Minimise Capital Gains Tax to NIL

Meet Alex, who launched an IT business from scratch in 2018 at the age of 35. Since 2020FY, over the past three years, the business has maintained an average annual turnover of $2.4 million. His team includes five full-time employees and ten contractors, operating under a discretionary trust with a corporate trustee.

Recent Developments: A larger IT firm has shown interest in acquiring Alex’s portfolio for $2.85 million, with payment terms of 80% in the first year and the remaining 20% in the second, provided the business exceeds $2 million in revenue. Alex is currently negotiating to increase the business’s valuation to $3.2 million. However, the potential buyers have made a counteroffer: maintaining the $2.85 million valuation and offering Alex a two-year employment contract with an annual salary of $200,000 to ensure a smooth transition.

Personal Financial Overview:

Alex and his wife Fiona own a debt-free home valued at $2 million.
Fiona has two investment properties worth $2 million, with a $1 million debt.
One of their investment trusts holds a property valued at $2.5 million, with a $500,000 debt.
Their combined superannuation fund balance is $300,000.
Alex has incurred a $50,000 capital loss from a previous investment.

Consultation with Investax: The couple is seeking advice on the sale, particularly regarding playing hardball to achieve a $3.2 million valuation. They are also concerned about the Capital Gains Tax (CGT) implications of selling at $2.85 million versus $3.2 million and whether to accept the proposed salary.

Challenges:

Assessing the business entity’s (Trust) eligibility for the small business entity test.
Exploring small business CGT concession options.
Considering the application of a capital gain discount for the business sale.
Managing cash flow for tax payments.

Findings and Solutions:

Alex is inclined to exit the business as soon as possible.
The trust doesn’t qualify for the small business concession turnover test due to its high turnover.
However, it meets the Maximum Net Asset Value test at the $2.85 million sale price.
Pushing for a $3.25 million sale price would result in losing the small business concession, leading to a capital gain tax of $1.6 million.
After careful consideration and consultation with us, Alex has chosen to accept the annual salary of $200,000. This decision is strategically beneficial for both parties involved, as it facilitates:
- For Alex: Receiving the remaining 20% of the payment along with a stable income of $200,000 annually. Plus, small business concession to reduce the capital gain tax significantly.
- For the acquiring company: Ensuring a smooth transition, aided significantly by the guidance and expertise of the current owner.
The Trust net capital gain can be NIL if he agrees to the $2.85 million sale price, a more favourable outcome compared to a $3.2 million sale.
By applying various small business concessions and other tax strategies the capital gain tax can be reduced to NIL.

Alex’s Trust calculation of the capital gain tax (CGT) will proceed as follows:

Initial Deduction of Capital Loss: We first deduct Alex’s $50,000 capital loss from the capital gain. This step reduces the taxable gain before any other discounts are applied.
50% CGT Discount Application: Since the business is structured as a Trust, and Trusts are eligible for a Capital Gain (CGT) discount, we apply a 50% CGT discount. After this discount, the gain is reduced to $1.4 million.
50% Active Asset Reduction: Following the CGT discount, we apply a 50% active asset reduction. This further lowers the gain to $700,000.
Utilising Small Business Retirement Exemption: Alex opts to use the small business retirement exemption’s lifetime limit of $500,000. He is also considering contributing additional $200K funds to their superannuation before the CGT (Capital Gains Tax) event occurs via his wife Fiona as she is also CGT concession stakeholder.
Limitation on Small Business Rollover: Unfortunately, due to the purchaser’s stipulation that Alex refrains from operating any business for 2 years while employed with them, he is unable to utilise the small business rollover concession.
Reduce the CGT to NIL – Alex has the opportunity to reduce the CGT to NIL by the time we report the income tax return by contributing more money into their super.

Conclusion:

Alex’s journey through the process of selling his IT business provides valuable insights into the complexities of business transactions and the importance of strategic financial and business tax planning. Through careful negotiation and a detailed understanding of tax implications, Alex successfully navigated the challenges of achieving a favourable sale outcome while mitigating his tax liabilities.
Alex’s scenario is evidence to the power of informed decision-making and strategic planning in business. It serves as a reminder of the potential financial benefits that can be realised through careful analysis, expert consultation, and a comprehensive understanding of one’s financial landscape.

Action Plan for the Reader –
- Carefully assess the benefits and drawbacks of selling your business.
- Exit Strategy Consultation:
  - Have you discussed an exit strategy with your accountant?
  - If not, now is the time to do so.
Develop a Comprehensive Plan:
- Work with your accountant to create a detailed exit strategy.
- Ensure the plan addresses both immediate sale aspects and long-term
  financial implications.
Align with Goals:
- The strategy should align the sale with your personal and financial objectives.
Continue Negotiations:
- Engage in ongoing discussions with the potential buyer.
- Focus on understanding the tax implications of various sale values.
Consult with Your Accountant:
- Prioritise consultation with your accountant before starting negotiations.
- Allow your accountant to create a comprehensive strategy.
Develop a Holistic Plan:
- To address immediate aspects of the business sale.
- To consider the overall impact on your tax situation.
Strategic Tax and Cash Flow Management:
- Seek strategies from your accountant for:
  - Effective tax obligation management.
  - Efficient handling of cash flow concerns.
Determine Eligibility for Small Business Status:
- Ensure you meet one of the following criteria:
  - Operate as a CGT small business entity with an aggregated turnover of
    less than $2 million.
  - Own assets used in a small business run by an affiliate or connected
    entity (CGT concessions on passively held assets).
  - Be a partner in a partnership that is a small business entity, where the
    asset in question is either:
    - Directly a part of partnership assets, or
    - Your personal asset, not an interest in a partnership asset, but
      used in the partnership’s business.
    - Satisfy the maximum net asset value test.
Understand Small Business Retirement Exemption Rules:
- Familiarize yourself with the conditions of the small business retirement
  exemption:
- If under 55, the proceeds must be contributed to a complying
  superannuation fund.
- If over 55, contributing to a superannuation fund is optional.
Explore Small Business Roll-Over Options:
- This allows deferral of capital gains from selling an active asset.
  - To defer gains, either acquire a replacement asset or incur capital
    improvements to an existing asset. Deferred gains will be realized
    upon the future disposal of these assets.
  - The replacement asset must be acquired within two years of the
    capital gains tax event.

We offer a 15-minute free consultation to discuss your tax, property investment and business needs. Book your complimentary consultation now.

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Reference:

CGT Small business Eligibility/ATO.gov.au –
https://www.ato.gov.au/business/income-and-deductions-for-business/concessions,-offsets-and-rebates/small-business-cgt-concessions/small-business-cgt-concessions-eligibility-conditions/cgt-small-business-entity-eligibility/
Maximum Net Asset Value test/ATO.gov.au –
https://www.ato.gov.au/Business/Income-and-deductions-for-business/Concessions,-offsets-and-rebates/Small-business-CGT-concessions/Small-business-CGT-concessions-eligibility-conditions/Maximum-net-asset-value-test/
50% Active Asset Reductinb/ATO.gov.au –
https://www.ato.gov.au/Business/Income-and-deductions-for-business/Concessions,-offsets-and-rebates/Small-business-CGT-concessions/Small-business-50-per-cent-active-asset-reduction/
Small business retirement exemption –
https://www.ato.gov.au/Business/Income-and-deductions-for-business/Concessions,-offsets-and-rebates/Small-business-CGT-concessions/Small-business-retirement-exemption/
CGT Concession Stakeholder –
https://www.ato.gov.au/business/income-and-deductions-for-business/concessions,-offsets-and-rebates/small-business-cgt-concessions/small-business-cgt-concessions-eligibility-conditions/additional-conditions-if-the-cgt-asset-is-a-share-or-trust-interest/?anchor=WhoisaCGTconcessionstakeholder#WhoisaCGTconcessionstakeholder