Funding retirement: Small business owners

For many business owners, their business represents a large part of their individual wealth and is integral to funding a comfortable life in retirement. There are many options available to business owners whom are seeking to bolster their retirement savings when exiting their business.

When Federal Treasurer Peter Costello announced the introduction of the small business concessions in 1999, he stated the objective was to provide, “small business people with access to funds for retirement”. As business owners often reinvest cashflow into their business, they do not necessarily have the same ability to access the concessionary superannuation environment as PAYG employees.

Who is a small business owner?

To qualify for the small business CGT concessions the “basic conditions” must be met. Firstly, one of the following conditions will need to be satisfied:

• the total net value of CGT assets owned must not exceed $6m.

Assets held within entities connected to the individual, or controlled by them, will typically need to be included under this cap. However, it does not include personal use assets, such as the family home or car.

• the individual is carrying on a business which has aggregated turnover of less than $2m.

There are three different methods which can be used to calculate aggregated turnover.

If the individual doesn’t carry on business, or is a partner in a partnership, there are variations of the above criteria that can apply.

It is also important to consider which entity is disposing of the asset as the tax implications vary significantly. As an example, an individual selling shares in their company will be treated differently to the company itself selling business assets.

The “active asset test”

The second step is that the asset being sold must satisfy the “active asset test”. This test will be met if the asset is either:

• used during carrying on a business. i.e. a shop-front or business premise; or
• an intangible asset inherently connected with a business; i.e. goodwill.

The asset will need to have met one of these two conditions for at least:

• half the time owned, if owned for less than 15 years; or
• 7.5 years if owned for more than 15 years.

Examples of assets that are unlikely to meet the active asset test are inventory, non-CGT assets, machinery or assets that depreciate. There are also additional conditions that apply if the asset is a share or trust interest.

Reducing the taxable gain

Having met the basic conditions, there are four exemptions that a retiring business owner may apply to improve their after-tax financial position, in addition to the general discount:

1. 15-year exemption
2. Active asset reduction
3. Retirement exemption
4. Small business roll-over

15-year exemption

The holy grail of CGT concessions is the 15-year exemption. There will be no assessable capital gain (i.e. no tax to pay) where:

• the asset has been continuously owned for 15 years or more, and
• the business owners are aged 55 or over and the CGT event occurs (i.e. the sale) in connection with retirement.

If the 15-year exemption is met, the remaining concessions will not need to be used.

Active asset reduction

The assessable gain can be reduced by a further 50%, in addition to the general discount. Having already met the basic criteria, no further eligibility criteria applies.

Retirement exemption

Taxpayers have a lifetime limit of $500k which can be used to disregard all or part of a remaining gain. The retirement exemption and active asset discount can be used in either order, giving flexibility to the amount of the gain that is disregarded. This is relevant and discussed in the interaction with superannuation section set out below.

Despite the name, there is no requirement to retire to apply this concession. The only additional criteria that applies is where the individual is under age 55, the amount disregarded must be contributed to superannuation. For those 55 or over, contributing the disregarded amount to super is optional.

Small business roll-over

The small business roll-over allows a person to disregard all remaining capital gain for up to two years to utilise the proceeds from the gain to reinvest in a replacement asset. The replacement asset must be an eligible asset, which broadly means an active asset. Where a replacement asset is acquired within the time the capital gain will be deferred until that replacement asset is disposed of or ceases to be an active asset. Where no replacement asset is acquired the previously disregarded capital gain occurs. This allows deferral of any remaining capital gain (and the associated tax liability) for a further two years.

General discount

The general discount allows for reducing assessable capital by 50% and is available where the asset has been owned for greater than 12-months.

The discount may be a lower amount depending on the structure of the business. Additionally, where the asset was acquired before 21 September 1999, the indexation method may also be applied.

Interaction with superannuation

Where the conditions of either the “15-year exemption” or the “retirement exemption” are met, an individual may be eligible to use their super CGT cap. Where these concessions are used. the taxpayer must notify their super fund provider or trustee in the case of a self-managed superannuation fund:

• where the contribution is made in conjunction with the ‘retirement exemption’, the maximum that can be contributed is the lesser of:
  • $500,000; or
  • the remaining gain (after applying the general discount and any capital losses and a chosen amount of the active asset discount). Recall from above that individuals under age 55 must contribute the amount disregarded to super when using the “retirement exemption”,

• where the “15-year exemption” has been applied, up to $1.565m can be contributed to superannuation. This is a lifetime limit, and is indexed, so increases every year.

Where contributions are made under the CGT cap:

• the contribution does not count toward the non-concessional contributions cap, which is currently $100,000 p.a.;
• contributions tax does not apply.

Case study

To illustrate how the concessions would be applied, here is a scenario where the business owner is eligible for all concessions, except the 15-year exemption.

Jarrod is aged 53 and will be retiring permanently. He will be selling the business that he started ten years ago (zero cost base) for $2.1m. Jarrod has never used his superannuation CGT cap and has $100,000 in crystallised capital losses from a prior financial year.

Jarrod meets the basic conditions on the basis that:

• his net assets are less $6m; and
• he is selling the business goodwill and office premise (i.e. these are active assets).