Small business CGT concessions – Case update

Taxpayers wanting to access the small business CGT concessions (SBCGTC) must satisfy either: the $6 million net asset test (MNAVT) or the $2 million turnover test (SBET) as well as the other precondition to access the SBCGTC – the active asset test.

The MNAVT and statute-barred loans In Breakwell v FCT [2015] FCA 1471, on appeal from the Administrative Appeals Tribunal (AAT), the Federal Court held that the face value of a loan of over $1 million owed to a taxpayer had to be included in the MNAVT despite the taxpayer’s argument that the loan was statute barred and had a market value of zero dollars.

The facts

The taxpayer was a beneficiary and the trustee of a discretionary trust that held units in a unit trust. The unit trust carried on a finance broking business. That business was sold giving rise to a capital gain to which the taxpayer was entitled. The discretionary trust (a connected entity of the unit trust) was owed $1 million by the taxpayer because the discretionary trust had lent that money to the taxpayer (presumably as the taxpayer was a beneficiary of the trust). The taxpayer argued that the discretionary trust could not recover the loan because it was ‘statute barred’ under the six-year state of limitations in the Limitation of Actions Act 1936 (SA) and therefore the loan had no value. Similar legislation exists in other jurisdictions.

The AAT decided that the loan was not ‘statute barred’ as it had been legally acknowledged by the taxpayer, as trustee of the discretionary trust, by the signing of the accounts evidencing the loan and

that the face value of $1 million should be included in the MNAVT.

The decision

The Federal Court dismissed the taxpayer’s appeal and found that:

The statutory time limit in section 35(a) of the Limitation of Actions Act 1936 (SA) did not of itself extinguish the discretionary trust’s claim in contract for the repayment of the loan because that section may provide a ‘bar to the remedy’ but not a ‘bar to the cause of action’. The provision effectively provides a debtor or defendant with a defence to a claim for recovery of the debt and that defence could be waived by the debtor or defendant.

Section 48 of the Limitation of Actions Act 1936 (SA) allowed a court to extend the limitation period. The fact that the taxpayer was the trustee and the debtor beneficiary was relevant to this consideration because: an arms-length trustee would be expected to seek an extension to the limitation period; and the

debtor beneficiary would be in a difficult position if limitation of action defence was raised when in his capacity as trustee of the trust he had fiduciary duties to act in the best interest of the trust.

This case highlights the non-tax technical issues that must be carefully considered when dealing with connected entity loans and transactions, especially where a tax advantage is sought.

The SBET and receipts for disbursements

The $2 million SBET requires a determination to be made about what receipts or inflows are included in the turnover.

Section 328-120(1) of the ITAA 1997 provides that the ‘ordinary income’ of a taxpayer derived in the ordinary course of carrying on a business is included in the SBET. Obviously capital receipts and income from passive investments are not included in the SBET and the ‘ordinary income’ must be derived from the business being carried on.

In Re PFGG v FCT [2015] AATA 972 the taxpayer made a capital gain from the sale on mining tenements it held in Western Australia. In order to access the SBCGTC, a connected entity of the taxpayer (Drill Co) had to satisfy the SBET. The issue in this case was whether fuel reimbursements received by Drill Co from its clients had to be included in the turnover for the purposes of the SBET. If so, the SBET would not be satisfied. The taxpayer argued that the fuel reimbursements were not the ‘ordinary

income’ derived in the course of carrying on its business, and alternatively the fuel

reimbursements were excluded from its turnover pursuant to section 328-120(3) of the ITAA 1997 as the receipts were from the sale of ‘retail fuel’.

The decision

The AAT found, after reviewing case law and the explanatory memorandum to the bill introducing the SBET, that although the fuel reimbursement receipts were not regularly derived as part of the business,

the receipts were to be included in the annual turnover.

The reimbursements were ordinary income and were derived from carrying on the drilling business. Further the AAT noted that the fuel reimbursement receipts were an incident of, or directly related to the business carried on by Drill Co.

As to the second argument the AAT found that Drill Co purchased and paid for the fuel, used it in its operations to provide the contracted drilling services to its clients and subsequently recovered the cost of the fuel from its clients. There was no sale of the fuel to the client as there was no intention to transfer title to the fuel to the client as is required in a ‘retail sale’ and the exception in section 328-120(3) did not apply. This case highlights the importance of determining what is and is not included in turnover for the SBET.

This article is for general information only and should not be relied upon without first seeking advice from an appropriately qualified professional.