CGT – Small Business CGT Concessions on sale of units in a Unit Trust
Question
A client has a 40% interest in a business operated by a Unit Trust. The client owns his interest by holding 40% of the units in the Unit Trust through his Family Trust. The client is looking at realising his interest in the Unit Trust by selling the units. Is the client eligible for the small business CGT concessions, and if so what does he need to do to qualify?
Answer
Changes in the provisions relating to the small business CGT concessions effective 1 July 2006 now enable (subject to satisfying particular conditions) companies or trusts to claim the active asset concessions in respect of a sale of company shares or units in a Unit Trust. The primary condition is that an individual is a significant individual in relation to the Unit Trust.
An individual will be a significant individual if, immediately before the sale, the individual has a small business participation percentage in the Unit Trust (direct or indirect) of at least 20%.
For units in a Unit Trust held by a trust (eg a Family Trust) to be eligible for the active asset concession, there is a further requirement that, just before the sale, the CGT concession stakeholders in the Unit Trust together have a small business participation percentage in the owner of the units (that is, the Family Trust) of at least 90%.
An individual will be a CGT concession stakeholder of the Unit Trust if that individual is a significant individual of the Unit Trust, or is a spouse of such significant individual, and the spouse has a small business participation percentage (direct or indirect) which is greater than 0.
The client will be a significant individual of the Unit Trust if the Family Trust (which holds a 40% interest in the Unit Trust) distributed at least 50% of its income to the client which would result in the client having an indirect participation percentage in the Unit Trust of 20% (40% x 20%). As noted, merely having a significant individual (being a person with a 20% interest in the Unit Trust) is not enough to be eligible for the concessions. It is also necessary that CGT concession stakeholders (significant individuals and their spouses) have a 90% interest in the Family Trust. That will require at least 90% of the income of the Family Trust in the year of sale to be distributed between the significant individual and the spouse (with at least 50% going to the significant individual to satisfy the primary condition). There are certain other active asset conditions to be satisfied.
CGT - Sell the business or the shares? – Application of Small Business CGT Concessions
Question
A company owns a business with a value of $1 million and a cost base of $nil. 60% of the shares in the company are held by a unit trust and 40% by various unrelated parties. The units in the unit trust are held by two unrelated discretionary trusts in the proportions 82%/18%. What is the best tax outcome: sale of the business by the company or a sale of the shares by the shareholders?
Answer
The retirement exemption is available where there is a sale of a business by a company, subject to the active asset test, maximum net asset value test and the significant individual test being satisfied. The effect of the exemption is that up to $500,000.00 (for each CGT concession stakeholder) of the capital gain from the sale will be tax free. In this case, significant individuals can only arise under the 82% discretionary trust (a maximum of 2 significant individuals and 4 CGT concession stakeholders). Since the gain is only $1 million, it could be reduced to nil by accessing the retirement exemption in respect of CGT concession stakeholders under the 82% discretionary trust.
The active asset concessions can also be applied upon a sale of the company's shares by the unit trust, subject to satisfying the necessary conditions. On a sale of shares, these concessions usually allow a fully exempt gain of up to $4 million per family (double that of a company). In addition to the active asset test and maximum net asset value test, it is also necessary that significant individuals and their spouses have a direct or indirect interest of at least 90% in the unit trust. In this case, a significant individual could only arise under the 82% discretionary trust and the maximum interest that they could have in the unit trust is 82%. Accordingly, the active asset concessions are not available on a sale of shares (they would be available on a sale of units by the 82% discretionary trust). However, if the unit trust was hybridised and 90% of the distributions in the year of sale is allocated appropriately, the unit trust would be eligible to apply the concession.
The unit trust and the other shareholders (that are individuals or trusts) could reduce the gain by the CGT discount.
In this case, because the gain could be reduced to nil by the Company through the retirement exemption, providing use of the retirement exemption is commercially acceptable, the best tax result is a sale of the business by the company.
