With the Capital Gains Tax (CGT) discount in the media of late, it’s a good time to understand what CGT is and how it works.
Reduce the capital gain on an active asset by 50% (in addition to the CGT discount if conditions are met).
Applying the 50% active asset reduction
To apply the small business 50% active asset reduction, you must meet the basic eligibility conditions common to all 4 small business CGT concessions.
Unlike the other small business CGT concessions, the small business 50% active asset reduction applies automatically. This is unless you choose for it not to apply.
Depending on what improves your situation, you may choose not to apply the small business 50% active asset reduction and instead apply the small business retirement exemption or small business roll-over. For example, a company or trust may choose not to apply the small business 50% active asset reduction to make larger tax-free payments with the small business retirement exemption.
After applying any current or prior year capital losses and the CGT discount (if applicable), any remaining capital gain is reduced by 50%.
Example: application of small business 50% active asset reduction
Lana owns land used in her business for more than 12 months. She sells the land and makes a capital gain of $17,000. In the same year, she also makes a capital loss of $3,000 from the sale of another asset.
After offsetting the $3,000 capital loss against her $17,000 capital gain, Lana is left with a net capital gain of $14,000.
Because Lana has owned the land for more than 12 months and meets the basic eligibility conditions, she is eligible for the:
- CGT discount
- small business 50% active asset reduction.
She can reduce her capital gain as follows:
$14,000 (net capital gain)
× 50% (CGT discount)
= $7,000
× 50% (small business 50% active asset reduction)
= $3,500 (capital gain)
End of example
Special rules for trust beneficiaries
Special rules allow concessions obtained by a trust to be passed on to beneficiaries who are entitled to a share of the trust’s net capital gain.
A beneficiary must gross up their share of any capital gain received from a trust. If the trust has applied:
- the CGT discount or the small business 50% active asset reduction, multiply the capital gain by 2
- both the CGT discount and the small business 50% active asset reduction, multiply the capital gain by 4.
Next, the beneficiary’s grossed up share of the trust capital gain is used to calculate their net capital gain to be included in their assessable income by reducing:
- trust capital gains by any capital losses of the beneficiary
- remaining trust capital gains by the CGT discount (unless the beneficiary is a company) and the small business 50% active asset reduction (if the trust’s capital gain was reduced by these 2 concessions).
A corporate beneficiary must gross up (as above) their share of any net capital gains received that the trust has reduced by the CGT discount. However, they are not entitled to reduce this grossed-up amount by the CGT discount because companies are ineligible for the CGT discount.
Example: beneficiary of a trust applies small business 50% active asset reduction
The LemInvest unit trust makes a capital gain of $100,000 when it disposes of an active asset.
LemInvest has no capital losses and meets all the conditions for the CGT discount and the small business 50% active asset reduction.
The trust’s net capital gain is $25,000 because no other concessions apply.
LemInvest has one individual beneficiary, Gert, who is presently entitled to the net income of the trust. She has a separate capital loss of $10,000.
Gert works out her net capital gain as follows:
$100,000 grossed up share of trust capital gain ($25,000 × 4)
− $10,000 (capital loss)
× 50% (CGT discount)
= $45,000
× 50% (small business 50% active asset reduction)
= $22,500 (net capital gain)
End of example
How trust distributions are treated
If a beneficiary’s interest in a trust is fixed (for example, an interest in a unit trust), there are rules where the trust distributes to the beneficiary an amount of capital gain that was excluded from the trust’s net income because it claimed the small business 50% active asset reduction.
The distribution of the small business 50% active asset reduction amount is a non-assessable amount under CGT event E4.
The payment of the non-assessable amount will firstly reduce the cost base of the beneficiary’s interest in the trust. If the cost base is reduced to zero, a capital gain may arise in respect of the beneficiary’s interest in the trust. This capital gain may qualify for the CGT discount (after applying any capital losses) if the interest in the trust has been owned by the beneficiary for at least 12 months.
If a beneficiary’s interest in a trust is not fixed (for example, the trust is a discretionary trust), there are no CGT consequences for the beneficiary.
Source: ato.gov.au
Reproduced with the permission of the Australian Tax Office. This article was originally published on https://www.ato.gov.au/businesses-and-organisations/income-deductions-and-concessions/incentives-and-concessions/small-business-cgt-concessions/small-business-50-percent-active-asset-reduction
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