Once again the complexity of the small business CGT concessions has been revealed in a recent Full Federal Court decision and shows the importance in understanding the correct operation of the provisions. One of the alternative basic tests for the availability of the small business CGT relief is that the net value of assets that the taxpayer and related entities own must not exceed $6m. In calculating the net value of assets that the taxpayer and related entities own, there may be deducted from the sum of the market values of those assets the sum of the liabilities of the entity that are related to the assets.

The Full Court had to consider whether certain liabilities were “related to the assets”.

Firstly the bank records of the taxpayer showed that it had cash asset of $1,252,112 in a bank account, and a loan liability of $1,085,824 which related to the acquisition of a main residence. The taxpayer had argued that there was a single account which was in credit so the net asset was the difference between these two amounts. However Full Court upheld the tribunal decision that there was not a single account but the bank records showed clearly that there were two accounts and the loan account did not related to the bank account in which the cash was held. It was an offset account. Therefore the cash asset of $1,252,112 was included in the maximum net asset value test and the loan account was not to be taken into account because it did not relate to an asset that was taken into account in calculating the maximum net asset value, the main residence being an excluded asset for this purpose.

Secondly, there was a liability of the taxpayer as trustee of his family trust (the income with respect to which the taxpayer was presently entitled) (“Trust”) to another trust (“Unit Trust”). The units of the Unit Trust were the CGT assets in question for the application of the CGT small business relief. The funds were borrowed by the Trust from the Unit Trust in order to make a capital distribution to the taxpayer. The issue was whether or not this liability of the Trust to the Unit Trust “related to the assets” of the Trust.

The Court held that the liability of the taxpayer as trustee of the Trust to the Unit Trust did not relate to the assets held by the taxpayer as trustee of the Trust. The Full Court held that in a situation in which the trustee of the Trust had resolved to make a distribution of capital, his decision to borrow funds rather than to use the existing resources of the Trust gave rise to a relation between the liability arising from the borrowing and the borrowed funds in the hands of the Trust. However that purpose having been effected by disposing of the cash which represented the borrowing meant that there was not a relevant ongoing relation between the liability and the generality of the assets of the Trust. This meant that the borrowing no longer had any connection with the assets of the Trust and therefore was not “related to the assets” of the Trust. The decision to borrow was made as an alternative to using the existing assets of the Trust. It was not a borrowing that involved the protection or maintenance of the existing CGT assets of the Trust. The Full Court therefore overrules the judge below who held the borrowing was “related to the assets” of the Trust.

The taxpayer therefore lost on both counts.

The decision indicates the complexities of the small business CGT relief provisions and the ability to apply those rules can be affected by niceties of principles of characterisation. Therefore it is important to get appropriate legal advice before transacting a sale of a business to ensure that the small business CGT relief is in fact available.