The ATO recently issued a statement noting that there has been an increased number of taxpayers mistakenly claiming capital gains tax (CGT) small business concessions (refer: ATO QC 67318).
As a result, the ATO is now actively following up those who have claimed CGT small business concessions advising them to ensure that they meet the eligibility conditions and have the necessary records to substantiate their claims and recommending their tax advisers check their past tax returns for accuracy.
The CGT small business concessions involve complex legislation (see div 152 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997). In particular, it is important for SMSFs in receipt of contributions that have been made as a CGT cap amount under s 292-100 of the ITAA 1997.
Under the CGT cap, you can potentially exclude non-concessional super contributions from your non-concessional contributions cap up to the CGT cap amount. For the current financial year 2021‑22 the CGT cap amount is $1,615,000.
A person eligible to claim CGT small business relief may be eligible to contribute up to $500,000 to superannuation if they satisfy the retirement relief criteria in division 152-D of the ITAA 1997. If they satisfy the criteria in the 15 year rule in division 152-B of the ITAA 1997 they may be eligible to contribute up to $1,615,000 to superannuation. These amounts are typically in addition to any other contributions that they may be eligible to make.
However, given the complexity of these CGT provisions, if the relevant legislative criteria in division 152 are not satisfied, then the superannuation contribution made as a CGT cap amount, will be counted as a non-concessional contribution (NCC). This may result in the member exceeding their normal contribution caps.
This position is made even worse if the member has more than $1.6 million in their total superannuation balance as they have no cap space, and any further contribution could be in excess of their cap. (Note from 1 July 2021 the total superannuation balance was indexed to $1.7 million.) Members can easily run into excess contributions territory if CGT relief is incorrectly claimed.
If there is an incorrect contribution to super, ie, where the CGT relief was mistakenly applies, the member’s first instinct to rectify the mistake is usually to withdraw the contribution from their super fund. However, before any withdrawal is made, you must first learn how to manage the excess contribution system. We recommend expert advice be obtained to minimise the risk of 45% tax being applied to any excess amount.
ATO hit list
The ATO provided the following list of situations that will attract its attention, including:
- entities that fail the small business entity test (eg, their aggregated turnover is greater than $2 million);
- entities that fail the maximum net asset value test – net assets of the entity, connected entities and affiliates exceeds $6 million and these tests can prove quite complex;
- the asset disposed of does not meet the definition of an active asset – refer to the discussion below on Eichmann v Commissioner of Taxation  FCAFC 155 (Eichmann);
- entities that do not meet the additional conditions where the CGT asset is a share or trust asset; and
- entities that fail to correctly identify significant individuals and CGT concession stakeholders.
Tax adviser actions
The ATO is actively encouraging tax advisers to check all or their clients’ CGT relief claims to ensure their accuracy and to correct any error as soon as practicable. Moreover, the ATO has stated that to ensure CGT concession eligibility and to avoid administrative time and cost to correct a mistake, tax advisers are able to:
- reach out to the ATO for an early engagement discussion to seek advice on a client’s small business complex transaction;
- seek a pre-lodgement compliance agreement for a client’s commercial deals and restructure events; and/or
- apply for a private ruling to attain certainty on a client’s position.
Recent case (Eichmann) on what is an active asset
One good example of a case involving CGT relief was Eichmann that examined whether a block of land used to store business equipment adjacent to Mr and Mrs Eichmann’s family home was used in the course of carrying on a business.
This case illustrates the difficulty of correctly applying the CGT small business concessions especially if the ATO disagrees with your claim. If the ATO disagrees with your claim, who is correct and who wins may eventually depend on who is prepared to fight it out and ultimately win the dispute.
In December 2016, Mr and Mrs Eichmann applied to the ATO for a private ruling. The ATO ruled that the real estate was not used in the course of carrying on a business and therefore not an ‘active asset’ under s 152-40 of the ITAA 1997. The taxpayer objected.
In July 2017, the ATO reaffirmed its ruling. The taxpayer appealed to the Administrative Appeals Tribunal, and in February 2019, the tribunal ruled that the real estate was used in the course of carrying on a business.
The ATO appealed to the Federal Court, and in December 2019, the Federal Court overturned the tribunal’s decision. The taxpayer then appealed to the Full Federal Court. In September 2020, the Full Federal Court ruled that the real estate was used in the course of carrying on a business (ie, that the ATO had been wrong from the beginning).
This illustrates that even if a taxpayer is ultimately right, it can take years and considerable costs to prove your case.
Also, if a taxpayer loses the desire or ability to dispute the matter after, for example, the Federal Court decision but before the Full Federal Court decision, the taxpayer would have been ultimately wrong instead of being ultimately right. Losing the desire or ability to dispute a matter (eg, the costs are too much or its not cost effective to proceed further) is a real possibility due to the extreme costs of a dispute (eg, hundreds of thousands of adviser costs can easily be incurred in this type of case).
If a taxpayer loses a court case, the taxpayer also typically has to pay a portion of the other side’s legal fees. Even if a taxpayer ultimately wins a court case, the taxpayer may still have significant out of pocket expenses and will need to ensure the cost/benefit of proceeding further is justified given the chance of success and the risks involved. Furthermore, a dispute with the ATO can be tremendously stressful and time-consuming. The emotional toll of a protracted dispute with the ATO should not be underestimated.
Therefore, the need to obtain proper advice upfront, that is in writing, fully documented and supported, before claiming CGT relief is strongly recommended. Advisers who do not have a well‑documented file with appropriate evidence are at risk. The ATO review is a reminder for advisers to encourage their clients to get the review done and documentation checked or face the consequences.
DBA Lawyers generally recommends that individuals seek upfront advice from a tax expert in relation to claiming CGT relief due to the complexity, risks and increased scrutiny of these claims by the ATO. It is especially important to ensure that this advice is in writing and is well documented and supported. This will ensure that taxpayers are in a much sounder position and can hold their adviser accountable if the advice given turns out to be incorrect.
If there are any errors, early engagement and voluntary disclosure and working cooperatively with the ATO is generally the best way forward. Naturally, its best to obtain advice from a lawyer with tax and superannuation expertise in this situations as legal advice is covered by legal professional privilege.
- Downsizer contributions –– the basics and some key tips and traps
- SMSFs and how the CGT rules work when a pension is in play – Part 1
- SMSFs and how the CGT rules work when a pension is in play — Part 2
- SMSFs –– the CGT withholding regime on property transfers is far broader than many think
- Transitional CGT relief for pension and TRIS assets for FY2017
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Note: DBA Lawyers presents regular SMSF Online Updates. For more details or to register, visit www.dbanetwork.com.au or call 03 9092 9400.
For more information regarding how DBA Lawyers can assist in your SMSF practice, visit www.dbalawyers.com.au.
This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.
26 November 2021