Small business capital gains tax concessions: The case for reform Paul Kenny

Former regime The previous regime series of limited CGT reliefs for small business criticised by the Review of Business Taxation as being too complex.

rationale “…will significantly improve the way in which CGT concessions are delivered to small business entities by: increasing the range of CGT concessions available; rationalising and improving the current law; and providing greater flexibility in accessing the various CGT concessions. “ Division 152 increased the range of concessions as follows: 15-year business asset exemption: sub-div 152-B; 50 per cent active asset reduction: sub-div 152-C; CGT retirement exemption: sub-div 152-D; and CGT rollover: sub-div 152-E

Overview Div 152 a taxpayer must satisfy the basic conditions before applying the SBCGT concessions to reduce or disregard a capital gain from a CGT event. The small business entity (SBE) test or the $6 million maximum net asset value test must be satisfied, Also, the active asset test basic condition must be satisfied If the CGT asset being disposed is a share in a company or an interest in a trust the concession stakeholder tests needs to be met. If these conditions are satisfied the four generous SBCGT concessions noted above can be potentially applied This resulted in very generous tax relief for certain small businesses (active asset rich) as seen by the significant tax expenditures in respect of Div 152 (Tax Expenditures Statement 2015). the SBCGT 15 year asset concession in 2015 amounted to $205 million The complexity of the labyrinthine layers of rules in Div 152 poses significant challenges for small business and tax practitioners to ensure eligibility  

post implementation review of Div 152 the Board of Taxation received numerous submissions that pointed out numerous anomalies. The Board subsequently made recommendations to provide a more homogeneous tax environment for small business and increase the incentives to small business generally to invest their capital to maximise employment, investment returns, innovation, reduce complexity and compliance costs (Board of Taxation 2005). Div 152 was subject to a series of amendments that broadened its scope

RESEARCH METHODOLOGY perspective of four well accepted tax policy criteria: fiscal adequacy, economic efficiency, equity, and simplicity

Economic efficiency it is argued that small business is important to the economy other research has criticised studies purporting to show the importance of small businesses for job creation In the United Kingdom (UK) Crawford and Freedman found that only a minority of small firms generate jobs This leads to the impossible problem of targeting tax concessions (if justified at all) Under these concessions small businesses which do not intend to grow will benefit. Tax concessions targeted at size are blunt instruments, they do not focus on jobs growth. Other parameters such as innovation appear more appropriate since these businesses are likely to grow. Identifying such firms is problematical.

Economic efficiency these CGT concessions may result in assets being acquired for tax planning purposes rather than for optimal business reasons. since the CGT concessions are available where the business is not being maintained as a going concern by the person or persons acquiring it, they do not meet the objective of encouraging continuity. As, Crawford and Freedman concluded, providing reliefs from capital taxes to small businesses seems likely to lead to distortion and demands for further reliefs

Economic efficiency Also, defining a small business is extremely challenging. Should a small business be defined qualitatively or quantitatively? The Australian experience that relies on quantitative measures based on turnover and asset value illustrates the dilemma simplified tax system (STS) originally required a $1 million STS average turnover and $3 million depreciating assets test SBE - a $2 million aggregate turnover replaced the $1million turnover test Setting parameters also poses the problem of manipulation as businesses restructure so as to access the small business concessions. This is evident with complex anti- avoidance measures in the former STS and in the SBE regime

Equity The SBCGT concessions generally result in significant inequities since the rules favour certain types of small business taxpayers that have active assets over other taxpayers. A relatively small proportion of small businesses with significant active assets (eg commercial property and good will) will obtain most of the CGT benefits. Since most of the larger small businesses are operated by high income and wealthier taxpayers, the breach of vertical equity is likely to be substantial. High income taxpayers operating small businesses will obtain significant tax benefits from the small business concessions given the top marginal income tax rate of 49 per cent in the income year ending 30 June 2016. arguable that small business should receive tax relief for retirement and roll over relief given the availability of superannuation concessions to employees and roll over relief for other businesses. However, the significant 25 per cent reduction and retirement concessions are not linked to retirement.

Simplicity The literature on tax compliance costs shows that these costs are significant and fall heavily on small business Sadiq and Marsden found most small business clients of practitioners did not understand the SBCGT concessions. A small business survey by Lignier and Evans found a lack of awareness about the that the SBCGT concessions and that they were perceived to be complex. Freudenberg found that advisors’ concluded that the tax benefits of a business form may exceed the additional compliance costs and that these concessions were in the top six of advisors’ considerations when recommending a business structure.

Fiscal Adequacy The SBCGT concessions are costly to tax revenue as seen by the estimated tax expenditure of $1.185 billion in 2015-16 In 2015 the exemption for capital gains on small business retirement amounted to $430 million; Exemption for small business assets held for more than 15 years $205 million; Small business capital gains tax 50 per cent reduction $550 million.

Conclusion The SBCGT concessions offer significant tax relief for many asset rich small businesses But it appears difficult to justify the SBCGT concessions in their current form, they are costly to the community since they generally breach all of the four tax policy criteria: economic efficiency, equity, simplicity and fiscal adequacy. As Burton finds, there is little evidence to suggest that the policy objectives are taken seriously