Small Business Tax Concessions Guide [5 ed.] 9781925554694

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ABOUT WOLTERS KLUWER Wolters Kluwer is a leading provider of accurate, authoritative and timely information services for professionals across the globe. We create value by combining information, deep expertise, and technology to provide our customers with solutions that contribute to the quality and effectiveness of their services. Professionals turn to us when they need actionable information to better serve their clients. With the integrity and accuracy of over 45 years’ experience in Australia and New Zealand, and over 175 years internationally, Wolters Kluwer is lifting the standard in software, knowledge, tools and education. Wolters Kluwer — When you have to be right. Enquiries are welcome on 1300 300 224. First edition....................................September 2008 Fourth edition....................................August 2016 Second edition....................................September Fifth edition....................................October 2017 2009 Third edition....................................July 2013 ISBN 978-1-925554-69-4 © 2017 CCH Australia Limited All rights reserved. No part of this work covered by copyright may be reproduced or copied in any form or by any means (graphic, electronic or mechanical, including photocopying, recording, recording taping, or information retrieval systems) without the written permission of the publisher.

FOREWORD The Small Business Tax Concessions Guide 5th Edition deals with the various tax concessions that are available for small business taxpayers. This up-to-date and practical guide is suitable for both taxpayers and practitioners. It enables readers to gain an understanding of the rules that apply in this complex area. The types of concessions range from exemptions, deferrals and reductions in tax to simplified accounting and compliance rules. In each case, the book explains the conditions that must be satisfied for a particular concession and how the rules apply in practice. It is now widely known that small businesses may be eligible for significant CGT relief. Feedback we have received also confirms that taxpayers and advisers are keen to find out how they can access these concessions. However, applying the small business CGT concessions is not without its pitfalls. The Small Business Tax Concessions Guide helps to cut through the complexity of the rules and avoid these pitfalls

by using clear explanations and detailed practical examples. The coverage reflects the series of rules that were designed to increase the availability of the CGT concessions. The book also contains separate chapters on the general rules for accessing the CGT relief and the specific CGT small business concessions. In addition to the CGT concessions, this book discusses the other tax concessions that are available to small business taxpayers. These consist of the various GST concessions, payroll tax concessions, simplified depreciation, trading stock and other special rules. The concessions available under the superannuation regime and the way in which they interact with the small business concessions, together with the comparative benefits of each for retirement planning, are also considered. The Small Business Tax Concessions Guide 5th Edition is based on the law as enacted at 30 June or 1 July 2017 as appropriate for the relevant chapter and commentary. Various more recent developments and proposed changes that are not yet law are also incorporated. Wolters Kluwer October 2017

WOLTERS KLUWER ACKNOWLEDGMENTS Director — Commercial & Strategy: Lauren Ma Head of Content — Tax, Accounting & Superannuation: Diana Winfield Head of Publishing & Digital Strategy: Lilia Kanna Editor: Marcus Lai Content Coordinator: Emily Hopkins Marketing & Communications: Eric Truong Cover Designer: Jessica Crocker

ABOUT THE AUTHORS Gaibrielle Cleary BEc, LLB, LLM, is the Head of Tax at Mazars. Gaibrielle practises in all areas of taxation with a focus on capital gains tax, employee share schemes, fringe benefits tax, corporate restructures and remuneration packaging. Gaibrielle’s previous career experience includes large legal firms, Big Four and boutique accounting firms and as the legal counsel for an ASX listed company. She also writes a number of taxation publications, including Wolters Kluwer’s Australian Federal Income Tax Reporter and Australian Master Tax Guide. Stephen Baxter BEc, FCA, is a Director of Indirectax.net and an Associate Director with Indirect Tax Consulting Group, having previously been at Price Waterhouse. He specialises in GST, Fuel Tax Credits and Land Tax particularly for the property, construction, transport, government, SME, IT, import/export and cross border sectors. Stephen is a member of the Assistant Federal Treasurer’s Board of Taxation Advisory Panel and Director of the Australian subsidiaries of several US corporations. Louise Biti CFP®, SSA, CTA, MTax, BEc, BA(AS), DipFP, has been providing technical analysis and support in relation to legislative issues and financial planning strategies to advice professionals for over 20 years. She has broad experience across taxation, superannuation, aged care, estate planning and social security legislation. Louise is a previous Director of the Financial Planning Association and SMSF Association boards and has been awarded the FPA’s Distinguished Service award. Currently she is a member of the Aged Care Financing Authority. Louise is a regular speaker at industry conferences and is often quoted in the media. Philip McCouat MA, LLB(Hons), LLM(Hons), MEnvL, has many years’ experience in business, publishing and the law. In the area of tax, he is the author of the Australian Master GST Guide, founder of Tax Navigator for Business Activities and a specialist contributor to many other major publications, most recently the Australian Federal Income Tax Reporter.

Shane Peters Dip Law, is a Director of Indirect Tax Consulting Group, a professional tax practice specialising in indirect taxes and government incentives. Shane specialises in payroll tax, fuel tax credits, GST and workers compensation premium liability. Shane’s previous career experience was with two of the Big Four accounting firms and with the ATO.

ABBREVIATIONS The following abbreviations appear in this book. AAT

Administrative Appeals Tribunal

ABN

Australian Business Number (see ¶1-500)

APRA

Australian Prudential Regulation Authority

ATO

Australian Taxation Office

AWOTE

Average weekly ordinary time earnings

BAS

Business Activity Statement

CGT

Capital gains tax

CPI

Consumer Price Index

DGR

Deductible gift recipient

FBT

Fringe benefits tax

FBT Act

Fringe Benefits Tax Assessment Act 1986

GDP

Gross Domestic Product

GIC

General interest charge

GST

Goods and services tax

GST Act

A New Tax System (Goods and Services Tax) Act 1999

ITAA36

Income Tax Assessment Act 1936

ITAA97

Income Tax Assessment Act 1997

ITR97

Income Tax Assessment Regulations 1997

ITRA

Income Tax Rates Act 1986

ITTPA

Income Tax (Transitional Provisions) Act 1997

LAFHA

Living-away-from-home allowance

PAYG

Pay As You Go

OSR

Office of State Revenue

RCTI

Recipient created tax invoice

RSA

Retirement savings account

SAM

Simplified accounting method

SG

Superannuation guarantee

SGA Act

Superannuation Guarantee (Administration) Act 1992

SIS

Superannuation Industry (“Supervision”)

SMSF

Self managed superannuation fund (see ¶1-500)

SRO

State Revenue Office

TAA

Taxation Administration Act 1953

TFN

Tax file number

TTR

Transition to retirement (see ¶1-500)

OVERVIEW, CHECKLISTS AND RATES Introduction

¶1-000

Checklist of the small business concessions ¶1-100 Checklist of key terms

¶1-500

Key rates, tables and thresholds

¶1-700

Editorial information

By Gaibrielle Cleary

¶1-000 Introduction The federal and various state-based taxation systems in Australia provide certain tax concessions for small business taxpayers. The primary concessions which are available may be separated into the following general areas: • CGT small business concessions • GST concessions • payroll tax concessions • FBT concessions • income tax concessions, and • superannuation concessions. The concept of a “small business entity” is generally used as a requirement for determining whether an entity can access the federal tax concessions. However, additional criteria may need to be satisfied in order to gain access to the particular concessions. An entity will constitute a small business entity where: • it carries on a business, and • it satisfies the aggregated turnover test of $10m. The definition is modified to have an aggregated turnover test of $5m for the purpose of applying the tax offset for non-corporate small business income. Further, for the purpose of applying the CGT small business concessions the concept of a CGT small business entity applies. A CGT small business entity is a small business entity that satisfies a $2m aggregated turnover test. The small business entity tests and its application are outlined in Chapter 2. The payroll tax system, being a state and territory based tax system, does not use the concept of a small

business entity. In general, the payroll tax provisions determine a taxpayer’s eligibility for the concessions by using a threshold value for the annual “wages” paid. While the concept of a small business entity is essential for determining whether a taxpayer is potentially entitled to the small business tax concessions, additional conditions generally need to be satisfied to apply the particular concessions. In some circumstances, the only additional condition is for the taxpayer to choose to apply the concession.

¶1-100 Checklist of the small business concessions The purpose of this book is to provide a comprehensive and practical guide to the small business tax concessions by: • outlining the various concessions available to small business taxpayers • explaining the conditions that must be satisfied to access the concessions, and • demonstrating the manner in which the rules apply in practice. There have been changes to the concessions and their application over time. To enable the book to be concise and relevant the book generally focuses on the rules as they apply at the start of the 2017/18 income year, unless specifically stated otherwise. The different tax exemptions and concessions that apply to small businesses are detailed in the following checklists. For details on the applicable concessions see the relevant cross-references. CGT small business concessions • An exemption from CGT may apply for capital gains made in relation to active assets held for at least 15 years pursuant to the CGT 15-year exemption (¶4-100). • Capital gains made in relation to active assets may be discounted by 50% pursuant to the CGT small business 50% reduction (¶4-300). • Capital gains made in relation to active assets may be exempted by taxpayers up to respective lifetime limits pursuant to the CGT retirement exemption (¶4-400). • Capital gains from active assets may be rolled over for at least two years or longer if replacement assets are acquired pursuant to the CGT small business roll-over (¶4-600). • A roll-over from CGT and income tax may be available for restructures of small business entities pursuant to the small business restructure roll-over (¶4-800). Income tax • A roll-over from income tax may be available for restructures of small business entities pursuant to the small business restructure roll-over (¶4-800). • Companies that are small business entities are entitled to a lower corporate tax rate of 27.5% (¶9050). • Individual taxpayers with business income from an unincorporated business that has an aggregated turnover of less than $5m will receive an 8% tax discount (¶9-060). • Small business entities are entitled to an immediate deduction for professional establishment expenses (¶9-080). • Small business entities are entitled to an immediate write-off for assets costing less than $20,000 first used or installed ready for use between 7.30 pm on 12 May 2015 and 30 June 2018. Pooling is available for depreciating assets of a cost of $20,000 or more (¶9-100).

• Small business entities with trading stock of less than $5,000 need not bring their stock to account, and any change in the value of trading stock need not be brought to account until the change exceeds $5,000 (¶9-200). • Certain tax concessions are available for investments made in innovation companies (¶9-300 and ¶9350). • Prepayments made by small business entities are entitled to concessional treatment (¶9-400). • A small business entity will generally be eligible for a two-year amendment period for tax assessments instead of the standard four years (¶9-700). Goods and services tax • Small business entities may lodge simplified business activity statements to report GST (¶6-010). • Small business entities may use the cash basis of accounting for GST purposes (¶6-100). • Small business entities can elect to lodge returns annually and pay GST by quarterly instalments (¶6300). • A small business entity can apportion GST input tax credits on an annual basis for acquisitions and importations that are partly creditable (¶6-500). Fringe benefits tax • Car parking provided by small business entities that are employers may be exempt from FBT where parking is provided on the business premises (¶9-500). • Small business entities may be entitled to an FBT exemption for multiple portable electronic devices provided to an employee during an FBT year (¶9-570). PAYG • Small business entities are eligible to pay PAYG instalments based on GDP-adjusted notional tax (¶9600). Payroll tax • Employers with payroll less than the specified thresholds, varying from state to state, are exempt from payroll tax (Chapter 7). Superannuation • Employers are able to claim tax deductions for superannuation contributions made for the benefit of their employees (¶8-200). • Individuals may claim tax deductions for certain personal contributions made to a complying superannuation fund (¶8-240). • A taxpayer that has accessed the CGT small business concessions may make additional contributions up to the lifetime CGT cap into a complying superannuation fund without counting towards the taxpayer’s annual concessional cap and the annual non-concessional contribution cap (¶8-500). • There are tax planning opportunities for small business taxpayers to transfer certain business assets into a complying superannuation fund (¶8-600). • There is ability of a taxpayer to receive concessionally taxed superannuation benefits in accordance with the transition to retirement rules, without being required to retire from the workforce (¶8-700).

¶1-500 Checklist of key terms

This alphabetical checklist briefly explains the meaning of a number of key terms used in this book, with cross-references to further explanations. Active asset: An asset that is used, or held ready for use, in a business and not otherwise excluded.................................... ¶3-600 Active asset test: A basic condition that must be satisfied for the CGT small business concessions to apply....................................

¶3-610

Affiliate: An individual or a company that acts, or could reasonably be expected to act, in accordance with another entity’s directions or wishes, or in concert with that entity, in relation to the affairs of the business of the individual or company....................................

¶2-080

Aggregated turnover: The sum of the annual turnovers of the taxpayer, an entity that is connected with the taxpayer and an entity that is an affiliate of the taxpayer....................................

¶2-050

Aggregated turnover test: A taxpayer can satisfy the aggregated turnover test in three ways, being based on its turnover for the previous year, its likely turnover for the current year or its actual turnover for the current year....................................

¶2-040

Australian Business Number (ABN): A number used to identify a business which also serves as the GST registration number for registered entities....................................

¶5-130

Basic conditions: The conditions that must be satisfied for any of the CGT small business concessions to apply....................................

¶3-200

CGT 15-year exemption: Allows a taxpayer to disregard the whole of a capital gain where the asset has been held for at least 15 years and certain conditions are met.................................... ¶4-100 CGT 50% small business reduction: Allows a capital gain to be reduced by 50% where a taxpayer satisfies all of the basic conditions for CGT small business relief....................................

¶4-300

CGT concession stakeholder: A significant individual in a company or trust or a significant individual’s spouse who has a small business participation percentage in the company or trust that is greater than zero....................................

¶3-870

CGT general discount: A CGT discount (being 50% for resident individuals and trusts) available to certain resident taxpayers that may be applied to capital gains made on assets that have been held for at least 12 months prior to the CGT event....................................

¶4-340

CGT retirement exemption: Allows a taxpayer to choose to disregard a capital gain from a CGT event based on an individual’s lifetime limit of $500,000....................................

¶4-400

CGT small business entity: A small business entity that satisfies the $2m aggregated turnover test....................................

¶2-025

CGT small business roll-over: Allows a capital gain to be deferred, but where a replacement asset is not acquired within the replacement asset period, the capital gain is until the end of the replacement asset period....................................

¶4-600

Connected with: An entity is connected with another entity if either entity controls the other entity or both entities are controlled by the same third entity....................................

¶2-070

Fourth element expenditure: Capital expenditure that is included in the fourth element of the cost base of a CGT asset, ie to increase or preserve the asset’s value or relating to installing or moving the asset.................................... ¶4-680 GST cash accounting: Under the cash basis of accounting, supplies and acquisitions made by an entity are attributed to the tax period in which the entity receives cash or pays cash respectively.................................... ¶6-100

GST registration: Only an entity that is carrying on an enterprise can register for GST. An enterprise includes all types of business activities but not activities of employees.................................... ¶5-100 GST return: An entity that is registered must give the Commissioner a GST return for each tax period applying to that entity....................................

¶5-400

Input tax credit: A credit for the GST payable on business inputs which a small business entity registered for GST can claim....................................

¶5-050

Look-through earnout right: An earnout right in relation to the disposal of a CGT asset that meets certain requirements and gives rise to look-through CGT treatment....................................

¶3-910

Margin scheme: This allows the GST payable on the sale of real property to be calculated on the margin for the supply instead of the full consideration....................................

¶8-600

Maximum net asset value test: The sum of the net values of CGT assets of the taxpayer, any entities connected with the taxpayer and any affiliates of the taxpayer or connected entities must not exceed $6m....................................

¶3-420

Passively held CGT asset: An asset that is used to derive passive income of the owner but is used in carrying on the business of an affiliate or connected entity of the owner....................................

¶3-245

Replacement asset period: Where the CGT small business roll-over happens in relation to the disposal of a CGT asset, the period starting one year before the last CGT event in the income year of the roll-over, and ending at the later of (i) two years after that last CGT event and (ii) where the CGT event occurred due to a look-through earnout right, six months after the latest time a possible financial benefit becomes or could become due under that right in relation to the asset....................................

¶4-625

Self managed superannuation fund (SMSF): A fund with fewer than five members where all members must be trustees, or directors of the trustee company, regulated by the ATO.................................... ¶8-600 Significant individual test: The significant individual test must be satisfied for a company or trust to be able to apply the CGT retirement exemption.................................... ¶3-800 Small business restructure roll-over: Roll-over relief from CGT and income tax for the transfer of an asset as a part of a change of legal structure without a change in the ultimate economic ownership of the assets....................................

¶4-800

Small business entity: An entity that carries on a business and satisfies the $2m aggregated turnover test....................................

¶2-020

Spouses: Includes a legally married couples, de facto partners and members of a same sex couple living together on a genuine domestic basis....................................

¶2-050

Transition to retirement (TTR): The transition to retirement rules allow a person to receive superannuation benefits without having to retire....................................

¶8-700

¶1-700 Key rates, tables and thresholds The following provides a summary of the relevant tax rates and thresholds for applying the small business concessions in 2017/18 (unless otherwise stated). For more detailed information please see ¶9-050. Income tax Income Year

Concessional income tax rate

Threshold for concessional rate

2016/17

27.5%

$10m

2017/18

27.5%

$25m

2018/19

27.5%

$50m

CGT small business concessions

CGT small business concessions CGT basic condition

Threshold

All concessions

Up to $6m

Maximum net asset value test

CGT small business concession CGT retirement exemption

Term

Value

Lifetime CGT exempt amount

$500,000

Small business entities Definition Small business entity

Aggregated turnover threshold $10m

Concessions available • Small business restructure rollover • Deduction for professional establishment expenses • Simplified depreciation provisions • Simplified trading stock provisions • Prepayment concessions • Two-year amendment period • GST cash accounting • Annual GST reporting • Simplified BAS • PAYG instalments on GDPadjusted basis

Small business entity (modified)

$5m

• Unincorporated small business income tax offset

CGT small business entity

$2m

• CGT 15-year exemption • CGT small business 50% reduction • CGT retirement exemption • CGT small business roll-over

Superannuation Superannuation cap

Cap for 2017/18

Concessional contributions cap

$25,000

Non-concessional contributions cap

$100,000

CGT cap

$1.445m

ELIGIBILITY FOR SMALL BUSINESS CONCESSIONS SMALL BUSINESS ENTITIES Introduction

¶2-000

Small business concessions

¶2-010

CGT Small business concessions

¶2-015

Meaning of “small business entity”

¶2-020

Meaning of “CGT small business entity” ¶2-025 Carrying on a business

¶2-030

$10m aggregated turnover test

¶2-040

Aggregated turnover

¶2-050

Annual turnover

¶2-060

Meaning of “connected with”

¶2-070

Meaning of “affiliate”

¶2-080

Editorial information

By Gaibrielle Cleary

SMALL BUSINESS ENTITIES ¶2-000 Introduction The federal tax system provides for a wide range of small business tax concessions. The availability and application of the various small business concessions are detailed in this book. The concept of a “small business entity” was first introduced with effect from 2007/08 for the purpose of providing a uniform standard eligibility criteria for determining whether a taxpayer was considered to be a small business and therefore eligible for certain concessions under the various federal tax regimes. This uniform term was split with effect from 2016/17 into two separate concepts being: (a) a small business entity, and (b) a CGT small business entity. With effect from this time a taxpayer is a small business entity where it: • carries on a business, and • satisfies the $10m aggregated turnover test.

A CGT small business entity is a small business entity that satisfies a $2m aggregated turnover test. The definition of a CGT small business entity is used for applying the CGT small business concessions, whereas the concept of a small business entity is used for the other concessions. The requirements to be a small business entity and a CGT small business entity are explained below. Unless otherwise indicated, all references to legislation in this chapter are to ITAA97.

¶2-010 Small business concessions Where a taxpayer is a small business entity for a particular year of income, the taxpayer is able to choose any of the following tax concessions, subject to meeting any additional conditions required for the particular concession: • Small business restructure roll-over (Subdiv 328-G) — see ¶4-800 • Simplified GST returns — see ¶6-010 • GST cash accounting (GST Act s 29-40) — see ¶6-100 • Payment of GST by quarterly instalments (GST Act s 162-5) — see ¶6-300 • Annual apportionment of GST input tax credits for acquisitions and importations that are partly creditable (GST Act s 131-5) — see ¶6-500 • A concessional corporate rate of tax — see ¶9-050 • A tax offset for non-corporate small business income (Subdiv 328-F) — see ¶9-060 • Immediate deduction for professional establishment expenses (s 40-880(2A)) — see ¶9-080 • Simplified depreciation rules (Subdiv 328-D) — see ¶9-100 • Simplified trading stock rules (Subdiv 328-E) — see ¶9-200 • Immediate deductions for certain prepaid business expenses (ITAA36 s 82KZM, 82KZMD) — see ¶9400 • FBT car parking exemption (FBT Act s 58GA) — see ¶9-500 • FBT exemption for multiple portable electronics devices (FBT Act s 58X(4)(b)) — see ¶9-570 • PAYG instalments based on GDP-adjusted notional tax (TAA Sch 1 s 45-130) — see ¶9-600 (s 32810(1)). Where a taxpayer is a small business entity for an income year, the standard two-year period for amending the taxpayer’s assessment in accordance with ITAA36 s 170 will also apply to the taxpayer for that income year (s 328-10(2)) — see ¶9-700. Note that some of these concessions will not be available where a taxpayer is only a small business entity as a result of satisfying the aggregated turnover test pursuant to the actual turnover test (see ¶2-040).

¶2-015 CGT Small business concessions A taxpayer that is a CGT small business entity for a particular year of income is able to apply any one or more of the following CGT concessions subject to meeting any additional conditions required for the particular concession: • CGT 15-year exemption (Subdiv 152-B) — see ¶4-100

• CGT small business 50% reduction (Subdiv 152-C) — see ¶4-300 • CGT retirement exemption (Subdiv 152-D) — see ¶4-400 • CGT small business roll-over (Subdiv 152-E) — see ¶4-600. Where a taxpayer is not a CGT small business entity, the above CGT small business concessions may still be available where the taxpayer satisfies any of: (a) the maximum net asset value test of $6m (b) the special requirements for passively held assets, or (c) the special requirements for partners in partnerships (¶3-240).

¶2-020 Meaning of “small business entity” A taxpayer will be a small business entity in an income year (the “current year”) where the taxpayer: (1) carries on a business in the current year, and (2) satisfies the $10m aggregated turnover test (s 328-110). Note that for the purpose of applying the tax offset for non-corporate small business income tax offset a modified aggregated annual turnover test of $5m applies (¶9-060). A taxpayer that is a partner in a partnership in an income year is excluded from being a small business entity in such a capacity (s 328-110(6)). The circumstances in which a taxpayer will meet each of the conditions to be a small business entity are addressed separately in ¶2-030 and ¶2-040 respectively. Where a taxpayer satisfies these conditions, the taxpayer will automatically be a small business entity. There is no requirement for a taxpayer to choose to be a small business entity or notify the Commissioner of its status as a small business entity. However, an entity is required to state its status as a small business entity for an income year in its tax return. The relevant small business concessions will apply where all of the relevant conditions for the particular concession are satisfied. In general, a taxpayer will need to choose to apply the simplified depreciation provisions.

¶2-025 Meaning of “CGT small business entity” An entity will be a “CGT small business entity” for an income year where: (a) it is a small business entity (¶2-020) for the income year, and (b) the entity would be a small business entity for the income year if the $10m aggregated turnover test referred to a threshold of $2m instead of $10m (s 152-10(1AA)). The $10m aggregated turnover test is outlined in ¶2-040. The definition of a CGT small business entity is used for the purpose of determining whether the CGT small business concessions are available.

¶2-030 Carrying on a business The first condition for a taxpayer to be a small business entity in an income year requires the taxpayer to carry on a business during that income year (the “current year”). The term “business” is defined to include any profession, trade, vocation or calling, but excludes any occupation carried on as an employee (s 995-1). Whether an entity is carrying on a business will be a

question of fact and degree based on the circumstances. In determining whether an entity is carrying on a business, the following factors are generally considered to be important: (1) Profitability: the fact that a profit is being made is usually a good indicator that a business is being carried on, although the lack of a profit does not necessarily mean there is no business. (2) Size: the larger the operations that are being conducted, the more likely a business is being carried on. (3) Effort: where the activities conducted by the entity involve a substantial and regular effort over a period of time, it is more likely to constitute a business. However, it is possible to carry on a business as a part-time activity. A single transaction can constitute the carrying on of a business if the results are from a concerted effort, especially if it is connected with the taxpayer’s normal business activities. (4) Business records: if detailed business records are kept, it is more likely that a business is being carried on. The lack of records is a strong indicator that a business is not being carried on. The Commissioner’s views on the indicators of carrying on a business are set out in the following: • Taxation Ruling TR 97/11 — carrying on a business of primary production • Taxation Ruling TR 2005/1 — carrying on a business as a professional artist • Taxation Ruling TR 2008/2 — carrying on business in the horse industry. A more detailed list of the factors involved is given below. Positive factors

Negative factors

More likely to be a business if …

Less likely to be a business if …

Large scale operations

Small scale operations

Involves employees

One person operation

Frequent acts/transactions

Infrequent acts/transactions

Conducted with a view to profit

Conducted as mere hobby

Profitable

Non-profitable

Conducted over long period

Short-term

Conducted continuously and systematically

Spasmodic

In commercial premises

At home

Involves items typically dealt with commercially

Involves items not ordinarily dealt with commercially

Involves exercise of specialised knowledge

Involves little knowledge or skills

Significant capital investment

Little or no capital investment

Business records kept

Records not kept, or inadequate

Full-time

Part-time

Market research done

No market research

Associated with other commercial activities of taxpayer

No other commercial activities

Existence of business organisation, business name Conducted personally/privately

Advertising

No advertising

Active

Inactive or preliminary

In most circumstances, it will be obvious whether an entity is carrying on a business. Cessation of a business For the purpose of determining whether a taxpayer satisfies the first condition to be a small business entity, a taxpayer will be treated as if it carried on a business in an income year where: • in that year the taxpayer was winding up a business it previously carried on, and • the taxpayer was a small business entity for the income year in which it stopped carrying on that business (s 328-110(5)). Therefore, the mere fact that a taxpayer has ceased to carry on a business in order to wind up the business will not prevent the taxpayer from being a small business entity.

¶2-040 $10m aggregated turnover test The second condition for a taxpayer to be a small business entity in an income year requires the taxpayer to satisfy the $10m aggregated turnover test. The $10m aggregated turnover test for an income year (“current year”) will be satisfied where any one of the following tests are satisfied: (1) “look back test”: the taxpayer’s aggregated turnover for the income year prior to the current year was less than $10m (s 328-110(1)(b)(i)). (2) “look forward test”: the taxpayer’s aggregated turnover for the current year, determined at the start of the current year, is likely to be less than $10m (s 328-110(1)(b)(ii)). This generally requires the taxpayer to determine its likely income as at the first day of the current year (s 328-110(2)(a)). Where the taxpayer only started to carry on the business during the current year, the likely income for the current year is determined as at the date the taxpayer started to carry on the business (s 328-110(2)(b)). However, the $10m aggregated turnover test will not be satisfied by the taxpayer under this test where the taxpayer had carried on business in the prior two income years, and the taxpayer’s aggregated turnover for each of those income years was $10m or more (s 328-110(3)). (3) “actual turnover test”: the taxpayer’s actual aggregated turnover for the current year, worked out as at the end of that year, is less than $10m (s 328-110(4)(b)). The taxpayer only needs to satisfy one of the look back, look forward or actual turnover tests to be a small business entity for the income year. Example The Tribiani Unit Trust carries on a bakery business in 2017/18 (the “current year”). The bakery business has been carried on since 2014/15. The Tribiani Unit Trust was not a small business entity in either 2015/16 or 2016/17 as the actual and expected aggregated turnover for each of those income years were $12m and $11m respectively. The likely aggregated turnover of the Tribiani Unit Trust for 2017/18, determined as at the start of the year, was $9.8m. As the Tribiani Unit Trust carries on a business during 2017/18, the first condition to be a small business entity will be satisfied. In relation to the aggregated turnover test, it is clear that the look back test will not be satisfied as the Tribiani Unit Trust was not a small business entity in 2016/17. In relation to the look forward test, while the Tribiani Unit Trust expects to have an aggregated turnover of less than $10m in 2017/18, it will not be a small business entity pursuant to the look forward test as its aggregated turnover for each of the two previous income years was more than $10m. Therefore, the Tribiani Unit Trust will only be a small business entity for 2017/18 where its actual aggregated turnover, determined at the end of the year, is less than $10m. In other words, the Tribiani Unit Trust will only be a small business entity where it satisfies the actual turnover test.

Accordingly, the Tribiani Unit Trust will only be able to determine whether it can be a small business entity as at the end of 2017/18.

The meaning of “aggregated turnover” is detailed in ¶2-050. Where a taxpayer only satisfies the $10m aggregated turnover test on the basis of the actual turnover test for an income year, the taxpayer is not able to choose to apply any of the following concessions for that income year: • GST cash accounting pursuant to GST Act s 29-40 (¶6-100) • paying GST by quarterly instalments pursuant to GST Act s 162-5 (¶6-300) • preparing simplified business activity statements (¶6-010) • making an annual apportionment of input tax credits for acquisitions and importations that are partly creditable pursuant to GST Act s 131-5 (¶6-500) • paying PAYG instalments based on GDP-adjusted notional tax pursuant to TAA Sch 1 s 45-130 (¶9600). These concessions are excluded from applying for the practical reason that they provide concessional treatment during a current income year. As the taxpayer’s status as a small business entity under the actual turnover test can only be determined at the end of the current year, the concessions are not able to be applied by such a taxpayer during the income year. Adjustments to the $10m aggregated turnover test The $10m aggregated turnover test is replaced with an aggregated turnover test of a lower threshold in accordance with the following: (a) for the purpose of applying the tax offset for non-corporate small business income (¶9-060) a $5m aggregated turnover test applies, and (b) for the purpose of applying the CGT small business concessions in accordance with the definition of a CGT small business entity (see Chapter 4) a $2m aggregated turnover test is used. These adjusted aggregated turnover tests apply by replacing the $10m threshold in the $10m aggregated turnover test with the relevant lower stated threshold.

¶2-050 Aggregated turnover A taxpayer will only be a small business entity where the aggregated turnover test is satisfied. This test requires the turnover of the taxpayer, the entities connected with the taxpayer and the affiliates of the taxpayer to be aggregated together to determine whether or not the relevant threshold is exceeded. The aggregation rule is designed to prevent large businesses from artificially splitting their operations into separate entities to gain access to the various concessions a small business taxpayer may be entitled to. A taxpayer’s aggregated turnover for an income year is the sum of the “relevant annual turnovers” excluding certain amounts (s 328-115(1)). The relevant annual turnovers are: • the taxpayer’s annual turnover for the income year • the annual turnover for the income year of any entity (a “relevant entity”) that is connected with the taxpayer at any time during the income year, and • the annual turnover for the income year of any entity (a “relevant entity”) that is an affiliate of the taxpayer at any time during the income year (s 328-115(2)). The meaning of the terms “connected with” and “affiliate” are detailed in ¶2-070 and ¶2-080 respectively. In calculating the taxpayer’s aggregated turnover, income derived through dealings between any of the

taxpayer, the taxpayer’s affiliates and any entities connected with the taxpayer, during the period of that connection or affiliation, will be excluded from the taxpayer’s aggregated turnover (s 328-115(3)(a), 328115(3)(b)). Also excluded from the calculation of the taxpayer’s aggregated turnover are any amounts derived in the income year by a relevant entity while the relevant entity was not connected with the taxpayer or was not an affiliate of the taxpayer (s 328-115(3)(c)). Where a taxpayer has no connected entities or affiliates, the taxpayer’s aggregated turnover will simply be the same as its annual turnover. Passively held CGT assets Where a taxpayer (“asset owner”) seeks to apply the CGT small business concessions to a passively held CGT asset (¶3-245) and does not satisfy the maximum net asset value test, the basic conditions for the traditional CGT small business concessions will only be satisfied where either: • an affiliate of, or an entity connected with, the asset owner is a CGT small business entity and carries on a business in relation to that asset (s 152-10(1A)), or • the owner is a partner in a partnership that is a CGT small business entity and carries on a business in relation to that asset (s 152-10(1B)). In determining whether the passively held asset owner’s affiliate or connected entity (“relevant business entity”) satisfies the aggregated turnover test, and therefore is a CGT small business entity, the following special rules apply in calculating the aggregated turnover of the relevant business entity: • where an entity is only taken to be an affiliate of, or connected with, another entity due to an individual’s spouse or child under the age of 18 years being deemed to be the individual’s affiliate (see ¶2-070), then that spouse or child is also taken to be an affiliate of the individual for the purpose of calculating the aggregated turnover (s 152-47(3)) • an entity that is an affiliate of, or is connected with, the owner of the passively held asset referred to in s 152-10(1A) or (1B) (see ¶2-080) is treated as being an affiliate of, or connected with, the relevant business entity (s 152-48(2)), and • where the owner of the passive asset is a partner in two or more partnerships and the asset is used in, held ready for use in, or is inherently connected with a business carried on by those partnerships, then each of those partnerships will be treated as being connected with the relevant business entity (s 152-48(3)). The rules only apply for determining the aggregated turnover of the relevant business entity for the purpose of the CGT small business concessions where the provisions apply to a passively held asset. They do not apply in any other circumstances. The above deeming rules also only apply to deem the entity to be an affiliate of, or connected with the relevant entity where that entity is not otherwise an affiliate of, or connected with the relevant entity under the general rules. Example Dan owns a commercial property which is leased to Lost Pty Ltd to carry on its private investigations business. The shares in Lost Pty Ltd are wholly owned by Dan’s wife, Roseanne. Roseanne also owns 100% of the units in the unit trust, Found Pty Ltd which also carries on a private investigations business. Dan owns 80% of the shares in an unassociated plumbing business, Taps Pty Limited. Dan does not satisfy the maximum net assets value test and does not carry on a business personally. The CGT small business concessions will only apply where Lost Pty Ltd is treated as a CGT small business entity connected with Dan. Under the ordinary rules, Roseanne is not an affiliate of Dan and Lost Pty Ltd is not an entity connected with Dan. However, as the property is a passively held asset, for the purpose of determining whether Lost Pty Ltd is connected with Dan, Roseanne will be Dan’s affiliate pursuant to s 152-47(2). As a result, Lost Pty Ltd will be connected with Dan (s 328-125). For the purpose of determining whether Lost Pty Ltd satisfies the $2m aggregated turnover test and therefore qualifies as a CGT small business entity, the turnover of the following are included: • Lost Pty Ltd • Found Pty Ltd (as it is an entity connected with Lost Pty Ltd)

• Roseanne (to the extent that she has a personal business) • Taps Pty Ltd (as it is an entity connected with Dan).

The definition of a spouse of an individual is: • another individual whether of the same sex or a different sex with whom the individual is in a registered relationship under state or territory law pursuant to s 2E of the Acts Interpretation Act 1901 (eg husband and wife), or • another individual who, although not legally married to the individual, lives with the individual on a genuine domestic basis in a relationship as a couple. Discretionary Trust Where a trustee of a trust nominates one or more beneficiaries to be controllers of the trust for an income year because the trust did not make any distributions of income or capital during the year and either had a tax loss or no net income for that year, any nominated beneficiaries will be treated as if they controlled the trust for that year (s 152-78). As a result, such nominated beneficiaries will each be connected with that trust for the relevant year (s 152-78(3), 328-125). Accordingly, in calculating the aggregated turnover of an entity, such beneficiaries are treated as being connected with the trust. The inclusion of such beneficiaries as connected entities only applies for determining whether the entity is a CGT small business entity. It does not affect the calculation of the aggregated turnover for determining whether an entity is a small business entity.

¶2-060 Annual turnover The annual turnover of an entity for an income year is the total ordinary income that the entity derives during that income year in the ordinary course of carrying on a business (s 328-120(1)). The term “ordinary income” means income according to ordinary concepts (s 6-5). Therefore, only the entity’s ordinary income that is derived from the business will be included in the calculation of annual turnover. The following types of income will be excluded from the calculation of an entity’s annual turnover: • ordinary income which is not derived in the ordinary course of the entity’s business (eg salary and wages) • any statutory income of the entity, irrespective of whether it is derived from the entity’s business (eg capital gains) • any of the following amounts of non-assessable non-exempt income pursuant to s 17-5: – GST payable on a taxable supply – an increasing adjustment in the GST payable on a supply – an increasing adjustment that relates to an acquisition and arises in circumstances that give rise to a recoupment that is included in assessable income (s 328-120(2)) • any amounts of ordinary income the entity derives from sales of retail fuel (s 328-120(3)). In calculating the annual turnover of an entity, special rules will apply in certain circumstances, as detailed in the following sections. Arm’s length value for dealings with associates In calculating an entity’s annual turnover for an income year, the amount of ordinary income the entity actually derives from any dealing with an associate is replaced with the amount of ordinary income the entity would have derived had the dealing been made on arm’s length terms (s 328-120(4)). The term “associate” is broadly defined in accordance with ITAA36 s 318 with different definitions for associates of

an individual, company, trustee of a trust and a partnership. While the calculation of an entity’s annual turnover includes the arm’s length value of dealings between the entity (“first entity”) and its associates, where the dealing is between any of the first entity, an entity connected with the first entity or an affiliate of the first entity, the income derived will be excluded from the definition of the first entity’s aggregated turnover (s 328-115(3); see ¶2-050). Carrying on business for part of year Where an entity does not carry on a business for the whole of an income year, the entity’s annual turnover for the income year is calculated using a reasonable estimate of what the entity’s annual turnover for the income year would have been if the entity had carried on a business for the whole of the income year (s 328-120(5)). This rule applies where the entity either started or ceased carrying on a business during the relevant income year. The Commissioner does not provide any guidance as to what method is to be used for determining a reasonable estimate of the annual turnover. Therefore, an entity can calculate the annualised turnover using any method that can be justified as reasonable in the circumstances. Example Zach started carrying on a consulting business in April of an income year. The ordinary income derived by Zach from the business during the first three months of business was $400,000. For the purpose of calculating his annual turnover, a reasonable estimate of the annual turnover may be $1,600,000 (being four times the actual turnover for the quarter of the year).

However, the method for determining a reasonable estimate of the annual turnover does not necessarily require the annual income to be determined based on a pro-rating of the turnover made for part of the year (as used in the example). The reasonable estimate of the annual turnover can take into account other factors that impact upon an entity’s revenue such as seasonal demand. Special rules under regulations There is provision for the calculation of the annual turnover to be determined in accordance with a different method as prescribed by the regulations (s 328-120(6)). Any special rule prescribed under the regulations will only apply to the extent that the calculation of the annual turnover would be less than the amount otherwise calculated under the general rules. As at the time of publication, there were no special methods prescribed under the regulations.

¶2-070 Meaning of “connected with” In applying the small business concessions, it is necessary to determine whether any entities are “connected with” the relevant taxpayer. This concept is essential for determining: • the aggregated turnover of the taxpayer and therefore whether the taxpayer is a small business entity or a CGT small business entity for an income year, and • the potential application of the CGT small business concessions in Div 152 (see Chapter 4). In relation to the CGT small business concessions, the term “connected with” is also relevant for determining each of the following: • whether the maximum net asset value requirement in s 152-20 is satisfied (¶3-400) • whether the asset is an active asset in accordance with s 152-40 (¶3-600), and • whether a taxpayer satisfies the special basic conditions for a passively held CGT asset in accordance with s 152-10(1A) or (1B) (¶3-245). An entity is connected with another entity if:

• either entity controls the other entity, or • both entities are controlled by the same third entity (s 328-125(1)). For the purpose of applying this test the special look-through rules in Subdiv 106-B to 106-D apply where there are absolutely entitled beneficiaries, bankrupt individuals, security providers and companies in liquidation involved. In this manner, the provisions look-through the nominee holders to the relevant underlying owners. There are different tests prescribed for determining control depending upon the type of entity being considered. The relevant entities and control tests are outlined in the following sections. Direct control of a company An entity (the “first entity”) will control a company if the first entity, its affiliates, or the first entity together with its affiliates, either: • own, or have the right to acquire the ownership of, interests in the company that carry between them the right to receive at least 40% of either: – any income distribution by the company, or – any capital distribution by the company, or • own, or have the right to acquire the ownership of, equity interests in the company that carry between them the right to exercise, or control the exercise of, of at least 40% of the voting power in the company (s 328-125(2)). This control test is based on legal ownership, rather than who benefits from the ownership. Accordingly, a trust can be a controller of a company. An entity only needs to satisfy one of the tests in order to be treated as controlling the relevant company. The relevant percentage interest under the test is referred to as the control percentage. Example 1 Alec is an individual who owns 20% of the ordinary shares in Baldwin Enterprises Pty Limited. His affiliate Kim owns 25% of the ordinary shares in Baldwin Enterprises. The ordinary shares hold equal voting, capital and dividend rights. As Alec and his affiliate together own 45% of the shares, Alec is considered to have direct control of Baldwin Enterprises. Accordingly, Baldwin Enterprises will be connected with Alec.

For the purpose of determining whether an entity controls a company, it is only necessary that the entity, its affiliates or the entity and its affiliates together have the right to at least 40% of any one of: • the income rights • the capital rights, or • the voting rights. This is distinguished from the test for determining the direct small business participation percentage an entity holds in a company, which effectively uses the lowest percentage held in any of those rights. The meaning of the direct small business participation percentage is outlined in ¶3-890. Example 2 Mason owns the following shareholding in Zoom Zoom Pty Limited: • 15% of the A Class shares which entitle the holder to income distributions • 46% of the B Class shares which entitle the holder to voting rights • 25% of the C Class shares which entitle the holder to capital distributions.

As Mason has the right to 46% of the voting rights in Zoom Zoom Pty Limited, Mason will have a control percentage of 46%. Accordingly, Zoom Zoom will be an entity connected with Mason. This applies despite the fact that Mason has lower percentage rights to income and capital distributions from Zoom Zoom. Note that Mason’s direct small business participation percentage in Zoom Zoom would be only 15% and therefore he would not be a significant individual for CGT purposes, despite being a controller.

Direct control of a non-discretionary trust An entity (the “first entity”) will control a non-discretionary trust if the first entity, its affiliates, or the first entity together with its affiliates own, or have the right to acquire the ownership of, interests in the trust that carry between them the right to receive at least 40% of: • any income distribution by the trust, or • any capital distribution by the trust (s 328-125(2)). The relevant percentage interest is referred to as the control percentage. Example 3 Marlo owns the following units in the Donohoe Unit Trust: • 20% of the income units • 25% of the capital units. Marlo’s affiliate, Roger, owns 30% of the income units but does not hold any capital units. While Marlo is only entitled to 20% of all income distributions and 25% of all capital distributions, she will have a direct control percentage of 50% due to her affiliate having a right to 30% of the income distributions.

An entity can have a direct control percentage as a result of rights that are only held by an affiliate of the entity. Example 4 Chandler is a taxpayer and holds 5% of the income units in the Badger Unit Trust. He owns no capital units. Chandler’s affiliate, Elizabeth, owns: • 5% of the income units, and • 45% of the capital units. Chandler will have a direct control percentage of 45% in the Badger Unit Trust as his affiliate (Elizabeth) is entitled to 45% of the capital distributions. This applies despite the fact that Chandler does not hold any capital units.

Direct control of a partnership An entity (the “first entity”) will control a partnership if the first entity, its affiliates, or the first entity together with its affiliates own, or have the right to acquire the ownership of, interests in the partnership that carry between them the right to receive at least 40% of the net income of the partnership (s 328-125(2)). The net income of a partnership is determined in accordance with ITAA36 s 92. The relevant percentage interest is referred to as the control percentage. Direct control of a discretionary trust There are two separate tests for determining whether an entity controls a discretionary trust. In addition, there is a special nomination rule which may be applied where the discretionary trust is in losses or has no net income for an income year. In accordance with the first test, an entity (the “first entity”) will control a discretionary trust if a trustee of the trust acts, or could reasonably be expected to act, in accordance with the directions or wishes of the first entity, its affiliates, or the first entity together with its affiliates (s 328-125(3)).

Whether a trustee is accustomed to act, or might be expected to act, in accordance with the directions or wishes of another entity is determined by having regard to the circumstances of the case. The factors that could be taken into account in determining whether this test is satisfied may include: • the past behaviour of the trustee • the relationship between the parties • the amount of any property or services transferred to the trust by the entities • any arrangement or understanding between the entities and persons who have benefited under the trust in the past. The mere presence in the trust deed of a requirement that the trustee should have no regard to such directions or wishes would not prevent an entity from controlling the trust where an examination of the actual circumstances demonstrates the contrary. In Gutteridge & Anor v FC of T 2013 ATC ¶10-347, the AAT outlined the principles relevant to determining whether a person or entity exercised effective control over the trustee of a discretionary trust within the meaning of s 328-125(3). In that case, it was held that the sole director of the corporate trustee of a discretionary trust was not a controller of the trust because no decisions were made by either the sole director or the trust’s appointor unless they were in accordance with the wishes of the sole director’s father. The AAT noted the parallels to the definition of a director in the Corporations Act 2001 and expressed that a reasonable expectation that a person will act in accordance with another person’s directions or wishes can readily be formed if a person is accustomed to act in that way. The ATO has advised that while in the particular circumstances a person could reasonably be expected to act in a certain way because they were “accustomed to act” in that way, this decision does not mean that a “reasonable expectation test” can be substituted with an accustomed to act test in all cases (Decision Impact Statement on Gutteridge, 19 March 2014). Example 5 Danny is the appointor of the Bhoy Discretionary Trust. In accordance with the trust deed, the trustee of the trust cannot make an investment decision or a distribution of either income or capital without the prior approval of the appointor. The trustee of the trust operates the trust in compliance with the trust deed. In these circumstances, the Bhoy Discretionary Trust will be controlled by Danny because the trustee of the trust acts in accordance with Danny’s directions and wishes. Therefore, the Bhoy Discretionary Trust will be connected with Danny.

The second test provides that an entity (the “first entity”) will control a discretionary trust for an income year if, in any of the preceding four income years: • the trustee of the trust paid to, or applied for the benefit of, the first entity and/or any of the first entity’s affiliates, any of the income or capital of the trust, and • the percentage of the income or capital paid or applied is at least 40% of the total amount of income or capital paid or applied by the trustee for that year (s 328-125(4)). The relevant percentage interest is referred to as the control percentage. However, the first entity will not be a controller of the discretionary trust under this test where the first entity is either: • an exempt entity, or • a deductible gift recipient (s 328-125(4)). Example 6 Over the previous four income years, the Reynolds Family Trust only made income distributions in the last three years. Burt received 15% of the distribution in Year 2, 1% in Year 3 and 44% of the distribution in Year 4. Burt will have a control

percentage of 44% as he received 44% of the income distribution in one of the previous four income years. Therefore, unless the Commissioner exercises his discretion otherwise, Burt will control the Reynolds Family Trust. In Year 4 the Reynolds Family Trust distributed the remaining 56% of the income distribution to a deductible gift recipient (DGR). The DGR will not be considered to control the Reynolds Family Trust.

Nomination of controllers of discretionary trust in losses There is an additional ability for a trustee of a discretionary trust that is in losses, or has no net income for the income year to nominate beneficiaries as controllers of the trust in limited circumstances. A trustee of a discretionary trust may nominate up to four beneficiaries as being controllers of the trust for an income year where the discretionary trust: (a) has a tax loss or no net income for that income year, and (b) the trustee of the trust did not make a distribution of income or capital during that income year (s 152-78(2)). Where such a nomination is made, each nominated beneficiary is treated as if it controlled the trust in the way described above (s 152-78(3)). This nomination is effective for the purpose of applying CGT small business concessions in relation to the control test and whether an entity is a CGT small business entity, including the calculation of aggregated turnover and whether the trust is connected with an entity (s 152-78(1)). Where a nomination is made, each nominated beneficiary will be connected with the trust. Example 7 During Year 5, the Reynolds Family Trust (as referred to in Example 6) made a trust loss of $11,500. As a result of the loss, there were no income distributions made during Year 5 to beneficiaries. Further there were no capital distributions made throughout the year. The trustee of the Reynolds Family Trust can nominate up to four beneficiaries as controllers of the trust for Year 5 for the purpose of applying the CGT small business concessions. For example, the trustee may nominate Benjamin as a controller even if he had not previously received an income or capital distribution provided he is a beneficiary under the terms of the trust deed.

The nomination can be applied even where there is a controller under one of the other two tests, provided the relevant conditions for nomination are satisfied. For a nomination to be effective it must be in writing and be signed by the trustee and each nominated beneficiary (s 152-78(4)). When making a nomination, a trustee needs to take into account the effect it will have on the application of the CGT small business entity test. A beneficiary so nominated will be treated as being a connected entity to the trust for the application of the CGT small business concessions (see ¶2-050). Commissioner’s discretion where the direct control percentage is less than 50% The Commissioner has a discretion to determine that an entity (the “first entity”) does not control the other entity — whether a company, trust or partnership — where the first entity’s control percentage is at least 40%, but less than 50% and the Commissioner believes that the other entity is controlled by an entity or other entities that do not include the first entity or any of its affiliates (s 328-125(6)). Indirect control of an entity Where an entity (the “first entity”) directly controls another entity (the “second entity”), the first entity will be treated as controlling any entity that is directly, or indirectly, controlled by the second entity (s 328125(7)). The test is designed to look through interposed entities in business structures to determine control. However, this indirect control rule will not apply where the second entity is any of the following: • a company in which its shares are listed for quotation in the official list of an approved stock exchange (except shares that carry the right to a fixed rate of dividend)

• a publicly traded unit trust • a mutual insurance company • a mutual affiliate company • a company in which all of the shares are beneficially owned by one or more of the above entities (s 328-125(8)). Example 8 Isabella owns 55% of the ordinary units in the Daniel Unit Trust. The units have the same income and capital rights. The Daniel Unit Trust owns 47% of the issued share capital in Bing Pty Limited. In the circumstances, Isabella will be a controller of the Daniel Unit Trust in accordance with the direct control test. The control percentage will be 55%. The Daniel Unit Trust will control Bing Pty Limited in accordance with the direct control test and have a control percentage of 47%. In accordance with the indirect control test, Isabella will be a controller of Bing Pty Limited.

Complying superannuation fund A complying superannuation fund cannot be connected with another entity for taxation purposes. This is because neither the members of the fund, nor the trustees of the fund, will be considered to have the necessary control over the superannuation fund (Taxation Determination TD 2006/68). Accordingly, in determining whether a taxpayer is a small business entity, the turnover of the complying superannuation fund of which the taxpayer is a member or a trustee will not be included in the aggregated turnover test. Moreover, any assets that a complying superannuation fund holds will not be counted in determining whether a member satisfies the maximum net asset value requirement for the CGT small business concessions (¶3-400). Special rule for passively held CGT assets Where a taxpayer seeks to apply the CGT small business concessions to a passively held CGT asset (¶3245) and the relevant business entity is not connected with, or an affiliate of, the asset owner under the ordinary definition, a special rule applies for determining the parties that may be connected with, or an affiliate of, the asset owner. For these purposes, in determining whether the relevant business entity is an affiliate of, or connected with, the asset owner, an individual’s spouse or child under the age of 18 years that is not otherwise an affiliate, is treated as being the individual’s affiliate (s 152-47(2)). Where the relevant business entity is treated as being connected with, or an affiliate of, the asset owner due to this special rule, the deemed treatment as an affiliate also applies for determining the aggregated turnover of the relevant business entity (s 152-47(3)). Additional special deeming rules also apply for calculating the aggregated turnover of a business entity where a taxpayer seeks to apply the CGT small business concessions to a passively held CGT asset (see ¶2-050).

¶2-080 Meaning of “affiliate” In applying the small business concessions, it is necessary to determine whether an entity has any affiliates. This concept is essential for determining: • the aggregated turnover of the taxpayer and therefore whether the taxpayer is a small business entity or a CGT small business entity for an income year, and • the potential application of the CGT small business concessions (see Chapter 3). In relation to the CGT small business concessions, the term affiliate is also relevant for determining each of the following: • whether the maximum net asset value requirement in s 152-20 is satisfied (¶3-400)

• whether the asset is an active asset in accordance with s 152-40 (¶3-600), and • whether a taxpayer satisfies the special basic conditions for a passively held CGT asset in accordance with s 152-10(1A) or (1B) (¶3-245). Definition of “affiliate” An individual or a company is an affiliate of an entity if the individual or company acts, or could reasonably be expected to act: • in accordance with the taxpayer’s directions or wishes, or • in concert with the taxpayer in relation to the affairs of the business of the individual or company (s 328-130(1)). Only an individual or a company can be an affiliate of an entity. Other entities such as trusts, partnerships or superannuation funds cannot be affiliates for these purposes. The affiliate test is designed to ensure that entities that genuinely carry on independent businesses are not aggregated. In this manner, an individual or a company that does not carry on a business cannot be an affiliate of an entity. Under the general rules, an individual will not necessarily be an affiliate of an entity merely because the individual is the entity’s spouse or child under the age of 18 years. Whether a spouse or child is an affiliate of an entity is a question of fact and degree based on all the circumstances. However, an individual’s spouse or child under the age of 18 years may be deemed to be an individual’s affiliate for the purpose of determining whether a relevant business entity is connected with, or an affiliate of, the owner of a passively held CGT asset (¶2-070) for the CGT small business concessions (s 152-47(2)). The factors which may be taken into account in determining whether an entity is an affiliate include: • family or personal relationships • financial relationships or dependencies • relationships created through links such as common directors, partners or shareholders • the degree to which the entities consult with each other on business matters • whether one of the entities is under a formal or informal obligation to purchase goods or services or conduct aspects of their business with the other entity, and • whether the individual or company has common employees. However, an individual or a company will not be an entity’s affiliate merely because of the nature of the business relationship the entity and the individual or company shares (s 328-130(2)). In this regard, a partner in a partnership would not be an affiliate of another partner merely because the first partner acts, or could reasonably be expected to act, in accordance with the directions or wishes of the second partner, or in concert with the second partner, in relation to the affairs of the partnership. Similarly, an individual or company is not an affiliate of another entity merely because of a business relationship that is shared with the entity. For example, the mere fact that individuals are directors of the same company will not result in them being affiliates. Similarly, a director will not be an affiliate of the company merely because of his or her position as a director (s 328-130 example). The test must be applied by reference to the relevant entity. In this manner, just because an individual or company is an affiliate of an entity does not mean that that entity is necessarily an affiliate of the first mentioned individual or company. Example 1 Dan is carrying on a successful plumbing business as a sole trader. At the same time, Dan is the sole shareholder and director of a

plumbing supply business, Plumbing Needs Pty Limited. Dan hires a manager of Plumbing Needs Pty Limited to carry out the dayto-day dealings. However, all business decisions are made by Dan. Plumbing Needs Pty Limited will be Dan’s affiliate as it operates in accordance with the directions and wishes of Dan. As a result of the success of his plumbing business, Dan enters into an agreement with his son, James, to establish another branch of the business. Dan provides James with the capital required to establish the new branch and assists in providing him with the expertise to carry on the business. Dan orders the relevant stock for both businesses and directs James on how to operate the business on a daily basis. James pays Dan a portion of the profits from the new branch to repay him for the initial capital contribution. James is an affiliate of Dan’s because James is operating his business in accordance with Dan’s directions and wishes. However, Dan is not an affiliate of James because Dan is not operating his business in accordance with James’s directions or wishes, or acting in concert with him.

Whether an entity is an affiliate or not is determined at the relevant time. An entity’s affiliates can change over time. Special rule for passively held CGT assets Where a taxpayer seeks to apply the CGT small business concessions to a passively held CGT asset (¶3245) and the relevant business entity is not connected with, or an affiliate of, the asset owner under the ordinary definition, a special rule applies for determining the parties that may be connected with, or an affiliate of, the asset owner. For these purposes, in determining whether the relevant business entity is an affiliate of, or connected with, the asset owner, an individual’s spouse or child under the age of 18 years that is not otherwise an affiliate, is treated as being the individual’s affiliate (s 152-47(2)). Additional special deeming rules apply for calculating the aggregated turnover of a business entity where a taxpayer seeks to apply the CGT small business concessions to a passively held CGT asset (see ¶2050). Where the relevant business entity is treated as being connected with, or an affiliate of, the asset owner due to this special rule, the deemed treatment as an affiliate also applies for determining the aggregated turnover of the relevant business entity (s 152-47(3)). Additional special deeming rules also apply for calculating the aggregated turnover of a business entity where a taxpayer seeks to apply the CGT small business concessions to a passively held CGT asset (see ¶2-050). Example 2 Carrie owns 100% of the shares in the company Big Co Pty Limited. Big Co owns business premises that are rented to John, Carrie’s husband. John uses the property as an office to carry on his financial planning business which he conducts as a sole trader. Big Co enters into a contract to sell the property. The property is a passively held CGT asset. For the purpose of applying the CGT small business concessions, Carrie and John will be deemed to be affiliates of each other pursuant to s 152-47(2). As a result, John’s affiliate will control Big Co and Big Co will be an entity connected with John.

SMALL BUSINESS CGT RELIEF — THE GENERAL RULES CGT SMALL BUSINESS CONCESSIONS Introduction

¶3-000

CGT events for which small business concessions are not available

¶3-010

Interaction of the CGT small business concessions

¶3-020

CGT general discount

¶3-025

Application of the CGT small business concessions

¶3-030

Where beneficiary of a trust is entitled to concessions

¶3-040

How the beneficiary’s income is calculated

¶3-050

BASIC CONDITIONS FOR CGT SMALL BUSINESS CONCESSIONS Basic conditions

¶3-200

Basic condition 1 — CGT event

¶3-220

Basic condition 2 — capital gain

¶3-230

Basic condition 3 — maximum net assets, CGT small business entity, or passively held CGT asset

¶3-240

Special conditions for a passively held CGT asset

¶3-245

Basic condition 4 — active asset test

¶3-250

Additional basic condition — CGT concession stakeholder test where CGT assets are company shares or trust interests

¶3-260

Alternative basic condition for CGT event D1

¶3-270

MAXIMUM NET ASSET VALUE TEST Introduction

¶3-400

Timing of calculation

¶3-410

How test is satisfied

¶3-420

Net asset value

¶3-430

Assets to prevent double counting disregarded

¶3-440

Main residence of individual disregarded

¶3-450

Other personal assets of individual disregarded

¶3-460

Non-business assets of affiliates disregarded

¶3-470

ACTIVE ASSET TEST Introduction

¶3-600

How test is satisfied

¶3-610

Active assets — general

¶3-620

Assets excluded from being active assets

¶3-650

Active assets — properties used to derive rent

¶3-660

Active assets — company shares and trust interests — 80% test

¶3-670

Relationship breakdown — extended period of ownership

¶3-680

Compulsory acquisition — extended period of ownership

¶3-690

SIGNIFICANT INDIVIDUAL TEST AND CGT CONCESSION STAKEHOLDER Introduction

¶3-800

Significant individual test

¶3-810

Significant individual

¶3-820

CGT concession stakeholder

¶3-870

Small business participation percentage

¶3-880

Direct small business participation percentage

¶3-890

Indirect small business participation percentage

¶3-900

Look-through earnout rights

¶3-910

Editorial information

By Gaibrielle Cleary

CGT SMALL BUSINESS CONCESSIONS ¶3-000 Introduction There are four different CGT small business concessions in Div 152 being: (1) CGT 15-year exemption (2) CGT small business 50% reduction (3) CGT retirement exemption (4) CGT small business roll-over. These CGT small business concessions are available for CGT small business entities and other taxpayers that either satisfy a maximum net asset value test of $6m or the special conditions for passively held CGT assets where a CGT event occurs in relation to an active asset. The specific requirements for each of the four concessions are considered in detail in Chapter 4. However, in order for any of the CGT small business concessions to apply the basic conditions for CGT small business relief in Subdiv 152-B must be satisfied. This chapter examines the basic conditions (¶3-200), including the various tests, that must be satisfied for any of these CGT concessions to apply. In particular, it outlines: • the maximum net asset value test (¶3-400)

• the active asset test (¶3-600) • the significant individual test (¶3-800) • the CGT concession stakeholder test that must be satisfied where the CGT asset is a company share or trust interest (¶3-260, ¶3-870), and • the special conditions for passively held CGT assets (¶3-245). The following commentary addresses the CGT small business concessions as they apply at the start of the 2017/18 income year. In addition to the CGT small business concessions, there is also a small business restructure roll-over available pursuant to Subdiv 328-G which can provide CGT relief. This is a separate roll-over which is available in relation to the taxation implications that arise from a restructure of a small business entity (as distinct from a CGT small business entity). This roll-over relief applies not only to the taxation implications arising in relation to CGT assets, but also to revenue assets, trading stock and depreciating assets. Unlike the CGT small business concessions in Div 152, it is not necessary for the basic conditions for CGT small business relief to be satisfied in order to apply the roll-over. The application of this roll-over and the necessary conditions which must be satisfied are detailed in ¶4-800. Unless otherwise indicated, all references to legislation in this chapter are to ITAA97.

¶3-010 CGT events for which small business concessions are not available The CGT small business concessions are potentially available for capital gains arising from any CGT event except for CGT event K7, which arises where there is a balancing adjustment for a depreciating asset a taxpayer used other than for wholly taxable purposes (s 152-10(1)). However, the following CGT small business concessions will not be available for certain CGT events: • the CGT 15-year exemption and the CGT small business 50% reduction are not available for CGT events J2, J5 and J6 • the CGT small business roll-over is not available for CGT events J5 and J6 (s 152-10(4)). CGT events J2, J5 and J6 only arise where the taxpayer has previously applied the CGT small business roll-over to a capital gain. Therefore, the exclusion of these CGT events from being eligible for the above concessions prevents a taxpayer from effectively obtaining multiple applications of the CGT small business 50% reduction to a capital gain, using the CGT small business roll-over to meet the requirements for the CGT 15-year exemption, or applying the CGT small business roll-over continuously without the taxpayer ever acquiring a replacement active asset. Note that the CGT retirement exemption may still be applied for each of these CGT events. The CGT small business concessions will also not be available for CGT events F3, G3, K2, K5, K11, K12, L1, L4 and L8 as these events cannot give rise to a capital gain.

¶3-020 Interaction of the CGT small business concessions A taxpayer is entitled to apply any one or more of the CGT small business concessions for which the relevant conditions are satisfied. However, the method of application of the concessions will depend upon the taxpayer and the relevant concessions claimed. Where the basic conditions for the CGT concessions are satisfied, the CGT small business 50% reduction will apply to the capital gain made by the taxpayer unless the taxpayer chooses not to apply the reduction (s 152-205, 152-220). All the other CGT small business concessions will only apply where the relevant conditions are satisfied and the taxpayer chooses to apply the relevant concession. Where a taxpayer satisfies the conditions for the CGT 15-year exemption, any capital gain made from the CGT event will be disregarded in whole. Accordingly, if the taxpayer satisfies the conditions for the CGT

15-year exemption, there is no need to consider the application of any of the other CGT small business concessions (s 152-215, 152-330, 152-430). Similarly, where this exemption applies, there is no need to consider the CGT general discount in Div 115 (s 102-5). Where the exemption applies, the disregarded capital gain will not reduce any capital losses of the taxpayer (s 102-5). Where the conditions for the CGT 15-year exemption are not satisfied, a taxpayer may choose to apply one or more of the other CGT small business concessions for which the relevant conditions are satisfied. Accordingly, where all the relevant conditions for each of these CGT small business concessions are satisfied, the taxpayer may apply them all in conjunction with each other. The CGT small business concessions also apply in combination with the CGT general discount in Div 115, which is available for certain taxpayers that hold the relevant CGT asset for at least 12 months prior to the CGT event. The CGT general discount is usually only available for taxpayers that are individuals, trusts and complying superannuation entities (see ¶3-025). In general, to the extent that the CGT small business concessions are available and chosen, they apply in the following order: (1) the CGT general discount in Div 115 (2) the CGT small business 50% reduction (3) the order chosen by the taxpayer: • the CGT retirement exemption • the CGT small business roll-over (s 102-5, 152-210). However, the taxpayer is able to choose not to apply the CGT small business 50% reduction if desired (s 152-220). The above CGT small business concessions will only apply to reduce a capital gain after the taxpayer first applies any current year or prior year carried forward capital losses against the relevant capital gain (s 102-5). As detailed above, current year and prior year losses of a taxpayer will not be applied against any capital gain disregarded under the CGT 15-year exemption. The application of the CGT small business concessions is detailed below.

¶3-025 CGT general discount The CGT general discount is available for taxpayers that are individuals, trusts and complying superannuation funds for CGT assets that have been held for at least 12 months prior to the relevant CGT event occurring to the CGT asset (Div 115). The discount is not available for a company. A taxpayer does not need to be a CGT small business entity to claim the CGT general discount. Where the conditions for the CGT general discount are satisfied, the taxable capital gain remaining after applying any current year or prior year carried forward capital losses, will be reduced by the applicable discount percentage. The discount percentage that applies to a capital gain a taxpayer makes is: • for an individual — 50% subject to a reduction for any periods in the ownership period since 8 May 2012 that the individual was either a foreign resident or a temporary resident (see below) • for a trust — 50%, or • for a complying superannuation entity — 33⅓%. Where the individual making the capital gain has been either a foreign resident or a temporary resident at any time since 8 May 2012 during the period of ownership, the standard discount percentage of 50% is reduced to take into such periods. The reduction applies irrespective of whether the taxpayer makes the capital gain for an asset owned directly or a discount capital gain received through a trust. The relevant discount that applies for an individual in the circumstances where he or she was not an

Australian resident (other than a temporary resident) at all times in the ownership period is as follows (s 115-115): (a) Where the asset was acquired after 8 May 2012 and the individual was either a foreign resident or a temporary resident at all times during the ownership period — the discount is nil (ie there is no discount available) (b) Where the asset was acquired after 8 May 2012 and the individual was not a resident for the whole of the ownership period — the discount is calculated using the formula: Number of days during the ownership period the individual was an  Australian resident (other than a temporary resident)  2 × Number of days the asset was owned (c) Where the asset was held by a resident as at 8 May 2012 and the individual was not a resident at all times since that date — the discount is calculated using the formula: Number of days in the  ownership period 

−

Number of days in ownership period since 8 May 2012 the individual was either a foreign resident or a temporary resident

2 × Number of days the asset was owned (d) Where the asset was held by a foreign resident or a temporary resident as at 8 May 2012 and the individual obtained a valuation of the asset as at that date — the discount is calculated using the

formula: (e) Where the asset was held by a foreign resident or a temporary resident as at 8 May 2012 and the individual did not obtain a valuation of the asset as at that date — the discount is calculated using the formula: Number of days during the ownership period since 8 May 2012 that the individual was an Australian resident (other than a temporary resident) 2 × Number of days the asset was owned

¶3-030 Application of the CGT small business concessions The CGT small business concessions will apply to reduce the capital gain which a taxpayer makes during a year and therefore the amount that is included in the taxpayer’s assessable income. The CGT small business concessions are applied against a capital gain for determining the net capital gain as detailed in the method statement in s 102-5(1). The method statement for determining the net capital gain of a taxpayer in a year of income broadly requires the following steps: Step 1

Reduce the capital gains the taxpayer made during the income year by the capital losses (if any) made during the income year.

Step 2

Reduce the balance by the taxpayer’s carried forward prior year capital losses (if any).

Step 3

Reduce the balance of each amount of a discount capital gain (if any) by the discount percentage.

Step 4

Reduce the balance of any capital gain by any of the applicable CGT small business concessions, other than the CGT 15-year exemption.

Step 5

Add up the amounts of capital gains (if any) remaining after step 4. The sum is the taxpayer’s net capital gain for the income year (s 102-5(1)).

Where the CGT 15-year exemption applies, the capital gain made from the relevant CGT event will be disregarded in whole (s 152-105, 152-110). As a result, it will not be included in any steps of the method statement above and therefore will not reduce any current year or prior year capital losses of the taxpayer. For the purpose of steps 1 and 2, a taxpayer is able to choose the capital gains against which the capital losses will be applied. Accordingly, to maximise the effect of the CGT small business concessions, where a taxpayer’s total capital gains will exceed the total of the taxpayer’s current year and prior year unapplied capital losses, the taxpayer can choose which capital gains the capital losses are applied against. In this manner, in order to maximise the benefit of the CGT concessions a taxpayer should generally choose to apply the capital losses against capital gains in the following order: (1) capital gains that are neither discount capital gains nor eligible for the CGT small business concessions (2) discount capital gains that are not eligible for the CGT small business concessions (3) capital gains that are eligible for CGT small business concessions but are not discount capital gains (4) discount capital gains that are eligible for the CGT small business concessions. Note that any current year or carried forward prior year income losses will only be applied to the net capital gain determined after step 5 of the method statement. The income losses will not reduce the capital gain against which the CGT small business concessions may be applied. Where the total of the taxpayer’s current year and carried forward prior year capital losses exceed the taxpayer’s total capital gains (excluding any disregarded capital gains) for the year, with the exception of the CGT 15-year exemption, the taxpayer will not receive any benefit from the CGT small business concessions. The CGT small business concessions other than the CGT 15-year exemption will be applied at step 3, after the application of any current year or prior year capital losses and the CGT general discount (if available). To the extent these CGT small business concessions are available, they will apply in the following order: (1) the CGT small business 50% reduction (2) the order chosen by the taxpayer: • the CGT retirement exemption • the CGT small business roll-over. A taxpayer chooses whether to apply the CGT retirement exemption or the CGT small business roll-over (s 152-305, 152-410). While the CGT small business 50% reduction will automatically apply where the basic conditions are satisfied, the taxpayer can choose not to apply this reduction (s 152-220). A taxpayer may choose not to apply the CGT small business 50% reduction where the taxpayer wishes to maximise the benefit of the CGT retirement exemption in order to increase the contributions the taxpayer may make to a complying superannuation fund (s 292-100). Capital gains that are disregarded in accordance with the CGT

retirement exemption may be contributed to a complying superannuation fund without counting towards the individual’s non-concessional contributions cap. The contributions will, however, count towards the lifetime contributions CGT cap (¶8-500).

¶3-040 Where beneficiary of a trust is entitled to concessions Special provisions apply for determining the taxable income of a beneficiary of a trust that receives a trust distribution that includes a capital gain that has been subject to the CGT general discount and/or any of the CGT small business concessions. From a CGT perspective, the effect of the provisions is to directly tax the beneficiaries on their “specific entitlements” to, and their share of, other capital gains made by the trust solely under the CGT provisions. Where a CGT event occurs in relation to a CGT asset owned by a trust, the CGT small business concessions and the CGT general discount apply at the level of the trust. The net capital gain made by the trust is calculated in accordance with the method statement in s 102-5(1). The calculation of the net capital gain takes into account the application of the CGT general discount and any applicable CGT small business concessions. The net capital gain is included in the trust’s assessable income and therefore the trust’s net income (s 102-5; ITAA36 s 95). Subject to adjustments for a beneficiary’s interest in the capital gains included in the net income, the beneficiaries that are presently entitled to a share of the net income of the trust are required to include their share of the net income in their assessable income (ITAA36 s 97). In determining present entitlement, where permitted by its trust deed, a trust is able to stream capital gains to particular beneficiaries. The beneficiaries are considered to be “specifically entitled” to such capital gains provided the beneficiary receives, or can reasonably be expected to receive, an amount equal to the net financial benefit referable to that capital gain and the entitlement is recorded as such in the accounts or records of the trust (s 115-228). A beneficiary can be reasonably expected to receive the net financial benefit from a capital gain even though the capital gain will not be established until after year end (Taxation Determination TD 2012/11). However, a beneficiary cannot be made specifically entitled to a capital gain calculated by using the market value substitution rule or that has been reduced to nil as a result of losses. The beneficiary’s fraction of the net financial benefit referable to a capital gain is reduced by trust losses or expenses applied to those gains. A trustee can be made specifically entitled to an amount of a capital gain by choosing to be assessed on it provided it is permitted under the trust deed and no trust property representing the capital gain is paid to or applied for the benefit of a beneficiary of the trust by the end of two months after the end of the income year (s 115-230). Any capital gain remaining after the specific entitlements have been determined will flow proportionately to the beneficiaries (and/or trustee) based on their share of the income of the trust, excluding amounts to which beneficiaries/trustee are specifically entitled. The proportionate interest is known as the beneficiary’s “adjusted Division 6 percentage” (s 115-227). Where a beneficiary has an entitlement to a capital gain made by the trust, whether due to a specific entitlement or otherwise, the beneficiary is treated as having made an extra capital gain for CGT purposes which is determined by the following four-step process: 1. Determine the beneficiary’s share of the capital gain of the trust, being the total of the capital gain to which the beneficiary is specifically entitled plus the beneficiary’s adjusted Div 6 percentage of capital gains to which no beneficiary is specifically entitled. 2. Divide that amount by the total capital gain to provide the beneficiary’s fraction of the capital gain. 3. Multiply that fraction by the taxable income of the trust that relates to the capital gain. This gives the “attributable gain”. 4. Gross up the result of step 3 based on any CGT concessions which were applied as follows: • if either, but not both, of the 50% discount or the CGT small business 50% reduction applied to the capital gain — double the step 3 amount

• if both the 50% discount and the CGT small business 50% reduction applied to the capital gain — quadruple the step 3 amount • if no discounts or concessions applied — use the step 3 amount (ie no gross up) (s 115-215). The beneficiary’s extra capital gain is equal to the amount resulting from step 4. The purpose of the special rule is to enable the beneficiary to effectively apply the benefit of the CGT general discount and the CGT small business 50% reduction in the same manner that would have applied if the beneficiary had made the capital gain in the same circumstances. In particular, it requires any current year or prior year capital losses in the hands of the beneficiary to be applied before the CGT concessions. To prevent double taxation in the hands of the beneficiary, any capital gains on which a beneficiary is liable to pay tax pursuant to Subdiv 115-C are excluded from taxation in the hands of the beneficiary under the trust provisions (ITAA36 Pt III Div 6E). Any capital gains that are disregarded under the CGT 15-year exemption, the CGT retirement exemption or the CGT small business roll-over are disregarded at both trust level and beneficiary level. Therefore, there will be no adjustment to the amount included in the beneficiary’s assessable income to the extent that these CGT small business concessions apply.

¶3-050 How the beneficiary’s income is calculated The following examples illustrate the application of the rules in ¶3-040. Example 1 The Seattle Discretionary Trust makes a capital gain of $100,000 in the 2017/18 income year from the sale of its goodwill. The goodwill was owned for three years prior to its sale. The trust makes no other capital gains or losses during the year and has no carried forward capital losses. The trust made trading income of $10,000 during the 2017/18 income year. All the basic conditions for the CGT small business concessions were satisfied but the trust only applies the CGT small business 50% reduction. The net capital gain of the Seattle Discretionary Trust is calculated as follows:

Capital gain Less: 50% CGT general discount

$100,000 $50,000 $50,000

Less: CGT small business 50% reduction

$25,000

Net capital gain

$25,000

The net income of the Seattle Discretionary Trust is $35,000 (being the $25,000 net capital gain and the $10,000 trading income). The trust did not make any specific entitlements for the year and distributed the whole of its income to Ellen during the year. Ellen has been a resident for the whole of the period of ownership and has current year capital losses of $20,000. Ellen’s taxable income for the year will be calculated as follows: (a) Assessable income from trust distribution Ellen includes her 100% share of the $10,000 net income pursuant to Div 6, as adjusted by Div 6E, that she was presently entitled to pursuant to ITAA36 s 97. (b) Capital gain As Ellen’s share of the trust income includes a net capital of $25,000, which was subject to both the 50% CGT general discount and the CGT small business 50% reduction, Ellen is deemed to make a capital gain equal to four times the amount of her share of the net capital gain included in her trust distribution being $100,000. The net capital gain included in Ellen’s assessable income will be calculated as follows:

Deemed capital gain Less: capital loss

$100,000 $20,000 $80,000

Less: 50% CGT general discount

$40,000 $40,000

Less: CGT small business 50% reduction

$20,000

Net capital gain

$20,000

Therefore, Ellen’s net capital gain is $20,000. The net amount included in Ellen’s assessable income is:

Trust income pursuant to ITAA36 s 97

$10,000

Net capital gain

$20,000

Net assessable income

$30,000

The method for grossing up the capital gain in the hands of the beneficiary also ensures that the benefit of the 50% CGT general discount is not available to a company. Example 2 The Angeles Unit Trust makes a capital gain of $200,000 in the 2017/18 income year from the sale of its goodwill. The goodwill was owned for four years prior to its sale. The trust made a capital loss of $10,000 in the 2017/18 income year. The trust also has carried forward capital losses of $30,000. The trust has other taxable income of $50,000. All the basic conditions for the CGT small business concessions were satisfied but the trust only applies the CGT small business 50% reduction. The units in the Angeles Unit Trust were owned 50% by LA Pty Ltd and 50% by Kayla. The net capital gain of the Angeles Unit Trust is calculated as follows:

Capital gain Less: current year capital loss

$200,000 $10,000 $190,000

Less: prior year capital loss

$30,000 $160,000

Less: 50% CGT general discount

$80,000 $80,000

Less: CGT small business 50% reduction

$40,000

Net capital gain

$40,000

Neither Kayla nor LA Pty Ltd have any current year or prior year capital losses. However, Kayla has income losses of $5,000. Kayla has been a resident of Australia at all times. The net income of the trust is $90,000 (being $40,000 capital gain plus the $50,000 assessable income). The assessable income of Kayla is calculated as follows: (a) Assessable income from trust distribution Kayla’s assessable income includes her 50% share of the trust net income pursuant to Div 6, as adjusted for the capital gain by Div 6E, being $25,000. (b) Capital gain As Kayla’s share of the trust’s net capital is $20,000, which was subject to both the 50% CGT general discount and the CGT small business 50% reduction, Kayla is deemed to make a capital gain equal to four times the amount of that net capital, being

$80,000. The net capital gain included in Kayla’s assessable income will be calculated as follows:

Deemed capital gain

$80,000

Less: 50% CGT general discount

$40,000 $40,000

Less: CGT small business 50% reduction

$20,000

Net capital gain

$20,000

Therefore, Kayla’s net capital gain is $20,000. (c) Deduction Kayla is also entitled to a tax deduction for her personal income tax loss of $5,000. The net amount included in Kayla’s assessable income is:

Assessable income

$25,000

Net capital gain

$20,000 $45,000

Deduction for income loss Net assessable income

$5,000 $40,000

The assessable income of LA Pty Ltd is calculated as follows: (a) Assessable income from trust distribution LA Pty Ltd’s assessable income includes its 50% share of the trust net income pursuant to Div 6, as adjusted for the capital gain by Div 6E, being $25,000. (b) Capital gain As LA Pty Ltd’s share of the trust’s net capital is $20,000, which was subject to both the 50% CGT general discount and the CGT small business 50% reduction, LA Pty Ltd is deemed to make a capital gain equal to four times the amount of that net capital being $80,000. The net capital gain included in LA Pty Ltd’s assessable income will be calculated as follows:

Deemed capital gain

$80,000

Less: CGT small business 50% reduction

$40,000 $40,000

As LA Pty Ltd is a company, it is not entitled to the 50% CGT general discount and therefore it is deemed to make a capital gain of $40,000. The benefit of the CGT general discount claimed by the trust is effectively reversed in the hands of the corporate beneficiary. The net amount included in LA Pty Ltd’s assessable income is:

Assessable income

$25,000

Net capital gain

$40,000

Net assessable income

$65,000

The calculation of the additional capital gain is based on the net capital gain that is actually included in the

beneficiary’s share of the net income of the trust prior to the adjustment pursuant to Div 6E. The presence of any capital losses or income losses in the hands of the trust affects the calculation of the assessable income in the hands of the beneficiary. The current year and carried forward prior year capital losses will be used to calculate the net capital gain in the hands of the trust (see ¶3-030). The capital losses are taken into account in determining any specific entitlement of a beneficiary to a capital gain (s 115-228). However, where the trust has income losses that are not offset against other ordinary income it can effectively offset the capital gain. This arises due to the net capital gain being included in assessable income, against which income tax losses may be applied. In these circumstances, where a beneficiary has been made specifically entitled to a capital gain, a rateable reduction will apply to offset the capital gain (s 115-225). Accordingly, where there are income losses in the trust, it can result in a company effectively getting a partial benefit of the 50% CGT general discount. Example 3 The Jungle Discretionary Trust makes a capital gain of $100,000 in the 2017/18 income year from the sale of its goodwill. The goodwill was owned for two years prior to its sale. The trust also made an income loss of $20,000 in the 2017/18 income year. The trust made no other capital gains during the year. The trust has no current or prior year capital losses. The Jungle Discretionary Trust was entitled to the 50% CGT general discount and the CGT small business 50% reduction. The trustee of the trust distributed 100% of the capital gain to Shields Pty Limited. Shields Pty Limited made no other income or capital gains during the year. The net capital gain of the Jungle Discretionary Trust is calculated as follows:

Capital gain Less: 50% CGT general discount

$100,000 $50,000 $50,000

Less: CGT small business 50% reduction

$25,000

Net capital gain

$25,000

The net income of the Jungle Discretionary Trust is $5,000 (being the $25,000 net capital gain less the $20,000 income loss). The assessable income of Shields Pty Limited is calculated as follows: (a) Assessable income from the trust distribution As the whole of the net income relates to the capital gain, the amount included in Shields Pty Limited’s adjusted net income of the trust is nil. (b) Capital gain As Shields Pty Limited’s share of the trust’s net capital is $5,000, which was subject to both the 50% CGT general discount and the CGT small business 50% reduction, it is deemed to make a capital gain equal to four times the amount of that net capital income, being $20,000. The net capital gain included in Shields Pty Limited’s assessable income will be calculated as follows:

Deemed capital gain

$20,000

Less: CGT small business 50% reduction

$10,000

Net capital gain

$10,000

As Shields Pty Limited is a company, it is not entitled to apply the 50% CGT general discount. Therefore, Shields’s net capital gain is $10,000. The net amount included in Shields Pty Limited’s assessable income is $10,000, consisting solely of the net capital gain. If Shields Pty Limited had itself derived the same capital gain with income tax losses of $20,000, the net assessable income of the taxpayer would have been $30,000 (being ($100,000/2) − $20,000).

BASIC CONDITIONS FOR CGT SMALL BUSINESS CONCESSIONS ¶3-200 Basic conditions The basic conditions which must be satisfied in order for the CGT small business concessions to apply are: (1) a CGT event happens in relation to the CGT asset (2) the CGT event would have resulted in a capital gain but for the CGT small business concessions (3) one of the following is satisfied: (a) the taxpayer is a “CGT small business entity” for the income year (b) the taxpayer satisfies the maximum net asset value test (c) the asset is an interest in an asset of a partnership which is a CGT small business entity for the income year, and the taxpayer is a partner in that partnership (d) the special conditions for passively held assets are satisfied in relation to the CGT asset in the income year (4) the CGT asset satisfies the active asset test (s 152-10(1)). The application of each of the basic conditions for the CGT small business concessions are detailed in ¶3-220–¶3-250. However, the basic conditions are not required to be satisfied in order to apply the small business retirement exemption to a capital gain from CGT event J5 or J6 (s 152-305(4)). An additional basic condition must be satisfied where the CGT asset is a share in a company or an interest in a trust. The additional condition requires that either: • the taxpayer is a CGT concession stakeholder in the object company or trust, or • CGT concession stakeholders in the object company or trust together have a small business participation percentage in the taxpayer of at least 90% (s 152-10(2)). This additional condition is referred to as the CGT concession stakeholder test and is detailed in ¶3-260. Conditions 1 and 4 are not required to be satisfied in relation to CGT event D1, being the creation of a contract or other right (s 152-12). Where CGT event D1 applies, the taxpayer is required to satisfy the alternative basic condition that the right the taxpayer created which triggered the CGT event was inherently connected with a CGT asset of the taxpayer that satisfies the active asset test (s 152-12). The application of this alternative condition is detailed in ¶3-270. In accordance with the 2017/18 Federal Budget, it is proposed that with effect from 1 July 2017, the CGT small business concessions will be tightened to deny eligibility for assets which are unrelated to the small business (Budget Paper No 2, 2017/18).

¶3-220 Basic condition 1 — CGT event The first basic condition for the CGT small business concessions to apply requires a CGT event, other than CGT event K7, to happen to a CGT asset that the taxpayer owns (s 152-10(1)(a)). The CGT events that can occur in relation to an asset are summarised in s 104-5. CGT event K7 arises where there is a balancing adjustment for a depreciating asset a taxpayer used other than for wholly taxable purposes (s 104-235). This condition is not required to be satisfied where the relevant event is CGT event D1. CGT event D1

happens where the taxpayer creates a contract or other right (s 104-35). Where CGT event D1 happens, an alternative basic condition will be required to be satisfied (see ¶3-250).

¶3-230 Basic condition 2 — capital gain The second basic condition for the CGT small business concessions to apply is that CGT event would have resulted in a capital gain if the CGT small business concessions did not apply (s 152-10(1)(b)). Whether a capital gain will arise is determined in accordance with the terms of the relevant CGT event. A summary of the capital gains are outlined in the table in s 104-5. As a result of a capital gain being required to be made, the CGT small business concessions will not apply to CGT events F3, G3, K2, K5, K11, K12, L1, L4 and L8. These events can only give rise to a capital loss. Where the relevant CGT asset was acquired prior to 21 September 1999, a taxpayer needs to choose whether to calculate the capital gain using either: • the asset’s indexed cost base (with indexation frozen from 30 September 1999), or • the cost base without indexation but applying the CGT general discount for holding an asset for at least 12 months pursuant to Div 115 (where available). A taxpayer cannot apply both. For example, where the taxpayer is a company, it would calculate the capital gain using an indexed cost base, as a company is not eligible for the CGT general discount. Example 1 On 15 September 2017, Peanuts Pty Ltd entered into an agreement to sell land it acquired on 20 May 1994 for $500,000. The sale price of the land was $1m. Peanuts Pty Ltd used the land to carry on a business and therefore the land satisfied the active asset test. The indexed cost base of the land (with indexation frozen from 30 September 1999) is $550,000. The capital gain from the sale of the property, calculated using the indexed cost base, is $450,000. Peanuts Pty Ltd satisfied the basic conditions for the CGT small business concessions. The CGT small business 50% reduction will apply to reduce the capital gain to $225,000. The reduction can apply to the capital gain calculated using the indexed cost base. The other CGT small business concessions can be applied to reduce the balance of the capital gain.

However, where the taxpayer is an individual, trust or superannuation entity, the taxpayer is able to choose the method of calculation which provides the best outcome. Example 2 Using the same facts as in Example 1, except that the land is owned by Jordan who has been a resident at all times. As Jordan is an individual that has held the land for more than 12 months, she can apply the CGT general discount of 50% provided the capital gain is determined without the benefit of indexation. Where Jordan calculates the capital gain using the indexed cost base, the taxable capital gain and the CGT small business concessions will apply in the same manner as detailed for Peanuts Pty Ltd. The balance of the capital gain after the application of the CGT small business 50% reduction is $225,000. However, where Jordan chooses to calculate the capital gain without the benefit of indexation the capital gain will be $500,000. The CGT general discount will apply to reduce the capital gain by 50%, to $250,000. As Jordan satisfies the basic conditions for the CGT small business concessions, the CGT small business 50% reduction will reduce the balance of the capital gain to $125,000. The application of the CGT general discount and non-indexed cost base provides the better outcome for Jordan. Jordan may utilise the other CGT small business concessions to further reduce the capital gain.

¶3-240 Basic condition 3 — maximum net assets, CGT small business entity, or passively held CGT asset The third basic condition for the CGT small business concessions to apply requires the taxpayer to satisfy one of four different alternatives, being:

(1) the taxpayer is a “CGT small business entity” for the income year (2) the taxpayer satisfies the maximum net asset value test (3) the asset is an interest in an asset of a partnership which is a CGT small business entity for the income year, and the taxpayer is a partner in that partnership (4) the special conditions for passively held assets are satisfied in relation to the CGT asset in the income year. Each of these alternatives are explained separately below. (1) CGT small business entity The first alternative will be satisfied where the taxpayer is a CGT small business entity (s 152-10(1)(c)). A taxpayer is a CGT small business entity for this purpose where the taxpayer is a small business entity in the year of income and satisfies the $2m aggregated turnover threshold. The full requirements to be a CGT small business entity are detailed in Chapter 2. The definition of a small business entity requires the actual taxpayer to be carrying on a business during the year of income. Where the taxpayer itself does not carry on a business during the year of income, the taxpayer cannot be a small business entity or a CGT small business entity and cannot satisfy this test. This applies even where a business is being conducted by an entity connected with, or affiliate of, the taxpayer. However, such a taxpayer may instead take advantage of the CGT small business entity provisions by satisfying the special conditions for passively held CGT assets under the fourth alternative. This condition cannot be satisfied by a partner in a partnership holding an asset in that capacity because such a partner is expressly excluded from being a small business entity (s 328-110(6)). (2) Maximum net asset value test The second alternative test requires the taxpayer to satisfy the maximum net asset value test in s 152-35 (s 152-10(1)(c)(ii)). The application of the maximum net asset value test is detailed at ¶3-400. Essentially, the maximum net asset test will be satisfied where the sum of the net assets of: • the taxpayer • the entities connected with the taxpayer, and • the affiliates of both the taxpayer and entities connected with the taxpayer does not exceed $6m. For the meaning of entities that are “connected with”, or “affiliates” of, a taxpayer see ¶2-070 and ¶2-080, respectively. (3) Partnership test The third alternative test requires all of the following to be satisfied in the income year: • the taxpayer is a partner in a partnership • the partnership is a CGT small business entity • the CGT asset is an interest in an asset of the partnership (s 152-10(1)(c)(iii)). Where the taxpayer is a partner disposing of an asset that is not an asset of the partnership, this alternative will not be able to be satisfied even where the asset is being used by the partnership. However, the taxpayer may still satisfy the third condition by satisfying the special conditions for a passively held CGT asset in the fourth alternative. (4) Special conditions for passively held CGT assets Where a CGT event occurs in relation to a passively held CGT asset, the taxpayer may access the benefit of the CGT small business entity provisions where it satisfies one of two alternative special

conditions. The special conditions are contained in s 152-10(1A) and (1B) and are detailed below in ¶3245.

¶3-245 Special conditions for a passively held CGT asset The fourth alternative for satisfaction of the third basic condition for the CGT small business concessions applies to passively held CGT assets (s 152-10(1)(c)(iv)). The fourth alternative was introduced to enable a taxpayer that does not carry on a business itself and has a passively held CGT asset to effectively access the CGT small business entity provisions where the asset was used in the business of a partnership or an affiliate or connected entity of the taxpayer. The alternative will only be satisfied where the conditions detailed in either s 152-10(1A) or (1B) are satisfied, which provide separate conditions for a taxpayer that is a partner in a partnership and other taxpayers. A general taxpayer The first alternative condition requires all of the following to be satisfied: • an affiliate of, or an entity connected with, the taxpayer (being the asset owner) is a CGT small business entity for the income year • the taxpayer does not carry on a business in the income year (other than in partnership) • if the taxpayer carries on a business in a partnership — the CGT asset is not an interest in an asset of the partnership • the CGT small business entity carries on the business, at a time during the income year, in relation to the CGT asset that results in the asset being an active asset (s 152-10(1A)). For these purposes, there are special rules for determining entities that are affiliates of or connected with the taxpayer (see ¶2-070, ¶2-080). Special rules also apply for calculating the aggregated turnover for determining whether the entity that is carrying on the business is a CGT small business entity (see ¶2050). Partner in a partnership The second alternative condition applies to partners in a partnership and requires all of the following to be satisfied: • the taxpayer is a partner in a partnership in the income year • the partnership is a CGT small business entity for the income year • the taxpayer does not carry on a business in the income year (other than in partnership) • the CGT asset is not an interest in an asset of the partnership • the business the taxpayer carries on as a partner in a partnership, at a time during the income year, is the business carried on in relation to the CGT asset that results in the asset being an active asset (s 152-10(1B)). Special rules also apply for calculating the aggregated turnover for determining whether the partnership carrying on the business is a CGT small business entity (see ¶2-050).

¶3-250 Basic condition 4 — active asset test The fourth basic condition for the CGT small business concessions to apply requires the CGT asset to satisfy the active asset test (s 152-10(1)(d)). The active asset test is provided for in s 152-35. The active asset test will be satisfied where:

• the taxpayer has owned the asset for 15 years or less and the asset was an active asset of the taxpayer for a total of at least half of the relevant period, or • the taxpayer has owned the asset for more than 15 years and the asset was an active asset of the taxpayer for a total of at least 7½ years during the relevant period (s 152-35(1)). The relevant period: • begins when the taxpayer acquired the asset, and • ends at the earlier of: – the CGT event, and – if the relevant business ceased to be carried on in the 12 months before that time or any longer period that the Commissioner allows — the cessation of the business (s 152-35(2)). The application of the active asset test and what constitutes an active asset is detailed at ¶3-600. The active asset test is not required to be satisfied where CGT event D1 arises. Where CGT event D1 happens, an alternative basic condition will be required to be satisfied (see ¶3-270).

¶3-260 Additional basic condition — CGT concession stakeholder test where CGT assets are company shares or trust interests If the relevant CGT asset is a share in a company or an interest in a trust, the taxpayer must satisfy the additional condition that either of the following alternatives is satisfied: • the taxpayer is a CGT concession stakeholder in the object company or trust, or • CGT concession stakeholders in the object company or trust together have a small business participation percentage in the taxpayer of at least 90% (s 152-10(2)). Where the taxpayer is an individual, the taxpayer will need to satisfy the first alternative. Where the taxpayer is any other entity, eg a company or trust, the taxpayer will need to satisfy the second alternative. The meaning of a CGT concession stakeholder is detailed in ¶3-870. Broadly, an individual will be a CGT concession stakeholder in a company or trust where the individual is either: • a significant individual in the company or trust • a spouse of a significant individual in the company and the spouse has a small business participation percentage in the company or trust at that time greater than nil (s 152-60). Only an individual can be a CGT concession stakeholder in a company or trust. The method for calculating an individual’s small business participation percentage is detailed in ¶3-880. The application of this condition is illustrated in the following examples. Example 1 Lara enters into a contract for the sale of her shares in Spencer Street Pty Ltd. At the time of the sale Lara owns 15% of the ordinary shares in Spencer Street Pty Ltd. Her husband Terry owns 25% of the ordinary shares. Terry will be a significant individual in Spencer Street Pty Ltd as he has a small business participation percentage of more than 20%. While Lara will not be a significant individual herself, she will be a CGT concession stakeholder in Spencer Street Pty Ltd as she has a small business participation percentage of 15% and her husband is a significant individual. Accordingly, Lara will satisfy the additional basic condition for the CGT small business concessions in relation to her shares.

Example 2

The Cars Unit Trust enters into a contract for the sale of 70% of the issued share capital in the company Hot Rods Pty Ltd. The Cars Unit Trust is a fixed trust which had one class of issued units that had equal entitlements to income and capital distributions. At the time of entering into the contract of sale, the units in the Cars Unit Trust are held as follows: • 10% by Buffy • 40% by Angel, being Buffy’s husband • 10% by Xander • 40% by Willow. The structure may be illustrated as follows:

The small business participation percentages that the above individuals hold in Hot Rods Pty Ltd are as follows: • Buffy — 7% (calculated as 10% × 70%) • Angel — 28% (calculated as 40% × 70%) • Xander — 7% (calculated as 10% × 70%) • Willow — 28% (calculated as 40% × 70%). The CGT concession stakeholders in Hot Rods Pty Ltd are Buffy, Angel and Willow. The small business participation percentages that these individuals hold in the Cars Unit Trust are as follows: • Buffy — 10% • Angel — 40% • Willow — 40%. Therefore, the total small business participation percentage the CGT concession stakeholders in Hot Rods Pty Ltd hold in the Cars Unit Trust is 90%. Accordingly, the Cars Unit Trust will satisfy the additional basic condition for the CGT small business concessions in relation to the sale of its shares in Hot Rods Pty Ltd.

¶3-270 Alternative basic condition for CGT event D1 Where the relevant CGT event is CGT event D1, being the creation of a contract or other right, basic conditions 1 and 4 are not required to be satisfied in order to apply the CGT small business concessions (s 152-12). In these circumstances, basic conditions 1 and 4 are replaced with the alternative basic condition that the right the taxpayer created which triggered the CGT event was inherently connected with

a CGT asset of the taxpayer that satisfies the active asset test (s 152-12). The most common example of CGT event D1 arising is where the taxpayer enters into a restraint of trade created on the sale of a business. Example Bonnie B carried on a business of producing home-made gourmet dog food. Bonnie B has decided to sell her business assets, including goodwill, to Deputy Dog Pty Ltd. In accordance with the sale agreement, Bonnie B entered into a restraint of trade that prevents her from carrying on a dog food business within New South Wales for a period of two years. In consideration for entering into the restraint of trade, Deputy Dog Pty Ltd pays Bonnie B $20,000 consideration. Entering into the restraint of trade creates a restrictive covenant, being a CGT asset, in the hands of Deputy Dog. The creation of the restrictive covenant gives rise to CGT event D1 in the hands of Bonnie B. The capital gain from CGT event D1 was equal to $20,000, satisfying basic condition 2. As the capital gain arose from CGT event D1, basic conditions 1 and 4 are not required to be satisfied. The restrictive covenant is entered into to protect the value of, and therefore is inherently connected with, the goodwill of the business. Accordingly, the restrictive covenant that triggered the CGT event satisfies the special basic condition for CGT event D1 as it is inherently connected with a CGT asset of Bonnie B’s that satisfies the active asset test. Therefore, provided Bonnie B satisfies one of the alternatives in condition 3, the basic conditions for the CGT small business concessions will be satisfied in relation to the capital gain arising from the creation of the restraint of trade.

MAXIMUM NET ASSET VALUE TEST ¶3-400 Introduction The maximum net asset value test is one of the four alternatives that can be met in order to satisfy the third basic condition for the CGT small business concessions (s 152-10(1)(c)(ii)).

¶3-410 Timing of calculation The net asset value is required to be calculated just before the CGT event. For these purposes, the time of the relevant CGT event is that time specified in the provision for the relevant CGT event. The timing of the CGT events are summarised in column 2 of the table in s 104-5. The most common CGT event is CGT event A1 which occurs on the sale or disposal of a CGT asset (s 104-10). CGT event A1 will occur at the time: • when the contract for the disposal of the CGT asset is entered into, or • if no contract is entered into when the change in ownership of the asset takes place, being the time when the taxpayer stops being the asset’s owner (s 104-5, 104-10(3)). The term “just before” is interpreted as being immediately before the time of the CGT event (Interpretative Decision ID 2003/744). Therefore, the calculation of the net asset value is required to be done immediately before the CGT event occurs. The Commissioner has interpreted this provision strictly which can be particularly relevant where the value of the CGT assets included in the test can vary in value over short periods, such as shares. In Interpretative Decision ID 2003/745, the day on which the taxpayer entered into a contract for the sale of an active asset, the taxpayer held shares in a public company. At the start of the day on which the contract was entered into, the value of the shares resulted in the net value of the assets held being just below the maximum net asset value threshold. However, the value of those shares increased during the day and at the time the contract for sale was signed the net value of the assets exceeded the maximum net asset value threshold. The Commissioner concluded that the taxpayer failed the maximum net asset value test as a result of the increased value at the time the contract was entered into.

¶3-420 How test is satisfied A taxpayer will satisfy the maximum net asset value test if, just before the relevant CGT event happens,

the sum of the following does not exceed $6m: (1) the net value of the CGT assets of the taxpayer (2) the net value of the CGT assets of any entities connected with the taxpayer (3) the net value of the CGT assets of any affiliates of: • the taxpayer • entities connected with the taxpayer’s affiliates (s 152-15). The terms “connected with” and “affiliates” are detailed in ¶2-070 and ¶2-080 respectively. In calculating the net value of assets in (3) of the test, the value of any net assets already taken into account pursuant to (2) is excluded to prevent any double counting of assets. In undertaking the calculation, certain CGT assets will be disregarded. The excluded assets are detailed at ¶3-440 onwards.

¶3-430 Net asset value In calculating the maximum net asset value test, it is necessary to determine the net value of CGT assets held by the specified entities. For these purposes, the net value of the CGT assets of an entity is the amount equal to: (1) the sum of the market value of the CGT assets held by the entity LESS (2) the sum of: (a) the liabilities of the entity that are related to the asset (b) the following provisions made by the entity: (i) provisions for annual leave (ii) provisions for long service leave (iii) provisions for unearned income (iv) provisions for tax liabilities (s 152-20(1)). The net value of the assets may be positive, negative or nil. For taxation purposes, gains on the disposal of depreciating assets used for wholly taxable purposes are treated as income, and disregarded for CGT purposes. Similarly, any gains or losses on the disposal of trading stock are disregarded for CGT purposes (s 118-25). However, for the purpose of applying the maximum net asset value test, the market value of any depreciating assets and trading stock held is included in the calculation of net assets value. For the purpose of the calculation the market value of an asset is determined on the basis of its “highest and best use” as recognised in the market (Decision Impact Statement on Syttadel Holdings Pty Ltd v FC of T 2011 ATC ¶10-199). In general, the arm’s length selling price is generally considered to be the most relevant information for determining the market value unless there is a rational explanation for disregarding the sale price (Excellar Pty Ltd v FC of T 2015 ATC ¶10-391; Miley v FC of T 2016 ATC ¶10418 (appeal pending); Syttadel Holdings Pty Ltd v FC of T 2011 ATC ¶10-199). For example, in Miley the market value of a sale of the taxpayer’s 33% share in the company was considered to be less than the sale price where all the shareholders sold their shares as part of a single arrangement. It was held that the market value of shares held by a minority shareholder is less than the value if all shares were sold at the same time. At the time of writing this decision was the subject of an appeal. The taxpayer bears the

burden of proof in establishing that its valuation is correct or reasonable. It is not sufficient to merely disprove the Commissioner’s valuation (M & T Properties Pty Ltd v FC of T [2011] AATA 857). In calculating the sum of the market value of CGT assets held by the entity certain assets will be disregarded. The disregarded assets are detailed in ¶3-440. For the purpose of this calculation, the term “liabilities” takes its ordinary meaning. The Macquarie Dictionary, revised 3rd edition, defines liability to mean: “an obligation, especially for payment; debt or pecuniary obligation”. “Liabilities” include legally enforceable debts due for payment and presently existing legal or equitable obligations to pay either a sum certain or ascertainable sums, but does not extend to future obligations, expectancies or liabilities that are uncertain as both a theoretical and a practical matter (Taxation Determination TD 2007/14). For example, legal fees for work done up to the date of the CGT event (but not after) are included in liabilities even where the fees are not invoiced by that time (FC of T v Byrne Hotels Qld Pty Ltd 2011 ATC ¶20-286). For the purpose of the calculation, the GST-inclusive expenses are counted (Excellar Pty Ltd). “Contingent liabilities” are relevant for the net asset calculation where the liability is a presently existing legal or equitable obligation and the only contingency is enforcement. Where a capital gain arises from the sale of a CGT asset, any liabilities connected to the sale which only crystallise as a part of completion are taken into account in determining the net value of the CGT assets held by the taxpayer. However, a mortgage liability was not taken into account in determining the net value test where it was not in place at the time of the CGT event, even though the sale the subject of the CGT event was made dependent upon the mortgage being granted (Phillips v FC of T 2012 ATC ¶10-245). A guarantee is excluded from being a liability for the calculation where it does not relate to the guarantor’s CGT assets. The term “liabilities” does not include any provisions that are included in the entity’s accounts. However, the net asset value test specifically allows for the four recognised provisions to be taken into account in the calculation of the net value of the CGT assets held by the entity. Where the value of a CGT asset held by an entity is excluded from the calculation of the net asset value, any liabilities of the entity which relate to such an asset will also be excluded from the calculation. However, any liabilities relating to shares, units or other interests (except debt) an entity holds in another entity that is connected with the first entity (or with an affiliate of the first entity) will not be disregarded (s 152-20(2)(a)). In undertaking the calculation, the only liabilities which are deducted from the market value of the CGT assets are the liabilities of the entity that relate to the CGT assets. This includes both: • liabilities that are directly related to the particular assets that are included in the calculation (eg the outstanding balance of a loan to purchase the asset) • liabilities that are not directly related to a particular CGT asset, but are related to the assets of the entity more generally (eg the outstanding balance of a bank overdraft that provides working capital for the operation of the business of the entity) (Taxation Determination TD 2007/14). Example Melissa carries on a clothing business as a sole trader. The CGT assets that Melissa owns and their market values are as follows: • business premises — $3,000,000 • goodwill — $3,000,000 • trading stock — $400,000 • depreciating assets — $500,000 • shares in listed companies — $100,000 • main residence — $2,000,000. Melissa’s liabilities are as follows: • mortgage over the main residence — $1,000,000 • mortgage on the business premises — $1,500,000

• overdraft of the business — $500,000 • provision for tax liabilities — $300,000. Melissa does not have any affiliates or connected entities. The net value of the CGT assets held for the purpose of the maximum net asset value test will be: • the market value of all the assets except for the main residence, being $7,000,000 less: • the mortgage on the business premises of $1,500,000 • the overdraft of the business of $500,000 because it is a general liability that relates to the assets of the business • the provision for tax liabilities of $300,000. Therefore, the net value of the CGT assets is $4,700,000 and the maximum net asset value test will be satisfied.

The requirement for a liability to be related to an asset requires more than just a remote or tenuous relationship (Tingari Village North Pty Ltd v FC of T 2010 ATC ¶10-131). The determination of a debt relationship to an asset was considered in Bell v FC of T 2013 ATC ¶20-380. In that case the Full Federal Court held that a loan taken out by a family trust to give effect to the trust’s capital distribution resolution was not “related” to any asset of the trust and could not be taken into account for the maximum net asset value test. It was also confirmed that an individual’s loan account used to purchase a main residence could not be used to reduce the balance of the offset bank account as they were considered to be two separate accounts and the loan account did not “relate” to the offset account. Rather, the loan “related” to the main residence asset that was excluded from the maximum net asset value test. Foreign resident Where the entity is a foreign resident, the worldwide CGT assets of the entity are included in calculating the net value of the CGT assets of the entity. The calculation is not limited to only those assets that constitute taxable Australian property (Interpretative Decision ID 2010/126). Therefore, the net value of the CGT assets calculation includes the market value of assets for which any capital gain arising to the entity from a CGT event would be wholly disregarded because they do not constitute taxable Australian property.

¶3-440 Assets to prevent double counting disregarded In calculating the net value of CGT assets held by an entity, any shares, units or other interests (except for debt) in another entity that is connected with either the first entity or an affiliate of the first entity will be disregarded (s 152-20(2)). These assets are excluded to prevent any double counting of essentially the same assets. However, any liabilities relating to those shares, units or other interests will still be included in the calculation (s 152-20(2)(a)). In accordance with the maximum net asset value test, the CGT assets of the following are included: • the taxpayer • entities connected with the taxpayer • affiliates of either the taxpayer and entities connected with the taxpayer. Accordingly, without the specific exclusion there would potentially be double counting of assets where an entity owns interests in the affiliate or connected entity as: • the share, units or other interests held in that entity would be included, and • the net assets of that affiliate or connected entity would also be included. Example On 1 July 2017, Jennifer sells the property from which Dining Alfresco Pty Ltd carries on a restaurant. Jennifer owns 70% of the

issued share capital in Dining Alfresco Pty Ltd which is an entity connected with Jennifer. Jennifer used borrowed funds to acquire the shares in Dining Alfresco which still has an outstanding liability. In applying the maximum net asset value test, Jennifer is required to include: • the net value of the relevant CGT assets she holds • the net value of the CGT assets that are held by Dining Alfresco Pty Ltd but exclude: • the market value of the shares she holds in Dining Alfresco Pty Ltd. However, the outstanding debt on the loan used to purchase the shares in Dining Alfresco will be counted in the maximum net asset value test to reduce the value.

While this provision is intended to prevent double counting of certain assets, the exclusion applies irrespective of whether the assets of the connected entity are actually included in the calculation or not. For example, the assets of a connected entity will be excluded where the entity is only connected to the taxpayer because of an affiliate of the taxpayer (see ¶3-470).

¶3-450 Main residence of individual disregarded When calculating the net value of the CGT assets of an individual, the market value of an asset that would qualify as the taxpayer’s main residence for the main residence exemption is disregarded. This includes: • a dwelling • an ownership interest in a dwelling • any adjacent land to the dwelling (s 152-20(2)(b)(ii)). However, the market value of the asset will not be disregarded to the extent that: • the dwelling, the ownership interest in the dwelling or any relevant adjacent land was used, during all or part of the ownership period of the dwelling, by the individual to produce assessable income to a particular extent, and • either: – the individual was entitled to claim a tax deduction for interest incurred on money borrowed to acquire the dwelling or interest, or – if the individual did not incur any such interest, had the individual borrowed such money, the individual would have been entitled to deduct some or all of the interest incurred on that money (s 152-20(2A), 118-190(1)(c)). Where this applies, the taxpayer will be required to include in the calculation of the net value of CGT assets of the individual such portion of the market value of the dwelling as is reasonable having regard to the production of assessable income. The same proportion of the debt associated with the dwelling, ownership interest in the dwelling or adjacent land will be used to reduce the amount included.

¶3-460 Other personal assets of individual disregarded The following personal assets of an individual will be disregarded in calculating the net value of CGT assets: • assets being used solely for the personal use and enjoyment of the individual, or the individual’s affiliate • a right to, or to any part of, any allowance, annuity or capital amount payable out of a superannuation fund or an approved deposit fund

• a right to, or to any part of, an asset of a superannuation fund or of an approved deposit fund • a life insurance policy (s 152-20(2)). For these purposes, a life insurance policy includes an insurance policy that not only provides for payment on the death of an individual but also policies that provide for payment of a “terminal illness benefit”.

¶3-470 Non-business assets of affiliates disregarded In calculating the net value of CGT assets of an affiliate of the taxpayer or an entity connected with an affiliate of the taxpayer, the only assets included in the calculation are assets that are used, or held ready for use, in carrying on a business by either the taxpayer or another entity connected with the taxpayer (s 152-20(3)). This applies irrespective of whether the business is carried on alone or jointly with others. Therefore, any non-business assets of an affiliate or an entity connected with an affiliate are excluded from the calculation. However, in making this calculation, any assets that are used, or held ready for use, in the carrying on of a business by an entity that is connected with the taxpayer only because of the taxpayer’s affiliate are disregarded (s 152-20(4)). For the purpose of these provisions, the Federal Court in White & Anor v FC of T 2012 ATC ¶20-301 applied a “but for” test in determining whether to exclude the assets of a connected entity. It was held that s 152-20(3) and (4) apply to exclude the net assets of a connected entity in calculating the maximum net assets value test where the company was only a connected entity due to shares held by the taxpayer’s affiliate. Therefore, the assets of the connected company were excluded because it would not have been a connected entity “but for” the taxpayer’s affiliate. Example 1 Adam decides to sell the cafe that he has carried on as a sole trader. At the time of the sale Adam also owns 40% of the shares in Diners Pty Ltd, being a company that carries on a restaurant business. Adam’s wife, Ali: • owns the remaining 60% of the shares in Diners Pty Ltd • owns 50% of the shares in a catering company, Food Express Pty Ltd • carries on a dietician business as a sole trader. Ali is an affiliate of the taxpayer. The assets of Ali’s dietician business are also used by Diners Pty Ltd. Diners Pty Ltd is not reasonably expected to act in accordance with Adam’s directions. The entities connected with the taxpayer will be: (1) Diners Pty Ltd — because Adam and Ali (his affiliate) own 100% of its issued shares (2) Food Express Pty Ltd — because Ali (his affiliate) owns 50% of its issued shares. In applying the maximum net asset value test, the net value of the following assets will be included: • the net value of CGT assets held by Adam, excluding any personal assets and the shares he holds in Diners Pty Ltd as the company is connected with the taxpayer • the net value of the CGT business assets held by Ali, including the assets used in the dietician business, but excluding the shares she holds in Diners Pty Ltd and Food Express Pty Ltd as those companies are both connected with Ali • the business assets of Diners Pty Ltd, because it is an entity connected with the taxpayer, through the share ownership by Adam and Ali. Note that the business assets of this company are not excluded as the entity would still be connected with Adam even if Ali was not an affiliate because Adam owns 40% of the share capital. However, the assets of Food Express Pty Ltd are excluded from the calculation because it is only connected with the taxpayer due to the shares held by Adam’s affiliate, Ali. If Ali was not an affiliate, Food Express Pty Ltd would not be connected with Adam.

It is noted that where the assets of a connected entity are disregarded due to the connection arising solely because of the association with the affiliate, the shares, units or other interests held by the affiliate in that entity are also disregarded from the calculation. The requirement to disregard the shares, units or interests held by an affiliate in a connected entity pursuant to s 152-20(2)(a) (which is intended to apply to prevent double counting of assets) still applies even where the assets of that connected entity are

disregarded because the entity is connected solely because of the affiliate pursuant to s 152-20(4). Example 2 Danny operates a butchery as a sole trader. He also owns 20% of the units in the Shooter Unit Trust which carries on a liquor business. The remaining 80% of the units in Shooter Unit Trust are owned by his wife, Jordan. Shooter Unit Trust is not considered to be an affiliate of Danny. Jordan is an affiliate of Danny. Shooter Unit Trust is connected with Danny as he and his affiliates own 100% of its units. Shooter Unit Trust would not be connected with Danny but for Jordan being his affiliate as he only owns 20% of its units. Where Danny sells his butchery, in calculating the net asset value Danny disregards the following assets: • the 20% of units Danny owns in Shooter Unit Trust (s 152-20(2)(a)) • the 80% of units Jordan owns in Shooter Unit Trust (s 152-20(2)(a)) • the business assets of his connected entity, Shooter Unit Trust (s 152-20(4)).

ACTIVE ASSET TEST ¶3-600 Introduction The fourth basic condition that must be satisfied in order for the CGT small business concessions to apply is that the relevant asset satisfies the active asset test. Broadly, a CGT asset satisfies the active asset test if the asset was an active asset of the taxpayer: • for a total of at least half the period from when the asset was acquired until the CGT event, or • if the asset is owned for more than 15 years, for a total of at least 7½ years during that period (s 15235). The test is modified where the relevant business ceased to be carried on by the taxpayer in the 12 months prior to the CGT event, or such longer period that the Commissioner allows. Whether an asset constitutes an active asset at a point in time depends upon the actual use of the asset. Essentially an asset will be an active asset where it is used, or held ready for use, in the business and not otherwise excluded. There are a number of assets that are specifically excluded from being an active asset.

¶3-610 How test is satisfied In order for a taxpayer to be eligible for the CGT small business concessions the relevant CGT asset must satisfy the active asset test (s 152-10(1)(d)). The active asset test is the fourth basic condition which must be satisfied in order for the CGT small business concessions to apply. A CGT asset will satisfy the active asset test where: (1) the taxpayer has owned the asset for 15 years or less and the asset was an active asset of the taxpayer for a total of at least half of the specified period, or (2) the taxpayer has owned the asset for more than 15 years and the asset was an active asset of the taxpayer for a total of at least 7½ years during the specified period (s 152-35(1)). For the purpose of this test, the specified period: • begins when the taxpayer acquired the asset, and • ends at the earlier of: – the CGT event, and – if the relevant business ceased to be carried on in the 12 months before that time or any longer

period that the Commissioner allows — the cessation of the business (s 152-35(2)). What constitutes an active asset is defined in s 152-40 and is addressed below in ¶3-620. In satisfying the active asset test, there is no requirement for the relevant CGT asset to be an active asset at the time of the CGT event. Example 1 BJ Bear Pty Ltd acquired a property on 25 August 1996. BJ Bear Pty Ltd initially rented the property out to third parties until 15 March 2002. From 16 March 2002 BJ Bear Pty Ltd used the property to carry on its own communications business. This business continued to be carried on from the property until 10 January 2012 when the business ceased. From 11 January 2012 until the property was sold on 22 July 2017 the property was rented to third parties. The specified period for the active asset test is from the date of acquisition 25 August 1996 until the date the contract for sale was entered into on 22 July 2017, being 20 years and 11 months. The property will be an active asset for the period from 16 March 2002 until 10 January 2012, being nine years and 10 months. As the property has been an active asset in excess of 7½ years of the specified period, the property will satisfy the active asset test. This applies despite the fact that the property was an active asset for less than half the period of ownership.

As detailed above, the specified period begins when the taxpayer acquired the relevant CGT asset (s 152-35(2)(a)). Under ordinary circumstances, the date the asset was acquired is the date detailed in Div 109. For example, where the asset was acquired as a result of a purchase from another party, the starting date will generally be the date the contract for purchase was entered into, not the date of settlement (s 109-5(2)). In determining the date of acquisition, the relevant asset needs to be identified. For example, where there is a sale of a post-CGT property, the land and buildings constructed thereon are treated as a single asset for CGT purposes. Therefore, where a building is constructed on the land subsequent to the date of acquisition, the date of acquisition of the whole asset for the purpose of the active asset test will be the date the taxpayer entered into the contract for the purchase of the land. The date of completion of the construction of the building is irrelevant in these circumstances. The end date of the specified period is the earlier of two alternatives. The first alternative is the time of the CGT event (s 152-35(2)(b)(i)). The time of a relevant CGT event is the time specified in the provision for that event in Div 104 as summarised in s 104-5. The second alternative only applies where the relevant CGT asset was used in a business that ceased in the 12 months, or such longer period as the Commissioner agrees, before the time of the relevant CGT event (s 152-35(2)(b)(ii)). Where this applies the end of the period will be the time of cessation of the business. This second alternative allows for the specified period to be shorter than under the first alternative and thereby may effectively increase the ability of the taxpayer to satisfy the active asset test by reducing the period for which the asset must have been active. Example 2 Mark personally purchased an office on 1 March 2016. The office is leased to the Hunter Unit Trust which uses the office to carry on an accounting business. The Hunter Unit Trust is an entity that is connected with Mark. During the period of this lease the office will be an active asset. On 1 September 2016, the Hunter Unit Trust ceases to carry on the accounting business. Mark begins to lease the office to Deva Pty Ltd from the date of the sale. Deva Pty Ltd is neither an affiliate of, nor connected with, Mark. The office will not be an active asset in Mark’s hands during the period of the lease to Deva Pty Ltd. On 15 July 2017, Mark enters into an agreement for the sale of the office to Deva Pty Ltd. In applying the active asset test, the property will be an active asset for six months being the period from 1 March 2016 until 31 August 2016. The specified period is determined as the shorter of the following two alternatives, being: • the period from the date of acquisition of 1 March 2016, to the relevant CGT event of 15 July 2017, being 16.5 months • the period from the date of acquisition of 1 March 2016, to the date of cessation of the business of 31 August 2016, being six months.

Therefore, the specified period is six months. As the office was an active asset of Mark’s for the whole of the six-month period, the office will satisfy the active asset test.

Example 3 Assume the same facts as detailed in Example 2, except that the contract for the sale of the property was entered into on 30 October 2017. In these circumstances, the active asset test will only be satisfied where the Commissioner exercises his discretion to extend the time period for the sale of the office beyond 12 months from the cessation of the business to 14 months, under the second alternative. Where the extension is granted the office will have been an active asset for the whole of the specified period and the active asset test would be satisfied. If the Commissioner does not choose to extend the period under the second alternative, the specified period will be 20 months. As the office will only have been an active asset for six months, being less than half the period of ownership, the active asset test will not be satisfied. Therefore, Mark would not be entitled to utilise any of the CGT small business concessions on the sale of the property.

Special rules may apply to modify the time requirements in the active asset test where there has been a roll-over as a result of a marriage or relationship breakdown or a compulsory acquisition (s 152-45). These rules are detailed in ¶3-680 and ¶3-690.

¶3-620 Active assets — general A CGT asset is an active asset at a given time, if at that time: • the taxpayer owns the asset (whether it is tangible or intangible) and it is used, or held ready for use in the course of carrying on a business that is carried on (whether alone or in partnership) by the taxpayer, the taxpayer’s affiliate or another entity that is connected with the taxpayer, or • if the asset is an intangible asset — the taxpayer owns it and it is inherently connected with a business that is carried on (whether alone or in partnership) by the taxpayer, the taxpayer’s affiliate or another entity that is connected with the taxpayer (s 152-40(1)). The most common examples of intangible CGT assets that constitute active assets are goodwill of a business and the benefit of a restrictive covenant. Such an intangible asset can satisfy either limb to be treated as an active asset. The meaning of the terms “connected with” and “affiliate” are detailed in ¶2-070 and ¶2-080 respectively. Passively held CGT assets — special rules For the purpose of determining whether an asset is an active asset, special rules apply where the asset is a passively held CGT asset. The first special rule applies for determining whether the entity carrying on the business is either an entity connected with, or an affiliate of, the asset owner (see ¶2-070, ¶2-080). In determining whether the relevant business entity is an affiliate of, or connected with, the asset owner, an individual’s spouse or child under the age of 18 years is treated as being the individual’s affiliate (s 152-47(2)). Example 1 Daniel owns a business office which is being rented to his wife Bridget. Bridget uses the office to carry on her interior design business. Despite being married to Daniel, Bridget is not an affiliate of Daniel for CGT purposes. The office is a passively held CGT asset of Daniel’s. However, as the office is being used by Bridget in the course of carrying on her business, and Bridget is Daniel’s wife, for the purpose of applying the active asset test the office is considered to be used in the course of carrying on a business by an affiliate of Daniel’s at that time pursuant to s 152-47(2). Therefore, the office will be an active asset of Daniel’s at that time.

The second rule applies in relation to an asset used in a partnership business. Where the passively held CGT asset is owned by a partner in a partnership but is not a partnership asset, for the purpose of determining whether the asset is an active asset at a time, the relevant business that the asset must be

used in or inherently connected with is the business that the partner carries on as a partner in the partnership (s 152-10(1B)(e)). Example 2 Peter and Mary carry on a legal business in the PPM partnership as equal partners. The property from which the business is carried on is personally owned by Mary and leased to the PPM partnership. The property is not a partnership asset. Mary enters into a contract to sell the property to her personal superannuation fund. Mary does not carry on a business other than as partner in a partnership. The property is a passively held CGT asset in Mary’s hands. For the purpose of determining whether the active asset test is satisfied, the relevant business is the business that Mary is carrying on as a partner in the PPM partnership. As the property is being used in carrying on the business of the PPM partnership the property will be an active asset.

The remaining special rules apply to a passively held CGT asset where the business in which the passively held CGT asset was being used is in the process of being wound up in the income year in which the CGT event occurs (“CGT event year”) and either: • the asset was used, or held ready for use, in the course of carrying on the business at a time in the income year in which the business stopped being carried on, or • if the asset is an intangible asset — the asset was inherently connected with the business that was carried on at a time in the income year in which the business stopped being carried on (s 152-49(1)). Where this applies for the purpose of determining whether the asset is an active asset at a time: (a) the entity (including a partner) is treated as carrying on a business at a time in the CGT event year, and (b) either: • the CGT asset is taken to be used, or held ready for use, in the course of carrying on the business at that time, or • if the asset is an intangible asset — the CGT asset is taken to be inherently connected with the business at that time (s 152-49(2)). Example 3 Sutcliffe Enterprises Pty Limited carries on a magazine publishing business. The shares in Sutcliffe Enterprises Pty Ltd are owned 50% by David and 50% by Christopher. David owns the property in which the business was conducted. The property was acquired on 18 June 2006 and was used by Sutcliffe Enterprises from the day of acquisition until the business ceased on 18 July 2016. David entered into a contract for the sale of the property on 30 August 2017. Sutcliffe Enterprises entered into winding up proceedings in April 2017 which continued throughout July 2017. In determining whether the property is an active asset in the 2018 income year, Sutcliffe Enterprises is treated as carrying on the business in the income year that the property is sold and the property is treated as being used, or held ready for use, in its business. This is because the property was used by Sutcliffe Enterprises until it ceased to carry on business in the 2017 income year and was still being wound up in the 2018 income year, being the income year in which the property was sold (s 152-49). Therefore, the property is an active asset at a time in the CGT event year because it is used in the business of an entity (Sutcliffe Enterprises) that is connected with the asset owner (David).

Primary production For the purpose of determining whether an entity is carrying on a business, the deeming provision in s 392-20 is disregarded (s 152-40(2)). Section 392-20 deems an entity to be carrying on a primary production business that is actually carried on by a trust during an income year where the entity is a beneficiary presently entitled to all or part of the trust income for the income year. Exclusion of assets Notwithstanding the satisfaction of the general test for determining whether an asset is an active asset, certain assets are specifically excluded from being active assets as detailed below in ¶3-650.

¶3-650 Assets excluded from being active assets While an asset may satisfy the general test to be an active asset in accordance with s 152-40(1), the asset will not be an active asset to the extent it is specifically excluded from being an active asset in s 152-40(4). The categories of assets that are excluded from being active assets of a taxpayer are detailed separately below. Interest in a connected entity An interest held by a taxpayer in an entity that is connected with the taxpayer, other than a share in a company or an interest in a trust that is an active asset in accordance with the 80% test, is excluded from being an active asset (s 152-40(4)(b)). The 80% test for determining whether a company share or trust interest is an active asset is contained in s 152-40(3) and detailed in ¶3-670. Shares in a company A share in a company will be excluded from being an active asset unless it is either: • a share in a widely held company that is treated as being an active asset pursuant to the 80% test, or one of its extensions, and is held by a CGT concession stakeholder, or • a share in any other company that is an active asset pursuant to the 80% test, or one of its extensions (s 152-40(4)(b)). The application of the 80% test and its extensions are detailed in ¶3-670. Interests in a trust An interest in a trust will be excluded from being an active asset unless it is either: • an interest in a specified widely held trust that is treated as being an active asset pursuant to the 80% test or its extensions and is held by a CGT concession stakeholder, or • an interest in any other trust that is an active asset pursuant to the 80% test or its extensions (s 15240(4)(c)). The application of the 80% test and its extensions are detailed in ¶3-670. For these purposes, a trust is a specified widely held trust if: • the interests in the trust are listed for quotation in the official list of an approved stock exchange, or • the trust has more than 50 members, and is neither a discretionary trust nor a trust where at least one of the following conditions is met during an income year: – no more than 20 persons held, or had the right to acquire or become the holders of, membership interests representing at least 75% of the value of the membership interests in the trust – if there are trust voting interests in the trust — at least 75% of the trust voting interests in the trust was capable of being controlled by no more than 20 persons – at least 75% of the amount of any distribution made by the trustee during the year was made to no more than 20 persons – if no distribution was made by the trustee during the year — the Commissioner is of the opinion that, if a distribution had been made during the year, at least 75% of the distribution would have been made to no more than 20 persons (s 152-40(5)). Financial instruments A CGT asset that is a financial instrument will be excluded from being an active asset (s 152-40(4)(d)). The term “financial instrument” specifically includes: • loans

• debentures • bonds • promissory notes • futures contracts • forward contracts • currency swap contracts, and • a right or option in respect of a share, security, loan or contract. Passive assets An asset whose main use in the course of carrying on business is to derive any of the following is excluded from being an active asset: • interest • an annuity • rent • royalties • foreign exchange gains unless: • the asset is an intangible asset and has been substantially developed, altered or improved by the taxpayer so that its market value has been substantially enhanced, or • its main use for deriving rent was only temporary (s 152-40(4)(e)). Assets that derive such income are traditionally considered to be passive assets. However, such assets are excluded from being active assets even if they are used in the course of carrying on a business. While an asset whose main use in the business is to derive rental income is usually excluded from being an active asset, there are certain exceptions to this rule. The provisions which apply to an asset that is used to derive rental income are detailed below in ¶3-660.

¶3-660 Active assets — properties used to derive rent A property that is used to derive rent is usually excluded from being an active asset. This exclusion even applies to a commercial property that is being used to derive rent as part of a business of leasing properties (Jakjoy Pty Ltd v FC of T 2013 ATC ¶10-328). In order to determine whether the exclusion has any application to an asset it is first necessary to determine whether the income derived from the property actually constitutes “rent” or other business income. The mere receipt of consideration from the provision of accommodation to another party does not necessarily result in the property being used to derive rent. Where a property is considered to derive rental income, the asset may still be considered to be an active asset in certain circumstances. The concept of the derivation of rental income and the circumstances in which a rental property will be considered to be an active asset are detailed separately below. Rental income Where a property is used to derive income from the provision of accommodation to another party, it is necessary to determine whether the income constitutes rent or not.

According to the Commissioner, “the term ‘rent’ has been described as follows: • the amount payable by a tenant to a landlord for the use of the leased premises (C.H. Bailey Ltd v Memorial Enterprises Ltd [1974] 1 All ER 1003 at 1010, United Scientific Holdings Ltd v Burnley Borough Council [1977] 2 All ER 62 at 76, 86, 93, 99) • a tenant’s periodical payment to an owner or landlord for the use of land or premises (The Australian Oxford Dictionary, 1999, Oxford University Press, Melbourne), and • recompense paid by the tenant to the landlord for the exclusive possession of corporeal hereditaments. … The modern conception of rent is a payment which a tenant is bound by contract to make to his landlord for the use of the property let (Halsbury’s Laws of England 4th Edition Reissue, Butterworths, London 1994, Vol 27(1) ‘Landlord and Tenant’, paragraph 212).” (Taxation Determination TD 2006/78). The Commissioner concludes that the key factor in determining whether an occupant of a property is a lessee, and therefore paying rent, is whether the occupier has a right to exclusive possession of the property (Radaich v Smith (1959) 101 CLR 209). Where the occupier is provided exclusive possession of the property under a lease agreement, the payments are likely to constitute rent, and the property will be excluded from being an active asset. However, if the arrangement provides a mere licence to occupy or use the property for certain purposes and does not amount to a lease granting exclusive possession, the payments involved are unlikely to constitute rental income. The determination of whether the occupation of the property constitutes exclusive possession or a licence to occupy is a question of fact depending on all the circumstances involved. The relevant factors that are used in making this determination are: • whether there is exclusive possession • the degree of control retained by the owner • “the extent of any services provided by the owner such as room cleaning, provision of meals, supply of linen and shared amenities (Allen v Aller (1966) 1 NSWR 572, Appah v Parncliffe Investments Ltd [1964] 1 All ER 838, Marchant v Charters [1977] 3 All ER 918).” (Taxation Determination TD 2006/78). The distinction is especially important in determining whether a property that is used for different types of accommodation can be considered to be an active asset or not. For example, this would be an issue in determining whether the income derived in respect of a boarding house, commercial storage, motel, holiday accommodation or caravan park constitutes rent. The Commissioner provides examples for each of these types of accommodation in Taxation Determination TD 2006/78. Example 1 Jetson Pty Limited owned a building on a beach with six different apartments therein. The apartments were used to provide accommodation to the holiday-makers. The general term of the stay by occupants was two to six weeks. The apartments were fully furnished, including the provision of linen. The apartments and linen were only cleaned by Jetson Pty Limited at the end of each stay. The occupants were responsible for cleaning the property and linen during their stay. In these circumstances, the occupants of the property would be considered to have exclusive possession of the apartments. The minimal involvement of, and the lack of services provided by, the owner in relation to the occupants and the units would result in the income from the property constituting rental income. Therefore, the property would be excluded from being an active asset at that time.

Example 2 Jetson Pty Limited changes the arrangements in relation to the properties. The apartments are now used to provide accommodation to the holiday-makers but their general term of stay is three days to four weeks. The apartments were provided fully furnished. Jetson Pty Limited services the apartments every second day, which involves the cleaning of the apartments and the provision of clean linen and towels. Each of the apartments have mini bars which are replenished

every second day, in-house movies are available on request and breakfast services are provided. In these circumstances, the occupants of the property would only be considered to have a licence to occupy the property. The involvement of the owner in relation to the properties by providing cleaning, linen, food and entertainment arrangements would result in the apartments being analogous to a hotel. Therefore, the fee for accommodation constitutes business income, as opposed to rental income.

Other examples of determining whether consideration for accommodation constitutes rent or other business income are detailed in Taxation Determination TD 2006/78. Similar principles will be relevant in determining whether a property used for agistment is an active asset or not. Where the income in relation to the property constitutes rental income, the general rule is that the property will not be considered to be an active asset. However, there are certain exceptions to this general rule. The relevant exceptions are detailed separately below. Temporary derivation of rent The first exception applies where the property is only used temporarily for the purpose of deriving rent (s 152-40(4)(e)(ii)). This ensures that the temporary use of a property for rental purposes will not prevent it from being an active asset at a point in time. Whether the use of the property for deriving rent was only temporary will be a question of fact and degree in the circumstances. Partial rental of property Where a property is used for the mixed purpose of rental and business, the property will still be an active asset where its main use is for business purposes. The determination of whether a mixed use property will be an active asset will depend upon whether the property is used mainly for rental purposes or not. The property will only be excluded from being an active asset where the property is used mainly for rental purposes. Therefore, where the property is used mainly for business purposes, and only partly for rental purposes, the property will still be an active asset. Whether the property is mainly used for rental purposes or primarily for business purposes will be a question of fact based on all the relevant circumstances surrounding the property. No one single factor will necessarily be determinative. The resolution of the matter is likely to involve a consideration of a range of factors such as: • the comparative areas of use of the property (between rent and business), and • the comparative levels of income derived from the different uses of the property (Taxation Determination TD 2006/78). Example 3 Astro Pty Limited owns a commercial property and uses 50% of the property, by land area, to carry on a clothes manufacturing business. The balance of the property is leased to various independent third parties as commercial offices. The income derived from the rental constitutes 30% of the gross income of Astro Pty Limited. The remaining 70% of the income is derived from the clothes manufacturing business. As Astro Pty Ltd uses 50% of the floor area of property to carry on an active business and the business generates 70% of its gross income from this business, the property will be considered to be used mainly in carrying on the business. Therefore, the property will be considered to be an active asset and will not be within the rental exclusion.

For the purpose of this test, a property that is used for mixed purposes will either be an active asset or not. The property will not be apportioned to be partly an active asset and partly a passive asset. Accordingly, provided the property is used primarily for business purposes, the whole of the property will be an active asset. Property used in business by affiliate or connected entity A property which is wholly used by a taxpayer for rental purposes will still be an active asset where:

• it is leased or rented to an entity that is an affiliate of, or an entity connected with, the taxpayer, and • that entity uses the property in carrying on its active business (s 152-40(1)(a); Taxation Determination TD 2006/63). The exclusion of an asset used mainly to derive rental income by a taxpayer in accordance with s 15240(4)(e) does not apply to prevent the asset from being an active asset in these circumstances. The exclusion of a rental property from being an active asset in s 152-40(4)(e) applies where the asset’s main “use in the course of carrying on the business mentioned in” s 152-40(1) is to derive rental income. The business detailed in s 152-40(1) refers to the business conducted by the affiliate or the connected entity. The use of the property by the taxpayer’s connected entity or affiliate is the relevant use, not the use by the taxpayer. For these purposes a passively held asset will only be an active asset where the connected entity or affiliate’s main use of the asset is for business purposes (s 152-40(4)(e), 152-40(4A)). Therefore provided the connected entity or the affiliate does not use the property mainly for the derivation of rental income, the rental property exclusion will not apply (Taxation Determination TD 2006/63). Example 4 Herman owns a commercial property which it leases to Spacely Pty Limited. Herman owns 50% of the shares in Spacely Pty Limited. Spacely uses the premises wholly for the purpose of carrying on its business of producing and selling spare parts for aircrafts. Spacely Pty Limited is an entity connected with the taxpayer. While Herman uses the whole of the property for the purpose of the derivation of rental income, as the property is used by Spacely Pty Limited, being an entity connected with Herman, in carrying on its business the property will be an active asset. The use of the property by Herman mainly for the derivation of rental income will not exclude the asset from being an active asset in the hands of Herman.

Correspondingly, where a taxpayer’s affiliate or connected entity uses the taxpayer’s property partly for rental purposes and partly for business purposes, the determination of whether the property will constitute an active asset will depend upon whether the property is used mainly for the derivation of rental income or mainly for business purposes.

¶3-670 Active assets — company shares and trust interests — 80% test A share in a company or an interest in a trust will also be an active asset where the company or trust satisfies certain conditions, known as the 80% test. Share in a company A share in a company will be an active asset at a given time, if at that time, the taxpayer owns it and: • the company is an Australian resident at that time, and • the total of: – the market values of the active assets of the company – the market value of any financial instruments of the company that are inherently connected with a business that the company carries on, and – any cash of the company that is inherently connected with such a business is 80% or more of the market value of all of the assets of the company (s 152-40(3)). Interest in a trust An interest in a trust will be an active asset at a given time, if at that time, the taxpayer owns it and: • the trust is a resident trust for CGT purposes for the income year in which that time occurs, and • the total of: – the market values of the active assets of the trust

– the market value of any financial instruments of the trust that are inherently connected with a business that the trust carries on, and – any cash of the trust that is inherently connected with such a business is 80% or more of the market value of all of the assets of the trust (s 152-40(3)). The active assets of a company or trust are determined in the manner described in ¶3-620 and ¶3-650. Example 1 Martha entered into an agreement for the sale of her shares in the company Very Thoughts Pty Limited which carried on the business of producing greeting cards. At the time of sale, Martha owned 40% of the issued share capital in Very Thoughts Pty Limited and the assets of that company comprised:

Asset

Active

Non-active

Total

$500,000

–

$500,000

–

$50,000

$50,000

$100,000

–

$100,000

–

$300,000

$300,000

Business property

$1,000,000

–

$1,000,000

Goodwill

$1,000,000

–

$1,000,000

Total value

$2,600,000

$350,000

$2,950,000

Cash (inherently connected with business) Loans to directors Trade debtors Rental property

In this case, the market value of the active assets of Very Thoughts Pty Ltd will comprise 88.1% of the market value of all its assets. As such, the shares held by Martha in the company will be active assets at the time of sale.

In applying the 80% test to determine whether a share in a company or an interest in a trust is an active asset, it is the market value of the assets at that time that is relevant, not the amount specified in the balance sheet of the relevant company or trust. The balance sheet of an entity is usually prepared on the basis of historical cost and generally does not include any value for internally created goodwill, which is an active asset of a company. For the purpose of the 80% test, the value of any debts or liabilities associated with an asset is irrelevant. It is merely the market value of those assets which is taken into account. In applying the 80% test, a share in a company or an interest in a trust can qualify as an active asset if the relevant company or trust itself owns interests in another entity that satisfies the 80% test (Taxation Determination TD 2006/65). In this manner, the 80% test can apply through a string of entities to determine whether a share or trust interest is an active asset. Example 2 Joseph owns 50% of the issued units in the Fiennes Unit Trust. The Fiennes Unit Trust carries on a business of selling greeting cards to the public. The assets of the Fiennes Unit Trust consist of: • 60% of the shares in Very Thoughts Pty Ltd (being the company detailed in Example 1) with a market value of $750,000 • goodwill of $600,000 • cash inherently connected with the business of $100,000 • loan to directors of $100,000. The 80% test applies to the units in the Fiennes Unit Trust at the same time as detailed in Example 1. Therefore, for the purpose of determining whether the units in the Fiennes Unit Trust are active assets, the shares in Very Thoughts Pty Ltd will be active assets, as determined in Example 1. The 80% test is applied to determine whether the units in the Fiennes Unit Trust are active assets as follows:

Asset

Active

Non-active

Total

Shares in Very Thoughts

$750,000

–

$750,000

Goodwill

$600,000

–

$600,000

–

$100,000

$100,000

$100,000

–

$100,000

$1,450,000

$100,000

$1,550,000

Loans to directors Cash (inherently connected to business) Total value

As the active assets comprise 93% (being 1,450,000/1,550,000) of the market value of the total assets, the units in the Fiennes Unit Trust will be active assets.

Extensions to 80% test While the active asset test requires the determination of whether an asset is active over the specified period, in determining whether a company share or a trust interest satisfies the test it is not necessary to apply the test on a day-to-day basis. There are two extensions to the 80% test which allow a share in a company or an interest in a trust to be treated as an active asset at certain times. The first extension applies to treat a share in a company or an interest in a trust as an active asset at a time later than the time at which the 80% test was applied where: • the share or interest was an active asset at an earlier time, and • it is reasonable to conclude that the share or interest is still an active asset at that later time (s 15240(3A)). Therefore, once it is determined that a company share or trust interest is an active asset under the 80% test, the share or trust interest will continue to be treated as an active asset provided it is reasonable to conclude that the 80% test would still be satisfied. The second extension to the 80% test provides that a share in a company, or an interest in a trust, will be an active asset at a time if the share or interest fails to meet the requirements in accordance with the 80% test, provided the failure is of a temporary nature only (s 152-40(3B)).

¶3-680 Relationship breakdown — extended period of ownership For the purpose of applying the active asset test, the period of ownership may be extended where the taxpayer acquired the asset as a result of a marriage or relationship breakdown. A taxpayer has the choice to extend the period of ownership for the purpose of the active asset test where the asset was acquired by the taxpayer as a result of a marriage or relationship breakdown for which CGT roll-over relief applied pursuant to Subdiv 126-A (s 152-45(2)). The extension applies irrespective of whether the asset was acquired from any of the taxpayer’s former spouse, a company or a trust (the “transferor”). A spouse includes a same sex partner of a bona fide domestic relationship (¶2-050). Where the taxpayer satisfies these requirements and chooses to apply the extension, the active asset test applies as if: • the taxpayer had acquired the asset when the transferor acquired the asset • the asset had been an active asset of the taxpayer at all times when the asset was an active asset of the transferor, and • the asset had not been an active asset of the taxpayer at all times when the asset was not an active asset of the transferor (s 152-45(2)). Example Daniel purchased a property on 10 January 2009. His wife Bridget used the property to carry on an interior design business from 10 January 2009 until 20 December 2012.

On 21 December 2012, Daniel and Bridget were divorced. In accordance with the terms of the divorce the property was transferred to Bridget. The transfer of the property was subject to CGT roll-over relief pursuant to Subdiv 126-A. Bridget continued to carry on the business on the property until 11 July 2014 when the business ceased. Thereafter, Bridget rented the property to a third party until it was sold on 15 July 2017. Under the ordinary rules for the active asset test, the specified period will be from the date of acquisition of 21 December 2012 until the date of sale on 15 July 2017, being a period just under four years and seven months. During this period the property was an active asset of Bridget’s for the period from 21 December 2012 until 11 July 2014, being a period just under one year and seven months. As this is less than half of the specified period, the active asset test would not be satisfied. However, as Bridget acquired the asset pursuant to a marriage breakdown for which CGT roll-over relief under Subdiv 126-A applied, she can choose to treat the property as being acquired on the date Daniel originally acquired the property, being 10 January 2009. In addition, the property will be treated as being an active asset for the period in which the property was an active asset in Daniel’s hands, being from 10 January 2009 until 21 December 2012. Therefore, where the choice is made, in applying the active asset test: • the specified period will be from the deemed date of acquisition of 10 January 2009 until the sale on 15 July 2017, being a period of approximately eight years and six months • the property is treated as being an active asset in Bridget’s hands for the period from 10 January 2009 until 11 July 2014, being a period of approximately five years and six months. As the property is treated as being an active asset for more than half of the specified period, the active asset test would be satisfied where Bridget chooses to apply the special rule in s 152-45(2).

The taxpayer must make the choice by the time of lodgment of the tax return for the income year in which the CGT event occurs, or such further time as allowed by the Commissioner (s 103-25(1)). The manner in which the taxpayer prepares the tax return for the relevant income year is sufficient evidence of the choice (s 103-25(2)). Where the taxpayer chooses to apply the special rule it will impact upon the application of the CGT 15year exemption (where available). The consequences of making the choice on the CGT 15-year exemption are detailed in ¶4-150. Where the taxpayer does not choose to apply the special rule, the taxpayer will be treated as having acquired the asset at the time of acquisition under the ordinary rules as detailed in ¶3-610.

¶3-690 Compulsory acquisition — extended period of ownership For the purpose of applying the active asset test, the normal rules determining the period of ownership will be amended where the taxpayer acquired the asset as a result of either a compulsory acquisition or the CGT roll-over available in relation to the transition to Financial Services Reform. Compulsory acquisition Special provisions will apply where the taxpayer acquired the CGT asset (“new asset”) as a replacement of an asset that was compulsorily acquired, lost or destroyed (“original asset”) and the taxpayer obtained CGT roll-over relief pursuant to s 124-70(2) or s 124-75(2) to disregard the capital gain arising on the original asset (s 152-45(1)). Where the roll-over applied, the active asset test will apply as if: • the taxpayer had acquired the new asset when the taxpayer acquired the original asset • the new asset had been the taxpayer’s active asset at all times when the original asset was the taxpayer’s active asset, and • the new asset had not been the taxpayer’s active asset at all times when the original asset was not the taxpayer’s active asset (s 152-45(1)). The special provisions automatically apply where the taxpayer obtained CGT roll-over relief. Unlike the special provisions for a marriage breakdown, there is no ability for a taxpayer to choose whether or not to apply the extended period of ownership.

Example Cameron acquired a property on 2 April 2009 which he leased out to third parties until 4 June 2014 when he started to use the property as the premises for his architecture business. The property was used in that business until the property was compulsorily acquired by the government on 5 December 2014. Cameron acquired a new property as a replacement asset on 6 September 2015 and used the property to carry on his architecture business until it was sold on 4 July 2017. Cameron chose to apply CGT roll-over relief pursuant to Subdiv 124-B. As a result of this CGT roll-over relief applying, for the purpose of applying the active asset test: • the specified period will be from the date of acquisition of the original asset on 2 April 2009 until the sale of the new asset on 4 July 2017, being eight years and three months • the property will have been an active asset during the following periods: – from 4 June 2014 until 5 December 2014, being six months – from 6 September 2015 until 4 July 2017, being one year and ten months totalling two years and four months. As the property was not an active asset for more than 50% of the specified period, the active asset test will not be satisfied. This is despite the fact that the new asset has been an active asset for the whole of the period of its actual ownership.

Where the special provision applies, it will also impact upon the manner in which the CGT 15-year exemption will apply. In these circumstances, the special provision in s 152-115 will apply (see ¶4-140). Financial Services Reform (FSR) transitions Special provisions will apply where the CGT asset is an Australian financial services licence, or another intangible asset, acquired as a result of the transition to the Financial Services Reform (FSR) regime and automatic CGT roll-over relief applied pursuant to the former Subdiv 124-O. A taxpayer was entitled to this automatic roll-over relief where, during the FSR transitional period of 11 March 2002 to 10 March 2004 (inclusive), any of the following applied: • an existing statutory licence, registration or authority was replaced with an Australian financial services licence • a qualified Australian financial services licence was replaced with an Australian financial services licence, or • an intangible CGT asset was replaced with another intangible CGT asset. The replacement Australian financial services licence or intangible CGT asset may have been acquired by any of: • the owner of the original licence, registration, authority, qualified Australian financial services licence or intangible CGT asset • a company or trust in the same consolidatable group as the owner of the original licence, registration, authority, qualified Australian financial services licence or intangible CGT asset, or • a company or fixed trust that is wholly owned by the owner of the original licence, registration, authority, qualified Australian financial services licence or intangible CGT asset (former s 124-880, 124-885, 124-890, 124-900, 124-905, 124-910). The special provision under which the extension is available will depend upon whether the roll-over relief was available in relation to a situation where: • the taxpayer owned the original asset for which roll-over relief applied (see s 152-45(1A)) • an entity other than the taxpayer (“original owner”) owned the original asset for which roll-over relief applied (see s 152-45(1B)). Where the special provision applies the active asset test will apply as if:

• the taxpayer acquired the new asset at the time the taxpayer or the old owner, as relevant, acquired the old asset • the new asset had been the taxpayer’s active asset at all times when the original asset was an active asset of the taxpayer, or the old owner, as relevant, and • the new asset had not been the active asset of the taxpayer at all times when the original asset had not been an active asset of the taxpayer, or the old owner, as relevant (s 152-45(1A), 152-45(1B)). The special provisions automatically apply where the taxpayer obtained CGT roll-over relief pursuant to the former Subdiv 124-O. There is no ability for a taxpayer to choose whether or not to apply the extended period of ownership. Where the special provision applies, it will also impact upon the manner in which the CGT 15-year exemption will apply. In these circumstances, the special provision in s 152-115 will apply (see ¶4-140).

SIGNIFICANT INDIVIDUAL TEST AND CGT CONCESSION STAKEHOLDER ¶3-800 Introduction The significant individual test must be satisfied in order for a taxpayer that is a company or trust to be able to apply the CGT retirement exemption (s 152-305(2)(b)). While the significant individual test itself is only relevant for the CGT retirement exemption, the determination of whether an entity has, or is, a significant individual will be relevant for the application of other provisions within the CGT small business concessions. The concept of a significant individual will be relevant for: • determining whether the CGT 15-year exemption is available for a taxpayer that is a company or a trust, and • determining whether a company or trust has a CGT concession stakeholder. The CGT 15-year exemption will only be available for a taxpayer that is a company or trust where the taxpayer has a significant individual just before the CGT event (s 152-110). This is known as the significant individual requirement and is detailed in ¶4-170. An individual taxpayer will be a CGT concession stakeholder of a company or trust where the individual is either: • a significant individual in the company or trust, or • a spouse of a significant individual in the company or trust, if the spouse has a small business participation percentage in the company or trust at that time that is greater than zero (s 152-60). The concept of a CGT concession stakeholder will be relevant for determining whether any of the CGT small business concessions will be available in relation to a CGT event that happens to a CGT asset that is a share in a company or an interest in a trust. Where a CGT event happens in relation to a share in a company or an interest in a trust, the taxpayer will only be entitled to the CGT small business concessions where either: • the taxpayer is a CGT concession stakeholder in that company or trust, or • CGT concession stakeholders have small business participation percentages in that company or trust of 90% or more (s 152-10(2)). The requirement to be a CGT concession stakeholder is also relevant for making distributions from a

company or trust that applied either the: • CGT 15-year exemption, or • CGT retirement exemption. The benefit of these concessions can be passed through to CGT concession stakeholders in a tax effective manner.

¶3-810 Significant individual test An entity will satisfy the significant individual test where the entity had at least one significant individual just before the CGT event (s 152-50). The phrase “just before the CGT event” has been interpreted to mean immediately before the time of the relevant CGT event being considered (Interpretative Decision ID 2003/744; see ¶3-410).

¶3-820 Significant individual An individual will be a significant individual in a company or a trust at a time if, at that time, the individual has a small business participation percentage in the company or trust of at least 20% (s 152-55). An entity’s small business participation percentage in an entity is detailed in ¶3-880. Only an individual can be a significant individual. For the purpose of this test it is only the individual’s interest in the company or trust which is taken into account. The interests held by a spouse, affiliate, connected entity or other associate of the individual will not be aggregated for determining whether an individual is a significant individual. Therefore, at any point in time, the maximum number of significant individuals a company or trust can have is five. Example Carlile Pty Ltd has the following six individual shareholders: • Mr Perry — two shares • Mrs Perry — two shares • Mr Cox — two shares • Mrs Cox — two shares • Mr Timber — two shares • Mrs Timber — two shares. The shareholders consist of three sets of husbands and wives. Each of the individual shareholders will have small business participation percentage in the Carlile Pty Ltd of 16.7%. No person is a significant individual of Carlile Pty Ltd. This is despite the fact that each married couple together would have a small business participation percentage of 33.4%.

However, as the determination of a significant individual depends upon the individual’s small business participation percentage, the entity can take into account both the direct and indirect interests held in the company or trust. The test requires the interests of the taxpayer to be traced through entities interposed between the individual and the object company or trust. An entity’s small business participation percentage is the sum of the entity’s direct small business participation percentage and indirect small business participation percentage.

¶3-870 CGT concession stakeholder Only an individual can be a CGT concession stakeholder. An individual taxpayer will be a CGT concession stakeholder of a company or trust where the individual is either:

• a significant individual in the company or trust, or • a spouse of a significant individual in the company or trust, if the spouse has a small business participation percentage in the company or trust at that time that is greater than zero (s 152-60). The term small business participation percentage is defined in s 152-65 and is detailed in ¶3-880. Example The ordinary shares in Jouets Pty Limited are held by the following shareholders: • 50% by Jane • 15% by Peter • 15% by Paul • 20% by Mary. Jane and Peter are married. Mary is married to Matthew. The CGT concession stakeholders in Jouets Pty Limited are: • Jane — who is a significant individual • Peter — who is a spouse of the significant individual Jane that has a small business participation percentage more than nil • Mary — who is a significant individual. Note that Paul will not be a CGT concession stakeholder as he has a small business participation percentage less than 20% and does not have a spouse that is a significant individual. Matthew will not be a CGT concession stakeholder despite being married to a significant individual, as his small business participation percentage in Jouets Pty Limited is nil.

At any point in time, the maximum number of CGT concession stakeholders a company or trust can have is eight.

¶3-880 Small business participation percentage An entity’s small business participation percentage in another entity at a time is the percentage that is the sum of: • the entity’s direct small business participation percentage in the other entity at that time • the entity’s indirect small business participation percentage in the other entity at that time (s 152-65). The manner in which these percentages are determined are outlined in ¶3-890 and ¶3-900, respectively.

¶3-890 Direct small business participation percentage The determination of an entity’s direct small business participation percentage in another entity depends upon the structure of the other entity. Company An entity’s direct small business participation percentage in a company at a relevant time is the following percentage that the entity has because of holding the legal and equitable interests in shares in the company: • the percentage of the voting power in the company • the percentage of any dividend that the company may pay • the percentage of any distribution of capital that the company may make or, if they are different, the smaller or smallest (s 152-70(1) item 1). For the purpose of determining the

percentage, any redeemable shares are ignored (s 152-70(2)). Where a taxpayer holds the legal and equitable interests in shares in a company jointly with another entity, only the last two tests apply. That is, the percentage of the voting power in the company is not considered (s 152-70(3)). This prevents a joint shareholder from having a nil direct small business participation percentage on the basis that no one joint owner individually controls the voting power on such shares. Example 1 Sammy Pty Ltd has three shareholders, Roger, Jeannie and Sam with two classes of shares, Ordinary and A Class (being nonredeemable shares). The Ordinary shares and the A Class shares have equal rights to the receipt of dividends and capital. However, only the ordinary shares have voting rights. The shares in Sammy Pty Ltd are held as follows:

Shareholder Ordinary A Class Roger

30

10

Jeannie

30

–

Sam

–

30

In the circumstances: • Roger has the right to 40% of any dividends, 40% of any capital distribution and 50% of any vote — his direct small business participation percentage is 40%. • Jeannie has the right to 30% of any dividends, 30% of any capital distribution and 50% of any vote — her direct small business participation percentage is 30%. • Sam has the right to 30% of any dividends, 30% of any capital distribution and 0% of any vote — his direct small business participation percentage is 0%.

Where a company has different classes of shares, it will be necessary to closely examine the Constitution and the rights attached to the shares to determine the relevant rights. This is particularly relevant where the relevant company has dividend access shares on issue. The effect of dividend access shares being issued was considered in the Full Federal Court decision of FC of T v Devuba Pty Ltd 2015 ATC ¶20-541. In that case, it was held that the presence of a dividend access share did not diminish the dividend entitlements of the ordinary shareholders in considering “the percentage of any dividend that the company may pay”. The wording of the Constitution was essential to this decision. At the relevant time for determining the direct small business participation percentage in the company, the holder of the dividend access share did not carry any entitlement to a dividend as the Constitution had removed the discretionary right of the directors to declare dividends on the dividend access share until such time as the directors had first resolved that such holders were again entitled to the future exercise of a discretion to pay a dividend. Fixed trust An entity’s direct small business participation percentage in a fixed trust at a relevant time is the following percentage: • the percentage of any distribution of income that the trustee may make to which the entity would be beneficially entitled to • the percentage of any distribution of capital that the trustee may make to which the entity would be beneficially entitled to or, if they are different, the smaller or smallest (s 152-70(1) item 2).

Example 2 The Master Unit Trust is a fixed trust that has no discretionary elements. There are two classes of units, being income units and capital units. The income units entitle the unitholders to distributions of income. The capital units entitle the unitholders to distributions of capital from the trust. The unitholders in the Master Unit Trust are as follows:

Unitholder

Income units Capital units

Nena

10

25

Jodie

40

45

Owen

50

30

In the circumstances: • Nena has the right to 10% of any income distribution and 25% of any capital distribution — her direct small business participation percentage is 10%. • Jodie has the right to 40% of any income distribution and 45% of any capital distribution — her direct small business participation percentage is 40%. • Owen has the right to 50% of any income distribution and 30% of any capital distribution — his direct small business participation percentage is 30%.

Non-fixed trust An entity’s direct small business participation percentage in a non-fixed trust (eg a discretionary trust) at a relevant time is the following percentage: • if the trustee makes distributions of income during the income year (the “relevant year”) in which that time occurs — the percentage of the distributions to which the entity was beneficially entitled, or • if the trustee makes distributions of capital during the relevant year — the percentage of the distributions to which the entity was beneficially entitled or, if two different percentages are applicable, the smaller (s 152-70(1) item 3). Example 3 During the relevant year, the Cape Discretionary Trust did not make any capital distributions but did make income distributions in the percentages detailed below:

Beneficiary

Income distribution

Peter

10

Rob

10

Emilio

20

Judd

45

Charlie

15

As no capital distributions were made during the year, the direct small business participation percentages of the beneficiaries in the Cape Discretionary Trust are the same as the percentage of income distributions received during the current year.

Example 4 In the following year, Cape Discretionary Trust made both income and capital distributions. The percentage distributions made during this year were:

Beneficiary

Income distribution

Capital distribution

Peter

10

0

Rob

40

0

Emilio

50

5

Judd

0

60

Charlie

0

35

In these circumstances, as Emilio is the only beneficiary that received both an income and capital distribution during the year, the direct small business participation percentage of all the beneficiaries, except for Emilio, for the year will be 0%. Emilio’s small business percentage will be 5%, being the lower of the percentage of income distributions made by the Cape Discretionary Trust that he received during the year (being 50%) and the percentage of capital distributions made by the Cape Discretionary Trust that he received during the year (being 5%).

Special rules apply for determining the direct small business participation percentage held by an entity where the discretionary trust is making losses or has nil net income and does not make an income or capital distribution during a year of income. In this case, an entity’s direct small business participation percentage in the trust is worked out based on the income or capital distribution the entity was beneficially entitled to in the last prior income year that the trustee of the trust made such a distribution (s 152-70(4) and (5)). The entity’s direct small business participation percentage in a trust will still be zero where no income or capital distribution is made during the income year of the CGT event if either: • the trust had net income for the income year and did not have a tax loss for that income year (s 15270(6)(a)), or • the trust had never made an income or capital distribution in an earlier income year (s 152-70(6)(b)). Example 5 The Blunt discretionary trust made the following distributions in Year 1 and Year 2.

Beneficiary

Year 1

Year 2

Income distribution

Capital distribution

Income distribution

Capital distribution

Eric

10%

35%

0%

0%

Matt

50%

35%

0%

0%

Emily

22%

20%

0%

0%

Mark

8%

10%

0%

0%

In Year 1, both Matt and Emily will be significant individuals as their direct small business participation percentages will be 35% and 20% respectively. The direct business percentages of Eric (being 10%) and Mark (8%) are less than 20%, and accordingly they will not be significant individuals in Year 1. No distributions were made in Year 2 during which the trust had no net income and tax losses for the year. As a result, the direct

small business participation percentages are based on the distributions made in the previous income year. Therefore, both Matt and Emily will again be the only significant individuals in Year 2.

Where a trust has not made any income or capital distributions since its establishment, the trust will not have a significant individual. This applies even where the trust has been in losses ever since its establishment. Accordingly, in such a case it will be necessary for the trustee of the trust to make a capital distribution in the relevant year to enable the trust to have a significant individual. Similarly, a capital distribution may be able to be made in a relevant income year where losses were made to provide a more desirable significant individual. Where a discretionary trust is involved it is essential for the trustee of the trust to carefully consider the manner in which income and capital distributions are made during the year where the small business concessions may apply. The actual distributions which are made can either prevent or ensure that the small business concessions apply. Given that most distributions of a non-fixed trust are determined at the end of the year of income, the trustee of the relevant trust will have the ability to make distributions in such a manner to determine the significant individuals of the trust. The prior year distributions that are made by a discretionary trust will also be relevant for the purpose of determining the controller of an entity and therefore whether an entity is either connected with or an affiliate of the taxpayer. This is particularly relevant for passively held CGT assets (see ¶2-070).

¶3-900 Indirect small business participation percentage The indirect small business participation percentage that an entity (the “holding entity”) holds at a particular time in another entity (the “test entity”) is determined by multiplying the holding entity’s direct small business participation percentage (if any) in another entity (the “intermediate entity”) at that time by the sum of: • the intermediate entity’s direct small business participation percentage (if any) in the test entity at that time • the intermediate entity’s indirect small business participation percentage (if any) in the test entity at that time (as worked out under one or more other applications of this test) (s 152-75(1)). This test applies to any number of intermediaries through a chain of entities. For the purpose of testing an intermediate entity’s indirect small business participation percentage in another entity, the intermediate entity then becomes the holding entity. Where there is a chain of entities, the ultimate holding entity’s indirect small business participation percentage is the sum of the percentages worked out under the test in relation to each of the intermediate entities (s 152-75(2)). The best way to explain the application of the rules is by a detailed example. Example The Bellows Unit Trust sells a CGT asset during the current year. It is necessary to determine the small business participation percentages that the beneficiaries of the Energizer Discretionary Trust hold in the Bellows Unit Trust for that year. The Bellows Unit Trust, being a fixed trust, has two classes of units, being income units (which entitle a holder to the income of the trust in proportion to those units held) and capital units (which entitle a holder to the capital of the trust in proportion to those units held). The unitholders in the Bellows Unit Trust are as follows:

Unitholder

Capital units Income units

Pedro Pty Limited

50

60

Paul

10

10

Others

40

30

Total

100

100

The Energizer Discretionary Trust owns 60% of the issued ordinary shares of Pedro Pty Limited. During the current year, the Energizer Discretionary Trust did not make any capital distributions, but made the following income distributions:

Beneficiary

Income distribution (%)

Paul

60

Chris

40

Total

100

The structure of the ownership may be illustrated as follows:

Direct small business participation interests In accordance with the structure, the direct small business participation interests in the relevant entities are as follows: Energizer Discretionary Trust • Paul has a direct small business participation percentage of 60%. • Chris has a direct small business participation percentage of 40%. Pedro Pty Limited

• Energizer Discretionary Trust has a direct small business participation percentage of 60%. Bellows Unit Trust • Pedro Pty Limited has a direct small business participation percentage of 50% (being the lower of the rights to income and capital distributions). • Paul has a direct small business participation percentage of 10%. Indirect small business participation interests In accordance with the structure, the indirect small business participation interests in the relevant entities are as follows: Energizer Discretionary Trust • As all the income beneficiaries during the year are individuals, no parties have indirect small business participation interests in the Energizer Discretionary Trust. Pedro Pty Limited • Paul has an indirect small business participation percentage of 36% (being Paul’s direct small business participation percentage in Energizer Discretionary Trust of 60% × Energizer Discretionary Trust’s direct small business participation percentage in Pedro Pty Limited of 60%). • Chris has an indirect small business participation percentage of 24% (being Chris’s direct small business participation percentage in Energizer Discretionary Trust of 40% × Energizer Discretionary Trust’s direct small business participation percentage in Pedro Pty Limited of 60%). Bellows Unit Trust • Energizer Discretionary Trust has an indirect small business participation percentage of 30% (being Energizer’s direct small business participation percentage in Pedro of 60% × Pedro’s direct small business participation percentage in Bellows of 50%). • Paul has an indirect small business participation percentage of 18% (being Paul’s direct small business participation percentage in Energizer Discretionary Trust of 60% × Energizer’s indirect direct small business participation percentage in Bellows of 30%). • Chris has an indirect small business participation percentage of 12% (being Chris’s direct small business participation percentage in Energizer Discretionary Trust of 40% × Energizer’s indirect direct small business participation percentage in Bellows of 30%). Small business participation interests of individuals Therefore, the small business participation interests of the beneficiaries of the Energizer Discretionary Trust in the Bellows Unit Trust are as follows: • Paul — 28% (being the sum of his direct small business participation percentage of 10% plus his indirect small business participation percentage of 18%). • Chris — 12% (being his indirect small business participation percentage). Therefore, Paul is the only significant individual in Bellows Unit Trust as he is the only individual with a small business participation percentage of 20% or more.

¶3-910 Look-through earnout rights Special rules apply where the parties to a CGT event entered into a “look-through earnout right” on or after 24 April 2015 which effects the application of the CGT small business concessions. The rules provide for special look-through treatment by: • disregarding any capital gain or loss relating to the creation of the right • for the buyer — treating financial benefits provided (or received) under the right as forming part of (or reducing) the cost base of the business asset acquired • for the seller — treating financial benefits received (or provided) under the right as increasing (or decreasing) the capital proceeds of the business asset sold. For these purposes, a “financial benefit” means anything of economic value and includes property and services (s 974-160). A taxpayer disregards the capital gain or loss relating to the creation of the right arising from:

• CGT event C2 in relation to a right received, or • CGT event D1 for a right created in another entity (s 118-575). A right will be a “look-through earnout right” where the following conditions are satisfied: (a) the right is a right to future financial benefits that are not reasonably ascertainable at the time the right is created (b) the right is created under an arrangement that involves the disposal of a CGT asset (c) the disposal causes CGT event A1 to happen (d) just before the CGT event, the CGT asset was an “active asset” of the seller (e) all of the financial benefits that can be provided under the right must be provided no later than five years after the end of the income year of the CGT event (f) the financial benefits are contingent on the performance of the CGT asset or a business that the CGT asset is expected to be an active asset for the period of the right (g) the value of the financial benefits reasonably relate to the economic performance, and (h) the parties to the arrangement are dealing at arm’s length (s 118-565(1)). The five-year requirement in (e) is treated as having never been satisfied where the arrangement includes an option to extend or renew that arrangement, the parties vary the arrangement or the parties enter into another arrangement over the CGT asset so that a party could receive financial benefits over a period ending later than five years after the end of the income year in which the CGT event happens (s 118565(2)). A CGT asset owned by an entity is an active asset for the purposes of requirement (d) where it meets the definition in s 152-40 (¶3-620) or it satisfies all of the following: • is a share in an Australian company or an interest in a resident trust • the holder of the share or interest is either: (i) an individual that is a CGT concession stakeholder (¶3-870) of the company or trust, or (ii) not an individual but has a small business participation percentage (¶3-880) in the company or trust of at least 20% • the company or trust is carrying on a business and has carried it on since the start of the prior income year • in the prior income year the assessable income of the company or trust was more than nil and at least 80% of it was from the carrying on of a business or businesses and was not from an asset used to derive interest, annuities, rent, royalties or foreign exchange gains (s 118-570). A look-through right also includes a right to receive future financial benefits that are for ending such a defined look-through right, provided the arrangement does not result in a breach of the five-year limitation (s 118-565(3)). Example 1 Tyrion entered into an agreement to sell his business to Snow Pty Ltd on 29 April 2016. The terms of the agreement were: • a payment of $80,000 on the date of signing, and • a payment equal to 25% of the gross turnover of the business that exceeds $200,000 during the 2017 income year, with payment due on 30 July 2017.

Tyrion had a cost base of $20,000 in the goodwill. The arrangement constituted a look-through earnout right. As at 29 April 2016, Tyrion will have made a capital gain of $60,000 during the 2016 income year. The gross turnover of the business during the 2017 income year was $400,000. Therefore, a payment of $50,000 was made on 30 July 2017. The effect of the look-through earnout right is that the capital gain from the sale of the business in the 2016 income year is revised to $110,000.

Temporarily disregard capital loss Where a taxpayer makes a capital loss from disposing of a CGT asset which may be reduced as a result of the receiving financial benefits under a look-through earnout right, a portion of the capital loss must be temporarily disregarded. The portion of the capital loss that is temporarily disregarded is: • where the maximum financial benefits cannot exceed a certain maximum amount — so much of the capital loss that equals that maximum amount • otherwise — the whole capital loss. The capital loss is only disregarded until and to the extent that the loss becomes reasonably certain (s 118-580). Example 2 Zoe entered into an agreement to sell the goodwill of her frozen fruit business on 31 May 2016. The terms of the agreement were: • a payment of $70,000 on the date of signing • a payment equal to 10% of the gross turnover of the business during the 2017 income year, with payment due on 1 August 2017. Zoe had a cost base of $100,000 in the goodwill. The arrangement constituted a look-through earnout right. As at 31 May 2016, Zoe had made capital loss of $30,000 during the 2016 income year. However, due to the look-through earnout provisions, this capital loss is disregarded until the loss is reasonably certain. The gross turnover of the business during the 2017 income year was $20,000. Therefore, a payment of $20,000 was made on 1 August 2017. The effect of the look-through earnout right is that a capital loss of $10,000 will be realised on the sale of the business in the 2016 income year.

CGT small business concessions The CGT small business concessions effectively apply to a sale of assets involving a look-through earnout right by extending both the time to choose to apply the concessions and the replacement asset period. The application of the provisions and their effect on the transactions are detailed in the specific concessions in Chapter 4.

SMALL BUSINESS CGT RELIEF — THE CONCESSIONS CGT CONCESSIONS FOR SMALL BUSINESS Introduction

¶4-000

Summary of CGT concessions for small business

¶4-010

CGT 15-YEAR EXEMPTION Introduction

¶4-100

Conditions for CGT 15-year exemption for individuals

¶4-110

Conditions for CGT 15-year exemption for companies and trusts

¶4-120

Fifteen years of ownership

¶4-130

Deemed continuous ownership — involuntary disposal

¶4-140

Deemed continuous ownership — relationship breakdown

¶4-150

Deemed continuous ownership — small business restructure

¶4-155

Significant individual requirement — taxpayer is an individual

¶4-160

Significant individual requirement — taxpayer is company or trust

¶4-170

Minimum age and retirement condition

¶4-180

Permanent incapacitation alternative

¶4-190

Exclusion of certain CGT events

¶4-200

Taxpayer’s choice to apply CGT 15-year exemption

¶4-210

Interaction with the other CGT small business concessions

¶4-220

Application of CGT 15-year exemption where taxpayer dies

¶4-230

Payments to CGT concession stakeholders

¶4-240

Application to capital gains made on pre-CGT assets

¶4-250

Contributions to complying superannuation fund

¶4-260

CGT SMALL BUSINESS 50% REDUCTION Introduction

¶4-300

Conditions for CGT small business 50% reduction

¶4-310

Application of the CGT small business 50% reduction

¶4-320

Exclusion of certain CGT events

¶4-330

Interaction with other concessions

¶4-340

Choosing not to apply the CGT small business 50% reduction

¶4-350

Application of CGT small business 50% reduction where taxpayer dies ¶4-360 CGT RETIREMENT EXEMPTION Introduction

¶4-400

Conditions for CGT retirement exemption for individuals

¶4-410

Conditions for CGT retirement exemption for companies and trusts

¶4-420

Company or trust conditions

¶4-430

Consequences of applying the CGT retirement exemption

¶4-440

CGT exempt amount

¶4-450

CGT retirement exemption limit

¶4-460

Taxpayer’s choice to apply CGT retirement exemption

¶4-470

Application to capital gains from CGT events J2, J5, J6

¶4-480

Interaction with other concessions

¶4-490

Choosing not to apply the CGT small business 50% reduction

¶4-500

Application of CGT retirement exemption where taxpayer dies

¶4-510

Contributions to complying superannuation fund

¶4-520

CGT SMALL BUSINESS ROLL-OVER Introduction

¶4-600

Conditions for CGT small business roll-over

¶4-610

Consequences of applying the CGT small business roll-over

¶4-620

Definition of replacement asset period

¶4-625

Exclusion of certain CGT events

¶4-630

Taxpayer’s choice to apply CGT small business roll-over

¶4-640

Interaction with other CGT small business concessions

¶4-650

Choosing not to apply the CGT small business 50% reduction

¶4-660

Application of CGT small business roll-over where taxpayer dies

¶4-670

Relevant terms for CGT events J2, J5 and J6

¶4-680

CGT event J5

¶4-690

CGT event J6

¶4-700

CGT event J2

¶4-710

Death of taxpayer that chose the CGT small business roll-over

¶4-720

SMALL BUSINESS RESTRUCTURE ROLL-OVER Introduction

¶4-800

Conditions for small business restructure roll-over

¶4-810

Consequences of applying the CGT small business roll-over

¶4-820

Editorial information

By Gaibrielle Cleary

CGT CONCESSIONS FOR SMALL BUSINESS ¶4-000 Introduction This chapter addresses the CGT concessions that are available for small business entities. These are the four CGT small business concessions that are available pursuant to Div 152 and the small business restructure roll-over in Subdiv 328-G. While the CGT small business concessions are available for CGT small business entities, an entity that is not a CGT small business entity can still qualify for these concessions if it either satisfies the maximum net asset value test of $6m or the special requirements for passively held assets (see ¶3-240). The basic conditions and the associated tests that must be satisfied for these concessions to apply are detailed in Chapter 3. The small business restructure roll-over is only available to small business entities. However, the roll-over applies not only to gains and losses that arise on the transfer of CGT assets, but also to those applying to trading stock, revenue assets and depreciating assets. The application of the small business restructure roll-over is detailed in ¶4-800. Unless otherwise indicated, all references to legislation in this chapter are to ITAA97.

¶4-010 Summary of CGT concessions for small business A brief summary of each of the four traditional CGT small business concessions is provided below. The separate small business restructure roll-over is detailed at ¶4-800. CGT 15-year exemption Where a taxpayer satisfies the conditions for the CGT 15-year exemption, any capital gain made in relation to the relevant CGT event will be disregarded in whole. The application of the CGT 15-year exemption is addressed at ¶4-100. CGT small business 50% reduction The CGT small business 50% reduction allows a taxpayer to reduce a capital gain by 50%. To the extent that the taxpayer is also entitled to the CGT general discount in Div 115, the CGT small business 50% reduction will apply to the balance of the capital gain after the general discount has applied. For example, where the taxpayer is an individual and the conditions for the 50% general discount and the CGT small business 50% reduction have both been satisfied, the taxable capital gain will be reduced to 25% of the original gain. The application of the CGT small business 50% reduction is addressed at ¶4-300. CGT retirement exemption The CGT retirement exemption allows an individual taxpayer to disregard up to $500,000 of capital gains during a lifetime. Where the taxpayer is a company or trust, the taxpayer may choose to disregard capital gains based on its CGT concession stakeholders up to their respective CGT retirement exemption limits of $500,000. Note that the $500,000 limit is a lifetime limit in relation to a particular individual. Any capital gains disregarded by the individual as the taxpayer, or a company or trust in relation to that individual as a CGT concession stakeholder, both count towards the individual’s $500,000 lifetime limit. Where the relevant individual taxpayer, or CGT concession stakeholder, is under the age of 55 at the time of making the choice to apply the exemption, or at the time the company or trust makes a payment to the CGT concession stakeholder, the chosen CGT exempt amount must be contributed to a complying superannuation fund or RSA. The application of the small business retirement exemption is addressed at ¶4-400. CGT small business roll-over

The CGT small business roll-over allows a taxpayer to roll-over a part or all of the balance of a capital gain arising in relation to an active asset. The concession effectively allows the chosen capital gain to be rolled over into a replacement active asset that is acquired by the taxpayer in the replacement asset period (as defined in ¶4-625). If a replacement asset is not acquired within that period, the application of the roll-over allows the capital gain to be deferred for a period of two years. The application of the CGT small business roll-over is addressed at ¶4-600. This roll-over is separate from the small business restructure roll-over that is detailed in ¶4-800. Additional conditions In addition to the basic conditions, a taxpayer needs to satisfy any additional conditions required for a particular CGT small business concession to apply. In particular, further conditions may be required to be satisfied in order for a taxpayer to choose to apply either of the following concessions: • the CGT 15-year exemption, or • the CGT retirement exemption. While there are no specific additional conditions to be satisfied in order for a taxpayer to apply the CGT small business roll-over, where the taxpayer does not satisfy additional conditions, CGT event J5 will arise where the taxpayer does satisfy additional requirements within a specified period. Further, CGT event J2 or J5 will arise at a later time on the happening of certain conditions. These CGT events result in a capital gain arising up to the capital gain that was previously rolled over under the CGT small business roll-over. Choice to apply the concessions The CGT retirement exemption and the CGT small business roll-over will only apply where the taxpayer makes the choice to apply these concessions. The choice to apply these concessions must be made by the day of lodgment of the tax return for the income year in which the relevant CGT event occurred. The manner in which the taxpayer prepares the tax return is sufficient evidence of the taxpayer making the choice to apply the CGT small business roll-over. However, the choice to apply the CGT retirement exemption must be prepared in writing prior to the lodgment of the tax return for the income year in which the CGT event occurred. The CGT 15-year exemption and the CGT small business 50% reduction will automatically apply where the taxpayer satisfies all the requirements for the concession. However, the taxpayer may choose not to apply the CGT small business 50% reduction to a capital gain (see ¶4-350). The manner in which the taxpayer prepares the tax return for the income year in which the CGT event happened is again sufficient evidence of making this choice.

CGT 15-YEAR EXEMPTION ¶4-100 Introduction The CGT 15-year exemption allows a taxpayer satisfying certain conditions to disregard the whole of a capital gain made from a CGT event where the asset has been held for at least 15 years and certain conditions are satisfied. The conditions that must be satisfied where the taxpayer is an individual are set out at ¶4-110. The conditions that apply where the taxpayer is a company or a trust are set out at ¶4-120. Where a company or trust is able to disregard a capital gain as a result of the application of this exemption, the capital gain is excluded from being either assessable income or exempt income of the taxpayer. The capital gain exempted does not reduce any current year or prior year capital losses. The CGT 15-year exemption also contains measures to enable an effective distribution of the disregarded capital gain made by a company or trust to its CGT concession stakeholders without any clawback of the exemption at the shareholder or beneficiary level. This measure also ensures that the distributions will not

be taken into account in determining the taxable income of the relevant company, trust or CGT concession stakeholder.

¶4-110 Conditions for CGT 15-year exemption for individuals Where the taxpayer is an individual, the CGT 15-year exemption allows the taxpayer to disregard the whole of the capital gain made from a CGT asset held for at least 15 years. The conditions that must be satisfied in order for the CGT 15-year exemption to apply to a capital gain made by an individual taxpayer are as follows: (1) the basic conditions for the CGT small business concessions are satisfied (2) the taxpayer owned the CGT asset for the 15-year period ending just before the CGT event (3) where the CGT asset is a share in a company or an interest in a trust, the company or trust in which the share or interest was held had a significant individual for a total of at least 15 years, and (4) either: (a) the taxpayer is 55 or over at the time of the CGT event and the CGT event occurs in connection with the retirement of the taxpayer, or (b) the taxpayer is permanently incapacitated at the time of the CGT event (s 152-105). The basic conditions for the CGT small business concessions are contained in s 152-10 and are detailed in Chapter 3. The requirements for satisfying each of the other conditions are detailed separately in ¶4-130–¶4-160. Where all the conditions for the exemption are satisfied, any capital gain made from the CGT event will be disregarded in whole (s 152-110(1)).

¶4-120 Conditions for CGT 15-year exemption for companies and trusts Where the taxpayer is a company or a trust, the CGT 15-year exemption allows a taxpayer to disregard the whole of the capital gain made on an asset held for at least 15 years prior to the CGT event. The conditions for the CGT 15-year exemption to apply to a capital gain made by a taxpayer that is a company or trust are as follows: (1) the basic conditions for the CGT small business concessions are satisfied (2) the taxpayer owned the CGT asset for the 15-year period ending just before the CGT event (3) the taxpayer had a significant individual for a total of at least 15 years during the period in which the taxpayer owned the CGT asset (4) an individual who was a significant individual of the taxpayer was either: (a) 55 or over at the time of the CGT event and the CGT event happened in connection with the individual’s retirement, or (b) permanently incapacitated at the time of the CGT event (s 152-110). In relation to condition 1, the basic conditions for the CGT small business concessions are contained in s 152-10 and are detailed in Chapter 3. The requirements for satisfying each of the other conditions are detailed separately in ¶4-130–¶4-170. Where all the conditions for the exemption are satisfied, any capital gain made from the CGT event will be disregarded in whole (s 152-110(1)).

In addition, any ordinary income or statutory income the company or trust derives from a CGT event that would be covered by the exemption, had the event given rise to capital gain, is neither assessable income nor exempt income (s 152-110(2)). However, this exclusion will not apply to income derived by the company or trust as a result of a balancing adjustment event occurring to a depreciating asset: • whose decline in value is worked out under Div 40, or • deductions for which are calculated under Div 328 (s 152-110(3)). Therefore, the CGT 15-year exemption will not apply to disregard a balancing adjustment amount that is assessable as a result of a balancing adjustment event happening for a depreciating asset (s 40-285).

¶4-130 Fifteen years of ownership In order for the CGT 15-year exemption to apply, the taxpayer must have continuously held the asset for the 15-year period ending just before the CGT event. This requirement must be satisfied irrespective of whether the taxpayer is an individual, company or trust. Period of ownership Under ordinary circumstances, the period of ownership starts on the date of acquisition of the CGT asset as detailed in Div 109. For example, where the asset was acquired as a result of a purchase from another party, the starting date will generally be the date the contract for purchase was entered into, not the date of settlement (s 109-5(2)). The end of the ownership period is just before the CGT event. The phrase “just before the CGT event” has been interpreted as being the “just before the time of the CGT event” (Interpretative Decision ID 2003/744). For these purposes, the time of the relevant CGT event is that time specified in the provision for the relevant CGT event and is summarised in column 2 of the table in s 104-5. For example, where there is a sale of the CGT asset, CGT event A1 will happen and the time of the event will be: • when the contract for the disposal of the CGT asset is entered into, or • if the taxpayer does not enter into a contract — when the change in ownership of the asset takes place, being when the taxpayer stops being the asset’s owner (s 104-5, 104-10(3)). Therefore, where there is a contract for the sale of the asset, it is the date the contract is entered into, not the date of settlement that is relevant for determining the time of both the acquisition and disposal of the asset. For this purpose, a contract may be an oral contract, provided it has all the attributes required by common law, eg an intention for the parties to be immediately bound. Care needs to be taken in determining the date that a contract is entered. It may not necessarily be the date of signing of the formal contract. Cases have demonstrated that the date of the contract may occur earlier such as on the countersigning of a letter of offer (Scanlon & Anor v FC of T 2014 ATC ¶10-378) or the signing of a heads of agreement despite the express statement it was “subject to and conditional upon” signing of a formal agreement (Case 2/2013 2013 ATC ¶1-051). Example 1 Thomas purchased the goodwill in a used car business by contract dated 10 September 2002 with settlement on 15 October 2002. Thomas was proposing to retire in November 2017 aged 58. To ensure that he received the best price for the sale of the business, Thomas started seeking buyers for the business in April 2017. A buyer of the business was found in July 2017. The parties entered into a contract for the sale of the goodwill of the business on 1 August 2017, which had a delayed settlement of 31 November 2017. CGT event A1 occurred on 1 August 2017. In the circumstances, the relevant period of the ownership is based on the two contract dates, being: • starting date — 10 September 2002 • ending date — 1 August 2017. For CGT purposes, Thomas owned the goodwill for less than 15 years. Accordingly, Thomas will not be entitled to the CGT 15-year exemption on the sale of the goodwill.

When a taxpayer is proposing to sell an asset it is important that the CGT small business concessions are taken into account in structuring the transaction. The manner in which the sale of the asset is structured can significantly impact upon a taxpayer’s ability to satisfy the 15-year ownership requirement. Example 2 Assume the same facts as in Example 1. However, instead of entering into a sale contract on 1 August 2017, Thomas entered into a put option with an exercise period of 1 November 2017 to 15 November 2018 and a call option with an exercise period of 5 November 2017 to 19 November 2018. The exercise of an option required the execution of the business sale contract with a settlement date of 31 November 2017. Thomas exercised the put option on 5 November 2017. In accordance with the terms of the put option, the business sale contract was also entered into on 5 November 2017. The entering into the contract of sale gave rise to CGT event A1 on 5 November 2017. Note that any capital gain arising on the exercise of the option is disregarded (s 134-1(4)). In the circumstances, the relevant period of the ownership is based on the two sale contract dates, being: • starting date — 10 September 2002 • ending date — 5 November 2017. In these circumstances, Thomas will satisfy the 15-year ownership period.

Therefore, a taxpayer on the borderline of the 15-year ownership period may be able to satisfy the 15year ownership requirement through the structuring of the transaction. In structuring any transaction the taxpayer will need to consider the potential application of the general anti-avoidance rules in ITAA36 Pt IVA. Continuous ownership In order to satisfy the 15-year ownership requirement, the CGT asset needs to be held “continuously” for the 15-year period. A taxpayer is not entitled to add together two different periods of ownership in determining whether the 15-year ownership period has been satisfied. Example 3 Robert acquired 100% of the units in the Twenty Unit Trust on 1 May 1998. The Twenty Unit Trust carried on a business of selling clothes. On 1 May 2002, Robert sold 50% of the units to an unrelated entity, being Durham Pty Ltd. Robert continued to own the remaining 50% of the units. On 1 May 2004, Robert reacquired the 50% of units which were sold to Durham Pty Ltd to increase his ownership back to 100% of the units in the Twenty Unit Trust. On 15 September 2017, Robert sold 100% of the units to a third party. For the purpose of considering whether the CGT 15-year exemption applies, the units need to be split into two parcels, being: (1) the 50% held by Robert from 1 May 1998 until 15 September 2017 (2) the 50% which were temporarily sold to Durham Pty Ltd. In relation to the units in (1), Robert will have owned the units for the continuous period of 1 May 1998 until 15 September 2017. As this period is in excess of 15 years, the 15-year continuous ownership period will be satisfied. In relation to the units in (2), the continuous period of ownership starts on 1 May 2004 and ends on 15 September 2017, being just over 13 years. The taxpayer is not able to include the prior three-year ownership period for the purpose of determining whether the 15-year ownership period is satisfied. Accordingly, as Robert has owned these units for less than 15 continuous years prior to the sale, he will not satisfy the 15-year ownership requirement and the CGT 15-year exemption will not be available for these units. Therefore, Robert will only potentially be entitled to the CGT 15-year exemption in relation to the sale of 50% of the units in the Twenty Unit Trust.

However, there are certain exclusions to the requirement for the taxpayer to own the relevant CGT asset for a continuous period of 15 years. These provisions are detailed in ¶4-140 and ¶4-150. Same CGT asset The 15-year ownership condition generally requires that the taxpayer holds a direct interest in the same asset for 15 years. For this purpose a taxpayer cannot combine a period in which the asset was indirectly held with a direct holding period to satisfy the 15-year requirement.

There is no general rule to allow the taxpayer to use a deemed earlier acquisition date for a CGT asset acquired as a result of a replacement asset roll-over or a same asset roll-over where the taxpayer acquired the original asset on or after 20 September 1985. There are special rules for applying the CGT general discount in s 115-30 which deem a taxpayer to have acquired an asset on a date prior to the actual acquisition where the asset was acquired as a result of a same asset roll-over or a replacement asset roll-over. However, these deeming rules only apply in determining whether the taxpayer has held the asset for at least 12 months in order to apply the CGT general discount in Div 115 (s 115-30). This deemed earlier acquisition date does not apply in determining the period of ownership for the purpose of the CGT 15-year exemption. Example 4 Rick personally started a plumbing business on 15 February 1998. On 1 July 2008, Rick restructured the ownership of the business by rolling the business into a wholly-owned company, Spring Fields Pty Ltd and chose to apply CGT roll-over relief in accordance with s 122-15. As a result, no CGT was payable on the disposal of the business. Rick entered into a contract for the sale of 100% of the shares in Spring Fields Pty Ltd on 17 July 2017. The period of ownership of the shares for the CGT 15-year exemption: • began on 1 July 2008 • ended on 17 July 2017. As the period of ownership is a little over nine years, the 15-year ownership test will not be satisfied. Rick cannot extend the period of ownership to include the period in which he owned the business directly prior to the roll-over. For the purpose of the 50% general discount in Div 115, Rick would be treated as having acquired the shares on the date he originally started the business which was rolled over, being 15 February 1998 (s 115-30). This deeming rule only applies for the purpose of Div 115 and does not extend to determining the ownership period under the 15-year exemption.

However, the ownership period may be extended in limited circumstances where roll-over relief applied as a result of the asset being acquired as: • a replacement for an involuntary disposal • pursuant to a marriage or relationship breakdown for which CGT roll-over relief was claimed • the financial services reform transition, or • pursuant to a small business restructure roll-over (s 152-115). The conditions for the extension to the ownership period are detailed in ¶4-140 and ¶4-150. Consolidated groups Where a CGT asset is legally held by a company or trust that is a subsidiary member of a consolidated group, the taxpayer, being the head company of the consolidated group, will be treated as having acquired the asset on the date the subsidiary member acquired the asset for CGT purposes. The taxpayer will inherit the subsidiary member’s ownership period pursuant to entry history rule (s 701-5; Taxation Determination TD 2004/43). Any changes in the actual ownership of the relevant CGT asset between members of a consolidated group while they are consolidated will not affect the ownership of the asset for these purposes (Taxation Determination TD 2004/44). Example 5 On 16 July 2008, Star Transport Pty Ltd acquired 100% of the shares in Five Star Pty Ltd. Five Star Pty Ltd acquired a business property on 10 February 1999. The property was used for the purpose of carrying on a transport business. On 1 July 2010, Star Transport Pty Ltd made an election to form a tax consolidated group with Five Star Pty Ltd being its subsidiary member. On 30 May 2012, there was a restructure of the group with the business property being transferred from Five Star Pty Ltd to the Starling Unit Trust. The Starling Unit Trust was 100% owned by Star Transport Pty Ltd and therefore a subsidiary member of the consolidated group.

On 17 July 2017, the Starling Unit Trust entered into an agreement for the sale of the property. For the purpose of applying the 15-year exemption, the relevant taxpayer is Star Transport Pty Ltd, being the head company of the consolidated group of which the Starling Unit Trust is a member. Star Transport Pty Ltd is treated as having owned the asset for the continuous period: • starting on 10 February 1999, being the date the asset was acquired by Five Star Pty Ltd, and • ending on 17 July 2017, being the date the asset was sold by the Starling Unit Trust. The change in ownership between Five Star Pty Ltd and the Starling Unit Trust does not impact upon the ownership for tax purposes as the property is treated as being owned by Star Transport Pty Ltd from the date of consolidation of 1 July 2010 pursuant to the single entity rule in s 701-5. Therefore, Star Transport Pty Ltd will satisfy the requirement that the property was owned for 15 years prior to the CGT event.

Change in majority underlying ownership Where the taxpayer actually acquired an asset prior to 20 September 1985 but due to a change in its majority underlying interests the asset is deemed for CGT purposes to have acquired the asset after that date pursuant to Div 149, the ownership period is determined using the actual date of the acquisition of the asset (s 152-110(1A)). That is, the deemed date of ownership under s 149-30, being the first date of a change in the majority underlying interest, will be disregarded for the purpose of determining the ownership period. Example 6 On 16 May 1984, Weeds Pty Ltd started carrying on the patisserie, Mini Cakes. On 10 December 2009, all the shares in Weeds Pty Ltd were sold. The market value of the goodwill of the business as at 10 December 2009 was $1m. For CGT purposes, Weeds Pty Limited is deemed to have acquired the goodwill for $1m on 10 December 2009 pursuant to s 149-30 and 149-35. The business is sold by Weeds Pty Limited on 30 September 2017, with the goodwill being sold for $1.5m. For the purpose of determining whether the 15-year exemption is available for the capital gain on the sale of the goodwill, the ownership period is determined as the period 16 May 1984 to 30 September 2017. The change in majority underlying ownership is disregarded. The ownership period of the goodwill exceeds 15 years.

See ¶4-250 for the application of the 15-year exemption to the sale of pre-CGT assets and CGT assets acquired prior to 20 September 1985 that are deemed to be post-CGT assets.

¶4-140 Deemed continuous ownership — involuntary disposal There are limited exceptions to the rule that the relevant CGT asset must have been held for a continuous period of 15 years. The exceptions apply to effectively extend the period in which a CGT asset is treated as being held for the purpose of the ownership test. For the purpose of applying the 15-year ownership requirement, a taxpayer is allowed to treat a CGT asset as being continuously owned where there was a disposal of the asset pursuant to which any of the following CGT roll-overs applied: • Subdiv 124-B roll-over — the taxpayer’s CGT asset is lost or destroyed, or is compulsorily acquired by an Australian government agency or another entity as a result of compulsory acquisition powers • the former Subdiv 124-O roll-over — dealing with financial services licences under Australian Financial Services Reform transitions • Subdiv 126-A roll-over — the asset is transferred because of a marriage or relationship breakdown • Subdiv 328-G — the asset is transferred in accordance with the small business restructure roll-over. The application of the extension rules for a compulsory acquisition and a Financial Services Reform licence are detailed below. For the application of the extension in ownership for a marriage or relationship breakdown and the small business restructure roll-over, see ¶4-150 and ¶4-155 respectively. Compulsory acquisition

Where the relevant CGT asset was acquired by the taxpayer as a replacement for an asset that was compulsorily acquired, lost or destroyed (“original asset”) and the taxpayer obtained CGT roll-over pursuant to s 124-70(2) or 124-75(2), the taxpayer will be treated as acquiring the replacement asset on the date of acquisition of the original asset (s 152-115(1)). A taxpayer is entitled to CGT roll-over relief pursuant to s 124-70 where a CGT asset, or a part of a CGT asset, that the taxpayer owns is: • compulsorily acquired by an Australian government agency • lost or destroyed • disposed of to an Australian government agency after being served a notice inviting the taxpayer to enter into negotiations for its sale to the agency and, if the negotiations are unsuccessful, the asset is compulsorily acquired, or • a lease granted by an Australian government agency under an Australian law which expires without renewal, and the taxpayer received money or another CGT asset either as compensation for the event happening or under an insurance policy (s 124-70). Where the taxpayer only received money, roll-over relief is only available where the taxpayer incurred expenditure in acquiring another CGT asset (other than a depreciating asset) or where part of an original asset is lost or destroyed, expenditure of a capital nature is incurred in repairing or restoring it (s 12475(2)). Where this roll-over relief was obtained the taxpayer is treated as having continuously owned the replacement asset from the date of acquisition of the original asset for the purpose of applying the CGT 15-year exemption. Example 1 Oust Pty Ltd carried on a cafe business at premises in Paddington from April 1995. In August 2008, the state government compulsorily acquired the property for $1m. With the money received Oust Pty Ltd purchased a new property for $1.2m in November 2008 and continued to carry on the same business. Oust Pty Ltd was eligible for, and chose to apply, CGT roll-over relief in accordance with s 124-70(2) and 124-75(2) in relation to the capital gain from the disposal of the original property. Oust Pty Ltd entered into an agreement for the sale of the new property in August 2017. For the purpose of determining whether the CGT 15-year exemption is available, Oust Pty Ltd is treated as having owned the property for the period: • starting in April 1995 • ending in August 2017. Accordingly, Oust Pty Ltd is treated as having held the property for just over 22 years and the 15-year requirement will be satisfied despite the fact the actual property was only physically owned for just under nine years.

This extension rule applies to determine: • the ownership period of the CGT asset by a taxpayer that is an individual, trust or company • where the taxpayer was a company or trust — whether the taxpayer had a significant individual for the period of 15 years (s 152-115(1)). Financial Services Reform (FSR) transitions Where the CGT asset is an Australian financial services licence or an intangible asset that was acquired as a result of the transition to the Financial Services Reform (FSR) regime, the period of ownership may be extended if the taxpayer acquired automatic roll-over relief pursuant to the former Subdiv 124-O and the taxpayer was the owner of both the original asset and the replacement asset. The extension in the period of ownership is available where the relevant asset was acquired pursuant to a situation covered by any of the former s 124-880, 124-885, 124-890, 124-900, 124-905 or 124-910 for which automatic roll-

over relief was available (s 152-115(1A), 152-115(1B)). A taxpayer was entitled to this automatic roll-over relief where, during the FSR transitional period of 11 March 2002 to 10 March 2004 (inclusive), any of the following applied: • an existing statutory licence, registration or authority was replaced with an Australian financial services licence • a qualified Australian financial services licence was replaced with an Australian financial services licence • an intangible CGT asset was replaced with another intangible CGT asset. The replacement Australian financial services licence or intangible CGT asset must have been acquired by any of: • the owner of the original licence, registration, authority, qualified Australian financial services licence or intangible CGT asset • a company or trust in the same consolidatable group as the owner of the original licence, registration, authority, qualified Australian financial services licence or intangible CGT asset • a company or fixed trust wholly owned by the owner of the original licence, registration, authority, qualified Australian financial services licence or intangible CGT asset (former s 124-880, 124-885, 124-890, 124-900, 124-905, 124-910). The provision under which the extension is available will depend upon whether the roll-over relief was available in relation to a situation where: • the taxpayer owned the original asset for which roll-over relief applied (s 152-115(1A)) • an entity other than the taxpayer owned the original asset for which roll-over relief applied (s 152115(1B)). Where the CGT event occurs in relation to a CGT asset which was the relevant replacement Australian financial services licence or intangible CGT asset pursuant to the roll-over, for the purpose of applying the CGT 15-year exemption the taxpayer will be treated as having acquired that asset on the date of acquisition of the original licence, registration, authority, qualified Australian financial services licence or intangible CGT asset (s 152-115(1A), 152-115(1B)). Example 2 Tony started a financial services business in July 1990. In accordance with the business, Tony held a financial licence that gave him regulated principal status within the meaning of s 1430 of the Corporations Act 2001. As a result of the introduction of the FSR regime, Eden Pty Limited, being a company wholly owned by Tony, acquired a financial services licence on 15 March 2004 to replace the previous licence held by Tony. Tony obtained automatic CGT roll-over relief in relation to the original licence pursuant to former s 124-900. Eden sold the financial services licence on 27 July 2017. For the purpose of applying the CGT 15-year retirement exemption, the financial services licence is treated as being owned by Eden Pty Ltd for the period: • starting from July 1990, and • ending on 27 July 2017. Therefore, Eden Pty Ltd will satisfy the 15-year ownership requirement in relation to the financial services licence. In satisfying the ownership period, Eden is able to use the period in which Tony held the original financial licence.

This extension rule applies to determine: • the ownership period of the CGT asset by a taxpayer that is an individual, trust or company

• where the taxpayer was a company or trust — whether the taxpayer had a significant individual for the period of 15 years (s 152-115(1A), 152-115(1B)).

¶4-150 Deemed continuous ownership — relationship breakdown The period of ownership of the CGT asset will be extended where the asset was acquired by a taxpayer pursuant to a marriage or relationship breakdown, irrespective of whether the asset was acquired from the former spouse, a company or trust. The extension in the ownership period applies where: • the asset was acquired as a result of a marriage or relationship breakdown • CGT roll-over relief pursuant to Subdiv 126-A applied in relation to the acquisition of that asset, and • the taxpayer chose, for the purpose of the active asset test, to treat the asset as being owned by the taxpayer for the period it was actually held by the asset’s former owner and deem that asset’s status as active or inactive in accordance with the manner in which it was held by the former owner pursuant to s 152-45(2) (see ¶3-680). Where this extension applies, the taxpayer will be treated as having owned the asset from the time the former owner, being the relevant spouse (which includes a same-sex partner (¶2-050)), company or trust, originally acquired the asset for determining the period of ownership (s 152-115(2)). The extension rule is relevant for determining: • the ownership period of the CGT asset by a taxpayer that is an individual, trust or company • where the taxpayer is an individual and the CGT asset is a share in a company or an interest in a trust — whether the company or trust had a significant individual for a period of 15 years • where the taxpayer was a company or trust — whether the taxpayer had a significant individual for the period of 15 years (s 152-115(2)). Example On 1 February 1999, while Will and Peter were in a bona fide domestic same-sex relationship, Will acquired 15% and Peter acquired 10% of the units in the Safe Unit Trust. The Safe Unit Trust carried on an active business. Pursuant to their relationship breakdown, Will transferred his units in the Safe Unit Trust to Peter on 18 July 2017. CGT roll-over relief applied to the transfer of the units in accordance with s 126-5. Peter then entered into an agreement to sell his units on 30 September 2017. For the purpose of the active asset test Peter chose to treat the units acquired from Will as being owned by himself in accordance with s 152-45(2). Accordingly, in determining the period of Peter’s ownership of the units for the CGT 15-year exemption: • the original 10% of units were acquired on the actual date of acquisition of 1 February 1999 • the remaining 15% of units are treated as being acquired on 1 February 1999, as a result of Peter choosing this acquisition date pursuant to s 152-45(2). For the purpose of determining whether there was a significant individual in the Safe Unit Trust, Peter is treated as having held the 15% of units in the Safe Unit Trust acquired from Will since 1 February 1999. When these units are combined with his original 10%, Peter is treated as holding 25% interest in the Safe Unit Trust since 1 February 1999. Accordingly, Peter will be treated as a significant individual of the Safe Unit Trust since 1 February 1999 and the significant individual test will be satisfied. Therefore, Peter will satisfy the ownership requirements for the CGT 15-year exemption.

¶4-155 Deemed continuous ownership — small business restructure The period of ownership of the CGT asset will be extended where the asset was acquired by a taxpayer pursuant to the small business restructure roll-over. The extension in the ownership period applies where the roll-over applied to the transfer of the asset in accordance with s 328-450 or s 328-455. The extension rule is relevant for determining: • the ownership period of the CGT asset by a taxpayer that is an individual, trust or company

• where the taxpayer is an individual and the CGT asset is a share in a company or an interest in a trust — whether the company or trust had a significant individual for a period of 15 years • where the taxpayer was a company or trust — whether the taxpayer had a significant individual for the period of 15 years (s 152-115(3)).

¶4-160 Significant individual requirement — taxpayer is an individual Where the taxpayer is an individual and the relevant CGT asset is a share in a company or an interest in a trust, the CGT 15-year exemption will only be available if the taxpayer satisfies the significant individual requirement. The significant individual requirement will be satisfied where the company or trust in which the CGT asset is held had a significant individual for a total of at least 15 years during which the taxpayer held the shares (s 152-105(c)). For the purpose of satisfying this requirement, the object company or trust is not required to have had a significant individual for the last 15 years prior to the CGT event or even a continuous 15-year period. There is only a requirement that the object company or trust had a significant individual for at least 15 of the years during which the taxpayer held the relevant share or trust interest. The test does not require the company or trust to have the same significant individual for each of the 15 years. The company or trust may use any number of different significant individuals to satisfy the test for the relevant 15 years during the taxpayer’s ownership period. The particular taxpayer itself is not required to be the relevant significant individual of the company or trust for each of those 15 years. However, the taxpayer will be required to be a CGT concession stakeholder in the company or trust at the time just before the CGT event in order for the CGT 15-year exemption to apply. This is one of the basic conditions of the CGT small business concessions (s 152-10(2); see ¶3-260). The determination of whether an individual is a significant individual of a company or trust is detailed in Chapter 3, particularly ¶3-820. Example 1 Sondra sold her shares in Ducette Pty Ltd. The shares represented 15% of its ordinary issued share capital. At the time of the sale, Sondra’s husband Harry owned 25% of the issued shares in Ducette Pty Ltd. Sondra has held the shares for 17 years prior to the sale. As Sondra is the wife of a significant individual and has a small business percentage of 15%, she will be a CGT concession stakeholder at the time of the sale. During the 17 years in which she owned the shares, the shareholding in Ducette was as follows:

Years

Sondra

Harry

Derek Melissa Jenny

Matthew

1–5

20%

10%

35%

35%

0%

0%

6

15%

19%

19%

19%

14%

14%

7–10

15%

19%

16%

16%

20%

14%

11–17

15%

25%

0%

0%

45%

15%

During the years in which Sondra owned 15% of the shares in Ducette Pty Ltd, the following applied: • Years 1 to 5 — each of Sondra, Derek and Melissa were significant individuals. • Year 6 — there was no significant individual. • Years 7 to 10 — Jenny was a significant individual. • Years 11 to 17 — each of Harry and Jenny were significant individuals. Therefore, Ducette Pty Ltd had a significant individual for a total of 16 years, being Years 1 to 5 and then Years 7 to 17, inclusive. Accordingly, the requirement that Ducette Pty Ltd had a significant individual for at least 15 years is satisfied despite Sondra only being a significant individual for five years.

Non-fixed trust Where the CGT asset is an interest in a non-fixed trust, the mere failure to make a distribution will not prevent the significant individual requirement from being satisfied. Where a non-fixed trust does not make a distribution of income or capital during a relevant year due to having a tax loss or no taxable income in that year, the significant individual will be determined based on the last prior income year in which a capital or income distribution occurred (s 152-70(4)–(6); see ¶3-820). Example 2 The Lazy Dog Trust has two classes of units, being income units and capital units. The capital units entitle its unitholders to proportional shares of any capital distributions. Income distributions are made to the holders of the income units in such proportions as the trustee of the trust decides in its absolute discretion. Mark owns one income unit and 25% of the capital units. Mark has held these interests in the Lazy Dog Trust for 20 years prior to the sale. During those 20 years Steven, Richard and John each held 25% of the capital units in the trust and one income unit. Cindy has owned one income unit for the past 12 years. The only year in which a capital distribution was made was in Year 4. The income distributions which were made during the 20 years were as follows:

Years

Mark

Steven Richard

John

Cindy

1–3

10%

35%

35%

20%

0%

4–10

0%

0%

0%

0%

0%

11–16

19%

19%

19%

20%

23%

17–20

25%

10%

10%

45%

10%

During Years 4 to 7, inclusive, no income distribution was made by the trust as it made tax losses. During Year 8, the trust had nil taxable income. During Years 9 to 10, the trust derived taxable income but failed to make any distribution of the income. Accordingly, the trustee of the trust was taxed due to no beneficiary being presently entitled. During the income years in which Mark owned the units, the Lazy Dog Trust had the following significant individuals: • Years 1 to 3 — each of Steven, Richard and John were significant individuals. • Year 4 — each of Mark, Steven, Richard and John would be significant individuals as they were each entitled to 25% of the capital distributions. • Years 5 to 8 — each of Mark, Steven, Richard and John would be treated as significant individuals. As the trust was either in losses or had nil net income and made no capital or income distributions during these years, the significant individuals are based on Year 4, being the last income year in which distributions were made (s 152-70(4) and (5)). • Years 9 and 10 — the trust had no significant individual. The trust cannot use the prior year distributions as the trust had net income in each of these years (s 152-70(6)). • Years 11 to 16 — both John and Cindy were significant individuals. • Years 17 to 20 — both Mark and John were significant individuals. As the Lazy Dog Trust had a significant individual for 18 years, the requirement that the trust have a significant individual for at least 15 years during Mark’s ownership will be satisfied. Note that Mark will be a CGT concession stakeholder at the time of the CGT event as he was a significant individual in that year.

Therefore, the failure to make an income or capital distribution from a non-fixed trust will not necessarily prevent the trust from having a significant individual if during that income year the trust had a tax loss or no taxable income. However, where the trust has never made any income or capital distributions, the trust will not have had a significant individual at any time and will not be able to satisfy the significant individual requirement (s 152-70(6)).

¶4-170 Significant individual requirement — taxpayer is company or trust Where the taxpayer is a company or trust, the taxpayer is required to have a significant individual for a

total of at least 15 years during the period in which the taxpayer owned the CGT asset (s 152-110(1)(c)). For the purpose of satisfying this requirement the 15 years in which the taxpayer had a significant individual are not required to be the last 15 years prior to the CGT event or even a continuous 15-year period. Similarly, the test does not require the taxpayer to have the same significant individual for each of the 15 years. The taxpayer may use any number of different significant individuals to satisfy the test for the 15 relevant years during the ownership period. The determination of whether an individual is a significant individual of a company or trust is detailed in Chapter 3, particularly ¶3-820. Example 1 PM Unit Trust enters into a contract for the sale of land on which its panel beating business was conducted. The asset has been owned for 16 years. The units in the PM Unit Trust entitle the holders to proportional entitlements to the income and capital of the trust based on the units held. During the 16 years of ownership, the units in PM Unit Trust have been held as follows:

Years

Angelina Christina

Nicole

Keith

1–3

55%

10%

35%

0%

4–6

10%

10%

80%

0%

7–15

0%

20%

10%

70%

16

0%

0%

10%

90%

During the years in which the PM Unit Trust owned the land the following applied: • Years 1 to 3 — each of Angelina and Nicole were significant individuals. • Years 4 to 6 — Nicole was a significant individual. • Years 7 to 15 — each of Christina and Keith were significant individuals. • Year 16 — Keith was a significant individual. The PM Unit Trust will satisfy the significant individual requirement for the whole of the period in which it held the asset, being 16 years. Therefore, the trust satisfies the significant individual condition.

Where the owner of the asset is a subsidiary member of a consolidated group at the time of the sale, the significant individual test is applied to the head company of the consolidated group (Taxation Determination TD 2004/45). Where the taxpayer actually acquired an asset prior to 20 September 1985 but due to a change in its majority underlying interests the taxpayer is deemed for CGT purposes to have acquired the asset after that date pursuant to Div 149, any change in majority underlying interest in an asset will be ignored for testing whether the entity had a significant individual for at least 15 years. Non-fixed trust Where the taxpayer is a non-fixed trust that did not make a distribution of income or capital as it had either a tax loss or no taxable income for that income year, the determination of that trust’s significant individuals for the income year, if any, is based on the last income year in which such a distribution was made (s 152-70(4)–(6); see ¶3-820). Example 2 Alias Discretionary Trust carried on a fancy dress business for 20 years. The trust decides to sell the business. During the 20-year period of ownership of the goodwill, the Alias Discretionary Trust made the following income distributions:

Years

Meredith

Charlie Jason Connor Adam

Sarah

1–3

10%

90%

0%

0%

0%

0%

4–7

0%

0%

0%

0%

0%

0%

8–12

20%

20%

10%

10%

20%

20%

13–14

0%

0%

0%

0%

0%

0%

15–20

25%

0%

10%

10%

45%

10%

Capital distributions were only made in Years 7 and 18. The capital distributions in these years were:

Years

Meredith

Charlie Jason Connor Adam

Sarah

7

19%

19%

19%

19%

19%

5%

15

10%

50%

10%

10%

10%

10%

During Years 4 to 7 inclusive, no income distribution was made by the trust as it made tax losses in those years. During Year 13, the trust made no income distribution as it had nil taxable income. During Year 14, the trust had taxable income but did not make any income distributions. During the relevant income years, the following applies: • Years 1 to 3 — Charlie was a significant individual. • Years 4 to 6 — Charlie will be a significant individual. As there were no income or capital distributions in the year and the trust had tax losses, the direct small business participation percentage is based on the last prior income year in which distributions were made, being Year 3. • Year 7 — the trust had no significant individual as there was a capital distribution during the year and no individual received 20% or more of the capital distribution. • Years 8 to 12 — each of Meredith, Charlie, Adam and Sarah were significant individuals. • Year 13 — each of Meredith, Charlie, Adam and Sarah were significant individuals. As there were no income or capital distributions and the trust had nil taxable income for the year, the direct small business participation percentages are based on the prior year in which distributions were made, being Year 12. • Year 14 — the trust did not have a significant individual. The prior year distributions are not considered as the trust had taxable income for the year. • Year 15 — the trust did not have a significant individual as no individual had a small business participation percentage of 20% or more. This is because the lower of the percentage of the income and capital distributions received by each individual was less than 20%. • Years 16 to 20 — Meredith and Adam were significant individuals. In accordance with the above, the Alias Discretionary Trust had a significant individual for 17 years during the ownership period. Therefore, it will satisfy the requirement for the taxpayer to have a significant individual for at least 15 years of the ownership period.

Therefore, the failure to make neither an income nor capital distribution from a non-fixed trust will not necessarily prevent the trust from having a significant individual if, during that year, the trust had a tax loss or no taxable income and the trust made distributions in a prior income year.

¶4-180 Minimum age and retirement condition In order for the CGT 15-year exemption to be available, the taxpayer must satisfy either: • the relevant minimum age and retirement condition, or • the permanent incapacitation condition. The permanent incapacitation alternative is detailed in ¶4-190. The satisfaction of the minimum age and retirement condition depends upon whether the taxpayer is an individual, company or trust. Where the taxpayer is an individual, the condition requires each of the following to be satisfied:

• the taxpayer is aged 55 or over at the time of the CGT event • the CGT event happens in connection with the taxpayer’s retirement (s 152-105(d)(i)). Where the taxpayer is a company or trust, the condition requires the taxpayer to have a significant individual just before the CGT event and that significant individual must satisfy both of the following: • the significant individual was aged 55 or over at that time • the CGT event happened in connection with the significant individual’s retirement (s 152-110(1)(d)(i)). This test is only required to be satisfied by one significant individual of the company or trust taxpayer. Where a taxpayer has more than one significant individual just before the CGT event, it is not necessary for each of those individuals to satisfy the requirements. Example 1 Sloane Pty Limited sold an asset that it had held for 18 years. At the time just before the CGT event, the issued share capital was held as follows: • 30% — Jacinta aged 56 • 45% — Molly aged 54 • 15% — Mare aged 25 • 10% — Vivian aged 33. Both Jacinta and Molly are significant individuals of Sloane Pty Limited. Immediately after the sale Jacinta will retire. As Jacinta is a significant individual aged 56 at the time of the sale and the sale was made in connection with Jacinta’s retirement, the minimum age and retirement condition for the CGT 15-year exemption will be satisfied by Sloane Pty Limited. The test is satisfied even though Molly, being a significant individual, is under the age of 55 as Jacinta satisfies the requirements.

The application of relevant minimum age and retirement requirements are outlined separately below. Minimum age requirement In order for the taxpayer to satisfy the relevant minimum age requirement: • where the taxpayer is an individual — the taxpayer must be aged 55 or over at the time of the CGT event (s 152-105(d)(i)) • where the taxpayer is a company or trust — a significant individual of the taxpayer just before the CGT event must be aged 55 at that time (s 152-110(1)(d)(i)). The time of the CGT event is that time specified in the provision for the relevant CGT event. These times are specified for each CGT event in column 2 of the table in s 104-5. Where there is a sale of an asset, CGT event A1 will usually happen at the time the contract for sale is entered into as opposed to the date of settlement or change in legal ownership. Whether the minimum age requirement of 55 years is satisfied will be a question of fact in the circumstances. Where a relevant taxpayer or significant individual is nearing the age of 55, it may be in the best interests of the taxpayer to plan the timing of the CGT event to ensure this requirement is satisfied. For example, a taxpayer may potentially use put and call options to effectively bind a potential purchaser in relation to the sale of an asset, but delay the point of time at which CGT event A1 happens. Required connection with retirement In order for the taxpayer to satisfy the relevant retirement requirement: • where the taxpayer is an individual — the CGT event must happen in connection with the taxpayer’s retirement (s 152-105(d)(i)) • where the taxpayer is a company or trust — the CGT event must happen in connection with the

retirement of a significant individual of the taxpayer (s 152-110(1)(d)(i)). The term “retirement” is not defined for the purposes of the CGT small business concessions. A retirement does not necessarily require the individual to completely cease employment in the workforce or even have a permanent cessation of employment. In order for there to be a “retirement” there needs to be at least: • a significant reduction in the number of hours the individual works, or • a significant change in the nature of the individual’s present activities. Example 2 Bailey carries on a management consultancy business in which she works on average 60 hours per week. Bailey is aged 57 and decides to sell the business. A condition of the sale contract requires Bailey to be an employee and work seven hours per week for a period of six months to assist in the handover of the business. Thereafter Bailey will cease work completely and move to the country. As Bailey has changed the nature of her activities, moving from self-employed to employee, and the hours of work will have reduced from 60 hours per week to seven hours per week, she will be considered to have retired for CGT purposes. Therefore, the sale of the business will be considered to be made in connection with the taxpayer’s retirement.

Example 3 George carries on a public relations business for which he works approximately 50 hours per week. George decides to sell his business to an associate and agrees to work for 35 hours a week for the associate. While George will have changed the nature of his activities from being self-employed to being an employee of his associate, he will still be carrying on the same type of activities. In the circumstances, there would not be a significant change in the activities which are carried on. The reduction in hours from 50 hours per week to 35 hours per week would not be considered to be significant reduction in the hours of work. As a result, George would not be considered to have retired and the sale will not be considered to have happened in connection with his retirement.

However, there is no requirement for a permanent and everlasting retirement from the workforce. It is possible for an individual to retire and later change his or her mind and re-enter the workforce. Therefore, provided the relevant individual has actually retired, a subsequent re-entry into the workforce will not prevent this requirement from being satisfied. Whether there is a retirement will depend upon the particular facts and circumstances of the relevant individual. “In connection with retirement” In order for the condition to be satisfied, the relevant CGT event must have happened in connection with the individual’s retirement. Therefore, there must be a causal nexus between the CGT event and the retirement of the relevant individual. Whether there will be a causal nexus between the CGT event and retirement of the individual will be a question of fact and degree in the circumstances. It is possible for there to be a causal connection between the CGT event and the retirement irrespective of whether the CGT event occurs before or after the retirement of the relevant individual. For these purposes, there may be a gap of time between the CGT event and the retirement. Where the CGT event occurs after the retirement of the relevant individual, it needs to have been prompted by the individual’s retirement. Example 4 Zoe held 30% of the shares in Madness Pty Ltd, which carried on a business selling novelty items. Zoe did not actively participate in the business. Zoe was employed as a lawyer. At age 58, Zoe retired from being a lawyer but maintained ownership of her shares in Madness Pty Ltd. One year after her retirement, Zoe decided to sell the shares she held in Madness Pty Ltd. Whether the sale of the shares was in connection with the retirement of Zoe will need to be determined based on an analysis of all the facts and circumstances.

Where Zoe held the shares in Madness, and she was neither a director nor actively involved in the business, the sale may not be considered to have been in connection with Zoe’s retirement. Where Zoe was a director of Madness Pty Ltd and at the time of the sale of the shares she also ceased to be a director of Madness Pty Ltd, the sale of the shares may potentially be in connection with Zoe’s retirement as a director. However, it will be a question of fact in the circumstances.

¶4-190 Permanent incapacitation alternative The satisfaction of the permanent incapacitation alternative of the fourth condition for the CGT 15-year retirement exemption depends upon where the taxpayer is an individual, company or trust. Where the taxpayer is an individual, the permanent incapacitation alternative will be satisfied where the taxpayer is permanently incapacitated at the time of the CGT event (s 152-105(d)(ii)). Where the taxpayer is a company or a trust, the permanent incapacitation alternative will be satisfied where, just before the CGT event, the taxpayer had a significant individual and the significant individual was permanently incapacitated at that time (s 152-110(1)(d)(ii)). The term “permanently incapacitated” is not defined for the purpose of the CGT provisions. However, the term has been used in relation to the retirement and superannuation provisions which provide some indication of its meaning for the purposes of the CGT 15-year exemption. Based on this interpretation, a broadly indicative description of permanent incapacity is: “… ill health (whether physical or mental), where it is reasonable to consider that the person is unlikely, because of the ill-health, to engage again in gainful employment for which the person is reasonably qualified by education, training or experience. The incapacity does not necessarily need to be permanent in the sense of everlasting.” However, the term “permanently incapacitated” does not include death. Where there has been a death of the taxpayer, special provisions will apply for determining whether the CGT 15-year exemption is available, which are detailed in ¶4-230.

¶4-200 Exclusion of certain CGT events The CGT 15-year exemption cannot apply to a capital gain arising from CGT event J2, J5 or J6. These events happen where a taxpayer has previously applied the CGT small business roll-over in s 152-410 (¶4-600). In broad terms: • CGT event J2 happens where the taxpayer has acquired a replacement asset prior to the end of the replacement asset period, but there is a change in relation to the replacement asset after the end of the replacement asset period (eg a sale of the asset). • CGT event J5 happens where the taxpayer does not acquire a replacement asset by the end of the replacement asset period. • CGT event J6 happens if the cost of the replacement asset acquired prior to the end of the replacement period is less than the amount of the capital gain the taxpayer disregarded pursuant to the CGT small business roll-over. These CGT events are described in more detail in ¶4-680–¶4-710.

¶4-210 Taxpayer’s choice to apply CGT 15-year exemption There is no requirement for a taxpayer to choose to apply the CGT 15-year exemption where all the conditions for the exemption are satisfied. The law merely provides that the taxpayer “can” disregard the capital gain where the conditions for the exemption are satisfied (s 152-105). Therefore, unlike the CGT retirement exemption or the CGT small business roll-over, the taxpayer is not required to choose to apply the 15-year exemption. This is similar to the application of the CGT small business 50% reduction.

Unlike the CGT small business 50% reduction, there is no ability for the taxpayer to choose not to apply the CGT 15-year exemption (s 152-220). However, there does not appear to be any logical reason why a taxpayer would not want to apply the CGT 15-year exemption. While there is no requirement for a specific notice to be lodged with the Commissioner when applying the CGT 15-year exemption, where the taxpayer is a company or trust, the taxpayer is required to complete and lodge a capital gains tax schedule with its tax return for the income year in which the CGT event occurred where: • total current year capital gains for the income year are greater than $10,000, or • total current year capital losses for the income year are greater than $10,000. The capital gains tax schedule requires the taxpayer to provide details of any CGT small business concessions, including the CGT 15-year exemption, that were applied by the taxpayer during an income year.

¶4-220 Interaction with the other CGT small business concessions Where the CGT 15-year exemption applies, it takes priority over the other CGT small business concessions (s 152-215, 152-330, 152-430). Accordingly, where the requirements for the CGT 15-year exemption are satisfied, there is no need to consider any of the other CGT small business concessions or the CGT general discount. In this regard, it is noted that the exclusion of the other concessions will not give rise to any adverse taxation implications to the taxpayer as the CGT 15-year exemption disregards the whole of the capital gain. In addition, the CGT 15-year exemption allows the taxpayer and any CGT concession stakeholders, where relevant, to make certain contributions to a complying superannuation fund without impacting upon the individual’s annual non-concessional contributions limit (see Chapter 8). Therefore, a taxpayer should not be placed at a disadvantage by applying the CGT 15-year exemption instead of any of the other CGT small business concessions.

¶4-230 Application of CGT 15-year exemption where taxpayer dies Special provisions will apply for determining whether a taxpayer is entitled to the CGT 15-year exemption for a CGT event that happens to a CGT asset that was acquired as a result of the death of an individual. The rules will apply to a taxpayer that is an individual’s legal personal representative, a beneficiary of the deceased estate (including a testamentary trust) or a surviving joint tenant. The special rules will apply where all of the following are satisfied: (1) the CGT asset either: (a) formed part of the estate of a deceased individual, or (b) was owned by joint tenants and one of them dies (2) any of the following apply: (a) the CGT asset either devolved to the legal personal representative of the individual (b) the CGT asset “passed” to a beneficiary of the individual (c) an interest in the CGT asset is acquired by the surviving joint tenant or tenants (d) the CGT asset devolves to a trustee of a trust established by the will of the individual (3) the deceased individual would have been entitled to disregard the capital gain pursuant to the CGT 15-year exemption: (a) had a CGT event occurred to the CGT asset immediately before the individual’s death, and

(b) had the third condition of the CGT 15-year exemption in s 152-105(d) been modified to only require the individual to either be aged at least 55 years or permanently incapacitated at that time (4) a CGT event happens in relation to the CGT asset within two years after the individual’s death (s 152-80(1), 152-80(2)). The second limb of condition (3) removes the requirement for the relevant CGT event to happen in connection with the individual’s retirement where the taxpayer is not permanently incapacitated. Where all the conditions are satisfied, the taxpayer will be entitled to disregard the capital gain made from a CGT event in relation to a CGT asset pursuant to the CGT 15-year exemption in the same manner as the deceased individual would have (s 152-80(2)). Example 1 Walter acquired 50% of the shares in Greeting Cards Pty Limited in September 1997. He held the shares continuously until his death on 10 November 2015. Walter was aged 55 at the time of his death. In accordance with Walter’s will, the shares passed to his son, Chris, aged 30. On 18 September 2017, Chris entered into an agreement for the sale of the shares. If the shares were sold by Walter immediately before his death he would have been entitled to the 15-year exemption (but for the connection with retirement requirement) as: • all the basic conditions for the CGT small business concessions were satisfied • Walter continuously owned the shares for over 15 years • Walter was aged 55 at the time of his death, and • Greeting Cards Pty Limited had a significant individual for 15 years during which Walter held the shares. As Walter would have been entitled to the 15-year exemption on the sale of the shares, and Chris sold the shares within two years after Walter’s death, Chris will be entitled to disregard the capital gain made from the disposal of the shares pursuant to the 15-year exemption.

Example 2 Kevin and Nelson were the joint tenants in a wig making business which commenced in January 2000. On 30 September 2016, Nelson died and his interest in the goodwill transferred to Kevin in accordance with the joint tenancy ownership. On 1 July 2017, Kevin was 52 and entered into an agreement for the sale of the business. If the business had been sold immediately before Nelson’s death he would have been entitled to the 15-year exemption (but for the connection with retirement requirement) on the sale of the goodwill as: • all the basic conditions for the CGT small business concessions were satisfied • Nelson continuously owned the goodwill for over 15 years • Nelson was aged 55 at the time of his death. As Nelson would have been entitled to the CGT 15-year exemption on the sale of the goodwill, and Kevin sold the goodwill within two years after Nelson’s death, Kevin will be entitled to disregard the capital gain made from the disposal of the interest in the goodwill acquired on the death of Nelson. However, Kevin is not entitled to the CGT 15-year exemption on the sale of the interest in the goodwill he personally owned since January 2000 as he was not aged 55 years or over at the time of the sale.

The Commissioner has the discretion to extend the two-year time limit (s 152-80(3)). Accordingly, where the CGT event in relation to the CGT asset does not occur within two years of the deceased individual’s death, the taxpayer may still be entitled to the CGT 15-year exemption if the Commissioner exercises that discretion.

¶4-240 Payments to CGT concession stakeholders Where a company or trust disregards the capital gain arising from a CGT event pursuant to the CGT 15year exemption, the company or trust is able to make distributions from the disregarded gain to its CGT

concession stakeholders without the company, trust or CGT concession stakeholders being liable for any taxation on those distributions. In order for the exemption to apply: • the capital gain made by the company or trust must be disregarded pursuant to the 15-year exemption (“exempt amount”), and • the company or trust must make one or more payments to an individual that was a CGT concession stakeholder of the company or trust just before the event in relation to the exempt amount before the later of: – within two years after the CGT event, and – if the relevant CGT event happened because the company or trust disposed of the relevant CGT asset — six months after the latest time a possible financial benefit becomes or could become due under a “look-through earnout right” relating to that CGT asset and the disposal (s 152125(1)). For an outline of the application of the CGT provisions to a “look-through earnout right” see ¶3-910. The relevant payment can be made directly or indirectly, through one or more interposed entities, to the CGT concession stakeholder. In order for the exemption to apply to a payment, it cannot be a normal business payment, such as the payment of a salary. For these purposes, an individual will be a CGT concession stakeholder of a company or trust at a particular time where the individual is either: • a significant individual in the company or trust, or • a spouse of a significant individual in the company or trust where the spouse has a small business participation percentage in the company or trust at that time greater than zero (s 152-60). For further details on a CGT concession stakeholder, see ¶3-870. Where the relevant conditions are satisfied, the payment that is made to the CGT concession stakeholder will be disregarded in determining the taxable income of the relevant company or trust, the CGT concession stakeholder and any interposed entities up to the limit determined in accordance with the following formula (s 152-125(2)): Stakeholder’s participation percentage × Exempt amount For the purpose of applying the formula, the “stakeholder’s participation percentage” means: • where the entity is a company or fixed trust — the stakeholder’s small business participation percentage in the company or trust just before the relevant CGT event, or • where the entity is a non-fixed trust — the amount determined in accordance with the following formula, expressed as a percentage:         100          number of CGT concession stakeholders    of the trust just before the CGT event 

Example 1 Tiger Tours Pty Ltd made a capital gain of $600,000 from CGT event A1. Tiger Tours Pty Ltd disregarded the capital gain arising from the CGT event pursuant to the CGT 15-year exemption. The CGT event happened in connection with the retirement of Addison. Just before the time of the CGT event, the shares in Tiger Tours were owned as follows:

Shareholder Percentage ownership Addison

40%

Age 56

Madison

20%

57

Elaine

10%

40

Jerry

30%

25

Elaine and Jerry are married. Each of the shareholder’s small business participation percentages will be equal to their percentage ownership in Tiger Tours Pty Ltd. Addison, Madison and Jerry were each significant individuals of Tiger Tours as they each held a small business participation percentage of 20% or more. All of the shareholders will be CGT concession stakeholders. Elaine will be a CGT concession stakeholder as she is the wife of a significant individual and has a small business participation percentage of 10%. Tiger Tours Pty Ltd is able to make payments from the disregarded capital gain to its shareholders within two years of the CGT event that will not be subject to taxation in the hands of the recipient in the following amounts:

Stakeholder

Participation percentage

Maximum exempt payment

Addison

40%

$240,000

Madison

20%

$120,000

Elaine

10%

$60,000

Jerry

30%

$180,000

It is noted that a CGT concession stakeholder can obtain the tax-free benefit of a capital gain that was eligible for the CGT 15-year exemption despite the fact that the stakeholder is neither aged 55 or over nor permanently incapacitated. This will apply provided there is at least one CGT concession stakeholder that satisfies the minimum age and retirement requirements or the permanent incapacitation requirement for the CGT 15-year exemption. Example 2 The Insider Discretionary Trust made a capital gain of $900,000 that satisfied all the requirements for the CGT 15-year exemption. In this regard, Adam was aged 57 and the sale was made in connection with his retirement. Accordingly, the capital gain of $900,000 is disregarded. Just before the CGT event the small business participation percentages of the beneficiaries were:

Beneficiaries

Participation percentage

Meredith

25%

Jason

10%

Connor

10%

Adam

55%

Sarah

0%

Meredith and Jason were married and Adam and Sarah were married. Meredith and Adam were each significant individuals of the trust, as they each held a small business participation percentage of 20% or more. The CGT concession stakeholders of the trust will be Meredith, Jason and Adam. Jason will be a CGT concession stakeholder as he is the husband of a significant individual and has a small business participation percentage of 10%. Sarah will not be a CGT concession stakeholder despite being married to Adam as Sarah does not have a small business participation percentage more than zero in the trust. Each stakeholder’s participation percentages will be 33⅓% each (being 100/3). Therefore, the maximum exempt payments that may be made to the CGT concession stakeholders are $300,000 each (being 33⅓% of $900,000).

To the extent that the payment to a CGT concession stakeholder does not exceed the exemption limit, for taxation purposes the payment will not be treated as either:

• a dividend, or • a frankable distribution (s 152-125(3)). The two-year time limit on the payments to the CGT concession stakeholders can be extended at the discretion of the Commissioner (s 152-125(4)). Example 3 The Arrow Unit Trust entered into an agreement on 30 April 2016 for the sale of its goodwill for $500,000 plus 20% of the net profit made during the year ended 30 June 2018. Payment of this earnout amount will be due on 20 August 2018. The arrangement meets the requirements to be a “look-through earnout right”. The cost base of the goodwill was $100,000. The Arrow Unit Trust is owned 70% by Felicity and 30% by Oliver who were both 56 at the time of the sale and the sale was made in accordance with their retirement. All the conditions for the 15-year exemption were satisfied and the choice was made to apply the exemption. On 20 August 2016, the $500,000 CGT exempt amount of capital gain was distributed as $150,000 to Oliver and $450,000 to Felicity. In accordance with the provision, the amounts will not be taxable in their hands and CGT event E4 will not arise in relation to the units from the distribution. Any payment made pursuant to the “look-through earnout right” will be a capital gain. Accordingly, the Arrow Unit Trust will have until 20 February 2018 to pay such CGT exempt amount to Felicity and Oliver in the relevant proportions to enable the payment to be tax exempt in their hands.

The same treatment will apply to an amount of income that is non-assessable non-exempt income of the trust pursuant to s 152-110. This concession enables a tax-effective manner by which a company or trust is able to distribute the disregarded capital gain without any clawback of the tax exemption applying in the hands of the CGT concession stakeholder as a result of either CGT event G1 or E4.

¶4-250 Application to capital gains made on pre-CGT assets The CGT 15-year exemption can have application to capital gains made from an asset acquired by the taxpayer prior to 20 September 1985. The provisions will have application in either of the following situations: (1) the asset was acquired prior to 20 September 1985 and is still treated as a pre-CGT asset for CGT purposes (2) the asset was acquired prior to 20 September 1985 but there has been a change in the majority underlying ownership of the asset that resulted in the asset being deemed to have been acquired after that date for CGT purposes pursuant to Div 149. These two situations are addressed separately below. Pre-CGT asset While the CGT 15-year exemption only applies to disregard capital gains arising from CGT events happening to CGT assets that were acquired, or are deemed to have been acquired, on or after 20 September 1985, the exemption can apply in certain circumstances to enable a company or trust to make tax-effective distributions from a pre-CGT capital gain. Generally, a capital gain made from a CGT event occurring in relation to a CGT asset acquired prior to 20 September 1985 is disregarded under Div 104. Where a company or trust makes a capital gain from a CGT event that occurs in relation to a pre-CGT asset, and that capital gain would have been disregarded in accordance with the 15-year exemption had the capital gain not been otherwise disregarded for being a pre-CGT asset, the company or trust is able to make distributions from the disregarded gain to its CGT concession stakeholders without the company, trust or CGT concession stakeholders being liable for any taxation on those distributions. In order for the exemption to apply:

• the capital gain made by the taxpayer company or trust would have been disregarded pursuant to the 15-year exemption had it not been disregarded because it was acquired prior to 20 September 1985 (“exempt amount”) • the company or trust must make one or more payments to an individual that was a CGT concession stakeholder of the company or trust just before the event in relation to the exempt amount before the later of: – within two years after the CGT event, and – if the relevant CGT event happened because the company or trust disposed of the relevant CGT asset — six months after the latest time a possible financial benefit becomes or could become due under a “look-through earnout right” relating to that CGT asset and the disposal (s 152125(1)). Where the conditions are satisfied, the payments that are made to the CGT concession stakeholders of the company or trust will be exempt in the same manner as for a post-CGT capital gain (¶4-240). This concession enables a tax-effective means by which the company or trust is able to distribute the disregarded pre-CGT capital gain without winding up the trust or company or potentially giving rise to either CGT event G1 or CGT event E4. Example 1 Rihanna Pty Ltd acquired the goodwill of a computer business on 4 April 1984 for no consideration. The shares in Rihanna Pty Ltd have always been owned by Patrick. On 7 August 2017, Rihanna Pty Ltd entered into a contract for the sale of the goodwill to a third party for $2m in connection with Patrick’s retirement. The sale of the goodwill gives rise to CGT event A1. The capital gain from CGT event A1 is $2m, but is disregarded because the goodwill was acquired prior to 20 September 1985 pursuant to s 104-10(5)(a). CGT event K6 did not arise as there has been no change in the beneficial ownership of the shares. The 15-year retirement exemption will not apply because the capital gain is otherwise disregarded. If the capital gain had not otherwise been disregarded, Rihanna Pty Ltd would have been eligible for the 15-year exemption. Rihanna Pty Ltd is able to make distributions of up to $2m to Patrick at any time prior to 7 August 2019 which will be non-assessable non-exempt income in his hands.

Pre-CGT asset deemed to be a post-CGT asset Where a taxpayer acquired an asset prior to 20 September 1985 but there has been a change in the asset’s majority underlying interests since that date, the asset is deemed for CGT purposes to have been acquired by the taxpayer at the time of the first change in the majority underlying interest in the asset pursuant to Div 149. The asset is taken to have been acquired for its market value at that time for general CGT purposes. However, the actual date of acquisition of the asset will apply for the purposes of determining the period of ownership and therefore whether the taxpayer can apply the CGT 15-year exemption to the capital gain on such an asset (s 152-110(1A)). That is, the deemed date of ownership under s 149-30, being the first date of a change in the majority underlying interest, is disregarded for the purpose of determining the ownership period. Similarly, any change in majority underlying interest in an asset is ignored for testing whether the entity had a significant individual for at least 15 years. For the purpose of determining the exempt amount that can be distributed to CGT concession stakeholders the capital gain is calculated using the original cost base of the asset (being the purchase price), not the deemed cost base of the asset at the time of the change in majority underlying interest (s 152-125(1)(a)(iv)). This ensures that the taxpayer is able to distribute the full amount of the actual capital gain made on the asset to CGT concession stakeholders tax free. Example 2 On 7 November 1980, Agrestic Unit Trust acquired a property for $500,000 on which it carried on an engineering business. At that

time the shares were owned 100% by Nancy. On 5 January 2006, Nancy sold her units to Patrick. At the time of the sale the market value of the property owned by Agrestic Unit Trust had a market value of $750,000. On 30 September 2017, the Agrestic Unit Trust sold the property for $900,000. The sale of the property was made as a result of Patrick’s decision to retire. Patrick was aged 58 at the time of the sale. The capital gain pursuant to CGT event A1 was $150,000, being $900,000 − $750,000. The CGT 15-year exemption will apply in the circumstances as: • the basic conditions for the CGT small business concessions are satisfied • Agrestic Unit Trust has owned the asset for the 15-year period ending just before the CGT event as the actual date of acquisition being 7 November 1980 applies for this purpose not the deemed date of acquisition of 5 January 2006 • the Agrestic Unit Trust had a significant individual for a total of at least 15 years during the period in which it owned the CGT asset as Patrick was a significant individual for over 11 years and Nancy was a significant individual for a little over 26 years prior to that time • at the time of the sale, Patrick was a significant individual of the Agrestic Unit Trust who was over 55 years old and the sale happened in connection with his retirement. As a result the Agrestic Unit Trust is entitled to apply the 15-year exemption to the capital gain. As the exemption applies, the exempt amount is calculated using the actual purchase price of the property, not the deemed purchase price. Accordingly, the exempt amount able to be distributed is $400,000 (being $900,000 − $500,000). The exempt amount of $400,000 is able to be distributed to Patrick in a tax-free manner as its only CGT concession stakeholder.

¶4-260 Contributions to complying superannuation fund Where an individual is entitled to the benefit of the CGT small business concessions, the taxpayer may make personal superannuation contributions to a complying superannuation fund from certain proceeds received from the relevant CGT event of up to a specified limit in a lifetime, being the “CGT cap”, that will not be included in the individual’s annual non-concessional contributions cap. The CGT cap is indexed annually for inflation. For the 2016/17 income year it is $1,415,000 and $1,445,000 for the 2017/18 income year. The amounts that an individual is able to contribute to a complying superannuation fund that will count towards the CGT cap fall within the following categories: (1) capital proceeds received from an asset that was entitled to the CGT 15-year exemption (or would have been but for no capital gain being derived) (2) the CGT exempt amount arising from the CGT retirement exemption (3) capital proceeds received from an asset that would have been entitled to the CGT 15-year exemption but for it being a pre-CGT asset. The contributions that may be made to a complying superannuation fund in this manner, the CGT cap and the specific requirements that must be met are detailed from ¶8-500.

CGT SMALL BUSINESS 50% REDUCTION ¶4-300 Introduction The CGT 50% active asset reduction will apply where a taxpayer satisfies all the basic conditions for the CGT small business concessions in s 152-10 (see Chapter 3). Where the conditions are satisfied, the capital gain is reduced by 50%. There is no requirement for the taxpayer to choose to apply the CGT small business 50% reduction. However, the taxpayer may choose not to apply the reduction. The CGT small business 50% reduction applies to the balance of the capital gain after first applying any current or prior year capital losses and the discount percentage in Div 115, which is available for a taxpayer that is an individual, trust or superannuation fund if the asset has been held for at least 12 months.

¶4-310 Conditions for CGT small business 50% reduction A taxpayer is entitled to the CGT small business 50% reduction where the taxpayer satisfies the basic conditions for the CGT small business concessions (s 152-205). The basic conditions for the CGT small business concessions are contained in s 152-10 and are detailed in Chapter 3. Where the CGT asset was acquired by the taxpayer prior to 21 September 1999, the capital gain for the purpose of the CGT small business 50% reduction can be calculated using the indexed cost base of the asset but with indexation frozen with effect from 30 September 1999. However, where the taxpayer is eligible for, and chooses to apply, the CGT general discount in Div 115, the capital gain must be determined without the benefit of indexation (s 115-20).

¶4-320 Application of the CGT small business 50% reduction The CGT small business 50% reduction will apply to reduce any applicable capital gain from a CGT event remaining after applying step 3 of the method statement for calculating the net capital gain in s 102-5(1) (see ¶3-030). Therefore, the CGT 50% active asset reduction applies to the balance of the capital gain from the relevant CGT event after first applying: • any current year capital losses • any prior year unapplied capital losses • any applicable discount percentage under the CGT general discount in Div 115. Where the taxpayer is eligible for the 50% general discount and the CGT small business 50% reduction, the taxable capital may be reduced to 25% of the capital gain. Example 1 Casey entered into a contract for the sale of her business property on 7 September 2017 for $700,000. The property was acquired by Casey on 4 July 2004 for $300,000. At the time of the CGT event Casey satisfies the maximum net asset value test and has no current year or unapplied prior year capital losses. The sale of the property was the only capital gain made by Casey in the 2017/18 income year. The sale of the property will give rise to CGT event A1 and will satisfy the requirements to be a discount capital gain. Therefore, Casey satisfies all the basic conditions for the CGT small business concessions to apply. Casey does not satisfy the requirements for the CGT 15-year exemption and does not choose to apply either the CGT retirement exemption or the CGT small business roll-over. As Casey satisfies the basic conditions for the CGT small business concessions, the CGT small business 50% reduction applies. Casey’s net capital gain for the 2017/18 income year will be $100,000, calculated as follows:

Capital proceeds

$700,000

Less: Cost base

$300,000

Capital gain

$400,000

Less: 50% general discount (step 3 of method statement)

$200,000

Balance

$200,000

Less: CGT small business 50% reduction (step 4 of method statement)

$100,000

Net capital gain

$100,000

Therefore, the taxable capital gain is reduced to 25% of the original gain.

For the purpose of steps 1 and 2 of the method statement (¶3-030), a taxpayer is able to choose the capital gains against which the capital losses will be applied. In calculating the net capital gain it is only the capital losses which are applied. Any income losses of the taxpayer will only be applied after step 5 of the method statement has been completed and the resulting net capital gain has been included in the taxpayer’s assessable income. Therefore, the presence of any income loss will not reduce the effect of the CGT small business 50% reduction. Example 2 Janine entered into a contract for the sale of her business and the land on which it was situated during the 2017/18 income year. The goodwill of the business and the land both satisfied the active asset test. The sale gave rise to the following: • a capital loss from the sale of the goodwill of $20,000 • a capital gain from the sale of the land of $600,000. The sale of the land satisfies the basic conditions for the CGT small business concession and was a discount capital gain. During the 2017/18 income year, Janine also made: • a capital gain of $50,000 from the sale of shares she acquired less than 12 months before which were not active assets • a capital gain of $100,000 from the sale of a rental unit, which was a discount capital gain but not an active asset. Janine had unapplied prior year capital losses of $200,000. Janine calculates the net capital gain in accordance with the method statement by making the choices detailed in the following table:

Description

Land

Capital gains

Apply Apply prior Apply 50% current year year capital general capital losses (Step discount losses (Step 2) (Step 3) 1)

Apply CGT small business 50% reduction (Step 4)

Net capital gain (Step 5)

$600,000

–

$70,000

$265,000

$132,500

$50,000

$20,000

$30,000

–

–

Nil

Rental unit

$100,000

–

$100,000

–

–

Nil

Total

$750,000

$20,000

$200,000

$265,000

$132,500

Shares

$132,500

$132,500

Janine’s net capital gain for the 2017/18 income year is $132,500. Therefore, by choosing to first apply the current year and prior year capital losses against her capital gains other than the land, which was eligible for both the CGT discount and the CGT small business 50% reduction, Janine preserves the benefit of the CGT small business concessions to their greatest extent. If Janine chose to apply the current year and prior year losses to the capital gain from the land only, the taxable capital would be increased to $195,000, calculated as follows:

Description

Land

Capital gains

Apply Apply prior Apply 50% current year year capital general capital losses (Step discount losses (Step 2) (Step 3) 1)

Apply CGT small business 50% reduction (Step 4)

Balance (Step 5)

$600,000

$20,000

$200,000

$190,000

$95,000

$95,000

$50,000

–

–

–

–

$50,000

Rental unit

$100,000

–

–

$50,000

–

$50,000

Total

$750,000

$20,000

$200,000

$240,000

$95,000

$195,000

Shares

A taxpayer can potentially save significant taxation by carefully choosing the manner in which to apply

any capital losses. Where the total of the taxpayer’s current year and unapplied prior year capital losses exceeds the taxpayer’s total capital gains for the year (excluding any disregarded capital gain), the taxpayer will not receive any benefit from the CGT small business 50% reduction. Example 3 The Yang Discretionary Trust entered into a contract for the sale of the goodwill of its bottling business on 1 August 2017 for $270,000. The business was started by Yang on 17 January 2013. The goodwill has a nil cost base. The Yang Discretionary Trust has current year capital losses of $200,000, carried forward capital losses of $160,000 and satisfies the basic conditions for the CGT small business concessions. Accordingly, it is entitled to the CGT small business 50% reduction. The capital gain from the sale of the goodwill is also a discount capital gain. The capital gain from the sale of the business, being CGT event A1, is $270,000. In calculating the net capital gain of the Yang Discretionary Trust, the method statement applies as follows:

Capital proceeds Less: Cost base

$270,000 –

Capital gain

$270,000

Less: Current year capital losses

$200,000

Capital gains and losses (step 1 of method statement)

$70,000

Less: Prior year capital losses applied (step 2 of method statement)

$70,000

Net capital gain

$Nil

As a result of the capital gain being reduced to nil, the CGT general discount and the CGT small business 50% reduction will have no application. The carried forward capital losses will be reduced to $90,000.

¶4-330 Exclusion of certain CGT events The CGT small business 50% reduction cannot apply to a capital gain arising from CGT event J2, J5 or J6. These events will only arise where a taxpayer has previously applied the CGT small business roll-over in s 152-410 (¶4-600). In broad terms: • CGT event J2 happens where the taxpayer has acquired a replacement asset prior to the end of the replacement asset period, but there is a change in relation to the replacement asset after the end of the replacement asset period (eg a sale of the asset). • CGT event J5 happens where the taxpayer does not acquire a replacement asset by the end of the replacement asset period. • CGT event J6 happens if the cost of the replacement asset acquired prior to the end of the replacement asset period expenditure is less than the amount of the capital gain the taxpayer disregarded pursuant to the CGT small business roll-over. These CGT events are described in more detail in ¶4-680–¶4-710. The application of the CGT small business 50% reduction is excluded from applying to a capital gain arising from these events because the taxpayer has effectively already claimed, or had previously been entitled to claim, the CGT small business 50% reduction in relation to the capital gain. The capital gain made from these events is either the whole or a part of a capital gain that was deferred in accordance with the CGT small business roll-over. The amount of the capital gain so deferred is the balance of a

capital gain that arises after disregarding an amount in accordance with the CGT small business 50% reduction, or the taxpayer choosing not to apply the CGT small business 50% reduction. If the taxpayer was entitled to claim the CGT small business 50% reduction to a capital gain from any of CGT events J2, J5 or J6, the taxpayer would be entitled to the CGT small business 50% reduction more than once to what is effectively part of the original gain rolled-over.

¶4-340 Interaction with other concessions The CGT small business 50% reduction will not apply to reduce a capital gain where the CGT 15-year exemption applies. The CGT 15-year exemption takes priority over the CGT small business 50% reduction (s 152-215). As the CGT 15-year exemption applies to disregard the capital gain in whole, the inability to utilise the CGT 50% reduction should not adversely impact upon the taxpayer. The CGT small business 50% reduction applies in conjunction with the CGT general discount available pursuant to Div 115 for assets that have been held for at least 12 months. The general discount is only usually available for taxpayers that are individuals, trusts and complying superannuation entities. The discount percentage is 50% for trusts and resident individuals and 33⅓% for complying superannuation entities. The discount percentage rate is reduced for individuals who have been foreign residents or temporary residents during any period in which the asset was owned since 8 May 2012. Where the individual was a foreign resident or a temporary resident as at 8 May 2012, the 50% discount will only be available for the capital gain accrued as at that date where a valuation of the asset at that time is obtained. If a valuation is not obtained, the discount percentage will be nil. The application of the discount percentage pursuant to Div 115 applies prior to the CGT small business 50% reduction (s 102-5). The CGT small business 50% reduction can also apply with one or both of the CGT retirement exemption or the CGT small business roll-over (s 152-210). Therefore, where the taxpayer meets the requirements for the CGT retirement exemption and the CGT small business roll-over, the taxpayer can choose which one or both of the concessions to apply in conjunction with the CGT small business 50% reduction. The CGT small business 50% reduction will apply before the other concessions. Where the taxpayer chooses to also apply the CGT retirement exemption and the CGT small business roll-over, the taxpayer can choose the order in which to apply those concessions (s 152-210(2)). There is no ability for the taxpayer to choose to apply either the CGT retirement exemption or the CGT small business roll-over before the application of the CGT small business 50% reduction (s 152-210(1)). However, the taxpayer does have the ability to choose not to apply the CGT small business 50% reduction (s 152-220; see ¶4-350). Example Board Unit Trust makes a capital gain of $5m. Board Unit Trust is eligible for, and chooses to apply, all of the CGT small business concessions except the CGT 15-year exemption. The Board Unit Trust has two CGT concession stakeholders and chooses to apply the CGT retirement exemption prior to the CGT small business roll-over. The trust does not have any current year or prior year capital losses. The net capital gain is calculated as follows:

Capital gains and losses (step 1 of method statement) Apply prior year capital losses

$5,000,000 –

Step 2 result

$5,000,000

Apply 50% CGT general discount

$2,500,000

Step 3 result

$2,500,000

Apply CGT small business 50% reduction

$1,250,000 $1,250,000

Apply CGT retirement exemption

$1,000,000

$250,000 Apply CGT small business roll-over Net capital gain

$250,000 $Nil

By applying all the concessions, the $5m capital gain is reduced to nil.

¶4-350 Choosing not to apply the CGT small business 50% reduction The CGT small business 50% reduction will apply automatically to a capital gain where the basic conditions for the CGT small business concessions are satisfied (s 152-205). However, the taxpayer is able to choose not to apply the CGT small business 50% reduction (s 152-220). The taxpayer may choose not to apply the CGT small business 50% reduction where the taxpayer wishes to maximise the CGT exempt amount, and therefore the benefit available, pursuant to the CGT retirement exemption. This is because a taxpayer is not able to choose to apply the CGT retirement exemption prior to the CGT small business 50% reduction. An increase to the taxpayer’s CGT exempt amount under the CGT retirement exemption may be beneficial for the following reasons: • where the taxpayer is a company or trust, it enables tax-free distributions of the capital gain to be made to its CGT concession stakeholders (s 152-325) • it enables larger contributions to be made by an individual to a complying superannuation fund without impacting upon the individual’s annual non-concessional contributions cap (s 292-100). Where there is a distribution of the capital gain disregarded under the CGT small business 50% reduction by a company or trust, there is a potential clawback of that exemption in the hands of the shareholder or trust beneficiary. Note that where the CGT exempt amount attributable to goodwill is distributed to a shareholder by a liquidator in the course of winding up, it will not be a dividend pursuant to ITAA36 s 47. However, clawback can still occur under CGT event C2 or G1 (Taxation Determination TD 2001/14). Example 1 Christina, age 57, owns 100% of the shares in Applegate Pty Limited. The cost base of the shares held by Christina was $1,000. The shares do not constitute active assets themselves. Applegate Pty Limited made a capital gain of $200,000 in relation to its goodwill. All the basic conditions for the CGT small business concessions were satisfied and it did not have current year or prior year capital losses. Applegate chooses to apply the CGT retirement exemption to reduce the net capital gain to nil in the following manner:

Capital gains and losses (step 1 of method statement)

$200,000

Apply CGT small business 50% reduction

$100,000 $100,000

Apply CGT retirement exemption Net capital gain

$100,000 $Nil

The distribution of the $100,000 capital gain disregarded pursuant to the CGT retirement exemption will not be taxable in Christina’s hands. Applegate Pty Limited is wound up and the $100,000 capital disregarded under the CGT 50% active asset is distributed as a final liquidator’s distribution which will give rise to CGT event C2. The capital gain will be equal to $99,000 (being $100,000 less the cost base of the shares of $1,000). Christina should be entitled to the 50% CGT general discount in relation to this capital gain. This would reduce the taxable capital gain to $49,500. The CGT small business concessions will not be available in the circumstances as the shares are not active assets. Therefore, there is a partial clawback of the CGT small business 50% reduction that applied to the capital gain in the hands of

Christina. However, where Applegate Pty Limited chooses not to apply the CGT small business 50% reduction, the net capital gain is calculated as follows:

Capital gains and losses (step 1 of method statement)

$200,000

Apply CGT retirement exemption

$200,000

Net capital gain

$Nil

In these circumstances, Applegate Pty Limited can pay the full $200,000 disregarded capital gain to Christina without a liquidation or any clawback. It also increases the amount that Christina may contribute to a complying superannuation fund without impacting on her non-concessional contributions cap.

By disregarding the CGT small business 50% reduction and increasing the CGT retirement exemption, a taxpayer can increase the amount of superannuation contributions that can be made into a complying superannuation fund. Example 2 Susan makes a capital gain of $900,000 during the 2017/18 income year. The capital gain is entitled to all the CGT small business concessions except for the CGT 15-year exemption. Susan is aged 56 at the time of the CGT event and has no current year or prior year capital losses. Susan is also entitled to the CGT 50% general discount. Susan has already reached her non-concessional contributions cap for the 2017/18 income year but wishes to make further superannuation contributions during the year. Where Susan does not make the choice to exclude the CGT small business 50% reduction the net capital gain would be calculated as follows:

Capital gains and losses (step 1 of method statement) Apply prior year capital losses

$900,000 –

Step 2 result

$900,000

Apply 50% general discount

$450,000

Step 3 result

$450,000

Apply CGT small business 50% reduction

$225,000 $225,000

Apply CGT retirement exemption Net capital gain

$225,000 $Nil

As a result of the CGT small business concessions, Susan will have a net capital gain of nil. The CGT exempt amount pursuant to the CGT retirement exemption is $225,000. Susan is able to make additional contributions of up to $225,000 into a complying superannuation fund without her non-concessional contributions cap being exceeded. However, where Susan chooses not to apply the CGT small business 50% reduction, the position will be as follows:

Capital gains and losses (step 1 of method statement) Apply prior year capital losses

$900,000 –

Step 2 result

$900,000

Apply 50% general discount

$450,000

Step 3 result

$450,000

Apply CGT retirement exemption Net capital gain

$450,000 $Nil

Under this scenario, Susan will still have a nil taxable capital gain but the CGT exempt amount pursuant to the CGT retirement exemption is $450,000. Susan is able to make a contribution of $450,000 into a complying superannuation fund without her nonconcessional contributions cap being exceeded.

The choice not to apply the CGT small business 50% reduction must be made by the day the taxpayer lodges its tax return for the income year in which the CGT event occurred or such later time as the Commissioner allows (s 103-25(1)). The way in which the taxpayer prepares its income tax return is sufficient evidence of making the choice (s 103-25(2)). Accordingly, provided the calculation of the net capital gain in the tax return does not take into account the CGT small business 50% reduction, the taxpayer will be treated as making the choice not to apply this concession. While there is no requirement for a specific notice to be lodged with the Commissioner when applying the CGT small business 50% reduction, where the taxpayer is a company or trust, the taxpayer is required to complete and lodge a capital gains tax schedule with its tax return for the income year in which the CGT event occurred where: • total current year capital gains for the income year are greater than $10,000, or • total current year capital losses for the income year are greater than $10,000. The capital gains tax schedule requires the taxpayer to provide details of any CGT small business concessions, including the CGT small business 50% reduction, that were applied by the taxpayer during an income year.

¶4-360 Application of CGT small business 50% reduction where taxpayer dies Special provisions will apply for determining whether a taxpayer is entitled to the CGT small business 50% reduction for a CGT event that happens to a CGT asset that was acquired as a result of the death of an individual. The special provisions will only apply in two broad situations. The first situation is where the asset forms part of the estate of the deceased individual and one of the following applies: • the asset devolves to the deceased individual’s legal personal representative • the asset passed to a beneficiary of the deceased individual, or • the asset devolves to a trustee of a trust established by the will of the individual (s 152-80(1)). In this case, the taxpayer entitled to the special treatment is: • the legal personal representative of the individual • the beneficiary of the individual, or • the trustee or a beneficiary of the trust (s 152-80(2A)). The second situation is where immediately before the individual’s death, the asset was owned by joint tenants, one of which was the deceased individual, and as a result of the individual’s death an interest in that asset is acquired by the surviving joint tenant or tenants (s 152-80(1)). The CGT treatment of the transfer of such an interest in an asset is mentioned in s 128-50. The taxpayer entitled to the special treatment is the surviving joint tenant or tenants (s 152-80(2A)(c)).

In each of these situations, the special rule enables the taxpayer to apply the CGT small business 50% reduction to reduce the capital gain on a CGT event occurring in relation to the asset, or the interest in the asset, in the same manner as the deceased individual would have provided: • the deceased individual would have been entitled to reduce the capital gain pursuant to the CGT small business 50% reduction if the CGT event had occurred immediately before the individual’s death, and • a CGT event happens in relation to the CGT asset, or the interest in the CGT asset, within two years after the individual’s death (s 152-80(1), 152-80(2)). This rule applies even though the taxpayer itself would not have personally satisfied the basic conditions for the CGT small business concessions. The Commissioner has a discretion to extend the two-year time period for the sale of the asset or the interest in the asset, as relevant (s 152-80(3)). Example 1 Harry personally owned land on which an entity connected with him carried on a business for the whole of the period of ownership. The land was acquired by Harry on 22 August 2014 and had a cost base of $500,000. Harry died on 30 October 2016, when the land had a market value of $800,000. In accordance with his will, the land passed to his beneficiary Katherine. Katherine took ownership of the land on 30 December 2016. From that time the land was only used for rental to a third party. The land was sold by Katherine on 18 August 2017 for $980,000. The land was not an active asset in Katherine’s hands. If the sale of the land had occurred immediately before Harry’s death on 30 October 2016, Harry would have been entitled to apply the CGT small business 50% reduction to the capital gain as all the basic conditions would have been satisfied. Katherine is entitled to apply the CGT small business 50% reduction to the capital gain as: • the land formed part of Harry’s deceased estate • the land passed to Katherine in accordance with Harry’s will • Harry would have been entitled to the CGT small business 50% reduction if the sale had occurred immediately before his death • CGT event A1, which arose from the sale of the land, happened within two years of the date of Harry’s death. The capital gain will be equal to the capital proceeds of $980,000 less the cost base of the land in Katherine’s hands of $500,000, being $480,000. The first element of Katherine’s cost base is the cost base of the land in the hands of Harry at the time of his death (s 128-15(4)). For general CGT purposes, Katherine is treated as having acquired the land on the date of Harry’s death, being 30 October 2016 (s 128-15(2)). However, in applying the 50% CGT general discount in Div 115 and determining whether the land has been held for at least 12 months, Katherine is treated as having acquired the land on the date Harry originally acquired the land (s 115-30(1) item 4). Accordingly, Katherine will also be entitled to the 50% CGT general discount (Div 115). Assuming Katherine had no current year or prior year capital losses, her net capital gain will be calculated as follows:

Capital gains and losses (step 1 of method statement) Apply prior year capital losses

$480,000 –

Step 2 result

$480,000

Apply 50% general discount

$240,000

Step 3 result

$240,000

Apply CGT small business 50% reduction

$120,000

Net capital gain

$120,000

Example 2 Married couple Jackie and Dan acquired a property as joint tenants on 1 July 2011 for $400,000. The property was used to conduct

Jackie’s consultancy business from the date of acquisition until 1 December 2013. Thereafter, the property was rented to a third party. Jackie died on 31 December 2015. As the property was held as joint tenants, Jackie’s 50% interest in the property passed to Dan on 31 December 2015 (s 128-50). Dan’s cost base of the 50% interest is equal to Jackie’s cost base of the interest as at the date of her death. A contract for the sale of the property was entered into on 6 December 2017 for $700,000. For CGT purposes, the sale of the land by Dan is treated as the sale of two separate CGT assets being: • the 50% interest in the property Dan acquired on 1 July 2011, and • the 50% interest in the property Dan acquired on 31 December 2015 as surviving joint tenant. Each of these assets needs to be considered separately. In relation to the 50% acquired on 1 July 2011, the 50% active asset reduction will not be available. This is because the asset has been owned for 6.5 years but was only an active asset for 2.5 years. As a result, only the 50% CGT general discount will be available. The capital gain will be equal to $150,000 being the capital proceeds of $350,000 less the cost base of $200,000. This capital gain will be reduced by 50% to $75,000 in accordance with the 50% general discount. In relation to the 50% acquired on the death of Jackie, the asset was acquired on 31 December 2015. The asset has not been an active asset since acquisition and, therefore, is not entitled to the CGT small business concessions under the general rules. However, as the 50% interest in the property was acquired by Dan as the surviving joint tenant and the sale takes place within two years of Jackie’s death, the special rule applies. If Jackie had sold the property immediately before her death, she would have been entitled to the 50% active asset reduction as the property would have been an active asset for 2.5 years of the 4.5 years the asset was owned. As Jackie would have been entitled to the 50% active asset deduction if the property was sold immediately before her death, Dan is able to apply the 50% active asset reduction to the sale of the 50% interest in the property. The 50% CGT general discount will also apply as the asset has been owned for at least 12 months. Accordingly, the capital gain of $150,000 will be reduced by 50% for the CGT general discount and another 50% for the CGT active asset reduction. The taxable capital gain will be $37,500. Therefore, as a result of the sale of the property the total taxable capital gain is $112,500.

In applying the reduction, it is the actual capital gain made by the taxpayer that is eligible for the CGT small business 50% reduction, not merely the capital gain that would have been made had the asset been sold by the deceased immediately before his or her death. Therefore, a taxpayer will also be entitled to apply the 50% active asset reduction to any increase in the value of the CGT asset since the deceased’s death.

CGT RETIREMENT EXEMPTION ¶4-400 Introduction A taxpayer can choose to disregard a capital gain from a CGT event occurring in relation to a CGT asset in accordance with the CGT retirement exemption. The CGT retirement exemption may be claimed by taxpayers that are individuals, trusts or companies. However, where the taxpayer is a company or trust, the taxpayer is only able to claim the exemption where the significant individual test is satisfied and the company or trust makes certain payments of the disregarded capital gain to its CGT concession stakeholders. The amount of the capital gain that can be disregarded will be determined by the following: • where the taxpayer is an individual — the individual’s CGT retirement exemption limit • where the taxpayer is a company or trust — the CGT retirement exemption limits of the taxpayer’s CGT concession stakeholders. Each individual has a lifetime limit of $500,000 in respect of which the CGT retirement exemption can apply. The amount of capital gains that can be disregarded and which count towards an individual’s lifetime limit will be: • amounts which an individual taxpayer personally chooses to disregard in accordance with the CGT retirement exemption • the portion of the CGT exempt amount, claimed by a company or trust taxpayer in accordance with the CGT retirement exemption, that represents the individual’s percentage interest as a CGT

concession stakeholder of the taxpayer. The individual’s CGT retirement exemption at any given time is $500,000 reduced by the capital gains previously disregarded under the exemption. The taxpayer must make a written choice to apply the CGT retirement exemption. The exemption is not able to be chosen merely by the manner in which the tax return is completed. Where the taxpayer is a company or trust and it has two or more CGT concession stakeholders, the written choice must specify the names of all its CGT concession stakeholders and the percentage of the capital gain disregarded which is applied towards each of those stakeholders. The percentage interest allocated to a particular CGT concession stakeholder may be nil. Where the taxpayer is an individual under the age of 55 at the time of making the choice to apply the CGT retirement exemption (as opposed to the date of the CGT event occurring), the amount chosen to be disregarded must be contributed by the individual into a complying superannuation fund or RSA. Where the taxpayer is a company or trust, the amount chosen to be disregarded must be paid to its CGT concession stakeholders in accordance with the relevant percentages nominated in the written choice. Where the CGT concession stakeholder is under the age of 55 at the time of the payment, the payment must be made by the taxpayer to a complying superannuation fund or RSA for the benefit of the CGT concession stakeholder. Any CGT exempt amount contributed to a complying superannuation fund or RSA will not count towards the individual’s annual non-concessional contribution limit. It will, however, count towards the individual’s lifetime CGT cap for superannuation contributions made in respect of the CGT small business concessions (see ¶4-260).

¶4-410 Conditions for CGT retirement exemption for individuals The conditions for an individual taxpayer’s entitlement to claim the CGT retirement exemption depends upon the age of the taxpayer at the time the taxpayer makes the choice to apply the exemption. The difference in the conditions is based on whether the amount disregarded under the CGT retirement exemption is required to be contributed into a complying superannuation fund or RSA. A contribution is only required to be made where the taxpayer is under the age of 55 at the time of making the choice. For these purposes, it is the taxpayer’s age at the time of making the choice, as opposed to the taxpayer’s age at the time of the CGT event, which determines the relevant conditions that must be satisfied in order to apply the CGT retirement exemption. The taxpayer is required to make the choice of whether to apply the CGT retirement exemption at the time the taxpayer lodges his or her tax return or such later time as the Commissioner allows (s 10325(1)). The timing and requirements for making the choice are detailed in ¶4-460. Therefore, where a taxpayer is aged 54 at the time of the CGT event, but turns 55 prior to the time of lodgment of the tax return in which the CGT event occurred, the taxpayer will not be required to contribute the capital gain disregarded under the CGT retirement exemption into a complying superannuation fund or RSA. Taxpayer aged 55 or over Where the taxpayer is aged 55 or over at the time he or she is required to make the choice to apply the CGT retirement exemption and the gain is not from CGT event J5 or J6, the exemption will be available provided the basic conditions for the CGT small business concessions are satisfied as detailed in Chapter 3 (s 152-305(1)). In these circumstances, provided the basic conditions are met, the taxpayer merely needs to make the choice to apply the CGT retirement exemption in the required manner (see ¶4-460). Where the taxpayer is aged 55 or over, there is no requirement for the taxpayer to make a contribution into a complying superannuation fund or RSA in order to be eligible for the CGT retirement exemption. Where the taxpayer is aged 55 or over at the time of making the choice and the relevant CGT event is

CGT event J5 or J6, the basic conditions are not required to be satisfied in order to apply the CGT retirement exemption. In these circumstances, the taxpayer will only be required to choose to apply the CGT retirement exemption in the required manner (s 152-305(4); see ¶4-460). Taxpayer aged less than 55 Where the taxpayer is less than 55 years of age at the time he or she is required to make the choice, the CGT retirement exemption will only be available where all of the following conditions are satisfied: (1) the basic conditions for the CGT small business concessions are satisfied (unless the relevant CGT event is CGT event J5 or J6) (2) the taxpayer contributes the “CGT exempt amount” to a complying superannuation fund or RSA (3) the contribution is made: • if the relevant CGT event is CGT event J2, J5 or J6 — at the time when the taxpayer made the choice • in any other case — the later of when the taxpayer made the choice or received the proceeds from the CGT event (s 152-305(1), (4)). In relation to condition 1, the basic conditions for the CGT small business concessions are detailed in Chapter 3. Where the capital gain is from CGT event J5 or J6, the basic conditions for the CGT small business concessions are not required to be satisfied (s 152-305(4)). For the purpose of condition 2, the CGT exempt amount is essentially the amount of the capital gain which is chosen to be disregarded in accordance with the CGT retirement exemption. The CGT exempt amount is described in further detail in ¶4-450. For the purpose of condition 3, where the capital proceeds from a CGT event are received by an individual in instalments, the contributions are required to be made into a complying superannuation fund or RSA by the later of the time of the choice and the receipt of the instalment (up to the CGT exempt amount) (s 152-305(1A)). For these purposes, an increase in capital proceeds received by an individual from the disposal of a CGT asset that was the subject of a “look-through earnout right” is treated as the receipt of capital proceeds in instalments (s 152-305(1B)). See ¶3-910 for details on a “look-through earnout right”. The contribution can be satisfied by the transfer of an asset such as business real property (Interpretative Decision ID 2010/217). CGT event J2, J5 and J6 may potentially apply where the taxpayer has previously applied the CGT small business roll-over in Subdiv 152-E (see ¶4-480).

¶4-420 Conditions for CGT retirement exemption for companies and trusts A taxpayer that is a company or trust is entitled to choose to claim the CGT retirement exemption where all the following conditions are satisfied: • the basic conditions for the CGT small business concessions are satisfied (unless the relevant CGT event is CGT event J5 or J6) • the entity satisfies the significant individual test • the company or trust conditions in s 152-325 are satisfied (s 152-305(2)). The significant individual test is detailed at ¶3-810. Where the capital gain is from CGT event J5 or J6 the basic conditions for the CGT small business concessions are not required to be satisfied (s 152-305(4)). Where the owner of the asset is a member of a consolidated group, the single entity rule in s 701-1 will apply such that the significant individual test applies to the head company of the consolidated group (Taxation Determination TD 2004/46).

The company or trust conditions essentially require the company or trust to make payments of the CGT exempt amount to its CGT concession stakeholders in the specified manner. The company or trust conditions are detailed in ¶4-430. Excluded public entities The CGT retirement exemption is not available for a public entity (s 152-305(2)). In particular, the following entities are not entitled to apply the CGT retirement exemption: (1) a company the shares in which are listed for quotation in the official list of an approved stock exchange (2) a publicly traded unit trust (3) a mutual insurance company (4) a mutual affiliate company (5) a company (other than one covered by item (1)) all the shares in which are beneficially owned by one or more of the entities covered by items (1) to (4) (s 152-305(3), 328-125(8)).

¶4-430 Company or trust conditions A company or trust is only able to choose to disregard the whole or part of a capital gain where the company or trust conditions in s 152-325 are satisfied. The company or trust conditions essentially require the entity to make payments from the CGT exempt amount to its CGT concession stakeholders in the prescribed manner. The company or trust is required to make a payment to at least one of its CGT concession stakeholders where either: • the company or trust makes a choice to disregard a capital gain from CGT event J2, J5 or J6 • the company or trust receives an amount of capital proceeds from any CGT event for which it chooses to disregard a capital gain under the CGT retirement exemption (s 152-325(1)). The payment may be made directly or indirectly through one or more interposed entities (s 152-325(1)). Where the company or trust receives its capital proceeds from the CGT event in instalments, the company or trust must make the payment in relation to each successive instalment up to the relevant CGT exempt amount (s 152-325(2)). For these purposes, an increase in capital proceeds received from the disposal of a CGT asset that was the subject of a “look-through earnout right” is treated as the receipt of capital proceeds in instalments (s 152-325(2A)). See ¶3-910 for details on a “look-through earnout right”. Accordingly, where the capital proceeds are received in instalments, the company or trust must make payments meeting conditions (1) to (3) specified below in relation to each instalment until the full CGT exempt amount is paid. (1) Amount of the payment The amount of each payment that the company must make is based on the CGT event that gave rise to the disregarded capital gain, the CGT exempt amount and the relevant percentage specified for each CGT concession stakeholder in the choice to apply the CGT retirement exemption. Where the capital gain arose because of CGT event J2, J5 or J6, the amount of the payment required to be made is equal to the lesser of: • the amount of the capital gain from the CGT event that the company or trust disregarded • the relevant CGT exempt amount (s 152-325(5)). In any other case, the amount of the payment, or the sum of the amounts of the payments, required to be made by the trust or company must be equal to the lesser of:

• the capital proceeds received • the relevant CGT exempt amount (s 152-325(5)). Where the company or trust has a single CGT concession stakeholder, all of the payment or payments must be made to that stakeholder. Where the company or trust has more than one CGT concession stakeholder, the amount of the payment or payments to be made to a CGT concession stakeholder is determined by reference to each stakeholder’s percentage of the CGT exempt amount as specified in the written notice to apply the CGT retirement exemption (s 152-325(3)). Where the company or trust is required to make two or more payments to a single CGT concession stakeholder, whether or not by the same time, this requirement may be satisfied by the company or trust making one payment or by making two or more separate payments (s 152-325(6)). Where the CGT concession stakeholder to whom the payment is made is an employee of the company or trust, the payment must not be of a kind mentioned in s 82-135, disregarding para (fa) (s 152-325(3A)). This section specifies certain types of payments that are not employment termination payments, including a payment that is deemed to be a dividend. See comments below in relation to deemed dividends. (2) Timing of the payment The timing of the payment depends upon the CGT event which gave rise to the disregarded capital gain. Where the capital gain arose from CGT event J2, J5 or J6, the payment must be made by seven days after the company or trust makes the choice (s 152-325(4)(a)). In any other case, the payment to be made by the company or trust must be made by the later of: • seven days after the company or trust makes the choice • seven days after the company or trust receives an amount of capital proceeds from the CGT event (s 152-325(4)(b)). (3) Additional requirement if CGT concession stakeholder under 55 Where the CGT concession stakeholder that will receive the payment is under the age of 55 just before the time of the payment, the company or trust must: • make that payment to the CGT concession stakeholder by contributing it for the benefit of the stakeholder to a complying superannuation fund or RSA • notify the trustee of the fund or the RSA provider at the time the contribution is made that the contribution is made pursuant to s 152-325(7). The contribution by the company or trust to the complying superannuation fund or the RSA provider will not be tax deductible to the company or trust (s 290-150(4)). For superannuation purposes, the payment by the company or trust is treated as a personal contribution made by the CGT concession stakeholder (s 152-325(8)). However, this personal superannuation contribution will not count towards the individual’s annual non-concessional contributions limit. The contribution into the complying superannuation fund or RSA will count towards the taxpayer’s CGT cap (see Chapter 8). Deemed dividend or frankable distribution A payment that satisfies the company or trust conditions pursuant to the CGT retirement exemption will not be a dividend or frankable distribution made by either: • the taxpayer, or • any entity interposed between the taxpayer and the CGT concession stakeholder (s 152-325(9)–(10)). This rule applies despite the application of the deemed dividend provisions in ITAA36 Div 7A and s 109 (s

152-325(11)).

¶4-440 Consequences of applying the CGT retirement exemption The CGT consequences from applying the CGT retirement exemption depend upon the type of taxpayer. All taxpayers The primary consequence to a taxpayer, whether an individual, company or trust, of making the choice to apply the CGT retirement exemption is that the “CGT exempt amount” will be disregarded (s 152-310(1)). The CGT exempt amount is the amount as nominated to be disregarded pursuant to the CGT retirement exemption in the taxpayer’s written choice. The CGT exempt amount is detailed in ¶4-450. Additional consequences for companies and trusts Where the taxpayer is a company or trust, there will be additional taxation consequences from applying the CGT retirement exemption. Any payments that are made by the taxpayer that meet the trust or company conditions, as detailed in s 152-325, will: • be non-assessable, non-exempt income in the hands of the recipient CGT concession stakeholder, and • not be tax deductible to the company or the trust (s 152-310(2)). The classification of the payment in the hands of the CGT concession stakeholder as non-assessable, non-exempt income ensures that the CGT exempt amount maintains its CGT exempt status in the hands of its CGT concession stakeholders and also prevents any clawback pursuant to CGT event E4 where the payment is received from a trust or CGT event G1 where the payment is received from a company. Where the payment is made through one or more interposed entities, the receipt of the payment will be non-assessable non-exempt income in the hands of each interposed entity and the payment will not be able to be deducted from the paying entity’s assessable income (s 152-310(3)). For these purposes, if the capital proceeds from the CGT event is received in instalments, the exemption in the hands of the relevant CGT concession stakeholder will apply to each instalment which is paid in succession, up to the CGT exempt amount (s 152-310(1)). The ability to apply the CGT retirement exemption applies irrespective of whether the capital proceeds are deemed or actual capital proceeds.

¶4-450 CGT exempt amount In accordance with the CGT retirement exemption, a taxpayer is able to choose to disregard the whole or part of a capital gain which has not otherwise been disregarded (s 152-315(1)). A capital gain for which the CGT retirement exemption is available will have been partly disregarded in accordance with the CGT small business 50% reduction, unless the taxpayer has chosen not to apply that concession (s 152-220). Similarly, where the taxpayer is an individual or a trust, part of the capital gain may have already been disregarded in accordance with the CGT general discount in Div 115 for owning an asset for at least 12 months prior to the CGT event. The amount of the capital gain that is chosen to be disregarded in accordance with the CGT retirement exemption cannot exceed: • where the taxpayer is an individual — the taxpayer’s CGT retirement exemption limit • where the taxpayer is a company or a trust — the CGT retirement exemption limit of each CGT concession stakeholder for whom the choice is made (s 152-315(2)). The amount of the capital gain chosen by the taxpayer to be disregarded is known as the CGT exempt amount (s 152-315(3)).

¶4-460 CGT retirement exemption limit Any one individual is entitled to disregard up to $500,000 of capital gains in accordance with the CGT retirement exemption during a lifetime. This limit is not indexed for inflation. The disregarded capital gains that count towards this lifetime limit are both: • capital gains that the individual personally disregarded pursuant to the CGT retirement exemption • the amount of any capital gain that is equal to the individual’s percentage of the CGT exempt amount that a company or trust, in which the individual was a CGT concession stakeholder, chose to disregard in the written choice. Therefore, an individual’s CGT retirement exemption limit at a given time is $500,000 reduced by the CGT exempt amount specified in previous choices made by, or in relation to, the individual in accordance with the CGT retirement exemption (s 152-320(1)). For these purposes, where the individual was one of at least two CGT concession stakeholders of a company or trust, and the company or trust made a choice for the individual, only the individual’s percentage of the CGT exempt amount is taken into account for that choice (s 152-320(2)). The percentage is the amount specified in the written choice pursuant to s 152-315(5) (see ¶4-470). Example 1 After applying the 50% general discount and the CGT small business 50% reduction, Giselle has a capital gain of $250,000 remaining. Giselle has not previously made, or been the subject of, any CGT retirement exemption. Accordingly, Giselle’s CGT retirement exemption limit is $500,000. Giselle chooses to apply the CGT retirement exemption to the whole of the remaining capital gain. The CGT exempt amount made in her written election is $250,000.

Example 2 Following on from Example 1, Ganz Pty Ltd, a company of which Giselle is a CGT concession stakeholder, chooses to apply the CGT retirement concession in the following year to disregard $1m of a capital gain. Ganz Pty Ltd has five CGT concession stakeholders and wishes to choose the CGT retirement exemption by applying equal portions of the CGT exempt amount to each of the stakeholders, being $200,000 each. Giselle’s CGT retirement exemption limit immediately prior to the choice is $250,000, being the $500,000 less the CGT exempt amount that Giselle personally chose in the previous year. As Giselle’s CGT retirement exemption limit is $250,000, the proposed $200,000 to be allocated to Giselle is within her CGT retirement exemption limit. The remaining allocations are also within the other CGT concession stakeholders’ CGT retirement exemption limits. Ganz Pty Ltd therefore makes a written choice to apply the CGT retirement exemption to disregard the CGT exempt amount of $1m, specifying the names of the five CGT concession stakeholders and stating that each stakeholder is entitled to a percentage of 20%. Therefore, Ganz is entitled to disregard $1m of the capital gain pursuant to the CGT retirement exemption.

Example 3 Following on from Examples 1 and 2, in the next year Giselle has a capital gain of $120,000 remaining after applying both the 50% general discount and the CGT small business 50% reduction. Giselle’s CGT retirement exemption limit for this year is only $50,000. This is calculated as $500,000, less the $250,000 Giselle personally disregarded two years ago, less a further $200,000 (ie $1m × 20%), being Giselle’s share of the CGT exempt amount of Ganz Pty Ltd from the previous year. The maximum amount CGT exempt amount that Giselle can choose to disregard under the CGT retirement exemption is $50,000. The remaining $70,000 of the capital gain can either be disregarded under the CGT small business roll-over or be included in Giselle’s taxable income.

¶4-470 Taxpayer’s choice to apply CGT retirement exemption A taxpayer choosing to apply the CGT retirement exemption needs to ensure that the choice is made by the correct time and in the correct manner.

Timing of choice The taxpayer must make the choice whether to apply the CGT retirement exemption by the day the taxpayer lodges its tax return for the income year in which the CGT event occurred, or such later time as the Commissioner allows (s 103-25(1)). For this purpose it is the actual date of lodgment of the tax return, not the due date for lodgment of the tax return, which is relevant. The taxpayer is also required to determine the CGT exempt amount by the date of lodgment of the taxpayer’s tax return for the income year in which the capital gain is made (s 103-25(1)). The date on which the choice is required to be made will also be relevant for determining the conditions which are required to be satisfied for the taxpayer to choose to apply the CGT retirement exemption (see ¶4-410). Where the taxpayer is an individual, the age of the taxpayer at the time the choice is made determines the number of conditions that must be satisfied. For these purposes, it is relevant whether the taxpayer is under the age of 55 or not at the time of making the choice. Therefore, a taxpayer can delay the timing of the choice whether to apply the CGT retirement exemption by delaying the time of lodgment of the relevant tax return. This would be particularly relevant where the taxpayer will turn 55 shortly after the due date for lodgment of the tax return and does not wish to make a contribution to a complying superannuation fund or RSA. By delaying the lodgment of the relevant tax return until the time the taxpayer turns 55 the taxpayer will be entitled to apply the CGT retirement exemption without making a contribution to a complying superannuation fund or RSA. However, the taxpayer needs to be aware that it may be liable for penalties and/or interest charges where there is a late lodgment of the tax return or late payment of tax. Form of choice The taxpayer’s choice to apply the CGT retirement exemption must be made in writing (s 103-25(3)(b)). Unlike most choices required to be made for CGT purposes, the manner in which the tax return is completed is not considered to be sufficient to make the choice to apply the CGT retirement exemption. The written choice of the taxpayer must specify the CGT exempt amount, being the amount chosen by the taxpayer to be disregarded pursuant to the CGT retirement exemption (s 152-315(4)). Where the taxpayer is a company or a trust and the taxpayer has more than one CGT concession stakeholder, the written choice must also specify the names of each of its CGT concession stakeholders and the percentage of each CGT asset’s CGT exempt amount that is attributable to each of those stakeholders (s 152-315(5)). For the choice to be effective, each CGT concession stakeholder of the taxpayer must have a specified percentage of the CGT exempt amount for the relevant CGT asset. One or more of the percentages specified may be nil, but the total of all the percentages must add up to 100% (s 152-315(5)). Accordingly, where no part of the CGT exempt amount is attributable to a CGT concession stakeholder, the amount nominated for that stakeholder is nil. Example During the 2017/18 income year the Dalmation Unit Trust made a capital gain of $4m. The unit holders in the Dalmation Unit Trust are: • Mikey — 50% • Paul — 25% • Frank — 15% • Claire — 10% (being Mikey’s wife). From the capital gain, the 50% general discount and the CGT small business 50% reduction applied to reduce the capital gain to $1m. The trust wants to disregard the $1m balance of the capital gain pursuant to the CGT retirement exemption. The Dalmation Unit Trust has three CGT concession stakeholders, being Mikey, Frank and Claire. In order for the CGT retirement exemption to apply, the trustee of the Dalmation Unit Trust must make a written choice to apply the exemption by the day of lodgment of the 2017/18 tax return. The written choice specifies the CGT exempt amount to be $1m. The written choice must also specify all the CGT concession stakeholders and the percentage of the CGT exempt amount they are each to receive. It is decided to split the CGT exempt amount 50% to Paul and the remaining 50% equally between Claire and Mikey. The election can specify the following:

CGT concession stakeholder

Percentage of CGT exempt amount

Mikey

25%

Paul

50%

Claire

25%

Total

100%

Alternatively, if it is decided to apply the CGT exempt amount between Mikey and Paul only, the written choice must specify:

CGT concession stakeholder

Percentage of CGT exempt amount

Mikey

50%

Paul

50%

Claire

0%

Total

100%

While the taxpayer is required to make a written choice in relation to the CGT retirement exemption, the written choice is not required to be lodged with the ATO. The choice must be retained with the taxpayer’s records to be produced in the case of an audit. In addition, where the taxpayer is a company or trust, the taxpayer is required to complete and lodge a capital gains tax schedule with its tax return for the income year in which the CGT event occurred where: • total current year capital gains for the income year are greater than $10,000, or • total current year capital losses for the income year are greater than $10,000. The capital gains tax schedule requires the taxpayer to provide details of any CGT small business concessions, including the CGT retirement exemption, that were applied by the taxpayer during an income year.

¶4-480 Application to capital gains from CGT events J2, J5, J6 The CGT retirement exemption can apply to a capital gain arising from CGT event J2, J5 or J6. These events can arise where a taxpayer has previously applied the CGT small business roll-over in s 152-410 (¶4-600). In broad terms: • CGT event J2 happens where the taxpayer has acquired a replacement asset prior to the end of the replacement asset period, but there is a change in relation to the replacement asset after the end of the replacement asset period (eg a sale of the asset). • CGT event J5 happens where the taxpayer does not acquire a replacement asset by the end of the replacement asset period. • CGT event J6 happens if the cost of the replacement asset acquired prior to the end of the

replacement asset period is less than the amount of the capital gain the taxpayer disregarded pursuant to the CGT small business roll-over. Where the relevant CGT event is CGT event J5 or J6, the taxpayer is not required to satisfy the basic conditions for the CGT small business concessions in order to apply the CGT retirement exemption (¶4410, ¶4-420). Both the CGT 15-year exemption and the CGT small business 50% reduction are excluded from being available for these events. However, no such exclusion applies in relation to the CGT retirement exemption. The CGT retirement exemption is able to be applied to these events as the CGT retirement exemption limit controls the amount of capital gains that can be disregarded in relation to this exemption, thereby preventing a taxpayer from obtaining multiple benefits. The CGT small business roll-over can be used to gain certain advantages in relation to the CGT retirement exemption in some circumstances. This may apply, for instance, where the taxpayer, or the CGT concession stakeholder, is under but near the age of 55 at the time of the CGT event and does not wish to contribute the relevant CGT exempt amount into a complying superannuation fund or RSA. The CGT small business roll-over can effectively be used to defer the taxation of the capital gain for two years. Where the taxpayer then satisfies the conditions for the CGT retirement exemption at the end of the two years and is aged 55, the exemption can then be claimed without making a contribution into a complying superannuation fund or RSA.

¶4-490 Interaction with other concessions The CGT retirement exemption will not apply to reduce a capital gain where the CGT 15-year exemption applies. The CGT 15-year exemption takes priority over the CGT retirement exemption (s 152-330). As the CGT 15-year exemption applies to disregard the capital gain in whole, the inability to utilise the CGT retirement exemption should not impact upon the taxpayer. The CGT retirement exemption can apply in conjunction with the CGT general discount available pursuant to Div 115 for assets that have been held for at least 12 months. The CGT general discount is usually only available for taxpayers that are individuals, trusts and complying superannuation entities. The CGT retirement exemption can apply with one or both of the CGT small business 50% reduction or the CGT small business roll-over (s 152-210). The application of the discount percentage pursuant to Div 115 and the CGT small business 50% reduction apply prior to the CGT retirement exemption (s 102-5). The taxpayer can choose the order in which to apply the CGT retirement exemption and CGT small business roll-over (s 152-210(2)). The taxpayer cannot choose the CGT retirement exemption before the CGT small business 50% reduction. However, the taxpayer can choose not to apply the CGT small business 50% reduction (s 152220). This may be done to increase the CGT exempt amount that may be claimed pursuant to the CGT retirement exemption.

¶4-500 Choosing not to apply the CGT small business 50% reduction Where a taxpayer satisfies the conditions to disregard a capital gain pursuant to the CGT retirement exemption, the taxpayer will also satisfy the CGT small business 50% reduction (s 152-205). The CGT small business 50% reduction applies automatically to such a capital gain unless the taxpayer chooses not to apply the reduction (s 152-205, 152-220). The taxpayer can choose not to apply the CGT small business 50% reduction where the taxpayer wishes to increase the benefit of the CGT retirement exemption and therefore the CGT exempt amount. This may be beneficial for two reasons: (1) where the taxpayer is a company or trust, it enables tax-free distributions to be made to CGT concession stakeholders without any clawback in the hands of the recipient (s 152-325)

(2) it enables larger contributions to be made by an individual to a complying superannuation fund without impacting upon the individual’s annual non-concessional contributions cap (s 292-100). In relation to (1), if there was a distribution of the tax exempt part of the CGT small business 50% reduction, there would be a clawback of that exemption in the hands of the shareholder or trust beneficiary. Therefore, the making of the choice may reduce the overall tax payable. Example Gossip Pty Ltd makes a capital gain of $2m and satisfies all the basic conditions for CGT small business concessions. Gossip Pty Ltd has four CGT concession stakeholders, who each have a CGT retirement exemption limit of $500,000. Gossip Pty Ltd satisfies all the requirements for the CGT retirement exemption and proposes to distribute the CGT exempt amount equally between its CGT concession stakeholders. Where Gossip Pty Ltd does not make the choice to exclude the CGT small business 50% reduction and uses the CGT retirement exemption to disregard the balance of any capital gain, the CGT consequences would be as follows:

Capital gains and losses (step 1 of method statement)

$2,000,000

Apply CGT small business 50% reduction

$1,000,000 $1,000,000

Apply CGT retirement exemption Net capital gain

$1,000,000 $Nil

As a result, Gossip Pty Ltd will have a nil taxable capital gain and the CGT exempt amount will be $1m. In addition, Gossip Pty Ltd will need to make payments to its CGT concession stakeholders of $250,000 each in accordance with the choice undertaken. The $1m exempted under the CGT small business 50% reduction will be retained in the company. Any payment of this amount to the shareholders is likely to give rise to CGT event G1 and result in a clawback of part of the exemption. However, where Gossip chooses not to apply the CGT small business 50% reduction, the position will be as follows:

Capital gains and losses (step 1 of method statement)

$2,000,000

Apply CGT retirement exemption

$2,000,000

Net capital gain

$Nil

As a result, Gossip Pty Ltd will have a nil taxable capital gain and the CGT exempt amount will be $2m. In addition, Gossip Pty Ltd will need to make payments to its CGT concession stakeholders of $500,000 each in accordance with the choice undertaken. The amount distributed to the CGT concession stakeholders will be exempt in their hands. There will be no clawback of this amount.

The choice not to apply the CGT small business 50% reduction must be made by the day the taxpayer lodges its tax return for the income year in which the CGT event occurred or such later time as the Commissioner allows (s 103-25(1)). The way in which the income tax return is prepared by the taxpayer is sufficient evidence of making the choice (s 103-25(2)). Accordingly, provided the calculation of the net capital gain does not take into account the CGT small business 50% reduction, the taxpayer will be treated as making the choice not to apply the concession.

¶4-510 Application of CGT retirement exemption where taxpayer dies Special provisions will apply for determining whether a taxpayer is entitled to the CGT retirement exemption for a CGT event that happens to a CGT asset that was acquired as a result of the death of an individual. The special provisions will only apply in two broad situations.

The first situation is where the asset forms part of the estate of the deceased individual and one of the following applies: • the asset devolves to the deceased individual’s legal personal representative • the asset passed to a beneficiary of the deceased individual • the asset devolves to a trustee of a trust established by the will of the individual (s 152-80(1)). In this case, the taxpayer entitled to the special treatment is: • the legal personal representative of the individual • the beneficiary of the individual • the trustee or a beneficiary of the trust (s 152-80(2A)). The second situation is where immediately before the individual’s death, the asset was owned by joint tenants, one of which was the deceased individual, and as a result of the individual’s death an interest in that asset is acquired by the surviving joint tenant or tenants (s 152-80(1)). The CGT treatment of the transfer of such an interest in an asset is mentioned in s 128-50. The taxpayer entitled to the special treatment is the surviving joint tenant or tenants (s 152-80(2A)(c)). In each of these situations, the special rules enable the taxpayer to apply the CGT retirement exemption to reduce the capital gain on a CGT event occurring in relation to the asset, or the interest in the asset, in the same manner as the deceased individual would have provided: • the deceased individual would have been entitled to reduce the capital gain pursuant to the CGT small business 50% reduction if the CGT event had occurred immediately before the individual’s death, and • a CGT event happens in relation to the CGT asset, or the interest in the CGT asset, within two years after the individual’s death (s 152-80(1), 152-80(2)). However, where the CGT retirement exemption is applied in this manner the taxpayer will not be required to contribute the CGT exempt amount to a complying superannuation fund or RSA if the individual was under the age of 55 years old immediately before his or her death (s 152-80(2)). This applies even though the taxpayer itself would not have personally satisfied the basic conditions for the CGT small business concessions. The Commissioner has a discretion to extend the two-year time period for the CGT event in relation to the asset (s 152-80(3)). Example Michael commenced an internet business on 2 May 2010. Michael still owned the business when he died at age 50 without a will on 19 December 2016. In accordance with the laws of intestacy the goodwill of the business passed to his only son, Pare, who was aged 22 at that time. Pare entered into a contract for the sale of the goodwill on 22 July 2017 for $3m. If Michael had sold the business immediately before he died, he would have been entitled to apply any of the CGT small business concessions, except for the CGT 15-year exemption. Pare is entitled to apply both the CGT small business 50% reduction and the CGT retirement exemption as: • the goodwill formed part of Michael’s deceased estate • the goodwill passed to Pare in accordance with the laws of intestacy • Michael would have been entitled to the CGT small business 50% reduction if the sale had occurred immediately before his death • CGT event A1, which arose from the sale of the goodwill, happened within two years of the date of Michael’s death. The first element of Pare’s cost base is the cost base of the goodwill in the hands of Michael at the time of his death (s 128-15(4)). As the cost base was nil, the capital gain will be equal to the capital proceeds of $3m.

For general CGT purposes, Pare is treated as having acquired the goodwill on the date of Michael’s death, being 19 December 2016 (s 128-15(2)). However, for the purpose of calculating whether the asset has been held for at least 12 months for the 50% CGT general discount in Div 115, Pare is treated as having acquired the goodwill on the date Michael originally acquired the goodwill (s 115-30(1) item 4). Accordingly, Pare will also be entitled to the 50% CGT general discount (Div 115). As Pare had prior year capital losses of $200,000, his net capital gain will be:

Capital gains and losses (step 1 of method statement) Apply prior year capital losses

$3,000,000 $200,000

Step 2 result

$2,800,000

Apply 50% general discount

$1,400,000

Step 3 result

$1,400,000

Apply CGT small business 50% reduction

$700,000 $700,000

Apply the CGT retirement exemption

$500,000

Net capital gain

$200,000

The CGT exempt amount chosen by Pare was the full $500,000.

The relevant CGT retirement exemption limit is based on the deceased individual’s limit immediately before the individual’s death. In accordance with these provisions, the beneficiary or a surviving joint tenant is entitled to reduce or disregard the capital gain under the CGT retirement exemption in the same way as the individual would have been entitled to (s 152-80(2)). There is no specific provision in the legislation which explains whether the CGT exempt amount claimed will be used to reduce the taxpayer’s CGT retirement exemption limit where the taxpayer is an individual beneficiary or surviving joint tenant. However, the fact that it is the deceased individual’s CGT retirement exemption limit that is the relevant limit would seem to indicate that the CGT exempt amount would not reduce the taxpayer’s CGT retirement exemption limit. This is also supported by the explanatory memorandum to the legislation. The explanatory memorandum states that the reason for the CGT exempt amount not being required to be contributed into a superannuation fund, even if the deceased was less than 55 years of age just before his or her death, was because it reflects the likely outcome if the deceased had disposed of the asset before death and paid the amount into a superannuation fund. In such circumstances, the superannuation benefit would have been released to the beneficiaries after the death. Based on these statements, the amount claimed should not reduce the taxpayer’s CGT retirement exemption limit as the taxpayer’s CGT retirement exemption limit would not have been reduced if the deceased had contributed the CGT exempt amount into a superannuation fund prior to the deceased’s death.

¶4-520 Contributions to complying superannuation fund Where an individual is entitled to the benefit of the CGT retirement exemption but was aged 55 or over at the time, the taxpayer may make personal superannuation contributions to a complying superannuation fund without the contributions forming part of the individual’s non-concessional contributions cap. The amounts will instead count towards the individual’s lifetime CGT cap. For the 2016/17 it is $1,415,000 and $1,445,000 for the 2017/18 income year. The contributions relevant to the CGT retirement exemption that may not count towards the individual’s

non-concessional contributions limit are: • the CGT exempt amount claimed by the individual • the individual’s relevant share of the CGT exempt amount of a company or trust in which the individual was a CGT concession stakeholder. The amounts that an individual is able to contribute to a complying superannuation fund that will count towards the CGT cap fall within the following categories: (1) capital proceeds received from an asset that was entitled to the CGT 15-year exemption (or would have but for no capital gain being derived) (2) the CGT exempt amount arising from the CGT retirement exemption (3) capital proceeds received from an asset that would have been entitled to the CGT 15-year exemption but for it being a pre-CGT asset. The contributions that may be made to a complying superannuation fund in this manner and the specific requirements that must be met are detailed in Chapter 8. To the extent that a contribution is made from these amounts that exceed the individual’s CGT cap, the contribution will count towards the individual’s non-concessional contributions cap.

CGT SMALL BUSINESS ROLL-OVER ¶4-600 Introduction A taxpayer can choose to defer a capital gain from a CGT event occurring in relation to an active asset provided the basic conditions for the CGT small business concessions have been satisfied. A taxpayer can choose to apply the CGT small business roll-over irrespective of whether a replacement asset is actually acquired, or fourth element expenditure is incurred. However, the amount of time that the capital gain can be deferred will depend upon whether the taxpayer obtains a replacement asset, or incurs fourth element expenditure (which is also referred to as a “replacement asset”). Where the taxpayer does not acquire a replacement asset, the capital gain will be deferred for two years after the original CGT event occurred. Essentially, where a taxpayer applies the CGT small business roll-over to disregard a capital gain, or part of a capital gain, the amount so disregarded, will be deferred until CGT event J2, J5 or J6 occurs. Broadly: • CGT event J2 happens if the taxpayer has acquired a replacement asset or incurred improvement expenditure within the replacement asset period but there is a change in relation to the replacement asset after the end of the replacement asset period • CGT event J5 happens if, by the end of the replacement asset period, the taxpayer does not acquire a replacement asset or incur the improvement expenditure • CGT event J6 happens if the cost of the replacement asset or the amount of expenditure incurred to improve the asset (or both) is less than the amount of the capital gain the taxpayer disregarded. The meaning of the replacement asset period is as outlined in ¶4-625. The capital gain arising in accordance with these events is based on the capital gain that was originally deferred. Where a capital gain arises in relation to these events, the only CGT small business concessions that may potentially apply to the capital gain are:

• the CGT retirement exemption for any of these events • the CGT small business roll-over in relation to CGT event J2. The following CGT concessions cannot apply to any capital gain made pursuant to CGT event J2, J5 or J6: • CGT general discount • CGT small business 50% reduction • CGT 15-year exemption.

¶4-610 Conditions for CGT small business roll-over A taxpayer is able to choose to apply the CGT small business roll-over provided it satisfies all the basic conditions for the CGT small business concessions (s 152-410). The basic conditions for the CGT small business concessions are detailed in Chapter 3. There is no requirement for a taxpayer to acquire any replacement asset, or incur fourth element expenditure, in order to apply the CGT small business roll-over. However, where the taxpayer does not acquire a replacement asset or incur fourth element expenditure by the end of the replacement asset period (see ¶4-625), CGT event J5 will happen to the taxpayer (s 104-197). The application of CGT event J5 is detailed in ¶4-690. CGT event J6 will arise where a replacement asset is acquired but the cost base of the replacement asset or the fourth element expenditure incurred does not exceed the capital gain rolled over. The application of CGT event J6 is detailed in ¶4-700.

¶4-620 Consequences of applying the CGT small business roll-over Where a taxpayer satisfies the basic conditions for the CGT small business roll-over in relation to a CGT event, the taxpayer can choose to disregard the whole or part of the capital gain that is eligible for this concession (s 152-415). The amount disregarded will not be included in the taxpayer’s assessable income. There is no monetary cap or limit on the amount of a capital gain that the taxpayer may disregard in accordance with the CGT small business roll-over. The amount that can be disregarded is merely limited by the amount of the capital gain that is made in relation to the CGT event. The CGT small business roll-over applies after the application of the general CGT discount pursuant to Div 115 (where relevant) and the CGT small business 50% reduction (s 102-5). The taxpayer can choose the order in which to apply the CGT small business roll-over and the CGT retirement exemption. Example Hathaway Unit Trust made a capital gain of $3.3m in the 2017/18 income year from the sale of shares in Smart Pty Limited. Hathaway Unit Trust satisfied the basic conditions for the CGT small business concessions. The shares were held for more than 12 months and the trust was entitled to the 50% general discount in Div 115. The Hathaway Unit Trust does not have a CGT concession stakeholder and therefore the CGT retirement exemption is not available.

Capital gains and losses (step 1 of method statement)

$3,300,000

Apply 50% general discount

$1,150,000

Step 3 result

$1,150,000

Apply CGT small business 50% reduction

$575,000 $575,000

Apply the CGT small business roll-over Net capital gain

$575,000 $Nil

By applying the CGT small business roll-over of $575,000 to the capital gain, the taxpayer has a nil net capital gain in the 2017/18 income year.

Where the taxpayer chooses to only disregard part of a capital gain, the taxpayer will make a capital gain equal to the amount remaining (s 152-415). Where available, a taxpayer may further reduce the capital gain by applying the CGT retirement exemption. CGT event if no replacement asset acquired It is not a condition of the CGT small business roll-over that the taxpayer either acquires a replacement asset or incurs fourth element expenditure. However, where the taxpayer does not acquire a replacement asset, or incur fourth element expenditure, by the end of the replacement asset period, CGT event J5 will happen to the taxpayer (s 104-197). The application of CGT event J5 is detailed in ¶4-690. The definition of the replacement asset period is outlined in ¶4-625. Therefore, a taxpayer that satisfies the basic conditions for the CGT small business concessions will be entitled to apply the CGT small business roll-over to defer any part of a capital gain that is not disregarded in accordance with the other CGT small business concessions. The roll-over can be applied even where the taxpayer has no intention of acquiring a replacement asset or incurring any fourth element expenditure in the future. In such a case, the capital gain can be deferred for a period of two years. This would be particularly effective where the taxpayer expects to be subject to a lower rate of tax in two years. For example, this may apply where there is proposed to be a reduction in the tax rates, the taxpayer expects to make a capital loss in a later year which would offset the deferred capital gain or the taxpayer will derive lower amounts of income in the future subjecting the capital gain to a lower marginal rate of tax. CGT events if replacement asset acquired Where the taxpayer does acquire a replacement asset, or incur fourth element expenditure, prior to the end of the replacement period, but the cost of the replacement asset or the amount of fourth element expenditure (or the sum of both) is less than the capital gain disregarded under the CGT small business roll-over, CGT event J6 will occur (s 104-198). The application of CGT event J6 is detailed in ¶4-700. Where the taxpayer acquires a replacement asset, or incurs fourth element expenditure, prior to the end of the replacement asset period and CGT event J6 does not arise, the capital gain from the roll-over will be deferred until CGT event J2 occurs (s 104-185). The application of CGT event J2 is detailed in ¶4-710.

¶4-625 Definition of replacement asset period Central to the application of the CGT small business roll-over and CGT events J2, J5 and J6 is the replacement asset period. The replacement asset period is the period starting: (a) one year before the last CGT event in the income year for which the taxpayer obtained the CGT small business roll-over, and (b) ending at the later of: (i) two years after that last CGT event, and (ii) if the CGT event happened because the taxpayer disposed of a CGT asset pursuant to a “lookthrough earnout right” (¶3-910) — six months after the latest time a possible financial benefit becomes or could become due under that “look-through earnout right” relating to the CGT asset and the disposal (s 104-190(1A)). However, the replacement asset period may be modified or extended in certain circumstances (s 104-

190). The replacement asset period will be modified if the taxpayer’s capital proceeds for the CGT event are increased under s 116-45(2) after the end of the replacement asset period (s 104-190(1)). The capital proceeds will be increased under s 116-45(2) where the capital proceeds from a CGT event were reduced as a result of part of the proceeds being unpaid in accordance with the non-receipt rule but the taxpayer subsequently received a part of those unpaid proceeds. The capital proceeds are increased by the part of the proceeds subsequently received (s 116-45(2)). In these circumstances, the taxpayer will have until 12 months after those additional proceeds are received to acquire a replacement asset, or incur fourth element expenditure in relation to a CGT asset, or do both (s 104-190). Therefore, the replacement asset period for only that part of the capital proceeds is extended until 12 months after the date of receipt of those proceeds. The replacement asset period is not extended for the capital proceeds that were previously received. Example On 5 July 2012, P Anderson Pty Ltd entered into a contract for the sale of a business for $2.5m. The sale price was payable in three instalments, being $1m on 5 July 2012, $500,000 on 15 August 2012 and the remaining $1m on 2 December 2012. The capital gain from CGT event A1 in 2012/13 was $2.5m as the cost base was nil. However, despite all reasonable attempts being made to recover payment, only the first two instalments were paid by the purchaser. As P Anderson Pty Ltd considered the capital proceeds were not likely to be received, the capital proceeds were reduced to $1.5m. Accordingly, P Anderson’s capital gain was reduced to $1.5m. Pursuant to the CGT small business concessions, $750,000 of the capital gain was disregarded in accordance with the CGT small business 50% reduction, $500,000 in accordance with the CGT retirement exemption and the $250,000 in accordance with the CGT small business roll-over. The taxpayer’s replacement asset period in relation to the capital gain disregarded ends on 5 July 2014. However, as a result of legal action, P Anderson received an additional $500,000 on 5 August 2015, thereby increasing the capital gain to $2m. In accordance with the CGT small business concessions, $1m is disregarded under the CGT small business 50% reduction, $500,000 pursuant to the CGT retirement exemption and $500,000 pursuant to the CGT small business roll-over. In relation to the additional $250,000 proceeds received which are subject to the CGT small business roll-over, the taxpayer’s replacement asset period ends on 5 August 2017. There is no automatic extension to the replacement asset period for the original $250,000 capital gain disregarded under the CGT small business roll-over. However, the replacement asset period for this gain may be extended at the discretion of the Commissioner.

The modification of the replacement asset period can apply for any of CGT events J2, J5 or J6 (s 104197(5), 104-198(4)). The modification of the replacement asset period also applies in the same manner as the non-receipt rule where there is an increase in capital proceeds pursuant to s 116-60(3). The capital proceeds are increased under s 116-60(3) where the capital proceeds from a CGT event were reduced as a result of misappropriation of capital proceeds from a CGT event by the taxpayer’s employee or agent but the taxpayer subsequently receives an amount as a recoupment of all or part of those funds. The capital proceeds are increased by the amount so received. The Commissioner has an absolute discretion to extend the replacement period, or the replacement asset period as modified in accordance with the above (s 104-190(2)).

¶4-630 Exclusion of certain CGT events The CGT small business roll-over cannot apply to a capital gain arising from CGT event J5 or J6 (s 15210(4)). These events are excluded as they only arise where the taxpayer has previously applied the CGT small business roll-over in s 152-410 to a capital gain. In broad terms: • CGT event J5 happens if, by the end of the replacement asset period, the taxpayer does not acquire a replacement asset or incur fourth element expenditure to improve an asset. • CGT event J6 happens if, by the end of the replacement asset period, the cost of the replacement asset acquired or the amount of fourth element expenditure incurred to improve an asset (or both) is

less than the amount of the capital gain the taxpayer disregarded pursuant to the CGT small business roll-over. If the CGT small business roll-over was applied to these CGT events, a taxpayer could effectively defer a capital gain arising from the CGT event indefinitely, without ever acquiring sufficient replacement assets or incurring sufficient fourth element expenditure to cover the capital gain. The CGT small business roll-over is available in relation to a capital gain that arises pursuant to CGT event J2. CGT event J2 may happen if the taxpayer has acquired a replacement asset or incurred improvement expenditure within the replacement asset period but there is a change in relation to the replacement asset after the end of the replacement asset period.

¶4-640 Taxpayer’s choice to apply CGT small business roll-over In order for the CGT small business roll-over to apply to disregard a capital gain, or a part of the capital gain, the taxpayer must choose to apply the roll-over (s 152-410). There is no limit on the amount of the capital gain that may be disregarded in accordance with this concession. The choice needs to be made by the day the tax return for the income year in which the CGT event happened is lodged, or within such further time as the Commissioner allows (s 103-25(1)). The manner in which the taxpayer prepares the tax return is sufficient evidence of the taxpayer’s choice to apply the CGT small business roll-over (s 103-25(2)). This would be evidenced by the disregarded capital gain not being included in the assessable capital gain of the taxpayer. In addition, where the taxpayer is a company or trust, the taxpayer is required to complete and lodge a capital gains tax schedule with its tax return for the income year in which the CGT event occurred where: • total current year capital gains for the income year are greater than $10,000, or • total current year capital losses for the income year are greater than $10,000. The capital gains tax schedule requires the taxpayer to provide details of any CGT small business concessions, including the CGT small business roll-over, that were applied by the taxpayer during an income year.

¶4-650 Interaction with other CGT small business concessions The CGT small business roll-over will not apply to reduce a capital gain where the CGT 15-year exemption applies. The CGT 15-year exemption takes priority to the CGT small business roll-over (s 152430). As the CGT 15-year exemption applies to disregard the capital gain in whole, the inability to utilise the CGT small business roll-over should not impact upon the taxpayer. The CGT small business roll-over can apply in conjunction with the CGT general discount available pursuant to Div 115 for assets that have been held for at least 12 months. The CGT general discount is only available for taxpayers that are individuals, trusts, complying superannuation funds and certain life insurance companies. The CGT small business roll-over can apply with one or both of the CGT small business 50% reduction or the CGT retirement exemption (s 152-210). The application of the discount percentage pursuant to Div 115 and the CGT small business 50% reduction apply prior to the CGT small business roll-over (s 102-5). Where the taxpayer chooses to apply both the CGT retirement exemption and the CGT small business roll-over, the taxpayer can choose the order in which they apply (s 152-210(2)). There is no ability for the taxpayer to choose to apply the CGT small business roll-over before the CGT small business 50% reduction. However, the taxpayer does have the ability to choose not to apply the CGT small business 50% reduction (s 152-220). The CGT small business roll-over can be chosen in order to enable a taxpayer to take advantage of the CGT retirement exemption at a later time. For example, where a taxpayer is near the age of 55 (say 53) at the time for making the choice, but does not wish to contribute the capital proceeds received from the

event into a complying superannuation fund, the taxpayer can apply the CGT small business roll-over to defer the capital gain for two years. At the end of the two-year period, the capital gain that was disregarded will be a capital gain in accordance with CGT event J5 (assuming the taxpayer did not acquire a replacement asset). At this time the taxpayer will be aged 55 and the taxpayer will be able to apply the CGT retirement exemption to the capital gain without being required to make any contribution into a complying superannuation fund or RSA. Example Georgiana owns a chain of beauty salons. At the age of 52 she enters into an agreement for the sale of the business on 27 July 2015. The consideration for the sale of the goodwill was $1.8m. The goodwill had a nil cost base. Georgiana has no current year or prior year capital losses. Georgiana satisfies all the basic conditions for the CGT small business concessions. As a result she is entitled to apply any of the CGT small business concessions except for the CGT 15-year exemption. She is also entitled to the 50% CGT general discount for owning the goodwill for more than 12 months prior to the sale. At the same time Georgiana needs the cash from the sale to buy a new home. Therefore, she does not wish to contribute any of the funds from the sale into a complying superannuation fund. As a result she does not choose to apply the CGT retirement exemption to the capital gain. However, in order to defer the capital gain, she chooses to apply the CGT small business roll-over in calculating the capital gain. The capital gain is determined as follows:

Capital gains and losses (step 1 of method statement)

$1,800,000

Apply 50% general discount

$900,000

Step 3 result

$900,000

Apply CGT small business 50% reduction

$450,000 $450,000

Apply the CGT small business roll-over Net capital gain

$450,000 $Nil

As a result of applying the CGT small business roll-over, Georgiana is not required to pay any tax in the 2015/16 income year. By 27 July 2017, being the end of the replacement asset period, as Georgiana has not acquired a replacement asset, nor incurred any fourth element expenditure, CGT event J5 arises. The capital gain will be equal to the $450,000 capital gain previously deferred in accordance with the CGT small business roll-over. By this time Georgiana is aged 54. However, as Georgiana waits until she is aged 55 to lodge her 2018 tax return she can choose to apply the CGT retirement exemption to disregard the full $450,000 capital gain arising from CGT event J5 and not be required to contribute any part of the capital gain to a complying superannuation fund.

¶4-660 Choosing not to apply the CGT small business 50% reduction The taxpayer has the ability to choose not to apply the CGT small business 50% reduction (s 152-220). However, the choice to disregard the CGT small business 50% reduction is usually only made to increase the CGT exempt amount that may be claimed pursuant to the CGT retirement exemption. It would not usually be made to increase the CGT small business roll-over because once the CGT small business 50% reduction is excluded, it cannot ever apply to the capital gain that was disregarded pursuant to the CGT small business roll-over. In this manner, neither the CGT general discount nor the CGT small business 50% reduction can be applied to a capital gain made pursuant to CGT event J2, J5 or J6, being the whole or part of the capital gain that was originally disregarded under the CGT small business roll-over (s 152-10(4)).

¶4-670 Application of CGT small business roll-over where taxpayer dies

Special provisions will apply for determining whether a taxpayer is entitled to the CGT small business rollover for a CGT event that happens to a CGT asset that was acquired as a result of the death of an individual. The special provisions will apply in two broad situations. The first situation is where the asset forms part of the estate of the deceased individual and one of the following applies: • the asset devolves to the deceased individual’s legal personal representative • the asset passed to a beneficiary of the deceased individual, or • the asset devolves to a trustee of a trust established by the will of the individual (s 152-80(1)). In this case, the taxpayer entitled to the special treatment is: • the legal personal representative of the individual • the beneficiary of the individual, or • the trustee or a beneficiary of the trust (s 152-80(2A)). The second situation is where immediately before the individual’s death, the asset was owned by joint tenants, one of which was the deceased individual, and as a result of the individual’s death an interest in that asset is acquired by the surviving joint tenant or tenants (s 152-80(1)). The CGT treatment of the transfer of such an interest in an asset is mentioned in s 128-50. The taxpayer entitled to the special treatment is the surviving joint tenant or tenants (s 152-80(2A)(c)). In each of these situations, the special rules enable the taxpayer to apply the CGT small business rollover to reduce the capital gain on a CGT event occurring in relation to the asset in the same manner as the deceased individual would have provided: • the deceased individual would have been entitled to reduce the capital gain pursuant to the CGT small business roll-over if the CGT event had occurred immediately before the individual’s death, and • a CGT event happens in relation to the CGT asset, or the interest in the CGT asset, within two years after the individual’s death (s 152-80(1), 152-80(2)). This applies even though the taxpayer itself would not have personally satisfied the basic conditions for the CGT small business concessions. The Commissioner has a discretion to extend the two-year time period for the time of the CGT event in relation to the asset (s 152-80(3)). Example Jordan personally owned land on which a sound engineering business was conducted by an entity connected with her. The land was acquired on 11 September 2010 and had a cost base of $500,000. Jordan died on 1 April 2016, and the land was left to her sister Siobhan. The business ceased at the time of Jordan’s death and the property was then left empty. Siobhan sold the land on 1 July 2017 for $3m. If the sale of the land had occurred immediately before Jordan’s death on 1 April 2016, Jordan would have been entitled to apply the CGT small business 50% reduction to the capital gain as all the basic conditions would have been satisfied. Siobhan is entitled to apply the CGT small business 50% reduction and the CGT small business roll-over to the capital gain as: • the business formed part of Jordan’s deceased estate • the land passed to Siobhan in accordance with Jordan’s will • Jordan would have been entitled to both the CGT small business 50% reduction and the CGT small business roll-over if the sale occurred immediately before her death • CGT event A1, which arose from the sale of the land, happened within two years of the date of Jordan’s death. The capital gain will be equal to the capital proceeds of $3m less the cost base of the land in Siobhan’s hands, being $500,000. The first element of Siobhan’s cost base is the cost base of the land in the hands of Jordan at the time of her death (s 128-15(4)). At the time of Jordan’s death, her CGT retirement limit was nil as it had previously been used up.

For general CGT purposes, Siobhan is treated as having acquired the land on the date of Jordan’s death, being 1 April 2016 (s 12815(2)). Siobhan is entitled to the 50% general discount as the land has been held for at least 12 months in accordance with Div 115. Assuming Siobhan had no current year or prior year capital losses, her net capital gain will be:

Capital gains and losses (step 1 of method statement)

$2,500,000

Apply 50% general discount

$1,250,000

Step 3 result

$1,250,000

Apply CGT small business 50% reduction

$625,000 $625,000

Apply CGT 50% small business roll-over Net capital gain

$625,000 $Nil

Where the relevant taxpayer applied the CGT small business roll-over, CGT event J2, J5 or J6 will still potentially apply to the taxpayer where the taxpayer does not meet the relevant requirements regarding the replacement asset or fourth element expenditure.

¶4-680 Relevant terms for CGT events J2, J5 and J6 For the purpose of determining whether CGT event J2, J5 or J6 apply, there are a number of terms that are relevant. These terms are defined separately below. Fourth element expenditure A taxpayer incurs fourth element expenditure in relation to a CGT asset if the taxpayer incurs capital expenditure that is included in the fourth element of the cost base of the asset (s 104-185(9)). The fourth element of the cost base of an asset comprises capital expenditure that the taxpayer incurred: • where the purpose, or the expected effect, of which is to increase or preserve the asset’s value, or • that relates to installing or moving the asset (s 110-25(5)). The capital expenditure can include giving property (s 103-5). Example Streets Fire Pty Ltd owns a land and building on which an interior design business is conducted. As a result of the expansion of the business, Streets Fire Pty Ltd incurs $100,000 on construction costs to extend the building. The construction costs will form part of the fourth element of the cost base of the land. Accordingly, the construction expenditure constitutes fourth element expenditure for CGT purposes.

Replacement asset period The replacement asset period is detailed in ¶4-625. CGT concession stakeholder The CGT concession stakeholder of a company or trust at a time is an individual that, at that time, is either: • a significant individual of the company or trust • a spouse of a significant individual in the company or trust, if the spouse has a small business participation percentage in the company or trust at that time that is greater than zero (s 152-60).

The definition of a CGT concession stakeholder is detailed in ¶3-870. Small business participation percentage An entity’s small business participation percentage is detailed in ¶3-880. The 152-E amount The 152-E amount is the amount of the capital gain the taxpayer chose to disregard in accordance with the CGT small business roll-over pursuant to Subdiv 152-E.

¶4-690 CGT event J5 CGT event J5 will happen to a taxpayer where the taxpayer chose to apply the CGT small business rollover to disregard a capital gain that arose in relation to a CGT asset in an income year and by the end of the replacement asset period either: • the taxpayer has not acquired a replacement asset (“the replacement asset”), or had not incurred fourth element expenditure in relation to a CGT asset (also “the replacement asset”) • the replacement asset does not satisfy the replacement asset conditions (s 104-197(1)). For these purposes, the replacement asset conditions are: • the replacement asset is an active asset of the taxpayer, and • if the replacement asset is a share in a company or an interest in a trust, either: – the taxpayer, or an entity connected with the taxpayer, is a CGT concession stakeholder in the company or trust – CGT concession stakeholders in the company or trust must have a small business participation percentage in the taxpayer of at least 90% (s 104-197(2)). Where CGT event J5 happens, it happens at the end of the replacement asset period (s 104-197(3)). The capital gain from CGT event J5 is equal to the amount of the capital gain that was disregarded in accordance with the CGT small business roll-over (s 104-197(4)). The taxpayer cannot make a capital loss from CGT event J5. Example The Hathaway Unit Trust chose the CGT small business roll-over to disregard $575,000 of a capital gain made on 10 July 2015. On 11 September 2016, the Hathaway Unit Trust acquired land for $800,000. The land was acquired by Hathaway Unit Trust for the purpose of conducting a business as a florist. The land was acquired to be a replacement asset. However, the florist business never commenced and the land was merely rented at all times to third parties. As at 10 July 2017, being the end of the replacement asset period, CGT event J5 will arise as the land acquired by the Hathaway Unit Trust will not be an active asset and therefore will not satisfy the replacement asset conditions. Accordingly, on 10 July 2017, the Hathaway Unit Trust will make a capital gain of $575,000 pursuant to CGT event J5.

The only CGT small business concession that a taxpayer can apply to reduce a capital gain made pursuant to CGT event J5 is the CGT retirement exemption. All the other CGT small business concessions are specifically excluded from being able to apply (s 152-10(4)). Similarly, a capital gain from CGT event J5 is not a discount capital gain and therefore the CGT general discount in Div 115 cannot apply to reduce the capital gain (s 115-25(3)(hb)). The CGT general discount and the CGT small business 50% reduction are prevented from applying to a capital gain from CGT event J5, because the taxpayer has already effectively received, or in the case of the CGT small business 50% reduction at least been entitled to receive, any benefit available from these concessions. The capital gain from CGT event J5 is the capital gain that was previously disregarded pursuant to the

CGT small business roll-over. As the CGT small business roll-over only applies after the CGT general discount in Div 115 (if applicable) and the CGT small business 50% reduction (unless the taxpayer chooses not to apply this reduction), these concession have already applied, or could have been applied, to reduce the capital gain (s 102-5). Therefore, there is no ability to apply the CGT small business 50% reduction to the capital gain in CGT event J5. This applies even where the taxpayer previously chose not to apply the CGT small business 50% reduction. The CGT small business roll-over is not available for a capital gain from CGT event J5. If the CGT small business roll-over was available for CGT event J5 the taxpayer could continuously defer the capital gain indefinitely without ever acquiring a replacement active asset.

¶4-700 CGT event J6 In broad terms, CGT event J6 will happen where a replacement active asset (or assets) is acquired within the replacement asset period, or fourth element expenditure has been incurred, but the cost base of the replacement asset, expenditure or both at that time is less than the capital gain previously disregarded under the CGT small business roll-over. More specifically, CGT event J6 will happen to a taxpayer where the taxpayer chose to apply the CGT small business roll-over to disregard a capital gain that arose in relation to a CGT asset in an income year and: (1) by the end of the replacement asset period the taxpayer had done either or both of the following: (a) acquired a replacement asset (“the replacement asset”), or (b) had incurred fourth element expenditure in relation to a CGT asset (also “the replacement asset”) (2) at the end of the replacement asset period, the replacement asset is the taxpayer’s active asset (3) if the replacement asset is a share in a company or an interest in a trust, at the end of the replacement asset period: (a) the taxpayer, or an entity connected with the taxpayer, is a CGT concession stakeholder in the company or trust, or (b) CGT concession stakeholders in the company or trust have a small business participation percentage in the taxpayer of at least 90%, and (4) the amount of the capital gain disregarded in accordance with the CGT small business roll-over was more than the total of the following amounts (the “amount incurred”) in relation to the replacement assets which satisfied para (2) and, where relevant, para (3): (a) the first element of the cost base (b) the incidental costs the taxpayer incurred, which can include giving property (c) the amount of fourth element expenditure incurred (s 104-198(1)). Where CGT event J6 happens, it happens at the end of the replacement asset period (s 104-198(2)). The capital gain from CGT event J6 is equal to the difference between: • the amount of the capital gain that was disregarded under the CGT small business roll-over, and • the amount incurred (s 104-198(3)). The taxpayer cannot make a capital loss from CGT event J6. Example

Cody applied the CGT small business roll-over to disregard a capital gain of $700,000 arising from CGT event A1 which occurred on 15 July 2015. On 15 December 2015, Cody acquired the land on which he conducted his security business for $400,000. Cody incurred incidental costs on the acquisition of $10,000. On 7 March 2017, Cody built a second building on the land to provide further space to conduct the business. The cost of this improvement was $170,000. The cost of the capital improvement was fourth element expenditure. On 15 July 2017, being the end of the replacement asset period: • Cody had acquired the land as a replacement asset and incurred fourth element expenditure • the property was an active asset of Cody’s • the total of the first element of the cost base (being $400,000), the incidental costs (being $10,000) and the fourth element expenditure (being $170,000) was $580,000, being less than the capital gain of $700,000 previously disregarded. Accordingly, CGT event J6 happened to Cody on 15 July 2017. The capital gain from CGT event J6 is $120,000 (being $700,000 less $580,000).

The only CGT small business concession that a taxpayer can apply to reduce a capital gain made pursuant to CGT event J6 is the CGT retirement exemption. All the other CGT small business concessions are specifically excluded from being able to apply (s 152-10(4)). Similarly, a capital gain from CGT event J6 is not a discount capital gain and therefore the CGT general discount in Div 115 cannot apply to reduce the capital gain (s 115-25(3)(hc)). The CGT general discount and the CGT small business 50% reduction are prevented from applying to a capital gain from CGT event J6, because the taxpayer has already effectively received, or in the case of the CGT small business 50% reduction at least been entitled to receive, any benefit available from these concessions.

¶4-710 CGT event J2 In broad terms, CGT event J2 will occur where a replacement active asset was acquired within the replacement asset period but the replacement asset ceases to be an active asset thereafter. More specifically, CGT event J2 will happen to a taxpayer where the taxpayer chose to apply the CGT small business roll-over to disregard a capital gain that arose in relation to a CGT asset in an income year and: (1) by the end of the replacement asset period the taxpayer had done either or both of the following: (a) acquired a replacement asset (“the replacement asset”), or (b) had incurred fourth element expenditure in relation to a CGT asset (also “the replacement asset”) (2) at the end of the replacement asset period, the replacement asset is the taxpayer’s active asset (3) if the replacement asset is a share in a company or an interest in a trust, at the end of the replacement asset period: (a) the taxpayer, or an entity connected with the taxpayer, is a CGT concession stakeholder in the company or trust, or (b) CGT concession stakeholders in the company or trust have a small business participation percentage in the taxpayer of at least 90%, and (4) a specified change happens after the end of the replacement period (s 104-185(1)). For these purposes a specified change for any replacement asset will be any one of the following: • the asset stops being the taxpayer’s active asset • the asset becomes the taxpayer’s trading stock, or

• the taxpayer starts to use the asset solely to produce the taxpayer’s exempt income or nonassessable non-exempt income (s 104-185(2)). In addition to the above, where the replacement asset is a share in a company or an interest in a trust, a specified change can be any of the following: • CGT event G3 happens to the asset (ie a liquidator or administrator declares the shares worthless) • CGT event I1 happens to the asset (ie the taxpayer, being an individual or company, ceases to be a resident of Australia) • either: – the taxpayer, or an entity connected with the taxpayer, ceases to be a CGT concession stakeholder in the company or trust, or – CGT concession stakeholders in the company or trust cease to have a small business participation percentage in the taxpayer of at least 90% (s 104-185(3)). For these purposes it is important to note that the sale of the replacement asset by the taxpayer will be a specified change as the asset will stop being an active asset of the taxpayer at the time of the sale. Where the replacement asset is a share in a company or an interest in the trust, the share or interest will only be an active asset where the relevant 80% test in s 152-40(3) is satisfied. This test is detailed in ¶3670 and effectively requires the total of the market value of the active assets of the company or trust and both the cash and financial instruments that are inherently connected to the business to comprise 80% or more of the market value of the total assets of the company or trust. However, a temporary failure to meet this test will not give rise to CGT event J2. A share in a company, or an interest in a trust, will still be treated as an active asset at a time if the share or interest fails to meet the requirements in accordance with the 80% test provided the failure is of a temporary nature only (s 152-40(3B)). Notwithstanding the above, where the replacement asset is a share in a company or an interest in a trust, CGT event J2 will not occur where the replacement asset ceased to be an active asset only because of changes in the market value of assets that were owned by the company or trust at the time the taxpayer acquired the share or interest or incurred the fourth element expenditure (s 104-185(8)). Where CGT event J2 happens, it happens at the time of the relevant specified change (s 104-185(4)). The capital gain from CGT event J2 will depend upon the number of replacement assets the taxpayer acquired within the replacement asset period that were active assets (ie the assets that satisfied condition (2)), and where relevant, satisfied the additional requirement for company shares or trust interests (being condition (3)). The capital gain will be as follows: • where there is only one such replacement asset — the amount of the capital gain that the taxpayer disregarded under the CGT small business roll-over (“the 152-E amount”) • if there are two or more such replacement assets and a specified change occurs for all of them — the 152-E amount • if there are two or more such replacement assets and a specified change occurs for one or more but not all of them — so much (if any) of the 152-E amount as exceeds the sum of the following: – the first element of the cost base of each of those replacement assets acquired – the incidental costs the taxpayer incurred to acquire each of those replacement assets (which can include giving property, see s 103-5) – the amount of fourth element expenditure incurred in relation to each of those replacement assets

in relation to which a specified change did not occur (s 104-185(5)). However, where CGT event J6 has happened in relation to the disregarded capital gain pursuant to the CGT small business roll-over, for the purpose of calculating the capital gain pursuant to CGT event J2, the 152-E amount is reduced by the amount of the capital gain under CGT event J6 (s 104-185(6)). The taxpayer cannot make a capital loss from CGT event J2. Example 1 Chandler applied the CGT small business roll-over to disregard a capital gain of $300,000 arising from CGT event A1 which occurred on 16 June 2013. On 1 January 2014, Chandler acquired 30% of the issued shares in Gottlieb Pty Ltd which carried on an active business. The cost base of the shares was $350,000. The shares satisfied all the replacement asset conditions. As at 16 June 2015, the shares still satisfied all of the replacement asset conditions and therefore CGT event J5 did not arise. Furthermore, CGT event J6 did not arise as the cost base of the shares exceeded the capital gain rolled over pursuant to the CGT small business concessions. On 20 October 2017, Gottlieb Pty Ltd issued additional shares to third parties. As a result of the issue of the shares Chandler only held 18% of the issued share capital in Gottlieb Pty Ltd. Accordingly, Chandler ceased to be both a significant individual and CGT concession stakeholder of Gottlieb Pty Ltd. As a result of the issue of shares, CGT event J2 arises on 20 October 2017. The capital gain from CGT event J2 will be equal to $300,000, being the capital gain previously disregarded on the asset.

Example 2 Jennifer applied the CGT small business roll-over to disregard a capital gain of $500,000 arising from CGT event A1 which occurred on 9 June 2013. On 5 February 2015, Jennifer acquired 50% of the issued units in Games R Us Unit Trust which carried on an active business. The cost of the units was $600,000. The units satisfied all the replacement asset conditions. As at 9 June 2015, being the end of the replacement asset period, the units still satisfied all of the replacement asset conditions and therefore CGT event J5 did not arise. Furthermore, CGT event J6 did not arise as the cost base of the units exceeded the capital gain rolled over pursuant to the CGT small business concessions. On 1 December 2017, Jennifer sold a quarter of the units in the Games R Us Unit Trust for $100,000 (being the 12.5% of the issued units). As a result of the sale of those units CGT event A1 and J2 arose. Jennifer will make a capital loss from the sale of the units equal to $50,000 being calculated as the reduced cost base of those units, being $150,000, less the capital proceeds from the sale of the units, being $100,000. Despite the sale of the units, Jennifer will continue to own 37.5% of the units in the Games R Us Unit Trust and therefore will still be a CGT concession stakeholder. Accordingly, a specified change will only occur in relation to 25% of the replacement assets which Jennifer held in the Games R Us Unit Trust (being the 12.5% of the total issued units in the trust which were sold). The cost base of the replacement assets that are not being sold is $450,000. The capital gain from CGT event J2 will be equal to $50,000, calculated as the amount of the original capital gain disregarded pursuant to the CGT small business roll-over of $500,000, less the cost base of the remaining replacement assets of $450,000.

The only CGT small business concessions that a taxpayer can apply to reduce a capital gain made pursuant to CGT event J2 are: • the CGT retirement exemption • the CGT small business roll-over (s 152-10(4)). The other CGT small business concessions are specifically excluded from being able to apply (s 15210(4)). Similarly, a capital gain from CGT event J2 is not a discount capital gain and therefore the CGT general discount in Div 115 cannot apply to reduce the capital gain (s 115-25(3)(ha)). Where CGT event J2 arises as a result of the sale of the replacement asset, CGT event A1 will also arise. The capital gain or loss from CGT event A1 will be calculated in the ordinary manner. There is no adjustment to the cost base of the replacement asset as a result of the taxpayer applying the CGT small business roll-over. To the extent that the taxpayer satisfies the CGT small business concessions, they may be applied to the capital gain arising from CGT event A1. Example 3 Ellen applied the CGT small business roll-over to disregard a capital gain of $500,000 arising from CGT event A1 which occurred on

10 June 2012. At that time she also applied the CGT retirement exemption to disregard a capital gain of $300,000. On 13 May 2014, Ellen acquired a new business. The purchase price of the goodwill was $800,000. As at 10 June 2014, being the end of the replacement asset period, the goodwill was still held and was an active asset. Therefore, CGT event J5 will not arise. Furthermore, as the purchase price of the goodwill was more than the capital gain disregarded, CGT event J6 will not arise at that time. On 16 July 2017, Ellen sold the business to a third party. The price of the goodwill was $1.5m. The sale of the goodwill will give rise to CGT events A1 and J2. At that time Ellen was 56 and satisfied all the basic conditions for the CGT small business concessions. She also had carried forward capital losses of $100,000. The capital gain from CGT event A1 will be calculated as the capital proceeds of $1.5m less the cost base of the goodwill of $800,000, being $700,000. The capital gain from CGT event J2 is equal to $500,000, being the capital gain previously disregarded under the CGT small business roll-over. The capital gain determined in accordance with the method statement in s 102-5 is calculated as follows:

CGT event A1

CGT event J2

Total

$700,000

$500,000

$1,200,000

–

$100,000

$100,000

Balance from step 2

$700,000

$400,000

$1,100,000

Apply 50% discount2

$350,000

–

$350,000

Balance from step 3

$350,000

$400,000

$750,000

Apply CGT small business 50% reduction3

$175,000

–

$175,000

$175,000

$400,000

$575,000

$175,000

$25,000

$200,000

$375,000

$375,000

–

$200,000

$200,000

Nil

$175,000

$175,000

Capital gain Apply prior year capital losses1

Apply CGT retirement exemption4

Apply CGT small business rollover5 Capital gain

1. Ellen chooses to apply the capital losses to the gain from CGT event J2 instead of A1, to preserve the discounts available to CGT event A1. 2. The 50% discount cannot apply to CGT event J2. 3. CGT small business 50% reduction cannot apply to CGT event J2. 4. Ellen’s CGT retirement exemption limit at the time is only $200,000 as she previously used $300,000. 5. Ellen chooses to disregard $200,000 of the capital gain pursuant to the CGT small business roll-over to defer the capital gain. Note that Ellen could have chosen to apply the CGT small business roll-over to disregard $375,000 of the capital gain and have a nil capital gain. The net taxable capital gain included in Ellen’s assessable income was $175,000.

¶4-720 Death of taxpayer that chose the CGT small business roll-over Special rules apply where an individual dies after applying the CGT small business roll-over. Death after acquisition of replacement asset CGT event J2 will happen on the death of an individual where the individual had acquired a replacement asset prior to death. However, any capital gain arising from CGT event J2 would be disregarded (s 12810). The death of the taxpayer will also give rise to CGT event A1 (s 104-10). The capital gain or loss from CGT event A1 will also be disregarded (s 128-10).

The replacement asset will pass through to the individual’s legal personal representative and ultimately to the beneficiary. For CGT purposes, the first element of the cost base of the asset in the hands of the legal personal representative, and then the beneficiary, will be the cost base of the asset in the hands of the deceased at the time of death (s 128-15). Therefore, the disregarded capital gain or loss from CGT event A1 will effectively pass through to the legal personal representative or the beneficiary. However, the disregarded capital gain from CGT event J2 will not pass through to the legal personal representative or the individual’s beneficiary. The disregarded capital gain that arose to the deceased individual from CGT event J2 is permanently disregarded. Example Jake applied the CGT small business roll-over to disregard a capital gain of $500,000 arising from CGT event A1 which occurred on 10 June 2012. On 13 May 2014, Jake acquired a new business. The purchase price of the goodwill was $800,000. As at 10 June 2014, being the end of the replacement asset period, the goodwill was still held and was an active asset. Therefore, CGT event J5 will not arise. Furthermore, as the purchase price of the goodwill was more than the capital gain disregarded, CGT event J6 will not arise at that time. On 16 July 2017, Jake died. In accordance with his will, the business passed to his de facto wife, Pia. Jake’s death will give rise to CGT event A1 and J2. However, the capital gain or loss from CGT event A1 and the capital gain arising from CGT event J2 will be disregarded. Pia sold the goodwill of the business for $1.5m on 19 December 2017. The sale of the goodwill will give rise to CGT event A1. The capital gain from CGT event A1 will be calculated as the capital proceeds of $1.5m less the cost base of the goodwill of $800,000, being $700,000. Pia inherited Jake’s cost base at the time of his death. Pia may be entitled to apply certain concessions to the capital gain made. CGT event J2 will not arise to Pia in the circumstances.

Notwithstanding the above, special provisions will apply which will impact upon a legal personal representative or beneficiary where CGT event J2 happened to the taxpayer on death. The special provision applies where all of the following are satisfied: (1) a replacement asset, or an asset in relation to which fourth element expenditure has been incurred, formed part of the estate of an individual who has died (2) either or both of the following apply: (a) the asset has devolved to the deceased’s legal personal representative (b) the asset has passed to a beneficiary of the deceased (3) a specified change that would give rise to CGT event J2 (being a change covered by s 104-185(2) or (3)) did not happen to the replacement asset while the deceased owned it or, if the asset has passed to a beneficiary, while the asset was in the hands of the deceased’s legal personal representative (s 152-420(1)). For the purposes of condition (3) a specified change for any replacement asset will happen where any of the following apply: • the asset stops being the entity’s active asset • the asset becomes the entity’s trading stock • the entity starts to use the asset solely to produce the entity’s exempt income or non-assessable nonexempt income (s 104-185(2)). Where the replacement asset is a share in a company or an interest in a trust, a specified change will occur where any of the following apply: (1) CGT event G3 happens to the asset (ie a liquidator or administrator declares the shares worthless)

(2) CGT event I1 happens to the asset (ie the entity, being an individual or company, ceases to be a resident of Australia) (3) either: • the entity, or an entity connected with the first entity, ceases to be a CGT concession stakeholder in the company or trust, or • CGT concession stakeholders in the company or trust cease to have a small business participation percentage in the entity of at least 90% (s 104-185(2), 104-185(3)). Where all the conditions apply, the special provision relating to the death of the individual applies such that: • anything done or not done by the deceased in relation to the asset is treated as though it had been done or not done by the legal personal representative (s 152-420(2)) • if the asset has passed to a beneficiary, anything done or not done by the deceased or by the deceased’s legal personal representative (including because of the previous point) in relation to the asset is treated as though it had been done or not done by the beneficiary (s 152-420(3)). Death before acquisition of replacement asset The special rule relating to the death of an individual that has applied the CGT small business roll-over only applies where the deceased individual has already acquired a replacement asset (s 152-420). There is no special rule where a taxpayer has not acquired the replacement asset prior to death and the replacement asset period has not yet expired. Where a replacement asset has not been acquired prior to death, none of CGT events J2, J5 or J6 will happen at the time of the death of the taxpayer. However, CGT event J5 or J6 can only occur at the end of the replacement asset period. As the individual will be deceased at this time, it would appear that these events cannot arise to the “taxpayer” as such. Therefore, the fact that the individual is deceased at that time should prevent any capital gain from these events arising. Accordingly, any deferred capital gain would be disregarded permanently. Such treatment would be in accordance with the principle that applies in relation to CGT event J2 for permanently disregarding the capital gain on death (as detailed above). There is no specific provision within ITAA97 which would allow the capital gain to be passed onto the legal personal representative or a beneficiary of the individual. However, we are not aware of any specific statements by the Commissioner in relation to capital gains from CGT event J5 and J6 being permanently disregarded upon death.

SMALL BUSINESS RESTRUCTURE ROLL-OVER ¶4-800 Introduction Optional roll-over relief is available where a small business entity undertakes a restructure pursuant to Subdiv 328-G. Roll-over relief is available for the transfer of assets as a part of a change of legal structure without a change in the ultimate economic ownership of the assets. Unlike the other CGT concessions, the relief available under this roll-over extends to the transfer of trading stock, revenue assets and depreciating assets, to provide greater flexibility for small business restructures. Accordingly, roll-over relief is available for: • capital gains and losses that arise on the transfer of a CGT asset • gains and losses that arise on the transfer of trading stock or a revenue asset, or • a balancing adjustment that arises on the transfer of a depreciating asset. The purpose of the roll-over is to facilitate flexibility for owners of small business entities to restructure

their businesses, and the way their business assets are held, without incurring adverse taxation implications.

¶4-810 Conditions for small business restructure roll-over A taxpayer is entitled to apply the small business restructure roll-over in relation to the transfer of assets where the taxpayer satisfies conditions (1) to (6) detailed below (s 328-430). (1) Genuine Restructure The first condition requires the relevant transaction is, or is part of, a genuine restructure of an ongoing business (s 328-430(1)(a)). The determination of whether there is a genuine restructure is a question of fact determined by all surrounding circumstances. The Commissioner outlines the meaning of the term “genuine restructure of an ongoing business” as it is used for these purposes in Law Companion Guideline LCG 2016/3. In accordance with the guidelines, the following features may indicate the transaction is part of a genuine restructure: • It is a bona fide commercial arrangement undertaken in a real and honest sense to facilitate growth, innovation and diversification, adapt to changed conditions, or reduce administrative burdens, compliance costs and/or cash flow impediments. • It is authentically restructuring the way in which the business is conducted as opposed to a “divestment” or preliminary step to facilitate the economic realisation of assets. • The economic ownership of the business and its restructured assets is maintained. • The small business owners continue to operate the business through a different legal structure. • It results in a structure likely to have been adopted had the small business owners obtained appropriate professional advice when setting up the business. While the Commissioner acknowledges that tax considerations are factors that can be taken into account under a genuine small business restructure, the restructure must not be contrived or unduly tax driven in the sense that it achieves a tax outcome that does not reflect the economic reality or creates an outcome that without the roll-over relief would ordinarily attract other integrity measures in the law. Other factors that would indicate that a restructure is not a “genuine restructure of an ongoing business” include: • Where the restructure is a preliminary step to facilitate the economic realisation of assets. • Where the restructure effects an extraction of wealth from the assets of the business (including accumulated profits) for personal investment or consumption or otherwise designed for use outside of the business. • Where artificial losses are created or there is a bringing forward of their recognition. • The restructure effects a permanent non-recognition of gain or the creation of artificial timing advantages. • There are other tax outcomes that do not reflect economic reality. Notwithstanding the general principles, there is a safe harbour rule pursuant to which a transaction will be treated as a genuine restructure. In accordance with the safe harbour rule, a transaction will be a genuine restructure where in the three-year period after the transaction takes effect: (a) there is no change in ultimate economic ownership of any of the significant assets of the business (other than trading stock) that were transferred under the transaction (b) those significant assets continue to be active assets, and

(c) there is no significant or material use of those significant assets for private purposes (s 328-435). (2) Parties to transaction are eligible entities The second condition requires that each party to the transfer is an entity to which one or more of the following applies: (a) it is a small business entity for the income year during which the transfer occurred (b) it has an affiliate that is a small business entity for that income year (c) it is connected with an entity that is a small business entity for that income year (d) it is a partner in a partnership that is a small business entity for that income year (s 328-430(1)(b)). However, neither the transferor nor transferee can be an exempt entity or a complying superannuation fund (s 328-430(2)). (3) Ultimate economic ownership of the assets must be maintained The third condition requires that the transaction cannot have the effect of materially changing: (a) the individual which has, or the individuals which have, the ultimate economic ownership of the asset, and (b) if there is more than one such individual, each such individual’s share of that ultimate economic ownership (s 328-430(1)(c)). In the circumstances where a discretionary trust is involved, there will not be considered to be a change in the ultimate economic ownership of an asset, or any individual’s share of that ultimate economic ownership, if: • immediately before and/or after the transaction took effect, the asset was included in the property of a non-fixed trust that was a “family trust” (ie a trust that had made a family trust election pursuant to ITAA36 s 272-80), and • every individual who, just before and just after the transfer took effect, had ultimate economic ownership of the asset was a member of the “family group” of that family trust (s 328-440). (4) The asset transferred is an eligible asset that satisfies the active asset test The fourth condition is that the asset being transferred is a CGT asset (other than a depreciating asset) and at the time of transfer is: (a) if the party to the transfer is a small business entity — an active asset (b) where the party to the transfer is an entity that has an affiliate or connected entity that is a small business entity — an active asset that satisfies the conditions for a passively held asset in s 15210(1A) (see ¶3-245) (c) where the party to the transfer is a partner in a partnership — an active asset and an interest in an asset of that partnership (s 328-430(1)(d)). While a depreciating asset is excluded from being an eligible asset in accordance with this provision, rollover relief for such an asset is effectively provided for under item 8 of the table in s 40-340(1). The inclusion of the condition will effectively prevent the transfer of a loan to a shareholder to avoid the application of Div 7A. (5) The parties to the transfer satisfy the residency requirement The fifth requirement is that the transferor and the transferee to the transaction must satisfy the Australian residency requirement as follows:

(a) if the entity is an individual or company — it is an Australian resident (b) if the entity is a trust — it is a resident trust for CGT purposes (c) if the entity is a partnership (other than a corporate limited partnership) — at least one of the partners is an Australian resident (d) if the entity is a corporate limited partnership — it is, under ITAA36 s 94T, a resident for the purposes of the income tax law (s 328-430(1)(e), 328-445). (6) The choice is made The sixth condition is that the transferor and the transferee must choose the roll-over to apply in relation to the assets transferred under the transaction (s 328-430(1)(f)). This choice must be made by the date of lodgment of the transferee’s income tax return for the income year in which the relevant transfer occurred or within such further time allowed by the Commissioner (s 103-25). The manner in which the transferor (and transferee) prepares its tax return is sufficient evidence of the transferor and the transferee making the choice to apply the roll-over.

¶4-820 Consequences of applying the CGT small business roll-over The intention of the roll-over is to be tax neutral such that there will be no direct income tax consequences arising from the transfer of asset pursuant to the roll-over (s 328-450). This includes the potential application of Div 7A where the transfer may otherwise have been treated as a deemed dividend. However, the roll-over relief will not prevent a potential application of GST, stamp duty or the antiavoidance rule in ITAA36 Pt IVA. Consequences for CGT purposes The CGT effect of applying the roll-over is as follows: (a) the CGT asset is treated as being transferred for an amount equal to the transferor’s cost base of the asset just before the transfer, thereby preventing any capital gain or loss from arising (s 328455(2)(a)) (b) any pre-CGT asset transferred maintains its pre-CGT status (s 328-460) (c) for the purpose of applying the 15-year exemption in Subdiv 152-B (¶4-100), the transferee is taken as having acquired the asset when the transferor acquired it (s 152-115(3)) (d) for the purpose of determining whether there will be a discount capital gain in the future, the transferee will be treated as having acquired the CGT asset at the time of the transfer. Unlike other roll-overs, there is no deemed acquisition back to the date of original acquisition by the transferor for the purpose of applying the CGT discount. Example 1 The PVH Family Trust is a small business entity that has been carrying on a marketing consulting business since 15 July 2006. The trust has made a family trust election. The beneficiaries of the PVH Family Trust are the Hector family, including Penny and Victor Haines. It is decided to restructure the ownership of the business into a new company, Suits Pty Limited which will be owned 50% by Penny Haines and 50% by Victor Haines. The restructure involves the transfer of the goodwill of the business which was started from scratch on 2 February 2005 which has a cost base of nil and a market value of $1.5m and the property from which the business is conducted which was acquired on 1 September 2011 for $700,000 and has a current market value of $1m. The transfer occurred on 20 July 2017. All the conditions for the small business restructure roll-over were satisfied and the PVH Family Trust and PVH Pty Limited chose to apply the roll-over. The effect of applying the roll-over is: • The PVH Family Trust is treated as having transferred the goodwill for nil consideration and the property for $700,000, thereby making no capital gain or loss on the transfer of the assets. • PVH Pty Ltd is treated as having acquired the property for $700,000 and the goodwill for nil consideration on 20 July 2017. However, for the purpose of applying the 15-year exemption in the future, the property is treated as being acquired on 1

September 2011 and the goodwill on 2 February 2005.

Consequences in relation to trading stock The consequences of applying the roll-over to an asset that is trading stock is that the asset is treated as being transferred for an amount equal to: (a) the cost of the asset for the transferor (b) if the transferor held the item of trading stock at the start of the income year — the value of the asset as at that time (s 328-455(2)(b)). The effect of the above is that the transfer should not give rise to any income taxation implications to the transferor as a result of the transfer of the trading stock. In effect, it prevents the trading stock from being transferred for its market value outside of the ordinary course of business pursuant to Subdiv 70-D. Example 2 Rory was carrying on a business of selling electronics as a sole trader. It was decided on 31 July 2017 that the business would be restructured into a corporate entity, GDH Pty Ltd, which is owned 100% by Rory. In accordance with the restructure the trading stock which had a cost of $100,000 was transferred from Rory to GDH Pty Ltd. The trading stock transferred comprised of the following: (i) $70,000 that was held as at 1 July 2017 which was included in the 2016 tax return at market selling value of $80,000, and (ii) $30,000 that was acquired on 15 July 2017. For taxation purposes, Rory is treated as selling the trading stock as (i) $80,000 for the stock held as at 1 July 2017, and (ii) $30,000 for the stock acquired on 15 July 2017. The transfer will not give rise to any taxation implications to Rory. GDH Pty Ltd is treated as having acquired the trading stock for a cost of $110,000.

Consequences in relation to revenue assets The effect of applying the roll-over to an asset that is a revenue asset is that the asset is treated as being transferred for an amount equal to the amount that would give rise to the transferor not making a profit or a loss on the transfer (s 328-455(2)(c)). The transferee will inherit the same cost attributes as the transferor just before the transfer. Consequences in relation to depreciating assets The roll-over relief available for the transfer of a depreciating asset applies in accordance with s 40340(1), item 8. This provision provides for roll-over relief on the transfer of a depreciating asset where a roll-over would have been available under Subdiv 328-G if the asset were not a depreciating asset. The roll-over relief in relation to a depreciating asset is automatic. The effect of the roll-over is that an amount that would otherwise be included in or deducted from the transferor’s assessable income because of a balancing adjustment event on the transfer of an asset will be disregarded (s 40-345). Instead, the transferee can deduct the decline in value of the depreciating asset using the same method and effective life (or remaining effective life if that method is the prime cost method) as the transferor was using (s 40-345(2)). Example 3 Tom and Jerry are the equal shareholders of HB Pty Ltd. It was decided to restructure the company into a partnership between Tom and Jerry as equal partners on 18 July 2017. As a part of the restructure the goodwill of the business was transferred together with the packing machine which has a 15-year life. The machine was acquired new on 18 July 2015 for $200,000 and had been claimed using prime cost depreciation. The written down value on 18 July 2017 was $173,333 and the market value of $160,000. The goodwill was acquired on 18 July 2017 for $100,000 as part of an acquisition and had a current market value of $250,000. The restructure was a genuine restructure in accordance with the safe harbour provisions and the parties chose to apply the small business restructure roll-over. The effect of the roll-over is that HB Pty Ltd is treated as: (a) transferring the goodwill to Tom and Jerry for its cost base of $100,000 thereby preventing a capital gain of $150,000,

(b) disregarding the $13,333 deductible balancing charge. The effect of the roll-over to Tom and Jerry is that they are treated as: (a) having acquired their respective interests in the goodwill for $50,000 each, and (b) having acquired the machine for $173,333 and being entitled to continue the decline in value of the machine over the remaining 13-year life on a straight line basis.

The roll-over relief is also available for pooled assets (s 328-243(1A)(3)). Consequences for new membership interests Where new membership interests are issued in consideration for the transfer of a roll-over asset or assets, the cost base and reduced cost base of those new membership interests is worked out based on the sum of the roll-over costs and adjustable values of the roll-over assets, less any liabilities that the transferee undertakes to discharge in respect of those assets, divided by the number of new membership interests (s 328-465). A capital loss that is made on any direct or indirect membership in the transferor or the transferee to which the roll-over has occurred will be disregarded except to the extent that the entity can demonstrate that the capital loss is attributable to a matter other than the transfer (s 328-470). Example 4 BB Family Trust restructured into the company, BB Pty Ltd. The conditions for the restructure roll-over were satisfied. The assets that were transferred were: (a) CGT assets with cost bases of $20,000 and $80,000 (b) a liability of $50,000, and (c) a depreciating asset with an adjustable value of $30,000. In exchange for the assets, 10 ordinary shares in BB Pty Ltd were issued to the BB Family Trust. The effect of the transfer is: (a) BB Family Trust does not make a capital gain or loss in relation to the CGT assets and any balancing adjustment in relation to the depreciating asset is disregarded. (b) BB Pty Ltd is treated as acquiring the CGT assets for their cost base in the hands of BB Family Trust and the depreciating asset for its adjustable value. (c) BB Family Trust obtains a cost base in the shares acquired in BB Pty Ltd of $80,000 (being 20,000 + $80,000 + $30,000 − $50,000), or $8,000 each.

Further examples of the application of the roll-over are detailed in Law Companion Guideline LCG 2016/2.

GST CONCESSIONS — REGISTRATION AND RETURNS OVERVIEW What this chapter covers

¶5-000

What is GST?

¶5-050

GST REGISTRATION CONCESSION Overview

¶5-100

Summary of GST registration concession

¶5-105

Pros and cons of adopting the GST registration concession

¶5-110

Registration

¶5-120

Australian Business Number (ABN)

¶5-130

What is an entity?

¶5-140

Carrying on an enterprise

¶5-150

Business

¶5-160

An adventure or concern in the nature of trade

¶5-170

Commercial activities which are not a business

¶5-180

Leases, licences or other grants of an interest in property

¶5-190

What other activities will be an enterprise?

¶5-200

What is not an enterprise?

¶5-220

Registration turnover thresholds

¶5-225

Turnover periods

¶5-230

Current GST turnover and projected GST turnover tests

¶5-240

Crossing the GST registration threshold at a future date

¶5-245

Current GST turnover: what makes it up?

¶5-250

Projected GST turnover: what makes it up?

¶5-255

Supplies disregarded when calculating projected GST turnover

¶5-260

Are property sales included in projected GST turnover?

¶5-265

Is GST registration required for a currently GST-registered entity? ¶5-270 Cancellation of registration

¶5-275

Time of cancellation and Commissioner’s requirements

¶5-280

Relations with customers and suppliers

¶5-285

Completion of final tax period and BAS

¶5-290

Increasing adjustments for assets on hand at cancellation date

¶5-295

Can an entity cancel GST registration to sell assets without GST? ¶5-300

GST RETURNS CONCESSION Overview

¶5-400

Quarterly tax period concession

¶5-405

Annual GST return concession

¶5-410

Who is required to lodge a GST return?

¶5-420

One-month tax periods

¶5-425

Tax period concessions for small businesses

¶5-430

When do tax periods end?

¶5-435

Concluding tax periods

¶5-440

When must a GST return be lodged?

¶5-445

Monthly tax periods

¶5-450

Quarterly tax periods

¶5-455

Annual tax periods

¶5-460

Extension of time for lodgment of GST return

¶5-465

Electing monthly tax periods

¶5-467

Annual GST return and payment

¶5-470

When must the election be made?

¶5-475

Making the annual tax period election

¶5-480

Effect of annual tax period election

¶5-485

Duration of annual tax period election

¶5-490

End of an annual tax period

¶5-495

Annual tax periods and GST groups

¶5-500

GST returns

¶5-510

Simplified quarterly reporting of actual GST liability

¶5-520

Electronic lodgment

¶5-530

Paper form lodgment

¶5-535

GST return lodgment where the entity conducted no activities

¶5-540

Net amounts

¶5-545

Correcting GST errors

¶5-550

Payment of net amounts

¶5-555

How to pay a net amount

¶5-560

Who is required to pay electronically?

¶5-565

Editorial information

Written and updated by Stephen Baxter

OVERVIEW ¶5-000 What this chapter covers This chapter deals with two GST concessions that are available to small businesses whose turnover is below certain thresholds: the GST registration concession and the GST returns concession. Under the GST registration concession, a small business whose annual GST turnover is below $75,000 (or $150,000 if it is a non-profit body) is not required to register for GST (¶5-100). Certain concessions are also available for lodgment of GST returns. A business that is not required to be registered (because its turnover is below the relevant threshold) can elect to lodge GST returns on an annual basis. A business whose turnover is above that threshold, but less than $20m, may lodge a GST return quarterly (¶5-400). Chapter 6 deals with a number of other GST concessions that apply specifically to small business entities.

¶5-050 What is GST? A 10% goods and services tax (GST) commenced in Australia on 1 July 2000. GST is similar to taxes known in other countries as value-added taxes. A “value-added tax” means that the net tax payable at any one stage is based on the increase in the price during that stage. Despite its name, GST is not limited to “goods and services” in the normally understood sense. For example, it also applies to real estate and the creation of or surrendering of rights. It is payable on transactions connected with Australia and on imports. GST is governed principally by the A New Tax System (Goods and Services Tax) Act 1999 (the GST Act). Unless otherwise stated, all references to legislation in Chapters 5 and 6 are to the GST Act. How does GST operate? GST applies to “taxable supplies” whereby an entity supplies goods, services, property and rights in the course of carrying on an enterprise such as a business. For there to be a taxable supply, the entity — called the “supplier” — must be registered, or required to be registered for GST (¶5-120), the supply must be made for consideration and it must be connected with the “indirect tax zone” which is broadly Australia less its external territories (Div 9). A typical example of a “supply” is a sale, but anything else that could be described as a supply in the normal sense of the word is also covered (s 9-10). The rate of GST is 10%. The entity must account for the GST amount to the ATO. Normally it will be included in the price charged to the customer. An entity that acquires goods or services in carrying on its enterprise can usually claim a credit for the GST component of the price. To do so, that entity — called the “recipient” — must be registered, or required to be registered, the acquisition must be of a taxable supply, be made for consideration and it must be connected with the Australian indirect tax zone (Div 11). As the credit is for business inputs, it is called an input tax credit. The combined effect of these rules is that the ultimate burden of the GST will normally fall on the end user, or private consumer. The businesses that form part of the chain of supply act as progressive collectors of the tax, but do not ultimately bear the burden of it. Some supplies are GST-free (Div 38). An entity that makes a GST-free supply is not required to remit GST on it, although it is entitled to claim input tax credits on acquisitions that relate to the GST-free supply.

Another type of supply is “input taxed” (Div 40). GST is not accounted for on an input taxed supply, however, the entity which makes it is not entitled to claim input tax credits on acquisitions which relate to that supply (s 11-15(2)). That entity pays GST on its inputs and cannot recover it from the ATO.

GST REGISTRATION CONCESSION ¶5-100 Overview Registration is fundamental to the operation of the GST system and all businesses need to consider whether they must or wish to register. “Entities” (¶5-140) which carry on an “enterprise” (¶5-150) can register. While most businesses must register for GST, there will be some for whom registration is optional. There is a registration turnover threshold. If an entity makes an annual volume of supplies which equals or exceeds the registration turnover threshold, it is required to register (¶5-120). Generally, only registered entities can charge GST and claim an input tax credit for any GST paid. If an entity is required to be registered, it is important that it does register at the right time, as failure to do so can result in penalties (TAA Sch 1 s 288-40). Registration can be backdated by the Commissioner, leaving the entity liable for any GST that should have been charged. The entity may have the option of cancelling its registration (¶5-270), or the Commissioner may unilaterally cancel the registration (¶5-275).

¶5-105 Summary of GST registration concession The primary GST concession available to an entity conducting a small business is to be outside of the GST system altogether. A small business can remain outside of the GST system if it does not register for GST and it is not required to be registered. If a small business is registered for GST, it may be able to leave the GST system by cancelling its registration (¶5-275). Provided that the entity is not required to be registered, then such an unregistered small business will not have a GST liability on supplies it makes. To describe a small business as remaining outside of the GST system is not to suggest that it is operating in the black economy or avoiding tax. Rather, the Australian GST system allows small businesses to have relief from GST compliance where they would only have to pay a small net amount of GST (¶5-545) if they were registered. A business is not required to register if its annual GST turnover is below the GST registration turnover thresholds of: • $75,000 unless it is a non-profit body, or • $150,000 if it is a non-profit body (s 23-15; A New Tax System (Goods and Services Tax) Regulations 1999 reg 23-15.01 and 23-15.02). Where a business is registered, it is not required to remain registered if its annual GST turnover is below the relevant thresholds applicable to its type of entity (¶5-225).

¶5-110 Pros and cons of adopting the GST registration concession In cases where a small business is not required to be registered, the advantages for it in remaining unregistered or cancelling registration, hence being outside the GST system, are: • no GST on supplies — the small business will not be required to charge GST on supplies that it makes • lower selling prices — the business may be able to charge lower prices than its GST-registered

competitors who are likely to have increased their prices to recover the GST they must pay. The lower prices charged by an unregistered small business can help generate greater market share and profits • greater margin — alternatively, a small business can generate greater margin and profit than its registered competitors where it charges the same total price and there is no GST amount payable that would have the effect of reducing its gross margin • compliance reductions — the small business does not need to keep records of GST charged on supplies or paid on acquisitions. It will not need to code each transaction for GST. It will not need to track the things it has acquired and make GST adjustments in the event of changes in their use. Typically, it will not need to lodge returns, keep up with GST developments, seek and pay for GST advice on transactions that it incurs or is planning, nor devote time to GST training, particularly in respect of the use of its accounting software. For many small businesses these compliance costs can be significant • increased profit on property sales — where the entity owned real property at 1 July 2000 and it intends to develop it for sale, its GST payable under the margin scheme will be lessened if it can delay any eventually required GST registration for as long as possible (Div 75) • audit risks will be reduced — an unregistered small business is very unlikely to be subject to an ATO GST audit. The disadvantages for a small business that chooses not to register for GST are: • no input tax credits — the small business cannot claim input tax credits for the GST it has been charged on the acquisition of goods, services and other things • higher cost base — the prices for supplies it makes may have to increase or its margins may fall because its inability to claim input tax credits increases its cost base • loss of business custom — many business suppliers and customers prefer, or even insist, on dealing only with other GST-registered businesses. Further, business customers can only claim input tax credits on purchases (usually 1/11th of their purchase price) where the supplier is registered, charges GST and issues a tax invoice. An unregistered small business may find it loses business customers whose net cost will be lower where they can buy from competing GST-registered suppliers and claim credits • monitoring GST turnovers — an unregistered small business faces the administrative chore of continually monitoring whether its current or projected turnover (¶5-245) is approaching the relevant threshold. An unregistered small business is effectively required to check its turnover every month • potential reputation damage and embarrassment — an unregistered small business is effectively “advertising” that its turnover is below the threshold. This may suggest to customers and others that it is a micro business that may not be commercial or sustainable • the purchase of another business may cost 10% more — where an entity is neither registered nor required to be, it will not be entitled to acquire another enterprise GST-free as a going concern. Rather, the business vendor will be required to charge the entity GST on the sale. Only GSTregistered businesses can purchase other businesses GST-free as a going concern • GST liabilities triggered for associates — a GST-registered associate may have a GST liability where it makes supplies to a non-GST registered related entity which are for no consideration or below market value. Some corporate groups fail to identify this risk especially for transactions with non-GST registered investment entities. By contrast, in most circumstances, where the entity is GSTregistered, a GST liability is not triggered for the associate in respect of the latter’s supplies made for no consideration or below market.

Example Effect of GST registration on costs and prices Unregistered P/L sells widgets in direct competition with Registered P/L. With the exception of GST, they have the same cost base and each sells its goods at net cost plus 20%. Each has only three inputs being stock and rent, upon which GST is payable, and wages, which are not subject to GST.

Cost element

Cost/price (ex GST) and margins for both competitors

Unregistered P/L’s costs and prices (including GST where applicable)

Registered P/L’s costs and prices (including GST where applicable)

Stock

$60

$66

$66

Rent

$40

$44

$44

Wages

$50

$50

$50

Total cost

$150

$160

$160

1/11th of stock and rent

Nil

$10

$160

$150

$32

$30

$192

$180

Nil

$18

$192

$198

Less input tax credits Net cost after input tax credits Margin

20% of net cost

Selling price before GST GST

10%

Total selling price

As Unregistered cannot claim input tax credits on the acquisition of its inputs (stock and rent), its net cost base is higher than Registered. However, its total selling price of widgets is lower than Registered as the latter must charge GST. The fact that Unregistered has a lower total selling price than Registered does not imply it has a competitive advantage. That will depend on the goods they are selling and the particular market. If they are selling solely to GST-registered enterprises who can claim input tax credits, then Registered will have a commercial advantage. That is because the net cost that Registered’s customers incur for the widgets will be $180 after they have claimed input tax credits of $18 for the GST charged to them. In comparison, the net cost to those customers should they buy from Unregistered is $192. By contrast, if the two businesses are selling solely to customers who cannot claim input tax credits, Unregistered will usually have a competitive advantage because its price of $192 is lower than the $198 charged by Registered.

Rules of thumb Small businesses that are not registered for GST usually will be able to sell their goods or services for lower prices than their GSTregistered competitors. It follows that customers who cannot claim input tax credits will usually incur a lower net cost where buying from an unregistered supplier. That is because their cost will be whatever total price they are charged. Suppliers that are not registered for GST will, all other things being equal, have a competitive advantage when supplying to the following customer types: • financial institutions and superannuation funds with limits on the input tax credits they can claim • residential property investors who typically cannot claim input tax credits for acquisitions relating to their properties • other unregistered businesses • individuals and families who are purchasing in a private capacity. By contrast, business customers who can claim input tax credits will usually have a lower net cost of goods and services where they buy from a GST-registered supplier. That is because: • the supplier itself can claim input tax credits on its inputs and then pass on the benefit of those credits to the business customer through lower prices (before GST is added) • the business customer can claim input tax credits for GST added by the supplier to its prices.

The ATO has advised that, during the 2016/17 year, approximately 974,000 taxpayers were voluntary GST registrants, representing 36% of all registrants.

¶5-120 Registration Only “entities” can be registered. The registration tests (s 23-5, 23-10) are written as if applied to “you” which itself is defined as applying to entities generally (s 195-1). “Entity” is widely defined and includes all kinds of legal persons (¶5-140). As far as registration is concerned, there are essentially three categories: (1) entities that are required to be registered (2) entities that are not required to be registered but have an option to register if they so choose (3) entities that are not entitled to be registered. Which entities are required to be registered? An entity is required to be registered if: • it carries on an “enterprise” (¶5-150), and • its GST turnover meets the registration turnover threshold (s 23-5). The registration turnover threshold is currently $75,000 except for non-profit bodies which have a registration turnover threshold of $150,000 (s 23-15). For turnover thresholds, see ¶5-225. Entities which supply taxi travel (including entities and drivers providing ride-sourcing services) have to register regardless of GST turnover (s 144-5). Which entities have an option to register? An entity has the option to be registered if: • it carries on an “enterprise”, and • its GST turnover is below the registration turnover threshold (s 23-10). Entities which cannot register Any entity which is not carrying on, or intending to carry on, an enterprise (¶5-150) is not entitled to be registered. Entities that are charitable or religious institutions, government bodies or certain superannuation funds are entitled to register even if they would not appear to be carrying on a business.

¶5-130 Australian Business Number (ABN) An Australian Business Number (ABN) is a critical part of the GST system. It is usually necessary to have an ABN before a business can register for GST (although the one process is usually used to apply for both). The ABN also acts as the GST registration number for GST-registered entities. The ABN is a number which is used to identify a business entity. It is required to be printed on many documents issued by the entity. It usually appears on official communications from the government to the entity. A small business is entitled to have an ABN if any of the following apply: • it is carrying on an enterprise in Australia • in the course or furtherance of carrying on an enterprise, it makes supplies that are connected with the Australian indirect tax zone • it is a Corporations Act company (A New Tax System (Australian Business Number) Act 1999 s 8(1), 8(2))

• certain deductible gift recipients and charities. The decision whether to have an ABN is related, but not identical, to the decision whether or not to register for GST. Many small businesses that remain unregistered for GST purposes have an ABN. They do so primarily for two reasons, namely: • so that PAYG withholding tax (currently at the rate of 47%) is not withheld on payments to them for supplies they have made • because many other businesses choose not, for practical system and operational reasons, to undertake transactions with entities that do not have an ABN.

¶5-140 What is an entity? “Entity” is widely defined and includes all kinds of legal persons, ie those capable of having and exercising legal rights and being subject to legal obligations and liabilities (s 184-1). An “entity” means any of the following: • an individual — ie a natural person • a body corporate — this includes a company, building society, credit union, trade union, statutory body, strata title body corporate, municipal council, incorporated association and certain governing bodies of various religious institutions (Miscellaneous Taxation Ruling MT 2006/1) • a corporation sole — ie a corporation consisting of one natural person only and that person’s successors to a particular position, eg a bishopric • a body politic — ie essentially a body of persons under a system of government. This would mean the Crown in right of the Commonwealth, or a state or territory • a partnership — ie an association of persons carrying on business as partners or in receipt of ordinary or statutory income jointly, not including a company, or a limited partnership • any other unincorporated association or body of persons. This might include barrister chambers, community groups, sporting clubs, sport associations and literary societies • a trust, or the trustee of the trust at any given time (see below) • a superannuation fund, or the trustee of the fund at any given time • non-charitable public ancillary funds. Trustees Although a trust is specified as an entity, the Commissioner does not accept that a trust in its own right can be registered on the Australian Business Register. Rather, the trustee of the trust or superannuation fund will be registered and will be issued with an ABN in its capacity as trustee. The entity consists of the person or persons who are the trustees at any given time (s 184-1(2)). The legal name of the entity will usually be identified on the Register as the trustee of the particular trust, eg “The Trustee for the Jones’ Family Trust”. Can an entity act in more than one capacity? A legal person may act in various capacities. For example, an individual may act in his or her personal capacity, as well as in the capacity of a trustee. In such cases the person will be treated as a different entity in each of those capacities (s 184-1(3)). Registration rules for specific types of entities Certain types of entities have specific GST registration rules applying to them including company groups (Div 48), branches and divisions (Div 54), resident agents of non-residents (Div 57), representatives of

incapacitated entities (Div 58), non-profit bodies and charities (Div 63), non-residents (Div 83), nonresident limited registration entities (Div 84), taxi operators (Div 144), and government departments (Div 149).

¶5-150 Carrying on an enterprise For an entity to be eligible for registration it must be carrying on an “enterprise” or intending to do so from a particular date. “Enterprise” covers a wide range of activities from activities in the form of business and trade to activities of charities (s 9-20). Activities done as an employee or for private recreational pursuits or as a hobby will not be an enterprise. The activities which are included and specifically excluded are discussed in the following paragraphs. Activity or series of activities An enterprise can be a single activity or a series of activities. A single entity may carry on more than one enterprise or it may carry on a number of activities, some of which qualify as an enterprise and some which do not. For an entity to be entitled to registration, it is only necessary to identify one qualifying activity. Examples (1) A self-employed doctor also runs a profitable farm. The doctor is carrying on two enterprises. If the doctor registers, the registration will cover both enterprises. (2) An individual is employed by a university as a lecturer. She also carries on a consultancy business independent of the university employment. The employment by the university would not qualify as an enterprise. The consultancy business would qualify as an enterprise. If she registers, her GST registration will only apply to the consultancy activities.

The Commissioner has issued a ruling dealing with the meaning of an entity carrying on an enterprise for the purpose of entitlement to an ABN (Miscellaneous Taxation Ruling MT 2006/1). In respect of that matter, the ruling can be applied for the purpose of entitlement to register for GST as the relevant legislative provisions are virtually the same and entities which are entitled to an ABN are usually entitled to register for GST (GST Determination GSTD 2006/6).

¶5-160 Business An activity, or series of activities, done in the form of a business will be an enterprise (s 9-20(1)(a)). Business includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee (definition of “business”, s 195-1). Example A self-employed accountant would be carrying on a business but an accountant employed by an accounting firm would not be carrying on a business, although the accounting firm would be carrying on a business.

The following table provides a summary of the main indicators of carrying on a business (Taxation Ruling TR 97/11). Indicators which suggest a business is being carried on

Indicators which suggest a business is not being carried on

A significant commercial activity

Not a significant commercial activity

Purpose and intention of the taxpayer in engaging in the activity

No purpose or intention of the taxpayer to carry on a business activity

An intention to make a profit from the activity

No intention to make a profit from the activity

The activity is or will be profitable

The activity is inherently unprofitable

Repetition and regularity of activity

Little repetition or regularity of activity

Activity is carried on in a similar manner to that of the ordinary trade

Activity carried on in an ad hoc manner

Activity organised and carried on in a businesslike manner and systematically and records are kept

Activity not organised or carried on in the same manner as the normal ordinary business activity and records are not kept

Size and scale of the activity

Small size and scale

Not a hobby, recreation or sporting activity

A hobby, recreation or sporting activity

A business plan exists

There is no business plan

Commercial sales of product

Sale of products to relatives and friends

Taxpayer has knowledge or skill

Taxpayer lacks knowledge or skill

¶5-170 An adventure or concern in the nature of trade An activity, or series of activities, done in the form of an adventure or concern in the nature of trade will be an enterprise (s 9-20(1)(b)). This essentially applies to one-off businesslike ventures as, generally, ongoing trading activities will in any case constitute a business (¶5-160). When determining whether the one-off venture is in the nature of trade, the character of the activity as a whole needs to be considered. The mere realisation of an investment asset or private asset will not usually qualify. For example, the sale of the family home, car or other private assets, even if it is at a profit or capital gain, will generally not be commercial and will not be an adventure or concern in the nature of trade. According to the Commissioner, an adventure or concern in the nature of trade includes a commercial activity that does not amount to a business but which has the characteristics of a business deal (Miscellaneous Taxation Ruling MT 2006/1, para 244). The Commissioner has accepted six identifying features or “badges” of an activity in the nature of trade. They are the form and quantity of any real or personal property realised, the length of period of ownership, the frequency and number of transactions, any supplementary work on or in connection with the property realised, the circumstances that were responsible for the realisation and motive (Miscellaneous Taxation Ruling MT 2006/1, para 245–257). The question of whether an entity is carrying on an enterprise when it makes an isolated real property transaction (eg a subdivision) is discussed in Miscellaneous Taxation Ruling MT 2006/1 (para 262–302). The sale of shares acquired as an investment would in most cases be the mere realisation of an investment asset and should not constitute an adventure or concern in the nature of trade. An adventure or concern in the nature of trade will also apply to ongoing commercial activities which are not business activities as such.

¶5-180 Commercial activities which are not a business The fact that the activities of a body are limited to making supplies to members of the body does not prevent those activities being in the form of a business or an adventure or concern in the nature of trade (s 9-20(3)). The Commissioner takes the view that organisations or associations such as non-profit clubs whose receipts consist entirely of mutual receipts may not be carrying on a business but rather carrying on activities that are similar to business activities (Miscellaneous Taxation Ruling MT 2006/1, para 223). A body corporate under strata title legislation was held to be carrying on an enterprise as its activities were done in a businesslike manner (Body Corporate, Villa Edgewater Cts 23092 v FC of T 2004 ATC 2056). The AAT observed that an enterprise may be conducted even though an entity only deals with its

own membership. It did not matter that many of the activities were provided for in statute and regulations.

¶5-190 Leases, licences or other grants of an interest in property An activity, or series of activities, done on a regular or continuous basis, in the form of a lease, licence or other grant of an interest in property, will be an enterprise (s 9-20(1)(c)). Thus, an enterprise can include the activity of leasing a residential or commercial building to a tenant. The ATO considers that an activity is “regular” if it is repeated at reasonably proximate intervals and is “continuous” if there is no significant cessation or interruption to the activity (Miscellaneous Taxation Ruling MT 2006/1, para 306). Example (1) Jennie has a holiday home used extensively by her family. She lets outs the home for a few weeks every year to make some money to contribute to its maintenance. The activity of leasing the holiday home is not an enterprise as the activity is not regular or continuous. (2) Jane has a holiday home used regularly by her family. She lets outs the home for 20 weeks every year with a view to making a profit. The activity of leasing the holiday home is an enterprise as the activity is regular and continuous. (3) Charles has a boat. Each weekend and during his holidays, Charles profitably operates the boat on charter for fishing trips. The charter activity is an enterprise as the activity is regular and continuous.

¶5-200 What other activities will be an enterprise? Various other activities will also constitute an enterprise. Non-profit charitable, religious and deductible gift funds An activity, or series of activities, done by the trustee of a fund, or an authority or institution to which deductible gifts for income tax purposes can be made, will be an enterprise (s 9-20(1)(d)). The organisations referred to must be covered by ITAA97 Subdiv 30-B. Further, an activity, or series of activities, done by a charity will be an enterprise (s 9-20(1)(e)). Generally these entities will be non-profit organisations and so will have a higher registration turnover threshold (¶5-120). Trustees of complying superannuation funds An activity, or series of activities, done by a trustee of a complying superannuation fund will be an enterprise (s 9-20(1)(da)). If there is no trustee, then the activities done by the person who manages the fund will be an enterprise. All complying superannuation funds can register for GST. Commonwealth, states, territories or public corporations An activity, or series of activities, done by the Commonwealth, a state or a territory, or by a body corporate, or corporation sole, established for a public purpose by or under a law of the Commonwealth, a state or a territory, will be an enterprise (s 9-20(1)(g)). However, activities by certain members of local councils do not constitute an enterprise (¶5-220). Public ancillary funds and private ancillary funds An activity, or series of activities, done by a public ancillary fund or a private ancillary fund will be an enterprise. However, the fund must be covered by item 2 of the table in ITAA97 s 30-15 or would be covered by that item if it had an ABN (s 9-20(1)(h)). These funds are typically those established and maintained under a will or instrument of trust solely for the purpose of providing money, property or benefits to gift deductible funds, authorities or institutions.

¶5-220 What is not an enterprise? Certain activities are specifically excluded from constituting an enterprise.

Employees and those subject to PAYG withholding An enterprise does not include an activity, or series of activities, done by a person as an employee or by a person in connection with earning an amount subject to specified PAYG withholding rules (s 9-20(2)(a)). This applies to employees, company directors, officeholders and persons hired under labour hire arrangements. Their activities may, of course, constitute the enterprise carried on by their employer. Religious practitioners carrying out pastoral and related duties are usually not treated as carrying on an enterprise (A New Tax System (Australian Business Number) Act 1999 s 5A). Private recreational pursuits and hobbies An enterprise does not include an activity, or series of activities, done as a private recreational pursuit or hobby (s 9-20(2)(b)). In some cases there is a fine line between a hobby and a business. A hobby can develop into a business (¶5-160). No expectation of profit An enterprise does not include an activity, or series of activities, done by an individual or a partnership of only or mostly individuals where there is no reasonable expectation of profit or gain (s 9-20(2)(c)). The expectation of profit or gain need not be for the current year or the short term. There are some activities for which the realistic expectation of profit or gain is only over the long term. For example, in some horticultural activities it may take some years before the plants bear fruits of sufficient quantity and quality to provide the horticulturist a profit. A reasonable expectation requires more than a possibility. While the subjective intentions of the individual or partnership carrying out the activities are important, the determination of “reasonableness” ultimately is an objective test. Example Catherine is a full-time employee. She uses most of her leisure time to paint in a dedicated studio she has set up in her home. Catherine has a stall at a weekend market at which she sells her paintings. She makes a very small profit which enables her to keep on painting. The Commissioner is likely to classify the painting activities as a hobby. If Catherine enters into a deal with a gallery which sells her work on an ongoing basis, arranges special exhibitions and promotes her work, then it might be arguable that there is a reasonable expectation of profit or gain in the longer term.

Members of local governing bodies An enterprise does not include an activity, or series of activities, done as a member of a local governing body established by or under a state or territory law (s 9-20(2)(d)). This essentially refers to members of local councils.

¶5-225 Registration turnover thresholds Entities carrying on an enterprise (¶5-150) must register for GST if their GST turnover meets the registration turnover threshold (s 23-5). If an entity’s GST turnover is below the registration turnover threshold, that entity does not have to register but it does have the option of registering if it so desires (s 23-10). The registration turnover threshold (other than for non-profit bodies) is $75,000 (s 23-15; reg 23-15.01). For non-profit bodies the registration turnover threshold is $150,000 (s 23-15; reg 23-15.02). An entity will meet the registration turnover threshold (and therefore must register) if: • its current GST turnover is $75,000 or more (or for non-profit bodies $150,000 or more) and the Commissioner is not satisfied that its “projected GST turnover” is below those amounts, or • its projected GST turnover is $75,000 or more (or for non-profit bodies $150,000 or more) (s 188-10).

¶5-230 Turnover periods

Current and projected GST turnovers are measured monthly rather than annually. An entity’s current GST turnover is measured over the 12-month period ending at the end of the current month (s 188-15). An entity’s projected GST turnover is measured over the 12-month period starting at the beginning of the current month (s 188-20). Example In November 2017: • the current GST turnover is measured from the start of December 2016 to the end of November 2017, and • the projected GST turnover is measured from the start of November 2017 to the end of October 2018.

¶5-240 Current GST turnover and projected GST turnover tests Whether an entity meets or does not exceed the turnover threshold depends on an objective assessment of its current GST turnover and projected GST turnover. An objective assessment is one that a reasonable person could be expected to arrive at, having regard to the facts and circumstances which apply to the enterprise at the relevant time. The supplies to be included are those that the entity has made or is likely to make, so there must be a level of expectancy. The ATO will usually accept the entity’s assessment unless the Commissioner has reason to believe that the assessment was not reasonable. For the purpose of calculating projected GST turnover, the Commissioner will accept a calculation based on a bona fide business plan, accounting budget or some other reasonable estimate (GST Ruling GSTR 2001/7, para 16 and 24). The table below shows various current GST turnover and projected GST turnover combinations and outlines whether the turnover threshold is met or exceeded. This table covers the GST turnovers required for determining whether each of the small business GST concessions discussed in Chapters 5 and 6 are applicable. Current GST turnover

Projected GST turnover

Is the turnover threshold met?

At or above the turnover threshold

At or above the turnover threshold

Yes (s 188-10(1))

At or above the turnover threshold

Not possible to determine

Yes (s 188-10(1))

At or below the turnover threshold

At or above the turnover threshold

Yes (s 188-10(1))

Current GST turnover

Projected GST turnover

Is the turnover threshold exceeded?

At or below the turnover threshold

At or below the turnover threshold

No (s 188-10(2))

At or below the turnover threshold

Not possible to determine

No (s 188-10(2))

At or above the turnover threshold

Below the turnover threshold

No (s 188-10(2))

Where registration may not be required It is possible for an entity not to meet the registration turnover threshold even where it has a current GST turnover at or above that threshold. That will only occur where the Commissioner is satisfied that its projected GST turnover is below the turnover threshold (GST Ruling GSTR 2001/7, para 16–18). Example Marek has a current GST turnover of $200,000 and is registered for GST. Due to loss of some major customers, his projected GST turnover is $50,000. Provided the Commissioner can be satisfied of that fact, Marek does not meet the registration turnover threshold and his GST registration can be cancelled subject to certain matters, see ¶5-270.

¶5-245 Crossing the GST registration threshold at a future date An entity’s status regarding the requirement to register may change monthly. An unregistered entity which is currently below the registration threshold and which is not currently required to register will need to monitor its current and projected GST turnovers on a monthly basis to ensure that the need to register does not arise. Example Rima commenced a mobile ice cream business on 1 July 2015. She did not register for GST as she expected her sales would be below the $75,000 registration turnover threshold and she was initially correct. Rima’s current GST turnover for the 12-month period ending December 2017 was $68,000 (being $10,000, $10,000, $15,000 and $33,000 for the March, June, September and December quarters respectively). Her current GST turnover is below the registration turnover threshold. However, from July 2017, she has noticed a significant increase in sales per month compared with the corresponding month in the previous year. By the beginning of December that growth has been maintained and she budgets the growth to continue across the full financial year and maintain the same level of sales thereafter. Her projected GST turnover for the 12-month period commencing 1 December 2017 is $78,000 ($11,000 for the month of December 2017, then $15,000 for March, June and September 2018 quarters respectively and $22,000 for October to November 2018). As her projected GST turnover meets the registration turnover threshold, Rima is required to register. As her current GST turnover does not meet the threshold and she had not met the threshold previously, she will only be required to register from 1 December 2017.

The example above shows the difficulties an entity faces where the turnover is expected to cross the registration turnover threshold based on future supplies. The difficulties are exacerbated where an entity realises that it has crossed the threshold during a month. Not only is the entity required to register for GST but it must commence charging GST immediately. Its price lists may now be inaccurate. It may have quoted prices to customers and commenced jobs where it now has to charge GST and may not be able to recover the GST payable from its customers. Rules of thumb Where the projected GST turnover of an unregistered entity approaches the registration turnover threshold, the entity needs to be fully prepared for the transition to GST registration and charging. There are numerous practical difficulties in moving from outside the GST system to GST registration at short notice and during the middle of a tax period. It may be prudent for an unregistered entity to apply for GST registration at the start of a tax period if there is any prospect that it will be required to register for GST during the period.

¶5-250 Current GST turnover: what makes it up? The current GST turnover is the sum of the values (excluding GST) of all the supplies that the entity has made, or is likely to make, in the 12-month period ending in the current month, other than: • supplies that are input taxed (s 188-15(1)) • supplies that are not for consideration (with the exception of certain supplies to associates) (s 18815(1)) • supplies not made in connection with an enterprise that the entity carries on (s 188-15(1)) • supplies that are not connected with the Australian indirect tax zone (s 188-15(3)) • supplies of certain rights or options to acquire other things such as holiday packages acquired overseas (s 9-25(5)(c)) • supplies of certain rights or options to use commercial accommodation in Australia (s 188-15(3)) • supplies for which the consideration is a payment of money, or a supply by an insurer in settlement of

a claim under an insurance policy (s 188-22). If the entity is a member of a GST group, the current GST turnover is the sum of the values of all relevant supplies by all members of the group during the period in question, other than both those excluded above and supplies between GST group members (s 188-15(2)).

¶5-255 Projected GST turnover: what makes it up? The projected GST turnover is the sum of the values (excluding GST) of all the supplies that the entity has made, or is likely to make, in the 12-month period beginning in the current month, other than the supplies which are excluded from the current GST turnover (¶5-250). In addition, the following supplies are excluded from the projected GST turnover: • supplies made, or likely to be made, by way of transfer of ownership of an entity’s capital assets (s 188-25(a)) • supplies made, or likely to be made, by an entity solely as a consequence of: – ceasing to carry on an enterprise, or – substantially and permanently reducing the size or scale of an enterprise (s 188-25(b)). Again, if the entity is a member of a GST group, then the projected GST turnover is the sum of the values of all relevant supplies by all members of the GST group during the period in question, other than both those excluded above and supplies between GST group members (s 188-20(2)).

¶5-260 Supplies disregarded when calculating projected GST turnover Supplies which can be disregarded when determining the projected GST turnover include expected transfers of the whole of an entity’s beneficial ownership of capital assets (s 188-25(a) and GST Ruling GSTR 2001/7, para 37). This means the profit-yielding subject of an enterprise and may include: • tangible assets such as a factory, shop, office, land, plant, machinery and motor vehicles, and • intangible assets such as goodwill (GST Ruling GSTR 2001/7, para 31–36). Others supplies which can be disregarded when determining the projected GST turnover include supplies made, or likely to be made, solely as a consequence of: • ceasing to carry on an enterprise, or • substantially and permanently reducing the size or scale of an enterprise. To be so excluded, the supplies in question must be only made as a consequence of the cessation or the substantial and permanent reduction (s 188-25(b)). Supplies must be included in projected GST turnover if they merely lead to the cessation of, or substantial or permanent reduction of the size and scale of, the enterprise (GST Ruling GSTR 2001/7, para 38–41).

¶5-265 Are property sales included in projected GST turnover? Property sales can be disregarded from the turnover calculations where they are capital assets and not trading assets. Sales of commercial buildings which an entity occupies or holds as an investment can be disregarded. Example Alan, a retiree, owns three shops each rented to tenants whose weekly tenancies are to terminate on 14 December 2017. The rent payable for each of the three shops is $200 per week. Alan sells the shops with vacant possession for $200,000. Alan’s only enterprise is renting the shops. He is not registered for GST. He is not intending to carry on any other enterprise in the next 12 months. Settlement is to take place on 20 December 2017.

Alan’s current GST turnover as calculated in December 2017 is the sum of the values of all the supplies that he has made, or is likely to make, during the 12 months ending on 31 December 2017. Alan’s current GST turnover is 50 weeks rent of $600 per week (up to 14 December 2017) plus the $200,000 from the sale of the shops, a total of $230,000. Alan’s current GST turnover is above the registration turnover threshold. Alan’s projected GST turnover is the sum of the values of all the supplies that Alan has made, or is likely to make, in December 2017 and up to 30 November 2018. Alan has made, or will make, supplies of two weeks rent of $600 per week (up to 14 December 2017) plus the $200,000 from the sale of the shops. His projected GST turnover would have been $201,200. In selling the shops, Alan will dispose of a capital asset in addition to ceasing to carry on his enterprise. Alan can disregard the $200,000 from the sale of the shops, so his projected GST turnover is $1,200. As Alan has calculated his projected GST turnover to be below the registration turnover threshold, his GST turnover does not meet that turnover threshold. He is not required to register for GST. (Based on example in GST Ruling GSTR 2001/7, para 53–57.)

Property sales made solely as a consequence of ceasing to carry on an enterprise can be disregarded. By contrast, expected sales by a developer of development sites or newly developed property usually are included in projected GST turnover. That is because they are typically: • revenue assets and not capital assets because their realisation is inherent in, or incidental to, the carrying on of a business (GST Ruling GSTR 2001/7, para 34), or • isolated transactions where the enterprise ceases as a consequence of disposal of the asset rather than the property being sold as a consequence of ceasing to carry on the enterprise (GST Ruling GSTR 2001/7, para 46–47). Example Camillie acquired land and built two town houses for sale. She has sold one town house and will retire from business after the sale of the remaining town house. The sale of the remaining town house is the transfer of a revenue asset. The sales are inherent in the operation of her enterprise as they were planned for at its commencement. The sale is not solely as a consequence of the cessation of the enterprise. As the town house is expected to sell within the next 12 months for $330,000, Camillie must include the sale of the town house in her projected GST turnover and must be registered for GST.

¶5-270 Is GST registration required for a currently GST-registered entity? A GST-registered entity must cancel its registration if it is no longer carrying on an enterprise (s 25-50). A GST-registered entity can apply for cancellation of its registration if it is not required to be registered because its projected GST turnover for the 12-month period beginning with the current month does not meet the registration turnover threshold. If the Commissioner is satisfied of that fact and the entity has been registered for at least 12 months, the Commissioner must cancel its registration (s 25-55(1)). If the entity applies for cancellation less than 12 months after being registered, the Commissioner may, but is not compelled to, cancel if the Commissioner is satisfied that its projected GST turnover does not meet the registration turnover threshold (s 25-57(1)). A GST-registered entity that continues to carry on an enterprise of supplying taxi or limousine travel for fares (including ride-sourcing services) is not entitled to cancel its GST registration. Note that the small business tax issue in question here is choosing to be unregistered for GST. For that reason a discussion of the GST registration process is not included.

¶5-275 Cancellation of registration The practical effects of the cancellation of GST registration to a previously registered entity include: • the process of cancellation • the day of cancellation and the Commissioner’s requirements • relations with suppliers and customers • the completion of the final tax period and BAS

• increasing adjustments required for assets on hand at cancellation date. Process of cancellation An entity which is currently GST-registered but is below the registration turnover threshold must apply to the Commissioner if it wishes to cancel its registration. The only circumstance where the Commissioner has the power to cancel the GST registration of an entity which has not applied for cancellation is when the entity is not carrying on an enterprise (s 25-55(2)).

¶5-280 Time of cancellation and Commissioner’s requirements While an entity can apply for its GST registration to be cancelled from a particular day, the Commissioner decides which date the cancellation takes effect. The date of effect can be any date in the past, present or future (s 25-60(1)). The cancellation application form, requires the entity to state that either, from the cancellation date, it has stopped operating, or has never operated, on a GST-registered basis. The statement needs to be made by whichever means the cancellation application is made, ie by phone, online, on the published form or in writing by other means. The Commissioner is satisfied that an entity has stopped operating (or never operated) on a GSTregistered basis from a certain date if, from that date or prospective date: • the entity has not informed other businesses that it is registered for GST • it has not issued any tax invoices or adjustment notes • it has cancelled any recipient created tax invoice arrangements that it had with suppliers or customers • it has not claimed any input tax credits, special transitional credits or indirect transitional credits. The Commissioner will consider these factors and any other matters to decide whether to cancel the GST registration and the date of effect of the cancellation. The Commissioner’s usual practice is to delay the date of effect of cancellation until the Commissioner is satisfied the entity is not operating on a GSTregistered basis. Example Manuel has been registered for GST for several years despite his GST turnover being just $40,000. On 30 June 2018, he applies to the Commissioner for cancellation of his GST registration from 1 April 2018. Based on his declaration and other information, the Commissioner is aware that he has made sales to business customers during the April–June 2018 period and issued tax invoices to those customers. The Commissioner is more likely to decide that the cancellation of the GST registration will take effect from 1 July 2018 or some later date.

¶5-285 Relations with customers and suppliers If it wishes to cancel GST registration, a currently GST-registered business must change the way it operates with suppliers and customers by: • refraining from issuing tax invoices or adjustment notes • changing pricing and price lists to GST-exclusive prices and to reflect higher cost bases because input tax credits can no longer be claimed on acquisitions • informing customers and suppliers with whom it has recipient created tax invoice (RCTI) agreements that it is no longer GST-registered • considering contracts in progress where prices and terms were struck on a GST-registered basis. Examples include those where it is a supplier and has agreed on a GST-inclusive price or where it is a recipient and has agreed to the purchase of a business as a going concern (s 38-325(1)(b))

• deciding whether to retain its ABN. Rule of thumb Entities which intend to cancel GST registration need to plan well ahead, particularly in respect of relations with suppliers and customers. Some suppliers and customers may refuse to deal with them after cancellation. Even where an entity decides to cancel GST registration, it is usually preferable to retain the ABN. Where an entity did not quote an ABN on a supply that it made its business customer may deduct 47% PAYG withholding tax from payments to the entity. Retaining the ABN and quoting it on invoices, for example, prevents the 47% withholding deduction.

¶5-290 Completion of final tax period and BAS After an entity cancels its GST registration, it will have a concluding tax period ending at the end of the day of effect of the cancellation (s 27-40(2)). The entity will be required to lodge a GST return for GST payable, input tax credits claimable and adjustments occurring during that concluding tax period. If the entity is accounting for GST on a cash basis (¶6-100), the Business Activity Statement (BAS) for the concluding tax period will include GST on any supplies made, input tax credits on any acquisitions made and any adjustments for the entity that: • were not attributable, to any extent, to a previous tax period during which it accounted on a cash basis, and • would have been attributable to that previous tax period had the entity not accounted on a cash basis during that period (s 138-15). Example Casey applies for cancellation of his GST registration from 15 October and the Commissioner cancels the registration from that date. He was operating on a cash basis. Casey has made $33,000 of supplies and $11,000 of acquisitions on credit during the tax period ending 30 September which have not been paid for at 15 October. In his GST return for the concluding tax period ending 15 October, Casey is required to include GST payable of $3,000 on the unpaid supplies made and $1,000 input tax credits on the unpaid acquisitions.

Note also that where an entity cancels its GST registration before receiving a tax invoice for a creditable acquisition, it is not entitled to claim input tax credits for the acquisition (GST Ruling GSTR 2000/34, para 10).

¶5-295 Increasing adjustments for assets on hand at cancellation date An entity may have an increasing adjustment where it had assets on hand immediately before its GST registration was cancelled. The increasing adjustment is required where the assets include anything in respect of which the entity was, or is, entitled to claim an input tax credit, even if it has not already claimed the credit (s 138-5(1)). The purpose of the adjustment is to pay back the input tax credits claimed on assets which are being removed from the GST system. The increasing adjustment is included in the concluding tax period and final GST return of the entity (s 138-10(1)). Broadly, the amount of the adjustment is the GST portion (1/11th) of the market value of the assets immediately before the cancellation, adjusted for the percentage that the entity used the assets for noncreditable purposes (which percentage of input tax credits should have already been adjusted or never been claimed in the first place). For assets that appreciate in value, the increasing adjustment is likely to be 1/11th of the purchase price (s 138-5(2)). No adjustments are required for assets that are treated as fully consumed for GST purposes (s 138-5(3)) because the last of the adjustment periods for them has passed (see Div 129 and particularly s 129-20(3) for businesses that do not make financial supplies). Example

Ezekial has his GST registration cancelled from 30 September 2018. At that date, his assets on hand include: • a car purchased in April 2015 for $44,000 (including GST) which has been used 50% for business purposes and is worth $11,000 • intellectual property rights acquired in 2016 for $550,000 (including GST) which are used wholly for business purposes and are now worth $660,000 • a commercial office acquired in 1999 for $260,000. Ezekial has an increasing adjustment of $50,500 which he must include in his GST return for the concluding tax period ending on 30 September 2018. The adjustment is calculated as follows: • for the car: $500 — being 1/11th of the 50% of the value of the car applied for business use multiplied by the market value at cancellation date ($11,000) • for the intellectual property: $50,000 — being 1/11th of the purchase price ($550,000) as that is less than the market value at cancellation date • for the commercial office: nil — as it was acquired prior to GST commencement, input tax credits were not claimable for it.

¶5-300 Can an entity cancel GST registration to sell assets without GST? Where an entity has a projected GST turnover (¶5-255) which is less than the registration turnover, it may be tempted to apply for cancellation of its GST registration in order to sell its assets without GST at a later time. The simple act of applying for cancellation of GST registration and sale of assets after that point would not appear, prima facie, to invoke application of the anti-avoidance provisions (Div 165) although the Commissioner might consider those provisions in certain circumstances. The legislation does however create hurdles to reduce the attraction of the deregistration strategy to sell assets without GST, those being: • the requirements to satisfy the Commissioner that the projected GST turnover is, in fact, below the turnover registration threshold • the prospect of an increasing adjustment in respect of any assets on hand at cancellation date and the resources needed to determine the relevant market values • the likelihood that many customers could claim input tax credits if the entity remained GST-registered and charged GST on the sale of the assets. It needs to be remembered that the estimated sales values of trading stock and trading assets may need to be included in the projected GST turnover calculations which may have the effect of triggering the requirement to remain registered (¶5-265, ¶5-270). Rule of thumb The only circumstances where there seems to be a clear advantage in applying for cancellation of GST registration in order to sell assets without GST at a later point would appear to be where: • the assets will be sold to entities that cannot claim input tax credits for them, and • most or all of the high value assets of the entity: – were acquired before the commencement of GST, or – are treated as fully consumed for GST purposes (s 138-5(3)) because the last of the adjustment periods for them has passed (¶5-295), or – have appreciated in value such that the GST saved by selling them outside the GST system is more than the increasing adjustment triggered by cancellation of registration.

GST RETURNS CONCESSION ¶5-400 Overview

Every entity that is registered, or required to be registered, must give the Commissioner a GST return for each tax period applying to the entity (s 31-5). Generally, a tax period is three months (s 27-5). However, tax periods are one month (s 27-15) if the entity’s GST turnover is equal to, or greater than, a specified threshold (currently $20m) or the entity elects to have one-month tax periods. Tax periods can be a financial year (Div 151, 162). A GST return is required to be lodged even where the entity does not have to pay GST to the Commissioner or even if it has not made any supplies or acquisitions during the period (s 31-5). The due date for lodgment of an entity’s GST return depends on whether the tax period that applies to the entity is a quarterly tax period, a monthly tax period or an annual tax period. An entity’s GST return for a tax period must be in the form approved in writing by the Commissioner and be given in the manner the Commissioner requires, which may be electronically (s 31-15). The approved form for GST returns is the entity’s BAS which also covers other taxes. An entity is liable to pay the assessed net amount for the tax period by the due date for lodgment of the GST return for the tax period (s 31-8, 31-10, 33-3, 33-5). The net amount is the entity’s GST liability on supplies less input tax credits on acquisitions plus or minus adjustments and an amount to correct certain errors made in working out the net amount for the immediately preceding tax period(s) (s 17-5). There are two GST return concessions for small businesses: • the entitlement to lodge GST returns on a quarterly basis (¶5-405) • the entitlement to lodge GST returns on an annual basis (¶5-410).

¶5-405 Quarterly tax period concession Entities with a GST turnover of less than $20m: • can have quarterly rather than monthly tax periods • can lodge their GST returns in paper form • have until 28 days after the end of the tax period to lodge their GST return and pay any net amount (and up to a further two weeks if they lodge their GST return online). By contrast, entities with a GST turnover of $20m or more are required to: • prepare monthly GST returns • lodge their returns electronically • lodge their GST return and pay any net amount owing by the 21st day after the end of the tax period. Pros and cons of lodging quarterly rather than monthly GST returns For a business with a GST turnover of less than $20m, the advantages of lodging GST returns quarterly rather than monthly are: • compliance savings — less administration and resources are required to prepare and lodge four GST returns per year as opposed to 12 • extra time to lodge — the entity has at least 28 days after the end of each tax period to prepare and lodge the GST return as opposed to 21 days • GST payments are delayed — by lodging quarterly GST returns, the GST liability an entity has on supplies it has made is payable, on average, 73 days after it is attributed (¶6-120). Assume that the average supply that an entity makes is attributable to the middle day of the tax period. On average the entity has 45 days from that supply to the end of the tax period and at least another 28 days before the GST return is due to be lodged and the net amount paid. The period before payment of

the GST is even longer for supplies made in the December quarter as the GST is not payable until 28 February. By contrast, a monthly GST return lodger must pay the GST liability on its supplies within, on average, 36 days after it is attributed • payment by instalments — quarterly lodgers can pay GST by instalments. The disadvantages of choosing to lodge GST returns quarterly rather than monthly are: • input tax credits are delayed — input tax credits represent a form of refund paid by the Commissioner of, in most cases, 1/11th of the cost of acquisitions. While being a quarterly GST return lodger enables an entity to delay its GST liability, the corollary is that it delays the claiming of input tax credits. By lodging quarterly GST returns, the receipt of that refund or effect of the credit is claimed, on average, between 45 and 73 days after it is attributed. The refund or credit for a monthly lodger is claimed, on average, between 15 and 36 days after it is attributed • deferral of GST on importations — the entity cannot use the importation deferral method whereby payment of the GST liability on importations is deferred until lodgment of the GST return for the tax period covering the importation. The ATO has advised that, during the 2016/17 year, approximately 2,359,000 taxpayers lodged activity statements quarterly, representing 86% of all GST registrants.

¶5-410 Annual GST return concession Entities that make an annual tax period election are only required to lodge one GST return per annum. Their tax period is the financial year (s 151-40). Entities can only make an annual tax period election if they are not required to be registered (s 151-5) because their GST turnover is below the GST registration turnover ($75,000 for most business organisations and $150,000 for non-profit organisations). The GST return for an annual tax period must be lodged either by: • the due date for lodgment of the entity’s income tax return, or • on or before the 28 February following the end of the annual tax period. Any GST liability for an annual tax period must be paid to the Commissioner on or before the due date for lodgment of the GST return (s 151-50). An entity cannot make an annual tax period election if it has elected to pay GST by instalments (s 151-5). Entities that pay GST by instalments will have an annual tax period. However, in many areas, the eligibility and effect of electing to pay GST by instalments differs from the election of an annual tax period. The election to pay GST by instalments is discussed further at ¶6-300. Pros and cons of making the annual tax period election For a business with a GST turnover of less than the registration turnover threshold ($75,000 for most businesses), the advantages in lodging GST returns annually rather than quarterly are: • compliance savings — less administration and resources are required as only one GST return needs to be prepared and lodged per year • extra time to lodge — the entity has four to eight months after the end of the annual tax period to prepare and lodge the GST return • GST payments are delayed — any GST amounts payable can be deferred until four to eight months after year end. The disadvantages of lodging GST returns annually rather than quarterly are: • input tax credits are delayed — the benefits of claiming input tax credits are delayed until the annual

return is lodged (a delay of six to 14 months on average) • correcting previous mistakes — the entitlement for an entity to correct GST errors in its next GST return is limited to those made in the previous annual return (a 12-month time limit) whereas a quarterly lodger can potentially correct GST errors made in the previous six GST returns (an 18month time limit). The ATO has advised that, during the 2016/17 year, approximately 233,000 taxpayers accounted for GST annually, representing 9% of all registrants. Rules of thumb If a critical objective of an entity is to reduce administration and paperwork, having to prepare and lodge just one GST return per year seems significantly more favourable than four or 12. If a critical objective is to improve cash flow, the decision is not as straightforward. It must be remembered that GST is only one of many liabilities paid by way of an activity statement. The amount of GST payable by many entities is dwarfed by other tax liabilities. The timing of payment and amount of those other liabilities need to be considered in evaluating the rules of thumb which follow below. Entities that consistently claim more input tax credits than the GST they pay should lodge GST returns as early as possible, ie on a monthly basis. Examples include medical practitioners and exporters who make mostly GST-free supplies. Entities that consistently pay significantly more GST than the credits they claim should lodge on a quarterly or annual basis, ie delay their GST payments. Examples include entities with high margins or which make low volumes of acquisitions. Other examples include those entities which make low volumes of GST-free or input taxed supplies yet make high volumes of GST-free or input taxed acquisitions. Entities that have customers and clients on long credit terms or which are slow payers should lodge on a quarterly or annual basis. Delaying the payment of GST increases the prospect that such entities will have received payment for their supplies before their GST liabilities are due. Finally, entities with high start up costs should commence business by lodging GST returns on a monthly basis. Those entities can claim input tax credits as soon as possible for major acquisitions at start up phase. They can change to a quarterly basis for lodging GST returns when they commence making significant volumes of supplies, subject to some conditions.

¶5-420 Who is required to lodge a GST return? Every entity that is registered, or required to be registered, must give the Commissioner a GST return for each tax period applying to the entity (s 31-5(1)). A GST return is required even though the entity has not made any taxable supplies that are attributable to the tax period. A return is also required even where the entity’s net amount for the tax period is zero or negative, so that no amount of GST is payable to the Commissioner for the tax period (s 31-5(2)). For an explanation of net amounts, see ¶5-545.

¶5-425 One-month tax periods Tax periods are one month if the entity’s GST turnover is equal to, or greater than, the tax period turnover threshold of $20m (s 27-15). To determine whether the tax period turnover threshold is met, an entity needs to make an objective assessment of its current GST turnover (¶5-250) and projected GST turnover (¶5-255). The entity needs to consider the turnover combinations in the table at ¶5-240 in light of the relevant tax period turnover threshold of $20m. An entity whose GST turnover is less than the tax period turnover threshold can, by notifying the Commissioner in the approved form, elect a one-month tax period (s 27-10). If an entity’s GST turnover is less than the tax period turnover threshold it can, by notifying the Commissioner in the approved form, withdraw a one-month tax period election that it has made. The date of effect of the revocation will be specified in the entity’s withdrawal notice and must be 1 January, 1 April, 1 July or 1 October, or any day occurring before the election took effect. It must not be a day occurring earlier than 12 months after the election took effect (s 27-20). The Commissioner may, if requested in the approved form, revoke an entity’s one-month tax period election provided its turnover is less than the tax period turnover threshold. A revocation by the

Commissioner can take effect from a day occurring earlier than 12 months after the original election took effect (s 27-22). The date can be a past day and, in any case, must be 1 January, 1 April, 1 July or 1 October. Example Akira commenced business in July 2017. He elected monthly tax periods despite having a turnover of just $500,000. By Christmas, he has found lodging GST returns monthly to be inconvenient. If he wishes to withdraw his monthly tax period election he can notify the Commissioner that his withdrawal takes effect from 1 July 2018 (at the earliest). If he wishes to move to quarterly tax periods before then, he will have to request the Commissioner to revoke his election.

The ATO can determine that a one-month tax period applies to an entity if the Commissioner is satisfied that: • the period that the entity will be carrying on an enterprise in Australia is less than three months, or • the entity has a history of failing to comply with its obligations under a taxation law (s 27-15).

¶5-430 Tax period concessions for small businesses For most entities with a GST turnover below $20m, the tax period is three months. The three-month tax periods end on 31 March, 30 June, 30 September and 31 December each year (s 27-5). Entities that are entitled to elect to lodge an annual GST return (Div 151) have an annual tax period.

¶5-435 When do tax periods end? An entity’s tax period is not required to end on the last day of a calendar month, quarter or year. Rather, an entity can change the day in which the tax period ends, subject to the following: • the tax period end date must be no more than seven days earlier or seven days later than the date on which the tax period would otherwise end if it was not changed, that is, typically the last day of the calendar month • the change must be consistent with the commercial accounting periods that apply to the entity, and • the next tax period starts on the day after the tax period end date that the entity changed to (s 27-35). An entity can apply to the Commissioner to change its tax periods to those that would not otherwise satisfy s 27-35. If the application is in the approved form, the ATO will change the tax periods to those requested by the entity provided the Commissioner is satisfied that: • the entity has a turnover of $20m or more • the tax periods requested are consistent with commercial accounting periods used by the entity, and • the tax periods requested amount to 12 complete tax periods in each year (s 27-37). Examples (1) Vince has a GST turnover of $5m. For commercial accounting purposes, he closes his accounts on the last Friday of each month. In 2017, this results in his September quarter tax period ending on 29 September and his next tax period ending on 31 December. He can utilise these tax period end dates for GST without obtaining the Commissioner’s approval. (2) Ursula has a turnover of $30m. To manage an unusual billing cycle, she cuts off for commercial accounting purposes on the tenth day of each month. Upon her application, the Commissioner may determine that each of her tax periods ends on the tenth day of the month.

¶5-440 Concluding tax periods

An entity’s final or concluding tax period ends at the following time: • at the end of the day before it dies or ceases to exist • at the end of the day on which it ceases to carry on any enterprise • at the end of the day on which its cancellation of registration takes effect (s 27-40), or • at the end of the day before it became bankrupt, went into receivership or liquidation, or otherwise became incapacitated (s 27-39).

¶5-445 When must a GST return be lodged? The due date for lodgment of an entity’s GST return depends on whether the tax period that applies to the entity is a monthly tax period, a quarterly tax period or an annual tax period. It can also depend on whether an entity is voluntarily registered for GST (see ¶5-120). The due dates are set out below. Where the due date is a Saturday, a Sunday or a public holiday, lodgment is taken to be due on the next working day (TAA Sch 1 s 388-52).

¶5-450 Monthly tax periods The general rule is that an entity’s GST return for a monthly tax period must be lodged on or before the 21st day of the month following the end of the tax period. However, if the tax period ends during the first seven days of a month, the return must be lodged on or before the 21st day of that month. In either case, the Commissioner has the power to extend the lodgment period (s 31-10). Example Marianne has a GST turnover in excess of $20m and has obtained a special determination of tax periods from the ATO. As a result, a tax period ends on 8 October. Marianne has until 21 November to lodge her GST return for the tax period. A later tax period ends on 3 December. She has until 21 December to lodge her GST return for that tax period.

¶5-455 Quarterly tax periods The due dates for GST returns for quarterly tax periods are as follows:

Quarterly tax period 1 July to 30 September

Due date The following 28 October

1 October to 31 December The following 28 February 1 January to 31 March

The following 28 April

1 April to 30 June

The following 28 July

In each case, the Commissioner has the power to extend the lodgment period (s 31-8). Examples (1) Margaret’s quarterly tax period ends on 30 June. She must lodge her GST return for that tax period by 28 July. (2) For consistency with her normal accounting practice, Jane, a speech pathologist, has changed the day on which her quarterly tax period ends from 30 June to 28 June. Her GST return must be lodged by 28 July. (3) Jane has also changed the day her September quarterly tax period ends from 30 September to 4 October. Her GST is due to be lodged by 28 October.

(4) Tatum lodges her June 2018 GST return online. Provided she meets the Commissioner’s terms and conditions, she has until 11 August 2018 to lodge her return and pay her net amount (¶5-545).

¶5-460 Annual tax periods Entities that elect annual tax periods are required to lodge a GST return for the financial year by: • the due date for the entity’s income tax return for the income year corresponding to, or ending during, the annual tax period, or • if the entity is not required to lodge an income tax return, the 28 February following the end of the annual tax period (s 151-45).

¶5-465 Extension of time for lodgment of GST return The Commissioner has the power to grant extensions of time for lodging returns (TAA Sch 1 s 388-55). Late lodgment of a GST return may give rise to a penalty and may also constitute an offence. To avoid a penalty, an application for an extension of time should be made before the due date for lodging the return and should state the reasons why the return cannot be lodged before that date. However, there seems to be no reason why the Commissioner cannot grant an extension after the due date.

¶5-467 Electing monthly tax periods When an entity applies for GST registration, it is required to disclose its turnover. If that turnover is $20m or more, it will be given monthly tax periods and not have the means of choosing quarterly or annual tax periods. If the new registrant’s turnover is less than $20m, it will be given the option of selecting monthly or quarterly tax periods. If an entity already using quarterly tax periods wishes to elect monthly tax periods, it must do so by notifying the Commissioner in the approved form (s 27-10). Currently, there appears to be no official “form” to, or path through the ATO website to, make the election. The ATO accepts that the monthly tax period election can be made through the mail function in the ATO portal and by calling the ATO’s business info line on 13 28 66.

¶5-470 Annual GST return and payment An entity that is voluntarily registered for GST (¶5-120) may elect to adopt an annual tax period, so that it reports and pays GST on an annual basis, instead of monthly or quarterly (s 151-5). The election is called an “annual tax period election”. This option is available to business enterprises with a GST turnover of less than $75,000 and non-profit organisations with a GST turnover of less than $150,000 (s 23-15). It does not apply to taxi operators (s 144-5) or to entities on the GST instalments system (¶6-300). An entity is not eligible to make an annual tax period election if the only reason it is not required to be registered is because it disregarded supplies under s 188-15(3)(b) or (c), or s 188-20(3)(b) or (c), which are about supplies of rights or options offshore (see s 151-5(2)). Entities which are voluntarily registered for GST are also eligible to pay PAYG instalments on an annual basis (¶9-610).

¶5-475 When must the election be made? Normally, the election must be made on or before 21 August in the financial year to which it relates (for entities with monthly tax periods) or before 28 October in that financial year (for entities with quarterly tax periods). The election usually applies from the start of the financial year (s 151-10, 151-20). However, a special rule applies where a taxpayer first becomes eligible to make an election after 28 October in any financial year, and its current GST lodgment record is no more than six months. The

taxpayer may make the election on or before the date its next GST return becomes due. The election takes effect from the start of the tax period to which that return relates (s 151-20). Example Zachary commenced business on 15 July 2017 and obtained GST registration from that date. By Christmas, he became aware that his GST turnover was $55,000. Before 28 February 2018, the date upon which he would be due to lodge his next GST return, he made an annual tax period election. Zachary’s annual tax period will take effect from 1 October 2017 and his first annual tax period will be from 1 October 2017 to 30 June 2018 (s 151-40(2)). Henceforth, his annual tax periods will be the full financial years ending on 30 June.

The Commissioner has the power to grant extensions to the annual tax period election deadlines (s 15120).

¶5-480 Making the annual tax period election An entity that is eligible to make an annual tax period election must notify the Commissioner of its election. This can be done by: • calling the ATO’s business info line on 13 28 66 • calling the ATO’s business direct self-help service on 13 72 26 where a path to elect annual reporting will be made available • writing to the ATO at PO Box 3524 ALBURY NSW 2640. The Commissioner has the power to disallow the election if the entity has failed to comply with one or more of its obligations under a Commonwealth taxation law (s 151-25).

¶5-485 Effect of annual tax period election Making a valid election means that the entity has an annual tax period. This takes the place of the monthly or quarterly tax periods that would otherwise apply. If the election takes effect part-way through the year, the balance of that year is still called an annual tax period (s 151-40). The entity must lodge an annual GST return and pay its GST for the annual tax period. This must be done on or before the date the entity is required to lodge its annual income tax return for that year (s 151-45, 151-50). If the entity is not required to lodge an income tax return, it must lodge its annual GST return and pay its GST by 28 February following the end of the financial year. Example Laura satisfies the Commissioner’s criteria to be exempt from lodging an annual income tax return for the 2017/18 income tax year. Her annual tax period election took effect on 1 July 2017. Therefore, for the 2017/18 year, Laura must lodge her annual GST return and pay her net amount no later than 28 February 2019.

¶5-490 Duration of annual tax period election Once made, an election remains in force indefinitely unless: • the entity revokes it. A revocation is effective for the whole of the financial year if made on or before 28 October in that year; otherwise it does not apply until the start of the next financial year • the entity’s circumstances (eg GST turnover) are such that it is required to be registered as at 31 July in the financial year. In this case, the election ceases to have effect from the start of that year (s 15125(5)). In effect, this means that an entity must review its eligibility each 31 July, or • the Commissioner disallows the election because the entity has failed to comply with one or more of

its tax obligations. If the disallowance occurs during the financial year in which the election first took effect, the election will have no effect. For later financial years, a disallowance is effective for the whole of the financial year if made on or before 28 October in that year; otherwise it applies from the start of the next financial year (s 151-25). Examples (1) In the early months of his 2017/18 annual tax period, Winston is considering whether to revoke his existing annual tax period election. If he revokes his election by 28 October 2017, his last annual tax period ends on 30 June 2017. If he does so, then by 28 October 2017, he must lodge his GST return for the September 2017 quarter. The annual GST return for the 2016/17 year must be lodged by the date of lodgment of his 2016/17 income tax return. (2) Xavier elected an annual tax period commencing for the 2017/18 financial year as his GST turnover was $60,000 at all times during that period. In June 2018, he tenders for a large contract which would enable him to bill $100,000 for three months work. If he has been awarded the tender and signed the supply contract by 31 July 2018, it is likely that his annual tax period election will be revoked. If so, he could use quarterly tax periods for the 2018/19 year. If Xavier does not know whether he has been awarded the tender by 31 July 2018, it is likely that he can continue to utilise an annual tax period until the end of the 2018/19 financial year, even if he is eventually awarded the contract later that year. (3) The Commissioner is investigating whether to disallow Albury’s annual tax period election during the first year it took effect (2017/18). If he notifies Albury of the disallowance by 30 June 2018, Albury cannot lodge an annual GST return for that year. Rather, Albury is likely to have GST returns for his tax periods in the 2017/18 year due almost immediately (or even overdue). If the Commissioner notifies Albury of the disallowance by 28 October 2018, Albury must lodge an annual GST return for the 2017/18 year but cannot do so for 2018/19. If the Commissioner notifies Albury of the cancellation in November 2018, Albury must lodge annual GST returns for the 2017/18 and 2018/19 years but not subsequent years.

¶5-495 End of an annual tax period If an individual taxpayer who has made an election dies during a financial year, the annual tax period continues until the end of that financial year (s 151-25(1), 151-55). The same applies if an entity ceases to carry on its enterprise, or has its GST registration cancelled. However, a different rule applies if a taxpayer becomes bankrupt, goes into liquidation or receivership, or ceases to exist during an annual tax period. In this case, the annual tax period ends at the end of the day before the bankruptcy, etc occurs (s 27-39, 27-40). Unless the Commissioner grants an extension, the GST return will become due and the GST becomes payable for that period on or before the 21st of the following month (s 151-25, 151-60).

¶5-500 Annual tax periods and GST groups The fact that an entity is a member or representative of a GST group does not prevent an annual tax period election being made. It can only be made by the representative member of the GST group. The representative member of a GST group (s 48-5(1)(d)) can only make an annual tax period election if all members of the group are eligible, ie none of the members are required to be registered (s 151-15). While the turnover of each of the individual members might not meet the GST registration turnover threshold, the annual tax period election cannot be made if the aggregate of those turnovers meets the registration turnover threshold (s 188-15(2), 188-20(2); see ¶5-250). An existing election continues to have effect if, within a tax period, either: • there is an alteration to a GST group, or • there is a change in the GST group representative member.

¶5-510 GST returns An entity’s GST return for a tax period must be in the form approved by the Commissioner (s 31-15) and be given in the manner the Commissioner requires, which may be electronically (s 31-25). Approved form — BAS

The law permits the Commissioner to combine more than one document in the same approved form. The approved form for GST returns is the entity’s BAS, which brings together in one form the reporting of entitlements and obligations under the GST law, the PAYG systems (both withholding and instalments) and the FBT, fuel tax, wine equalisation tax and luxury car tax laws. It also covers the payment of deferred company tax instalments. These debts and credits are collectively referred to as “BAS amounts”.

¶5-520 Simplified quarterly reporting of actual GST liability Up until the 2016/17 financial year, entities with quarterly tax periods could choose to pay their actual GST liability quarterly on the basis of limited information in their quarterly returns, supported by a more detailed annual return, or Annual GST Information Report. The simplified quarterly BAS contained only total sales (label G1), GST payable (label 1A) and credits for GST paid (label 1B). The Annual GST Information Report contained annual amounts for exports (label G2), other GST-free sales (label G3), capital acquisitions (label G10) and other acquisitions (label G11). Those entities which had chosen simplified reporting for 2016/17 will still be required to lodge the Annual GST Information Report by the due date for lodging annual GST returns (¶5-460). The simplified BAS eligibility and GST reporting methods from 1 July 2017 are discussed at ¶6-010.

¶5-530 Electronic lodgment Some entities are required to lodge their GST returns electronically. An entity must lodge electronically if its GST turnover meets the electronic lodgment turnover threshold (currently $20m). However, an entity will not be required to lodge electronically if the Commissioner approves otherwise (s 31-25(2)). To determine whether the electronic lodgment turnover threshold is met an entity needs to determine its current GST turnover (¶5-250) and projected GST turnover (¶5-255). The entity needs to consider the turnover combinations in the table at ¶5-240 in light of the relevant electronic lodgment turnover threshold of $20m. An entity whose turnover does not meet the electronic lodgment turnover threshold can choose to lodge their GST returns electronically (s 31-25(1)). If they choose to do so, they may be entitled to lodge and pay their GST return 14 days after the date it was otherwise due (¶5-455). A GST return is lodged electronically if it is transmitted to the ATO in an electronic format approved by the Commissioner (s 31-25(3)). Typically, in the days immediately preceding the end of a tax period, the ATO sends an email confirmation that a personalised BAS has been placed in the entity’s account in the ATO’s business portal. By completing and sending the BAS from the portal, the entity will have transmitted the GST return to the ATO in the approved form. Failure to lodge or give information electronically An entity is liable to a penalty if it is required to lodge a GST return electronically and fails to do so. An entity can also be penalised if it lodges its GST return electronically (whether by choice or compulsion) and fails to electronically notify the Commissioner of other BAS amounts that are required to be notified on the same day as the GST return is required to be lodged (TAA Sch 1 s 288-10; TAA s 8C, 8E).

¶5-535 Paper form lodgment An entity that does not meet the electronic lodgment turnover threshold and has not chosen to lodge electronically will lodge its GST returns on a paper form. The ATO normally sends a personalised BAS to a registered entity before the end of the relevant tax period and before the GST return is due for lodgment. The BAS indicates the tax period that applies and when it is due to be lodged.

¶5-540 GST return lodgment where the entity conducted no activities Where an entity’s net amount for a tax period is zero because it has not made any supplies, acquisitions or importations, the ATO may allow the entity to lodge its return in some other manner, for example, by

telephone (s 31-15(2)). This concession does not apply to a resident agent acting for a non-resident if the non-resident made supplies or acquisitions through the resident agent during the tax period (s 57-45).

¶5-545 Net amounts The net amount (s 17-5) is generally calculated in the GST law as follows: • GST on taxable supplies made during the tax period • minus input tax credits for acquisitions made during the tax period • plus increasing adjustments for adjustment events occurring during the tax period • minus decreasing adjustments for adjustment events occurring during the tax period • plus/minus wine equalisation tax and luxury car tax liabilities and credits • plus/minus adjustments to correct small errors made in a preceding GST return(s) (¶5-550). The GST information that must be included in a GST return for a quarterly, monthly or annual tax period is intended to support the calculation of the entity’s net amount for the period, which is payable with the GST return. Examples (1) The amount of GST payable on taxable supplies made by Complete Chemical Supplies during the three-month tax period ending 31 December is $20,000. Input tax credits for the tax period are $16,000. However, the net amount for the tax period is reduced to nil by a decreasing adjustment of $4,000, which has arisen because of the return of a defective batch of chemicals supplied in an earlier tax period. Although Complete Chemical Supplies does not have any GST to pay, it is required to lodge a GST return for the tax period ending 31 December. (2) All of the supplies made during a tax period by David, a dentist, are GST-free dental services. GST-free supplies are not taxable supplies. Although David has not made any taxable supplies during the tax period, he is required to lodge a GST return.

¶5-550 Correcting GST errors The Commissioner can make a determination permitting net amounts for a tax period to be adjusted to correct errors made in working out the net amount for the immediately preceding tax periods (s 17-20). The Commissioner has issued a determination which sets out how correction of GST mistakes can be made (Goods and Services Tax: Correcting GST Errors Determination 2013). Where the mistake was the failure to claim input tax credits in an earlier BAS, the input tax credit can be claimed in a BAS for another tax period for which the entity gives the Commissioner a GST return. However, that BAS must be lodged within a period of four years after the date by which the entity was required to give a GST return for the tax period to which the input tax credit was originally allocated (Div 93). For other mistakes and omissions, there are limits on the amount of the correction that can be made on a later BAS and, in some cases, a time limit on when the correction can be made. Four-year limits already apply in certain circumstances (TAA Sch 1 s 105-50, 105-55). Corrections may be needed to cover clerical mistakes (eg double counting a taxable supply or creditable acquisition) and incorrectly recording or classifying a GST-free supply as a taxable supply (or vice versa). In the Goods and Services Tax: Correcting GST Errors Determination 2013, the Commissioner defines errors as “debit errors” or “credit errors”. A debit error is a mistake in the reporting period that would have resulted in the entity reporting or paying too little GST. By contrast, a credit error is a mistake in the reporting period that would have resulted in the entity reporting or paying too much GST. The determination provides that corrections to debit errors to increase the GST payable, or decrease

input tax credits claimed, on a subsequent BAS can only be made if the errors fall within the following time limits: GST turnover

Time limit in which errors can be corrected

Less than $20m

The error must be corrected in an activity statement that is lodged within 18 months of the due date of the activity statement for the reporting period in which the error was made (typically 18 monthly BASs, 6 quarterly BASs or 1 annual GST return)

$20m or more

Up to 12 months (typically 12 monthly BASs)

Where the mistakes were made beyond the relevant time limit above, the original BAS in which the mistake was made must be revised. Thus, businesses with a GST turnover of less than $20m have longer time limits than do larger businesses within which they can correct errors in the following BAS. However, the corrections that can be made in the next BAS are subject to the correction limits which favour businesses with higher turnover. The determination specifies that error correction limits apply to debit errors only. Credit errors may be offset against the sum of debit errors. An entity may correct a debit error to the extent that the sum of debit errors less the sum of the credit errors is within the debit error value limits. If a debit error puts the entity over the relevant debit error value limit, it can only correct the error up to the following limits:

GST turnover

Correction limits

Less than $20m

Less than $10,000

$20m to less than $100m

Less than $20,000

$100m to less than $500m

Less than $40,000

$500m to less than $1b

Less than $80,000

$1b and over

Less than $450,000

Where the net errors would exceed these limits, the original BAS has to be revised. In straightforward cases the ATO may be able to do this over the telephone. Alternatively, a new BAS will be sent to the entity for completion. Examples (1) Snowy failed to claim an input tax credit for an acquisition it made and paid for on 15 September 2017. The credit could have been claimed in the September 2017 BAS due on 28 October 2017. Snowy can claim the credit in his December 2017 BAS which he lodges on 20 January 2018. (2) Julian has a GST turnover of $3m. In the March 2018 tax period, he realises that he failed to account for GST on taxable supplies of $33,000 made in the March 2016 tax period. While the GST error of $3,000 fell within his correction limit ($5,000), it fell outside his time limit (18 months). Thus he must amend the March 2016 BAS rather than correct the error through the March 2018 BAS. (3) Declan has a GST turnover of $2m. In the September 2017 tax period, he realises that he failed to record an increasing adjustment for a rebate received in March 2017. The rebate included a GST amount of $6,000 and related to acquisitions for which he had previously claimed input tax credits. While that error fell within his time limit (18 months), it fell outside his correction limit ($5,000). Thus he must amend the March 2017 BAS rather than correct the error through the September 2017 BAS.

The arrangements in the determination can only be used to correct genuine and reasonable mistakes. No penalties or interest will be applied where the determination is followed correctly.

¶5-555 Payment of net amounts Generally, the net amount for the tax period is payable by the entity at the same time as the GST return is due to be lodged (¶5-445 and following). If the net amount is less than zero, the ATO must make a refund to the entity after offsetting the amount owing to the entity against any tax debts owed by the entity to the Commonwealth (s 35-5; TAA Div 3A of Pt IIB). Late payment of GST net amounts may give rise to an interest liability in the form of the general interest charge (GIC). However, the Commissioner has the power to extend the time for payment in special circumstances, or to allow the amount to be paid by instalments, particularly for entities with a GST turnover of less than $2m and a recent activity statement debt of $50,000 or less which has been outstanding for no more than 12 months (www.ato.gov.au: Help with paying).

¶5-560 How to pay a net amount Any net amount that is not paid electronically must be paid in the manner determined by the Commissioner, ie by mail (cheque), by providing the Commissioner with a direct debit authority, or at Australia Post. Some entities must pay their net amount for a tax period by electronic payment (¶5-565). Any entity may pay its net amount by electronic payment even if not required to do so, and whether or not it lodges its GST return electronically. Electronic payment means a payment by way of electronic transmission, in an electronic format approved by the Commissioner. The approved formats are BPAY, direct credit and direct debit.

¶5-565 Who is required to pay electronically? An entity must pay its net amount for a tax period by electronic payment if its GST turnover meets the electronic lodgment turnover threshold of $20m (s 33-10(2)). An entity that is required to lodge its GST return electronically must pay the net amount for the tax period by electronic payment. Note, however, that if an entity meets the turnover threshold, but is not required to lodge electronically because the Commissioner approves otherwise, the entity is still required to pay electronically.

GST CONCESSIONS — SMALL BUSINESS ENTITIES OVERVIEW What this chapter covers

¶6-000

Change of turnover threshold to $10m

¶6-005

Simpler BAS reporting for small business

¶6-010

GST CASH ACCOUNTING CONCESSION Overview

¶6-100

Summary of GST cash accounting concession

¶6-105

Pros and cons of accounting for GST on a cash basis

¶6-110

Attributing GST and credits to a tax period

¶6-120

Cash basis

¶6-130

Small business entity and $10m aggregated turnover test

¶6-140

Cash accounting turnover test

¶6-150

Seeking Commissioner’s approval to use the cash basis

¶6-155

Ceasing to account on a cash basis

¶6-160

How the cash basis operates

¶6-165

Asset and instalment acquisitions under the cash basis

¶6-170

Hire purchase acquisitions

¶6-175

How cash basis taxpayers account for adjustments

¶6-180

How the non-cash basis operates

¶6-185

Invoices and tax invoices

¶6-190

Progressive or periodic supplies

¶6-195

When consideration is provided or received

¶6-200

Change of accounting basis

¶6-205

Change from non-cash to cash basis

¶6-210

Change from cash to non-cash basis

¶6-215

PAYMENT OF GST BY INSTALMENTS Overview

¶6-300

Pros and cons of paying GST by instalments

¶6-305

Which entities can elect to pay GST by instalments?

¶6-320

Net refund position

¶6-325

How is the election made?

¶6-330

Extension of time to make the election

¶6-340

Revocation or cessation of election

¶6-345

Entities that move into a net refund position

¶6-347

GST groups that pay GST by instalments

¶6-350

Tax periods for GST instalment payers

¶6-355

Annual GST return and net amount

¶6-360

Due dates for instalments

¶6-365

Due dates for instalments for primary producers and special professionals

¶6-370

Carrying on a business of primary production

¶6-375

Net income of primary producers and special professionals

¶6-380

Amount of instalments

¶6-385

Instalment amounts for primary producers and special professionals

¶6-390

Notified instalment amounts for entities in net refund position

¶6-395

Varied instalment amounts

¶6-400

Reasons for varying instalment amounts

¶6-410

Further variations of instalment amounts

¶6-415

Varied instalment amounts for new businesses

¶6-420

Penalties where varied instalment amount is too low

¶6-430

GST instalment shortfall

¶6-435

Penalty notification, due date, remission

¶6-440

ANNUAL APPORTIONMENT OF GST INPUT TAX CREDITS Overview

¶6-500

Pros and cons of making the annual apportionment election

¶6-505

The usual rules: claiming input tax credits for things used for private expenses ¶6-520 The usual rules: when is the apportionment decision made?

¶6-525

The usual rules: adjustments for change in use

¶6-530

Which entities are eligible to make an annual apportionment election?

¶6-535

How is an annual apportionment election made?

¶6-540

Annual apportionment election — timing and effect

¶6-545

Revocation or cessation of election

¶6-550

Annual apportionment election by GST groups

¶6-555

Effect of annual apportionment election on acquisitions

¶6-560

When is the annual apportionment adjustment made?

¶6-565

How is the increasing adjustment calculated?

¶6-570

Later adjustments for change in use

¶6-575

SIMPLIFIED ACCOUNTING METHODS Overview

¶6-600

Pros and cons of simplified accounting methods

¶6-605

Eligibility for retailers to use simplified accounting methods

¶6-620

Sale of both taxable and GST-free food from the same premises

¶6-625

Adequate point-of-sale equipment

¶6-630

SAM turnover threshold

¶6-635

Eligibility of small enterprise entities to use simplified accounting methods

¶6-640

The choice to apply a simplified accounting method

¶6-645

Revocation and cessation of simplified accounting methods

¶6-650

Notifying the ATO

¶6-655

Effect of election to use simplified accounting methods

¶6-660

What are the alternative simplified accounting methods?

¶6-675

Business norms method

¶6-680

Observation regarding business norms percentages

¶6-690

Stock purchases method

¶6-700

Every tax period option

¶6-710

Two four-week sample periods option

¶6-715

5% GST-free stock estimation basis option

¶6-720

Snapshot method

¶6-730

Two sample periods option

¶6-740

Every tax period option

¶6-745

5% GST-free stock estimation option

¶6-750

Sales percentage method for supermarkets and convenience stores

¶6-760

Purchases snapshot method for restaurants, cafés and caterers

¶6-770

How the purchases snapshot method works

¶6-775

Simplified accounting methods for government prisons

¶6-780

GST concessions not available for small business entities

¶6-785

Editorial information

Written and updated by Stephen Baxter

OVERVIEW ¶6-000 What this chapter covers This chapter deals with a number of GST concessions that are available to small business entities with a GST turnover of less than $10m and concessions for other entities with a GST turnover of $2m or less

(¶6-005). Unless otherwise stated, all references to legislation in this chapter are to the A New Tax System (Goods and Services Tax) Act 1999 (the GST Act). GST cash accounting concession Small business entities and certain other entities with a turnover of less than $10m can choose to account for GST on a cash basis (¶6-100). Payment of GST by instalments Small business entities and certain other entities whose turnover is less than $10m can elect to pay their GST in quarterly instalments (¶6-300). Annual apportionment of GST input tax credits Small business entities and enterprises with a turnover of less than $10m can elect to apportion GST input tax credits on an annual basis (¶6-500). Simplified accounting methods The Commissioner can determine simplified accounting methods for retailers and entities with a turnover of $2m or less (¶6-600).

¶6-005 Change of turnover threshold to $10m The small business entity turnover threshold increased from $2m to $10m from 1 July 2016. The small business entity turnover threshold determines whether businesses can account for GST on a cash basis, pay GST by instalments calculated by the ATO and undertake an annual apportionment of GST input tax credits. The $2m threshold continues to determine entitlement to use simplified accounting methods and whether enterprises that are not carrying on a business can pay GST by instalments calculated by the ATO and undertake an annual apportionment of GST input tax credits.

¶6-010 Simpler BAS reporting for small business From 1 July 2017, small businesses with a turnover of less than $10m will only need to report against three GST labels on their business activity statement (BAS) being: • GST on sales (currently 1A) • GST on purchases (currently 1B), and • Total sales (currently G1). From 1 July 2017, those small businesses will not be required to report against four current labels being: • Export sales (currently G2) • Other GST-free sales (currently G3) • Capital purchases (currently G10), and • Non-capital purchases (currently G11). Businesses with a turnover of $10m or more will continue to need to report against those four labels.

GST CASH ACCOUNTING CONCESSION ¶6-100 Overview GST accounting rules are required to ensure that GST liabilities on supplies and input tax credits on

acquisitions are allocated to GST returns. In the absence of GST accounting rules, supplies and acquisitions may not trigger liabilities and credits at all, let alone at the correct time. The Australian GST legislation does not have “time of supply” rules as such. Rather, the process of allocating the GST on supplies and input tax credits on acquisitions to tax periods is known as “attribution” (Div 29). The two GST accounting bases are cash and non-cash. Under the cash basis, supplies and acquisitions made by an entity are attributed to the tax period in which it receives cash or pays cash respectively (¶6-130). For an entity accounting on the non-cash basis, supplies and acquisitions are typically attributed to the tax period in which the relevant transaction supplier issues an invoice for the supply. However, they will be attributed to an earlier tax period where the recipient provides, or the supplier receives, part or all of the consideration for the supply (¶6-180). Entities may only account for GST on a cash basis if they meet certain criteria. Typically, entities with a GST turnover of less than $10m are entitled to account on a cash basis (¶6-005). Special adjustment rules exist if an entity operating on a non-cash basis seeks to switch to a cash basis and vice versa (¶6-215). In addition to being a concession, the entitlement for certain entities to account for GST on a cash basis is an essential element of the GST system. Enormous costs would be imposed on small businesses if they were not entitled to account for GST on a cash basis because that is how most complete their accounts for reporting and income tax purposes. The ATO would face considerable auditing difficulties as well. For example, in many cases, it would need to perform reconciliations between the taxpayer’s accounts and its GST returns to ensure all supplies were captured.

¶6-105 Summary of GST cash accounting concession Entities with a turnover of less than $10m (¶6-005) are usually entitled to account for GST on a cash basis (s 29-40). The transactions that such an entity includes in its GST return are: • supplies it makes for which it has received some consideration during the tax period (s 29-5(2)) • acquisitions it makes where it has paid some consideration during the tax period (s 29-10(2)). Arguably, this gives such entities cash flow relief as they are not required to pay GST on supplies until they have received some payment from their customers or clients. By contrast, entities with a GST turnover of $10m or more (¶6-005) are required to account for GST on a non-cash basis. The transactions that such an entity includes in its GST return are: • supplies it makes for which it has issued an invoice or received some consideration during the tax period (s 29-5(1)), and • acquisitions it makes for which the supplier issued an invoice or it has paid some consideration during the tax period (s 29-10(1)). It is very common for entities that account for GST on a non-cash basis to be required to pay GST to the ATO on their supplies before they have received payment from their customers.

¶6-110 Pros and cons of accounting for GST on a cash basis The advantages of accounting for GST on a cash basis for those entities entitled to do so are: • consistent accounting — they can account for GST on the same basis that small businesses will typically prepare their accounts and income tax returns • cash flow benefit on supplies — they will not have to account for GST on supplies they make until

they have received payments from customers or clients • cash flow benefits at commencement — net amounts of GST payable (¶5-545) will tend to be reduced during the commencement of a business which is beneficial as most entities are cash flow constrained at start up (see example below) • cash flow benefits on instalment receipts — a large portion of the total GST payable on supplies is deferred where instalments are received • bad debts — GST is not paid on debts that are eventually written off, nor do debts need to be monitored for GST purposes. Example Two identical businesses, Sime and Garf, commence business in March 2018. Each is GST-registered and lodges GST returns on a quarterly basis. Sime accounts for GST on a cash basis while Garf accounts on a non-cash basis. Sime and Garf both issue GST-inclusive invoices totalling $110 per month from March to September 2018. Their customers take two months to pay. Each receives GST-inclusive invoices totalling $55 per month for acquisitions and each takes a month to pay. Their GST returns would include the following transactions:

SIME’S GST

GARF’S GST

Month

GST on supplies

Input tax credits on acquisitions

Explanation

GST on supplies

Input tax credits on acquisitions

Explanation

March

Nil

Nil

No cash received or paid

10

5

Invoices issued and received

March BAS

Nil

Nil

10

5

April

5

Payments for March acquisitions

10

5

Invoices issued and received

May

10

5

Receipts for March supplies; payments for April acquisitions

10

5

Invoices issued and received

June

10

5

Receipts for April supplies; payments for May acquisitions

10

5

Invoices issued and received

June BAS

20

15

30

15

July

10

5

Receipts for May supplies; payments for June acquisitions

10

5

Invoices issued and received

August

10

5

Receipts for June supplies; payments for July acquisitions

10

5

Invoices issued and received

September

10

5

Receipts for

10

5

Invoices issued

July supplies; payments for August acquisitions September BAS

30

15

and received

30

15

The cash basis provides Sime with a considerable cash flow advantage during the earlier months following the commencement of a business. By the June BAS, Sime’s net amounts have totalled just $5 compared to $20 for Garf. However, for the September 2018 quarter onward, Sime and Garf will each pay the same net amount of GST ($5) per quarter. The early cash flow advantage by accounting for GST on a cash basis is not necessarily sustained. Note that in different circumstances, for example where sales are increasing at a much faster rate than acquisitions, there may still be ongoing cash flow advantages for entities that account for GST on a cash basis.

The disadvantages of accounting for GST on a cash basis for those entities entitled to do so are: • deferred credits — input tax credits cannot be claimed in the tax period where an invoice is issued by the supplier but are deferred until the tax period when payment is made • deferred credits on instalment payments — full input tax credits are deferred where payments are made via instalments (¶6-170) • regular monitoring of projected GST turnover to ensure the eligibility to account on a cash basis continues. Rules of thumb Entities are likely to benefit from being able to account for GST on a cash basis where: • they prepare their accounts and income tax returns on a cash basis • a significant percentage of their supplies are on credit and under extended credit terms or are to slow paying customers • they receive payments for their supplies in instalments • most of the acquisitions they make are paid in cash and few are on credit • they are in the commencement phase of a business where acquisitions exceed sales and are usually made in cash and where supplies are usually small and on credit.

The ATO has advised that, during the 2016/17 year, approximately 2,220,000 taxpayers accounted for GST on the cash basis, representing 81% of all taxpayers.

¶6-120 Attributing GST and credits to a tax period Entities need to work out the GST and input tax credits attributable to each tax period because they are required to lodge a GST return for every period (s 31-5(1)). The allocation of GST and input tax credits to tax periods is known as attribution (Div 29). There are two alternative bases of attribution: • the cash basis, or • the non-cash (or accruals, invoice) basis. These two bases are discussed below.

¶6-130 Cash basis Under the cash basis, GST is attributed to the tax periods in which consideration is received (s 29-5(2)) and input tax credits are attributed to the tax periods in which the entity provides consideration (s 2910(2)).

Who can account for GST on the cash basis? Accounting for GST on the cash basis is not compulsory. An entity may choose to adopt it in any of the following situations (s 29-40): • where it is a “small business entity”. To be a small business entity it must satisfy two requirements: – it must be carrying on a business (s 9-20(1); ¶5-160), and – it must satisfy the $10m aggregated turnover test. Broadly, this means that its income and the income of any associated entities must be less than $10m (¶2-020, ¶6-005). • where it is not carrying on a business (s 9-20(1)) and its GST turnover does not exceed $10m (¶6005, ¶6-150 and the www.ato.com.au website guideline Accounting for GST on a cash basis). Examples of entities not carrying on a business include an owner of a single commercial property who leases it to a tenant (¶5-190) • where it is a charitable institution, gift-deductible entity or government school (s 157-5) • where it accounts for income tax on a receipts basis (this method is commonly used by individual professional practitioners: see Taxation Ruling TR 98/1) • where each of the enterprises that it carries on is of a type that has been approved by the Commissioner as being able to adopt a cash basis (s 29-40). Under such an approval, liquidators, receivers, interim managers and trustees in bankruptcy may adopt a cash basis for the enterprises that they carry on as representatives (A New Tax System (Goods and Services Tax) Act 1999: Choosing to Account on a Cash Basis Determination (No 39) 2015 — Representatives of Incapacitated Entities) • where it obtains the approval of the Commissioner to use the cash basis in its particular circumstances (s 29-45). The choice to adopt the cash basis will generally take effect from the first day of the tax period that the entity chooses.

¶6-140 Small business entity and $10m aggregated turnover test Entities that carry on a business determine their eligibility for most small business concessions using the turnover calculation under the small business entity test. That test is the same turnover test used to determine whether the small business concessions apply for CGT, FBT and PAYG instalments purposes. In addition to the requirement to carry on a business, the small business entity test requires an entity to satisfy the $10m aggregated turnover test (¶6-005) which requires inclusion of the turnover of related entities (ITAA97 Subdiv 328-C). For a detailed explanation of the small business entity test see Chapter 2. The small business entity’s turnover calculation excludes amounts relating to GST such as the GST payable on supplies and the GST component of increasing adjustments (ITAA97 s 17-5). The small business entity test was originally designed to allow entities access to various income tax concessions. For those concessions, the test is applied when an income tax return is being prepared, in other words, after the end of the income year. A business that only qualifies as a small business entity because its turnover, as worked out at the end of the year of income, is less than the $10m threshold (¶6-005) is excluded from eligibility as a “small business entity” for most GST concessions for that year. Such an entity is only entitled to choose the GST concessions if, at the start of the financial year, its turnover is likely to be less than $10m (s 29-40, 1237(1)(a), 131-5, 162-5; ITAA97 s 328-110(4)).

¶6-150 Cash accounting turnover test

Where an entity, which does not carry on a business, wishes to use the cash basis, it needs to make an objective assessment of its current GST turnover (¶5-250) and projected GST turnover (¶5-255). The entity needs to consider the combinations in the table in ¶5-240 in light of the relevant cash accounting turnover threshold of $10m (¶6-005). In summary, the entity will have the option of using the cash basis if either of the following apply: • its current GST turnover does not exceed $10m, and if the ATO is not satisfied that the projected GST turnover exceeds $10m (¶6-005), or • its projected GST turnover does not exceed $10m (s 188-10; ¶6-005). Example As at July 2017, Shelley’s current GST turnover (ie the turnover for the period from 1 August 2016 to 31 July 2017) is $1,900,000. Her projected GST turnover (ie the turnover for the period from 1 July 2017 to 30 June 2018) is $2,100,000. Therefore, Shelley will lose the option of using the cash basis unless she has the ATO’s permission.

¶6-155 Seeking Commissioner’s approval to use the cash basis As noted at ¶6-130, an entity that does not otherwise qualify can still adopt the cash basis where it can satisfy the Commissioner that the cash basis is appropriate in its circumstances. The Commissioner will take into account the following factors: • the nature and size of the entity’s enterprise, and • the nature of its accounting system (s 29-45). To obtain this permission, the entity must apply in the approved form. The Commissioner has provided the following guidelines regarding how it will consider the applications (GST Ruling GSTR 2000/13): • Whether supplies are on cash or credit basis Where the vast majority of sales are made for cash, then the cash basis may apply, eg a men’s hairdresser, convenience store, or hot bread shop. • Value and volume of supplies Generally, a cash basis business will have high volume supplies of low value, eg ice cream vendors, milk or paper runs. • Circulating capital and consumables The cash basis will be more appropriate where the business does not rely on its circulating capital or consumables to produce supplies. For example, it may not be appropriate for a motor vehicle spare parts and repairs business. • Capital items The greater the reliance on the use of capital items, the greater the likelihood that it would not be appropriate to use the cash basis. The cash basis is more appropriate where labour is the major component of the business. For example, the non-cash basis may be more appropriate for a car rental company, but the cash basis may be more appropriate for a driving school where the use of the vehicles is only for the purpose of providing lessons. • Credit policy and debt recovery If the business has formal procedures for extending credit and collecting debts, the cash basis is less likely to be appropriate. The cash basis is more likely to be appropriate where the entity does not usually provide credit. • Size

The cash basis is less likely to be appropriate where the business has a large number of employees, large overheads, a large amount of trading stock or a complex business structure. • Nature of the accounting system This requires consideration of the books of account and the way they are kept for day-to-day business operations; the appropriateness of the accounting method used; the ability of the system to readily provide lists of creditors and debtors; ordinary accounting principles and commercial practice; and Accounting Standards AAS 6 and AASB 101, which require companies to use the accrual basis. For example, a cash basis would not be appropriate for a business that is totally operated on invoice sales and has an accounting system with the capacity to readily obtain invoice information. • Timing advantages The cash basis will not be permitted if the principal support for it is that the entity seeks to avoid the timing disadvantages that may apply under the non-cash basis. The ATO must notify the applicant entity of its decision. If permission is granted, the cash basis will take effect from the date notified by the ATO. Both the decision and the date of effect are reviewable decisions (s 29-45(2)).

¶6-160 Ceasing to account on a cash basis A small business entity which has chosen to adopt the cash basis must cease accounting for GST on that basis if it ceases to be a small business entity, unless it has the ATO’s permission (s 29-50(1)(a)). The date of effect of the cessation is the first day of the next tax period to commence after the start of the income year in which the entity is not a small business entity (s 29-50(2)(a)). Example At 1 July 2017, Jaiden determines that he is no longer a small business entity. Unless he obtains the Commissioner’s approval, his entitlement to use the cash basis ceases with effect from 1 October 2017, the next tax period to start after he ceased to be a small business entity.

If an entity is not carrying on a business and its GST turnover exceeds $10m (¶6-005), it must stop using the cash basis for future tax periods, unless it has the ATO’s permission (s 29-50(1)(ab), 29-50(2)(b); ¶5170, ¶5-190). An entity may, at its own option, notify the ATO that it is ceasing to use the cash basis for future tax periods (s 29-50(1)(b), 29-50(2)(c)).

¶6-165 How the cash basis operates An entity using the cash basis of accounting attributes the GST to the tax period in which it received consideration for supplies it makes. If it only received part of the consideration for supplies during the tax period, it attributes the corresponding part of the GST to that period. The GST which is attributed to the tax period is the amount that is included in its GST return for the period (s 29-5(2)). The time of invoicing or supply is irrelevant. Where an entity using the cash basis makes an acquisition, it attributes the input tax credit for the purchase to the tax period in which it provided the consideration. If it only provided part of the consideration during the tax period, it attributes the corresponding part of the credit to that period (s 2910(2)). This is subject to the requirement that in most cases the entity must have held a tax invoice for the acquisition at the time of lodging the return (s 29-10(3)). Examples (1) Seller and Buyer operate on a cash basis and both have the same tax periods. Seller sells goods and issues a tax invoice in the first tax period of the year. Buyer pays for the goods in the second tax period of the year.

Seller should attribute the GST on the sale to the second tax period because that is when payment is received. Buyer should attribute the input tax credit to the second period because it paid for the goods in that period and had a tax invoice. (2) Supplier and Recipient operate on a cash basis and both have the same tax periods. Recipient makes a part-payment for goods in the first tax period, receives the goods in the second period, together with a tax invoice, and pays the balance owing in the third period. Supplier should attribute the GST on the part-payment to the first tax period, and the GST on the balance to the third tax period. As Recipient does not receive a tax invoice until the second tax period, the input tax credit for the part-payment made during the first tax period should be attributed to the second tax period. Recipient should attribute the input tax credit for the balance to the third period.

¶6-170 Asset and instalment acquisitions under the cash basis During the infancy of Australia’s GST, one of the main disadvantages of using the cash basis was the delayed entitlement to input tax credits for certain acquisitions, particularly of higher value capital assets. Full input tax credits have always been claimable in the BAS for the tax period of acquisition where the entire consideration was paid at that time. Examples include assets where full consideration was paid by cash, cheque or credit card or by way of chattel mortgage entered at the time of acquisition (¶6-165, ¶6185). By contrast, for cash basis entities, the input tax credit for a tax period was generally restricted in respect of instalment or hire purchase payments (¶6-175). Where consideration is provided in instalments by a cash basis purchaser, only 1/11th of the payment made is attributable as an input tax credit in the period of payment (s 29-10(2)(b)). This is so even where the parties to the supply have agreed that all the GST is paid with the first instalment. Example A cash basis purchaser entered into a financing agreement to acquire a motor vehicle. The effect of the agreement was that it was a sale with payments made in monthly instalments of $1,000. The finance company advised the purchaser that the GST amount for the vehicle purchase (in this case $4,000) would be paid upfront, hence combined with the first monthly instalment of $1,000, the first payment was $5,000. The purchaser sought to claim a full input tax credit of $4,000 for the period in which the first instalment was paid on the basis that all the GST was paid in that period. As the purchaser accounted for GST on a cash basis, under s 29-10(2)(b), only the amount actually paid ($5,000) was attributed to that first tax period, hence only part of the input tax credit ($454) was claimable in that tax period. A private agreement treating an amount as the GST component cannot override the law and bind the Commissioner (example based on Lancut (Aust) Pty Ltd v FC of T 2003 ATC 2204).

The input tax credit claimable is usually 1/11th of the amount of each instalment paid. Note that some purchases by instalments may technically qualify as hire purchase acquisitions (¶6-175).

¶6-175 Hire purchase acquisitions For contracts entered into until 30 June 2012, acquisitions by cash basis entities under hire purchase arrangements were treated similarly to acquisitions by instalments. One difference during that period was that the input tax credit claimable by the entity may only have been 1/11th of the principal component (the effect of GST Regulations reg 40-5.09(3) item 8). The Commonwealth Government became concerned that the GST treatment of hire purchase acquisitions by cash basis entities had become distortionary. Financial institutions were reporting that, since GST was introduced, the numbers of hire purchase contracts written had proportionately reduced whereas the number of chattel mortgages had risen. The inability to claim full GST credits up front had led to a preference by cash basis entities to use chattel mortgages which are generally recognised as a riskier form of financing. For new hire purchase contracts written from 1 July 2012, all of the components of the supply are taxable if made by a GST registered enterprise (GST Regulations reg 40-5.12 items 19 and 20). A cash basis entity acquiring under a hire purchase contract will be entitled to claim an input tax credit for the entire

GST in the BAS for the tax period in which it makes the first payment. Example In September 2017, Albert acquires a freezer under a hire purchase agreement requiring monthly instalments of $670 payable over five years. The total amount repayable under the contract is $40,200 comprising $33,000 for the freezer and interest charges of $7,200. Albert accounts for GST on a cash basis. In the September 2017 BAS, Albert can claim input tax credits of $3,654.54 being 1/11th of the total repayments of $40,200 even though he has only paid one instalment of $670 (based on the ATO website (www.ato.com.au) guideline GST — Hire purchase and leasing).

¶6-180 How cash basis taxpayers account for adjustments There may need to be an adjustment to the GST or input tax credits because of a change in circumstances, for example, a transaction is cancelled, goods are returned, the price is changed or there is a change in planned use (s 19-10). Generally, an adjustment is attributed to the tax period in which the entity becomes “aware” of the adjustment (s 29-20(1)). Entities that account for GST on a cash basis do not have adjustments because of bad debts. Whether they were the supplier or purchaser, they will not have accounted for GST on the debt as consideration has not been paid or received for that amount of the debt. Entities that account on a non-cash basis can have GST adjustments for bad debts. A special attribution rule applies if: • the entity accounts on a cash basis, and • the adjustment arises from an “adjustment event” (s 19-10) that results in the entity becoming liable to provide consideration. In this case, the adjustment is attributed to the tax period in which the consideration is provided. If the entity only provides part of the consideration during the tax period, it attributes a corresponding part of the adjustment to that period (s 29-20(2)). If the entity has a decreasing adjustment arising from an adjustment event, the adjustment is not attributable to a tax period unless the entity holds an adjustment note at the time it lodges its GST return for that tax period (s 29-20(3)). The Commissioner can waive this requirement.

¶6-185 How the non-cash basis operates Unless an entity qualifies to account on a cash basis (¶6-130), it must use the non-cash or accruals basis. Under the non-cash basis, the GST payable on a supply is attributed to the tax period in which the entity: • received any consideration for the supply, or • issued an invoice for the supply whichever comes first (s 29-5). The input tax credit which it is eligible to claim for an acquisition is attributed to the tax period in which: • the entity provides any of the consideration for the goods or services, or • the supplier issued an invoice for the acquisition whichever comes first (s 29-10). However, normally an entity cannot claim an input tax credit unless it also has a tax invoice for the purchase at the time of lodging the return (s 29-10(3)).

Examples (1) Seller and Buyer operate on a non-cash basis and both have the same tax periods. Seller sells goods and issues an invoice at the end of the first tax period of the year. The invoice does not comply with the requirements for a tax invoice (¶6-190). Buyer pays for the goods in the second tax period of the year. Seller becomes entitled to be paid when it issues the invoice and should therefore attribute all of the GST on the sale to the first tax period. Buyer becomes liable to pay when it receives the invoice in the second tax period, but cannot attribute the input tax credit to that period because it does not have a tax invoice. Until it receives this, it cannot claim the credit. (2) Supplier and Recipient operate on a non-cash basis and both have the same tax periods. Recipient makes a part payment on goods in the first tax period, receives the goods in the second period (together with a tax invoice) and pays the balance owing in the third period. As Supplier receives some of the consideration in the first tax period, all of the GST on the sale should be attributed to that period. Buyer does not receive a tax invoice until the second tax period. Hence, all of the input tax credit for the purchase should be attributed to that period. (3) Vendor and Purchaser operate on a non-cash basis and both have the same tax periods. Vendor requires payment in advance in the first tax period, and delivers the goods in the second tax period, together with a tax invoice. Vendor should attribute all of the GST on the sale to the first period. Purchaser does not receive a tax invoice until the second tax period. Hence, all of the input tax credit for the purchase should be attributed to that period.

¶6-190 Invoices and tax invoices An invoice is a document notifying an obligation to make a payment (s 195-1). It may be in written or electronic form. The ATO considers that the obligation must be a legal obligation (GST Ruling GSTR 2000/34). However, it seems that a document may be an invoice even though it does not specify a time for payment (Shell NZ Holding Company Ltd v CIR (1994) 16 NZTC 11,163, at p 11,168). An invoice may include a delivery docket, but not a mere job quote or an insurance or membership renewal notice. The ATO also considers that a notification of a conditional obligation is not an invoice. On this basis, a standard contract for the sale of land would normally not be an invoice because the sale is conditional on both parties completing their side of the agreement (GST Ruling GSTR 2000/28). It has been held that a tax invoice is not “issued” until some act is done to convey it to the intended recipient, though it is not clear whether it is necessary to show actual receipt (Tavco Group Pty Ltd v FC of T 2008 ATC ¶10-049). The ATO considers that an invoice is issued when it is electronically transmitted, posted, couriered, hand delivered or similar. The recipient is entitled to rely on the date of issue noted in the invoice in the absence of any evidence to the contrary (GST Ruling GSTR 2000/34). The ATO considers that an invoice posted on a website is “issued”, provided: (1) it is posted in an area that is readily accessible by the entity to whom the invoice is to be issued (2) it can be downloaded or printed in a readable format, and (3) the receiver has been informed that the invoice has been placed on the website (eg by email), or is aware by arrangement or agreement that invoices will be placed on the website (GST Determination GSTD 2005/2). Invoices would normally be issued by the supplier, but the ATO considers that a recipient created tax invoice (s 29-70) would also qualify (GST Determination GSTD 2005/1). A tax invoice is a special type of document which must include enough information to enable ascertainment of, among other things, the supplier’s identity, the thing supplied, the price and the GST (s 29-70(1)). It is not necessarily the same as an ordinary invoice, though they will commonly be the same document (s 29-70).

¶6-195 Progressive or periodic supplies If an entity is not operating on a cash basis, a special rule applies for transactions which are progressive or periodic supplies. The rule applies to agreements where a single supply or acquisition is made for a period or on a progressive basis, and the payment is made either on a progressive or periodic basis (Div 156). The rule specifically applies to leases and hiring arrangements (s 156-22), but other examples would include annual subscriptions paid on a monthly basis, building and construction contracts, real estate property management services, pay-by-the-month insurance cover, or an office equipment maintenance contract payable monthly. In this situation, the contract is treated as a series of contracts for supplies that are paid for separately (s 156-5, 156-10, 156-20). From the supplier’s point of view, this means that each progressive or periodic component of the supply is treated as a separate supply, so that the GST is attributed to the tax period in which the earlier of invoicing or receipt of payment for that component occurs. Correspondingly, from the recipient’s point of view, it means that the input tax credit for each progressive or periodic payment is attributed to the tax period in which the earlier of invoicing or provision of payment for that component occurs. Without this special rule, entities would have been required to attribute all the GST and input tax credits to the tax period in which earlier of invoicing or the first payment for the supply occurred (s 156-5, 156-10; GST Ruling GSTR 2000/35). The special rules regarding progressive and periodic supplies apply even where only one party (the supplier or the recipient) accounts for GST on the non-cash basis, but only for that party. Example Lily agrees to provide consultancy services to Mendosa for a period of six months, with payments made monthly. Lily is on the cash basis and Mendosa is on the non-cash basis. The special rule in Div 156 will therefore apply to Mendosa but not to Lily. Under the normal cash basis rules, Lily must attribute the GST on each payment to the tax period in which she receives it. In accordance with Div 156, Mendosa must attribute the input tax credit for each payment to the tax period in which the earlier of invoicing or his payment occurs.

¶6-200 When consideration is provided or received Consideration will normally be the payment for the supply, but also covers almost anything of value. It can include any payment or any act or forbearance: • in connection with a supply of anything, and • in response to or for the inducement of a supply of anything (s 9-15). GST Ruling GSTR 2003/12 describes various methods of payment that may be used in transactions. It provides guidelines for determining when consideration is provided or received for supplies, some of which are summarised as follows: • Cash When a payment is made by tendering Australian currency, consideration is both provided and received when the payment is tendered. • Cheque When payment is made by cheque, the recipient of the supply provides consideration when the cheque leaves his or her possession, ie when the cheque is either handed or posted to the supplier or the supplier’s agent. Consideration is received by the supplier when the cheque is received, not when it is banked or cleared. Where payment is made by traveller’s cheque, consideration is both provided and received when the cheque is countersigned, as this is the point at which the order to pay becomes unconditional. • Credit card

When a payment is made by credit card in person, consideration is provided and received when the recipient of the supply signs the docket to authorise the transaction. When a payment is made remotely (eg by telephone or through the internet), the consideration is provided and received when the cardholder gives the card number and other required details. • Debit card (EFTPOS) Where payment is made using a debit card (EFTPOS), consideration is both provided and received when the transaction is accepted by the system. This will usually be when a point-of-sale machine accepts the transaction. • Direct credit Direct credit transactions are initiated by the recipient of the supply. Consideration is provided on the date the payment is authorised by the recipient, and consideration is received when the payment is credited to the supplier’s account. • Direct debit The consideration for direct debit transactions is both provided and received at the time of the transfer. As the supplier initiates the direct debit transaction, the consideration is received when the supplier makes the transfer from the transaction or credit accounts of the recipient. Other payments methods discussed in GST Ruling GSTR 2003/12 include interbank transfers, digital cash, vouchers, stored value cards, barter schemes, direct barter, sale on credit, lines of credit/overdraft, book entries as consideration and money held on trust pending disbursement.

¶6-205 Change of accounting basis If an entity changes its basis of accounting, there are transitional rules to prevent transactions being taxed twice or falling out of the GST system altogether. For example, GST and input tax credits may arise twice if the change was from the non-cash basis to the cash basis. Conversely, if an entity changes from the cash basis to the non-cash basis, GST and input tax credits may not arise at all on transactions that were invoiced before the change but not paid until after. To overcome these anomalies, the following transitional rules apply.

¶6-210 Change from non-cash to cash basis If the GST was attributable to a tax period before the change, it remains attributable to that period and no other (s 159-20). Corresponding rules apply to input tax credits and adjustments. Example 1 Jorge operates on a non-cash basis. In the March tax period, Jorge issues an invoice for a supply. In the September tax period, he starts accounting on a cash basis. In the December tax period, Jorge receives payment of the invoice. The GST on the supply is attributable to the March tax period, because at that time Jorge was on the non-cash basis and had issued an invoice. In the absence of the transitional rule, the GST would also have been attributable to the December tax period because Jorge was on a cash basis and had received payment. The effect of the transitional rule is that the GST remains wholly attributable to the March tax period, and not to the December tax period.

If an entity changes from a non-cash to a cash basis, and a debt is written off as bad after the change, there will be a GST adjustment in the same way as if it was still on the non-cash basis (s 159-25). Example 2 Kareem operates on a non-cash basis. In the June tax period he issues an invoice for a supply. In the September tax period Kareem changes to a cash basis. In the December tax period he writes off the whole of the debt because the customer has gone out of business. Under the normal transitional rule on a change of accounting basis, the GST on the supply remains attributable to the

June tax period. However, because the debt is bad, there will be a decreasing GST adjustment as if Kareem was still on the noncash basis. This is attributed to the December tax period and will have the effect of reducing the net GST on the supply to nil.

¶6-215 Change from cash to non-cash basis If the GST on a supply was not attributable to a tax period before the change to the non-cash basis, but would have been if the entity was accounting on a non-cash basis at that time, the GST is attributed to the first tax period in which the change applies (s 159-5). If the GST on a supply was partly attributable to a tax period before the change, but would have been fully attributable if the entity was accounting on a non-cash basis at that time, the balance of the GST is attributed to the first tax period in which the change applies (s 159-10). Corresponding rules apply to input tax credits and adjustments. Example 1 Gerhard operates on a cash basis. In the September 2017 tax period, Gerhard issues an invoice for a supply. For the March 2018 tax period, Gerhard stops accounting on a cash basis. In the June 2018 tax period he receives payment for the supply. The GST on the supply is not attributable to the September 2017 tax period, because at that time Gerhard was on a cash basis and had not received payment. However, the GST would have been attributable to that period if he had been on the non-cash basis, because he had issued an invoice. It is therefore attributed to the first tax period in which he is on the non-cash basis, ie the March 2018 tax period.

Example 2 Helga operates on a cash basis. In the September 2017 tax period, Helga issues an invoice for a supply and receives 25% of the payment. For the March 2018 tax period, Helga stops accounting on a cash basis. In the June 2018 tax period, she receives the balance of the payment for the supply. 25% of the GST on the supply is attributable to the September 2017 tax period because at that time Helga was on a cash basis and had received 25% payment. The GST would have been fully attributable to that period if she had been on a non-cash basis because she had issued an invoice. Therefore, 75% of the GST is attributed to the first tax period in which she operates on a non-cash basis, ie March 2018.

Where an entity attributes GST or credits on a cash basis, and a relevant debt was written off as bad before the change to the non-cash basis, there will be a GST adjustment in the same way as if the entity was always on the non-cash basis. The GST adjustment is attributed to the first tax period in which the entity is actually operating on the non-cash basis (s 159-15). Example 3 Indira operates on the cash basis. In March, she issues an invoice for a supply. In the June tax period, she writes off the whole of the debt because the customer has gone out of business. In the September tax period, she changes to the non-cash basis. Under the normal transitional rule on a change of accounting basis, the GST on the supply will be attributed to the September tax period. However, because the debt is bad, there will also be a decreasing GST adjustment in that same period which will have the effect of reducing the net GST on the supply to nil.

PAYMENT OF GST BY INSTALMENTS ¶6-300 Overview Small business entities with an aggregated turnover of less than $10m and certain other entities which have a GST turnover of $2m or less (¶6-005) can elect to pay their GST in quarterly instalments (s 162-5). Generally, instalments are worked out by the ATO and notified to the entity in a BAS before the due date for payment. The amount of the instalment is usually based on the previous year’s net amount, adjusted by a GDP change factor. Alternatively, the entity can vary the instalment amount on the basis of an estimate of its annual GST liability (s 162-140).

An entity which pays GST by instalments must lodge an annual GST return by the date its income tax return is due (s 162-60). By the same time, the entity is required to make a balancing payment if their net amount exceeds the sum of the four quarterly instalments (s 162-110). If the sum of the four quarterly instalments exceeds the net amount for the financial year, the entity is entitled to a refund. GST instalments may be paid by electronic payment, by mail (cheque), by providing the Commissioner with a direct debit authority, or at Australia Post (¶5-560).

¶6-305 Pros and cons of paying GST by instalments The advantages of paying GST by instalments are: • managing cash flow — it can be simpler for entities to manage cash flow where they can budget up to four equal payments of GST and their respective payment dates • less compliance — only one GST return needs to be lodged per year hence entities may incur less administration than if four or twelve BASs had to be prepared based on actual results • GST payment deferral — instalment amounts are typically based on previous net amounts. For an entity whose quarterly net amounts (GST liabilities less input tax credits) are increasing, the payment of notified GST amounts can lead to a deferral of significant portions of the annual GST payable until the income tax return is due. Further, entities whose input tax credits exceeded their GST liabilities in the previous financial year will usually be given an instalment rate of zero for the current year. This means they do not pay any GST in the current year until they lodge their annual GST return for it. The disadvantages of paying GST by instalments are: • early payments of GST — entities below the registration turnover threshold lose the entitlement to defer payment of the full year’s GST liability until the time of lodgment of their income tax return • loss of GST flexibility — the advantages in managing GST cash flows by structuring the timing of receipts and payments are lost if GST instalments are paid • GST Import Deferral Scheme — importers paying GST by instalments cannot use the Import Deferral Scheme, hence they cannot delay GST payments on imports • complex transitional rules apply for entering and leaving GST instalment paying arrangements • net GST refund entities — entities that typically obtain refunds of GST because they make predominantly GST-free supplies, eg medical practitioners or exporters, gain no benefit and may even delay their input tax credit claims and refunds • businesses with steady or declining sales face GST payment acceleration — that is because notified GST instalment amounts are likely to be based on the higher turnover previous year’s result adjusted upwards for a GDP factor • annual apportionment of input tax credits — the compliance and cash flow benefits of this option are not available • regular monitoring of projected GST turnover may be required to ensure the entity continues to be eligible • instalment shortfall penalties — variations of instalment amounts can lead to penalties in certain circumstances. The ATO has advised that, during the 2016/17 year, approximately 105,000 taxpayers paid GST by quarterly instalments, representing around 4% of taxpayers entitled to do so.

Rules of thumb Payment of GST by instalments is generally of most benefit to entities that: • have increasing sales • are net GST payers and are only rarely entitled to net refunds • have uneven trading patterns such that: – a larger proportion of their taxable supplies are made in the July to December period rather than later in the financial year – a larger proportion of their acquisitions are in the January to June period rather than earlier in the financial year • value the budget discipline of four fixed GST payments per year • prefer the lesser compliance of one GST return per year prepared at the time of preparing their income tax return.

¶6-320 Which entities can elect to pay GST by instalments? An entity can elect to pay GST by instalments if, at the time of the election (s 162-5): (1) it is a “small business entity” for the income year in question, meaning it has an annual turnover (including the turnover of related entities) of less than $10m (see Chapter 2, ¶6-005 and ¶6-140), or it does not carry on a business (¶5-160) and its GST turnover (¶5-240) is $2m or less (¶6-005). Examples of entities which carry on an enterprise, but not a business, can include property owners that derive their only income from rentals (¶5-190) and charitable institutions, trustees of complying superannuation funds and some government bodies (¶5-200) (2) it does not have monthly tax periods. If the entity has previously lodged monthly returns, it will need to change to lodge quarterly returns (3) it has lodged GST returns for tax periods covering a continuous period of at least four months immediately preceding the current tax period — eg two quarterly returns, or four monthly returns if it previously lodged monthly. This period is the entity’s “current GST lodgment record” (4) it has complied with all its obligations to lodge GST returns. The effect of these conditions is that an entity is generally not eligible to elect to pay by instalments for a financial year if it was not a GST instalment payer for the previous financial year and, by 28 October of the current financial year, it is not up to date with lodgment of its quarterly GST returns for the previous year (5) it is not in a “net refund position” for certain tax periods immediately preceding the entity’s current tax period, and (6) it is not a limited registration entity (s 146-5). A limited registration entity is a registration category introduced to facilitate simplified GST compliance by certain non-resident suppliers. The relevant non-resident suppliers are those who make supplies not connected with the Australian indirect tax zone and which involve either supplies of intangibles to Australian consumers or low value imports (Div 84).

¶6-325 Net refund position The net refund position is determined from the standpoint of the current tax period. However, the calculations do not include the net amounts from the current tax period but only those in tax periods before the current one. An entity is in a net refund position if the sum of its net amounts for those tax periods is less than zero (s 162-5(3)), that is, the sum of its credits exceeds the total of its GST payable (¶5-545). In calculating the net amounts, it is necessary to include any wine equalisation tax and luxury car tax payable or refundable (s 17-5). The net refund position provision was drafted deliberately to exclude the first tax period for any new business. It is understood that this is because new entities commonly have a net amount less than zero in

their first tax period because their start up costs exceed the income they generate. The first tax period of a new business is usually not typical of its ongoing trading pattern or net amounts. By excluding the first tax period, the GST instalment system reduces the possibility that the instalments during the first instalment year will be reduced because of the impact that the unrepresentative first tax period would have on the entity’s net amount for the year. Where an entity’s current GST lodgment record is at least 13 months, the entity determines whether it is in a net refund position by considering the 12 months preceding the current tax period. Example 1 Mustaq registered for GST in 2012 and lodges his GST returns on a quarterly basis. In August 2017, he is considering whether to pay GST by instalments. He will not be able to if he is in a net refund position for the tax periods covering July 2016 to June 2017.

Where the entity’s current GST lodgment record is less than 13 months, fewer tax periods are taken into account in working out whether it is in a net refund position, as follows: Current GST lodgment record

Take account of tax periods covering this period

10 months to less than 13 months

The 9 months preceding the current tax period

7 months to less than 10 months

The 6 months preceding the current tax period

Less than 7 months

The 3 months preceding the current tax period

Example 2 Nina commenced operations in Australia on 1 October 2016. On 15 October 2017, she wants to elect to pay GST by instalments. She qualifies as a small business entity for the 2016/17 income year. She has lodged GST returns for the three quarters to 30 June 2017. For the quarter ending 31 December 2016, Nina’s net amount was $5,000, for the March 2017 quarter it was — $4,000 and for the June 2017 quarter it was $3,000. Her current GST lodgment record is therefore nine months. She has satisfied the five of the six tests listed above which determine eligibility to elect to pay GST by instalments. As her current GST lodgment record is nine months, she needs to have been in a net refund position for any tax periods for which GST returns fell due in the six months preceding the current tax period. As she is considering an election on 15 October 2017, her current tax period is the quarter commencing 1 October 2017. She must consider her net refund position for the GST returns which fell due in the six months prior to 1 October 2017. The September 2017 return did not fall due in that period — it only falls due in October 2017. The March and June 2017 tax periods fell due in the six months (in April and July 2017 respectively). It follows that Nina is not eligible to elect to pay GST by instalments. She is in a net refund position because the sum of her net amounts for the March and June 2017 quarters is — $1,000 (ie less than zero). The net amount of $5,000 for the December 2016 quarter is ignored.

¶6-330 How is the election made? The ATO will typically notify the entity that it is entitled to pay GST by instalments by including that option in the first BAS issued after it has become so entitled. The entity will notify the Commissioner of its election by selecting that option in the BAS. Timing and effect of the election to pay by instalments Generally, the election must be made by 28 October in the financial year (s 162-25). Where the ATO notifies an entity in its September BAS that it is eligible to pay GST instalments, it can make the election by selecting that option on the BAS and lodging the BAS by 28 October. An election takes effect from the start of the earliest tax period for which the entity’s GST return is not yet due. That is, the election will apply to a tax period for which the entity has not yet lodged a GST return with the Commissioner. However, the Commissioner may allow the election to take effect from some other tax period (s 162-15). For entities with a current GST lodgment record of more than six months, an election made by 28 October

will take effect from the preceding 1 July (s 162-25). Thus, typically, the first tax period in which the entity pays GST by instalments is the one in whose BAS the election was actually made. Example 1 Alex has been registered for GST since 2009. He notifies the Commissioner of his election to pay GST by instalments in the September 2017 BAS. His election takes effect from 1 July 2017.

A new business can elect to pay GST by instalments but not immediately upon commencement. Eligible entities that have been lodging GST returns for six months or less can make their election after 28 October, but it must be made by the day on which the entity would otherwise have to lodge its next quarterly return after it becomes eligible to make an election. Example 2 Fadia commences operations on 1 July 2017 and lodges quarterly GST returns on 28 October 2017 and 28 February 2018. From 28 February, Fadia first becomes eligible to elect to pay by instalments (prior to then her lodgment record was less than four months). On 15 March 2018, she decides to make her election. The first tax period for which Fadia has not yet lodged a GST return is the March 2018 quarter. She will be a GST instalment payer from the start of that tax period, ie from 1 January 2018. She would have had to make that election by 28 April 2018 for it to take effect by 1 January 2018.

¶6-340 Extension of time to make the election An entity can request an extension of the election deadlines. The Commissioner’s decision on the request for extension is reviewable under the objection, review and appeal provisions. An application for extension must be made in the approved form (s 162-25). In determining whether to allow an entity to make a late election, the Commissioner will take into account the taxpayer’s previous compliance history, whether the taxpayer has a valid reason for the late election, whether the failure to elect was isolated or habitual and any exceptional circumstances. The Commissioner has allowed late exceptions in circumstances where a BAS with the election has been lost in the mail and where the taxpayer had a serious illness and paid the resulting instalment on time but inadvertently failed to lodge the BAS with the election on it (Interpretative Decisions ID 2004/447 to ID 2004/449).

¶6-345 Revocation or cessation of election An election will continue in force indefinitely, unless: • the entity revokes it • the Commissioner disallows it because the entity has failed to comply with one or more of its tax obligations • the entity loses its eligibility • during a financial year the entity becomes a limited registration entity (¶6-320), or • the entity is the representative member of a GST group and the membership of the GST group changes (s 162-30). An entity may revoke its election by notifying the Commissioner of its revocation. If an entity notifies the Commissioner of the revocation on or before 28 October in a financial year, its election will cease to have effect from the start of that same financial year. If an entity notifies the Commissioner of its revocation after 28 October in a financial year, the election will cease to have effect from the start of the following financial year. This means that an entity is usually either in or out of the instalment system for a full financial year (s 162-30).

Example 1 Lizzy’s election to pay GST by instalments has continued in force from 1 July 2014 to 30 June 2017. In October 2017 she is considering whether to revoke the election. If she does so by 28 October 2017, then (unless she can make an eligible annual tax period election) she will have to lodge quarterly returns from 1 July 2017. In November 2017, she decides to revoke the election. She will continue to pay by instalments for the full 2017/18 financial year. It is only from 1 July 2018 that she will have to lodge quarterly GST returns based on actual results.

If the Commissioner disallows an entity’s election during the financial year in which the election first took effect, the election will cease to have effect from the start of the tax period in which the election first took effect. For later financial years, if the Commissioner disallows an entity’s election on or before 28 October, the disallowance will have effect from the start of that financial year. If the Commissioner disallows the election after 28 October the disallowance will take effect from the start of the next financial year (s 16230(1)(b), 162-30(4)). Example 2 Miloslav’s election to pay GST by instalments took effect on 1 July 2017. On 30 April 2018, the Commissioner disallowed Miloslav’s election. As a result, Miloslav’s election ceased to have effect from 1 July 2017 and the Commissioner is likely to require him to lodge GST returns for the September 2017, December 2017 and March 2018 quarters based on actual results.

An election made by an entity on the basis that it is a small business entity ceases to have effect once the entity is no longer a small business entity. The cessation is taken to have ceased from 1 July in the income year in which it is not a small business entity (s 162-30(1)(c), 162-30(5)). Once an entity that carries on an enterprise, but not a business, has made a valid election to pay GST by instalments, the entity is required to determine on 31 July of each financial year whether its GST turnover exceeds the instalment turnover threshold of $2m (s 162-30(1)(ca), 162-30(5A); ¶6-005). An entity that does not meet this criteria will be ineligible to continue in the GST instalment system and its election will cease to have effect from the start of the financial year in which it becomes ineligible to continue in the GST instalment system (s 162-30(6)). Example 3 Rick is the owner of a commercial property whose GST turnover in 2016/17 was below $2m. He paid GST by instalments during that full financial year. He has exchanged contracts for the purchase of another property. By 31 July 2017, he had to consider whether the likely additional commercial rental from the property would take his projected GST turnover over $2m. If so, he would no longer be eligible to elect to pay GST by instalments and his election would cease to have effect from 1 July 2017.

Once a valid election has been made and the other obligations are complied with, an entity’s election continues in force even where the entity happens to have received net refunds for later quarters in the financial year.

¶6-347 Entities that move into a net refund position An entity can only elect to pay GST by instalments if it is not in a net refund position. Additionally, until 30 June 2013, an election to pay by instalments ceased to have effect if, during the first tax period applying to an entity in a financial year, it was in a net refund position (former s 162-30(1)(d)). Thus, an entity which was validly entitled to pay GST by instalments (as it was not previously in a net refund position) was no longer able to do so if it had moved into a net refund position. The enactment of the Tax and Superannuation Laws Amendment (2013 Measures No 2) Act 2013 removed that disallowing provision. The amendments also provided that small business entities which move into a net refund position and wish to continue to pay GST by instalments will receive an instalment amount of zero each quarter. The Explanatory Memorandum to the Bill included the following example: Example

Ashley operates a shop selling homewares and is eligible to pay GST by instalments. She has paid GST by instalments continuously from the quarter ending September 2010. Ashley made a large equipment purchase in August 2016. On 31 July 2017 she lodges her annual GST return and receives a refund because she is entitled to more input tax credits on her purchases than she is required to pay GST on her sales. Ashley wants to continue paying GST by instalments from the quarter ending September 2017 despite being in a net refund position when she lodged her most recent annual GST return. As she was paying GST instalments in the previous year she will be eligible to continue to use the GST instalment system because of the law change. She will be offered an instalment amount of zero in the quarter ending September 2017. Ashley may choose to vary the instalment amount upwards from zero to better reflect her trading conditions.

The amendment applies in relation to GST instalment quarters starting on 1 July 2013.

¶6-350 GST groups that pay GST by instalments Members of GST groups can elect to pay GST by instalments provided they satisfy certain extra criteria. A representative member of a GST group can elect to pay by instalments only if each member of the group is eligible to elect. If the representative member makes the election, the instalment tax period applies to each other member, but those other members are not GST instalment payers themselves (s 162-20). Rather, the representative member pays GST by instalments for the entire GST group. If an entity is a member of a GST group, it cannot count towards its current GST lodgment record tax periods during which membership of the group has changed. Further, an entity cannot count towards its current GST lodgment record a tax period during which it was the representative member of a GST group if it is no longer the representative member. Example 1 Shaz, Faccin and Clancy are all members of a GST group for which Faccin is the representative member. They are registered for GST and account for GST on a quarterly basis. On 1 January, Clancy leaves the GST group. Faccin would like to pay GST by instalments but is ineligible to do so until two quarterly GST returns have been lodged in respect of the new GST group membership of Shaz and Faccin. (This example is based on Example 2.5 in the Explanatory Memorandum to Taxation Laws Amendment Bill (No 3) 2001.)

The reason behind these special eligibility criteria for GST groups and past representative members is to ensure the payment history of GST groups is representative for the purposes of determining future instalments. If the membership of the GST group changes or the representative member leaves the group, the instalments, which are usually based on past net amounts, may not reflect the entity’s new structure. An election by the representative member of a GST group to pay by instalments ceases to have effect where the membership of the GST group changes. That cessation enables the GST group to be able to account for its supplies and acquisitions and be able to offset from these the previous GST instalments paid by the group. The GST return for the instalment tax period will be due on the 21st day of the month following the change in membership of the GST group (s 162-95). Example 2 Amy, Boris, Candy and Dimitri are members of a GST group. They have elected to pay GST by instalments and their instalment tax period started on 1 July 2017. On 15 December 2017, Dimitri leaves the group. The instalment tax period of the GST group ends on 15 December 2017. The GST group must lodge the GST return in respect of that tax period by 21 January 2018 (and pay any net amount for that tax period by this date). Dimitri and the new GST group of Amy, Boris and Candy will revert back to quarterly tax periods from 16 December 2017. Both Dimitri and the representative member of the new GST group will need to lodge GST returns for the period from 16 December to 31 December 2017. After Dimitri and the new GST group have lodged two quarterly BASs, both may elect to pay GST by instalments provided that they satisfy the other eligibility criteria. (This example is based on Example 2.9 in the Explanatory Memorandum to Taxation Laws Amendment Bill (No 3) 2001.)

¶6-355 Tax periods for GST instalment payers

The effect of the election to pay GST by instalments is to substitute the tax period that would otherwise apply with the instalment tax period (s 162-55). The instalment tax period that applies to a GST instalment payer for a financial year is the full financial year. For an entity that is a GST instalment payer for only part of the financial year, the tax period is that part. Example From the examples in ¶6-330, Alex’s instalment tax period is the 2017/18 financial year. By contrast, Fadia’s instalment tax period is the six months from 1 January to 30 June 2018.

Unlike the position for entities with monthly or quarterly tax periods (¶5-450, ¶5-455), an instalment tax period is not terminated by the entity’s death, cessation of business or cancellation of registration (s 16285). In those cases, an instalment will be payable at the usual time following the end of the quarter that the event occurred. An instalment will not be payable for any quarter commencing after the event. An instalment tax period of a member of a GST group ends if the membership of the group changes (s 162-95).

¶6-360 Annual GST return and net amount A GST instalment payer does not lodge quarterly GST returns, although it does lodge a quarterly BAS that includes its GST instalment (s 162-60, 162-70, 162-75). The entity then accounts in an annual GST return reporting the net amount payable for the full instalment tax period. The net amount (¶5-545) for the instalment tax period is calculated as: (1) what would otherwise be the entity’s net amount (2) less the sum of all the GST instalments payable by the entity for the instalment tax period (s 162105). A GST instalment payer’s annual GST return and net amount are due no later than the due date for its annual income tax return (s 162-60). If the entity is not required to lodge an income tax return, the annual GST return and net amount are due by the 28 February following the end of the annual tax period. Where the entity becomes bankrupt or goes into liquidation or receivership, or the membership of its GST group changes (¶6-355), the return must be lodged by the 21st day of the month following the end of the instalment tax period (s 162-90). If the net amount for the full instalment tax period is greater than zero, the entity is required to pay that amount to the Commissioner on or before the due date of the GST return. Where a net amount is negative, the entity may be entitled to a refund.

¶6-365 Due dates for instalments Quarterly GST instalments for a financial year are due as follows (s 162-70): Quarter ending

Due date

30 September

The following 28 October

31 December

The following 28 February

31 March

The following 28 April

30 June

The following 28 July

Where an entity’s election to pay by instalments takes effect during a financial year, instalments are payable only for subsequent quarters of the financial year. The Commissioner has the power to defer a due date. General interest charge (GIC) accrues if any part

of a GST instalment remains unpaid after the due date. For payment concessions, see ¶5-555.

¶6-370 Due dates for instalments for primary producers and special professionals Primary producers and special professionals (eg authors and sportspersons) who elect to be GST instalment payers generally pay only two instalments (s 162-80) due on 28 April and 28 July (ie for the third and fourth quarters). This concession is to ensure that the instalment system accommodates entities subject to very large inherent fluctuations in income patterns. The first instalment amount due on 28 April is intended to equate to 75% of the total net amount for the year (¶6-385). An entity which has elected to be an instalment payer will pay GST in two instalments in an income year if: • it is carrying on a primary production business or it is a special professional such as an author, inventor, performing artist, production associate or sportsperson (ITAA97 s 405-25(1)), and • its gross primary production income or special professional income exceeded the deductions for that income in its most recent income tax return — that is, its net income from the business in its most recently assessed income year was at least $1. Primary producers and special professionals are generally informed in the relevant BAS that they are entitled to pay two GST instalments only.

¶6-375 Carrying on a business of primary production An entity is carrying on a business of primary production if it carries on a business of: • cultivating or propagating plants, fungi or their products or parts (including seeds, spores, bulbs and similar things) in any physical environment • maintaining animals for the purpose of selling them or their bodily produce (including natural increase) • manufacturing dairy produce from raw material that the entity produced • conducting operations relating directly to taking or catching fish, turtles, dugong, bêche-de-mer, crustaceans or aquatic molluscs • conducting operations relating directly to taking or culturing pearls or pearl shell • planting or tending trees in a plantation or forest that are intended to be felled and felling trees in a plantation or forest, or • transporting trees, or parts of trees that the entity felled in a plantation or forest, to the place where they are first to be milled or processed, or to the place from which they are to be transported to the place where they are first to be milled or processed (ITAA97 s 995-1(1)).

¶6-380 Net income of primary producers and special professionals For the purpose of working out the net income for primary producers and special professionals: • any carried forward losses are ignored, and • net farm management deposits and withdrawals are included if withdrawals exceeded deposits. Example 1 Primary producer Russell owns and operates a dairy farm. On 28 October 2017, he chooses to pay GST by instalments. While Russell has not yet lodged his income tax return for the 2016/17 income year, in his 2015/16 income tax return he had $200,000 income from dairy sales, farm expenses of $150,000 and a carried forward loss of $60,000 ($40,000 of which is related to his dairy farm). While

Russell has a net loss of $10,000 for his most recently lodged income tax return, he still pays GST for the year in two instalments. This is because he carries on a business of primary production and his assessable income from that business ($200,000) was more than his deductions related to that income ($150,000) in his most recent income tax return. Carried forward losses are not taken into account when determining whether a business pays GST by two or four instalments.

Example 2 Special professional Jana writes romance novels and short stories. On 28 October 2017, she chooses to pay GST by instalments. Jana lodged her 2016/17 income tax return in August 2017. In that year she earned $33,000 for her novels and $6,000 for a series of stories in a magazine. Her allowable deductions for expenses incurred in producing this income were $5,000, leaving her with net assessable income from her writing activities of $34,000. Jana pays GST for the year in two instalments because she is a special professional and her assessable professional income ($39,000) was more than her deductions related to that income in her most recent income tax return. (Examples based on “PAYG instalments for primary producers and special professionals”, see the ATO’s website — www.ato.gov.au.)

¶6-385 Amount of instalments The amount of the instalment depends upon a series of factors particularly whether it is the entity’s first instalment tax period. Where an entity first becomes eligible to make an election after 28 October in a financial year (eg a new business) the instalment will generally be the entity’s most recent quarterly net amount adjusted by a GDP change factor. For entities in their second or later instalment tax periods, the ATO notified instalment amount is ordinarily based on the previous year’s net amount, adjusted by a GDP change factor. However, where the entity was an instalment payer in the previous year and has not yet lodged its annual GST return, its ATOnotified instalments are initially an amount equal to its previous year’s instalments, adjusted by a GDP change factor. For quarters after an entity elects to pay GST by instalments, the instalment amount is calculated by the ATO and pre-populated (filled-in) on the BAS. Typically, the notified instalments in the next BAS will be the same amounts until the entity lodges its GST return or varies its instalment amount (s 162-130, 162135).

¶6-390 Instalment amounts for primary producers and special professionals Primary producers and special professionals who elect to be GST instalment payers (¶6-370) will have their notified instalment amount pre-populated in their BAS so that these entities pay: • 75% of their annual GST liability by 28 April, and • the remaining 25% by 28 July. Primary producers and special professionals can also vary their instalment amounts.

¶6-395 Notified instalment amounts for entities in net refund position Entities cannot elect to pay GST by instalments if they are in a net refund position within the current GST lodgment record period (¶6-325). If that is not the case and an entity has validly elected to pay GST by instalments, the election continues to have effect even if the entity later moves into a net refund position (¶6-347). Amendments within the Tax and Superannuation Laws Amendment (2013 Measures No 2) Act 2013 provided that, from 1 July 2013, small business entities which move into a net refund position and wish to continue to pay GST by instalments will receive an instalment amount of zero each quarter. An entity’s estimated GST amount used to calculate the instalment is taken to be zero if it would otherwise be less than zero (s 162-140(6)). See the example at ¶6-347 and below.

Example Tomiko paid her notified GST instalments each of $5,000 during the 2016/17 year and $5,500 for the September 2017 quarter. However, when she eventually completed her accounts she calculated a loss in the June 2017 quarter as her sales fell substantially. When she lodged her 2016/17 GST return in November 2017 with an annual net amount of $2,000 before instalments, she was entitled to an $18,000 refund for that year. As a result, the Commissioner will issue notified instalment amounts of nil to Tomiko for the December 2017 and later quarters. Thus, Tomiko might also be entitled to a refund once her 2017/18 GST return is lodged.

¶6-400 Varied instalment amounts An entity can vary the amount of an instalment by notifying the Commissioner by the instalment due date (s 162-140). The amount of the first “varied instalment amount” for an instalment tax period can be any amount as long as it is not less than zero (s 162-140(6)). A notice to vary the instalment amount must be in the approved form. In practice, the notice is given on the BAS for the instalment and includes: • an estimate of the entity’s annual GST liability for the instalment tax period. This “estimated annual GST amount” is the entity’s net amount for the period and for any earlier tax periods in the financial year, before the offset of instalments (s 162-140) • the varied instalment amount, and • the reason or reasons for varying the instalment amount. Subsequent instalments for the instalment tax period will either be 25% of the entity’s last estimate of its annual GST liability or any new varied instalment amount notified to the Commissioner together with the entity’s latest estimate of its annual GST liability. Again, the new varied instalment amount must not be less than zero (s 162-140(6)). Once an entity varies an instalment amount, subsequent instalments for the instalment tax period will technically not be ATO-notified ones (s 162-135). In practice, the ATO typically pre-populates an instalment amount on the entity’s BAS, based on the previous varied instalment amount. Where the entity’s estimate of its annual GST liability changes it should not rely on the ATO pre-populated figure. If the figure is incorrect, the entity could be subject to penalties. Example For the September 2017 quarter, Carol received a notified instalment amount of $20,000. This would equate to an annual GST liability of $80,000. Carol’s estimated annual GST amount is $60,000. In her BAS for the September 2017 quarter, Carol substitutes the notified instalment amount with a varied instalment amount of $15,000 and pays that amount. She inserts an estimated annual GST amount of $60,000. For the December 2017 and following two quarters, the ATO is likely to pre-populate the BAS with an instalment amount of $15,000 (being 25% of Carol’s estimated annual GST amount of $60,000). She can again give notice to the Commissioner of a varied instalment amount by the due date of lodgment of the relevant BAS.

¶6-410 Reasons for varying instalment amounts The Commissioner requires entities that vary their instalment amounts to provide a reason for the variation. Entities are instructed to mark their variation on the appropriate box in the BAS and indicate their reason for varying by choosing one of the reason codes from the table below. An entity intending to vary should choose the reason code that best describes its reason for varying its GST instalment amount and write it in the appropriate box on its new BAS.

Variation reason codes Code

Reason

Reason description

22

Current business

Your current business has stopped trading or has changed its structure.

structure not continuing

For example, you have permanently closed or sold your business, it has stopped trading because of a merger or takeover, or it has gone into bankruptcy or liquidation or been placed in the hands of a receiver/manager.

23

Significant change in trading conditions

Abnormal transactions relating to your business income or expenses will significantly affect your annual tax liability. For example, you have bought or sold a major piece of machinery or your trading conditions have been affected by local or global competition.

24

Internal business restructure

You have restructured your business. For example, it has undergone an expansion or contraction, and this will significantly affect your annual tax liability.

25

Change in legislation or product mix

A change in legislation, or in the product mix of your business, will significantly change your annual tax liability.

26

Financial market changes

Your business has been affected by domestic or foreign financial market changes. This reason code is for businesses involved in financial market trading, including those whose income is affected by changes in financial products, for example, banks, finance and insurance businesses.

The Commissioner offers seven other reason codes which are relevant for PAYG instalment and FBT variations, but not for GST, so they have not been listed here. The Commissioner has indicated that if an entity varies its GST instalment amount, it would use reason code 22, 23, 24, 25 or 26 (see “How to vary the amount you pay” on the ATO’s website — www.ato.gov.au).

¶6-415 Further variations of instalment amounts The Commissioner has indicated that an entity which has varied its instalment amount should vary it again if its estimated annual GST liability, on which it based its earlier variation, has changed. The following example is a modified version of one on the ATO’s website www.ato.gov.au “How to vary the amount you pay”. Example 1 Les is a plumber who is eligible to pay GST by instalments. He chooses to pay by instalments from the September 2017 quarter. Les pays the notified amount of $20,000 for the September quarter, but he decides to vary his December 2017 quarter instalment amount. This is because by the time that instalment is due, Les estimates his GST liability for the year to be $70,000. Les works out his varied instalment amount for the December quarter as follows:

Estimated annual GST liability

$70,000

Amount to be paid by December quarter ($70 000 × 50%)

$35,000

less GST instalment amount paid for September quarter

$20,000

Varied instalment amount for December quarter

$15,000

Les writes $15,000 as his varied instalment amount and $70,000 as his estimated annual GST liability on his December quarter BAS, and also provides a reason code.

Example 2 For the March 2018 quarter, Les may either pay 25% of his annual estimate from the previous quarter if this is still what he estimates his annual GST liability to be, or he may choose to vary this amount. As Les has not changed his estimated annual GST liability of $70,000, his instalment amount for the March quarter is $17,500 (that is, 25% of $70,000). For the June 2018 quarter, Les estimates that his GST liability for the year will be $73,000. He works out his varied instalment amount for the June quarter as follows:

Estimated annual GST liability

$73,000

Amount to be paid by June quarter ($73,000 × 100%)

$73,000

less GST instalment amounts paid for previous quarters ($20,000 + $15,000 + $17,500)

$52,500

Varied instalment amount for June quarter

$20,500

Les writes $20,500 as his varied instalment amount and $73,000 as his estimated annual GST liability on his June quarter BAS, and also provides a reason code.

¶6-420 Varied instalment amounts for new businesses An entity which is a new business can become eligible to elect to pay by instalments part way through a financial year (¶6-330). If so, it can choose to vary its instalment amount when it first became eligible. When working out its varied instalment amount, the new business entity estimates its annual GST liability, calculates the proportion of that which is payable by the quarter in question and then deducts the early net amounts from the tax periods that ended earlier in the financial year before the instalment tax period began (s 162-145). Example Lyn is a landscape designer and registers her business for GST in July 2017. She receives a net GST refund of $2,000 for the September 2017 quarter and pays a net GST amount of $13,000 for the December 2017 quarter. Lyn becomes eligible to use the instalments option for the March 2018 quarter and is notified that her instalment amount for that March quarter is $13,000. As Lyn estimates her annual GST liability to be $30,000, she decides to vary her instalment amount for the March quarter, as follows:

Estimated annual GST liability

$30,000

Amount to be paid by March 2018 quarter ($30,000 × 75%)

$22,500

less the net GST amount paid for the September and December 2017 quarters ($13,000 − $2,000)

$11,000

Varied instalment amount for March quarter

$11,500

Lyn writes $11,500 as her varied instalment amount and $30,000 as her estimated annual GST liability on her March 2018 quarter BAS, and also provides a reason code (¶6-410).

¶6-430 Penalties where varied instalment amount is too low Any one of three potential penalties can arise for an instalment quarter if the varied instalment amount for the quarter is too low. The penalty is deductible for income tax purposes. An entity is liable to penalty for an instalment quarter if it has a varied instalment amount for the quarter and the following circumstances exist: s 162-175

Total instalments are too low in relation to actual annual GST liability — this applies where the sum of the entity’s instalments for the instalment tax period (and any net amounts for earlier tax periods in the financial year where the instalment tax period is less than the full financial year) is less than 85% of its actual annual GST liability, or

s 162-180

Estimated annual GST liability is too low in relation to actual annual GST liability — this applies where all of the following conditions are satisfied: • the entity is not liable to penalty for the quarter under s 162-175 • the varied instalment amount is less than or equal to 25% of the entity’s actual annual GST liability, and

• the estimated annual GST liability is less than 85% of its actual annual GST liability, or s 162-185

Cumulative instalments are too low in relation to estimated annual GST liability — this applies where all of the following conditions are satisfied: • neither s 162-175 penalty nor s 162-180 penalty applies for the quarter, and • the “appropriate percentage” of the estimated annual GST liability exceeds the sum of the varied instalment amount and any earlier instalment amounts for the instalment tax period (and any net amounts for any earlier tax periods in the financial year where the instalment tax period is less than the full financial year). The “appropriate percentage” is: – where the varied instalment is for the September quarter — 25% – where the varied instalment is for the December quarter — 50% – where the varied instalment is for the March quarter — 75% – where the varied instalment is for the June quarter — 100%.

In each case, the amount of the penalty is worked out by applying the GIC to the relevant “GST instalment shortfall” for each day in the period from the due date for the instalment to the due date for the net amount for the instalment tax period.

¶6-435 GST instalment shortfall The GST instalment shortfall for a quarter for the respective penalties is generally worked out as follows, using the “appropriate percentages” for the s 162-185 penalty (¶6-430) where relevant. • For s 162-175 penalty: [actual annual GST liability − × appropriate percentage]

GST payable by that quarter (ie the sum of the varied instalment amount and any earlier instalments)

the sum of any GST instalment shortfalls for this kind of penalty − for which the entity is liable for any earlier quarters

Note: There is a further reduction where any ATO-notified instalment for the year is less than 25% of the annual GST liability or the Commissioner is satisfied that, had there been an ATO-notified instalment, it would have been less than 25% of the annual GST liability (s 162-195 and see Example 1 below). • For s 162-180 penalty: [(actual annual GST liability − estimated − annual GST liability) × appropriate percentage]

the sum of any GST instalment shortfalls for this kind of penalty for which the entity is liable for any earlier quarters

Note: There is a further reduction where any ATO-notified instalment for the year is less than 25% of the annual GST liability or the Commissioner is satisfied that, had there been an ATO-notified instalment, it would have been less than 25% of the annual GST liability (s 162-195 and see Example 1 below). • For s 162-185 penalty: the excess in the description of the s 162-185 penalty above. For all three penalties, a shortfall for a quarter can be reduced to the extent that an instalment for a later quarter exceeds 25% of the entity’s actual annual GST liability. The penalty is then based on the reduced shortfall from the time the later instalment is paid (s 162-200). Example 1 Winnie chooses to pay GST by instalments from 1 July in a particular year. She pays the ATO-notified instalment amount ($12,000)

for the first and second quarters but pays varied instalment amounts for the third and fourth quarters of $10,000 and $11,000 respectively. At the end of the year Winnie lodges her GST return with an actual GST liability of $55,000. As the sum of the instalments ($45,000) is less than 85% of $55,000, Winnie is liable for the s 162-175 penalty for the third and fourth quarters. Assuming the Commissioner would have notified Winnie to pay an instalment of $12,000 in all four quarters, the GST instalment shortfalls would be: • third quarter: ($55,000 × 75%) − $34,000 − $5,250* = $2,000, and • fourth quarter: ($55,000 × 100%) − $45,000 − $2,000 − $7,000* = $1,000. *These are the reductions in the GST instalment shortfalls because an ATO-notified instalment is less than 25% of the annual GST liability. The reductions are calculated as:

[actual annual GST liability × appropriate percentage]

−

instalments notified (or deemed notified) by ATO up to that quarter

The reductions for the third and fourth quarters are: third quarter: (75% × $55,000) − ($12,000 × 3) = $5,250, and fourth quarter: (100% × $55,000) − ($12,000 × 4) = $7,000. The effect is that the sum of the GST instalment shortfalls for the year is reduced to the amount by which the ATO-notified (or deemed notified) instalments ($48,000) exceeds the actual instalments ($45,000).

Example 2 Amenko chooses to pay GST by instalments from 1 January 2018. His notified instalment amount in the third quarter is $25,000. In the fourth quarter he estimates his annual GST liability to be $85,000. However, he varied his fourth quarter instalment to $21,000. In the first quarter and the second quarter of the 2017/18 financial year, he paid the ATO an amount of $10,000 and $25,000 respectively. Amenko works out his actual GST liability for the year to be $95,000. He is therefore not subject to a s 162-175 or 162-180 penalty as both 85% of total GST liability was paid by the end of the year and Amenko’s estimate was within 85% of $95,000. However, since for the fourth quarter the varied amount of $21,000 is less than 100% of ($85,000 less $60,000), he is liable to a s 162-185 penalty. The amount on which the penalty applies is: ($85,000 × 100%) − ($21,000 + $25,000 + $25,000 + $10,000) = $4,000 (The examples above are based on examples in the Explanatory Memorandum to Taxation Laws Amendment Bill (No 3) 2001.)

¶6-440 Penalty notification, due date, remission The Commissioner is required to notify an entity of the amount of penalty. The notice can be included in any other notice, such as a notice of assessment (TAA Sch 1 s 298-10). Penalties are generally due for payment on the day specified in the notice, which must be at least 14 days after the notice is given to the entity. GIC accrues if any part of a penalty remains unpaid after the due date. The Commissioner has the power to remit all or part of a penalty (TAA Sch 1 s 298-20). The Explanatory Memorandum to Taxation Laws Amendment Bill (No 3) 2001 which introduced the GST instalment provisions (para 2.89) indicated that the Commissioner would remit the s 162-180 penalty for a quarter (estimated annual GST liability too low in relation to actual annual GST liability) where the entity could adequately prove that the estimate for the quarter was a fair and reasonable estimate of its liability at that time. Rules of thumb To avoid a penalty for a quarter, an entity’s varied instalment amount, together with GST instalments paid (and other payments for GST such as wine equalisation tax and luxury car tax) for any previous quarters in the year, should be at least the following percentage of its estimated GST liability for the year:

Quarter

September

If the entity pays four instalments

If the entity pays two instalments (primary producers and special professionals)

25%

–

December

50%

–

March

75%

75%

June

100%

100%

To avoid instalment shortfall penalties, an entity that has varied its instalments should re-estimate its annual shortfall amount at the time each instalment becomes due.

ANNUAL APPORTIONMENT OF GST INPUT TAX CREDITS ¶6-500 Overview An entity which carries on an enterprise may purchase things solely for private use. It cannot claim input tax credits for GST paid to the extent that the acquisition is of a private or domestic nature (s 11-15(2)(b)). If an entity makes an acquisition partly for private use, it can only claim input tax credits for the portion of the purchase that is for creditable purposes. Under the usual rules, the entity needs to estimate the extent of business versus private use at the time of acquisition and only claim input tax credits for the business portion. If the actual use for business purposes turns out to be different, it needs to adjust the input tax credits that it claimed (Div 129). Small business operators are more likely than larger businesses to use things acquired for a private purpose. An annual apportionment concession allows small businesses the option of determining their private use of acquisitions on an annual basis rather than when preparing each BAS. The small business can make the determination at the same time as it prepares its income tax return. The annual private apportionment concession can be elected by small business entities with an aggregated turnover of less than $10m and certain other entities with a GST turnover of less than $2m (Div 131; ¶6-005). They can claim full GST credits at the time of acquisitions that are partly (but not solely) for private purposes (s 131-40). After the end of their income year, businesses can make a single adjustment to account for the actual private use of the acquisition (s 131-55). The adjustment, usually an increasing adjustment, is made in the BAS for the tax period covering the date their income tax return is due for that year (s 131-60). The annual private apportionment concession does not change the liabilities and compliance that entities have for supplies they make or for acquisitions that relate to input taxed supplies or which are solely for private purposes.

¶6-505 Pros and cons of making the annual apportionment election The advantages to an entity in making the annual apportionment election are: • single decision point — the entity needs to determine the private portion of an acquisition only once per year. The apportionment can be based on actual use rather than estimated use. The entity typically will not have to estimate the private use at the time of acquisition and later adjust it for actual use • efficiencies from scale — the entity may be able to determine, at one point in time, the portion of private use of all acquisitions made during the year • streamlining with other tax compliance — the entity may be able to determine the private use portion for income tax and GST purposes at the same time • improved cash flow — the entity can claim full input tax credits of GST paid at the time of acquisition. On average, the GST component of the price of acquisitions which relates to the private use portion can be retained interest free by the entity for up to 10 months before it is repaid to the ATO.

The disadvantages to an entity in making the annual apportionment election are: • it cannot pay GST by instalments — that option is not available if the entity elects the annual apportionment of input tax credits (¶6-300) • it cannot lodge an annual GST return — that option is also not available (¶5-460) • it must regularly monitor its projected GST turnover to ensure its eligibility continues • it may need to make an extra decision at acquisition — the entity will need to ensure that it separates those acquisitions which are partly for private purposes from those which are wholly for private purposes or for making input taxed supplies. It is likely that some entities will be tempted to, or will mistakenly, claim full input tax credits up-front for acquisitions they are not entitled to • it needs to record and quarantine eligible acquisitions — the entity will need to record acquisitions made partly for private purposes separately from other acquisitions. Up to 16 months after an acquisition was made, an entity will need to be able to locate the acquisition detail and make a decision regarding the extent of private use to which it was put. Rules of thumb Entities are best to make the annual private apportionment election only if all of the following criteria apply: • the entity is an individual or partnership of individuals • the entity acquires significant volumes of things partly for a private purpose • those significant volumes are mostly of services or goods that are fully consumed in the year that they are acquired • it is not easy to accurately estimate the private use when the things are acquired, and • the entity and/or its staff know only to apply the concession to things acquired partly for a private purpose.

¶6-520 The usual rules: claiming input tax credits for things used for private expenses Input tax credits can be claimed where, among other things, a GST-registered entity acquires a thing for a creditable purpose (s 11-5). An entity acquires a thing for a creditable purpose to the extent that it acquires it in carrying on its enterprise. It does not acquire a thing for a creditable purpose to the extent that: • the acquisition is of a private or domestic nature, or • the acquisition relates to making supplies that would be input taxed (s 11-15). The amount of the input tax credit for a creditable acquisition is an amount equal to the GST payable on the supply of the thing acquired (s 11-25). For acquisitions that relate solely to one purpose, the decision whether to claim credits is usually straightforward (with the exception of luxury cars and entertainment expenses). The entity can claim an input tax credit for 100% of the GST paid if the acquisition will be used solely for making taxable or GST-free supplies. It cannot claim any credits if the acquisition is used solely for a non-creditable purpose. Examples (1) Nerissa pays GST on packaging materials which she uses to wrap the curtains she makes. She can claim full input tax credits as the sale of the curtains is taxable. (2) Oswald Superannuation Fund, which holds only share investments, pays GST when it acquires tax return preparation services. As the fund makes only input taxed supplies, it cannot claim input tax credits for the tax return services. (3) Shane operates a GST-registered furniture retailing business. He buys a bed for use at his house. As the bed is for private purposes, he cannot claim input tax credits.

It is rare that an acquisition which is solely of a private or domestic nature will be made in carrying on an enterprise (GST Ruling GSTR 2008/1 at para 78). Typically only individuals and partnerships of individuals make acquisitions in the course of carrying on an enterprise that are of a private or domestic nature. If an entity makes an acquisition only partly for a creditable purpose, the amount of any credit is reduced (s 11-25, 11-30). The formula to calculate the input tax credit for an acquisition made only partly for a creditable purpose is: Full input tax credit (if it was acquired solely for a creditable purpose)

Extent of creditable purpose Extent to which the entity (expressed as a percentage of × × provides or is liable to provide the the total purpose of the consideration for the acquisition acquisition)

¶6-525 The usual rules: when is the apportionment decision made? The specific attribution rules for claiming input credits are discussed at ¶6-130 and ¶6-185. Theoretically, the extent of creditable purpose is determined at the time of acquisition of the thing. The extent of creditable purpose is an objective estimate of the intended use of the thing. In practice, an entity does not claim an input tax credit for an acquisition until after the tax period in which the GST is attributed. In many cases, by that time, the entity is able to determine the extent of creditable purpose based on actual use. Example 1 A school purchases a box of taxable fruit juice cartons on 15 September. At that time, it does not know if it will use them in the staff room, for which it could claim credits, or for input taxed sales in the tuck shop. By 30 September, the school knows that it can claim credits for 1/4th of the GST paid because 20 out of the 80 juice cartons were used in the staff room.

For acquisitions of other things, such as assets, an entity may not know the actual use by the end of the tax period in which they were acquired, or even by the date of lodgment of the GST return for that period. In those cases, the input tax credit claim made in the GST return is based on an estimate of the intended use of the thing. Example 2 Mikhael acquires a car for $33,000 including GST. He pays for the car in cash on 31 March. He will use the car to travel to and from both a residential property and a commercial property that he owns and manages as investments. He also will use it for private travel. His mix of use of his previous car was 30% for travel in respect of the residential property, 40% for the commercial property and 30% for private travel. The residential property that he manages is used to make input taxed supplies of residential rental. He expects that his use of the new car will not change from the previous one. The amount of input tax credit he claims in the March quarter BAS due by 28 April is $1,200 (40% of the GST amount of $3,000). The travel for the residential property (30%) and the private travel (30%) are not for a creditable purpose.

¶6-530 The usual rules: adjustments for change in use Where the actual use of a thing differs from the intended use, an entity may need to make a GST adjustment. The adjustment reflects the actual use of the thing since it was acquired. Division 129 establishes an adjustment regime with adjustment thresholds and a number of adjustment periods. Example Mikhael in Example 2 above (¶6-525) finds that his residential investment property was burnt down on 1 April. He no longer travels to it. His actual travel in the car changes to 60% for the commercial property and 40% for private use. In the BAS for the first adjustment period, Mikhael claims a decreasing adjustment of $600. This reflects that his extent of use for a

creditable purpose has increased from 40% to 60%. The decreasing adjustment is for the extra 20% of the $3,000 GST paid on the car.

¶6-535 Which entities are eligible to make an annual apportionment election? An entity is entitled to make an annual apportionment election (s 131-5) if: • it is a “small business entity” for the income year in question, meaning it has an annual turnover (including the turnover of related entities) of less than $10m (¶6-005, ¶6-140), or • it does not carry on a business and its GST turnover is $2m or less (¶6-005, ¶6-150). Examples of entities which carry on an enterprise, but not a business, can include property owners who derive their only income from rentals. Other examples include charitable institutions, trustees of complying superannuation funds and some government bodies. For the meaning of “carrying on a business”, see ¶5-160. The GST turnover test is discussed at ¶5-240. To be eligible to make the election, the entity must not have made: • an election to pay GST by instalments that is still in force (¶6-320), or • an annual tax period election that is still in force (¶5-480).

¶6-540 How is an annual apportionment election made? An entity is not required to notify the ATO when it makes its election. Unlike other GST concessions, the election is not made on the GST registration application or on a BAS. The ATO advises that entities must keep a record of their election (for example, by file note) detailing the date the election was made and the date it took effect (www.ato.gov.au website guideline Annual private apportionment of GST).

¶6-545 Annual apportionment election — timing and effect The annual apportionment election takes effect from the start of the first tax period for which a GST return is not yet due at the time of the election (s 131-10). For example, if a quarterly taxpayer makes an election on 20 April, before the 28 April deadline for lodging a return for the March quarter, the election takes effect from the beginning of that March quarter. If an entity wants its election to take effect from a date other than the start of the tax period for which its GST return is not yet due, it must make an application to the ATO. The application must include relevant identification details, the date the entity wishes the election to take effect, a brief reason for the request and must be signed. The date of effect requested must be the start of a tax period which applies to the entity (www.ato.gov.au website guideline Annual private apportionment of GST). If an entity wishes the election to take effect earlier than it would otherwise, its application can be a request for an extension of the election deadlines. The Commissioner’s decision on the request for extension is reviewable under the objection, review and appeal provisions. An application for extension must be made in the approved form (s 131-10). If the application is approved by the ATO, the entity may need to revise its previous BASs and may be entitled to refunds. Example Peter has been GST-registered for several years and has lodged all required quarterly GST returns. On 15 September he chooses to make an annual apportionment election. However, he forgets to make any record of his election. The input tax credits claimed in his September BAS have been reduced to exclude the part private use of the acquisitions. In November, he applies to the ATO for an extension of time to make the election and requests his election to take effect from 1 July. The ATO may approve his request. Peter can then amend his September BAS to claim full input tax credits for the acquisitions made partly for private purposes and can expect a GST refund.

¶6-550 Revocation or cessation of election An election will continue in force indefinitely, unless: • the entity revokes it • the Commissioner disallows it because the entity has failed to comply with one or more of its tax obligations, or • the entity loses its eligibility (s 131-20). An entity may revoke its election at any time. The revocation takes effect at the start of the first tax period for which a GST return is not yet due. This means that if an entity revokes its election before the GST return for a tax period is due to be lodged, the revocation will have effect from the start of the tax period to which the GST return relates (s 131-20(2)). Example 1 Heidi revokes her election on 20 April. Her quarterly GST return for the quarter ended 31 March is due for lodgment with the Commissioner on 28 April. Heidi will complete her GST return for the quarter ending 31 March as if the election has been revoked from 1 January (the start of that quarter).

The ATO has indicated that entities do not need to notify it of their decision to cancel their election. However, they must keep a record of their cancellation (for example, a file note) detailing the date they decided to stop using annual private apportionment (www.ato.gov.au website guideline Annual private apportionment of GST). Where the Commissioner disallows an entity’s annual apportionment election because the Commissioner is satisfied that the entity has failed to comply with one or more of its tax obligations, the disallowance will take effect from the start of the tax period in which the Commissioner notifies the entity of the disallowance. Therefore, the entity will not be required to amend GST returns already lodged with the Commissioner where the Commissioner disallows an election (s 131-20(3) and 131-20(4)). An annual apportionment election made by a small business entity (¶6-140) ceases to have effect once the entity is no longer a small business entity for an income year. The election is taken to have ceased from the start of the tax period in which the first day of that income year falls (s 131-20(5)). An annual apportionment election made by an entity that carries on an enterprise, but not a business (¶6130), ceases if, at 31 July in a financial year, it exceeds the annual apportionment turnover threshold of $2m (¶6-005). The date of cessation is the start of the tax period in which 31 July in that financial year falls. Example 2 Dragona owns and leases a commercial property. She is registered for GST and lodges GST returns quarterly. She made an annual apportionment election for the 2016/17 year. At 31 July 2017, she estimates that her projected GST turnover for the 2016/17 year will rise above $2m. Her annual apportionment election ceases to have effect from 1 July 2017, the start of the quarterly tax period in which 31 July 2017 falls.

¶6-555 Annual apportionment election by GST groups The GST annual apportionment concession is available for GST groups. A representative member of a GST group can only make an annual apportionment election if each member is eligible to make the election. If the representative member makes the election, or revokes the election, then each member of the GST group is taken to have made or revoked the election (s 131-15).

¶6-560 Effect of annual apportionment election on acquisitions

The effect of an election to undertake annual apportionment of input tax credits is that where an acquisition is partly for private use, a full input tax credit can be claimed in the BAS for the tax period when the acquisition occurred (s 131-40). Example 1 Brendan has made the annual apportionment election. He pays $220 for mobile phone services which he expects to use 30% for business purposes and 70% for private calls. He can claim a $20 input tax credit for the purchase in the first BAS he lodges after receiving a valid tax invoice for the purchase.

The election does not apply to acquisitions that are not creditable at all, eg where they are applied or intended to be applied solely for a private purpose, or solely for the purpose of making input taxed supplies. It does not apply to acquisitions that are of a kind specified in regulations (there are none at the time of publication). Nor does it apply to reduced credit acquisitions in relation to financial supplies (Div 70). The input tax credit claimable will be reduced pro rata where the acquisition relates partly to making supplies that would be input taxed, or where the taxpayer provided, or was liable to provide, only part of the consideration (s 131-40). The formula for calculating the up-front input tax credit entitlement for an acquisition where an annual apportionment election is in force is: Full input tax credit (if it was acquired solely for a creditable purpose)

Extent of non-input taxed purpose (expressed as a percentage of × × the total purpose of the acquisition)

Extent to which the entity provides or is liable to provide the consideration for the acquisition

Example 2 Marion carries on several enterprises, one of which involves renting out residential premises (the supply of residential premises by way of rent is input taxed). Marion has made an annual private apportionment election. Marion purchases telephone services from a local telephone company. In September 2016, she pays $220 for these services including $20 GST and she is liable to pay the full purchase price. Marion anticipates that she will use the services for: • regular (taxable) business activities (30%) • private purposes (55%), and • her supply of (input taxed) residential premises (15%). Marion’s input tax credit is subject to the extent the services relate to the input taxed supply of her rental property so she must use the formula:

Full input tax credit

×

Extent of non-input taxed purpose

×

Extent of consideration

$20

×

85%

×

100%

= Input tax credit =

$17

Therefore, Marion can claim an input tax credit of $17 in her BAS for September 2016 (this is a modified version of an example in the www.ato.gov.au website guideline Calculate your GST credits).

The input tax credit allowed on the acquisition of a “luxury” car generally cannot exceed the limit normally allowed (s 69-10, 131-50). In respect of all these matters, corresponding rules apply to importations as well as acquisitions in Australia (s 131-45, 131-50, 131-55).

¶6-565 When is the annual apportionment adjustment made? Any necessary apportionment for the private use of the thing acquired is made by way of an increasing adjustment for the tax period in which the next annual income tax return is due to be lodged with the ATO

(s 131-55, 131-60). It can be made in an earlier tax period if the entity so chooses. Example Marion (see Example 2 at ¶6-560) claimed the credit in her BAS for the September 2017 quarter. She is required to lodge her income tax return for the 2017/18 year by 31 October 2018. This due date falls within the December 2018 tax period. She is required to make an increasing adjustment in the December 2018 BAS for the private use proportion.

If no income tax return is required to be lodged, the adjustment is made in the BAS for the tax period ending 31 December after the end of the financial year in which the tax period occurred (s 131-60 Method statement). If an entity revokes, or the Commissioner disallows, an election during a financial year, the entity will attribute the increasing adjustment to the tax period in which the revocation or disallowance takes effect, or earlier if the entity elects (s 131-60(2)). However, if the cancellation or disallowance takes effect from 1 July in any year, the entity’s annual increasing adjustment is made in the same BAS that it would have otherwise made had its election not been cancelled or disallowed. An entity may have a concluding tax period under s 27-40 or 29-39, because: • it goes into liquidation or receivership, or becomes bankrupt • it dies or ceases to exist • it ceases to carry on an enterprise, or • its registration is cancelled. In those circumstances, the entity will attribute any increasing adjustments that were not attributable to an earlier tax period to its concluding tax period (s 131-60(3)).

¶6-570 How is the increasing adjustment calculated? The increasing adjustment is calculated by subtracting the input tax credit based on the actual creditable use from the input tax credit originally claimed. Any other adjustments that would normally apply are also taken into account (s 131-55). Example 1 In March 2017, Jill, a quarterly GST payer, pays $550 for telephone services, including $50 GST. She uses the services partly for her business and partly for private purposes. She has made a valid annual apportionment election, so she claims the full $50 as an input tax credit in her BAS for the March 2017 quarter. It turns out that Jill applies the telephone services 80% for business purposes during 2016/17. Tuan is therefore liable for an increasing adjustment of $10, calculated as follows:

Input tax credit originally claimed

$50

Less: credit allowable on basis of actual business use (80% × $50)

$40

Increasing adjustment

$10

Assuming that Jill’s income tax return is due by 31 October 2017, the increasing adjustment must be made in the BAS for the tax period ending 31 December 2017, which itself is required to be lodged by 28 February 2018.

In calculating the increasing adjustment, the entity must take into account certain other adjustments, if any, that it had with respect to its purchase (such as adjustments that have arisen due to a change in the purchase price or instances where the supplier has written off a bad debt).

Example 2 Ron is registered for GST and has made an annual apportionment election. He purchases an item partly for business purposes not related to making input taxed supplies (10%) and partly for private purposes (90%). The purchase price is $1,100. After receiving a valid tax invoice, Ron claims an input tax credit of $100 using the non-cash GST accounting basis (¶6-185). Before Ron makes his annual apportionment increasing adjustment, the supplier increases the price of the item by $110 under a rise and fall contract clause. As a result, Ron must pay a total of $1,210 for the item. Included in this amount is $110 GST (1/11 × $1,210). Ron must make a decreasing adjustment of $10 to account for the fact that he has only claimed an input tax credit of $100. Ron makes this decreasing adjustment in the BAS that covers the date on which he receives an adjustment note relating to the price increase. The annual apportionment increasing adjustment To work out his increasing adjustment, Ron must subtract the amount he would have claimed if he did not elect annual private apportionment from the amount he did claim. These amounts must take into account both the input tax credit Ron claimed and the decreasing adjustment that he made due to the price increase. Step 1: determining the amount Ron claimed

Initial input tax credit

$100

+ decreasing adjustment

 $10

= total amount Ron claimed for his purchase

$110

Step 2: determining the amount Ron would have claimed Ron purchased the item only partly for business purposes (10%). If he had not elected annual private apportionment, he would have claimed an input tax credit and a decreasing adjustment only for the business portion of the GST included in the original purchase price and the subsequent price increase.

Initial input tax credit Ron would have claimed ($100 × 10%)

$10

+ decreasing adjustment Ron would have made ($10 × 10%)

 $1

= total amount Ron would have claimed for his purchase

$11

Step 3: calculating the amount of the annual apportionment increasing adjustment

Amount Ron claimed

$110

− amount Ron would have claimed

$11

= amount of the annual apportionment increasing adjustment

$99

Note that the input tax credit Ron claimed ($100), plus the decreasing adjustment he had ($10), minus the increasing adjustment ($99), equals the total amount Ron would have claimed if he did not have an annual private apportionment election in effect ($11). After making his increasing adjustment, Ron received a rebate of $220 for the item he purchased. After the rebate, Ron has effectively paid a total of $990 for his purchase ($1,210 − $220). Included in this amount is $90 GST. As Ron purchased the item partly for business purposes not related to making input taxed supplies (10%) he is entitled to an amount of $9 (10% × $90 GST included in the amount he paid).

Input tax credit and previous adjustments Ron has claimed

$11

− the amount Ron is actually entitled to

$9

= increasing adjustment

$2

Ron is required to make the increasing adjustment in the BAS that covers the date on which he became aware of the rebate.

To determine the adjustments required for private use in respect of motor vehicle expenses, see GST Bulletin GSTB 2006/1.

¶6-575 Later adjustments for change in use After making an annual apportionment increasing adjustment an entity may later need to make further adjustments to account for changes in private purpose if: • its actual private use of the purchase differs from the estimate of private use it used to calculate the increasing adjustment, and • its purchase had a GST-exclusive value of more than $1,000 — see Div 129 (¶6-530). These adjustments will only apply in respect of the things which continue to be used after the end of the financial year in which they were acquired. Examples include cars, computer equipment and property. By contrast, most services tend to be fully consumed in the year they were acquired. An annual apportionment increasing adjustment under s 131-55 is not required if the entity does not use the acquisition for private purposes to any extent. However, as discussed above, an adjustment in later years may still be required under Div 129 for change of use of that acquisition. The Div 129 adjustment might apply where, in later years, the entity began to use the thing acquired for a private use.

SIMPLIFIED ACCOUNTING METHODS ¶6-600 Overview The Commissioner has the discretion to offer simplified accounting methods to enable retailers and small enterprise entities to reduce their GST compliance costs. The simplified accounting methods are only available to entities with a turnover of $2m or less (Div 123; ¶6-005). These methods allow eligible entities to estimate their total GST-free sales and/or purchases at the end of each tax period rather than having to record each GST-free product as it is sold or at purchase. To date, the Commissioner has only determined simplified accounting methods for entities that sell GST-free food by retail, hospitality and caravan park operators. The Commissioner has had the power to specify simplified accounting methods for small enterprise entities that make both taxable and GST-free supplies, or entities that make acquisitions that are taxable and GST-free. Simplified accounting methods typically work by establishing percentages which can be applied to: • total sales of stock items in order to calculate the GST liability on taxable sales • total acquisitions of stock items to calculate the input tax credits for taxable purchases. The simplified accounting method for caravan park operators differs markedly from the various methods used for food retailers. It provides a simplified means of apportioning input tax credits. While it uses the simplified accounting method label “SAM” it applies to all caravan park operators and is not restricted to use by those that are small businesses. Simplified accounting methods cannot be used to calculate the GST liabilities or input tax credits on capital acquisitions or on non-stock sales or acquisitions.

¶6-605 Pros and cons of simplified accounting methods The advantages of electing and using the simplified accounting methods are: • savings in compliance — some methods, particularly the business norms method, appear to have considerable compliance savings both in respect of sales and purchases. Even the methods that require sampling would appear to have significant savings in compliance and resources during the tax periods where the sample results are applied • sample periods are short and self-selected — the sample periods where entities are required to

record all transactions are short (no more than four weeks). Further, the entity has some flexibility in selecting what time of year to take the sample • GST savings from method and sample period choice — entities could conceivably select a method or sample period which results in them paying lower net amounts of GST than if they calculated their GST under the usual rules. The number of businesses using the simplified accounting methods was once estimated by the ATO to be only 5,000 and is expected to gradually decline over time. The disadvantages of these methods, which could explain that limited take up by small businesses, are: • eligibility — currently the methods are limited to food retailers only • limited coverage — the simplified accounting methods cannot be used for non-stock transactions • complexity — the methods may not be easy to understand and contain many rules and restrictions. Some of the methods require application of mark ups which may involve multiple calculations if costs and prices vary during the period • limited period of use — in most cases, the methods involve sampling which must be repeated each year or half year • monitoring of turnover — an entity which has chosen the simplified accounting methods must monitor its turnover to ensure it continues to qualify for the methods • uncertainty regarding possible overpayments of GST — small businesses that adopt simplified accounting methods will not calculate their actual net amount, ie the GST that they would otherwise pay on supplies nor the input tax credits they would otherwise claim on acquisitions had they not adopted the methods. Particularly in times of cash flow constraint, such businesses may face the nagging doubt whether they are paying too much GST under the simplified accounting methods. Rules of thumb At this point in time, the only entities which should consider using simplified accounting methods are food retailers with a turnover of $2m or less. Entities which do not meet those criteria must calculate their GST under the usual rules. Even then, small food retailers may not be able to use a beneficial simplified accounting method if they have point-of-sale equipment that clearly distinguishes between taxable and GST-free sales. Many entities with a turnover of $2m or less may incur less cost, compliance obligations and uncertainty in the long run if they acquire point of sale equipment and introduce basic systems for GST compliance.

¶6-620 Eligibility for retailers to use simplified accounting methods The Commissioner can determine simplified accounting methods for working out the net amount of GST payable for the retailers and small enterprise entities to whom the method applies (Div 123). A retailer is eligible to use simplified accounting methods if it (s 123-5(2)): • is an entity that, in the course or furtherance of carrying on its enterprise, sells goods to people who buy them for private or domestic use or consumption (s 195-1) • is registered for GST • sells both taxable and GST-free food at the same premises • has a “SAM turnover” (see below) that is not more than $2m (¶6-005) • with two exceptions, does not have adequate point-of-sale equipment to identify and record the mix of taxable and GST-free sales (¶6-760 and ¶6-770).

Simplified accounting methods can also be used by charitable institutions in the course of certain noncommercial activities (s 123-5(2)(b) and Subdiv 38-G).

¶6-625 Sale of both taxable and GST-free food from the same premises To use a simplified accounting method, the retailer must sell both taxable and GST-free food at the same premises. For example, a small sandwich bar which sells GST-free fruit and taxable sandwiches and soft drinks would qualify. However, a farmer who sells taxable livestock at an auction site and also sells GSTfree vegetables at the farm gate would not qualify to use a simplified accounting method. That is because the farmer’s sales are not from the same location or premises. In that case, if the farmer only sells vegetables at the farm gate, he should be able to determine the GST-free sales at that point of sale.

¶6-630 Adequate point-of-sale equipment The simplified accounting methods are designed for those entities which cannot accurately determine their correct GST using their existing systems. Thus, generally they can only be used by entities which do not have point-of-sale equipment which is adequate to record taxable and GST-free sales separately (but see ¶6-760 and ¶6-770). Point-of-sale equipment will be regarded as adequate if it is able to identify and record each separate supply as being GST-free or taxable, and identify and record the total amount of GST-free sales and the total amount of sales. Adequate point-of-sale equipment will generally include: • electronic scanning systems • touch-screen registers, and • product-specific cash registers. A cash register that has GST-free and/or taxable keys relies on the operator to determine the GST status of each of the goods sold. As it cannot identify an item as GST-free or taxable without the operator’s intervention, the ATO does not consider it to be “adequate point of sale equipment” for Div 123 purposes only. Hence, a retailer with a cash register of that kind can use simplified accounting methods.

¶6-635 SAM turnover threshold “SAM turnover” is defined in Goods and Services Tax: Simplified Accounting Methods Determination 2017 for Retailers who sell Food — Business Norms, Stock Purchases and Snapshot Methods (F2017L01274) to mean either: • the total GST-exclusive amount of the retailer’s trading sales for the last financial year, or • the projected GST-exclusive amount of the retailer’s trading sales for the current financial year (or if the business is commenced during the financial year, the projected trading sales for the financial year as if it were a 12-month period). The Commissioner makes the following points about the application of the turnover threshold: (1) The threshold amounts are GST-exclusive, ie GST is excluded when working out whether sales are lower than the relevant threshold (GST Ruling GSTR 2001/7). (2) The threshold test is only applied to trading sales, ie sales of trading stock and any other trading income, eg receipts from services but not certain sales (¶6-680). Any sales of capital assets (eg land and buildings or plant and equipment) or other supplies made solely in ceasing or scaling down the business are ignored (www.ato.gov.au website guideline GST for food retailers — simplified accounting methods).

¶6-640 Eligibility of small enterprise entities to use simplified accounting methods

A small enterprise entity is eligible to use simplified accounting methods if: • it is a small business entity (¶6-140) for the income year in question, or • it is an entity that does not carry on a business (¶6-130) but has a GST turnover that does not exceed $2m (s 123-7; ¶6-005), and • in the course or furtherance of carrying on its enterprise, it makes both: – taxable and GST-free supplies, and – acquisitions for which it can claim input tax credits and acquisitions which are GST-free where it would have been entitled to claim credits if they were taxable (s 123-5(3)). Note: From 1 July 2016, an entity can qualify as a small business entity if it has an aggregated turnover of less than $10m. To be entitled to use simplified accounting methods, it must also satisfy the turnover test applicable to each method. As these remain at $2m for food retailers, many small business entities will not be entitled to use simplified accounting methods. Division 123 allows the Commissioner to make determinations for particular classes of small enterprise entities that will be able to use the simplified accounting methods. It is not generally intended that the Commissioner would make specific determinations for individual entities. Example 1 Tina carries on a small business as a widget manufacturer. She sells widgets to retailers in Australia and also exports widgets to distributors in overseas markets. As she makes mixed supplies, she can apply to the Commissioner to use a simplified accounting method, if there is one, that applies to a class of entities to which her business is a member. She would use the method to calculate her GST liabilities on supplies that she makes.

Small businesses that have mixed inputs and which can apply a simplified accounting method do not need to identify the GST status of each input. Instead, they can apply a ratio to their total inputs. Example 2 Laura carries on a small business running a child care centre. She acquires basic food items GST-free in order to supply morning tea, lunch and afternoon tea to children in her care. She also acquires a range of products that are creditable acquisitions. As she has mixed acquisitions, in calculating her entitlement to input tax credits, she can apply to the Commissioner to use a simplified accounting method that applies to a class of entities to which her business is a member. Laura will no longer need to identify whether each of her trading stock acquisitions is GST-free or taxable. Instead, she will apply a ratio to determine for what portion of her acquisitions she can claim an input tax credit.

¶6-645 The choice to apply a simplified accounting method A qualifying entity may, by notifying the Commissioner in the approved form, choose to apply a simplified accounting method or revoke that choice (s 123-10). An entity is not able to continuously change the particular simplified accounting method that it has chosen in order to reduce its net amount. Similarly, an entity cannot choose to apply two different simplified accounting methods concurrently. The prohibitions are established primarily by the choice and revocation provisions.

¶6-650 Revocation and cessation of simplified accounting methods Where a retailer chooses to apply a simplified accounting method, it must be used for 12 months. This is because, once a choice is made to use a simplified accounting method, that choice cannot be revoked within 12 months after the day on which the choice was made. Further, the retailer cannot choose to apply a simplified accounting method within 12 months after revoking an earlier decision to apply a simplified accounting method (s 123-10(2)(a), 123-10(2)(b)).

Similar restrictions apply to small enterprise entities (s 123-10(1)(aa), 123-10(1)(b), 123-10(2)(ba)). An entity’s choice to apply a simplified accounting method ceases to have effect where it no longer qualifies as one of the kind of entities to whom the method is available. The cessation takes effect from the start of the tax period occurring after the day on which the entity ceases to qualify. An entity’s revocation of its choice to use a simplified accounting method ceases to have effect from the start of the tax period specified in the notice of revocation (s 123-10(4)). An exception to these rules applies during the first 12 months after the choice to use a simplified accounting method. If a retailer or small enterprise entity’s actual turnover exceeds the threshold before the end of the year (¶6-640), it remains eligible to use the simplified accounting method for the rest of the 12-month period, but will not be eligible to use a simplified GST accounting method for the next 12 months (www.ato.gov.au website guideline GST for food retailers — simplified accounting methods). Example 1 Mohandas chooses to use the business norms method (¶6-680) on 1 July 2017. During February 2018, he notices that his turnover is approaching the turnover threshold. He is also contemplating the purchase of point-of-sale equipment that would enable him to record taxable and GST-free sales accurately. If, at that time, he determines that he has actually exceeded the turnover threshold, he must continue to use the simplified accounting method until 30 June 2018. The same applies if he revokes his choice from that time. However, if he acquires adequate point-of-sale equipment in February 2018, his choice to use the business norms method ceases to have effect from the start of the next tax period (1 April 2018 if he is on quarterly tax periods). If in August 2018, he determines that he has exceeded the turnover threshold, his choice to use the business norms method ceases to have effect from the start of the next tax period (1 October 2018 if he is on quarterly tax periods). The same would apply if he purchased adequate point-of-sale equipment in August 2018 or he lodged the approved form revoking his choice of the business norms method from 1 October 2018.

Entities which revoke their simplified accounting method will need to ensure they do not double claim input tax credits. An example of a possible scenario would be where an entity receives a tax invoice after the revocation of its simplified accounting method took effect. The input tax credit for the underlying acquisition may have already been validly made and accounted for in a tax period before the tax invoice was received.

¶6-655 Notifying the ATO An entity electing to use a simplified accounting method (or to revoke its choice) can notify the ATO by completing and lodging the following forms: • Election To Use A Simplified GST Accounting Method, and • Notice To Revoke An Election To Use A Simplified GST Accounting Method. An entity making the election needs to indicate which simplified accounting method it is electing to use. Once the appropriate form is completed, it can be lodged with the ATO by either: • lodging it via the Business Portal or Tax Agent Portal (in each case by selecting Mail, creating a New Message and selecting Food, entertainment and SAM (Simplified Accounting Method) from the GST subject list) • faxing it to 1300 139 031 • emailing it to [email protected], or • mailing it to Australian Taxation Office, GPO 3524 ALBURY NSW 2640.

¶6-660 Effect of election to use simplified accounting methods An entity which chooses a simplified accounting method can calculate its net amount for GST purposes based on the method (s 123-15(1)).

The simplified accounting methods only apply to the purchase, conversion and sale of trading stock items. Entities will need to use normal GST rules and not simplified accounting methods to account for GST on: • other sales (eg non-stock or capital items), and • non-stock purchases (eg rent, telephone and any capital items). Record keeping If a simplified accounting method is chosen, any percentages derived from samples or snapshots must be fair and reasonable. Where percentages are based on actual purchases or sales from a sample or snapshot, the period should be representative of the usual purchases (or sales) of the entity’s business. A period of abnormal sales should not be used. The calculations and any documentation that supports the method used must be retained, so they can be reviewed by the ATO if necessary. Records can be kept in hard copy or electronic form, for the usual five years. Tax invoices for supplies In accordance with the usual rules applying to other entities, an entity that uses simplified accounting methods is required to issue tax invoices where the recipient of the supply requests one and the GSTinclusive price exceeds $82.50 (value exceeds $75 per s 29-70(2), 29-80; reg 29-80.01). The GST amount shown on that tax invoice will be 1/11th of the price of the taxable supply made. That is so even though the use of simplified accounting methods means that the entity may not have calculated the exact amount of GST payable on any particular supply.

¶6-675 What are the alternative simplified accounting methods? The Commissioner has issued a number of determinations that set out the following simplified accounting methods: • the business norms method (¶6-680) • the stock purchases method (¶6-700) • the snapshot method (¶6-730) • the sales percentage method for supermarket and convenience stores (¶6-760) • the purchases snapshot for restaurants, cafés and caterers (¶6-770). The following table is a summary of the simplified accounting methods: Method

Stock purchases

Snapshot

Sales percentage

Purchases snapshot

Turnover threshold $2m or less

$2m or less

$2m or less

$2m or less

$2m or less

How to estimate Apply standard the GST-free sales percentages to and purchases sales and purchases

Take a sample of purchases and use the sample results

Take a snapshot of sales and purchases and use the snapshot results

Calculate the percentage of GST-free sales made in a tax return and apply to purchases

Take a snapshot of purchases and use the snapshot results to claim input tax credits

Prohibitions

Converters

Adequate point-ofsale equipment

Business norms

Not used

Not used

Converters Not used

Used

Either used or not used

Notes: Turnover thresholds: The business norms, stock purchases and snapshot turnover thresholds are based on SAM turnover. The threshold tests are applied to the GST-exclusive value of trading stock and trading income but not sales of capital items or other supplies made solely in ceasing or scaling down the business. It can be applied to trading sales for the last financial year or projected trading sales for the current financial year. The sales percentages and purchases snapshot turnover thresholds are based on the usual GST turnover (¶5-240). Prohibitions: The stock purchases and sales percentage simplified accounting methods are not available to certain converters. They are entities that buy GST-free goods (eg potatoes) and convert them into taxable goods (eg cooked chips). The sales percentage method can only be used if the entity converts 5% or less of its goods into taxable products. Adequate point-of-sale equipment: The business norms, stock purchases and snapshot methods are only available if the entity does not use adequate point-of-sale equipment. Converters: Entities which buy GST-free goods and convert them into taxable goods, eg they sell taxable cooked chips converted from GST-free potatoes (as opposed to “resellers” below). Resellers: Entities which resell stock without converting it into different products. The term “resellers” is used later in this chapter. Comprehensive worked examples of each method can be found at the www.ato.gov.au website guideline GST for food retailers — simplified accounting methods.

¶6-680 Business norms method The business norms method is available if the entity’s annual turnover, called “SAM turnover”, is $2m or less (¶6-635). It is available only if the entity does not use adequate point-of-sale equipment. Under the business norms method, entities which supply food by retail can choose to apply standard percentages, called “business norms percentages”, to their total sales and purchases of stock to estimate their GST-free sales and purchases. These standard percentages have been predetermined by the Commissioner for nine types of entities as listed in the following table. GST-free sales

GST-free purchases

Cake shops (that sell mainly cakes, pastries or similar products rather than the products of bakeries or bread shops and do not operate as a café)

2%

95%

Continental delicatessens (that sell mostly processed meats, small goods, salamis and cheeses and do not sell mostly grocery items nor make any café or restaurant sales)

85%

90%

22.5%

30%

Convenience stores that do not prepare takeaways or sell fuel or alcoholic beverages

30%

30%

Fresh fish shops (that sell fresh fish and some cooked fish, but are not mainly “fish and chip” or takeaway shops)

35%

98%

Health food shops (that do not convert GST-free food into taxable food)

35%

35%

Hot bread shops (that sell mainly bread, rather than cakes)

50%

75%

98%

0%

Convenience stores that prepare takeaways and do not sell fuel or alcoholic beverages

Pharmacies (with both taxable and GST-free food sales) Dispensary: non-claimable

Over the counter

47.5%

2%

22.5%

30%

30%

30%

Rural convenience stores (that may sell fuel or have an Australia Post agency, but do not sell alcoholic beverages) Converters Resellers

The business norms percentages are applied to the entity’s total stock sales and total stock purchases to determine the GST-free sales and purchases. These amounts are then entered on the entity’s BAS. For the rural convenience stores, the business norms do not apply to fuel or Australia Post agency sales (F2017L01274). Pharmacies should also refer to F2017L01274 to determine their SAM turnover and the sales and purchases to which the business norms apply. To estimate an entity’s GST-free sales and purchases using the business norms, the steps to follow are: Step 1

Work out total stock sales for the tax period.

Step 2

Multiply total stock sales by the relevant percentage from the above table. The result is the retailer’s total GST-free sales.

Step 3

Work out total stock purchases for the tax period.

Step 4

Multiply the total stock purchases by the relevant percentage from the above table. The result is the retailer’s total GST-free purchases.

Example A hot bread shop has an old cash register that simply records the total money received. The shop’s records show that the takings for the quarter are $120,000, while total stock purchases for the period was $95,000. The shop can then use the business norms method as follows:

Formula

Amount

Sales Total sales for quarter

$120,000

less percentage of GST-free sales

50% of $120,000

$60,000

equals taxable sales

$120,000 − $60,000

$60,000

Total GST payable

Taxable sales ($60,000) divided by 11

$5,454

Purchases Total stock purchases for quarter

$95,000

less percentage of GST-free purchases

75% of $95,000

$71,250

equals taxable purchases

$95,000 − $71,250

$23,750

Total input tax credits for GST

$23,750 divided by 11

$2,159

Net amount of GST payable

GST payable − input tax credits

$3,295

¶6-690 Observation regarding business norms percentages The business norms percentages were calculated by the ATO from sample businesses reviewed. The business norms describe the industry targeted in broad terms and the business norms are whole number percentages. The ATO has not revealed its sample selection, methodology or calculations. It is probably

reasonable to suspect that the percentages issued are not generous. There must be a reasonable prospect that the business norms err on the side of the revenue, even if only marginally. Anecdotally, many of the percentages of GST-free sales in the business norms appear to be less than one might expect for businesses of the relevant kinds. Business norms percentages must, by definition, be derived from averages for the whole sample group. Taxpayers that are already able to calculate the GST they would otherwise pay will typically not adopt a business norms percentage if it results in them paying more GST. The class of taxpayers who will use business norms will typically be: • the 50% of the industry that will pay less GST by using them than they would otherwise pay, or • the small percentage of the industry that will pay marginally more GST under them but will save the same or more in compliance costs.

Consider the outcome if an issued business norms percentage was truly the average of a representative sample for the entire industry. The businesses who actually adopted the business norm would not be representative of the entire industry but heavily skewed towards those who would gain by doing so. The result would be that the ATO would in fact lose revenue by issuing a business norms percentage which was primarily aimed at reducing the compliance costs of small businesses. Hence, it is understandable if the business norms percentages of GST-free supplies issued by the ATO are in fact an adjustment “downwards” from the truly representative sample averages. This practice would enable the ATO to protect the revenue by making the percentage more representative of the industry population likely to adopt them. This necessarily leads to the result that, if all taxpayers in the industry in fact used the business norm percentage, on average they will each pay more GST by doing so than they otherwise would have.

¶6-700 Stock purchases method The stock purchases method is only available for food resellers, ie entities which purchase food and sell it in an unchanged form. Converters, ie those who convert GST-free purchases into taxable products, cannot use this method. It is available only if the entity does not use adequate point-of-sale equipment. It is also only available if the food retailer’s annual turnover, called “SAM turnover”, is $2m or less (¶6635). Examples of the types of resellers that may want to use the stock purchases method are: • grocery store or supermarket • convenience store or milk bar • video hire outlet • health food shop • continental delicatessen • butchery • service station • news agency, or • greengrocer’s store. The stock purchases method is based on the assumption that if the retailer only resells goods that it purchased, then the percentage of GST-free sales will be about the same as the percentage of GST-free purchases. To estimate GST-free purchases and sales, GST-free stock purchases are calculated as a percentage of total stock purchases. The percentage is then applied to total stock purchases and total sales. The stock purchases method may be used: • for every tax period (¶6-710) • for two four-week sample periods (¶6-715), or • if it applies, on a 5% GST-free stock estimation basis (¶6-720). A worksheet, completed daily, must be maintained detailing the calculations. The worksheet should contain a breakdown of the total purchases for the period and it should distinguish between taxable and GST-free purchases.

If the 5% GST-free stock estimation basis is used, the worksheet should show the GST-free purchases that are resold GST-free for each period.

¶6-710 Every tax period option This option for resellers accurately calculates input tax credits on acquisitions and estimates GST on sales. The retailer needs to calculate the percentage of total purchases that are GST-free for every tax period. GST-free purchases can be determined from the retailer’s tax invoices and receipts. The steps to follow are: Step 1

The reseller records its total stock purchases.

Step 2

The reseller records its total GST-free stock purchases.

Step 3

The total GST-free stock purchases is divided by the total stock purchases to calculate the reseller’s percentage of GST-free purchases.

Step 4

This percentage is then applied to the reseller’s total stock sales to estimate GST-free sales for the period.

Example A grocery store (which is a reseller only) decides to use the stock purchase method for its quarterly tax period.

Formula Total stock purchases for the quarter

Amount $203,000

Total GST-free purchases for the quarter

$99,470

Percentage of GST-free purchases for the quarter

($99,470/$203,000 × 100)

Total taxable purchases

$203,000 − $99,470

Total sales takings for the quarter

49% $103,530 $219,500

Amount of sales treated as GST-free

49% of $219,500

$107,555

Total taxable sales

$219,500 − $107,555

$111,945

¶6-715 Two four-week sample periods option Resellers can reduce their administrative workload even further by choosing to estimate both their GSTfree sales and purchases based on actual results for two four-week sample periods. Under this method, the same steps as the previous “every tax period option” calculation is followed (ie calculate GST-free purchases as a percentage of total purchases), but it is only done for two four-week periods during the financial year. The percentage calculated is then applied to both the retailer’s total purchases and sales to calculate the GST-free purchases and sales. This method is similar to the snapshot method (¶6-730), except that only a snapshot of purchases is taken, not sales as well. To account for seasonal fluctuations the percentage is calculated twice during the financial year, and should take place between: • 1 June–31 July (used for July to December tax periods), and • 1 December–31 January (used for January to June tax periods). If a business which started during a financial year wishes to use this method, the first sample period should be in the first two months of trading.

The steps to follow are: Step 1

The reseller records its total stock purchases for the four week sample period.

Step 2

The reseller records its total GST-free stock purchases for the sample period.

Step 3

The total GST-free stock purchases is divided by the total stock purchases to calculate the reseller’s percentage of GST-free purchases for the sample period.

Step 4

This percentage is then applied to the reseller’s total stock purchases to estimate GST-free purchases for the tax period.

Step 5

The same percentage is then applied to the reseller’s total stock sales to estimate GST-free sales for the tax period.

Example A grocery store’s tax invoices for a four-week sample period show that it has total stock purchases of $60,000 and total GST-free purchases of $29,400. For the tax period it has total stock purchases of $203,000 and total trading sales of $219,500.

Formula Percentage of GST-free purchases

$29,400/$60,000 × 100

Total GST-free purchases for the tax period $203,000 × 49% Total GST-free sales for tax period

$219,500 × 49%

Amount 49% $99,470 $107,555

The grocery store applies the 49% rate to its total stock purchases and sales for subsequent tax periods until the next four-week sample is completed.

¶6-720 5% GST-free stock estimation basis option A simplified variant of the stock purchases method may apply where a retailer’s GST-free sales does not exceed 5% of the total stock sales. It is likely to be applicable to retailers such as kiosks that do not prepare takeaways and to service stations, video hire outlets and newsagencies. This estimation basis is only used for goods (such as bottled water, pure fruit juice, milk or fresh fruit) that are purchased GST-free and that will be sold GST-free. This basis may be used if the retailer’s past or projected trading patterns or the supplier’s tax invoices for the tax period reflect that GST-free stock purchases (that will be sold GST-free) is not more than 5% of total stock purchases. The Commissioner has provided the following steps for using this method: Step 1

For each GST-free product line, record and add purchases.

Step 2

Add each GST-free product line total to calculate the total GST-free stock purchases.

Step 3

Apply the mark-up(s) to the totals from step 1 to estimate total GST-free sales for each product.

Step 4

Add the estimated GST-free sales for each product line to calculate total GST-free sales.

If the mark-up is the same for each product line, there will be no need to separately record totals for each product line, only the total amount of GST-free stock purchases. Apply the mark-up to this amount to calculate the GST-free sales. Example Valda’s Video Hire’s records show the total GST-free stock purchases for her store for the quarterly tax period amount to $750, made up as follows: • bottled water = $300 • pure fruit juice = $450.

She can use the 5% GST-free stock estimation basis as the GST-free sales amount to less than 5% (3.1% in fact) of her total quarterly sales of $24,000. Valda’s mark-up is 40% for bottled water and 30% for fruit juice. She estimates her total GST-free sales for the tax period is $1,005, calculated as follows:

Formula

Amount

Bottled water

$300 + 40% mark-up

$420

Pure fruit juice

$450 + 30% mark-up

$585

Her GST liability on sales for the quarter is 1/11th of the taxable sales which are calculated as total sales ($24,000) less GST-free sales ($1,005).

¶6-730 Snapshot method The snapshot method is only available for food retailers which do not use adequate point-of-sale equipment. The food retailer’s annual turnover, called “SAM turnover”, must be $2m or less (¶6-635). Examples of the types of entities that may want to use the snapshot method are: • grocery store or supermarket • convenience store or milk bar • video hire outlet • fish and chip shop • health food shop • continental delicatessen • butchery • cake shop • hot bread shop or bakery • restaurant (dine-in or takeaway) • sandwich bar • kiosk or canteen, or • tuckshop that is not input taxed. Food retailers using the snapshot method will be able to take a snapshot of their trading and use the results to estimate their GST-free sales and GST-free purchases. The snapshot may be taken: • for two sample periods (¶6-740) • for every tax period (¶6-745), or • if applicable, on a 5% GST-free stock estimation basis (¶6-750).

¶6-740 Two sample periods option Food retailers can take a snapshot of their trading and use the results to estimate their GST-free sales and GST-free purchases. The snapshot is done twice a year to account for seasonal fluctuations and should take place between:

• 1 June–31 July (used for the July to December tax periods), and • 1 December–31 January (used for the January to June tax periods). If a food retailer starts a business during the financial year, then the first sample period must occur within the first two months of trading. To accurately calculate the percentage of GST-free trading, the food retailer must examine its sales over a continuous two-week period, and its purchases over a continuous four-week period. Purchases are examined over a four-week period to ensure irregular purchases are accounted for. During the snapshot periods, the retailer must record the amount and type of transaction (ie whether it is taxable or GST-free) for all sales and stock purchases. A worksheet of all transactions during these times must be maintained. This worksheet should be completed daily and contain a breakdown of total sales. At the end of the snapshot periods, the food retailer should have recorded: • for sales: the total amount of sales and the total amount of GST-free sales over two weeks, and • for purchases: the total amount of stock purchases and the total amount of GST-free stock purchases over four weeks. From this sample period the food retailer then calculates what percentage of total sales are GST-free and what percentage of total stock purchases are GST-free. These percentages are used for each tax period until the next snapshot is taken. Example Esther, a corner store operator, sells a variety of items including groceries, newspapers, sandwiches, fresh fruit and vegetables. She decides to use the snapshot method to calculate her GST-free sales and purchases. She examines her business transactions during 1 June to 31 July for the two-week and four-week continuous periods and records the following:

Formula

Amount

Sales during snapshot period Total sales over the two-week sample period

$24,500

GST-free sales for the two-week period

$17,640

Percentage of GST-free sales

($17,640/$24,500) × 100

72%

Sales during quarter Total sales for the quarter

$160,000

less GST-free sales for the quarter

72% × $160,000

$115,200

equals Taxable sales for the quarter

$160,000 − $115,200

$44,800

Total GST payable

$44,800 divided by 11

$4,073

Purchases during snapshot period Total purchases over the four-week sample period

$19,750

GST-free purchases for the four-week period

$15,405

Percentage of GST-free purchases

($15,405/$19,750) × 100

78%

Purchases during quarter Total stock purchases for quarter less Percentage of GST-free purchases

$121,140 78% of $121,140

$94,489

equals Taxable purchases

$121,140 − $94,489

$26,651

Total input tax credits for GST

$26,651 divided by 11

$2,423

Net amount of GST Payable

GST payable − input tax credits

$1,650

¶6-745 Every tax period option If food retailers believe that the four-week snapshot method for stock purchases does not accurately represent their purchases for other tax periods, they can calculate their purchases every tax period from their suppliers’ invoices in the normal way. These retailers can still use the two-week snapshot method for estimating GST-free sales. However, once they have chosen not to use the snapshot method for their purchases, they must continue to work out the actual purchases for the year. Retailers must still maintain a worksheet detailing their calculations.

¶6-750 5% GST-free stock estimation option A simplified variant of the snapshot method may apply where a retailer’s GST-free sales do not exceed 5% of the total stock sales. A retailer may use this basis if its past or projected trading patterns reflect that GST-free stock sales are not more than 5% of total stock sales. Examples of food retailers for which the 5% GST-free stock estimation basis is applicable include: • cafés and restaurants with takeaway sales of some GST-free items • other takeaway food retailers (such as fish and chip shops) • kiosks and canteens • tuckshops that are not input taxed. This estimation basis is only used for goods (such as bottled water, pure fruit juice, milk or fresh fruit) that are purchased GST-free and that will be sold GST-free. If GST-free goods are bought and then resold or converted (eg plain milk resold as GST-free milk or converted into taxable milkshakes), then only the proportion of goods sold GST-free should be included. Example 1 Vera’s kiosk has total sales of $30,000 a year of which $1,200 are GST-free (made up of bottled water of $600 and milk of $600). Vera can use the 5% of stock estimation basis as less than 5% of its total sales (in fact, 4%) are GST-free.

The Commissioner has provided the following steps for using this method: Step 1

For each product line that will be resold GST-free, record and add the net amount of GSTfree purchases (reduced by the amount of purchases converted into taxable goods). Note that if the retailer’s mark-up is the same for each product line, there will be no need to record totals for each product line, only the total amount of GST-free purchases.

Step 2

Apply the retailer’s mark-up(s) to the net GST-free purchases from step 1 to work out the retailer’s GST-free sales for each product line.

Step 3

Add the retailer’s estimated GST-free sales for each product line to calculate the retailer’s total GST-free sales.

Step 4

To work out the GST-free purchases, either a snapshot of purchases must be done or GSTfree purchases must be worked out for every tax period.

Example 2 Louise’s Luncheon Bar purchases a number of GST-free products in the tax period. Louise examines her records and notes her GST-free purchases for the tax period are bottled water for $500 and milk for $1,000. Louise converts $200 worth of the milk purchases into taxable milkshakes and resells $800 worth of the milk GST-free. Louise works out her GST-free sales as follows:

Step 1

GST-free product lines resold GST-free are bottled water for $500 and milk for $800.

Step 2

Mark-ups applied are 60% for bottled water and 30% for milk.

Step 3

GST-free sales are $1,840 (ie bottled water = $500 + 60% = $800; milk = $800 + 30% = $1,040).

The worksheet should show how the GST-free purchases and GST-free sales are worked out for each tax period.

¶6-760 Sales percentage method for supermarkets and convenience stores The sales percentage method can apply to supermarkets and convenience stores that have an annual turnover of $2m or less (A New Tax System (Goods and Services Tax) Act 1999 Simplified GST Accounting Methods Determination (No 29) 2015). It does not apply to petrol stations. To use the sales percentage method, the retailer must have adequate point-of-sale equipment. In addition, less than 5% of the retailer’s total sales can be taxable sales of food that the retailer converted from GST-free inputs (for example, sandwiches made from bread, cheese and tomato). The method does not apply to sales of alcohol. It also does not apply to products that are not commonly sold at, or are held by, the retailer in substantially greater quantity or variety than is common for supermarkets or convenience stores. The rationale for this method is that the percentages of acquisitions that are creditable for these retailers would be expected to be in line with the percentage of sales that are taxable. The input tax credits can therefore be calculated by subtracting estimated GST-free acquisitions from total acquisitions and multiplying the result by 1/11. The GST-free acquisitions are estimated by using the percentage that represents the GST-free proportion of sales and multiplying it by total acquisitions (trading stock only) for each BAS period. Once elected, the sales percentage method must be used for all tax periods for at least the first 12 months for which it was chosen. When this method is used, tax invoices for the acquisitions need not be held. Example Anita operates a small supermarket. Only 2% of sales are of taxable food items she converts from GST-free food. Her point-of-sale equipment records $200,000 in total sales and $60,000 of GST-free sales in a tax period. Her total trading stock purchases for the period is $100,000. The portion of GST-free sales for the tax period (30%) is applied to the total purchases ($100,000) to arrive at the total GST-free purchases during the period.

Formula Total sales for the tax period

$200,000

Total GST-free sales for the tax period Percentage of GST-free sales for tax period

$60,000 ($60,000/$200,000) × 100

Total purchases during the tax period Total GST-free purchases

Amount

30% $100,000

$100,000 × 30%

¶6-770 Purchases snapshot method for restaurants, cafés and caterers

$30,000

An optional simplified accounting method for calculating input tax credits for trading stock purchases is available to eligible restaurants, cafés and caterers. This additional method is provided by the Goods and Services Tax: Simplified Accounting Method Determination (No 38) 2016 (SAM 2016/38). The sales percentage method can be used by restaurants, cafés and caterers (“eligible food retailers”) that: • mainly sell a range of food that is commonly sold by restaurants, cafés and caterers, and • have a GST turnover of $2m or less. The presence or adequacy of point-of-sale equipment is not relevant to the use of this method.

¶6-775 How the purchases snapshot method works The purchases snapshot method is only for purchases of trading stock items. It cannot be used to calculate input tax credits on non-trading stock acquisitions or to calculate GST liabilities on sales. It is designed for restaurants, cafés and caterers. Eligible food retailers can estimate input tax credits on trading stock by taking a sample of acquisitions over a four-week period (sample period) and calculating the percentage that represents GST-free acquisitions. The percentage must be calculated twice during the financial year and should take place between: • 1 June–31 July (used for July to December tax periods) • 1 December–31 January (used for January to June tax periods). For a new business which wants to use the purchases snapshot method from business commencement, the first sample period must be within two months of the date it starts selling food to customers. For an existing business which wants to use the purchases snapshot method from a start date which does not fall between 1 June and 31 July or between 1 December and 31 January, the first sample period can either be: • a four-week period in the tax period in which it starts to use the method, or • a four-week period during either 1 June to 31 July or 1 December to 31 January, whichever has most recently elapsed. Two new calculations of the GST-free percentage must be done about six months apart for each financial year. Example 1 Jacques has monthly tax periods and chooses to use the purchases snapshot method from 1 October 2017. He can use the GSTfree percentage of his trading stock purchases for the sample period in the July 2017 tax period (or any four-week period during 1 June to 31 July 2017). This percentage can be used to calculate the amounts of GST-free stock for tax periods October, November and December 2017. Alternatively, he can record the amounts and GST status for stock purchases in October 2017 to work out the GST-free percentage to be used for the tax periods November and December 2017. He would then need to determine the proportion of GST-free purchases during a four-week period from 1 December 2017 to 31 January 2018. That percentage could be used to determine the GST-free acquisitions for the months of January to June 2018.

The percentage is multiplied by total trading stock acquisitions in each tax period to determine an estimated amount of GST-free acquisitions in each tax period. The purchases snapshot method allows the input tax credits to be calculated by subtracting the estimated GST-free acquisitions from total acquisitions and multiplying it by 1/11. The rationale behind this formula is that the percentage of acquisitions which are creditable acquisitions at one point in time would be expected to be in line with the percentage of creditable acquisitions in subsequent tax periods.

Example 2 Syama has been operating a restaurant for some time and she is on quarterly tax periods. Her GST turnover is below $2m. From 1 October 2017, she elected to use the purchases snapshot method to work out her input tax credits. Syama can use a sample period from 1 June to 31 July 2017 or choose a four-week period from 1 October to 31 December 2017. Prior to 1 October 2017, Syama had already identified the GST status and the amounts of all trading stock she acquired during a sample period in June 2017. She calculated the GST-free percentage of trading stock for the sample period to be 70%. During the tax period October–December 2017, Syama purchased $65,000 of trading stock. Using the purchases snapshot method, the amount of GST-free trading stock for the October–December 2017 tax period is $45,500 (ie 70% of $65,000). The amount of input tax credit is 1/11th of the difference between $65,000 and $45,500. Therefore, the input tax credit entitlement on trading stock purchases for the October–December 2017 tax period is $1,773. The next sample period is a four-week continuous period between 1 December 2017 and 31 January 2018. The GST-free percentage of trading stock from this sample period is used to calculate the amounts of GST-free trading stock for the tax periods January–March and April–June 2018. For each financial year, Syama is required to do two new calculations of the GST-free percentage about every six months in order to calculate the amounts of GST-free trading stock.

When the purchases snapshot method is used, tax invoices for the trading stock acquisitions generally need not be held. However, they will need to be maintained for the acquisitions during the sample period.

¶6-780 Simplified accounting methods for government prisons In September 2015, a simplified accounting method determination was made for government sub-entities that sell food in prisons or other institutions where people are lawfully detained (A New Tax System (Goods and Services Tax) Simplified Accounting Method Determination (No 28) 2015 (SAM 2015/28)). The determination repealed a previous determination made in 2004. The 2015 determination offers two alternative simplified accounting methods both of which are variations of the stock purchases method (¶6700) but it only applies to eligible government entities (SAM 2015/28, para 6).

¶6-785 GST concessions not available for small business entities The GST legislation includes two administrative concessions which are either not available for many small businesses entities or which prevent such entities from using other small business tax concessions. These involve the deferred GST scheme and recipient created tax invoices. The deferred GST (DGST) scheme allows importers to import goods into Australia without paying GST upon entry. Rather, the GST payable on all imports during a tax period is recorded by Customs, totalled and pre-populated into the 7A field in the activity statement of the entity for that tax period. The importer continues to be liable for the GST on those imports but, in effect, is not required to pay that liability until the due date for lodgement of its activity statement. However, the deferred GST scheme can only be elected by an entity that lodges its activity statements monthly. Therefore, to utilise the DGST scheme and gain the cash flow benefit of delayed GST on imports, the entity cannot use the concessions of either quarterly or annual activity statements. To gain the benefit of DGST on imports, small business entities need to lodge activity statements monthly, hence, bring forward their GST liabilities on their taxable supplies. For this reason, few small businesses elect the DGST scheme. Recipient created tax invoices (RCTIs) are tax invoices created by the recipient of a supply rather than by the supplier. They are permitted (s 29-70(3)) to enable the tax invoice to be created and issued by the transaction party in the most appropriate position to do so. The recipient is typically that party where they, rather than the supplier, have the information to determine the transaction value or amount. For example, a scrap metal processor will weigh metal components delivered to it and issue an RCTI to the scrap metal collector. In many cases, RCTIs are the only practical or the most efficient means of recording the transaction between the parties, hence, represent an important compliance mechanism in the relevant industries. RCTIs are only allowed to replace supplier generated tax invoices in four scenarios: • for taxable supplies of agricultural products made to registered recipients who determine the value of the agricultural products

• for taxable supplies made to registered government related entities • for taxable supplies made to registered recipients that have a GST turnover (including input taxed supplies) of at least $20m annually, or • where the Commissioner has made a determination, after an application by an industry association, whose members are registered recipients of taxable supplies that are not covered by the three broad classes above, that RCTIs can be utilised for those supplies. Where a small business entity makes taxable supplies, which do not fit into the classes above, to another small business entity, RCTIs cannot be used. By contrast, where the recipient is an entity with a turnover of at least $20m annually, RCTIs can be used. The obstacles to small businesses using the deferred GST scheme and recipient created tax invoices were raised in the Board of Taxation review of small business tax impediments in 2014. The Board declined to recommend legislative or administrative measures to overcome these obstacles. It is understood that the ATO was concerned that removal of these impediments would create revenue risk.

PAYROLL TAX CONCESSIONS OVERVIEW What this chapter covers

¶7-000

The exemption threshold

¶7-100

Exempt wages and rebates

¶7-200

Traps for small businesses

¶7-300

Grouping provisions

¶7-400

Employee or contractor?

¶7-500

Editorial information

By Shane Peters

OVERVIEW ¶7-000 What this chapter covers The commentary in this chapter is based on the states’ and territories’ payroll tax legislation at 1 July 2017 and relates to the 2017/18 financial year. There are often changes to payroll tax legislation from year to year, so it is important for businesses to confirm any such changes if using this reference for the 2018/19 year or later years. Payroll tax is imposed by all states and territories (referred to as “states” in this chapter) and is a tax calculated by reference to the wages (as defined) paid by employers. The exemption threshold and the rate of payroll tax are different in each state, as set out in the table below. Exemption thresholds and rates: 2017/18 State/Territory

Exemption threshold

Rate

NSW

$750,000

5.45%

Victoria

$625,000

4.85%1

$1,100,0002

4.75%

South Australia

$600,000

2.5–4.95%3

Western Australia

$850,0004

5.5%

Tasmania

$1,250,000

6.1%

Northern Territory

$1,500,0005

5.5%

ACT

$2,000,000

6.85%

Queensland

1From

1 July 2017, the payroll tax rate is 3.65% for regional employers that have a workforce made up of at least 85% “regional employees”. 2In

Queensland, the exemption threshold reduces progressively. It falls by $1 for every $4 of taxable wages over the threshold. Therefore, no exemption threshold is available where taxable wages are in excess of $5.5m. 3From

1 July 2017, South Australia introduces a low rate of 2.5% for employers with taxable wages between $600,000 and $1m. The rate gradually increases from $1m and reaches the top rate of 4.95% for employers that have taxable wages of $1.5m and more. 4In

Western Australia, the exemption threshold reduces progressively. It falls by $1 for every $7.8235 of taxable wages over the threshold. Therefore, no exemption threshold is available where taxable wages are in excess of $7.5m. As part of its 2017/18 Budget, the Western Australia government announced its intention to introduce increased payroll tax rates from 1 July 2018 for businesses with national payrolls in excess of $100m, being 6% for employers with a payroll over $100m and 6.5% for employers with a payroll over $1.5b. This progressive payroll tax scale is a temporary Western Australia Budget repair measure to be applied for a finite period of five years. 5In

the Northern Territory, the exemption threshold reduces progressively. It falls by $1 for every $4 of taxable wages over the threshold. Therefore, no exemption threshold is available where taxable wages are in excess of $7.5m. The exemption threshold is the main small business concession provided under the payroll tax regime. For those small businesses that have wages in excess of the threshold, and consequently a payroll tax liability, it is important to be aware of the forms of remuneration that are exempt or concessionally valued (¶7-200). It is also critical that small businesses are aware of the payroll tax grouping provisions (¶7-400) and the contractor provisions (¶7-500), as these provisions can bring small businesses within the payroll tax net, even though the general payroll in respect of their employees is below the exemption threshold. Payment and lodgment frequencies In general, employers or deemed employers who are registered or required to be registered for payroll tax must lodge payroll tax returns and pay their payroll tax liabilities on a monthly basis. However, subject to the approval from the state tax authorities, most states have concessional payment and lodgment frequencies for smaller payroll tax payers. Each state has a different policy in terms of approving concessional payment frequencies. Most states have clear guidelines which specify a set threshold below which monthly lodgments and payments are not required. In Queensland and Tasmania, eligibility for the concessional lodgment and payment frequencies are assessed on a case-by-case basis without specific thresholds published by the state tax authorities. The table below provides a summary of payroll tax lodgment and payment frequencies. This table is a guide only. As mentioned above, concessional lodgment and payment frequencies are subject to the approval from the state tax authorities. Further, the thresholds may change from year to year. Lodgment frequency State/Territory NSW Victoria

Monthly

Annually ≤$20,000 liability pa

>$40,000

≤$40,000

✓

South Australia

✓

Tasmania

Half-yearly

>$20,000 liability pa

Queensland

Western Australia

Quarterly

≥$100,000 ✓

Assessed and approved by OSR

$6,000

≤$6,000

The due date for lodgment is generally the 7th day of the month immediately following the end of the period to which the return relates, with the June/annual reconciliation return due by 21 July.

¶7-100 The exemption threshold Employers are not liable for payroll tax where their taxable wages, as defined, are below the exemption threshold. Where their taxable wages exceed the threshold, payroll tax is only payable on the taxable wages in excess of that threshold. Where a business only pays wages in one state, is not grouped with any other business, and operates for a full financial year, then it is entitled to the full exemption threshold available in the relevant state. However, businesses need to be mindful of the way the exemption threshold rules apply where they pay wages in more than one state, they are grouped with other businesses, or the business commences or closes part way through a financial year. The following examples illustrate the application of the exemption threshold and are based on the rates and thresholds applicable to the 2017/18 year. For ease of discussion, all wages in the following examples are taxable wages. Example 1 Companies A, B and C are unrelated and operate only in Queensland, NSW and Victoria respectively and each has annual wages of $800,000. Company A has no liability because its wages are below the Queensland threshold of $1,100,000. Company B has a liability of $2,725 because its wages exceed the NSW threshold of $750,000 ($800,000 − $750,000 = $50,000 × 5.45% = $2,725). Company C has a liability of $8,488 because its wages exceed the Victorian threshold of $625,000 ($800,000 − $625,000 = $175,000 × 4.85% = $8,488).

Example 2 Companies A, B and C are unrelated and operate in Tasmania, South Australia and the Northern Territory respectively and each has annual wages of $1,400,000. Company A has a liability in Tasmania of $9,150 ($1,400,000 − $1,250,000 = $150,000 × 6.1% = $9,150). Company B has a liability in South Australia of $39,600 ($1,400,000 − $600,000 = $800,000 × 4.95% = $39,600). Company C has no liability because its wages are below the Northern Territory threshold of $1,500,000.

Example 3 Company A and B are unrelated and only operate in Queensland and Western Australia respectively and have annual wages of $2,100,000. Company A has an annual liability of $59,375 ($2,100,000 − $850,000 = $1,250,000 × 4.75% = $59,375). The Queensland exemption threshold is reduced by $250,000 from $1,100,000 to $850,000, on the basis that the wages in excess of $1,100,000 reduce the threshold by $1 for every $4 that the wages are in excess of the threshold, ie $2,100,000 − $1,100,000 = $1,000,000/4 = $250,000 reduction in the threshold. Company B has an annual liability of $77,538 ($2,100,000 − $690,225 = $1,409,775 × 5.5% = $77,538). The Western Australian exemption threshold is reduced by $159,775 from $850,000 to $690,225, on the basis that the wages in excess of $850,000 reduce the threshold by $1 for every $7.8235 that the wages are in excess of the threshold, ie $2,100,000 − $850,000 = $1,250,000/7.8235 = $159,775 reduction in the threshold.

As payroll tax is normally paid on a monthly basis, businesses would normally take up the relevant portion of the threshold each month and make adjustments in their annual reconciliation return.

Example 4 Company A operates in Victoria only and has wages of $100,000 in July 2017. Its monthly liability would be $2,324 ($100,000 − $625,000/12 = $47,917 × 4.85% = $2,324), assuming that the business is not eligible for the regional employee concession. If it were, the payroll tax rate would be 3.65%.

It is critical to note that businesses which operate in more than one state do not receive the full exemption threshold in each state. Rather, the threshold is allocated proportionately, ie the exemption threshold available is in the same proportion as that state’s wages is to national wages. Example 5 If Company A has $1,000,000 in taxable wages in NSW and $1,000,000 in taxable wages in Victoria, the exemption threshold available in NSW is $375,000, being $750,000 × $1,000,000/$2,000,000 and the exemption threshold available in Victoria is $312,500, being $625,000 × $1,000,000/$2,000,000.

Similarly, where businesses are grouped (¶7-400), only one exemption threshold is available. The states have provision for one group member to be the Designated Group Employer (DGE). Under the arrangement, the DGE takes the full threshold and the other members of the group take no threshold. Example 6 Company A and Company B are grouped. Both companies only operate in NSW. If Company A has wages of $1,000,000 and Company B has wages of $500,000, then Company A would have an entitlement to the full $750,000 threshold, resulting in taxable wages of $250,000 ($1,000,000 − $750,000 = $250,000). Company B would have no threshold and have taxable wages of $500,000.

This arrangement can create a problem where a group has collective wages in excess of the threshold, but no member of the group has wages in excess of the threshold (the problem being that the DGE cannot claim the full threshold). The states deal with this administrative issue in different ways and businesses need to liaise with their relevant State Revenue Office if they have this situation. In NSW, for example, Revenue NSW allows members of a group in this situation to become registered as a “single lodger”, so that the members can avail themselves of the full threshold collectively. From 1 July 2017, payroll tax groups lodging joint returns in Victoria that have regional employers as group members will apply a proportionate method to calculate taxable wages that are eligible for the 3.5% payroll tax rate. Where businesses commence or close part way through a financial year, they are only entitled to a proportionate part of the threshold. Example 7 Company A commences operations in Victoria on 1 January 2018 and for the six-month period to 30 June 2018 pays $1,000,000 in wages. As the company has paid wages for only one-half of the financial year, it is only entitled to one-half of the annual exemption threshold (ie $625,000 × 6/12 = $312,500). Its payroll tax liability for the 2017/18 financial year would be $33,344 ($1,000,000 − $312,500 = $687,500 × 4.85% = $33,344).

¶7-200 Exempt wages and rebates All of the states have some types of wages or payments which are exempt from payroll tax. In addition, some states have rebate schemes, providing for a rebate of payroll tax where the relevant criteria are satisfied. The main exemptions and rebates are detailed below. Adoption and maternity/paternity leave In all states an exemption applies to maternity or adoption leave paid in addition to an employee’s normal leave entitlements, up to a maximum of 14 weeks’ wages. Such leave can be taken before or after the

child-birth or adoption. In NSW, Queensland, Western Australia and the Northern Territory, the exemption extends to paternity leave. In the ACT, the exemption extends to primary carer leave and in Queensland the exemption includes surrogacy leave. Note that the employer must obtain a relevant medical certificate or statutory declaration confirming the pregnancy, birth or adoption. Also, the Commonwealth government’s parental leave payments do not attract payroll tax. Annual, sick, recreation, long service leave or any similar leave taken while the employee is absent due to pregnancy or adoption is not exempt. Nor does the exemption extend to fringe benefits provided during the relevant period. Allowances Genuine reimbursements of work-related expenses are not allowances and are not subject to payroll tax. By contrast, most allowances are subject to payroll tax. However, there are concessions for kilometre allowance, accommodation allowance and living-away-from-home allowance (LAFHA). Kilometre allowance As part of a national harmonisation project, the states adopted standard exemption rates for motor vehicle allowance and accommodation allowance. The exempt rate for motor vehicle allowance is 66c per kilometre for the 2017/18 year. If an allowance is paid in excess of 66c per kilometre, then the excess amount is subject to payroll tax. The exempt rate is the rate prescribed by the regulations under ITAA97 s 28-25 for calculating a deduction for car expenses using the “cents per kilometre method” in the financial year immediately preceding the financial year in which the allowance is paid. Therefore the exempt rate for future years can be determined by reference to those regulations. Accommodation allowance The exempt rate for accommodation allowance is $266.70 per day for the 2017/18 year. If an allowance is paid in excess of $266.70, then the excess amount is subject to payroll tax. Many employers pay a daily travel allowance to cover accommodation, meals and incidentals while an employee is away from his or her usual place of work. Provided this composite allowance does not exceed the amount of the exempt rate, the whole allowance will be exempt. If the accommodation is paid by the employer directly to the hotel, motel or serviced apartment and the employee is only paid an allowance for meals and incidentals for the period of absence from the employee’s usual place of residence, then the allowances for meals and incidentals are exempt from payroll tax up to the respective ATO limits for these payments. The overnight accommodation exempt rate for a financial year is the total reasonable amount for daily travel allowance expenses using the lowest capital city for the lowest salary band for that financial year determined by the Commissioner of Taxation of the Commonwealth. Thus the exempt rate for future years can be obtained from the ATO website, but will also be available on the State Revenue Office websites. Living-away-from-home allowance (LAFHA) A LAFHA is a fringe benefit. The value of a LAFHA for payroll tax purposes is the value determined in accordance with the FBT Act. If the allowance does not qualify as a LAFHA benefit under the FBT legislation, for payroll tax purposes it would be treated in the same manner as an accommodation allowance. Apprentices and trainees The treatment of wages paid to apprentices and trainees varies widely between the states. In NSW, employers may claim a rebate of payroll tax paid on wages paid to qualifying apprentices and trainees (within the meaning of the Apprenticeship and Traineeship Act 2001). In the case of trainees, the concession is essentially directed at persons engaged to be trainees and does not apply to a trainee who

was an employee of the employer for more than three months full-time, or 12 months casual or part-time, immediately prior to commencing employment as a trainee. Wages paid to persons employed under an approved group apprenticeship scheme or approved group traineeship scheme also qualify for the rebate. As the rebate can be offset against general payroll tax liability, employers can offset the rebate against their monthly liability or make an adjustment in their annual return. A further concession in NSW is that apprentice and trainee wages are exempt (as distinct from being subject to a rebate) where paid by an approved non-profit organisation in accordance with an approved group apprenticeship scheme or approved group traineeship scheme. In Victoria, wages paid to eligible apprentices or trainees (“new entrants”) employed by a non-profit organisation declared by the Treasurer to be an approved training organisation are exempt from payroll tax. In Queensland, wages are exempt where they are paid to a person who is an apprentice or trainee under the Further Education and Training Act 2014. The exemption does not apply if, before the traineeship started, the trainee had been employed by the employer for a continuous period of three months or more (full-time), or 12 months or more (part-time). However, the exemption applies if the trainee starts a Certificate III traineeship within 12 months after completing a Certificate II qualification as part of the same training package. In addition to the exemption, there is also a payroll tax rebate that reduces the employer’s periodic liability (currently available until 30 June 2018). South Australia and the Northern Territory did have concessions for wages paid to apprentices or trainees, but these were withdrawn in 2012 and 2015 respectively. In Western Australia, wages are exempt where they are paid to apprentices (including trainees) under a training contract registered under the Vocational Education and Training Act 1996. In Tasmania, wages are exempt where they are paid to an employed apprentice or trainee of a registered not-for-profit group training organisation under an approved training contract. Additionally, a new payroll tax rebate scheme takes effect from 1 July 2017, providing rebates in relation to the employment of apprentices, trainees and youth employees (the latter group covering 15–24 years old). In the ACT, wages are exempt where they are paid to a person who is a “new starter”, who is employed for the first time in an industry or occupation and who is receiving eligible training under the Training and Tertiary Education Act 2003. The eligible training must start within the first 12 months after the new starter is employed and continue for no more than 12 months. Wages are also exempt where they are paid to an employed apprentice or trainee of a registered not-for-profit group training organisation under an approved training contract. Superannuation contributions fall within the definition of “wages” for payroll tax purposes. Consequently, in calculating exempt wages or payroll tax rebates, employers should take into account the superannuation contributions made for those eligible persons. Compensation payments Payments of compensation made under the various states’ workers compensation legislation are not subject to payroll tax. However, the states take the position that make-up pay is subject to payroll tax, eg where an employer voluntarily agrees to make-up the difference between the employee’s previous pay and the amount provided under the workers compensation legislation. Contractors’ non-labour charges Payments to contractors are deemed to be wages for payroll tax purposes in certain instances. However, a non-labour component of contractors’ charges can be deducted where approved by the Commissioner. The states have rulings setting out standard approved deductions (eg engineers 5%, carpenters 25%, bricklayers 30%) and employers may apply for a determination from the Commissioner where their circumstances fall outside the standard approved deductions. See ¶7-500 for further details. Defence Force Service Wages are exempt where they are paid to a person while on military leave as a member of the Australian defence forces or the armed forces of a Commonwealth country.

Film Production In South Australia, wages are exempt where paid by a motion picture production company to persons involved in the production of a feature film, where the Treasurer is satisfied that the film will be produced wholly or substantially within the state, will involve the employment of South Australian residents and that economic benefits will accrue to the state. In Queensland, film producers may be able to claim a rebate of payroll tax under Screen Queensland’s production incentives. Types of production eligible to apply for rebates include feature films, telemovies and television series (including reality drama and mini-series) that satisfy minimum contract expenditure and eligibility criteria. NSW — rebate scheme (Jobs Action Plan) The scheme is designed to give small to medium NSW businesses the incentive to employ new workers and expand their enterprises in both metropolitan and non-metropolitan areas. Under the plan, businesses that increase the number of full-time equivalent (FTE) employees are eligible for a payroll tax rebate for each additional employee in a position that is a new job. An overriding condition of the scheme is that the new employee levels have to be maintained for two years, however, there is allowance for short-term drops in employee levels. The rebate is $6,000 for new jobs created after 31 July 2016. It is payable in two parts, being $2,000 at the end of the first year of employment and $4,000 at the end of the second year of employment. The scheme was first introduced in 2011 and initially open to NSW employers of any size. However, from 31 July 2016, once an employer has more than 50 employees, rebates cannot be claimed on new employees engaged after that point. The scheme currently runs until 30 June 2019. Redundancy payments That part of a redundancy payment that is tax-free for income tax purposes is also exempt from payroll tax in all states. However, payments in excess of the tax-free threshold are subject to payroll tax. Volunteer exemptions In all states, where employers continue to pay (ordinary) wages to an employee during a period that the employee undertakes, as a volunteer, bush firefighting activities or emergency services activities, the wages will be exempt. In Queensland, the exemption extends to an employee who performs duties as an honorary ambulance officer. The exemptions do not extend to recreation leave, annual leave, sick leave or long service leave. So, if an employee performs qualifying volunteer work while on annual leave, long service leave, etc these leave payments cannot be treated as exempt for payroll tax. Miscellaneous exemptions and rebates The states also have miscellaneous exemptions and rebates that may only be applicable in the particular state, or for a particular period, so an annual check of the relevant State Revenue website would be prudent. For example, Western Australia also has a concession for disability employment, with an exemption being available for wages paid to some employees with a disability. Queensland has an exemption for certain wages paid to Aboriginal persons or Torres Strait Islanders. Western Australia has a rebate scheme in relation to qualifying indigenous wages.

¶7-300 Traps for small businesses When payroll tax was first introduced, it was essentially a tax on ordinary wages paid to employees. However, as the commercial world developed and the ways in which employees were remunerated became more diverse, the payroll tax legislation was continually broadened to capture new means of

remuneration. For example, all states have taxed superannuation contributions and fringe benefits for many years. In more recent years, all states started taxing employee shares and options. Similarly, as the workplace changed and the use of contractors, rather than employees, became more widespread, the payroll tax legislation was extended to make some contractor payments taxable. Also, because all of the states have exemption thresholds, there would normally be a temptation for businesses to create a new business entity whenever their wages got close to the exemption threshold. Because of the potential revenue leakage, all of the states have grouping provisions, the consequence of which is that grouped businesses have to share a single exemption threshold. It is important for small businesses to be aware of the breadth of the payroll tax net, as history shows that many such businesses only become aware of the full extent of their liability in an audit situation. The two areas where small businesses particularly get caught is in relation to the grouping provisions (¶7400) and the contractor provisions (¶7-500). Some other potential areas of exposure relate to fringe benefits and share schemes. Fringe benefits Benefits provided by employers to employees are treated as wages for payroll tax purposes. The basic rule is that benefits which are fringe benefits under the FBT Act are also benefits for payroll tax purposes. The value of the benefit for payroll tax purposes is the grossed-up FBT value. Note, however, that a single gross-up factor (type 2) is used to calculate the benefit for payroll tax purposes. Therefore, when preparing the annual payroll tax reconciliation return, it is important not to simply transfer the total grossed-up amount from the FBT return to the payroll tax calculations. Example If the FBT return for the 2017/18 year shows:

Type 1 aggregate amount

$100,000 × 2.0802 = $208,020

Type 2 aggregate amount

$100,000 × 1.8868 = $188,680

Total grossed-up amount (“fringe benefits taxable amount”)

$396,700

Then the value of the benefit would be calculated as follows for payroll tax purposes:

Total type 1 and 2 aggregate amount

$200,000

Type 2 gross-up factor

  1.8868

Grossed-up value for payroll tax purposes

$377,360

Employee share schemes For payroll tax purposes, “wages” includes the grant of a share or option to an employee or director in respect of services performed by the employee or director. The liability arises on the “relevant day”. An employer can elect to treat as the relevant day either the date on which the share or option is granted to the employee or the vesting date. The vesting date for shares is normally the date when any conditions applying to the grant of the share have been met and the employee’s legal or beneficial interest in the share cannot be rescinded. Thus, where the grant of a share is unconditional, the grant date and the vesting date will be the same. The vesting date for options is normally the date on which the share to which the option relates is granted to the employee or the date on which the employee exercises a right under the option to have the share transferred or allotted. Where the grant of a share or option constitutes wages, the amount paid or payable as wages is taken to be the value of the share or option on the relevant day, less the consideration, if any, paid or given by the

employee in respect of the share or option. The value of the share or option is the market value on the relevant day or the amount determined in accordance with the Commonwealth income tax provisions, being s 83A-315 of ITAA97 and the regulations made for the purposes of that section.

¶7-400 Grouping provisions The grouping provisions are anti-avoidance provisions. In the absence of the grouping provisions, businesses could simply employ staff under a new entity whenever wages reached the exemption threshold. Under the grouping provisions, entities that are “grouped” have to share a single threshold. Businesses can be grouped in three main ways: (1) They are related corporations within the meaning of the Corporations Act 2001, ie holding companies and subsidiaries. (2) A person or set of persons has a controlling interest in two or more businesses, eg by controlling more than 50% of the voting shares (or a class of voting shares) in a company, by controlling more than 50% of the voting power at directors’ meetings, or controlling more than 50% of a partnership business. Note that there is a special provision covering businesses operated by a discretionary trust. Under that provision, any beneficiary of a discretionary trust operating a business is deemed to have a controlling interest in that business, regardless of whether the beneficiary ever receives a distribution. Therefore, in a business operated by a typical family discretionary trust, the members of the business owner’s family (who are typically beneficiaries) are deemed to have a controlling interest in the business. This creates a potential grouping exposure where the members of the family have their own businesses. (3) An employee of one business performs duties for, or in connection with, a second business (the inter-use of employees provision), eg there is an arrangement between two businesses whereby a financial controller or bookkeeper employed by one of the businesses performs similar duties for the second business. In relation to controlling interests (point 2 above), there are tracing provisions in the legislation which take into account indirect interests in incorporated businesses, ie where a person owns shares in one company which in turn owns shares in one or more other companies. Example John and Mary Smith each own 50% of shares in Company A which in turn owns 40% of shares in Company C. Mary Smith owns 100% of shares in Company B which in turn owns 40% of shares in Company C. Under the normal grouping provisions, John and Mary Smith, as a “set of persons”, have a controlling interest in Company A because they control 100% of the shares. Mary, in her own right, has a controlling interest in Company B, because she owns 100% of the shares. Under the tracing provisions, John and Mary, as a set of persons, have a controlling interest in Company C, because together they indirectly control 60% of the shares in Company C, ie John’s indirect interest is 20% (50% × 40%) and Mary’s indirect interest is 40% (100% × 40%). Using the tracing provisions, Company A is grouped with Company C, because John and Mary Smith, as a set of persons, have a controlling interest in both companies (100% in Company A and 60% in Company C).

As the grouping provisions are quite broad, they can often group businesses that have little relationship with each other. Consequently, the legislation gives the Commissioner power to determine that a business is not a member of a group, if the Commissioner is satisfied that the business is carried on independently of, and is not connected with the carrying on of, any other business in the group. In making any such determination, the legislation prescribes that the Commissioner shall give regard to the nature and degree of ownership and control of the business, the nature of the business and any other matters the Commissioner considers relevant. Note that the Commissioner’s de-grouping power does not extend to businesses grouped as a consequence of being related corporations within the meaning of the Corporations Act 2001. Because the grouping provisions are so broad, it is easy to overlook that a person’s business could be

grouped with another business. Examples (1) A father and son operate independent businesses through separate discretionary trusts. As the father and son would normally be potential beneficiaries under both trusts, then they individually and together have a controlling interest in both businesses and the businesses are grouped. (2) Two families operate independent businesses on the same premises. One of the businesses employs a receptionist and a bookkeeper and has an arrangement with the second business whereby these two employees perform the same duties for the second business, for which a fee is charged. The businesses are grouped under the inter-use of employees’ provision. In both of these cases the businesses can apply to the Commissioner for a de-grouping determination.

¶7-500 Employee or contractor? The payroll tax legislation in all states contains provisions to tax certain payments made to contractors. The provisions can tax contractor payments regardless of whether the contractor is an individual (sole trader), partnership, company or trust. Is the “contractor” actually an employee? Where employers engage contractors, they should review their potential liability as a two-step process. In the case of contractors who are sole traders or partners in a partnership, an employer needs to first consider whether the contractor is actually a common law employee, notwithstanding that he or she considers themselves as a contractor. A common situation where employers have audit problems is where they treat an individual as a contractor, determine that one of the contractor exemptions apply (see “Contractor provisions” below) and pay no tax in respect of the payments to that individual. A State Revenue Office audit is then conducted and the auditor determines that the workers are not contractors at all, but are common law employees and their wages consequently subject to payroll tax. This situation often arises because the question of whether a person is an employee or contractor can be quite complex in many cases. There is no definition of the term “employee” in the payroll tax legislation. The term simply takes on its common law meaning, and this is determined by reference to the extensive case law on the distinction between employees and contractors. In broad terms, in deciding this question, the courts these days look at the total relationship between the parties, to see whether the overall relationship has primarily the indicia of an employer–employee relationship or primarily the indicia of a principal–contractor relationship. Three of the key indicia that the courts look at are the level of “control” the employer has over the worker (the greater the level of control, the greater the likelihood the worker is an employee), the form of remuneration (if “results-based”, the worker is more likely to be a contractor, but if paid an hourly, daily or weekly rate, the worker is more likely to be an employee) and whether the worker has power to delegate the work to someone else (employees cannot delegate). In complex cases, employers may need to seek professional advice. However, in many cases, the situation is straightforward. For example, a typical situation is where a person advises an employer that the person is a contractor because he or she has an ABN. However, if that individual is being paid on a time basis for his or her labour, and the employer provides the premises and other facilities and generally has control over where, when and how the work is done, then it is more than likely that the worker is a common law employee. Having an ABN does not preclude a person from being an employee when working for a specific employer. Employers should note that the determination of whether a person is an employee or contractor is not just a critical issue for payroll tax purposes but is also relevant for PAYG, SGC, workers compensation and vicarious liability purposes. Contractor provisions All states except Western Australia have contractor provisions, which deem payments to contractors to be

wages for payroll tax purposes in certain cases. Western Australia has an anti-avoidance provision to achieve a similar outcome. These provisions were originally introduced into the payroll tax legislation as a consequence of a perception by the various state governments that there was revenue leakage arising from the growing use of contractors, as an alternative to using employees. Prior to the legislative change, employees’ wages were taxed, but payments to contractors were not. As a general comment, the legislation is primarily seeking to capture payments to contractors who are working exclusively or mainly for a single employer. The provisions work by initially bringing all contractor payments (for services which include the provision of labour) within the net, but then allowing for the exclusion of any contractor who is covered by one of the exclusions contained in the provisions (see list below). The end result is that payments to those contractors left in the net are wages for payroll tax purposes. The contractors left in the net are normally those working exclusively or mainly for a single principal. It is important to remember that these provisions are not restricted to contractors who are individuals (sole traders), which is a common misconception. They can also capture contractors providing services through a company, trust or partnership structure. In Queensland, Victoria and South Australia, payments to contractors will not be subject to payroll tax where they fall within one of the following exclusions: (1) the supply of labour is ancillary to the supply of goods (eg the contract is for the supply of a mobile crane plus an operator) (2) the services are of a kind not ordinarily required by the principal and are performed by a person who ordinarily performs services of that kind to the public generally (eg a manufacturer engages a painter to repaint the manufacturing premises) (3) the services are of a kind ordinarily required by the principal for less than 180 days in a financial year (eg contractors engaged on a seasonal basis) (4) the services are provided for a period that does not exceed 90 days in a financial year (eg a contractor providing services one day a week) (5) the services are supplied under a contract to which exclusions 2–4 above do not apply and the Chief Commissioner is satisfied that the services are performed by a person who ordinarily performs services of that kind to the public generally in that financial year (eg a principal engages a contractor three days a week but the contractor concurrently provides similar services to other customers) (6) where the work performed under the contract is performed by two or more persons, being either two or more persons engaged by a company or trust, or a partner of a partnership and an employee(s), or a sole trader and one or more employees of the sole trader (eg a building company engages a sole trader carpenter and the contracted work is performed by the sole trader carpenter and his employed apprentice) (7) the labour provided by the contractor is solely for or ancillary to the conveyance of goods by means of a vehicle provided by the person conveying them (carriers) (8) the labour services are solely for, or in relation to, the procurement of persons desiring to be insured by the principal (insurance sales contractors) (9) the labour services are for, or in relation to, the door-to-door sale of goods solely for domestic purposes on behalf of the principal (door-to-door sales contractors operating in the domestic market). NSW, Tasmania and the Northern Territory have similar legislation, but only exemptions 1 to 7 are available. The ACT also has similar legislation, but only exemptions 1, 2, 5 and 7 are available.

Note that the aim of the contractor provisions is to tax the labour component of the contractor’s charges, not any charge for the supply of equipment and materials. However, in Queensland, NSW, Victoria, South Australia, the Northern Territory and Tasmania, the non-labour component can only be treated as exempt to the extent that it is a deduction approved by the Commissioner. In other words, in determining taxable wages, payments made under a relevant contract can only be reduced by the approved deduction, regardless of the actual amount of non-labour component charged by the contractor. Most of the State Revenue Offices have rulings setting out default percentages that can be used for specified industries. For example, in NSW, PTA 018 sets out approved deduction percentages for a range of trades (eg engineers 5%, carpenters 25% and bricklayers 30%). If a deduction is not approved in the ruling for a particular class of contract, an employer may apply to the Commissioner for a determination. Similarly, if an employer believes that the contractor’s non-labour component is higher than the approved deduction, the employer can apply to the Commissioner for a determination. Western Australia does not have the same contractor provisions as the other states. Rather, the legislation in that state contains an anti-avoidance provision, which, in broad terms, treats payments made to certain contractors as wages for payroll tax purposes, where the use of an interposed entity between an employer and worker results in the reduction of tax payable. Employers engaging contractors in Western Australia should refer to Revenue Ruling PT 6.1, for the Commissioner’s position on how the anti-avoidance provision will be applied by State Revenue where businesses engage contractors.

SUPERANNUATION CONCESSIONS OVERVIEW What this chapter covers

¶8-000

Contributions to superannuation

¶8-100

Eligibility to contribute and tax concessions

¶8-110

TRANSFER BALANCE CAP Considering the transfer balance cap

¶8-130

Exceeding the transfer balance cap

¶8-150

EMPLOYER SUPERANNUATION CONTRIBUTIONS Tax deduction for employer superannuation contributions

¶8-200

Contributions for employees

¶8-205

Personal services income rules may deny deduction

¶8-210

Salary sacrifice superannuation contributions

¶8-215

Reportable superannuation contributions

¶8-220

PERSONAL SUPERANNUATION CONTRIBUTIONS Eligibility to make personal contributions

¶8-240

Tax deduction for personal contributions

¶8-250

Conditions for personal deductibility

¶8-255

Employees and the 10% rule (pre-1 July 2017)

¶8-260

Notice requirements

¶8-265

Strategies for employees

¶8-270

EXCESS CONTRIBUTIONS TAX Introduction

¶8-300

Excess concessional contribution rules

¶8-305

Excess non-concessional contribution rules

¶8-310

Contributions not counted towards a cap

¶8-315

Collection of excess contributions tax

¶8-320

TAX FILE NUMBERS TFNs and contributions

¶8-350

GOVERNMENT CO-CONTRIBUTIONS Eligibility conditions

¶8-400

Amount of co-contribution

¶8-405

Payment of co-contribution

¶8-410

SPOUSE CONTRIBUTIONS

Making contributions for a spouse

¶8-450

Tax offset for spouse contributions

¶8-455

SUPERANNUATION CONTRIBUTIONS AND CGT CONCESSIONS Using a business to provide retirement savings

¶8-500

Qualifying for the CGT cap

¶8-510

Amounts that can be contributed under the CGT cap

¶8-520

Tax status of amounts contributed under the CGT cap

¶8-525

Notification to trustee for CGT cap

¶8-530

Contributions and the retirement exemption

¶8-535

SELLING BUSINESS ASSETS TO SUPERANNUATION FUNDS Issues to consider

¶8-600

Investment strategy

¶8-605

Restrictions on acquisition of assets

¶8-610

Business real property

¶8-615

In-house asset rules and business assets

¶8-620

Compliance with sole purpose test

¶8-625

Borrowing restrictions

¶8-630

Co-ownership by SMSF and another entity

¶8-635

TRANSITION TO RETIREMENT RULES Introduction to TTR

¶8-700

TTR pension features

¶8-705

TTR and salary sacrifice strategy

¶8-710

Steps to commence a TTR pension in an SMSF

¶8-715

TAXATION OF TTR PENSION Introduction

¶8-750

Splitting the components

¶8-755

Tax collected under the PAYG system

¶8-760

SOCIAL SECURITY TREATMENT OF TTR PENSION Assets test

¶8-770

Income test

¶8-775

DEATH BENEFITS FROM TTR PENSIONS Payment of death benefits

¶8-780

Taxation of death benefit income stream

¶8-785

Editorial information

By Louise Biti

OVERVIEW ¶8-000 What this chapter covers This chapter deals with a number of concessions which may provide incentives for small business owners to invest in superannuation. It also discusses various strategies which may assist small business owners who have invested everything in their business and neglected their retirement savings. Unless otherwise indicated, all references to legislation in this chapter are to ITAA97. Concessions for superannuation contributions Concessions are available for various forms of superannuation contributions, ie employer contributions (¶8-200), personal contributions (¶8-250), government co-contributions (¶8-400) and spouse contributions (¶8-450). Decisions about how much to contribute should take into account the impact of the transfer balance cap that applies from 1 July 2017 (¶8-130). Superannuation contributions and CGT concessions Superannuation contributions made from the disposal of certain small business assets may be made under the CGT cap, instead of using the concessional or non-concessional contribution caps (¶8-500). Selling business assets to superannuation Certain business assets can be transferred into superannuation either as a sale to the trustee of an SMSF or as a contribution to superannuation (¶8-600). Transition to retirement rules Transition to retirement rules allow a person who has reached his or her preservation age, but is still working, to commence a non-commutable income stream using preserved superannuation benefits (¶8700). This may be an option to give business owners a boost in their superannuation savings through lower tax rates on earnings compared to non-superannuation investments or to help with access to a limited amount of preserved superannuation to boost cash flow.

¶8-100 Contributions to superannuation Getting money into superannuation and building savings can occur in one of three ways: (1) rolling over existing superannuation benefits from another superannuation fund (2) making contributions — whether they are employer contributions, personal contributions or other forms of contributions (3) investment earnings on assets held inside super. This chapter discusses the second option — the rules around contributing to superannuation — and also examines the tax concessions available to the contributor of those contributions.

¶8-110 Eligibility to contribute and tax concessions Quick checklist Before making a superannuation contribution on a person’s behalf, the following items should be noted: (1) check if the person is eligible to contribute or have a contribution made on his or her behalf

(2) ensure the person is a member of a complying superannuation fund, or is eligible to become a member (3) ensure the contribution does not exceed the contribution caps (¶8-305) (4) ensure the person’s TFN is quoted (¶8-350) (5) if the contribution is an in-specie asset (representing an acquisition of the asset by the fund), ensure the trust deed allows such contributions, that it is within the guidelines of the fund’s documented investment strategy and that SIS investment rules are not breached (¶8-600) (6) check the overall balance held in superannuation and compare against the transfer balance cap ($1.6m for 2017/18) to determine if superannuation is appropriate (¶8-130).

Eligibility to contribute The eligibility rules for contributing to superannuation depend on the person’s age. Contributions can only be made for or by a person who meets one of the following criteria (SIS Regulations reg 7.04): • the person is under age 65 • the person is aged 65 or over but under age 75* and has been gainfully employed for at least 40 hours within 30 consecutive days in the current financial year, or • the contribution is a superannuation guarantee (SG) or mandated employer contribution (at any age). Personal contributions can only be made if the person has a total superannuation balance less than the transfer balance cap ($1.6m for 2017/18) as at 30 June of the previous financial year (¶8-130). *Contributions can be made up to the 28th day of the month following the month in which the person turns 75. Tax concessions for contributions Tax concessions may be available for superannuation contributions depending on: • who is making the contribution (eg employer, member or other person) • the status of the fund receiving the contribution (ie complying or non-complying), and • the contribution amount (ie within or in excess of the relevant contributions cap). Concessions can be obtained through a tax deduction, a tax offset or a government co-contribution (see below). Type of contribution

Is a tax deduction available to the contributor?

Employer contribution (¶8-200)

Yes*

Salary sacrifice contributions (¶8-215)

Yes*

Personal contributions by an individual (¶8-250) Yes* — classified as concessional contributions Non-concessional contributions by an individual No, but may be eligible for government co-contribution (¶8-310) (income test applies to individual) By a person for his or her spouse (¶8-450)

No, but a tax offset may be available for the contributor depending on income of the receiving spouse

By a person for a child under 18 (¶8-255)

No, unless child is an employee

*There is no limit on the amount of the deduction that can be claimed but any contribution amount that exceeds the concessional contribution cap will be classified as an excess contribution. The rules have changed over time in relation to the taxation of excess contributions (¶8-305).

Tip Contributions must be physically received by the trustee before the end of the financial year for the contributor to claim a tax deduction or other concession in that year. For an SMSF, it is preferable for the trustee to bank the cheque before the end of the financial year to prove receipt. If the employer is using a clearing house it is important to allow enough time for the contribution to be processed by the clearing house and received by the superannuation fund before 1 July.

Concessional and non-concessional contributions Contributions are classified as either concessional or non-concessional contributions. Concessional contributions are basically contributions for which a tax deduction will be claimed and which are included as assessable income of the superannuation fund. All employer contributions are concessional contributions regardless of whether a tax deduction is claimed or not. Non-concessional contributions are basically those made by someone (other than an employer) for which a tax deduction is not claimed and which are not included as assessable income of the fund. The amount of concessional and non-concessional contributions that can benefit from concessional tax treatment is subject to annual limits (caps). Contributions that exceed the caps are subject to tax penalties, although the excess amounts may be withdrawn to minimise the tax penalties (¶8-305 and ¶8310).

TRANSFER BALANCE CAP ¶8-130 Considering the transfer balance cap A client can choose to remain in the accumulation phase indefinitely or they can choose to roll over superannuation savings to commence an income stream. When making decisions about contributions to superannuation clients need to take into consideration the impact of the transfer balance cap which commenced on 1 July 2017 to limit the amount that can be rolled over to start an income stream. The cap starts at $1.6m for 2017/18. If more than the cap is accumulated in superannuation, the excess can be retained in the accumulation phase or be withdrawn from superannuation. What counts against the cap? The cap applies to the total value of all pension accounts but does not include pensions paid under transition to retirement (TTR) rules (¶8-700). Retirement income streams commenced with superannuation money will be assessed against the transfer balance cap at the date of commencement. Income streams commenced before 1 July 2017 are also included, but are assessed at the value as at the end of 30 June 2017. Account-based income streams are assessed at purchase price (or 30 June 2017 balance if commenced before 1 July 2017). Death benefit pensions are assessed to the beneficiary with special rules for child account-based pensions. Amounts that are not counted include: • the growth in an income stream after commencement (unless captured in the 30 June 2017 balance for a pension commenced before 1 July 2017) • pensions paid under transition to retirement rules, and

• personal injury structured settlement contributions that have been transferred into the pension phase. Indexation of the cap The cap is indexed in line with the consumer price index (CPI) each year but is rounded down to the nearest $100,000. If a person has used part of the cap, they will only receive part of the indexation in subsequent years, based on a proportion of the available cap remaining, ie only the available cap is indexed. If the cap is fully used (or exceeded) the person will not benefit from any future indexation.

¶8-150 Exceeding the transfer balance cap A person who has accumulated superannuation savings greater than the transfer balance cap should not transfer more than the cap amount (or available cap amount) into the pension phase to start an income stream. Example Bert has superannuation savings of $1.8m when he retires at age 66 in October 2017. Bert rolls $1.6m into an account-based pension and uses his full transfer balance cap. The remaining $200,000 can remain in the accumulation phase or be withdrawn as a lump sum. Bert will not create an excess transfer balance. He will not benefit from any future indexation of the transfer balance cap so he is not able to top-up his pension balances with any future superannuation savings.

If the value of a person’s transfer balance account exceeds the transfer balance cap they will create an excess transfer balance. The excess transfer balance is the sum of: • the amount in excess of the transfer balance cap, and • the notional earnings on the excess amount. The excess amount needs to be withdrawn from the pension phase. It can be rolled back into accumulation phase or be withdrawn as a cash lump sum. Excess transfer balance tax is payable on the notional earnings. Notional earnings If the transfer balance cap is exceeded a notional earnings amount is calculated on this excess amount. The earnings are compounded daily until the excess is removed from the income phase or an excess transfer balance determination is issued by the ATO (earlier of). The daily rate for earnings is calculated as: 90-day bank accepted bill yield + 7 percentage points Number of days in the calendar year The 90-day bank accepted bill yield is a benchmark indicator published by the Reserve Bank of Australia (RBA). Excess determination The ATO may issue an excess transfer balance determination to crystallise the amount that needs to be withdrawn from the income phase. This stops the accumulation of the notional earnings. The excess amount and notional earnings advised in the determination must be withdrawn from the income phase. This amount can be rolled back into the accumulation phase or be withdrawn as a cash lump sum. If the withdrawal has not been made within 60 days of the determination being issued, the ATO will issue an automatic withdrawal notice to the superannuation fund. Tax on excess amount

Excess transfer balance tax is payable on the notional earnings. The tax rate is 15% for 2017/18. From 1 July 2018 the tax rate is: • 15% for first time that an excess transfer balance is created, and • 30% for any subsequent excesses. If a person is liable for this tax, the ATO will issue an excess transfer balance tax assessment. The tax is due and payable 21 days after the assessment is issued. The general interest charge will apply to any late payments. The tax cannot be paid by the superannuation fund. Note: If on 1 July 2017, a person with existing income streams exceeded the $1.6m cap by less than $100,000, this amount can be removed before 31 December 2017 without creating a liability to pay excess transfer balance tax.

EMPLOYER SUPERANNUATION CONTRIBUTIONS ¶8-200 Tax deduction for employer superannuation contributions The deduction rules for employer contributions are in Subdiv 290-B (s 290-60 to 290-100). A deduction is not allowed under any other provision of ITAA97 or ITAA36 for employer superannuation contributions (s 290-10). Employer contributions are classified as concessional contributions even if a tax deduction is not claimed by the employer. The amount of an employer’s deduction is not limited. However, an excess concessional contribution will arise if the employee’s concessional contribution cap is exceeded for the financial year (¶8-305). For 2017/18, the cap is $25,000 per individual. Employer contributions are wholly deductible if they comply with the following conditions: • the employee is under age 75 (contributions can be made up to the 28th day of the month after the person turns age 75) or the contributions are “mandated employer contributions” under an award or industrial agreement. Historically, superannuation guarantee (SG) was only mandated for eligible employees under age 70 but from 1 July 2013 no upper age limit applies • the employee is engaged in producing the employer’s assessable income or is an Australian resident who is engaged in the employer’s business (s 290-70) (¶8-205) • the contributions are not made on behalf of an associate of an employee (eg a spouse) • the contributions are made to a complying superannuation fund (or RSA) • the deduction is not denied or limited due to the personal services income rules (¶8-210). Important points to note about employer contributions (1) Although a contribution by an employer may be deductible, the personal services income rules may deny or limit the deduction (¶8-210). (2) Employer contributions in excess of what is commensurate with income earned by an employee may be deductible, although the potential application of the anti-avoidance provisions in Pt IVA of ITAA36 needs to be considered. (3) A deduction may be disallowed and FBT payable if an employer knowingly makes a contribution to a non-complying superannuation fund.

(4) A contribution is not deductible if the employer elects that it be offset against an SG charge liability. (5) In all the states and territories, employer contributions to any superannuation, provident or retirement fund or scheme are treated as forming part of wages for payroll tax purposes. This includes amounts to cover an SG charge. See Chapter 6 for further details. (6) Amounts salary sacrificed by an employee into superannuation are treated as employer contributions. These amounts can be used to satisfy the employer’s SG obligations. However, in July 2017, the government issued a press release announcing its intention to introduce legislation into parliament to amend legislation so that salary sacrifice contributions will no longer count towards meeting SG obligations. At the time of writing, legislation had not yet been introduced. (7) In the case of a non-employment relationship (eg between an employer and a contractor), s 29010(1) ensures that a deduction is not allowed under s 8-1 for contributions made by the employer, but the contributions may be deductible under s 290-60 if the contractor is treated as an employee for SG purposes.

¶8-205 Contributions for employees Employer contributions are only deductible if made for an employee. Two main issues need to be considered under s 290-60(1): (1) the aim of the contribution must be to provide superannuation benefits for another person, and (2) the person must be an employee. Making provision for superannuation benefits The purpose is the key factor when determining if contributions are made to provide superannuation benefits for another person. For example, employer contributions to an employer-sponsored fund are not deductible if the main purpose is to generate tax-deductible payments which can be returned to the employer, for example, low-interest loans as in Raymor Contractors v FC of T 91 ATC 4259. It is necessary to examine the facts of each case to determine the purpose of the taxpayer and, if required, to look beyond the terms of the trust deed to establish the purpose. Relevant considerations include the use of the contributed funds by the superannuation fund, the extent to which the employees actually receive benefits from the fund, and the extent to which the funds are used to benefit persons who are not employees (Case 25/93 93 ATC 314). Meaning of “employee” For a contribution to be deductible, the person for whom the contribution is made must be: (1) an employee (within the expanded meaning of “employee” given by s 12 of the Superannuation Guarantee (Administration) Act 1992 (SGA Act)) of the employer, or (2) engaged in producing assessable income of the employer, or (3) an Australian resident who is engaged in the employer’s business (s 290-70). Point 1 covers two types of persons who are employees for the purposes of the deductibility of employer superannuation contributions: • persons who are common law employees, and • persons who are employees under the expanded meaning in the SGA Act s 12 — this covers an individual who works for the employer under a contract wholly or principally for his or her labour. If contributions are made for individuals who are not SG employees, the individuals must be engaged in producing assessable income of the employer or engaged in the employer’s business. In either case, the wording of s 290-60(1) indicates that the person for whom the contribution is made

must be “another person” — it cannot be the same person as the employer taxpayer who is claiming the deduction. For the purposes of the deductibility of employer contributions, if a partnership makes a contribution on behalf of an employee of the partnership, the employee is treated as an employee of the partnership, and if a partner in a partnership makes the contribution, the employee is treated as an employee of the partner (s 290-65(2)). Former employees A former employee may be treated as an employee for the purposes of the deduction rules in s 290-60(1), enabling the employer to make a deductible contribution for the person. This will be the case if the contribution by the employer: • reduces the employer’s SG charge percentage for the employee • is a one-off payment made in lieu of salary or wages that relate to a period of service during which the person was an employee of the employer, or • is a payment (other than a one-off payment) in lieu of salary or wages that relates to a period of service where the payment is made within two months after the person ceased to be employed by the employer (s 290-85(1)). Example 1 After Samantha is dismissed from her employment on 1 September 2017, she brings an action for back payment of underpaid wages. She is awarded $1,000 which is paid to her six months later. Her employer is required to make SG contributions for Samantha because of the SGA Act s 15B which, for SG purposes, includes former employees in the “employees” for whom SG contributions must be made. The contributions are deductible because they reduce the employer’s SG charge percentage.

Section 290-60 may also apply if a person with a controlling interest in an employer makes a contribution on behalf of a former employee of the employer (s 290-85(1A)). Example 2 Company 1, which has a controlling interest in Company 2, makes a contribution on behalf of Company 2 to a superannuation fund to satisfy Company 2’s SG obligation for a former employee. Company 1 may be allowed a deduction for the contribution even though the former employee was never an employee of Company 1.

Contributions by taxpayers with controlling interests A deduction for a contribution may be allowed under s 290-60 if a taxpayer makes a contribution for another person and: • that other person is an employee of a company in which the taxpayer has a controlling interest, or • the taxpayer is connected to the employee in the following circumstances: – the taxpayer is the beneficial owner of shares in the company that employs the employee, but does not have a controlling interest – the taxpayer is at arm’s length from the employee in relation to the contribution, and – neither the employee nor a relative of the employee has set aside an amount to provide superannuation benefits for the taxpayer, or • the taxpayer is a company connected to the employee either because: – the employee is an employee of an entity that has a controlling interest in the company, or – an entity that has a controlling interest in the company also has a controlling interest in a

company in which the employee is an employee (s 290-90). If any one of these conditions is satisfied, the employee is treated as an employee of the taxpayer for the purposes of s 290-60(1), making the contribution deductible if the other relevant conditions for deductibility are also met.

¶8-210 Personal services income rules may deny deduction In certain circumstances, a tax deduction for superannuation contributions may be denied to an individual or a personal services entity under the personal services income regime. A “personal services entity” is a company, trust or partnership whose assessable income includes the personal services income of one or more individuals (s 86-15). Personal services income is income that is gained mainly as a reward for the personal efforts or skills of an individual (s 84-5). The limitations on deductions for superannuation contributions do not apply if the individual or the personal services entity is conducting a “personal services business” (ie one of the personal services business tests is met) (s 87-10). Contributions by individuals An individual cannot deduct a contribution made to a superannuation fund or RSA to provide superannuation benefits for an associate of the individual (eg a spouse) to the extent that the associate’s work relates to gaining or producing the individual’s personal services income (s 85-25). This is the case even if the associate is an employee of the individual. A deduction, however, may be allowed to the extent that the associate performs work which is part of the “principal work” of the individual. Principal work is work that is central to meeting the individual’s obligations under agreements between the individual or a personal services entity and the acquirer of the personal services. Generally, principal work would not include clerical or administrative work. If the associate is engaged in providing part of the individual’s principal work, superannuation contributions that are related to that engagement may be deductible, but the deduction is limited to the minimum amount required to be contributed by the individual on behalf of the associate to comply with the SG obligations. The minimum contribution is calculated as if the associate’s ordinary time earnings for SG purposes is the amount paid to the associate to perform the principal work. Example 1 Mary employs her husband Brad in her sign-writing business. He is paid $40,000 pa in 2017/18. Of this amount, $15,000 is for the work he carries out in delivering signs to clients and $25,000 is for administrative support. Although Mary contributes $3,800 to a superannuation fund on behalf of Brad (ie 9.5% of $40,000), she is only entitled to a deduction of $1,425. This is the amount of the contribution (ie 9.5% of $15,000) that relates to the income earned by Brad from performing the principal work of Mary’s business. Note the SG rate is 9.5% until 30 June 2021 and will then progressively increase up to 12% by 1 July 2025.

Contributions by personal services entity A personal services entity is entitled to deduct certain contributions it makes to a superannuation fund or RSA on behalf of an individual whose personal services income is included in its income (s 86-75). This applies, for instance, if an individual provides personal services and the personal services income from providing those services is paid to a personal services entity (eg a company, trust or partnership) rather than to the individual. If a contribution is made on behalf of an associate of an individual whose personal services income is included in the entity’s income, and the associate performs less than 20% (by market value) of the entity’s principal work, the deduction is limited to the amount required to be contributed to avoid an individual SG shortfall. The deduction may be limited, for example, if the entity contributes for a non-working spouse of the main worker. The required minimum contribution is calculated as if the associate’s ordinary time earnings for SG purposes is the amount paid to the associate to perform the principal work.

Example 2 Nataco, a personal services entity, is paid $200,000 for personal services performed by John in 2017/18. John’s son, Peter, is paid $10,000 to carry out certain tasks, comprising 10% (by market value) of the principal work that generates the personal services income. Peter is also paid $30,000 for secretarial support. Regardless of the actual contributions made, the maximum deduction to which Nataco is entitled for superannuation contributions made for Peter that year is: 9.5% × $10,000 = $950 Contributions in excess of $950 are not deductible.

¶8-215 Salary sacrifice superannuation contributions A salary sacrifice arrangement arises where an employee contractually agrees to give up part of the remuneration that he or she would otherwise receive as salary or wages in return for the employer providing benefits of a similar value (eg superannuation benefits). Employer contributions made to a complying superannuation fund on behalf of an employee are not a taxable fringe benefit. However, superannuation contributions on behalf of an employee’s associate (eg a spouse) are a taxable fringe benefit, as are all employer contributions to a non-complying superannuation fund. Effective and ineffective arrangements An effective salary sacrifice arrangement involves the employee agreeing to sacrifice part of his or her future remuneration to superannuation before the employee has earned the entitlement to receive that amount as salary or wages (Taxation Ruling TR 2001/10). By contrast, an ineffective salary sacrifice arrangement involves the employee directing that an entitlement to receive salary or wages that has already been earned (because the work has already been done) is to be paid in a form other than as salary or wages. Only an effective salary sacrifice arrangement involving the employee giving up a future entitlement to salary or wages can be tax-effective. The agreement should be initiated by the employer. Example 1 An employee is given an annual bonus and he or she decides to sacrifice the bonus into superannuation. This arrangement would be considered an ineffective salary sacrifice arrangement if the bonus has already been paid into the employee’s bank account or it is not yet paid but the amount has been agreed based on performance already achieved. However, if the employee instructs the employer to sacrifice the bonus for the following financial year into superannuation, this would be considered an effective salary sacrifice arrangement.

Example 2 Andrew (aged 52) is paid $80,000 in salary plus $8,000 in employer superannuation contributions in the 2017/18 year of income. On 30 June 2018, Andrew renegotiated his employment contract for the 2018/19 year of income to receive $65,000 salary and $23,000 employer contributions to a complying superannuation fund. This is an effective salary sacrifice arrangement because it is entered into before performance of the services for which payment is to be made. The superannuation contributions made on Andrew’s behalf are not taken to be salary or wages. Instead, they qualify as employer superannuation contributions for SG purposes and Andrew’s employer also qualifies for a tax deduction.

SG expanded definition employees Taxation Ruling TR 2001/10 applies only to common law employees and does not extend to employees within the extended definition in s 12 of the SGA Act. However, SG Determination SGD 2006/2 states that a person who is an “employee” for SG purposes because of s 12(3) or 12(8) of the SGA Act (ie a person who works under a contract that is wholly or principally for the labour of the person, or artists, musicians, sportspersons, etc) can enter into an effective salary sacrifice arrangement with his or her employer. In that case, the salary sacrificed contributions under the arrangement, in lieu of “salary or wages” for the person, are employer contributions for the purposes of the SGA Act.

Changes from 1 July 2017 From 1 July 2017, all individuals under age 75 who are eligible to contribute to superannuation can choose to claim tax deductions for personal superannuation contributions, even if an employee (¶8-250). This may reduce the need to enter into salary sacrifice arrangements with employees as the tax impact is the same under either option. However, salary sacrifice may provide a greater savings discipline.

¶8-220 Reportable superannuation contributions From 1 July 2009, many income definitions (used to determine eligibility for superannuation taxation concessions) include reportable superannuation contributions or reportable employer superannuation contributions. Reportable superannuation contributions (ITAA97 s 995-1) are the total of: • reportable employer superannuation contributions • personal tax deductible superannuation contributions. Reportable employer superannuation contributions (TAA Sch 1 s 16-182) are employer contributions made under voluntary arrangements and/or salary sacrifice arrangements that are in addition to the minimum contributions that must be made under: • superannuation guarantee law • an industrial agreement • the trust deed or governing rules of a superannuation fund, or • a federal, state or territory law. Employers are required to record the amount of reportable employer superannuation contributions on an employee’s payment summary at the end of the financial year.

PERSONAL SUPERANNUATION CONTRIBUTIONS ¶8-240 Eligibility to make personal contributions A person can make personal superannuation contributions if that person: • meets the age and work test eligibility rules to contribute, and • has quoted his or her TFN to the fund. A complying fund cannot accept any single contribution that exceeds the member’s fund-capped contribution limit for the year. This is effectively the member’s non-concessional contribution cap. For 2017/18, this limit is up to $300,000 for a person under age 65 or $100,000 for a person aged 65