For small business owners operating through a company structure, accessing the small business 50% active asset reduction can be complex. While the company may benefit from the CGT concession, challenges arise when distributing the exempted amount to shareholders. Without careful planning, the tax benefit can be clawed back, resulting in additional taxation at the individual level.
This article explores strategies to ensure that business owners maximise the tax efficiency of the 50% active asset reduction, allowing them to retain the benefit of the concession upon distribution.
Understanding the 50% Active Asset Reduction
The 50% active asset reduction allows eligible small businesses to reduce a capital gain by 50% on the sale of an active business asset. For companies, the reduced capital gain is recognised at the company level. However, distributing this benefit to shareholders can be problematic, as any payment may be classified as an unfranked dividend, making it taxable in the hands of the shareholders.
Key Strategies to Release the 50% Active Asset Reduction
1. Selling Shares Instead of Business Assets
Instead of the company selling its assets and retaining the CGT concession internally, individual shareholders could consider selling their shares in the company. This may allow the shareholders to personally access the small business CGT concessions, rather than the company. This approach ensures the tax benefit is passed directly to the shareholders, avoiding dividend taxation issues.
2. Liquidating the Company
If selling shares is not an option and the company has already sold its assets, another approach is to liquidate the company following the asset sale. Upon liquidation, the exempted capital gain may be treated as capital proceeds rather than an unfranked dividend, providing shareholders with the opportunity to apply additional small business CGT concessions.
3. Using the Small Business Retirement Exemption Instead
A simpler alternative is for the company to forgo the 50% active asset reduction and instead rely on the small business retirement exemption. This exemption allows each CGT concession stakeholder to disregard up to $500,000 in capital gains. In cases where multiple shareholders are eligible, this strategy may allow for a full tax exemption without locking up benefits inside the company.
Case Study: Jack & Jill’s Business Sale
Scenario
Jack and Jill own a small business operating under Small Busz Pty Ltd, where they each hold one share. A multinational company offers to buy their business, and the company sells its active assets for $1 million, generating a capital gain.
Challenges
- The company qualifies for the 50% active asset reduction, reducing the gain to $500,000.
- If the company distributes this amount to Jack and Jill as a dividend, it will be unfranked and taxable.
- Jack and Jill want to minimise tax and access the funds efficiently.
Solution 1: Liquidating the Company
Jack and Jill decide to liquidate the company after the sale. Upon liquidation:
- The $500,000 distribution is treated as a capital gain on their shares rather than a taxable dividend.
- They apply the 50% CGT discount, reducing the gain to $250,000 each.
- They then apply the small business retirement exemption, reducing the gain to nil.
Outcome: By liquidating the company, Jack and Jill avoid unnecessary tax and retain the full benefit of the concession.
Solution 2: Relying on the Small Business Retirement Exemption
Instead of claiming the 50% active asset reduction, Small Busz Pty Ltd could opt for the small business retirement exemption:
- The company exempts $1 million in capital gains (as Jack and Jill each qualify for the $500,000 limit).
- Jill, being under 55, contributes her share of $500,000 to superannuation under the CGT cap.
Outcome: This approach allows Jack and Jill to avoid the complications of locked-in company profits while leveraging tax-free benefits.
Final Thoughts
The 50% active asset reduction provides valuable tax relief for small businesses, but structuring the distribution of benefits from a company is critical. By carefully considering strategies such as selling shares, liquidating the company, or using the small business retirement exemption, business owners can ensure they retain the full tax advantage. Consulting a professional tax adviser is essential to determine the most effective approach based on individual circumstances.