What Is the Small Business CGT Retirement Exemption?
Explore the small business CGT retirement exemption, a provision that allows owners to thoughtfully reduce tax on an asset sale and fund their retirement.
When a small business owner sells an asset, the resulting capital gain can create a substantial tax liability. A tax provision, known as the retirement exemption, allows these individuals to disregard a portion of this capital gain, reducing their tax bill. This concession helps business owners use the proceeds from the sale of their business assets to support their financial future. The exemption is not automatic and is governed by specific rules, providing a pathway to convert business wealth into personal retirement savings in a tax-effective manner.
Foundational Eligibility for Small Business CGT Concessions
Before considering any specific capital gains tax (CGT) concessions, a business owner must first pass a set of gateway tests. The initial condition is the $2 million aggregated turnover test. This test requires that the business, along with any connected or affiliated entities, has a combined annual turnover of less than $2 million.
If a business does not meet the turnover threshold, it may still qualify under the $6 million maximum net asset value (MNAV) test. This alternative requires that the total net value of all assets owned by the individual and their related entities does not exceed $6 million just before the sale of the asset. The net value is calculated by taking the market value of the assets and subtracting any related liabilities. Personal assets, such as a primary residence and superannuation funds, are excluded from this calculation.
Once one of the financial threshold tests is met, the asset itself must satisfy the active asset test. An asset is considered active if it has been used or held ready for use in the course of carrying on a business. The asset must have been active for at least half of the total period it was owned, or for a minimum of 7.5 years if owned for more than 15 years.
A final layer of conditions applies when the asset being sold is shares in a company or an interest in a trust. In these situations, the individual claiming the concession must be a CGT concession stakeholder in the company or trust. This means the individual holds a significant voting power or right to distributions. Additionally, the company or trust itself must ensure that the value of its active assets is a substantial majority of its total assets.
Specific Conditions of the Retirement Exemption
After satisfying the foundational criteria, a business owner must meet the conditions of the retirement exemption. This concession has a lifetime limit of $500,000 for each individual. This limit is not indexed for inflation and applies to all capital gains for which an individual uses this exemption.
The rules for the exemption depend on the individual’s age. For individuals 55 or older, the process is straightforward. They can disregard a capital gain up to their lifetime limit without any further obligation to place the funds into a retirement account.
A different requirement applies to individuals under 55. These younger business owners must pay the exempt amount into a complying superannuation fund or a retirement savings account (RSA). This action ensures the tax-free proceeds are preserved for retirement, and the payment must equal the disregarded capital gain.
When a company or trust holds the asset, it cannot use the retirement exemption for itself. The entity can disregard a capital gain but must pass the payment to its CGT concession stakeholders. Each stakeholder applies their own $500,000 lifetime limit, and if a stakeholder is under 55, the company or trust must contribute that amount to a superannuation fund on their behalf.
Applying the Exemption to Your Capital Gain
Once eligibility is confirmed, the taxpayer must make a formal choice to use the exemption. This choice specifies the exact amount of the capital gain to be disregarded, up to their remaining $500,000 lifetime limit.
As a condition of the exemption, individuals under 55 must contribute an amount equal to the chosen exempt amount into a superannuation fund or RSA. This payment must be made by the time the choice is made or when the sale proceeds are received, whichever is later.
Business owners often structure their tax planning to maximize the benefits of multiple concessions. The retirement exemption is frequently used after applying the 50% active asset reduction. This strategy involves first reducing the capital gain by 50% with the active asset reduction, and then applying the retirement exemption to the remaining gain. This sequencing allows the $500,000 lifetime limit to shelter a larger initial capital gain.
Documentation and Tax Reporting Requirements
Finalizing the claim involves specific documentation. Taxpayers must keep a written record of their choice to use the exemption, specifying the amount of the capital gain being disregarded. If a company or trust applies the exemption, it must also document the percentage of the exempt amount for each CGT concession stakeholder.
When lodging an annual income tax return, the capital gain and the exemption must be correctly reported. The total capital gain is disclosed on the CGT schedule. The amount claimed under the retirement exemption is then subtracted, reducing the net capital gain subject to tax.
If an individual under 55, or a company or trust on their behalf, contributes the exempt amount to a superannuation fund, an additional form is necessary. The “Capital gains tax cap election” form must be completed and provided to the superannuation fund on or before the date the contribution is made. Its purpose is to notify the fund that the contribution should be counted towards the separate CGT cap, not the standard non-concessional contribution caps.