Introduction

The basic conditions for small business CGT concessions (SBCGT) relief require that certain conditions are met ‘just before the relevant CGT event, that is, it is a snapshot test at that time, including:

• the maximum net asset value test; and
• the significant individual test.

The problem

Given the ‘just before’ requirement above, a difficulty arises in circumstances involving a discretionary trust as:

• No beneficiary has any interest in the income or capital of the trust unless and until the trustee exercises discretion in their favor for a particular income year; and
• The trustee generally exercises such discretion at the end of the relevant income year.

For example, if the trustee of a discretionary trust disposes of a business or shares in a company carrying on a business on 5 August 2024 and exercises its discretion to distribute the income and/or capital of the trust on 30 June 2025, what is the situation ‘just before’ the relevant CGT event (i.e., 5 August 2024) for SBCGT purposes?

Can the relevant requirements ‘just before’ the CGT event be satisfied on account of some retrospective deeming arrangement? If not, are the SBCGT concessions simply not available in these circumstances?

ATO administrative treatment

Although it would be preferable if the tax law was specifically amended in this regard, or at least the subject of a public ruling, the ATO’s position in this regard is outlined in NTLG Minutes as follows:

“The opening words of section 152-70 are ‘An entity holds a direct small business participation percentage at the relevant time in an entity equal to the percentage worked out using this table.’ Looking at item 3 of the table in relation to discretionary trusts if the trustee makes a distribution of income or capital during the income year in which that time occurs, then you take the percentage that is distributed in that year, and if the percentages are different, then you take the lowest percentage.

From these concepts, two related questions arise.

(a)        Is it correct that a discretionary trust that distributes say 30% of income and capital gains to an individual in the income year that the CGT event arises that individual will pass the relevant requirements noted above ‘just before the CGT event

. . .

Response

(a)        ‘Just before’

Subsection 152-70(1) Table item 3 is applied to work out an entity’s direct small business participation percentage in a discretionary trust based on distributions to which the entity was beneficially entitled.

The percentage applies for the whole of the income year in which the relevant distributions are made. An individual who was beneficially entitled to 30% of the distributions of income and 30% of the distributions of capital from a discretionary trust during an income year will have a direct small business participation percentage (and hence a small business participation percentage) of 30% in the discretionary trust at all times during that income year. The individual will therefore be a significant individual of the trust at all times during that year and accordingly, the trust will satisfy the significant individual test in section 152-50 for a CGT event that happens during that year.

If a CGT event happens during that income year to a share in a company or interest in a trust owned by the discretionary trust, the direct small business participation percentage of 30% held by the individual is taken into account in determining if the additional basic conditions in subsection 152-20(2) are satisfied.”

Based on the above:

• trust distributions at the end of the relevant income year (or interim distributions made after the relevant CGT event earlier in that income year) will give the relevant individual beneficiary/ies that portion of the trust income and/or capital for the entire income year (including the period ‘just before’ the relevant CGT event for present purposes); and
• the individual beneficiary/ies will determine their small business participation percentage (SBPP) for SBCGT purposes accordingly.

Finally, we note:

• where there are both income and capital distributions by the trustee of a discretionary trust in the relevant income year, in working out the SBPP of an individual, you take the lower of the two; and
• trust resolutions should be specifically tailored to the particular trust deed, including the definition of income (if any), in order to achieve the intended outcome.

For more information on the SBCGT concessions, see our Explainer Video here.

If you would like to discuss this issue, or any other eligibility issues surrounding the SBCGT concessions and how you, or your clients, can benefit from them, contact Mosaic Tax Legal at info@mosaictaxlegal.com.au or 1300 115 841.