SMSFs, Business real property and the small business CGT cap

By Yvonne Chu, Senior Technical Manager, Colonial First State

Small business clients often want to transfer their business premises into their SMSF as an in-specie contribution to take advantage of the tax effective superannuation environment.

To facilitate the transfer, some clients have sought to utilise the CGT small business concessions and make an in-specie contribution to super using the lifetime CGT cap - simultaneously.

However, the ATO has indicated via a number of private binding rulings that in-specie contributions of active assets, such as business real property, may not qualify for the lifetime CGT cap where the in-specie super contribution is also the CGT event that qualifies for the small business CGT concessions. 

As a result, a client’s ability to access these valuable concessions may be impacted and careful planning is required to ensure they structure their contributions to meet these complex rules.

Lifetime CGT cap 

When a small business owner disposes of an active asset, they may be eligible to disregard some or all of the capital gain resulting from the disposal under the CGT small business concessions.  In addition, they may be able to contribute some or all of the sale proceeds to superannuation and elect for the contributions to count towards the lifetime CGT cap.

The lifetime CGT cap for 2018-19 is $1.48 million (indexed annually).  Contributions that count against the lifetime CGT cap are neither concessional nor non-concessional contributions.

Broadly, to access the lifetime CGT cap it is necessary for an individual, company or trust to qualify for the 15-year exemption or the $500,000 retirement exemption. 

The following table outlines the types of contributions that can be contributed under the lifetime CGT cap:

Contribution type

Amount that counts against lifetime CGT cap

Individual able to disregard capital gain under retirement exemption

Amount of capital gains disregarded under the retirement exemption (up to maximum of $500,000)

Individual able to disregard capital gain under the 15 year exemption

Amount of capital proceeds

Company or trust able to disregard capital gain under retirement exemption

Amount of payment to CGT concession stakeholder of their share of the exempt amount (up to maximum of $500,000)

Company or trust able to disregard capital gain under the 15 year exemption

Amount of payment received by CGT concession stakeholder of their share of capital proceeds


When making small business CGT contributions, depending on the circumstances, the contribution must be made within strict timeframes.

Case study - contribution under the lifetime CGT cap:

  • Matthew and Lily (both age 70) are farmers who have been running a primary production business for over 15 years. They run their business on a farm they own jointly which qualifies as a business real property.
  • They decide to retire and sell the farm for its market value of $1.4 million to a third party purchaser.
  • As Matthew and Lily meet all the basic conditions for small business CGT exemptions as well as the 15 year exemption, they can disregard any capital gains as a result of the sale.
  • Subject to satisfying the work test, they can then each contribute their share of the capital proceeds ($700,000) from the sale into superannuation under the lifetime CGT cap.

Note – this applies regardless of whether the value of Matthew and Lily’s total superannuation balance at the end of the previous financial year exceeds $1.6m, as the contributions are not non-concessional contributions.  

In-specie contributions and the lifetime CGT cap

In the Matthew and Lily example, the active asset of the farm was sold and a cash contribution made into superannuation under the lifetime CGT cap.  However, the situation is more complex when the transaction involves an in-specie contribution.

For example, if Matthew and Lily transferred their farm into their SMSF as an in-specie contribution, they may not be able to qualify for the lifetime CGT cap as the super contribution is also the event that qualifies for the small business CGT concessions.  That is, the ATO has indicated in a number of private rulings[1], that the contributor is not able to utilise the lifetime CGT cap in the event of an in-specie transfer of an active asset into a SMSF, where the small business CGT exemption is applied for the same CGT event.

The Commissioner has stated that the legislation does not contemplate the CGT event, choice (if paid from a company or trust) and contribution of the CGT exempt amount all happening simultaneously. Therefore, the CGT event must occur before a contribution is made and not at the same time.

This view has important implications as in-specie contributions that do not count against the lifetime CGT cap will instead be treated as personal non-concessional contributions and count against the non-concessional cap (assuming the member does not claim a tax deduction for some or all of the contribution), which may result in excess non-concessional contributions.

Due to these issues, advisers should encourage clients to seek a private binding ruling if they are looking to utilise the lifetime CGT cap for an in-specie transfer where the small business CGT exemption is applied for the same CGT event.

Potential solutions

Below we outline three possible alternative strategies that achieve the goal of moving the asset into the SMSF, without the in-specie contribution issue outlined above applying.

  1. SMSF purchasing active asset from client

The SMSF could purchase the active asset from the client (or their trust/company) where they have the required funds available.  This achieves the goal of moving the asset into the SMSF, as well as providing cash proceeds to the client (or their company or trust) which can then be contributed to super under the lifetime CGT cap.

Coming back to the example of Matthew and Lily, if their SMSF had cash reserves of $1.4 million, the SMSF could purchase the farm from them. Matthew and Lily could then use the cash proceeds to make contributions under the lifetime CGT cap.

When implementing this strategy, there are a few important things to be mindful of:

  • A SMSF is only allowed to acquire certain assets from a related party[2], e.g. business real property that’s used wholly and exclusively in any business. Generally active assets other than business real property e.g. goodwill of a business, shares in a private company or units in a related trust, cannot be acquired[3].
  • The purchase must be on arm’s length terms and at market value. The SMSF may need to obtain an independent professional valuation to determine the sale price, refer to ATO’s Valuation guideline for SMSFs

  1. SMSF uses limited recourse borrowing arrangement (LRBA) to purchase active asset from client

In situations where the SMSF does not have the required funds available to purchase the active asset from the client, an alternative is for the SMSF to borrow the money via an LRBA to complete the purchase.

The cash sale proceeds could then be re-contributed to the fund under the lifetime CGT cap and used to extinguish the outstanding LRBA loan amount. However, it is important to note that this arrangement will incur additional costs as the fund will be required to establish a complying LRBA including the required bare trust arrangements.

Where a fund borrows from a related party, additional care needs to be exercised to ensure the loan complies with the safe harbour guidelines as specified in ATO PCG 2016/5. Otherwise the trustee will need to demonstrate that the loan is on arm’s length terms – otherwise any income earned from the asset may be taxed as non-arm’s length income.

  1. In-specie contribution of an asset for a different small business CGT event

If a client is disposing of multiple active assets, they could consider triggering a CGT event in relation to one of those assets and then making an in-specie contribution under the CGT cap of a different asset in lieu of the capital proceeds they received.  

For example, in ATO ID 2010/217, the ATO confirmed that where a taxpayer sold an asset that qualified for the $500,000 retirement exemption, the taxpayer could contribute a separate asset under the lifetime CGT cap in lieu of the cash proceeds actually received. This is important as it may allow a client to contribute an allowable asset via an in-specie transfer direct to their SMSF under the lifetime CGT cap.   

Case study: Winston

Winston (aged 60) ran a successful real estate agent business for more than two decades and has now decided to sell his business and retire. The real estate business operated through a company structure.  Winston owned 100% of the shares and the commercial premises. Details are as follows:

Asset

Owner

Ownership period

Cost base

Market value

Shares in SuperAgent Pty Ltd

Winston

20 years

$0

$600,000

Commercial office

Winston

10 years

$200,000

$800,000

Winston wants to sell his shares in the company, but retain ownership of the commercial office within his SMSF which will then be leased to the new business owner.

Sale of shares in the company (CGT event no.1)

Winston sold the shares in SuperAgent Pty Ltd to an unrelated purchaser for $600,000. As he meets the basic conditions for small business CGT exemptions and qualifies for the 15 year exemption, he can fully disregard any capital gains associated with the sale of these shares. He is also eligible to contribute the capital proceeds up to $600,000 into super under the lifetime CGT cap[4].

Small business CGT contribution strategy

While Winston could use the cash proceeds from the sale of shares to make a contribution under the lifetime CGT cap he instead chooses to contribute his commercial office into his SMSF under the lifetime CGT cap instead – as per the scenario in ATO ID 2010/217.

In-specie transfer of commercial office (CGT event no.2)

When Winston in-specie transfers his business real property into his SMSF it will trigger an assessable capital gain of $600,000. However, as the commercial office qualifies for the 50% individual exemption the assessable gain is reduced to $300,000. Winston can then apply the $500,000 retirement concession to fully offset the remaining $300,000 assessable gain - assuming he skips the 50% active asset exemption.

In this case, Winston is then eligible to contribute an additional $300,000 under the lifetime CGT cap – being the amount of the gain offset by applying the retirement concession to the transfer of the commercial office to the SMSF. In this case, Winston could then use $300,000 of his original cash proceeds from the sale of the shares to contribute to super under the lifetime CGT cap.

Mixed contributions

In the above scenario, it is important to note the market value of the BRP ($800,000) contributed in lieu of the share sale proceeds exceeded their value ($600,000) by $200,000. Therefore, only $600,000 of the property can be contributed under lifetime CGT cap. However, as Winston is under 65 years of age (and hasn’t previously triggered the bring forward provision) the additional $200,000 could be treated as a non-concessional contribution. He can then make additional non-concessional contributions of up to $100,000 under the bring forward rule.

Summary of contributions:

  • In-specie transfer of BRP valued at $800,000:
    • $600,000 contribution under lifetime CGT cap; and
    • $200,000 non-concessional contribution.

  • Cash contribution of $300,000:
    • $300,000 contribution under lifetime CGT cap.

The end result is that Winston could make total contributions of $900,000 under the lifetime CGT cap (relating to two separate CGT events) and a non-concessional contribution of $200,000. He also has the option of making a further non-concessional of $100,000 to maximise his NCC cap.

The following diagram illustrates the strategy:

Important note

The above example is for illustrative purposes and does not consider the application of the anti- avoidance measures in Part IVA of Tax Act. As this is a complex area of tax law, clients should seek advice from a registered tax agent or obtain a private binding ruling from the ATO before making any decisions relating to the sale of their active business asset, and in-specie transfer of business real property into their SMSF.

 

[1] Private ruling PBRs: 1013008906784; 1013054081138; 1013021531190; 1012862148885

[2] Section 66 of the SIS Act prohibits a SMSF from acquiring assets from a related party unless an exception applies. A related party is defined as: a member of the fund; a standard employer-sponsor of the fund; and a Part 8 associate of either of these two entities.

[3] Note – SMSFs can acquire units or shares in related companies and trusts under the 5% in-house exemption.

[4] CGT cap election form must be submitted at or before the time of contribution

Disclaimer: This article is not legal or personal financial advice and should not be relied on as such. Any advice in this document is general advice only and does not take into account the objectives, financial situation or needs of any particular person. You should obtain financial advice relevant to your circumstances before making investment decisions. Where a particular financial product is mentioned you should consider the Product Disclosure Statement before making any decisions in relation to the product. Whilst every reasonable care has been taken in distributing this article, Australian Unity Personal Financial Services Ltd does not guarantee the accuracy or completeness of the information contained within it. Any views expressed are those of the author(s) and do not represent the views of Australian Unity Personal Financial Services Ltd. Australian Unity Personal Financial Services Ltd does not guarantee any particular outcome or future performance. Taxation Information in this document should not be relied upon without seeking specialist advice from a tax professional. Australian Unity Personal Financial Services Ltd ABN 26 098 725 145, AFSL & Australian Credit Licence No. 234459, 114 Albert Road, South Melbourne, VIC 3205. This document produced in December 2018. © Copyright 2018