When a client is considering selling their shares in a Company we, as their legal and financial advisors, need to consider whether they have access to any small business CGT concessions.
Our office has seen an increase in clients who encounter issues with shares not satisfying the 80% active asset test, which you must satisfy in order to be eligible for the small business CGT concessions.
As a brief summary, in order to satisfy the active asset test, the total of:
the market value of the active assets of the Company;
the market value of any financial instruments of the Company that are inherently connected with the business that the Company carries on; and
any cash of the Company that is inherently connected with such a business,
must be 80% or more of the market value of all of the assets of the Company.
An inherent connection with the business requires more than just some form of connection between the cash or financial instrument and the business.
The shares must also be active assets for at least 50% of the time if owned under 7.5 years and 7.5 years if owned for greater than 15 years.
It is important to note that Division 7A loans form part of the assets of the Company but are not active assets, as these loans are not inherently connected with the business. The issue we have found is that clients often overlook their Division 7A loans, resulting in large Division 7A loans causing them to fail the 80% active asset test. This is occurring more frequently in real life circumstances that we have been asked to provide advice on.
There are avenues of recourse available for the client, provided they implement these strategies well before they consider selling their shares. Long-term planning is essential because, as mentioned above, the shares must be active assets for at least 50% of the time.
We have detailed our strategies below.
Facts (Trust Shareholder):
Trust T owns all of the shares in Company C and has owned these shares for 3 years.
Trust T wishes to sell all of these shares to an unrelated third party in the next year.
However, Company C does not satisfy the 80% active asset test, as it has significant Division 7A loans for the previous 3 years.
Tax Tip:
The Division 7A loans are assigned to a Bucket Company as follows:
Company C pays dividends to Trust T. In order to satisfy that dividend, Company C assigns the Division 7A loans to Trust T;
Trust T makes a trust distribution to the Bucket Company. In order satisfy that trust distribution, Trust T assigns the Division 7A loans to the Bucket Company.
The end result is that the Division 7A loans are with the Bucket Company, and importantly, not Company C.
The Bucket Company may be required to pay top-up tax of 5% if it is not a base rate entity.
Company C now satisfies the 80% test for the relevant year (being year 4).
However, it should be noted that Company C must now continue to ensure that it satisfies the 80% test for subsequent years so that the shares are active assets for at least 50% of the time Trust T owned the shares. At present, only 1 year satisfies the 80% test out of the 4 years Trust T has owned the shares, which equates to 25% (1 year/4 years), being less than the required 50%. It must satisfy the 80% test for another 3 years in order to satisfy the 80% test for shares i.e. 4 years out of 7 years.
Facts (Individual Shareholder):
Person A owns all shares in Company C.
Person A now wishes to sell all shares to an unrelated third party in the next year.
However, Company C does not satisfy the 80% active asset test as it has significant Division 7A loans for the previous 3 years.
Tax Tip:
The Division 7A loans are assigned to a Bucket Company as follows:
Company C issues a separate class of redeemable dividend access shares to a Bucket Company. Person A is the sole shareholder of the Bucket Company to ensure no dividend stripping. The redeemable dividend access shares must be redeemed within 4 years so that the share issue does not trigger a value shift.
Company C distributes dividends to the Bucket Company. To satisfy that dividend, Company C assigns the Division 7A loans to the Bucket Company.
The end result is that the Division 7A loans are with the Bucket Company, and importantly, not Company C.
The Bucket Company may be required to pay top-up tax of 5% if it is not a base rate entity.
Company C now satisfies the 80% test for the relevant year (being year 4).
However, it should be noted that Company C must now continue to ensure that it satisfies the 80% test for subsequent years so that the shares are active assets for at least 50% of the time Person A owned the shares. At present, only 1 year satisfies the 80% test out of 4 years Person A has owned the shares, which equates to 25% (1 year/4 years) being less than the required 50%. It must satisfy the 80% test for another 3 years in order to satisfy the 80% test for shares i.e. 4 years out of 7 years.
Clients should start their exit plan many years in advance and review, in particular, any Division 7A loans they may have early on so that they are not caught off guard when they do not satisfy the 80% active asset test for shares.
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