You have successfully operated your pharmacy for many years and it is time to sell – maybe to retire or look at other business opportunities.
Many issues would be on your mind like finding the right buyer and receiving a top price for your business.
From a financial advising prospective, we are interested in what you will receive after tax and increasing this as much as possible by utilising the small business capital gains tax (CGT) concessions. Then we can assist with the investment of those proceeds should retirement be the key objective.
Let’s look at the first step. You’ve found a buyer and agreed on a price. What are the small business CGT concessions that may be available to you and importantly what mistakes are people making when utilising these tax exemptions as reported by the Australian Taxation Office.
Small Business CGT concession
Small business owners may be eligible for various concessional treatments for transactions that involve capital gains tax (CGT). These concessions can reduce, defer or at times even eliminate tax payable from capital gains. Applying these concessions can often trip up small business taxpayers.
The Tax Office recently reported that its compliance work had revealed some common mistakes occurring on a regular basis from small business owners when applying the relevant tests for eligibility to these CGT concessions.
There are four concessions that may be available to reduce capital gains made by a small business in respect of eligible assets:
- The 15 year exemption: When a retiring taxpayer has held an asset for at least 15 years
- The retirement exemption: Where capital proceeds are put towards retirement savings (there is no need to actually retire)
- The 50% active asset reduction: The capital gain may be discounted by 50% (not to be confused with the 50% general discount for assets held for at least 12 months by certain taxpayers), and
- The CGT rollover: A capital gain may be deferred if a replacement asset is acquired within a specified time frame.
The concessions are subject to a number of eligibility criteria and conditions which we can discuss with you once we know your circumstances.
In an effort to stem the tide of erroneous claims, the Tax Office issued a statement, directed to both small business entities and to their tax agents, about its areas of concern.
Maximum net asset value
The Tax Office said that one of the most common errors seems to surround the maximum net asset value test, which is one of the basic conditions that may need to be satisfied in order to gain access to the concessions in some circumstances.
Under this condition, just before the relevant CGT event happening, the total “net value” of CGT assets that the tax payer and specified related entities own cannot be more than $6 Million. (This is inclusive of the CGT asset subject to the CGT event).
Broadly, the net value of the CGT assets of an entity is the total market value of its assets, less any liabilities relating to those assets. The net asset value of an entity is also reduced by any provisions for annual leave, long service leave, unearned income and tax liabilities.
As noted, the maximum net asset total not only includes the value of assets that are owned by the taxpayer conducting the business, but also assets of any “connected entities” and “affiliates” of the taxpayer (again, these are issues we discuss with you when we understand you own situation). The Tax Office said that failing to identify “connected entities” and “affiliates” is one of the common mistakes, but other errors include:
- The valuation of assets at historical cost rather than market value just before the CGT event;
- Not including the CGT asset sold in the calculation;
- Not including the relevant goodwill assets in the calculation.
The Tax Office added that where a market value is required, accepted valuation principles should be applied.
Use contract date, not settlement date
The Tax Office also found that business owners had incorrectly used the settlement date instead of the contract date when recording details of the CGT event. This can end up resulting in:
- An “active asset” test not being met (broadly, that the asset be “actively” used in the business for a certain period of time), or
- Incorrectly applying the 15 year exemption when the asset had not been held for that time.
Where contract and settlement dates cross over financial years, the capital gain or loss should be declared in the financial year in which the contract was signed.
Earn-out arrangements
The sale of a business often includes a clause that the seller will obtain further payments based on the business achieving certain future goals, otherwise referred to as earn-out rights. The Tax Office said that earn-out rights must be included in the capital proceeds when selling a CGT asset and also when calculating the maximum net asset value.
Michelle Summers
T: (02) 9241 7701
E: michelle@holbol.com.au
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