Tag Archives: small business CGT concessions

Budget housing and CGT reforms – the missing path to fairness

The recent 2026 Federal Budget has announced transitional measures to impose:

the abolition of negative gearing on residential property other than new builds;
a minimum 30% capital gains tax (CGT) rate; and
abolition of the general 50% CGT discount with a proposed return to the indexation of cost base as was in place before 1999 before the price increases in residential housing then turbocharged when compared to incomes.

But is this fair?

The announcements have been attacked notably by entrepreneurs who purport to speak for small business start-ups and tech innovators as being anti-business and as a sop to aspiration.

Are they? Can I answer this free of the bias of politics and instead rely on a forty year career advising on Australian taxes understanding that some political parties have aligned themselves with the entrepreneurs’ position?

I suggest:

their claim that the abolition of the CGT 50% discount hurts small business claim is a furphy. The Federal Treasurer Mr. Chalmers referred to the four small business CGT concessions (small business concessions) and exemptions that can still be applied to reduce the taxable capital gains on CGT assets used actively in a business.[1] Often the reduction in CGT after the small business concessions are applied is to a very low overall rate which leaves little or zero CGT to be paid[2]. Often CGT does not apply to business assets at all[3]. So the entrepreneurs’ fairness gripe should really be about whether the small business concessions are adequate once the CGT 50% discount is taken away and a minimum 30% CGT is imposed by the measures should there be any taxable gain remaining after the small business concessions are applied; and
it is disappointing that these activists and party political decision makers, who are often diligent in taking accurate professional tax advice on their own affairs, are less concerned whether their views about these measures that impact the rest of us are accurate.

More about this later in this piece but let me:

first ask: will potential entrepreneurs be deterred from becoming wealthy, or if I should use the euphemism, high net worth? because of high taxes should they make a lot of money or will they be more interested in the opportunity to become wealthy and make the money they will keep? and
move to what would make the measures fairer and more aligned with the objectives of the measures which I understand to be:
comparable, or at least more comparable, income taxation of gains from capital with gains from personal exertion: notably that of workers who earn wages and salary; and
removing tax advantages to investors, which other taxpayers cover or pay for, of negative gearing and the CGT 50% discount so that young people and others, who principally earn their income from personal exertion, can compete for a limited stock of housing on a more equal footing.

What tax professionals like me appreciate is the tax policy which most distorts housing affordability in Australia is the very generous and complete CGT main residence exemption (MRE) given to ensure the family home isn’t subjected to CGT at all. This is where the disparity been taxation of personal exertion income and gaining from owning property becomes really apparent. Can I say it isn’t necessarily in my professional interest to call out how the CGT MRE becomes a rort. I earn professional income from advising on the lucrative extent of the CGT MRE in complex and borderline cases, and I may continue to do so should the CGT MRE continue as it is. The CGT MRE legislation I work with reveals that the parliament has gone to great and sometimes surprising lengths to ensure doctrinal integrity of no CGT on the family home[4].

Consider a home presently up for sale at Wategos Beach, Byron Bay. (The owner is not my client; I heard about this in the news). This home was up for sale for $75m but, as of May 2026, the seller is looking for $50-$60m.

The land was purchased for $3.7m in 2014.

Let us assume demolition costs of the shack that stood on the site when the owner bought it and that capital costs of building a mansion on the site were about $10.3m meaning costs of around $14m all up.

Let us also:

assume that the budget announcements are an otherwise reasonable basis on which gains from property may be fairly taxed: that is by indexing the cost (cost base) of the property to the owner so the owner is taxed on the true gain and is relieved of tax on the impact of inflation on costs accepting that inflationary drift while the property was owned by the owner doesn’t reflect real gain; and
say this home sells soon for $55m.

The magnitude of capital gain to which CGT could apply, should there be no CGT MRE and after allowing for an upwards inflation adjustment in the cost base, is in the order of $36.5m.[5]

Income from personal exertion/work – nurse lifetime tax comparison

Assume a nurse on a middle income in the low‑to‑mid $80,000s pays, say, $18,000 in income tax per year.[6]

Over a 35‑year career, that’s ≈ 18,000 × 35 = $630,000 of lifetime income tax on, and Medicare contribution by, the nurse.

Now let us compare $17.2m (tax foregone on the $36.5m indexed gain on the Wategos Beach sale) to see how many nurses lifetimes it takes to cover this tax foregone:

17.2 ÷ 0.63m ≈ 27.3.

So 27 nurses’ full working lifetimes of income tax and Medicare payments are needed to make up for the tax and Medicare lost on the indexed and untaxed gain on this one Wategos Beach main residence because the capital gain on the family home is fully exempt under the CGT main residence rules.

I should not pretend this exceptional capital gain at Wategos Beach, which I use to highlight the inequity of the CGT MRE, commonly occurs at these levels around the country. But equally the number of cases where lesser multiples of tax on nurses working lifetimes, say 5 to 15? are being lost in CGT MREs extended are being lost all of over the country should not be understated.

Could the CGT MRE be withdrawn or changed?

Introducing CGT on the family home is political anathema. I infer that an exemption from CGT on the family home was a political cost of introducing the CGT in 1985 just as exemptions on food, education and health came to be political costs of introducing the goods and services tax in 1999.

But if the sale and likely gain at Wategos Beach, Byron Bay reveals anything it reveals the CGT MRE could be altered and be better targeted, at least, so it becomes less exclusive (to home owners) and regressive. There is a case for limits on the CGT not collected because of the CGT MRE which nurses and other workers, many of whom are unable, or never will be able, to become home owners able to use the CGT MRE, can be called on to cover with their taxes.

To my mind this can be remedied with a CGT MRE cap.

A CGT MRE cap

How would that work? Actually there are already lifetime CGT caps in the CGT small business concessions which the entrepreneurs’ group may think inconsequential but let me return to them later.

A cap on capital gains on homes eligible for the CGT MRE could be imposed on Australian taxpayers on a lifetime basis: singles and couples use of the CGT MRE could be restricted during their lifetime. In other words the MRE could be redesigned so the MRE wouldn’t exempt the whole capital gain on an unlimited basis on every family home a well heeled home owner ever sells but instead limits their lifetime usage of the family home CGT free privilege on the basis that other taxpayers, principally workers and others who earn their living and pay taxes from their personal exertion, are funding and covering for these taxes not paid.

It seems to me, given what I have said about the political toll on whoever may introduce CGT on the sale of the family home, a CGT MRE cap would need to be generous to be palatable.

A generous MRE cap?

A cap has to be big enough so that most ordinary households will never hit it. That is cap policy would need the generosity, courtesy of other taxpayers like nurses, of no CGT on the average home, but the cap would be low enough so that very large gains start to be taxed.

Typical Australian house prices as reflected in median house values are well below $2m even in the big cities; only a minority of properties see multi‑million‑dollar gains over a single ownership.

Maybe caps could be in this range:

individuals: $2–3 million of real capital gains? or
couples: in the range of, say, $4–6 million of gains?

depending on whether they too are indexed to ensure they will continue to stand higher than median home prices.

At these levels:

nearly all ordinary owner‑occupiers, including those in expensive cities who move several times, would still pay no CGT on their home sales over their lifetimes; and
very large capital gains, like on Wategos Beach, Byron Bay, could still be partially exempt, up to the cap, but most of the gain would be taxable, greatly reducing the number of nurse working lifetimes needed to offset the forgone tax.

These caps would still let people own and sell quite expensive homes tax‑free, while signalling that the CGT MRE is not intended to allow well resourced home owners to shelter many millions of dollars of untaxed capital gains at enormous community cost.

Implementation

To implement CGT MRE caps with a minimum of grandfathering in pursuit of fairness and equity, the home sales caught could be grandfathered to sales of homes, or purchases and sales after certain dates on or after the introduction of a CGT MRE cap regime. But I don’t see reason to grandfather the cap itself. That is historical use, and not just use after introduction of a cap, of the CGT MRE by people can be counted against their MRE CGT cap to ascertain whether they have cap remaining with which they can reduce the CGT on the gain on their next sale of their home.

Not only is there the political challenge of reforming the CGT MRE there is a significant practical problem: Under the Australian CGT system, uses of the CGT MRE have not been reported and tracked by the Australian Taxation Office (ATO). That is capital gains free of CGT made on the sale of homes have not been returned in income tax returns to the ATO. But this problem is not insurmountable.[7]

Using the cap before you buy

The present CGT MRE is of absolutely no use to nurses, workers, and other people who are yet to buy a home to whom the budget measures are meant to be targeted. This is what the “property ladder” and getting “in the market” has been all about – getting on the bottom rung of the ladder with:

a home to live in; and
a tax shelter to grow equity in the home tax free thanks to the CGT MRE.

For a yet-to-be-first-home buyer (YTBFHB) who cannot yet afford to enter the housing market, denying access to the CGT 50% discount and a 30% minimum CGT on investment gains stifles the policy intent of measures aimed at assisting their first home acquisition. Saving for a deposit on a first home will be impeded by CGT on investment growth as the individual builds capital through savings and portfolio accumulation. As investments are realised and rebalanced over time, CGT, after the proposed budget changes, reduces the net proceeds available for reinvestment and ultimately diminishes the after-tax capital available to a YTBFHB for a first-home deposit.

As I see it, this is where the CGT MRE cap can help if the cap, or least some of it, is portable strictly to YTBFHBs. That is: why not allow a single or a couple YTBFHB to transfer some of their yet to be used CGT MRE cap to apply to investments in a portfolio being used to fund or finance their first home?

Further I do not follow the need for a 30% minimum CGT which applies under the measures even where a resident taxpayer’s whole assessable income, including capital gains, falls below $45,000 which means capital gains on investments will be taxed at a higher marginal rate than, say, income from personal exertion or income from business activity: the measures are directed at evening up taxation of income from property and taxation of income from personal exertion. If the policy objective is parity between taxation of gains from property and gains from personal exertion, why replace a CGT discount that taxed capital gains less favourably than labour with a rule that taxes capital gains more heavily than labour?

Under the pre-1999 CGT rules which taxed indexed capital gains, applicable marginal rates were averaged to ameliorate the effect of a capital gain taking a taxpayer into a higher tax bracket. Unlike with the similar minimum 30% income tax which is to apply to discretionary trust beneficiaries, there seems to be no anti-income splitting purpose behind the 30% minimum CGT initiative. Or is the argument taxpayers will deliberately reduce their income in a tax year before they realise property (CGT assets) that have increased in value?[8]

Involved but doable

A CGT MRE cap wouldn’t be a simple evolution of the current CGT law but it would be doable. Nuance would be needed when figuring out to whom the cap applies. If couples are to be assessed against the cap, which seems necessary to stop spouses double dipping for the MRE, there would need to be exceptions for edge cases. For instance where someone who is a YTBFHB:

enters into a relationship and lives with someone who has become a home owner; and

the relationship ends and occupation by the YTBFHB of the home ends after a short time;

that person could be allowed to resume YTBFHB status.

Given allowing every YTBFHB the full generous CGT MRE cap of $2-4m would seriously impact CGT collections by government there is a case for restricting the portable part of a CGT MRE cap considerably further so investments of a YTBFHB, which become CGT free (by the way, more generous than the CGT 50% discount) are limited to say $500,000? $500,000 and saved (taxed) salary may be enough to significantly help a YTBFHB buy their way into a moderately priced first home.

Entrepreneurs, tech founders and the small business concessions

Let’s return to entrepreneurs and the small business concessions. If their point is that the small business concessions are not enough not to stifle aspiration then let us understand more precisely when an entrepreneur or a tech start up founder will qualify for the small business concessions.

The media often reports that the concessions are limited to businesses with turnover below $2 million. The reality is more generous.[9]

Are the aspirations of entrepreneurs and startup founders who may become too wealthy to apply the small business concessions really impacted because of that.[10]

But I struggle to see how this group is more in need of CGT relief than YTBFHBs who presently struggle to buy a home and to whom the budget measures are purportedly directed.

Which aspiration that is more worthy of support by other taxpayers?

The small business concessions lifetime cap experience

Among the small business concessions rules, there is a $500,000 cap which works to limit CGT exemption on small business gains with great similarity to the CGT MRE cap I am canvassing here. This is the lifetime cap on the small business retirement exemption.[11]

Eligible entrepreneurs can currently access a $500,000 lifetime retirement exemption and have no more than 50% of remaining gains to which the small business concessions apply subjected to CGT on their sale of business goodwill and, where it is subject to CGT, capital interests in intellectual property they own.

As stated the entrepreneurs and tech founders’ criticism hardly reflects their actual experience of the tax law on which they are likely not expert and on which they likely rely on accountants’ advice. Significant categories of intellectual property used in business have never enjoyed the benefit of the CGT 50% discount in the first place., the CGT 50% discount has never been available to reduce tax when selling much intellectual property (IP) applied by tech innovative businesses. Where IP is depreciable viz. where depreciation deductions allow the cost of the IP to be written off over a period of years, gains on sale of the IP over the written down value is assessable as a balancing charge which is not treated as a capital gain under the income tax system.

Entrepreneurs aspirations and indexation

If the concern is truly aspiration, whose aspiration deserves greater support from the tax system: established entrepreneurs seeking lower taxation of realised business wealth, or YTBFHBs seeking to accumulate enough capital to enter the housing market?

Can I suggest that indexation of:

costs in determining taxable net capital gains;
the $2m aggregated turnover test and $6m aggregated MNAV test thresholds of the small business concessions perhaps with phase outs; and
a CGT MRE cap (commencing at $2m?) and its portable part (commencing at $500,000??); and
the $500,000 lifetime small business CGT retirement exemption cap;

are fairer aspirations and it is YTBFHBs, rather than entrepreneurs and tech innovators, who have the more compelling economic case for shelter from taxes made up for by the taxes paid by other Australians.

[1] the small business concessions referred to are the small business 50% reduction, the small business 15 year exemption, the small business retirement exemption and the small business rollover which take effect under the Division 152 of the Income Tax Assessment Act 1997

[2] where the small business CGT 15 year exemption applies or the small business retirement exemption applies to sub $1m capital gains which in any case is a far lower rate than 50% rate after the CGT 50% discount is applied

[3] most business assets are depreciable plant and equipment so gains on them, should they have value after their use in a business and being written down, are subjected to assessable balancing charges rather than taxable capital gains

[4] this is particularly apparent in how the CGT MRE rules are extended in the cases of absences i.e. cases where a home owner is not living in their home for a long period, cases where owners are transitioning between homes and to deceased estates and beneficiaries where a home owner has died to keep the CGT MRE at distance from being a “death tax”

[5] The costs of the home to the owner – nominal cost base

Land purchase: $3.7m.

Demolition + new build: $10.3m.

Total nominal cost base: 3.7 + 10.3 = $14.0 million.

Apply indexation from 2017 to mid‑2026

I understand the land was purchased in 2014 with the build costs incurred later. Let’s now say the weighted average time when all costs were incurred was 2017 with the build known to have finished after that. From CPI data, a reasonable index factor from a 2017 average to early/mid‑2026 is about 1.32 (prices roughly 32% higher at the time of sale in 2026).

Indexed cost base to the owner of acquiring and building the home is then: $14.0m × 1.32 ≈ $18.50m.

Indexed capital gain at a $55m sale price

So we have

• Inferred sale price: $55m.

• Indexed capital gain: 55.0 − 18.5 ≈ $36.5m.

• Possible CGT on the sale if it was paid on the indexed capital gain at the top marginal rate plus Medicare (about 47%): ≈ 36.5 × 0.47 ≈ $17.2m.

[6] This is a rough, ball‑park figure for a full‑time worker in the middle brackets in the Australian income tax system; the actual number depends on taxable income, deductions, and current thresholds. Typical tax plus Medicare per year ≈ $18,000 on a salary around the low‑to‑mid 80,000s.

[7] Despite holding no or negligible historical CGT MRE use data on taxpayers, the government and the ATO has wide and unrestricted access to property information collected in the states and territories. Along with title information about residential property, most Australian state and territory governments have allowed a principal place of residence exemption from their land taxes and so the ATO would have access to a significant trove of data with which to:

• ascertain and verify how much CGT MRE people have applied to exempt gains on sales of their homes up to introduction of a MRE cap regime and

• track MRE cap usage in earnest.

Coupled with that the government could require taxpayers, who seek to apply a capped CGT MRE, to complete a once off lifetime main residence return/statement to the ATO which sets out:

• Australian homes where the applicant for a MRE has lived;

• the homes among them where the taxpayer has realised their stake in the home; and

• those homes where the MRE has been used and where remaining lifetime cap to the applicant should be reduced.

[8] the idea that CGT will skew taxpayer behaviour so they will earn less income to bring down their effective rate of CGT, and the CGT system therefore needs to be protected from that by a 30% minimum CGT, is an idea in parallel to the entrepreneurs’ thinking that, with higher CGT on them if that is in fact right, they too will behave to earn less income. The Tax Justice Network has done work on global econometrics which reveal that very few entrepreneurs, wealthy business owners and their acolytes, who may threaten to leave the country after progressive tax changes are implemented in their home country; actually leave – The Millionaire Exodus Myth

[9] Generally speaking a business owner can qualify as a small business owner eligible for the small business concessions where their business has a turnover of less than $2m. An entrepreneur can also qualify to use the small business concessions if they satisfy the $6m maximum net asset value (MNAV) test. This is best simply illustrated with an example. An entrepreneur and spouse who have a business with a turnover of $3m, who fail the $2m turnover test but who have:

• a home they own worth $8m;

• personal assets of $1m; and

• $6m in superannuation between them;

(being excluded assets none of which count against the $6m MNAV) and $5m in other assets net of debt viz. $20m in overall wealth; can still qualify for the small business concessions so long as there are no related entitles, associates and entities related to those associates with further assets which take the aggregated group tested to $6m or over. Or an entrepreneur with twice that wealth and who thus fails the $6m MNAV test but whose business(es) has a turnover of $1.6m can similarly qualify under the $2m turnover test where those same related entitles et al. don’t own businesses which aggregate with that turnover to then take aggregated turnover over $2m in the tax year in which the capital gain is made.

[10] Admittedly the small business concessions have their confronting side – be a few dollars over satisfying either test and fail both the $2m turnover and the $6m MNAV test and the small business concessions are wholly denied to the business owners. That is the business owners won’t be considered eligibly small business. That is there is no phase out. Also the $2m and the $6m used in the respective tests are not indexed and have not been increased for nearly nineteen years since their introduction as basic conditions for the small business concessions. So there may be some fairness case for indexation of those numbers.

[11] Briefly and generally, where the conditions for this small business concession are met, an individual behind a business can be exempted on up to $500,000 in taxable net capital gains on small business assets during their lifetime. So a CGT MRE cap is hardly a novel idea. It too hasn’t been indexed or increased from $500,000 in the nineteen years since the inception of the small business retirement exemption.

The retirement requirements of this small business concession are not demanding: either the capital gains must be paid into preserved complying superannuation where the individual is under the age of 55 years or where the individual has reached 55 they can either pocket the tax fee capital gains of up to $500,000 or pay them into superannuation at his or her option.

Aggregating for dual $6m MNAV tests following 2018 small business CGT concession integrity changes – with the aid of chess!

Those seeking the small business capital gains tax (CGT) concessions in the 2018 and later income years need to be wary of modified small business CGT concession integrity rules which apply from 8 February 2018 by virtue of Schedule 2 of the Treasury Laws Amendment (Tax Integrity and Other Measures) Act 2018 (TIOMA).

The small business CGT concessions in Division 152 of the Income Tax Assessment Act (ITAA) 1997 may look straight forward but there are subtle complications within the misnamed “basic” conditions for the relief which can be matrixlike. The small business CGT concessions are generous so perhaps it is right that rules to protect their integrity, as ramped up by the TIOMA, are more complicated than the rules that ordinarily impose a CGT liability on sales of small business related CGT assets.

Share or interest sales need to meet additional basic conditions

For CGT events involving sales of shares in companies or interests in trusts “additional” basic conditions have commenced with the TIOMA. The additional basic conditions go further than what I describe here. In this post I wish to focus on the significance of the dual $6m maximum net asset value tests that the TIOMA initiates. So in the below considerations I am going to assume that the other basic conditions for the small business CGT concessions, including the additional basic conditions, such as the dual active asset test, which also needs to be considered following the introduction of the TIOMA, will be met.

The dual MNAV and SBE tests

The dual $6m maximum net asset value (MNAV) tests are alternative tests with the similarly dual small business entity ($2m aggregated turnover) (SBE) tests which apply where the small business CGT relief is sought on a sale of shares in a company or an interest in a trust. The dual MNAV tests and SBE tests separately test both the taxpayer (“you”) and the object entity which is the relevant company or trust in which the shares are or interest is held by the taxpayer as the case may be. To obtain relief under the basic conditions, and under the additional basic conditions set out in sub-section 152-10 as revised by the TIOMA, the dual tests must be separately satisfied to obtain any small business CGT concession relief:

Taxpayer must satisfy	AND	Object entity must satisfy
MNAV test or SBE test		Modified MNAV test or SBE test and carried on business up to day of sale

When the object entity MNAV test becomes vital

In practice, there is a significant slew of sales of shares or trust interests where the object entity won’t satisfy the SBE test because of:

an aggregated annual turnover of the object entity of more than $2 million; or
alternatively, the object entity may satisfy that SBE test but paragraph 152-10(2)(a) may apply because the object entity ceased to carry on its business some time before the sale.

In those cases the object entity also needs to satisfy the MNAV test even where the taxpayer has separately satisfied either of the MNAV test or the SBE test or both.

Satisfaction of the MNAV test by the object entity may thus be vital to the availability of the small business CGT concessions to a taxpayer selling shares or a trust interest. Where the object entity, let us say a private company with multiple owners, is worth more than $6m overall, this may well be a problem for minority owners who otherwise are:

on or over the 20% significant individual/CGT stakeholder threshold; or
with net asset value (NAV) under $6m who sell their shares looking for the small business CGT concessions.

The Explanatory Memorandum with the TIOMA gives the following example:

Example 2.4: Investment in large business

Karen carries on a small consulting business as a sole trader. She is a CGT small business entity (according to the general rules) for the 2019-20 income year. Karen also owns 30 per cent of the shares in Big Pty Ltd, a large private company with annual turnover in excess of $20 million in both the 2018-19 and 2019 CGT assets exceeds $100 million throughout this period. On 1 October 2019, Karen sells her shares in Big Pty Ltd. She would not be eligible to access the Division 152 CGT concessions for any resulting capital gain. Even if Karen satisfies the other basic conditions for relief, she cannot satisfy the new condition. Big Pty Ltd is not a CGT small business entity in the 2019-20 income year. It also does not satisfy the maximum net asset value test in relation to the capital gain, as its net assets exceed $6 million immediately prior to the CGT event happening (being in excess of $100 million for the entire income year).

MNAV test complexities

Like the SBE test with aggregated turnover of the taxpayer, affiliates and their connected entities, compliance with the MNAV test relies on, or more specifically NAV (net asset value) must stay under the relevant $6m limit after, aggregation.

Before aggregation is considered there is a flip side: the exclusions from the MNAV test: The substantial exclusions are confined to individual taxpayers viz. interests in an individual’s main residence, personal use assets, superannuation and insurance: section 152-20 of the ITAA 1997. The other exclusions in this section are largely to prevent accounting anomalies with:

accounting provisions; and
the double counting of the value of an asset indirectly held in an entity and the value of the stake in the entity including the asset, representing the same value, in NAV.

Liabilities are also excluded from NAV where they relate to assets so the MNAV test can be a maximum net asset value test.

The value of assets that are not excluded are tallied in NAV when applying the MNAV test. Then aggregation must be done. Just like with the complexity of small business CGT concessions integrity more generally, MNAV tests and sometimes qualification for the concessions, involve a hierarchy of constructs which, for the purposes of illustration, can be loosely compared to the pieces on a chessboard one’s opponent in chess may hold:

Chess piece: King

Div 152 construct: The taxpayer

Comment: If the King falls, it’s game over. If either NAV of the taxpayer or (modified) NAV of the object entity exceeds $6m in each required MNAV test the basic condition is failed unless there is a pathway to compliance through the SBE test as described above.

Chess piece: Queen

Div 152 construct: An affiliate

Comment: Although an affiliate is not the taxpayer (or object entity), the NAV of the affiliate also counts/aggregates to the taxpayer (or object entity) when applying the MNAV test to the taxpayer (or object entity), in all directions including NAV aggregated from connected (and Oconnected in the case of an object entity – see below) entities of the affiliate. Affiliates remain determined under section 328‑130 without modification by TIOMA.

Chess piece: Bishop

Div 152 construct: Connected entities

Comment: The whole of the NAV of the connected entity (excluding the exclusions described above) counts in the MNAV test. So if a taxpayer, or an affiliate, has a stake of 50% in a connected entity X, all (100%) of X’s net value is aggregated to the taxpayer’s NAV (including NAV relating to the stake in X of minority stakeholders unrelated to the taxpayer or affiliate). If Y is a connected entity of X then aggregate all (100%) of Y’s net value to the taxpayer’s NAV too.

Chess piece: Knight

Div 152 construct: Oconnected entities

Comment: The Oconnected entity (my terminology – I thought of using “controlled entity” which is in contrast to a connected entity which can either control or be controlled by the other entity it is connected to. But controlled entity is misleading for, as we shall see, only a 20% stake, hardly control in any sense, is needed to trigger this link) is a new construct introduced with the additional basic conditions in the TIOMA relating to the object entity.

The NAV of a Oconnected entity is aggregated to the NAV of the object entity but it is look through forward to aggregate and not look through back too (unlike “controlled by the other entity” which can connect too to a connected entity). For instance, the object‑entity notional tests in section 152‑10(2B), aggregation ‘looks through’ forward to entities controlled by the object entity using section 328‑125 with a 20% threshold, but does not ‘look back’ to unrelated co‑owners or controllers of the object entity, unless they are separately directly connected with the object entity on the modified basis or separately affiliates.

Example: If O (the object entity) controls Q at or above 20% under section 328‑125 (as notionally modified), Q is a later entity and Q’s CGT assets are included in O’s MNAV notional test; by contrast, P, an unrelated co‑owner of O, is not a later entity and P’s own net assets are excluded from O’s notional tests, aside from P’s proportional interest reflected in O itself.

In chess the Knight moves in a weird way so the Knight is the allegory chosen here!

Chess piece: Pawn

Div 152 construct: Asset or investment of the above

Comment: A pawn generally moves one space in chess. $1 in value of an asset or investment owned by a taxpayer or object entity, which is not excluded, counts $1 to the NAV of the taxpayer or an object entity. $1 in value of an asset or investment owned by affiliates, connected entities and Oconnected entities, which are not excluded, count $1 to the affiliate, connected entity and Oconnected entity, as the case may be, but if that NAV is in an affiliate, a connected entity or a Oconnected entity of the taxpayer or object entity in applying the dual tests, the whole NAV of the relevant entity is aggregated to the taxpayer/object entity, not its proportionate NAV based on percentage stake. i.e. A percentage stake is only used for an interest in an entity where the entity the interest is held in is not an affiliate, connected entity or, in the case of the object entity MNAV test, an Oconnected entity.

I don’t play chess and I accept my chess analogy with the workings of the MNAV tests is far from perfect. My endeavour is to make this consideration of the hierarchical workings of the MNAV tests a little more comprehendible and so, perhaps, if you are still reading by this point I have succeeded? If the comparison with chess conveys:

that counts of over $6m by either of the taxpayer NAV or the object entity NAV will generally mean failure of a basic condition for the Division 152 CGT relief so can lead to loss of the game; and
that high value pieces accelerate aggregation of NAV to the $6m limit. That is they can move more than one space: every $1 of a stake a taxpayer (or object entity) in a connected entity (or Oconnected entity), and affiliates and their connected entities without needing any stake in the affiliate of the taxpayer (or object entity) will generally aggregate more than $1 to NAV as the value of others’ stakes in these entities will count to the NAV attributed to the taxpayer (or object entity) too.

The modified MNAV test of the object entity & the modified Oconnected entity

The NAV for controlled entities of an object entity is different due to sub-paras 152-10(2)(c)(iii), (iv) & (v) in the TIOMA:

The threshold between unrelated entity, counted simply as an asset or investment (pawn) to NAV and connected entity (bishop) consistent with other tests of control in the ITAA 1936 and the ITAA 1997 is 40% with a discretion given to the Commissioner where:

there is 40% or over and under a 50% stake; and
it can be established to the Commissioner that some other entity controls the entity that would otherwise be the connected entity.

In practice this means expect the Commissioner to de-connect A from connection with X if A owned 48% of X and B (unconnected to A) owned 52% of X.

When applying the object entity MNAV test, sub-paras 152-10(2)(c)(iii), (iv) & (v) have operation so that the threshold is lowered to a 20% stake in the other entity. That is enough “control” to make the other entity, otherwise an asset or investment, an Oconnected entity (knight). This is apparent from another example in the Explanatory Memorandum with the TIOMA:

Example 2.5: Indirect investment in large business

Tien owns 20 per cent of the shares in Investment Co, a company that carries on an investment business. Investment Co is a CGT small business entity (according to the general rules) for the 2020-21 income year. Investment Co holds 20 per cent of Van Co, a transport company. Van’s assets mean that it is not a CGT small business entity in the 2020-21 income year and does not satisfy the maximum net asset value test at any point during the income year. On 15 May 2021, Tien sells his shares in Investment Co. He is not eligible to access the Division 152 CGT concessions for any resulting capital gain. Even if Tien satisfies the other conditions, he cannot satisfy the new condition requiring the object entity be a CGT small business entity or satisfy the maximum net asset value test due to the modifications that apply when determining this matter for the purposes of this condition. For the purposes of this condition, Investment Co is considered to be connected with Van Co, as Investment Co holds 20 per cent of Van.

As stated in the table above there is no look through back so in a case where an object entity has a stake of 21% of X, the NAV in entities connected to X by virtue of the remaining 79% stakes in X are excluded from the object entity NAV although the NAV of the assets of X, including that relating to the other stakeholders, counts to the object entity NAV.

The discretionary capital distribution – it’s a CGT free gift!

Annual income distributions by family discretionary trusts (FDTs) are routine for trustees for apparent Australian income tax reasons but trustees of FDTs can be reluctant to distribute trust capital. What would be the reason for that reluctance? Why don’t trustees of FDTs make capital distributions more often?

The trust deed

The regime in a FDT deed typically centres on distribution of capital on the vesting of the FDT. However even older and archaic FDT deeds usually expressly allow for interim distribution of capital, that is, distribution of trust capital before the FDT vests and winds up. Interim distribution of capital to beneficiaries, rather than holding it for them until the vesting day, is often conditional on the distribution being for the “maintenance education advancement in life or benefit” either for infant beneficiaries or for beneficiaries generally – see Fischer v Nemeske Pty. Ltd. [2016] HCA 11: a condition which, in ordinary family dealings, can readily be met.

Purpose of a FDT

A FDT is, in its essence, an arrangement to benefit family members. A FDT can be seen as a pool set aside to gift to family members. But is a distribution to a family beneficiary from a FDT treated the same for tax as a family gift to a family member?

It is useful to think about differences between a FDT and other types of entities before answering that:

Difference to a proprietary company

A proprietary company has the legal status of a separate person and the release of company capital to a shareholder of a company is subject to a number of corporations law and tax technicalities. A company can have wide objects but giving its value away to other persons would not usually be one of them. Under tax rules the enrichment of a shareholder’s family member from a company’s capital is likely dividend income assessable to income tax either directly or as a “payment” under section 109C of the Income Tax Assessment Act 1936.

Difference to a unit trust

A trustee of a genuine unit trust would generally be required to make capital distributions in equal proportions based on the unit holdings of unit holders. If capital distributions from a unit trust are feasible the capital gains tax (CGT) rules can discourage the trustee from making these distributions before vesting. CGT event E4 applies to distributions of capital of a unit trust which are not in connection with the disposal of the units to reduce the cost base of the unit holder by the amount of the distribution and, to the extent the cost base doesn’t cover the amount of the distribution, the excess is a capital gain assessable to unit holders.

How CGT applies to distributions of capital by FDTs

CGT event E4 does not apply to non-assessable capital distributions from a FDT. In Taxation Determination TD 2003/28 Income tax: capital gains: does CGT event E4 in section 104-70 of the Income Tax Assessment Act 1997 happen if the trustee of a discretionary trust makes a non-assessable payment to: (a) a mere object; or (b) a default beneficiary? the Commissioner of Taxation confirms his longstanding view and practice, since the introduction of CGT in 1986, that CGT event E4 does not happen if a trustee of a discretionary trust makes a non-assessable payment to a mere object. That is, a mere discretionary beneficiary where the entitlement to the payment arose because the trustee exercised its discretion in the beneficiary’s favour and the interest was not acquired by the beneficiary for consideration or by way of assignment.

The CGT similarity of FDT cash distributions and cash gifts

The enrichment of a family beneficiary of a FDT by an interim distribution of the capital of a FDT is not, of itself, subject to CGT based on TD 2003/28 i.e. there is no CGT on a distribution of cash to a beneficiary from the capital of a FDT. If there is a distribution of a CGT asset from the capital of a FDT to a beneficiary that is a different story. CGT events E5 and E7 can apply to subject the realisation of the CGT asset by the FDT to a family beneficiary to CGT (see sub-sections 104-75(3) and 104-85(3) respectively of the Income Tax Assessment Act 1997 which visits the CGT event on the the trustee of the trust – sub-sections 104-75(6) and 104-85(6) generally enable the beneficiary of a FDT to disregard a capital gain or capital loss under either of these CGT events where the beneficiary acquired the asset within the trust without incurring expenditure viz. on a capital distribution by the trustee the beneficiary is treated only as the acquirer of the asset for CGT purposes).

But there is no fundamental difference between a distribution of a CGT asset from the capital of a FDT, and the CGT events that apply to it, and how a family gift of a CGT asset by an individual is treated for CGT. That is, a gift of cash is CGT free and a gift in the form of property that is a CGT asset is subjected to CGT: not because of the gift but because a CGT asset is being realised and the CGT regime brings gains in value on a CGT asset to tax on a change of ownership.

So cash distributions of capital by a FDT, where permissible under a trust deed of a FDT, can generally occur, either with income year end income distributions or at other times during the currency of a FDT, without income tax consequences.

However there is a problematic exception:

Small business CGT concessions participation percentage

Under item 2 in the table in section 152-70 of the Income Tax Assessment Act 1997 the “small business participation percentage” of a beneficiary of a FDT is the smaller of the percentages of the beneficiary’s entitlement to income and the beneficiary’s entitlement to capital in an income year if both income distributions and capital distributions are made in that year. Generally beneficiaries are better off qualifying for a sufficient small business participation percentage to qualify for the concessions if no distribution of capital, or no divergent distribution of capital (bearing in mind that a capital gain on an active asset distributed by a FDT is likely to have a capital component), has been made in the income year the relevant capital gain has been made in to some other beneficiary.

So if a capital gain arises to a FDT in an income year which can attract the small business CGT concessions in Division 152 of that Act, then a distribution of the income in that income year substantially to family member A, including entitlement to a capital gain, may not count or count sufficiently in the measurement of small business participation percentage where a cash distribution of capital has been made to family member B and not family member A who is left with a “smaller” participation percentage. It could be that family member A may thus not qualify as a significant individual or as a CGT concession stakeholder without the sufficient interest in capital distributions of the FDT in the relevant income year in which the capital gain was made.

So a trustee of FDT needs to be wary of cash distributions of capital from a FDT and, indeed, the streaming of capital gains where there has been a capital gain that can attract the small business CGT concessions to ensure that the desired beneficiaries have sufficient entitlements to capital that can attract the concessions. If the small business CGT concessions participation percentage is not in issue a cash distribution from from the capital of a FDT to a beneficiary can be a tax benign.

Preparing to change land ownership from a company to a trust

A company controlled by X owns land. X would prefer it if the land was held by a trust or in an individual name such as X or Y, X’s spouse.

Significant capital gains tax (“CGT”) on the transfer of the land is not expected by X and Y. Is a transfer of the land to a trust or to X or Y or both worthwhile? Here are some tax implications X may want to think about:

Capital gains tax

If the land has increased in value X will want to consider CGT more closely:

If the land is not an active asset, or if the small business CGT concessions or the new small business restructure roll-over, can’t apply for some other reason, the value of the land, when disposed of, will be taken into account in determining CGT. i.e. the market value substitution rule will apply in the event of an undervalue transfer of the land. An undervalue transfer of the land is rarely likely to be effective under tax rules.

The small business CGT concessions and the new small business restructure roll-over don’t apply if the asset is not an active asset. The land won’t be an active asset if it is mainly used by the company, and related parties of the company, to earn rent. As the land is held in a company, the 50% CGT discount is not available to the company on the transfer of the land.

Problems with a gift or an undervalue transfer

If full value is not payable to the company for the land then, without more, a transfer of the land could be treated as a dividend taxable in full to the transferee as a shareholder of the company, as a deemed dividend taxable to the transferee as an associate of the shareholders of the company, or may possibly be taxable to the company as a fringe benefit. Further if the company has taken the approach of gift there may be difficulties establishing that the company was legally entitled to give the land away to the transferee if that is what is done. Indications of a gift might give a creditor of the company additional rights to pursue the transferee for the value of the land that belonged to the company especially if the stance of the company is that the transfer was not any sort of dividend or remuneration to X or Y.

A sale of the land by the company for full value is more defensible. The sale can be on terms rather than for cash payable on settlement. If the transferee doesn’t follow through, and pay the value in cash or on the agreed terms, then the sale for value can be treated as a sham and the consequences of undervalue transfer can then follow.

So defensible transfers of the land include:

sales at full value on (genuine) terms; and
distribution of the value of the land to the shareholders of the company (not in the form of cash) on the voluntary liquidation of the company.

CGT event A1 – but watch out for CGT event E2 if a transfer to a trust

Usually CGT event A1 is attracted when land is transferred from one beneficial owner to another. CGT event A1 is taken to occur at the time of (in the income year of) the disposal, that is, the time of the transfer unless the transfer is made under a contract. If the transfer occurs under a contract and CGT event A1 applies, CGT event A1 is taken to occur at the time of making of the contract.

This can be significant where a contract and settlement straddle the end of an income year, with the time of the contract bringing forward the capital gain into the earlier income year if CGT event A1 applies. If the transferee is a related trust of the vendor then CGT event E2 can apply rather than CGT event A1. CGT event E2 though, unlike CGT event A1, does not bring forward the time of the CGT event to the time of the contract so, if CGT event E2 applies, the capital gain will be made in the later income year.

Stamp duty on a transfer

Stamp duty varies from state to state but generally applies to acquisitions of land based on the market value of the land, not the price to the transferee/purchaser. Very generally speaking it is usually charged at around 5% of the land value. The states offer limited stamp duty relief when acquisitions occur without a change in ultimate beneficial or economic ownership of the land. For instance, in New South Wales and Victoria relief exists in the form of corporate reconstruction concessions. These concessions are generally not available where the acquisition is by a trust or an individual. Thus stamp duty would need to be budgeted for by X as a further cost of transferring the land.

Goods and services tax

If the company is registered or ought to be registered for the goods and service tax and the land in used in an enterprise carried on by the company then the company may be obliged to charge 10% GST to the transferee on the transfer (taxable supply) of the land. If the transferee is also registered for GST, and will use the land in the transferee’s enterprise, then the transferee can obtain an input tax credit/refund of the GST charged to the transferee. The company and the transferee, if registered for GST, may also:

be able to claim the GST going concern exemption if they take the necessary steps for the exemption; or
be members of a GST group;

which would relieve the company of the obligation to charge GST to the transferee.

Is a family trust a good way for setting up a new franchisor business?

A family discretionary trust structure is a slightly more complicated and costly structure but it has more flexibility than a holding company structure for distributing income tax effectively while also being capable of having limited liability protection for the franchisor along with potential access to the company tax rate through a beneficiary company.

But is one trust enough?

For asset protection and management reasons it may be multiple structures are desirable into the future to separately hold IP and property interests (including lease interests to be sub-let).

Trust a conduit to beneficiaries

A family trust can distribute business profits as trust distributions as a conduit of taxable income to adult resident beneficiaries.

Division 7A would not usually apply

A significant advantage with a family trust structure is that Division 7A does not apply to loans from the trust to associated parties (where companies are not involved) to treat them as taxable/unfrankable deemed dividends.

Capital gains tax advantages

The adult resident beneficiaries of a family trust can also use the CGT discount if the trust makes a capital gain. Sometimes a trust is a more difficult structure than a company if a new franchise venture makes losses (say due to difficulties finding and keeping franchisees on good terms).

Bringing in new equity

A family trust isn’t as good as a unit trust or a company for bringing in new equity participants however it appears that, with the new small business restructure CGT rollover relief, a later conversion to a unit trust structure can be done for a low cost.

CGT discount and small business CGT concessions

Capital gains made by a family trust structure could attract the CGT discount and the small business concessions (a company can only get the latter), such as the 50% active assets reduction. A family trust structure has the tax advantage over a company structure if CGT assets of the business, including goodwill, are at some stage sold for a capital gain by the trust.