Fortuna Advisory Group: How To Sell Your Business Tax-Free

from District32 Business Prophet - November 2022

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How To Sell Your Business Tax-Free

A "small business" owner can normally sell their business without paying any capital gains tax (CGT) as a result of certain exemptions and concessions in tax law, called the CGT Small Business Concessions ("CGT Concessions" for short).

Basic conditions

To be eligible for the CGT Concessions you must satisfy various conditions. The first condition is that you must meet one of two alternative tests:

Your family home and superannuation are not counted under the Net Asset Test. Assets which are held by any trust or company (referred to in this article as an "Entity") which you control, or which are held by your Associate, are included. (You "control" an Entity if you have at least a 40% share in it). A person is your "Associate" if they act in accordance with your directions in connection with a business which they operate – for example, if you have a business together with a spouse or domestic partner, and they are in effect a "silent partner".

The turnover of any business operated by any Entity which you control, or which is operated by your Associate, is also included in your turnover under the Turnover Test.

You have net assets worth less than $6 million ("Net Asset Test"); or Your business has a turnover of less than $2 million ("Turnover Test"). If you hold your business through a company or unit trust and your business exit involves selling shares or units in the trust, the company or trust must itself also satisfy the Net Asset Test or the Turnover Test.

Active asset test

Your business must also pass the Active Asset Test. This means that at least 80% of the gross assets being sold (or 80% of the assets of the company, where you are selling company shares) must have been an "Active Asset" for at least half the time you owned the asset you are selling. An asset is an "Active Asset" if it is used in a business or held ready for use in a business. Assets used mainly to produce rent or earn interest are, however, specifically excluded from being an Active Asset. Therefore, if you have a rental property business or lending business (even if it satisfies the ATO definition of business for other purposes) it is not an active asset.

If you have accumulated too much cash in your business, the excess over what the ATO considers reasonable will also not be an active asset.

Other conditions

There are various other technical conditions which apply. We find that these conditions are normally satisfied, or can be satisfied fairly easily, where the main tests above are also met. You should, however, take professional advice on how the CGT Concessions apply to your business specifically before assuming that you can sell it tax-free. Certain additional conditions also apply to certain specific concessions. The main ones are covered below.

15-year exemption

If you have owned your business for at least 15 years and intend to retire in connection with the sale, you can eliminate all liability for CGT using the 15-year exemption. You can also contribute up to $1,650,000 (in the 22-23 financial year –it increases each year) to superannuation out of the proceeds of sale (CGT Cap Contribution), over and above the ordinary annual limits which apply to super contributions. You can even make a CGT Cap Contribution if your total super balance exceeds $1.7 million, which would prevent you from making other kinds of contributions. If you qualify for the 15-year exemption, you do not need to consider the other CGT Concessions. These are covered below for people who have not held their business for the above period.

General 50% CGT Discount

As is well known, if you hold an asset for more than 12 months, only 50% of the amount of any capital gain you make on selling it is included in your taxable income. This is called the General CGT Discount.

Although this is not a Small Business CGT Concession, it applies anyway when you sell your business, before you need to apply those other CGT Concessions, except that the CGT General Discount does not apply to a business sold by a company.

Active asset discount

This discount entitles the taxpayer to discount the capital gain which remains after applying the General CGT Discount by a further 50%, down to 25% of the original gain.

Retirement exemption

This exemption is misnamed, because it does not require you to retire to claim it. The only connection it has with retirement is that, if you are under 55 years, you must contribute the amount of the capital gain which you eliminate using this concession to a super fund. If you are 55 or above you may make that super contribution, but you are not required to. As with the 15-year exemption, this contribution is in addition to your ordinary, annual super contribution caps. There is a $500,000 lifetime limit on the amount you can eliminate using the retirement exemption, however.

Worked example

Dave and Jill sell their business, which they run as a partnership, for $2 million. They built it up from scratch, so they have a very low-cost base. Therefore, if it were not for the CGT Concessions, they could only eliminate $1 million of that amount, and the remaining $1 million would be included in their taxable incomes for that year – $500k each. But, because they pass the above tests and meet other technical conditions, they can eliminate 50% of that remaining $1 million capital gain using the Active Asset Discount, and then eliminate the $500,000 which remains after that using the retirement exemption, provided they each contribute $250,000 to their super fund, because they are under 55.

Conclusion

This is one of the few good news stories in tax law. For some business holders, however, it can be too late to see their advisor about it when planning a sale. It is appropriate to check with your advisor several years in advance of a business exit whether your business is structured in a way to enable you to take maximum advantage of the CGT Concessions on an eventual sale. If your business is not structured to entitle you to claim the CGT Concessions, restructuring just before a sale to qualify for the Concessions may not be possible.

Dinesh Aggarwal