Capital Gains Tax and Business Valuations
Capital Gains Tax (CGT) is triggered from the sale of a business, restructuring your business arrangements or a change in ownership of a business.
Whenever there is a likelihood that you will be liable to pay capital gains tax, it pays to have an ATO compliant business valuation to support your claims.
What is Capital Gains Tax
The broad definition of a capital gain or loss is when there is a difference between the price obtain when you dispose of an asset and the cost to acquire the asset. A capital gain is made when the sale price is greater than the cost base (allowing for CPI indexation).
ATO compliant business valuations are required by SMEs in a number of circumstances, such as:
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changes in capital structure
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changes of shareholders or unitholders
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capital gains tax rollovers
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company sales or acquisitions
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formation of a consolidated group
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entry into or exit from a consolidated group
Each of these events relate to the transfer or sale of an asset – usually in the form of shares or units. These events are typically called Capital Gains Tax (CGT) events.
The ATO requires the concept of market valuation to be applied to both the price at which the asset has been exchanged and the cost base of the asset (the initial acquisition value of the asset). We have explored further the various definitions of market value here.
How is Capital Gains Tax Calculated?
What is the very first thing EVERY business owner should do when trying to calculate the capital gains tax associated with any CGT event? Put your pen and your mouse away and speak to your accountant – or any accountant familiar with CGT issues. This is a complex area and requires professional tax accounting advice.
Basically: Capital Gain = Sale Price – Cost Base
In the case of a capital loss, there are changes to the way the cost base is worked out (see your accountant to get the details).
The Capital Gain Tax that you are liable for (in principal) is then: Capital Gain * Personal Marginal Tax Rate.
Let’s look at an example:
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You start a business from scratch – Cost base = Nil
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You sell the business after three years for $1.0m so the capital gain is $1m.
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Your marginal tax rate is 37% (assuming you were paid between $90k - $180k for the year.
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So your capital gains tax (CGT) is likely to be $370k.
Now let’s assume you qualify for a 50% CGT reduction which means your capital gains tax liability will reduce by $185k. Again – see your accountant to make sure you qualify and that you have the right advice.
But let’s say you sold the business to your brother and it was not an “arm’s length transaction”. There may be a case to argue that the market value was only $750k instead of $1m, and therefore there is a lower CGT to be paid.
In this case a restructuring business valuation will help answer the question and provide evidence to the ATO that support the assessment your accountant makes.
How does Business Valuations help with CGT?
Some of the key questions that the ATO ask when checking a CGT claim include:
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Has the cost base and sale price been recorded at market value?
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Has any of the exemptions, concessions or other relief mechanism’s been applied correctly?
In both these questions the business valuation becomes a key part of the evidence to support your accountant’s submission.
The ATO often examine the issues around the definition of market value. We have discussed the
definition of market value and other related items elsewhere, but there are some key tests that can be applied to determine if the price paid or received for an asset is representative of market value.
A properly documented business valuation report that complies with ATO market valuation guidelines will support your case.
The other key issue that is often checked is the Maximum Net Asset Test – do you and your entities own less than $6m in net assets at the time of the CGT event? If that is the case then you may be eligible for Small Business CGT Concessions.
The way this is sometimes determined is to have a business valuation determine the market value of the business at the time of the CGT event.
Disclaimer: The information contained on this page is general in nature and should not be taken as personal and/or professional advice. Readers should make their own inquiries and obtain independent, professional advice before making any decisions, taking any action or relying on any information on this page.
Business Valuation Articles and Hot Topics
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Types and definition of value (market value and strategic value)
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Div 7A Impacts on Business Valuations
Are CGT Exemptions and Rollover Relief Different to Small Business CGT Concessions?
The ATO provide a number of CGT concessions, exemptions and options when managing your Capital gains tax liability. The small business CGT concessions primarily consist of the 15 year exemption and the 50% exemption, with additional exemptions associated with retirement.
Basically they are:
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15 Year exemption – no CGT payable if you are 55 years old or over, are retiring and have owned the business for 15 years or more.
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50% exemption – reduced CGT liability where you have owned an “active asset”.
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Retirement exemption – Where sale proceeds up to $500k can be paid into a superannuation fund tax free.
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Rollover relief – deferring CGT liability under certain conditions.
These have basic conditions that you must meet to qualify for small business CGT concessions, and in some cases there are additional requirements.
These conditions change often (federal government budgets and tax reform) so it is critically
important that you get advice from someone experienced in capital gains tax legislation and CGT reporting.
In most cases the ATO will make a risk assessment on the likelihood that:
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That any capital gain reported is accurate.
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That any exemptions have been correctly and consistently applied.
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The tax liability determined is consistent with ATO expectations.
The CGT business valuation forms part of the evidence to support the accountant’s claim or submission.
Small Business CGT Concessions and Business Valuations
The central aim in CGT business valuations is to determine the market value at the required date (whether for a cost base report or sale price report). In most cases the market value at the time of sale will also support any future CGT calculation, as the sale price of a transaction today becomes the cost base of another potential CGT event in the future.
It is important to realise that CGT business valuations done for ATO reporting requirements (such as CGT concessions) may have a different outcome from business valuations done for investment or other reasons.
The tests for market value required in a CGT business valuation may be more conservative than those considered by investors or partners.
A merger of two companies can occur at a valuation that may be different to the market value considered relevant by the ATO.
The ATO will determine the extent of any unreported tax liability, and if there is insufficient evidence to support any report then they will look further to see whether you have allocated a reasonable business valuation to the transaction. If the business valuation has simply relied on “directors advice” then you may be liable for both unpaid tax, interest and penalties.
When your CGT savings bill may be anywhere from $35k to $350k, it surely pays to invest a small amount in arming your accountant with the right evidence.
Disclaimer: The information contained on this page is general in nature and should not be taken as personal and/or professional advice. Readers should make their own inquiries and obtain independent, professional advice before making any decisions, taking any action or relying on any information on this page.