Capital gains tax is calculated as the difference between the cost of purchasing and maintaining the asset (called the cost base) and the consideration you receive on disposal. Businesses must report capital gains and losses in their income tax return and pay capital gains tax (CGT) on any capital gains. However, they may have access to a CGT rollover relief in some cases. The rollover relief allows businesses to defer or disregard this tax payment. This article explains when CGT may be payable on your business transactions and when CGT rollover relief may apply.
Restructuring Your Business Structure
Restructuring your business structure can better align with your current and future business goals. For example, you may wish to transition from operating as a sole trader and move towards operating your business through a company. Another example is moving from a single company structure to a dual company structure (holding company and operating company).
Moving from one business structure to another involves the current business entity selling the business to the new entity. Suppose you are a sole trader and want to operate the business through a company. In that case, you need to sell the business’ assets, employees, lease, goodwill (reputation) and intellectual property, amongst others, to the company. Accordingly, the company owns the assets and the rights to operate the business.
When restructuring, the new entity must pay market value to acquire the business. Disposing of business assets triggers a capital gains tax event. If the value of the business is more than the amount you paid to acquire or maintain the business, you will have a capital gain and will need to pay tax on it.
There are a few reasons why you would want to restructure to operate your business through a company, including:
- better asset protection (for partnerships and sole traders) where they are previously personally liable for the business’ debts. In a company, the individual shareholders will not be personally liable for company actions (unless there are exceptional circumstances, such as fraud);
- a more attractive structure for investors;
- ability to separate non-business assets from personal assets;
- access to R&D or innovation ESIC concessions; and
- a company structure provides multiple exit strategies such as a sale of shares, sale of assets and IPO.
What Are CGT Assets?
Broadly, a CGT asset covers any kind of property and includes:
- land and buildings;
- shares in a company or units in a unit trust;
- the right to enforce contractual rights (e.g. restraints of trade); and
- business goodwill.
Sometimes, an entity can effectively ignore the CGT implications of an asset’s disposal despite the asset falling within the CGT asset definition. This happens when that gain is taxed elsewhere under tax law, and the asset is:
- trading stock;
- a depreciating asset; or
- a revenue asset.
These ‘anti-overlap’ rules mean the CGT regime has a residual operation behind other tax rules.
Continue reading this article below the formWhat is a CGT Event?
A capital gain or loss can only arise where a CGT event occurs. There are 52 different CGT events, but your business will most likely deal with the three common events below.
- Disposals: When your business enters into a contract to dispose of a CGT asset.
- End of a CGT asset: When an asset is destroyed, lost, cancelled, surrendered or otherwise ends. It also includes the end of an option to acquire shares.
- Creation of a CGT asset: When a business creates contractual rights or grants an option. For example, Company A grants $100,000 worth of options to an individual for free outside of an employee option plan that utilises the ESS startup tax concessions. As soon as Company A grants the options, the individual will likely have to add $100,000 to their taxable income that year.
What is Rollover Relief?
Where available, CGT rollover relief allows your business to defer or disregard a capital gain or loss. It applies in specific situations, either automatically or by election. The relevant entity generally makes the election based on how it prepares its income tax return. However, some rollover reliefs require specific written elections within specified time frames to apply.
There are various CGT rollover relief available under the Income Tax Assessment Act 1997. These allow you to defer CGT to a later time when there is continuity of economic ownership.
The rollovers available include (but are not limited to):
- subdivision 122-A (disposal by an individual or trustee to a wholly owned company);
- subdivision 122-B (disposal of assets from a legal partnership to a wholly owned company);
- subdivision 124-N (disposal of assets from a unit trust to a company);
- subdivision 328-G (small business restructure rollover); and
- division 615 (inserting a holding company between shareholders and another company).
This guide will help you to understand your corporate governance responsibilities, including the decision-making processes.
Specific Rules
Most rollover relief concessions have very specific rules about how the new entity is to be initially owned and what steps and documents to implement and prepare for the rollover to qualify.
Accessing a CGT rollover will generally take longer, as your tax advisor and legal advisors must work together. Your tax advisor will generally outline the circumstances and process you must follow to access the rollover relief. Your legal team will then use that tax advice and prepare and provide advice to realise the tax advice.
The general process for restructuring and accessing a CGT rollover is as follows:
- Discuss your business goals with your legal advisors and whether the current business structure achieves your goals. For example, you cannot effectively take on investment as a sole trader. As a company, you can issue shares to investors in exchange for their cash.
- Your legal advisor will generally ask you questions that will give a very high-level and initial indication of whether there is value to the business. Among others, such questions include:
- How many physical assets does the business own?
- Do you have employees?
- Do you have intellectual property that forms the base of the business?
- Does the business own any property?
- Does the business have a large reputation?
- Engage your accountant or tax lawyers to determine whether you will have a CGT liability if you restructure. If you do, discuss what each of you (your tax and legal advisor) needs to do and implement to access the CGT rollover relief.
- Work together to prepare relevant documents.
Key Takeaways
As a business owner, you may wish to or need to restructure depending on your circumstances. Operating as a sole trader carries unlimited liability. Investment opportunities are also limited for sole traders. As a company, you can take on investments and limit your personal liability in some circumstances.
Your business may be in the process of restructuring, disposing, creating or acquiring assets. These events can trigger a CGT liability. Therefore, when disposing of your assets, it is important to know if CGT rollover relief applies and other transactional taxes arise. This can significantly impact the overall tax payable and even whether you decide to proceed with a transaction.
For further advice on when CGT rollover relief can apply, our experienced taxation lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
We appreciate your feedback – your submission has been successfully received.
