Navigating CGT strategy impacts on business real property transfer
SMSFs seeking to transfer business real property into the fund will need to ensure greater planning around strategies to structure the contribution when facing capital gains tax (CGT) impacts and regulatory risks from the ATO, said a technical specialist.
In a recent FirstTech update, Colonial First State head of technical services Craig Day said 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.
“However, the ATO have 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,” Mr Day said.
“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.”
When a small business owner disposes of an active asset, Mr Day noted 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 2021-22 is $1.615 million (indexed annually). Contributions that count against the lifetime CGT cap are neither concessional nor non-concessional contributions,” he noted.
“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.”
In an example, 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," Mr Day explained.
“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.
“This applies regardless of whether the value of Matthew and Lily’s total superannuation balance at the end of the previous financial year exceeds the upper non-concessional cap threshold (currently $1.7m for 2021-22), 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 was made into superannuation under the lifetime CGT cap. However, the situation is more complex when the transaction involves an in-specie contribution, according to Mr Day.
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 small business CGT cap as the super contribution is also the event that qualifies for the small business CGT concessions.
“That is, the ATO have indicated in a number of private rulings, that the contributor is not able to utilise the small business CGT cap in the event of an in-specie transfer of an active asset into an SMSF, where the small business CGT exemption is applied for the same CGT event,” he said
“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 small business CGT cap for an in-specie transfer where the small business CGT exemption is applied for the same CGT event.”