to ensure they are appropriate, fit for purpose and are meeting their objectives. In undertaking such a review, a substantial public consultation period is essential as small businesses are an incredibly diverse category of business taxpayer and they have significant time barriers, warns Franks.   

CA ANZ submission lodged with Treasury on 1 March 2018. 

Helen Ozolins is the Deputy Editor of Acuity.